Monday, March 9, 2015

FDI in Hydropower and Choice of Jurisdiction

Nepal is facing severe energy crisis, not only in regard to electricity from hydropower but also with other energy sources such petrol, natural gas, and coal. Because nature hasn’t endowed Nepal with these minerals, Nepal has incurred a huge balance of trade deficit as imports have been surpassing exports many times over. The balance of trade deficit was more than Rs. 600 billion in last fiscal year (import more than 6 times of export). The import of fossil fuel alone contributed Rs. 140 billion to the trade deficit while import of electricity amounted to Rs 8.25 billion. (It is indeed strange that a country deemed rich in hydropower is having to import electricity from India!); These deficits are putting pressure on balance of payment as well.

At the end of the most recent fiscal year, the Nepal Electricity Authority (NEA) system had only 787 MW installed capacity while peak demand for Nepal was 1,200 MW. NEA supplied 458 MW from its own sources and 216 MW was generated by independent power producers (IPPs) and 116 MW was imported. However, in spite of the imports, there was a shortfall of 410 MW. Meanwhile, another 700 MW power was generated from standby generators, which required imported petroleum products for operation. All told, still, only 45% of the population had access to electricity supplied by NEA while industries need additional 1,000 MW (an estimate) to operate at full capacity and to enable new industries to be established.

If Nepal could generate enough hydroelectricity to meet its current demands, we could reduce the trade deficit by making LPG for kitchens and diesel for irrigation pumps unnecessary. Currently there is a 1,000 MW demand for kitchens and 700 MW demand for irrigation pumps. The electrification of transportation, which would require another 500 MW, could also help reduce petroleum consumption. This would also reduce our balance of trade/payment deficit. Considering all these needs together, Nepal will require an additional 5,000 MW of energy. And, in five years time, that requirement will double if we are to achieve normal economic growth. Current demand projections have been made under suppressed economic growth scenario. Nepal will need a higher quantum of electricity to achieve accelerated economic growth, which would be needed to elevate Nepal from the status of “developing country.”

Nepal has been endowed with ample water resources. This potential could be harnessed to meet our current energy needs and also to export. But hydropower projects are capital intensive and entail long gestation period for construction and installation/erection. Investors often cannot recover their investmnet and return thereon until after the projects are commissioned and debt service obligation has been fully met.

Therefore, proper and timely financing is key to the solution of Nepal’s balance of trade deficit and energy problems. Although sufficient funds for hydropower development can be mobilized from within the country, foreign direct investment (FDI) also has an important role to play in harnessing hydropower potential.

FDI and Lack of Confidence in Nepal’s Legal System
Nepal’s legal system is a leading obstacle to foreign investment. Many foreign investors do not have confidence in Nepal’s legal system: its body of law, the judiciary, and legal experts. Foreign investors insist on being afforded right to choose foreign jurisdiction, which means that all associated hydropower documents and agreements (project development, power purchasing, loan documentation) are governed by the law of a specific foreign country for settling potential disputes.

Choice of Law to Govern Documents
Prior to the amendment of the Foreign Investment and Technology Transfer Act (FITTA) in 1996, the choice of law to govern documents related to foreign investment was not exercisable even if a project was financed with FDI. However, as it was not expressly prohibited anywhere in the law, except for activities under FITTA, involving foreign parties, the liberty to choose existed per se, but enforcement of the same was dubious for lack of legal mandate.

In this backdrop, it was deemed imperative that FITTA be amended to afford choice of governing law to foreign investors (sponsors of Khimti project, at that time, insisted on choosing foreign jurisdiction) so as to make investment in Nepal more attractive. Therefore, FITTA was amended by adding Subsection (4) in Section 7, which stipulated that “disputes arising in regard to foreign investment made in the industries with investment as prescribed may be settled as mentioned in the foreign investment agreement.” In this manner it became possible to choose foreign jurisdiction when foreign entities are involved in industries above a certain level of capitalization (in the case of Khimti project, for example, Norwegian jurisdiction was chosen for construction/supply contracts and New York law for loan documentation, while the Project Agreement and power purcase agreement (PPA) were governed by Nepal law). FITTA is also clear that no such choice is available in the case of agreements where no FDI is involved.

Settlement of Dispute by Arbitration
Arbitration is one of the courses available for settling disputes. With the adoption of New York “Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958” by the Government of Nepal, foreign arbitral awards have become enforceable by courts in Nepal. Section 34 of the Arbitration Act, 1999 has a provision for this purpose under which arbitral awards delivered in countries that lack reciprocity with Nepal cannot, however, be enforced in Nepal. Similarly, if the dispute concerned cannot be settled through arbitration under the laws of Nepal and if implementation of arbitral award is detrimental to public policy, such arbitral awards too will not be enforced in Nepal.

