Tuesday, February 28, 2012

Hydropower - WATER GOVERNANCE IN “FEDERAL” NEPAL

“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.

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

LICENSING MECHANISM
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.

WATER RIGHT
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.”

INSTITUTIONAL ARRANGEMENT
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.”

FACILITIES PROVIDED BY STATE
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.

LIBERTY TO CHOOSE GOVERNING LAW
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.

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

FEES PAYABLE TO GON
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.

TAX AND CUSTOMS FACILITIES
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.

FINANCING/INVESTMENT
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.

MARKET AND PRICING
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.

DOMESTIC MARKET
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).

INTERNATIONAL TRADE
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.

BULK TARIFF

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.

RETAIL TARIFF
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.

ENVIRONMENTAL ASPECTS
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.

IMPACT ASSESSMENT STUDIES
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.

ENVIRONMENTAL FLOW
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.

WCD GUIDELINES
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.

ISSUES RELATED TO CLIMATE CHANGE
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.

INFRASTRUCTURE-RELATED ASPECTS
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.

2 comments:

thakur said...

Thank you for your valuable article...

lavraj bhatt said...

nice article>