Wednesday, February 29, 2012


“And what is a man without energy? Nothing – nothing at all.”
Mark Twain

According to Wikipedia, hydropower which is also known as hydraulic power or water power is defined as “power that is derived from the force or energy of moving water, which may be harnessed for useful purposes”. Similarly, Columbia Encyclopedia describes it as “mechanical energy derived from falling or flowing water, e.g., rivers, streams, and the overflow of dams. The wooden water wheel, long utilized for driving machinery in flour mills and factories, was largely supplanted by the steam engine in the early 19th century. In modern practice, water flowing from a higher level to a lower level (as from a dam or waterfall) is used to activate a turbine that drives an electric generator, a process called hydropower generation. The amount of power furnished is proportional to the rate of flow of the water and the vertical distance through which it falls.

However, it also needs to be remembered that water is needed for the generation of electricity even from nuclear power plant as large quantities of water is needed for cooling in many electricity generating methods, including power plant based on coal. Due to hydrological cycle water needed to generate power from water is inexhaustible and, therefore, it is deemed to be renewable energy source; except for the risk of rivers drying up (!) due to global warming. Similarly, hydropower is deemed to be clean energy as it doesn’t generate any green house gas (GHG) during its generation; except by the rotting vegetation in a reservoir of storage project, mainly in tropical areas.

Hydropower project could be a (i) run of river project (RoR), (ii) daily pondage (also known as peak-in RoR project (PRoR), (iii) storage project, (iv) multipurpose project or (v) even pumped storage project. Kulekhani I (60 MW) and II (32 MW) are storage projects and Devighat (14.1 MW), Marshyangdi (69 MW), Trishuli (24 MW), Kali Gandaki A (144 MW) and Middle Marshyangdi (70 MW) projects have daily pondage facility (total installed capacity 321.1 MW). Rest of the projects (totaling 231.336 MW) are RoR projects of which 22 projects of 166.806 MW capacity are developed/owned by the private sector (called independent power producers – IPPs) projects which sell electricity in bulk to NEA pursuant to power purchase agreements (PPAs). Pancheshwar and Koshi High Dam projects have been conceived as multipurpose projects which are a long way from implementation. No pumped storage project is being conceived at the moment, which will not be financially viable until time-sensitive bulk buy back tariff is introduced by NEA. Begnas and Rupa lakes in Kaski district are the perfect gift of nature to Nepal for an ideal pumped storage project.

Various processes related to governance and institutional mechanism for the purpose shall be discussed in this section.

Section 3 of Electricity Act stipulates that “No person shall be entitled to conduct survey, generation, transmission or distribution of electricity without obtaining license under this Act” except for such work related to projects of up to 1,000 kW. There is provision for issuance of two types of licenses under Section 4; one for survey (to conduct feasibility studies) and the other for the implementation of the project (which could be for generation of electricity, for transmission/evacuation of power or for distribution amongst the consumers).

Survey License: Sub-Sections (1) and (2) of Section 4 of the Act read together makes it mandatory for GoN to issue survey license within 30 days of receipt of an application. However, there is no record of any applicant being issued with a license within the specified period. As there is no mechanism to appeal against government’s failure, questions arise as to how to get the problem redressed. Besides counter questions were also posed as to why, particularly, a foreign investor should even bother to appeal. Private sector feels that time frame must be adhered to by GoN. The failure to issue the survey license within 30 days is being viewed as abuse of authority on the part of GoN. The strong feeling in the private sector is, if even GoN flouts the law of the land then how it can expect its citizen to abide by the same law. Additionally, GoN, reportedly, does not formally give any reason for its failure to issue the license within the time prescribed by the law. This also is being viewed as lack of transparency.

Under section 5(1) of the Act “The term of license to be issued for the survey of electricity may be of 5 (five) years in maximum.”

Till November 11, 2010 GoN has issued survey licenses for 13,530.289 MW (for 201 projects of less than 1 MW capacity totaling 148.126 MW, 226 projects of 1 to 25 MW capacity totaling 1504.313 MW, 60 projects of 25 to 100 MW capacity totaling 3,325.61 MW and 28 projects of more than 100 MW capacity for 8,552.24 MW). Many of these licenses are floating around without moving forward; that is even without being able to come up with a bankable feasibility study which could potentially have led to financial closure and eventually construction of the project, culminating in its commissioning and, therefore, generation of electricity. A significant part of the current problem of load shedding can be ascribed to the gap between survey licenses issued and such license holders graduating to developer of hydropower projects.

This leaves one with the impression that GoN is mandated to be too liberal in the matter of issuing licenses by the enactment. This phenomenon also pre-empts other developers, with necessary financial capability, from implementing such projects. There is no mechanism prescribed for the purpose of evaluating applications in order to ensure that any specific applicant has capability to implement a project. Specifically, a mechanism to test the financial capability of the applicant to conduct the feasibility study and eventually mobilize necessary finance to implement the project is wanting. A number of licensees are, reportedly, going about trying to hand over the license to those with ability to mobilize finance, for a price. A tragicomic situation exists wherein people with financial muscle don’t have access to licenses whereas most of the licensees have been hanging on to the licenses in the pretext of trying to mobilize finance.

Moreover, without spelling it out as such, the existing hydropower development policy, in effect, has enunciated “first come first served” concept with regards to issuing of license implying that this practice does not allow for competition as there is no provision in the policy and the Act to ensure competition. This is a policy failure. In the clutch of amendments proposed by the members of Constituent Assembly (CA) to the Electricity Bill pending, there is an amendment requiring introduction of the element of competition in the process of issuing licenses.

Starting in late 90s, perhaps to rectify the policy defect, GoN invited RFPs for a few projects and licenses were issued accordingly; examples are upper Karnali and Arun III. There is another dimension to the process of inviting bids for survey license from the private sector instead of granting them on the basis of initially conceptualized policy in this respect. In this scenario, the private sector is apprehensive that there is no guarantee as to whether a survey licensee ultimately finishes up getting a generation license or not. Because the generation license will also have to be granted on the basis of competitive bidding and the original license-holder for survey may not be awarded a generation license eventually. In this case how does the survey license holder recover its cost of the feasibility study, the report of which becomes GoN’s property? To get private sector to conduct feasibility study without any assurance of them getting generation licenses, in case GoN decides to invite tender for generation licenses, is being described in certain circles as the naiveté on the part of GoN. Therefore, it is incumbent upon GoN to make up its mind as to the way forward, formulate a specific policy for the purpose, make necessary changes in the law and then go about having such projects requiring huge investment implemented, instead of doing things on ad hoc basis.

License for Generation, Transmission and Distribution: Sub-Sections (1) and (2) of Section 4 of the Electricity Act, both read together, also makes it mandatory for GoN to issue license for generation, transmission and distribution of electricity within 120 days. The policy is deafeningly silent with regard to how to strike a best deal in order to maximize return to the State. No mechanism for the purpose is spelled out in it. This is a serious flaw needing prompt remedy.

According to Section 12 of Electricity Regulation 1993 a person wishing to obtain generation license has to make available (a) feasibility study report, (b) assurance of financial closure, (c) environmental impact assessment (EIA) or initial environmental examination (IEE) report, as may be applicable and (d) PPA. It is held to be logical for a generation license to be conditional upon successful financial closure within a certain date. This allows GoN necessary latitude to have another investor come into the picture if the original licensee is not able to arrange funding for the implementation of the project within certain time period. However, a conditional license, reportedly, has also been issued with an instruction to have the Power Project Agreement (PPA) amended. Current Nepal law does not empower GoN to dictate a developer to get PPA amended and the private sector is deeming this action, on the part of GoN, not business-like [however, as GoN fully owns NEA, it is in a position to ask it to renege on the deal – the PPA]. It is being reported that the reason behind needing to have the PPA amended was the excessively high return on investment in that particular project, which became apparent afterwards. However, reviews of PPAs have not been required from other developers whose total project cost has also reportedly gone down, with the resultant effect of enhancement of return on investment.

GoN has issued generation licenses for 50 projects for a total installed capacity of 821.892 MW by November 11, 2010 of which only 22 projects with the installed capacity of 166.806 MW are currently generating electricity and 8 projects with installed capacity of 47.308 MW are under construction.

GoN hasn’t issued any license for transmission/evacuation of power so far; nor is it in receipt of any application for the purpose. However, it has issued a number of licenses for the distribution of electricity to the consumers, including one to Butwal Power Co. (BPC) for certain village development committees (VDCs) in Syangja, Palpa, Pyuthan, Arghakhanchi and Dang districts, which has been servicing 34,428 connections at end of last fiscal year (mid July 2010). It is 1.86% of the consumer base of NEA. Unfortunately, there is no further information available in this regard.

Tenure of License and Hand-over of Hydropower Plant after Expiry of License: Sub-section 2 of Section 5 of Electricity Act has fixed 50 years as the maximum term of a license for generation, transmission and/or distribution of electricity. Sources in the industry feel that the duration of license for electricity generation, transmission or distribution of a maximum of 50 years is too long for foreign owned project. However, this is a discretionary power vested in GoN. A change in the term of the license for a project for domestic use can result in change in the buyback rate required for the project to be feasible. Similarly, variation of the term of license can be matched with revenue stream to GoN from an export-oriented project. Therefore, judicious use of this leverage can result in all round benefit.