In this manner, a foreign investor in a hydropower project in Nepal has been afforded liberty to choose to settle dispute through arbitration held in foreign country under the laws of that country. And there is provision for Appellate Court of Nepal to enforce arbitral awards.

Settlement of Dispute through Judiciary
Although the liberty to choose the laws of a specific foreign country to govern a document is now exercisable, use of judicial decisions for the purpose of settling a dispute, in case the law of a foreign country governs the document, is problematic at best. There are three ways of settlement of dispute through judiciary: (a) settlement by foreign court, (b) settlement by Nepal’s court according to the law of the designated foreign country, and (c) settlement by Nepal’s court in accordance with Nepal law.

The aggrieved party in a hydropower venture with FDI is at liberty to approach the judiciary of the country whose law has been chosen to govern the document. However, enforcement of a foreign court’s judgment in Nepal is not possible under the existing legal environment. Therefore, the whole exercise of getting the judiciary of a foreign country to hand down a verdict to settle a dispute in Nepal is meaningless because verdict will not be implemented in Nepal.

Choosing a foreign jurisdiction also entails having Nepal’s judiciary settle the dispute in accordance with the foreign law chosen in the agreement. But application of a foreign country’s law by a Nepali Court for the settlement of disputes is untenable since it would require Nepali judiciary having facile knowledge of the law in many foreign countries. If judgments under foreign law are to be allowed in Nepal, our courts will have the unenviable and onerous task of interpreting the laws of foreign countries written in foreign languages. At present, Nepal’s courts generally don’t even accept documentation in English.

Moreover, adjudicating litigation that arises out of an agreement governed by foreign law by a Nepali Court by applying Nepali law is also likely to be out of the question. In other words, if a foreign investor has chosen a foreign jurisdiction, such an investor may even be precluded from having the dispute settled by courts in Nepal because it is likely that Nepali courts may refuse to rule on a dispute related to a document written under a foreign jurisdiction. In the present set up of our judiciary structure, the first reaction of a judiciary could be to tell the parties to seek the assistance of the judiciary of the country whose law governs those documents. There are no known precedents in Nepal in this respect. And it is yet to be tested in Nepal’s judiciary. However, an Indian Court reportedly refused to adjudicate a dispute arising out of a document governed by Japanese law; the parties were told to have the dispute settled by Japanese Court.

Our current legal situation is illustrated by following diagram.

Besides arbitration, the three avenues for settlement of disputes through adjudication by judiciary 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. In other words, except for the settlement of dispute by arbitration, the right to choose the governing law is meaningless at the moment for settlement of dispute by judiciary.

Published in Issue No. 16 of Hydro Nepal Journal of January 2015

Do your writings bring about any change?

Dear colleague

Thank you for reverting back.

First of all I appreciate the fact that you agree with me that my "reasoning and logic they make sense to Nepal." There are many who disagree with me and some even allege that I do all this to get "paid," which is outright silly as I have explained in my article itself.

Looking at positives there are concerned citizen of Nepal like you who read my writings carefully. Besides, at least few people have started to listen to me. In the past the likes of me were treated as pariah. One concrete evidence of it is me being appointed as a member of National Development Council last year, which approved current plan prepared by NPC.

However, as far as bringing about any change is concerned, the result isn't very encouraging. However, it isn't that discouraging either as proved by following two examples:

We succeeded to get Arun III (201 MW) cancelled by world bank in 1995, which paved path for private sector involvement in hydropower starting with Khimti. Instead of just 201 MW, if Nepal had gone ahead with Arun III, Nepal succeeded to add 355 MW in the system and importantly private sector has been attracted in hydropower sector. If Arun III hadn't been cancelled, there was no way for Khimti to be implemented and consequently, other private sector projects also wouldn't have moved forward. The silver lining of implementation of Khimti, notwithstanding the fact that it has been highly condemned, was that private sector realized that there is profit to be made in hydropower.

Similarly, I count West Seti too as a success. SMEC planned to export peaking electricity from it at less than 5 US cents and provide water free of cost to India. now with CWE developing it, Nepal is being prioritized for electricity and lean season augmented flow of water will be harnessed in Nepal for its multidimensional uses.

I don't know whether these are "small" changes or big ones. In any case I will continue with my crusade till my last breadth.

