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Friday, June 20, 2014

Hydro Power Project Financing Scenario in India


Hydro Power Project Financing Scenario in India –

A Case Study on Hydro Power Projects in India


Abstract

Although India has 1,50,000 MW Hydro Potential, but hardly 30,000 MW has been developed so far. Initially Government of India has been funding the development of Hydro Project from their budgetary support only. In 90s Government of India offered the various hydro sites for development for Private Sector. Although 20 years have been passed but there is a not significant addition in Hydro development took place in India. Over the years hydro power projects have proven that it is the most cost-effective power projects for commercial scale hydro power generation in country like India. However, the question must be asked why such a slow growth has taken place in the development of hydro power projects inspite of enormous potential available in India. So far Hydro Power Projects of 37367 Mw as on December 2010 have been installed with an investment of Rs.1500 billion in debt and equity financing. Investors and bankers who make these investments are the real clients for hydro power projects. They are not interested in hydro power project efficiencies, but in risk, return on investments and coverage ratios. This paper will take a look at hydro power projects from the project financier’s perspective. The challenge in moving forward is to attract private investors, commercial lenders, and international development agencies and to find innovative solutions to the difficult issues that investment in Indian power market poses for hydro power projects.

Keywords: Hydro Projects, Project Financing, Private Investors, Commercial lenders


Introduction


For any growing economy, power is a vital input needed to fuel the engine of economic growth and to fulfill the basic needs of the entire population of a country. Energy differentiates a least developed or developing economy from a developed economy. Empirical evidence suggests that lack of energy can whittle down the pace of economic development while its abundance can stimulate the development. As per some research data, an average an American consumes approximately 40 percent more energy than an Indian does. This stark gap in consumption levels may safely be attributed to the government’s failure to maintain an appropriate ratio of Hydel and Thermal power and not properly harnessing hydro power which is possible only through the construction of large river valley projects. Apart from storing water, river valley projects not only produce electricity but also ensure cleanliness of the air in the process.

Hydropower currently accounts for nearly one-quarter of the world's electricity production, with a total some 777,000 megawatts (MW)2 installed as on 2010. It is not only a significant contributor in terms of the overall global energy balance, but is arguably the only renewable energy resource that is commercially exploitable on a large scale at present levels of technology.

Despite the obvious advantages that hydropower offers to a world that is becoming increasingly conscious of the problems of sustainability, and global warming in particular, there are serious challenges facing the industry. These arise primarily from the worldwide trend toward deregulation of the power sector, which means that the development and ownership of new power stations has passed into the hands of the private investors whose commercial priorities tend to favor other forms of generation. A secondary, but still important, factor is the environmental concerns that are tending to cast a negative image over hydro as a whole, although these are primarily triggered by projects with large storage reservoirs.

Prior to 19913 the provision of electric power in India was the responsibility of the public sector, and where this was not the case the task was undertaken by closely regulated private utilities. In either situation the funding of new projects was based on the financial strength of the utility or the creditworthiness of the government that lay behind it. With the deregulation of the power industry
there has been a fundamental shift in the way projects are financed. The devolution of the industry into smaller competing units meant that it was no longer possible to rely upon traditional utility-based financing. The trend has been toward the funding of individual projects on a limited-recourse basis where the lender relies for debt servicing on the revenue stream of the project in question, with little or no security being provided by the sponsoring organizations. Under such conditions it is inevitable that financiers become much more closely concerned about the viability of the project itself, rather than the strength of the sponsors to whom they would have little recourse if things go wrong.

As a consequence of these trends the hydro industry finds itself at a crossroads. The past has been dominated by projects financed in the public sector, usually under concessional arrangements. The future will be driven by private finance, and projects will have to stand on their individual merits in a world that is geared toward quick commercial returns. Under this scenario the record to date shows that hydro is finding it difficult to hold its position.

This deterioration in the apparent attractiveness of hydropower is not as a result of any change in its underlying economics. Hydro still remains a sound long-term investment whose shelf life is almost indefinite compared with the 15- to 20-year life cycle of a typical thermal power station. But what have changed are the criteria by which projects are selected for development, with the emphasis now being on the ability to finance a project from private sources. In consequence the bias has been toward low-cost thermal projects, particularly gas-fired plants, which are relatively easy and risk-free to construct, and whose limited life span comfortably matches the short tenor of most commercial lending.


Indian Power Sector Scenario


The Indian Power Sector is undergoing a rapid growth phase with a vision to provide reliable, affordable and quality power for all by 2012. The demand for power is growing exponentially in accordance with the high level of developments on both infrastructure and social fronts. In the infrastructure sector the focus is on the progress in telecommunication, roads, airports and ports. On the social front the aim of providing reliable power has emerged as the main reason for increased focus on the power sector.

India is the 5th largest power producer in the world with an achievement of increasing installed power capacity from 1362 MW at the time of independence to 1,81,558.12 MW4 as on July 2011. In spite of this growth, the power sector is plagued by a large gap in the demand and supply.The electricity sector in India supplies the world's 6th largest energy consumer, accounting for 3.4% of global energy consumption by more than 17% of global population. the Energy policy of India is predominantly controlled by the Government of India's, Ministry of Power, Ministry of Coal and Ministry of New Renewable Energy and administered locally by Public Sector Undertakings (PSUs).

About 65.22% of the electricity consumed in India is generated by thermal power plants, 21.04% by hydroelectric power plants, 11.10% by Renewable Energy Sources and 2.63% by nuclear power plants. More than 50% of India's commercial energy demand is met through the country's vast coal reserves. The country has also invested heavily in recent years in renewable energy utilization, especially wind energy.