However, what is important in this connection is the fundamental philosophy behind inviting foreign private investment in the hydropower sector under build, own, operate and transfer (BOOT) concept such that Nepal stands to receive the hydropower plant at the end of the term of the license, all clear . This is, for example, how the hydropower revolution occurred in Norway. She has undergone a metamorphosis from a relatively poor European country less than five decades ago to an affluent one at present and one of the contributing factors was the extensive exploitation of hydropower with foreign investment.
The precondition for meaningful hand-over is the simple assumption that the plant remains operational even after the expiry of the license and for a substantial number of years thereafter. For this purpose the construction and erection of the plant including the quality of equipment used for the purpose needs to meet high international standard. Similarly, But, unfortunately, the law is silent in this respect. Therefore, an amendment to the Electricity Bill has been introduced to insert a provision on fixation of design life which will depend on design and construction standards.

A certain segment of legal fraternity deemed the provision of transfer of ownership of a hydropower plant, established with more than 50% of the total investment made by foreign entities, to GoN after the expiry of the license in 50 years, mandated by Section 10(1) discussed above, as the infringement of constitutionally enshrined fundamental right to equality. This argument does not hold water as the fundamental idea behind inviting foreign investment is to allow the investors to use the plant to reap necessary benefit in such a way that after a certain period of time the ownership and the benefit appurtenant thereto gets transferred to Nepal and Nepal gets to be ultimately benefited from the exploitation of its own natural resources. As mentioned above this is how it was done, for example, in Norway. The whole deal will be geared up for such eventual transfer and the foreign investor(s) so far have and will develop and use the plant in such a way that they will be ready to leave after the period. Hence, there is no question of unequal treatment.

Section 3 of Water Resources Act categorically state that “the ownership of the water resources available in the Kingdom of Nepal shall be vested in the Kingdom of Nepal.” Under the authority vested in GoN by this provision GoN is fully empowered to issue licenses, permits, approvals for the exploitation of the water resources for its various potential uses.

Under the Proviso Clause of Section 3 of the Electricity Act no license is required for generation of electricity up to 1 MW at present. The bill introduced to supplant this Act envisages de-licensing hydropower plants of up to 3 MW. As a step in line with the policy of liberalization and deregulation this is a welcome step. However, a license has two important roles to fulfill. Firstly it is very comforting for an investor to be armed with an authentic document from GoN stating that the licensee is entitled to do whatever is mentioned in it and the appurtenant legal provisions. This sort of comfort is very important, especially for the foreign investors, as they would be very unfamiliar with conventions and practices of Nepal. This becomes, in fact, imperative in the case of foreign lending institutions (one even will need to include Nepali financial institutions in this category).

Second important reason for a developer preferring to choose the comfort of a license is the fact if the developer happens to be from somewhere else he will be as good as a foreigner for that part of the world. In such a circumstance the pertinent question begging answer will be who will assure of the availability of water for the plant and how is the access to water gained. Conversely if the developer is locally from the area of project site then he will face relatively very little problems from his neighbors and villagers. For an investor/developer being able to produce a license issued by GoN, subsequent to due process, goes a long way in commanding respect for the project from the users of the water for time immemorial.

Besides, a developer will need stronger evidential document to get away with depriving users in the dewatered area of the river from the benefit they were enjoying in the past. Similarly, the developer will need documentary help to safeguard his prior right against future bulk users in the upstream areas as the reduction in the flow will reduce the project’s revenue stream thereby making the project unviable. The provision of Section 20 of Electricity Regulation confirms this in stipulating that “The licensee, who has obtained license for production of electricity, shall have the right to use the water resources for the works as mentioned in the license to the extent of such place and quantity as specified in the license.”

Last year the Ministry of Water Resources (MoWR) was bifurcated into the Ministries of Energy (MoE) and Irrigation (MoI); the former reposed with the responsibilities related to hydropower projects. The policy, in Clause 4 (l) on “institutional arrangement,” envisaged setting up a “hydropower development unit” to promote the private sector's participation in the hydroelectric projects and to make the optimum utilization of water resources, to approve projects with a capacity of more than 1000 KW, to render necessary assistance to the private sector in the operation of the project and to follow up the aforesaid works.” This unit was initially named Electricity Development Center (EDC), which eventually was rechristened as Department of Electricity Development (DoED). MoE issues licenses on the basis of applications processed by DoED. Clause 4(i)(1) of the Policy states that “all facilities concerning exchange of foreign currency shall be provided to the foreign individual, firm or company who invests in the construction of project for generating, transmitting and distributing the electricity at the private sector under the foreign investment and single door policy.” DoED had been designated as “one window” for the development of hydropower projects. However, it has yet to be effective in this respect as the developers have come to learn, the hard way, of existence of many “doors behind that one window”.

Project implementers are required to secure permits and approvals from a multitude of GoN agencies: Company Registrar’s Office for incorporation of an entity, Department of Industry (DoI) to set up “hydropower industry”, Ministry of Finance (MoF) for tax and duty facilities, Ministry of Population and Environment (MoPE) along with Ministry of Forest (MoFr) for environmental clearance. DoI’s approval of joint venture agreement is necessary if foreign investment is involved.

Section 9 of the Act envisages GoN entering into an agreement with the bulk producer of power for the purchase of electricity. However, GoN has yet to do so. Moreover, it also does not sound logical for GoN to do so. In practice to date it is NEA that has been signing agreements with IPPs for the purchase of power in bulk, known as PPA, if a project aims to sell electricity domestically.

A PPA embodies assurance of the fact that the power produced by a developer will get purchased. It is felt that there should be a model of it, which will achieve standardization and which also, will result in bolstering effective transparency. A long term PPA as such mitigates market risk and revenue risk of a hydropower developer.

There is no provision for a regulatory body in the current body of law. However, an Electricity Tariff Fixation Commission has been set up, pursuant to Section 17 (1) of Electricity Act. This is not an autonomous statutory commission. This commission is mandated to “fix the electricity tariff and other charges on the basis of the rate of depreciation, reasonable profit, mode of the operation of the plant, changes in consumer's price index, royalty, etc.” Basically, this commission’s jurisdiction is limited to retail tariff and private sector developers/investors hydropower projects don’t come under its regulation. Sensing this to be a lacuna, GoN has already tabled Nepal Electricity Regulation Commission Bill 2009 in the parliament which is awaiting deliberation in the “Legislative Committee.”

For the promotion and development of hydropower projects, GoN provides various facilities to the hydropower projects in Nepal.

Repatriation: Under the heading “facility of foreign exchange”, section 13 of the Act stipulates that “in case foreign currency has been invested in the generation, transmission or distribution of hydro-electricity as a loan or share capital, His Majesty's Government shall make available necessary foreign currency at the prevailing market rate of foreign exchange for repatriation of investment or repayment of principal or interest of loan”, thereby guaranteeing repatriation facility. The same is also guaranteed by Section 5 (2) of Foreign Investment and Technology Transfer Act (FITTA) 1992 which specifies that a foreign investor is entitled to repatriate (i) “amount received by sale of share of foreign investment”, (ii) “amount received as profit or dividend in lieu of foreign investment” and (iii) “amount received as the payment of the principal of and interest on any foreign loan.”

Facilities under other laws: Section 14 of Electricity Act also clearly states that a licensee is entitled to facilities pursuant to other prevailing laws in addition to the facility under this Act.

Employment of Expatriates: As universally practiced, foreigners are not allowed to work in Nepal without work permit. For a poor country like Nepal employment of foreign manpower not only deprives Nepali national of the much needed employment opportunity, but it also increases the price, for example of electricity, that the Nepali consumers are forced to pay. However, even from the perspective of technology transfer it is beneficial for Nepal to allow employment of expatriates selectively. Accordingly under Section 6 of FITTA a foreigner investing at least $ 100,000 is entitled to residential visa for him/her and her/his dependent.

Prior to amendment of Section 7 of FITTA in 1996, the choice of law to govern foreign investment agreements was not exercisable even if a project is financed with foreign investment. However, as it was not expressly prohibited by any law, theoretically at least, the choice existed.

The amendment of FITTA availed the choice of law for all documents when industries are set up with foreign investment. It is still not clear as to whether such choice is available in the case of agreements where no foreign parties are involved because there is no law, which expressly bars such choice.

Settlement of Dispute: The issue of choice of law becomes relevant mainly for the purpose of settlement of disputes between parties to an agreement. The main two courses available for the settlement of disputes are arbitration and judicial decision. With the adoption of New York “Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958” by GoN in March 1998 foreign arbitral award have become enforceable by a Court in Nepal as Section 34 of Arbitration Act, 1999 has made express provision for this purpose.

Although the liberty to choose the laws of a specific country to govern a document is now exercisable, the parties to such agreement will stand to benefit only if the foreign jurisdiction is implementable which depends upon possibility of enforcement of verdict of foreign court in Nepal and courts in Nepal adjudicating on the basis of the law of the chosen jurisdiction. Unfortunately, the use of judicial decision for the purpose of settlement of dispute, in case the law of a foreign country governs the document, is problematic at best.
The concerned parties are at liberty to approach the judiciary of the country whose law is chosen to govern the document. However, enforcement of a foreign court’s judgment in Nepal is not possible. Therefore, the whole exercise of getting the judiciary of a foreign country to hand down a verdict in settlement of dispute between the parties becomes futile, as the verdict will not get implemented in Nepal.

