The world of Nepali IPPs: An analysis of independent power producers in Nepal

Nepal is said to have one of the highest hydropower potentials in the world with an electricity generation capacity of 83,000 MW of which 42,000 MW is said to be economically feasible. While these resources could be developed to transmit large scale benefits for the country, only 712.63 MW; which constitutes less than 1.70% of the economically feasible capacity, has been harnessed. Additionally hydropower comprises of only 2% of the total energy consumed within the country despite the various hydropower projects under development.

Hydropower projects in Nepal are generally undertaken through Nepal Electricity Authority (NEA), Independent Power Producers (IPPS), or micro hydro projects wherein the private sector and local communities work towards generating electricity. NEA is a major player in the electricity sector with 65% of hydropower projects in operation being owned by it. IPPs on the other hand constituting primarily of private players own approximately 35% of hydropower projects in operation.

The problem therefore lies behind the country’s inability to fully take advantage of its hydropower potential and develop fully functioning hydropower projects. This primarily stems from a business atmosphere fraught with bottlenecks and political instability which therefore fails to inspire confidence among investors – public and private. This inability to facilitate substantial investments in the hydropower sector has subsequently led to significant negative impacts on the economic development of the country. Additionally, focus primarily on seeking foreign aid and grants, rather than developing projects via private and foreign investments has also significantly contributed towards the slow pace of growth. Lessons learned from the Khimti and Bhotekoshi Power Projects also indicate how private power development is being discouraged through adoption of non-financeable policies to protect the government owned and controlled utilities.

Some of the main reasons behind the country’s inability to adequately take advantage of its hydropower potential report have been identified below.

1. Most projects promoted by NEA fall behind schedule, and therefore incur losses in billions. While demand is slated to increase over the next few years, development of hydropower projects continue to be fraught by delays.
2. There is a high dependence on electricity generated through Run of the River (RoR) projects, due to which there is a significant gap in the demand and supply of electricity in the dry seasons.
3. The inability of NEA to meet the annual peak demand for electricity has resulted in additional imports from India, further increasing the trade deficit.
4. NEA projections of increase in demand are based on current demand which is centered on load shedding. Projected future demand is therefore restricted due to load shedding and will therefore be significantly higher on availability of electricity.
5. Energy demands are currently met primarily through traditional sources; firewood or petroleum products, energy substitution with electricity could therefore result in further increases in demand. Future economic development also warrants further increases in per capita consumption of electricity. There is however no studies to identify this latent demand for electricity, which must be taken into consideration to adequately identify future demand and supply.
6. While Nepal has high hydropower potential, it is also one of the lowest per capita energy consumers in the world. The energy crisis during the dry seasons in particular has had negative effects on industries, particularly manufacturing.

There is no certainty and security for investors in the energy sector in Nepal, which would otherwise have led to projects being executed on time, and wherein the contribution of IPPs to the national grid would have surpassed that of NEA by now. Some issues that have resulted in the poor participation of IPPs or caused hindrances towards the development of the sector are listed below.

Nepal Electricity Authority

As the NEA is the sole buyer of electricity in the Nepali market it holds a monopoly over power producers, additionally it is also involved in hydropower development. While NEA is fraught with in-house inefficiencies and limited financial capacities, therefore resulting in projects being delayed and incurring high cost over runs, it still manages to reserve the good projects for itself. NEA also has long term financing sources at interest rates lower than the market as it has access to soft loans from the government and its subsidiaries. This therefore acts as an uneven playground for IPPs.

Operational inefficiencies and prices being administered by the Electricity Tariff Fixation Commission (ETFC) also means that the NEA has been unable to transfer its costs to its buyers. NEA therefore does not have stable financial health and lacks credit worthiness. IPPs therefore have to take into consideration NEA’s ability to make future payments when considering entering the hydropower market.