The other positive aspect lies in "conscience." My writings have succeeded to shake conscience of many, although they may not admit that I am speaking in Nepal's interest. It is easy to wake up a person that is actually asleep, but no sense in trying to wake up a person that is pretending to be asleep.

Second facet of conscience is my own. Future generations to come will blame our generation for the mess that they will inherit due to adverse impact on Nepal's overall economy (having to go abroad for employment, balance of trade and payment deficit for failure to produce in Nepal to at least substitute import), lifestyle, etc. But it will not be possible for them to blame me personally, as I have done my duty by speaking up and telling people that "emperor is not wearing any clothes" contrasted with the masses who are praising the emperor's nonexistent "clothe."

Thanking you once more and with best regards,

Ratna Sansar

On Mar 8, 2015 … … … wrote:

Ratna Sansar ji,

While reading your reasoning and logic they make sense to Nepal. I am just wondering do your writings bring about any change, however small, in Nepal in any quarters? If not, why not?


Thursday, March 5, 2015

Hydropower and Hydrocratic Intellectuality

Nepal is facing severe scarcity of, among other commodities and services, energy sources like cooking gas, petroleum products, electricity, etc., which can be mitigated by prudent harnessing of Nepal’s water resources. Whereas Nepal is rich in intellectuals, pseudo intellectuals as well as self-declared and self serving intellectuals (this scribe doesn’t consider himself to be an intellectual, though). But the problem lies in the fact that very few “intellectuals” understand economics of hydropower subsector within water resources sector, economic linkages of hydropower projects (forward, backward, investment and fiscal linkages) to macro and micro economy. Nor do they understand that the concept of optimum harnessing of water resources by rising above the wrong mantra that “river equals hydropower.” Conducting comprehensive options assessment to decide whether Nepal will benefit by building hydropower project at a particular site or putting it to other uses is simply unheard of. Even with respect to hydropower, deciding whether Nepal will benefit from multipurpose reservoir project or run of river project, including optimization based on river basin-wide approach is rare (GoN failed in this respect in projects like UKP). It manifests in what they claim/pretend to understand and the way they pontificate.

There are many self-declared intellectuals in GoN and outside holding important sounding degrees, who general public don’t credit for any intellectuality and no point in discussing them. However, some intellectuals have proved their intellectuality and few amongst such intellectuals, sadly, have demonstrated lack of understanding of economics of hydropower.

Failure to understand high finance
A former finance secretary of GoN, who became popular amongst general public by resigning on the ground of principle, is one. He opined, in an article published in a vernacular daily, that Nepal should allow projects to be implemented and afterwards if the project doesn’t serve Nepal’s interest, Nepal can bring it under her ownership (hope he is NOT advocating expropriation by GoN unconstitutionally). It sounds rather naïve in the backdrop of failure, for example, to have power purchase agreements (PPAs) with Khimti and Bhote Koshi projects amended in Nepal’s interest, notwithstanding the fact that there is consensus amongst voters (general consumers), voted (parliamentarians), business community, bureaucrats and policy makers that these PPAs are detrimental to NEA’s (hence, Nepal’s) interest.

Divert energy for export to Nepal
To reinforce his argument, he adds that if Nepal wishes to buy electricity from export-oriented project at the export tariff, there shouldn’t be any problem. Alas! He doesn’t seem to appreciate the mechanism of “high finance.” As hydropower projects are capital intensive requiring long gestation period and fraught with a number of serious risks, even people possessing ample financial resources don’t implement projects with just equity. Just to share/transfer risks, developers inject just a small portion (around 25 to 30%) of cost as equity and borrow the rest, which involves signing loan agreements. From the perspective of risks, financial intermediaries don’t avail fund without having a PPA in place to mitigate market and revenue risk. Once a PPA for an export-oriented project is signed, it will be well-nigh impossible to divert electricity to Nepal, thereby depriving buyers abroad and breaching PPA and defaulting on loan agreement. The exporter cannot sell to Nepal even if she is to offer higher tariff. It is heartrending that a highly educated person, who had been a finance secretary, doesn’t understand mechanism of hydropower finance.