Similarly, application of a foreign country’s law by a Nepali Court for the settlement of disputes is also out of question. This takes the form of physical impossibility, as this will involve Nepali judiciary studying law of foreign countries in foreign languages. Once such a practice is allowed Nepal will have unenviable and onerous task of interpreting laws of foreign land in foreign language which exists in one too many languages.

Moreover, adjudication of litigation arising out of an agreement governed by foreign law by a Nepali Court by applying Nepali law is likely to be precluded, too. In the present set up of judiciary structure, the first reaction of a judiciary could very well be to tell the parties to seek the assistance of the judiciary of the country whose law has been chosen to govern the documents. There are no known precedents in Nepal in this respect so far, though. But an Indian Court reportedly refused to adjudicate a dispute arising out of a document governed by Japanese law; the parties were told to get the dispute settled by a Court in Japan.
However, these three avenues for settlement of disputes are deemed to be the integral part of the benefit accruing from being allowed to choose foreign law to govern documents by the international community of investors. Thus there are some problems if the liberty to choose governing law is exercised and needs to be enforced. In other words, except for the settlement of dispute by arbitration, the right to choose the governing law is meaningless at the moment. The situation has been diagrammatically depicted in Appendix 5.

Some of the economic, fiscal and financial issues related to hydropower development will be discussed in this section.

The main fee a hydropower project has to pay to GoN is royalties. Export oriented projects are also required to pay token export tax.

Royalties: No royalty is levied on hydropower projects of up to 1,000 kW capacity pursuant to clause 4(f) of the published policy. However, there is no direct articulation to this effect in the Act except that Section 3 of the Electricity Act states that no license is required to develop a plant of the capacity of up to 1,000 kW and under Section 11 only a license holder is required to pay royalty as such (in other words, if a hydropower project does not need a license then it does not need to pay any royalty). A developer pays royalty to GoN for being allowed to exploit the nation’s natural resource. Present hydropower development policy has provision for two-tier royalty; for the first fifteen years from the date of commercial operation and the second thereafter. In the first tier, capacity royalty of Rs 100 per kW and energy royalty of 2% is applicable. From sixteenth years onwards, the capacity royalty rate is Rs 1,000/kW and energy royalty is 10%.

However, in the MoUs signed for Arun III and Upper Karnali projects, both export-oriented, the developers have agreed to pay royalty rates as specified by the new policy (of 2001), instead of in accordance with the Act which doesn’t make any distinction between projects for electricity use domestically vs. export-oriented projects. Under the MoUs, applicable capacity royalty is Rs 400/kW for first 15 years and thereafter Rs 1,800/kW while energy royalty is payable at the rate of 7.5% for first 15 years and at 12% thereafter. Additionally, the developer of Arun III project has agreed to avail 21.9% energy free of cost whereas the developer of Upper Karnali project has agreed to provide 12% free energy and 27% free equity.
Export Tax: Rule 27 of Electricity Rules stipulates that the “export tax to be payable for exporting electricity, pursuant to subsection (3) of Section 22 of the Act, shall be as determined in the agreement made with His Majesty's Government.” The West Seti project company was to pay export tax at the rate of 0.05% of the revenue. However, both Upper Karnali and Arun III projects have been assured in the respective MoUs that the rate of export tax “shall not be exceeding 0.005% (Point Zero Zero Five Per cent) of export sales revenue.” On the other hand GoI is planning to levy an import duty of Rs 3.20 per unit on the import of power from Nepal.

In order to promote hydropower development in the country GoN has made provision to avail various facilities to hydropower projects.

Exemption of Import Duties: Section 12 (7) stipulates that “Only 1 percent customs duty will be payable on import of plant, equipment and machinery as well as the spare parts thereof, required for the construction and operation of hydro-electricity project involved in generation, transmission or distribution and no charge for import license and sales tax shall be levied on such imports if such items are not produced in Nepal.” Meaning no custom duty (except for 1% for record purposes) and sales tax (eventually converted to value added tax which was exempt till FY 2005/6 which was withdrawn in 2006/7 just to be reinstated in 2007/8), and license fee is required to be paid on the import of plant, equipment and machinery, including spare parts, required for the construction/operation of a hydropower plant or transmission/distribution network. However, licensees in Nepal are clamoring for the exemption of custom duty and VAT (collectively known as import duties) on the imports of construction materials too, like cement, steel rod, etc.

Income Tax Holiday: Prior to amendment of Section 12 of Electricity Act by the Income Tax Act 2001, hydropower projects enjoyed certain income tax facilities. Projects of up to 1,000 kW didn’t have to pay any income tax, ever. Other hydropower projects didn’t have to pay any income tax for first 15 years and thereafter such projects are required to pay it “lessened by 10 percent than the corporate income tax.”

However, all provisions related to income tax facility were deleted by the Income Tax Act 2001; thereby doing away with the concept of income tax holiday in its entirety which created a lot of disenchantment amongst investors in hydropower. After a lot of pressure it was reinstated by Finance Act 2009 with some modifications; under which projects that will be commissioned by mid April 2019 are entitled to a tax holiday for first 7 years and would be entitled to a 50% reduction in the tax payable for 3 years afterwards.

Till 1990 hydropower projects were implemented as public infrastructure projects. Some projects were built by donor countries and some with funding from multilateral financial institution as soft loan. With the advent of economic liberalization in Nepal, private (both domestic and foreign) investment has flowed into hydropower subsector too.

Investment to date: In the past two decades NEA has invested about $ 800 million for the addition of 235 MW in the system:

Similarly, private sector investment to date in 149.706 MW installed capacity is US $ 343 million of which $ 233 million is foreign direct investment (FDI) (Appendix 6). Moreover, $13.5 million was invested by the private sector in buying up shares in BPC (owner of Andhikoha, 5.1 MW and Jhimruk, 12 MW) held by the GoN. Thus, in a span of two decades, the private sector has succeeded in mobilizing $357.286 million into the hydropower sector.

Interestingly, multilateral financial institutions like International Finance Corporation (IFC) of the World Bank group and private sector wing of Asian Development Bank (ADB) too have invested in the projects (Khimti and Bhotekoshi) implemented by the private sector. Moreover, inhabitants of the project area are also taking interest in investing in hydropower.

Investment by general public, by local populace: There is a roaring debate as to the ratio of equity to be earmarked for investment by the general public including the local populace in a hydropower project. Amidst whether at least 10% should be set aside, or not exceeding 10% should be set aside Securities Registration and Issuance Regulation 2008 was amended in May 2010 by GoN to make it mandatory for enterprises dealing in local natural resources as raw materials to set aside 10% of the issued capital for the inhabitants of the affected area and 15% to the general public.

While champions of the local populace have been left unhappy with this, in practice there are very few takers for the equity earmarked for people in the affected area. From the experience so far it has been seen that the general public including the local populace aren’t too eager to invest in greenfield projects as they will be exposed to a range of risks like inter alia project construction risk, cost/time overrun risk, etc. They feel confident in investing in projects already commissioned which deprives the promoter group from a level playing field, who take all such risks.

In view of this the debate is redundant. The only important consideration in this respect is that the strategic investor (or the group) will need to be able to keep 51% to ensure smooth and effective management and local populace can be allowed to invest up to 49% in the case of greenfield projects. In the case of projects already commissioned the shares can be issued at a premium on the basis of preapproved formula.

To close, it needs to be noted that the investment friendly environment is sine qua non for the development of hydropower subsector in particular and water resource sector in general, due to absence of which hydropower sector is failing to attract investment in a meaningful manner and the country is suffering from load shedding problem with no solution at sight.

As NEA is the only entity in Nepal that purchases (and also in a position to purchase) electricity in the bulk, a monopsony market situation exists. The monopsony will be broken only when wholesale competitive market is introduced subsequent to successful unbundling of NEA. This will result in the retailers buying electricity from the producers of their choice directly and open grid (INPS) system will be introduced, allowing producers to transmit their power at the payment of certain wheeling charge to it; allowing access to third party buyer. Currently, even retailers are non-existent, except for some rural electrification entities (REEs) in the rural areas that buy power from NEA in bulk to retail amongst its members.

There is a school of thought which is of the opinion that there is no market for Nepal’s economically feasible potential of 43,000 MW. However, this view isn’t valid as in this age and time 87 percent of energy source Nepal comprise of traditional sources like firewood, animal residue and agricultural reside. Of the modern energy sources, coal and petroleum products comprise 1.95% and 7.87% respectively. Only 2.14% comprise of electricity and 0.72% renewable energy simply because over 60% of the population do not have access to electricity (most of those who have access to it, use it for lighting purposes only) and the economy is yet to be industrialized at the optimum level for lack of electric energy and in the absence of any conscious attempt at electrification of transportation the economy is bleeding in terms of balance of trade and of payment deficits. This has been diagrammatically depicted in the chart below:

This definitely manifests availability of the market for electricity. Same inference can be drawn on the basis of facts like, low electricity consumption per capita of 70.865 kWh in 2006, lack of energy intensive industries, etc. In other words the domestic market can be developed by setting up fertilizer, agro-processing and mineral based industries. Electrification of transportation could also increase the size of electricity market which will not only contribute in reducing the problems of balance of trade and balance of payment deficits, but also reduce emission of GHGs and benefit from trading in it under Clean Development Mechanism (CDM).