Lastly NEA has stopped signing additional Power Purchase Agreements (PPAs) for projects with an installed capacity above 25MW. The absence of other private distributors of electricity in Nepal therefore means that investments in hydropower projects are stuck for the next 5-7 years until the NEA may potentially sign new PPAs.

Domestic Investment

Domestic investment in hydropower is difficult to come by as the government lacks the capacity as well as capability to invest in the hydropower sector. Banks and Financial Institutions (BFIs) in Nepal are also underdeveloped and lack the managerial capacity to implement such huge projects. Additionally asinvestment in hydropower projects is highly technical and risky compared to other sectors, despite growing interest, participation of Nepali BFIs has not been encouraging.

Project financing is also a relatively new concept in a market still working under collaterals and personal guarantee backed financing. Generally longer gestation and repayment periods for hydropower projects further means that BFIs often show hesitancy in financing such long term projects.

Foreign Direct Investment

While FDI is essential for hydropower development, there are various issues that have emerged such as the failure to arrive at a common denomination of currency for PPAs. This in addition to the absence of Project Development Agreements (PDA) between the government and power producers, results in IPPs being exposed to various risks, which therefore acts as a key deterrent to FDI in hydropower projects. Additionally while contribution of IPPs is key to hydropower development in Nepal, FDI to this sector has been discouraged due to unnecessary and baseless allegations.

Others

There are various other risks other than those identified above, such as construction risks, insurance risks, political, legal and regulatory risks, lack of an internationally accredited credit rating system in Nepal, involvement of multiple entities in the development of hydropower projects rather than a single one, all of which often leads to difficulties in coordination and increases overall time and costs involved. To unleash the country’s potential in hydropower, concerted efforts of multiple stakeholders is required with the role of the private sector, international donors, government and local communities better identified.

With government finances proving to be inadequate in developing the hydropower sector, private and foreign investments are essential for overall development of the sector. While there have been various issues in bringing in foreign investments, adequate support from the government will help in inspiring confidence among private and foreign investors. Hydropower development can therefore positively impact the country’s economy and its balance of payments position.

To ensure energy security through hydropower, certain recommendations have been listed below to facilitate investment in the hydropower sector.

• Restructuring of NEA as NEA activities currently includes generation, transmission and trading and distribution of electricity. Weak management and inadequate resources has spawned inefficiency resulting in low quality of services. NEA needs to be restructured to focus primarily on the distribution business, and create a favorable environment for private sector involvement in hydroelectricity.
• Establishment of a regulatory body for more active regulation of the hydropower sector.
• Revisit demand forecast which is likely to increase based on the ease of obtaining a connection and subsequent energy substitution from LPG and firewood to electricity. Other factors such as upgrading from a two-phase to a three-phase electrical power distribution system, and urbanization with increased usage of electrical appliances, should also be taken into consideration.
• Open market to the private sector in generation, distribution and transmission of power to not only encourage private sector investments but also create a level playing field.
• Transparency in NEA particularly in licensing is a must as most licenses for projects are held by individuals or institutions that do not have the technical or financial capacities to implement hydropower projects.
• Project Development Agreements is essential to inspire confidence among foreign investments, and without which various projects will not be successful.
• Tariff Rates need to be relooked at as various hydropower projects have postponed investment plans due to unattractive tariff structures.
• High voltage transmission lines need to be developed to keep pace with power generation.
• Dollar based PPAs need to be developed to attract large scale investments, with a clear policy on determining the rate and denominations for greater operational clarity.
• Hedge risks through dollar based revenue models to hedge against volatility in USD, and local currency bonds should be issued by multilateral agencies to mitigate foreign exchange fluctuations risks.
• Inclusion of USD and NPR components in PPA while ensuring free flow of foreign investment will at the same time help in mitigating foreign exchange risk.

This is an extract from a report commissioned by the Royal Norwegian Embassy in Nepal. This document is solely the work of Nepal Economic Forum. The information documented and the views expressed by this economic periodical do not necessarily reflect the ideas of the Royal Norwegian Embassy.