Nepal will own the project after quarter of century
He also took solace in the fact that after expiry of license period Nepal will own the project. He is correct to the extent that it is an important element of BOOT (build, own, operate and transfer) mechanism. However, there are two important points he has missed. One, it will be grave injustice to deprive people and economy of Nepal from electricity generated in Nepal in order to export (there is no problem exporting excess, though). Installed capacity in Nepal’s system is about 800MW (which generates less than half during dry season), while peak demand, based on suppressed economic growth scenario, was 1,200MW last year. Under normal economic growth scenario Nepal needs more than 6,000MW right now: 2,700MW to provide access to electricity to 100% population as against currently obtaining scenario of access to 45% of population, 700MW to displace standby generators, 1,000MW to power industries at full capacity, 1,000MW to displace LPG from urban and peri-urban kitchens (to displace firewood from rural kitchen will be too ambitious at the moment), 500MW for electrification of transportation, 700MW to displace diesel pumps used for irrigation in Tarai, etc.

Secondly, after expiry of license period, the power plant will become old and dilapidated and will require costly rehabilitation and refurbishment (being past its prime); nor will it be able to generate fully. A groom having borrowed to marry taking comfort in the assurance that the lender will return his bride in 25 years’ time after loan has been fully repaid is a good analogy!

Export mutually un-exclusive with domestic use
There was another intellectual associated with Investment Board who came up with convoluted logic to prove that electricity export and internal use of electricity are "mutually un-exclusive". His logic even defies principle of physics; something used by Tom will not be available to Harry. He may have been pontificating as such on account of the fact that there is stipulation for Upper Karnali Project (UKP) to provide 12% free energy to Nepal. However, it has since been established that even free energy from UKP is to be exported and, therefore, Nepal doesn’t get to use single watt.

Nepal doesn’t need electricity
Another intellectual who was active in the campaign to have Arun III project (201MW) cancelled in 90s, justifies new incarnation of export-oriented Arun III project (900MW), by drawing a parallel between it and Andhi Khola (5.1MW) that was commissioned in June 1991. Electricity from latter was evacuated to Rupandehi district for lack of demand in Syangja district.

It has been clearly established that Nepal right now needs more than 6,000MW and, therefore, there is no justification for exporting now or in about a decade by when demand would have further escalated. He also has demonstrated his lack of knowledge of high finance by presuming that Nepal can start using electricity from export-oriented project as and when she needs; requiring developer breach PPA.

An interesting (rather saddening) facet of Andhi Khola is that even after almost a quarter of century since its commissioning, Syangja doesn’t use electricity generated by it fully, which manifests vision and policy failure on the part of GoN which failed to encourage/facilitate establishment of industries in Syangja including energy intensive ones.

However, demand of Eastern Development Region, where Arun III is sited, was around 350MW last year, while installed capacity of hydropower was 33.7MW and multi-fuel 39MW (total 72.7MW). Obviously the recorded demand is based on suppressed economic growth and this region can use additional 200MW right now as most industries are operating at half the capacity and no power available for new industries. In this manner this region will require close to 1,000MW by the time Arun III is commissioned (without including electrification of transportation, irrigation, etc.). In this backdrop it is futile comparing Andhi Khola with Arun III and condoning the crime committed by GoN in this respect.

Remuneration for advocating in Nepal’s interest
Former finance secretary has also opined that the likes of this scribe receive remuneration for opposing projects. It is obvious that certain sources do pay its agents in Nepal to lobby and write in favor of projects that benefit foreign countries at the cost of Nepal’s economy; some also lobby in favor of bad projects due to the prospect of being able to earn through subcontracts (contract for projects of this scale is beyond capacity of business people in Nepal) for construction/supply. Similarly, those who bend over backwards to justify projects detrimental to Nepal must have been remunerated by the beneficiaries.
But one wonders who would pay those advocating in Nepal’s interest; especially in the backdrop of the fact that even policy makers, politicos and bureaucrats, reportedly, get paid in cash/kind when they advocate/work in the interest of foreign country/business; Mahakali treaty was reportedly ratified by parliament for pecuniary benefit. Actually it will be nice for the likes of us at least to be recognized for advocating/lobbying in Nepal’s interest instead of calling such people “anti-development”; this bunch isn’t selfish to expect to be paid for serving the interest of the motherland.

Hydrocratic intellectuality
Hydrocratic intellectuality is the curse on Nepal, Nepal’s economy and Nepali people. Hydrocrats believe that Nepal will prosper by mitigating load shedding in India, including industrialization there. Due to such intellectuality, Nepal has to import from power-starved India in the name of mitigating load shedding now, contrasted with dream peddled by hydrocrats since more than 2 decades ago that Nepal will become rich by exporting electricity. Nepal is now facing tragic consequence of this dream. Consequence of current spree of signing documents for export will result in Nepal importing the very electricity it exported at around Rs 2.50 from India at more than Rs 10. Wonder when would hydrocrats understand it!

Published in Peoples Review on 4th March 2015
Ratna Sansar Shrestha