There is an enormous energy-demand of neighboring countries, for example India with the installed power generation capacity in 2010 of 167,278.36 MW the deficit was 20,000 MW. Nepal has been engaged in the international trade (basically bilateral trade with India) of power since a long time. Nepal exported 74.48 GWh last year (ending mid July 2010) while importing 612.58 GWh (NEA 2010). With the commissioning of Kali Gandaki A project in the beginning of this millennium, Nepal had become net exporter of power. However, with increasing demand for power in the country, turned her into net importer by the middle of this decade.

Export-oriented projects: At the moment there are a number of projects in the pipeline dedicated for export to India which has triggered a series of debates in Nepal from a number of perspectives. The Article 126 of the Constitution of Nepal 1990 made the ratification of the agreements related to the natural resources (which includes water resources) and the division of use thereof mandatory. Same provision has been continued with in the Interim Constitution in article 156. A section of the society feels that export oriented projects fall in the ambit of this provision and, therefore, parliamentary ratification of the agreements (viz. West Seti, Upper Karnali and Arun III projects) is imperative. However, some feel that export of power is trading in electron and, hence, should be treated like any other commodity export.

These projects are set to export (even peak-in power from West Seti project) at around US 5 ¢ (equivalent to Rs 3.50 approx) per unit while Nepal is importing from India at Rs 10.72. Even the cheaper power exchange rate of Rs 7.81 is more than double of this rate. Therefore, there is a lot of disagreement with the idea of exporting power whilst there is no dearth of market in Nepal. People feel that Nepal should export only after saturating the demand/market in Nepal. It is even suggested that GoN should arrange to buy all generation by a government entity which will sale domestically at fair price and export remaining after saturating domestic market at competitive price

In any case a prudent course for Nepal is to ensure optimum consumption of its own generation to take Nepal on the path of industrialization resulting in employment generation, electrification of transportation, modernization of agriculture sector through the extensive use of electricity etc. and also to maximize benefit by using the complementarities of export market.


NEA has fixed standard tariff to projects up to 5 MW and the rate is fixed on the basis of negotiation to others.

Standard Feed-in Tariff: For the first group projects of up to 5 MW NEA announced the standard feed-in tariff in June 1998. Under which the feed-in tariff of Rs. 2.76 per kWh was fixed for the wet season (mid-April through mid-December) and Rs 4.03 for the dry season (mid-December through mid-April) if the Plant Capacity Factor of the project is 90%; otherwise Rs 2.76 per kWh was to be paid throughout the year. The announcement sought to work in partnership with the private sector in adding to the installed capacity of its system by formulating a policy to purchase electricity in bulk from the projects developed by the latter. However, this overture failed to attract investors and NEA had to amend the announcement in November 1998. Under the amended announcement NEA agreed to purchase electricity from projects of up to 5 MW capacity at a standard tariff of Rs. 3 in the wet season (mid-April through mid-December) and Rs. 4.25 in the dry season (mid-December through mid-April), denominated in Nepali Rupee, with FY1998/99 as the base year. The required exceedance was also lowered at 65% (Q65). Under this policy, a PPA is signed for 25 years for projects in the vicinity of NEA’s transmission network; the proponent needing to invest in the infrastructure to enable the NEA to evacuate power if the proposed plant is not in the proximity of the transmission network. The feed-in tariff is escalated at the rate of 6% per annum for 5 years on the rate for the base year (not compounded), after which the rate was to be reviewed.

With the private sector clamoring for an escalation of the standard feed-in tariff to reflect inflation and increasing load shedding problem for failure to attract private investment in the power sector compared to previous decade, NEA decided to revise the standard feed-in tariff in December 2008. Dry season rate was raised to Rs 7/kWh and wet season rate to Rs 4/kWh, to be effective from the year of project commissioning, subject to 9 escalations at the rate of 3% each year. While required exceedance was further lowered to 40% and PPA period was raised to 30 years. Unfortunately this revision too failed to encourage/attract the private sector as the effective weighed average tariff of a project that will be commissioned in two years is worth Rs 4.56/kWh at today’s price level which is only marginally high compared to Rs 4.44/kWh being paid to the crop of projects built under old standard feed-in tariff.
Negotiated tariff: Section 21 (2) of the Electricity Act makes provision for determining the rate of electricity “on the basis of (a) fixed percentage of avoided cost or (b) an addition to the generation cost, or (c) fixed percentage of average tariff of NEA.” The Act has not envisaged fixing different rates for primary and secondary energy, nor for the peak energy.

Four projects (Khimti, Bhote Kosi, Indrawati and Chilime) are in operation under this category. Based on the information available in the public domain the tariff for these projects were fixed on the basis of second method which is known also as “cost plus.” Meaning, no PPAs have so far been signed under the first method; nor under the last one . Fact of the matter is that there is a lack of transparency as to which method was actually used and justification of why did NEA buy at any specific price as nothing has never been made public in this respect. The requirement is to come to a clear agreement with the developer as to which method is to be used and then use that method without beating around the bush.

In contrast to the two methods that have not been used so far, in the case of the method involving an addition to the generation cost, full transparency on the part of the developer as to how did the developer arrive at a certain figure as its generation cost becomes sine qua non or simply mandatory and this method also calls for definition/determination as to the “addition” to the generation cost. Over time, 16% has been tossed around as the appropriate rate of “addition” for the proponent’s margin. Suggestions are being advanced that a formula must be incorporated in the legislation to provide certain fixed return on investment.

The determination of the tariff by the second method will involve a two-phase process. In the first phase the parties will need to arrive at the estimated of total cost of the project. Simultaneously with this, an agreement will have to be reached as to what is the reasonable “addition” a developer expects or should be allowed. The two of these components should culminate into a tentative rate of tariff for the purpose.

In the second phase the developer will have to call for competitive bids/tenders for various contracts (or single, if turnkey or Engineering, Procurement and Construction contract) and the revised estimate of total project cost will have to be worked out on the basis of result of bidding/tender of the construction contract(s) and the revised “interest during construction,” and any other revision based on further information becoming available. Working out the required rate subsequent to provision of the “addition” will result in the specific developer’s final tariff.

This aspect is the manifest reason for the issue of conditional license to a developer requiring it to have its PPA with NEA amended to curtail excessive return on investment that became apparent after the PPA was signed. This particular developer cannot be blamed for holding a grudge against GoN, as other developers, whose total project cost has also reportedly gone down (with the resulting effect of enhancement of return on investment), have not been required to do so. For the sake of argument they are even opining that other developers also must be made to confide in GoN as to their actual return on investment at present and told to make adjustments in the tariff if the rate of return seems excessively high.

The Section 17 (1) of Electricity Act has made provision for the constitution of Electricity Tariff Fixation Commission (ETFC) for the purpose of fixing electricity tariff and other charges. The retail tariff cannot be changed without its approval. The retail tariff prevalent now was brought into force in September 2001 and hasn’t been revised; notwithstanding the inflation all these years. NEA submitted revised tariff rates to ETFC in august this year. However, a final decision has yet to be reached.

The bulk as well as retail tariff fixation should follow the economic reality of forces of demand and supply.

GoN promulgated Environment Protection Act 1997 “in order to maintain clean and healthy environment by minimizing, as far as possible, adverse impacts likely to be caused from environmental degradation on human beings, wildlife, plants, nature and physical objects; and to protect environment with proper use and management of natural resources, taking into consideration that sustainable development could be achieved from the inseparable inter-relationship between the economic development and environment protection.” Implementation of a hydropower project is known to cause certain adverse impact on the environment (also known as negative externalities) and, therefore, it is imperative for a hydropower project to adhere to the provisions of this Act.

Environmental Protection Rules 1997 requires IEE to be carried out in the case of construction of transmission lines (T/L) of 33 kV to 66 kV, hydropower projects of 1 to 5 MW and any water resources development activity which displaces twenty-Five to hundred persons from permanent residence under the heading “water resources and energy sector” in Clause E of Schedule 1 under Rule 3. In other words, even IEE is not required for T/L of less than 33 kV and hydropower projects below 1 MW capacity.
Similarly, Schedule 2 includes construction of transmission lines of more than 66 kV, hydropower project of more than 5 MW capacity, any water resources development activity which displaces more than one hundred people, construction of multipurpose reservoirs in activities requiring EIA.

However, GoN has increased the IEE requirement from 5 MW to 50 MW during the course of announcing budget for 2008/09, thus making EIA unnecessary for projects up to 50 MW. This step was taken in response to perceived hassle in implementation of hydropower projects which was mainly related to felling of trees and getting permits/approval for the purpose, already incorporated in approved EIA report. Thus GoN has ended up administering wrong medicine for a properly diagnosed ailment. As getting EIA approved was not the cause of the problem.

Clause 6.1.1 of Hydropower Development Policy 2001 requires release of at least 10% of the minimum monthly downstream discharge of the river or stream by a project as the environmental flow. In case environmental impact assessment (EIA) study report identifies higher quantum as environmental flow, then the project is obliged to release that quantum of water downstream. Unfortunately, this provision is not properly enforced as evidenced by the bone dry dewatered areas of various hydropower projects.

In the report of the World Commission on Dams (WCD) it is recommended that the future decisions on water and energy resource development should be guided by “rights-and-risks” approach rather than by the conventional balance sheet criterion (WCD 2000). It points out that there are competing interests involved in the development of water and energy resources. For example, the construction of large dams may result in involuntary relocation, loss of livelihood and increased flood. The commission felt that till now, the affected people were excluded from the decision-making process regarding the use of resources in their localities. It is of the opinion that it is important to recognize the rights of these people and involve them in all stages of decision-making in matters that pose risks to them. The report asserts that the decisions should be guided by the following core values: equity, efficiency, participatory decision-making, sustainability, and accountability.

Guided by such core values and drawing on the lessons derived from the review, the report outlines the following seven strategic priorities for the development of water and energy resources in future: gaining public acceptance, comprehensive options assessment, addressing existing dams, sustaining rivers and livelihood, recognizing entitlements and sharing benefits, ensuring compliance, and sharing rivers for peace, development and security.

The report then goes on to develop detailed guidelines for achieving the strategic priorities outlined above. It identifies five key decision-making points: needs assessment, selecting alternatives, project preparation, project implementation and project operation. Finally, the report makes some suggestions about how the national governments, civil society groups, the private sector, bilateral aid agencies and multilateral development banks, intergovernmental organizations and academic and research bodies can contribute to the implementation of the recommendations of the report.

Whether one agrees with all the findings of the report or not, the guidelines enunciated in it is relevant from the perspective exploitation of Nepal’s hydro resources as multilateral financial institutions would like to ensure that the guidelines are adhered to if they are to be involved in any such project in any manner whatsoever, to ensure that the adverse impact in the affected areas is kept to the minimum or properly mitigated.

Nepal’s Himalayan range is considered water tower of South Asia, but the receding snow lines is becoming worrisome. It plays a significant role in precipitation, cloud formation and triggering rain in this region. The receding snow lines is also contributing to the formation of glacial lakes with potential for glacial lake outburst flood (GLOF) in the floodplain of respective rivers which endangers people’s life and property in it flood path including hydropower projects that are sited on the banks of the rivers. This problem is being ascribed to climate change which is also interchangeably called global warming. Apprehension is being expressed that with the snow of the Himalayas melting away (!), the quantum of water flowing in the rivers too will be reduced with resultant adverse impact on Nepal’s hydro resources. However, according to a study conducted by Dr Donald Alford (title of the study: Annual Runoff from Glaciers of the Nepal Himalaya) “runoff from the glacierized portion of the three catchments (Karnali, Narayani and Sapta Kosi) was calculated to be slightly less than 5200 million cubic meters annually, representing approximately 4% of the estimated 145,000 million cubic meters flowing on average into the Ganges River from Nepal each year”.
In any case, the world is turning to renewable sources of energy, including hydropower, to mitigate the problems wrought by the climate change. Compared to other modes of generation of power, the life cycle emission by a RoR hydropower project is lowest. Due to rotting vegetation in the reservoir, a storage project is also said to generate methane, which have higher global warming potential compared to carbon, in substantial quantum. However, it is also said that such a phenomenon is limited to tropical regions.

In this backdrop the CDM and Joint Implementation (JI) measures were established by the Kyoto Protocol which seeks to provide incentives for the use of low carbon-emitting and renewable energy technologies in developing countries, through the sale of carbon credits arising from clean energy investments.

As hydropower is considered to be the baseline of Nepal, no environmental additionality is deemed to be generated by the consumption of Nepal’s hydropower domestically and, therefore, no carbon offset is deemed be generated. Conversely, sources of energy in India predominantly comprise of unclean sources and hydropower isn’t deemed to be its baseline. Therefore, export of power from Nepal is a good candidate for trading in carbon offset. However, there is an ongoing debate as to who will be credited for the carbon offset, if hydropower is exported from Nepal to India. Majority opine that as the offset takes place in India, she will have first claim on the revenue stream generated by carbon trading. If this is the case then there will be very little interest in exporting power.

With the country being ravaged by load shedding, which is hampering Nepal’s industrialization, there is a growing emphasis on generation of more power; including for export to India. However, the lack of basic infrastructure like access road, transmission network, etc. is obstructing implementation of hydropower projects in a faster pace. The feasibility of any site depends upon the availability of necessary infrastructure. If a project is required to bear the cost of constructing of access road and transmission line, the project may not be financially viable and vice versa.

Chapter 3 of the report submitted to Forum of Federations, part of which was published by FoF.

Tuesday, February 28, 2012


According to Elazar (1987) federalism is a “combination of regional self-rule for some purposes and shared rule for others within a single political system so that neither is subordinate to the other has been applied in different ways to fit different circumstance.” Whereas Finer (1961) opines “A federal State is one in which part of the authority and power is vested in the local areas while another part is vested in the central institution deliberately constituted by an association of the previously independent local areas.” He also adds that “Neither has the right to take away power and authority belonging to the other.”

Montes has defined federalism as “a system that accommodates both self-rule (of the constituent unit) and shared rule (at the federal level)” (Ilago and Montes 2006). Watts (2006) lays down the essential characteristics of federation as “they are composed of two (or more) orders of government operating within a constitutional framework, with one order providing shared-rule through common institutions for certain specified purposes and with the other order (or orders) providing regional or local self-rule through the governments of the constituent units for certain specified purposes.” John Kincaid (Griffiths 2005) rightly opines that “federalism, then, can be said to be both a structure and a process of governance that establishes unity on the basis of consent while preserving diversity by constitutionally uniting separate political communities into a limited, but encompassing, polity.”

Federalism has yet to be defined from Nepal’s perspective, which will be enshrined in the constitution to be promulgated by CA. However, Nepal has already been “declared a federal, democratic, republic” upon abolition of monarchy in May 2008 by amending the Preamble of Interim Constitution of Nepal, 2007 (by the fourth amendment to it). Similarly, in Article 33(d) it has been specified that an inclusive, democratic and progressive restructuring of the State shall be undertaken to eliminate the existing form of centralized and unitary structure in order to address the problems related to women, Dalits, indigenous tribes, Madheshis, oppressed and minority communities and other disadvantaged groups, by eliminating class, ethnicity, language, gender, cultural, religious and regional discriminations” as the obligations of State.

Article 138 (1) of the Interim Constitution has stipulated that “to bring an end to discrimination based on class, ethnicity, language, gender, culture, religion and region by eliminating the centralized and unitary form of the State, the State shall be made inclusive and restructured into a progressive, democratic system.” There was no mention of word “federal” at the time of proclamation of Interim Constitution in January 2007. It was amended for the first time in June 2007 to insert the word “federal” in Article 138 (1) to enunciate that “the State shall be made inclusive and restructured into a progressive, democratic federal system.”

In Article 138 (2) there is provision for formation of a “High Level Commission” “to make recommendations for the restructuring of the State”. But, according to Article 138 (3) “The final decision relating to the structure of the State and federal system shall be made by the Constituent Assembly.” However, such a commission is yet to be constituted.

Interestingly, the rationale for adoption of federalism in Nepal was only provided by the Fifth Amendment to the Interim Constitution which envisaged it “in order to address the concern of Madheshis, indigenous people and other marginalized groups which have been suffering for long due to centralized State” by adding Sub Article (1A) to Article 138 in December 2008.

Ordinary citizenry have yet to understand and/or comprehend federalism. Some people view it as the panacea for all ills like marginalization, exclusion, etc. and also for salvation women, Dalits, indigenous tribes, Madheshis, oppressed and minorities. But mere spinning off of a number of constituent units (states or provinces) with autonomy and right to self-determination is unlikely to treat/cure such ailments and the likelihood of disenchantment amongst the populace due to failure to redress such issues is high.

According to a survey conducted by Interdisciplinary Analysts (IDA) (Sharma 2010) only 50% of the respondents answered in affirmative when asked if the respondent has “heard about unitary and federal systems” while the percentage was only 32.4% in July 2009 and 16% and 23% respectively in 2006 and 2007; indicating that with the passage of time larger section of the populace are coming to hear about it. Of the people who have responded this year to have heard about it, the average rating for support for federalism was 3.8 only (10 being fully support and 0 for no support). However, having heard about it and plugging a number for support is different by a magnitude with understanding the manifestations and ramifications of it. On the other hand Lawoti (2005) opines that “there may be potential for identity movements with possibility of violence” in view of the increased awareness about exclusion in the marginalized ethnic groups if Nepal doesn’t restructure on ethnocentric (ethnic, linguistic, religious, cultural) lines. However, according to the survey result quoted above, 53% expressed their ignorance as to what will be the result of restructuring on ethnocentric lines, while 26% opined that the country could disintegrate as a consequence; 18% and 12% respectively opining that “country will be weakened” and “there will be ethnic conflict”.
Similarly, 50% of this year’s survey respondents expressed their ignorance as to how the state should be restructured while 18% opined that Nepal shouldn’t go federal. Only 7% supported restructuring on ethnocentric lines that has been recommended by the concerned Committee of CA.

In any case, Anderson (2008) is right in saying that “Federalism is not always best, and there is no best version of federalism. Federalism seems particularly suited to democracies with very large populations or territories or with highly diverse populations that are regionally concentrated. Over time, federalism requires a significant part of the population to have a sense of identity with the whole country, as well lively and engaged political communities at the regional levels.”

The views about federalism ranges from outright opposition to its adoption, demand for restructuring on ethnocentric lines and opposition to restructuring on ethnocentric lines, etc. CA’s Committee on State Restructuring and Distribution of State Power has come up with a proposal for the purpose which will have to be adopted by the two-third majority of CA. However; it is unlikely that this proposal will pass the muster in the CA as a number of political parties hold opinion divergent to this recommendation and, therefore, it is unlikely that this recommendation will find a place in the future constitution.

Under Rule 66(3) of the Constituent Assembly Rules, 2008, a 43-member Committee for Restructuring of the State and Distribution of State Powers was formed in December 2008. It recommended, in January 2010, creation of 14 states; (a) 10 states on the basis of identity [viz. (i) Limbuwan, (ii) Kirat, (iii) Sherpa, (iv) Tamsaling, (v) Newa, (vi) Tamuwan, (vii) Magrat, (viii) Jadan, (ix) Lumbini-Awadh-Tharuwan and (x) Mithila-Bhojpura-Kochi-Madhesh] and (b) 4 states on the basis of capability [viz. (i) Sunkoshi, (ii) Narayani, (iii) Karnali and (iv) Khaptad)]. For the purpose of delineation of state on the basis of identity, the Committee recognized that a person has plural identity at the same time and it may be (a) ethnic group, (b) cultural group, (c) geographical and regional continuity and (d) historical continuity. Similarly, the capability criteria has been taken to be the manifestation of (a) interrelationship with capabilities and economy, (b) conditions of development infrastructure and possibilities, (c) availability of natural resources and (d) accessibility.

An important feature of the State restructuring was to accord prioritization to the main ethnocentric group of a particular region based on whose identity a particular state was conceived for a certain period; which has been variously described as positive discrimination, affirmative action, preemptive right, et al. But this could result in relegating other ethnocentric groups in such states to second class citizenry. Moreover, minority could end up ruling over the majority as the main ethnocentric community enjoy majority in none of states proposed on these lines.

In the meantime Unified Communist Party of Nepal (UCPNM) came up with a proposal for 12 states which results in the annexation of territories of (i) Sunkoshi and (ii) Narayani states by the neighboring ones, in the draft constitution it unveiled in May 2010. Surprisingly, the 14-state recommendation of the Committee, under the convenership of UCPNM stalwart, was based on the idea floated by UCPNM earlier. Meanwhile Nepal Workers and Peasants Party (NWPP) has put forward its proposal for 14 provinces more or less based on present 14 zones (NWPP 2010); indicative map in Appendix 3. Other political parties seem to lack clarity in this respect but are rooting for the formation of the High Level Commission under Article 138 (2) of the Interim Constitution to come up with a recommendation.

The author of this report has proposed 3 provinces (Shrestha, 2009) on the basis of three main river systems (basins): (i) Sapta Koshi-Mechi, (ii) Sapta Gandaki and (iii) Karnali-Mahakali (map with proposed 3 states in Chapter 5) with an eye on ensuring optimum exploitation of Nepal’s hydro resources without causing any problem of second class citizen or minority rule over the majority.

Under the universally accepted principle of right to natural resources each Nepali citizen bred and brought up in any part of the country is entitled to equal right to the available natural resources of the country in any part of the country. For example, a Nepali living in the concrete jungle of Kathmandu valley is entitled to right to the trees, plants, woods, wildlife, herbs, etc. of any forest anywhere. However, after the country is divided into different provinces under the federal system, complexities over sharing of natural resources is certain to arise as evidenced by what transpired in Nar valley of Manang district. People there, for example, unfortunately belaboring in the mistaken belief that the right to harvest ‘Yarsagumbu’ (a medicinal herb) in the district is in their exclusive domain, killed seven unarmed, innocent people from Gorkha, hunting for this herb, in cold blood in 2008. This incident has revealed that with the imminent implementation of federal structure people have started subscribing to the idea that people of one province will not get anything from the other province. Therefore, it is high time to analyze the negative impacts of adoption of federalism.

Some people take water resources only as hydropower forgetting that this natural resource can be instrumental in meeting basic need for livelihood along with the need for adequate pure and healthy drinking water, as well as its use in sanitation, irrigation, fisheries, water transport, tourism based on water sports and industrial use; besides the electricity generation. Basically failing to see and comprehend the water-food-energy nexus.

The concern is with regard to if there will be any obstacle in the optimum exploitation of this resource, its effective management and usage of it for the benefit/betterment of Nepal and Nepali people under federal structure? In case of obstacles, how should they be resolved? How could it be addressed? What issues should get special attention while adopting federalism? How could people’s participation be made more meaningful and inclusive for equitable access to and utilization of water resources while ensuring equitable sharing of benefits? What kinds of decisions on water resources will result in the maximum benefit of the country and the people? It is essential to have serious thoughts and extensive discussions on this matter.

Despite being one of the natural resources, the nature and form of utilization and benefiting therefrom in the case of water resources is entirely different from other natural resources. It is necessary to identify the existing differences between water resources and other natural resources in the context of the federalism. By involving themselves and working as entrepreneurs local people can benefit directly from natural resources like land, forests, herbs, wildlife, minerals, etc. through collection, utilization and other forms of use i.e., harvesting fruit from trees and by cultivating land, collecting herbs, etc. Water resources, however, cannot be utilized in this manner. At the micro level local people can benefit from micro irrigation schemes, micro hydropower plants, tourism based on water sports and other cottage and small industries. But the benefit from water resources can only be maximized by ensuring its optimum exploitation which is likely to be hindered by fragmentation of the country in very small units in the name of federal structure. People are already discussing division of water resources under federalism which is premature without its optimum exploitation.

Drinking Water: There has been an age old practice of buying a source of water of one village by another village. After twenty years of conception of the idea of diverting water from Melamchi River of Sindhupalchowk district through underground tunnel into Kathmandu Valley to resolve the drinking water problem of the capital city, the contract for the execution of the project was concluded last year. Although, this will deprive the local people from using the water of this river, traditionally used by them, no arrangement has been made to recompense them for being deprived as such. In the meantime, local people have been putting forward various demands for compensation, including sustained source of income for them. However, it will not be possible to make arrangements for such sustained source of income by hiking the cost of drinking water for consumers. If source of this project is to lie in one autonomous constituent unit with right to self determination (proposed Tamsaling state) while the consumers in another state, the complexity of this project will get compounded.

Water is an essential “commodity” for human beings; also for plants and other land and aquatic/marine wildlife. Water has also become a product for sale like other commodities. The tap water also bears a ‘price’ because of the stance taken by multilateral financial institution with respect to water supply utilities. The water sold in plastic bottles, jar or similar vessels and tankers has become a profit making business rather than a service oriented activity.

It was heartrending that about 500 Nepali citizens had to lose their lives untimely last year due to the outbreak of diarrhea/cholera, mainly in Rukum and Jajarkot districts of Mid-west region (and several districts of Far-west region), which was caused by lack of potable drinking water and sanitation facilities. In this backdrop, people feel that it has become imperative, to incorporate a clause in the constitution declaring access to potable water supply in adequate quantum and also for sanitation facilities as one of the fundamental rights.

Hydropower as an industry does not recognize any political boundary; manifest in electricity being electron that travels through a transmission network freely. However, implementation of a large hydropower project may mean economic prosperity for some, but it also entails several negative, socio-economic, impacts on the local people, including on indigenous populations. We have numerous examples where local people living in the vicinity of the large hydropower project sites do not have access to electricity even for lighting their homes after them having suffered to have the project built in the area

From the perspective of production and use, even though the Western development region produces the highest quantum of electricity (about 330 MW) in the country, it consumes only half of what it produces. However, the Eastern development region consumes 20 times more electricity than what it produces (14 MW). The Central development region consumes a little more than its production (277 MW). Probably far western development only a little more than what it produces (less than 1 MW). Such a scenario exists because of higher electricity demand in certain areas due to (a) higher density of population and (b) concentration of industrial belts (Sunsari-Morang, Bara-Parsa and Rupandehi-Nawalparasi) and (c) for extraction of ground water for water supply and irrigation. Whereas, hydropower project sites are mainly concentrated in the mid-hills which are sparsely populated, with not much of industrialization.

Currently there is no debate with regard to which region is producing or not producing and which region is consuming more than it produces. Even if the existing five development regions are to be declared as the five provinces, this type of happy sharing will not be possible. Simple issue like pricing can spin out of control and provinces with more generation capacity can shut off power if the price is not right. There is even a possibility that if India is to buy at a higher rate, then a province could choose to export it rather than supply to other provinces (keeping them starved for energy).

Prioritizing Consumption: Regarding the utilization of water resources, the Section 7 (1) of Water Resource Act, 1992, categorizes drinking water including for water for domestic use, irrigation, and agriculture based utilization like animal husbandry and fishery with first, second and third priority, respectively, whereas electricity generation rates fourth priority. However, after the implementation of hydropower project, the priority of the Water Resources Act will be superseded by the license granted which will entitle the hydropower project water in a specific quantum thereby rendering the priority ranking of the law irrelevant.

Following the implementation of a hydropower project, the local people living in the upstream reaches of a river will not be able to undertake projects to irrigate new land because of the project’s water rights. The project’s electricity production will decrease if the quantum of water available to the project is reduced, and consequently, project’s revenue too will decrease; thereby rendering the project unfeasible. In order to avoid this, the Rule 20 of the Electricity Regulation guarantees specific quantum of the water to the licensee in accordance with the license. If, for example, the Upper Karnali Project is launched, the people of Jumla district will be denied of the opportunity of developing new irrigation schemes from the water of the Tila River. Thus, it is clear from the existing laws that even though irrigation is the second priority, the implementation of hydropower project will have negative impact on the amount of water guaranteed by the license and, in such a situation, above mentioned priority will be limited to paper. In effect the Electricity Regulations, which has a subsidiary status to the Water Resources Act, has curtailed the right of people provided by the Act.

No one is unfamiliar with the incidents when, due to lack of rain, farmers have broken drinking water pipeline to irrigate their field during the plantation season, which trigger extreme scarcity of drinking water in the densely populated areas, like Kathmandu valley. Even though drinking water deserves first priority people have been denied the right to drinking water. This may have been a simple happening in the unitary system but it could lead to serious incident in the federal system.

It has been said that the water of Yangri and Larke Rivers of Sindhupalchowk district will be channelized to supply drinking water to Kathmandu Valley in the second and third phase of Melamchi Project. It may create problems if water is supplied to Kathmandu Valley and other areas from the rivers where the hydropower project has already been implemented or construction work is underway. Thus, necessary provision in the new constitution is not made to deal with such issues prior to adopting federalism, the country may be embroiled in serious disputes later on.

There is also ultra-modern use of water resources, which is associated with the hydrogen economy. Hydrogen and oxygen gases can be separated through electrolysis of the water. The technology to use hydrogen as energy has already been developed. When the cost of this technology comes down, the hydrogen energy could be used for cooking as well as to operate vehicles and industries. The use of this technology may also contribute significantly to Nepali economy through trading in carbon offset. Adequate production and supply of oxygen to hospitals of the country will also save foreign currency used for oxygen import. But prior right established by a project in the downstream reaches of a hydropower project will preclude any such activity in the upper reaches of a river.

Additionally, hydrology of a river depends on how well the watershed in the upper reaches is maintained. In the absence of a system of compensation for environmental services, e.g. eco-compensation, projects could suffer if project site and upper reaches of the project are to be under the jurisdiction two different constituent units.

Dewatered area in the River: Diverting river water through canal/tunnel for the hydropower project may create a situation similar to Marshyangdi project, wherein a specific stretch of river becomes devoid of any water. If the electricity produced in one constituent unit is to be utilized in another then the local people are not likely to agree to the construction of the hydropower plant, and the possibility of producing the targeted amount of electricity also becomes slimmer.

A hydropower project with reservoir produces more negative externalities than by a RoR project. Whereas a PRoR project like, Kali-Gandaki A, which collects daily river flow has less negative externalities compared to the Kulekhani (storage) project, which stores water all year round. Apart from submerging land, forests (including wildlife), tourist site, temple and local infrastructure, the construction of the reservoir results in involuntary relocation of people. But such a project also generates high quality peak-in power.

Downstream Benefits: However, a storage project, if built as a multipurpose project, results in positive externalities in a number of ways in addition to the hydropower it generates. The water stored in the reservoir will become available in the downstream areas in the form of augmented/regulated flow in the dry season. This will not only avail water for drinking and sanitation purposes, but also for dry season irrigation, animal husbandry and fisheries, industrial uses of water, etc. With the water flowing in the lower riparian area even during the dry season, the watershed along the river will improve and benefits could be reaped by using the river for navigation and recreational purposes. Moreover, construction of reservoir will also control floods and landslides in the downstream areas during the rainy season.

According to the official record, Nepal has nearly 4 million hectares of arable land (more than one-third Terai). Of which only 500,000 hectares (less than 13 percent) has some irrigation (that too only during the rainy season) yielding only one rainy season crop, if the rainfall is good. Crop production suffers if the rain is inadequate or late, triggering famine. By implementing multipurpose projects in the mid-hills, food security can be achieved which will also promote cash crop and help increase cropping intensity (at least three crops a year or more).

If Nepal’s Terai is become a separate constituent unit/s, the possibility of reaping downstream benefit as such will diminish as building reservoirs in the upper reaches of a river will inundate the constituent units in the upstream areas entailing submergence of land and displacement of local people. Similarly, constituent units in the upper reaches of a river will be constrained by their inability to use water for consumptive uses if a project is built in the lower reaches of the river. Typically, if the official proposal of the committee of CA is adopted, for example, it will be difficult to build projects on Sapta Koshi river as, large tracts of land will be submerged in Sunkoshi and Kirat provinces, Sherpa province will not be able to use the water for consumptive purposes (including going to hydrogen economy) and Mithila-Bhojpur-Madhesh province will stand to benefit from augmented/regulated flow.

Further, the construction of a dam for a hydropower project is not possible in the plains. It is possible only in the hilly area; with river valleys to store water, entailing involuntary relocation of the inhabitants. However, there is not enough land for resettlement of the displaced people in the hills because of lack of habitable lands. Good land is available in the plains where the resettlement of the displaced people may be deemed to disturb the ethnocentric balance of the area as various constituent units are being planned on these lines. The Tharus of the Western Terai have already refused to let the people displaced by the West Seti Project to resettle in their area. In sum, after the delineation of separate constituent units, the people of the upstream constituent unit will lose their right to consumptive use of the water, people of constituent unit in the project site will lose their land and also be displaced by project construction which will provide electricity to consumers in other constituent units and irrigate land in the constituent units in the lower riparian. In such a scenario it may not be easy to have a project implemented.

Additionally, rivers have been used to delineate most of the districts, administrative zones and development areas of Nepal from time immemorial. However, the two constituent units on the two banks of a particular river tend to have different aspirations, needs and priorities, which too may result in disputes as regards harnessing hydro resource. The CA committee too has used rivers delineate various provinces. In the example cited above Sunkoshi and Kirat provinces may not be able to agree as to how best to harness Sapta Koshi River, which mostly delineates the border of these two provinces.

Provincial conflicts: As Nepal is about to adopt federalism, the disputes over sharing river waters in the neighboring countries of India and Pakistan should serve as an eye opener. There exists dispute between Punjab and Haryana over sharing river water. Likewise, Madhya Pradesh, Maharashtra, Gujarat and Rajasthan are involved in a dispute over Narmada project. Similarly, the dispute between Tamil Nadu and Karnataka over Cauvery project is still hanging fire. Pakistan too isn’t immune from the disease. The dispute between Punjab and Sind provinces over whether or not to implement Kalabag project has yet to be resolved.

Long before the discussion on federalism began Nepal already has had a bad track record in terms of benefitting from trans-boundary rivers, through treaties on Koshi, Gandak and Mahakali. In future disputes between two constituent units could weaken the State and result in Nepal losing further.

According to Section 3 of Water Resource Act, the ownership of the water resources available in Nepal is vested in the State. In this backdrop, subsequent to restructuring of the State questions are likely to arise as to whether the ownership should lie at the central, provincial or local levels. Some are already demanding that resources within a constituent unit should be in the ownership of that particular constituent unit, which could impede optimum exploitation of the resource.

Similarly, highly emotional debate has been generated by the issue of division of “hydro resources”. This becomes particularly difficult as a number of constituent units are being proposed to be delineated using rivers as the boundary. This will not only render division of the resource a tricky affair, but optimum exploitation too will become problematic.

The ideal course will be to ensure optimum exploitation and focus on sharing benefits; ranging from benefiting from opportunity to invest to benefiting from end use of electricity for industrialization, employment generating activities and income generating activities, energizing agriculture sector (using electricity for irrigation, for storage agricultural produce, agro-processing etc.), royalties revenue, etc. (in the case of multipurpose project, from the augmented/regulated flow, from water way, from increase in tourism related activities, etc.).

Besides, as looking to benefit from royalty reflects rent seeking attitude, all concerned should focus on using electricity to benefit from industrialization and employment generation thereby. In any case, royalties will go to the owner of “hydro” resources and if the ownership is to vest in the respective constituent units, then there will not be any division issues. However, if the ownership vests at the center, then royalty revenue will constitute one of the revenue sources that will be shared based on a formula under fiscal regime.

In any case, it has been proposed to incorporate a provision in the draft constitution to constitute a “National Natural Resource Commission” which will be reposed with the responsibility ranging from ensuring optimal exploitation to settling disputes between the constituent units and between center and constituent unit.

There are five distinct phases in the history of Australian water management. Only the second phase commenced with federation in 1901 and the final phase, commencing in 2007 heralded use of political deal making allowing Federal Government to create the agenda over water in the States. Compared to this, Nepal hasn’t even attained infancy in this matter; Nepal’s’ federalism is still in the conception phase and we could learn quite a lot from Canadian experience.

In Argentina “regarding hydroelectric uses, the source or fall is a resource that is separate from the land, which is owned by the province wherever it may be located. Therefore, the receipt of a royalty corresponds to the province.” Some people in Nepal are recommending that large and mega hydropower projects should be under the jurisdiction of the center, medium and small hydropower projects under provincial level and mini, micro and pico hydro at local level. This will not only pose impediment in the optimization of hydro resources but also create unnecessarily high number of disputes as a particular hydropower site may be deemed a specific size and could be optimized at a very high level (300 MW upper Karnali project is actually a potential site for 4,180 MW storage project).

The situation of Nepal is comparable with Canada to an extent as she faces special challenges as a federal state in managing its vast water resources, many of which are transjurisdictional in nature, shared either with the United States or amongst Canadian provinces and territories. Therefore, Nepal is in a position to learn quite a lot from Canadian experience.

The Federal Constitution of Ethiopia provides that the water resources of the country are publicly owned and that the Federal Government has the overall mandate to determine the administration and management of the utilization of the waters that are inter-regional and trans-boundary in nature while Regional States have the mandate to administer the water resources within their respective States in accordance with federal laws. This structure, however, may not enable optimum exploitation of hydro resources.

The experience of Germany may not have any relevance for Nepal as Germany is required to abide by “EC Water framework Directive” whereas there is nothing as such under SAARC.

Dr Goldface opines that in Nigeria “The three levels of government, Federal, State and Local Government, share responsibility for water resources management. Thus, leading to fragmentation, duplication and lack of inter-sectoral coordination with each segment pursuing its own independent water agenda. The salient features of water resources management in Nigeria include: weak data base, fragmented responsibility and weak institutional framework among others. Because of the fragmented and uncoordinated approach to water management issues, the regulatory and monitoring machinery within the water sector in Nigeria is diverse, diffused and weak.” Nepal should learn from this experience not fragment the authority and responsibility regarding hydro resources.

In South Africa the National Water Act (Act 36 of 1998) enables the establishment of Catchment Management Agencies which is supposed to ultimately take responsibility for all activities required to enable and support water resources regulation, including authorizing the use of water and ensuring that water related activities are performed in accordance with the Catchment Management Strategy. However, the water sector has not been particularly effective at pragmatically implementing these sentiments nor making them operational. Whereas in USA, state water allocation laws are regularly subordinated to wide-ranging federal laws concerning navigation, fish and wildlife, and environmental protection as well as national defense. Nepal needs to emulate success story of latter and be enriched from lessons learnt in South Africa.

Chapter 4 of the report submitted to Forum of Federations, part of which was published by FoF.

Monday, February 27, 2012

WATER GOVERNANCE IN “FEDERAL” NEPAL -Conclusions and Recommendations

Adoption of federalism in Nepal has serious ramifications on Nepal’s natural resources, including on her hydro resources. Water can not only generate hydropower, but there is no alternative to water whereas power can be generated with a number of alternative sources. Although, Nepal is famous for being rich in water resources, the richness is limited to statistics as long as it is not harnessed. She is actually rich in potential for a number of its uses, not in the conventional sense of the term evidenced by the load shedding as well as water scarcity problems.

History of Nepal’s hydro resource is a checkered one; milestones being various treaties and agreement signed till now. However, cancellation of Arun III in 1995 by the World Bank amounted to a breakthrough in implementing hydropower projects with domestic and foreign investment.

The provisions of Interim Constitution, Electricity Act, etc. have become anachronistic in as much as these were enacted when federalism was not envisaged. All relevant legislation will have to be brought in tune with the aspirations and expectations of federal Nepal. Similarly, various policy, plan and strategy related to water and hydropower to will not be able to cope with the requirements of federal Nepal.

Water is needed for generation of energy not only as hydropower but also in nuclear as well as thermal power plants. Nepal has succeeded to harness very little of her hydro resources. The reasons behind such a phenomenon may lie in defective licensing mechanism. Or it could be ascribed to the institutional arrangement that fails to create conducive environment for exploitation of hydro resources.

In its endeavor to attract domestic as well as foreign private capital, GoN has announced several facilities like, repatriation, employment of expatriates, etc. Moreover, there provision for exemption of import duties during construction period, and income tax holiday during operational phase.

GoN has even allowed liberty to choose foreign jurisdiction, but, unfortunately, the effectiveness of this right to choice is limited to dispute resolution through arbitration. There is provision for payment of modest royalties to GoN and infinitesimal amount as export tax.

During last two decades, NEA and the private sector succeeded to add 384 MW to the INPS which had accumulated 239.918 MW in 80 years; private sector (including general public) mobilizing $357.286 million to $797 million mobilized by GoN/NEA.

Some people are belaboring under the misconception that there is no market for Nepal’s hydropower potential while others don’t want to hear about export of power. Both of these are extreme stances. Aim should be to reap benefit by using electricity in increasing quantum domestically and also to benefit from the complementarities of export market.

There are various issues involved in hydropower tariff but a prudent course will be to fix tariff at a point closure to the equilibrium of demand and supply which will entail fixing season and time-of-day sensitive tariff for both wholesale and retail market. This will become more effective when both wholesale and retail markets become competitive.

Negative externalities in the form of adverse environmental impact are a fact of life and each development activity is fraught with these. It is not wise to stop all development work due to these. The best course lies in following standard guidelines, like WCD guidelines, to eliminate/minimize such externalities while harnessing hydro resources.

There are some negative ramifications of federalism on hydropower. Therefore, care should be taken while agreeing on the basis of restructuring of the State, deciding on the number of constituent units, developing criteria for delineating the constituent units, deciding between whether to share resources or the benefits, fixing dispute resolution mechanism, etc.

In this backdrop, the study has arrived at following recommendations:

Sentimentally speaking even Himalayan range is Nepal’s natural resource. But only water resource has the capability to metamorphose her by ramping up her industrialization and employment generation at a higher plane. Forest has depleted to such an extent that there isn’t much scope to further exploit it. Nepal lacks mainstream minerals like fossil fuel, iron ore, precious metals, etc. However, she possesses lime stone and magnesium in abundance, processing which requires energy intensive industry. Therefore, by harnessing water resources for the generation of hydropower and to generate regulated/augmented flow, Nepal’s destiny can be rewritten. In this backdrop restructuring of the State to adopt federalism needs to be handled with care, in order to ensure that nothing comes in the way of optimum exploitation of Nepal’s hydro potential with effective management for the benefit of Nepal and her people.

In this backdrop, the best possible restructuring of Nepal is formation of three constituent units based on the river basins of three major rivers: Sapta Koshi-Mechi, Sapta Gandaki and Karnali-Mahakali, based on the watershed of each river as follows:

In order to ensure that there are no impediments to harnessing of Nepal’s hydro resources subsequent to implementation of federalism, it will be prudent to conduct a study as regards how to mitigate negative ramifications of it. Such a study could also work out the basis of restructuring, developing criteria for delineating constituent units, determining whether it will be beneficial to all concerned to share resources or the benefits, fixing dispute resolution mechanism, etc. such that the high level commission, wherever it is formed, is afforded valuable help.

Various legislations related to hydropower development are on the anvil for amendment. But the ground reality is about to change significantly after State restructuring. Therefore, extensive studies should be undertaken before making any amendment that will become redundant after Nepal goes federal such that Nepalese authorities at the different tiers of government could be supported to make informed decisions on constitutional design and issues of legislation regarding water resource use in the backdrop of positive and negative externalities of harnessing it. Besides, legal aspects of access to and control of water resources (ownership) and attribution of water user rights, inter alia in the backdrop of ILO Convention 169, both for consumptive uses and non-consumptive uses needs to be fully explored.

A study needs to be undertaken to formulate strategies for protection and conservation of water resources in quantity and quality and the concept of integrated water resource management such that disputes between centre and constituent units and amongst the constituent units could be kept to bare minimum. Similarly, conflict at international level also could increase in the future and well thought through mechanisms and institutions for conflict resolutions have to be developed, for which comparative studies of countries like Switzerland, India and Canada will have to be undertaken.

In above background the decision-makers needs to be assisted by providing input for a new regime of Water Resource Management for hydropower generation by providing quality information and expertise on policy issues and options.

Investment friendly environment is a precondition to hydropower development and GoN is responsible to create enabling environment for the purpose. The enthusiasm of the first decade of economic liberalization doesn’t exist anymore. Besides, there is uncertainty as to how the State restructuring will affect private sector investment in the sector. Therefore, it is imperative that studies be undertaken to ascertain how to engender investment friendly environment in the country.

Endeavoring to attract foreign investment GoN did amend FITTA to afford choice of governing law to foreign investors. But for lack of necessary ground conditions, settlement of dispute by taking recourse to judicial decision is nonexistent. Therefore, an in-depth study needs to be undertaken to determine how to make the liberty to choose foreign jurisdiction effective.

People are still quoting the oft repeated theoretical and economic feasible potential determined by Dr Hari Man Shrestha in early 60s when not a calculator was available to him, let alone a computer. It is high time that a study is undertaken to develop an inventory list of potential projects and also to determine realistic hydropower potential of Nepal.

Some people are not in favor of exporting power. However, such a predilection is not pragmatic. Hydropower potential of Nepal should be exploited to the utmost possible level and energy should be exported after Nepal’s demand is fulfilled to the saturation level. It will be prudent to conduct a domestic market survey to determine the quantum of power that could be consumed domestically.

IPPs are clamoring for revision of bulk tariff upwards, but NEA is unable to afford any such revision without corresponding revision of retail tariff which tends to be unpopular with the retail consumers as well as politicians that depend on the vote bank comprising of the electricity users. Besides, it is high time to introduce both time and season sensitive tariff based on the forces of demand and supply. Moreover, subsequent to implementation of federalism in Nepal, a user residing in a constituent unit producing more than its need should not be paying same level of tariff as a user in deficit prone constituent unit. A thorough study needs to be conducted to develop criteria for fixation of bulk and retail tariff.

It is possible that a constituent unit may be required to bear most of the negative externalities while positive externalities fall in the lap of other constituent unit. Therefore, it is imperative that a mechanism is developed to “price” both positive and negative externalities and also a mechanism to share such externalities fairly and equitably.

Chapter 5 of the report submitted to Forum of Federations, part of which was published by FoF.