The power sector has registered significant progress since the process of planned development of the economy began in 1950. Hydro -power and coal based thermal power have been the main sources of generating electricity. Nuclear power development is at slower pace, which was introduced, in late sixties. The concept of operating power systems on a regional basis crossing the political boundaries of states was introduced in the early sixties. In spite of the overall development that has taken place, the power supply industry has been under constant pressure to bridge the gap between supply and demand. Indian Power sector has grown in terms of installed generation capacity from 1713 MW in 1950 to 1,81,558.12 MW as on July 2011. The per capita electricity consumption has also increased from 18.17 kWh in 1950 to 1032.25 kWh in 2011.

India is expected to add up to 113 GW of installed capacity by 2017. Further, renewable capacity might increase from 15.5 GW to 36.0 GW. In the private sector, major capacity additions are planned in Reliance Power (35 GW), Adani Power (20 GW), TATA Power (12 GW) and CESC (7 GW).


Table-1: Installed Power Generation Capacity in India as on July 2011

Fuel
MW
% share
Thermal (Coal)
99,503.38
54.81%
Thermal (Gas)
17,706.35
9.75%
Thermal (Oil)
1,199.75
0.66%
Hydro
38,206.40
21.04%
Nuclear
4,780.00
2.63%
Renewable Energy Sources
20,162.24
11.10%
Total
1,81,558.12
100.00%

Indian Power Sector Funding Requirement

Considering Hugh demand supply gap and 12th Five year plan target, there is a wide gap between demand and supply of power in the country. Serious efforts are required to finance projects to meet this wide gap. There has also been difference between public generation targets and achievements, which has seen many ups and downs. Only in the seventh plan there was a shortfall of 4 percent which was also the lowest among all 11 five year plans so far. But in the very next plan i.e. eighth plan the shortfall shot up dramatically.
  
Five Year Plan
Target Capacity
Installed Capacity
Percentage
(in KW)
(in KW)
shortfall
1st Plan
1,300
1,100
15
2nd Plan
3,500
2,300
36
3rd Plan
7,000
4,500
36
4th Plan
9,300
4,600
50
5th Plan
13,200
8,600
35
6th Plan
19,670
14,230
28
7th Plan
22,250
21,500
4
8th Plan
30,540
16,420
46
9th Plan
40,245
19,119
47.5
10th Plan
41,110
21,180
51.5
11th Plan
78,530
47,178*
60
12th Plan
82200**
**

   *  Projects under construction and likely to be commissioned
    **  Preliminary studies have been conducted on identified projects and work would be started on these projects for adding capacity of 82,200 MW

As per the estimates of Planning Commission, the total capacity addition in 10th plan was only around 21,180 Mw against 41,110 Mw. The main reason for shortfall was Government's withdrawal of budgetary support for power projects in the anticipation that Independent Power Projects (IPP) would come up with the required investment. In fact, a large number of projects were selected by the Government and several "Memorandum of Understanding" (MOUs) were signed for power generation. Ironically State governments have not done much besides showing interest in such projects. A lot needs to be done on issues relating to environmental clearance, availability of land etc.

The working group report on power envisages a capacity addition of 78,530 Mw during the 11th Plan. The Planning commission, on the other hand, estimated that the installed capacity requirement in the year 2011 would be 1,82,660 Mw. The installed generation capacity (as on December 2010) was 1, 69,749 Mw. This way capacity addition required during in the remaining part of 11th Plan (Year 2011-2012) would be 31,352 Mw. In addition the Planning Commission considered all sanctioned, ongoing and pipeline projects and arrived at the conclusion that a capacity addition of the order of about 82,200 Mw would be possible during the 12th Plan Period. The envisaged composition is:
Central: 13,914 Mw (17 %), State: 17,350 Mw (21%), Private: 50,936 Mw (62%)


The whole exercise does not seem to be feasible on account of three reasons:

The state sector has neither the financial resources nor managerial capacity to add 17,350 Mw in 12th five year plan. The capacity addition of 50,936 Mw by private sector is too mammoth target considering worsening economic situation and fiscal imbalance situation in India.

Given the Government's expectations of a high investment from private players, the prospects

of capacity addition in the 12th Plan look bleak looking at the past record of private investment. The private sector power policy was introduced in 1992 but it has failed to attract desirable level of investment.

Therefore, one of the major issues in the power sector is, “raising of funds for carrying out the operations” to meet the demand & supply gap. The companies in the power sector finance their outlay through both the internal as well as external sources. They plough back own profits to finance their outlay. They also enter into agreements with various multilateral agencies for financial support. A look at the following table would give us the idea of the size and dimension of funds requirements in Indian Economy.
Table 2: Estimated Phasing of Funding Requirement for Generation during 12th Plan















Type of Power Projects
2012- 2013
2013- 2014
2014- 2015
2015- 2016
2016- 2017
Total Fund Requirement for Generation
Hydro
218.57
236.9
250.6
271.4
289.04
1266.49
Thermal
763.67
669.1
627
618.7
628.28
3306.68
Nuclear
57.53
69.55
74.43
82.55
93.6
377.66
Total
1039.8
975.5
952
972.6
1010.9
4950.83

(All figures in Billion Rupees)
Note: The calculation assumes a US $ to Rupee conversion rate of Rs.45 and average price of $ 1 million per MW of generation capacity added.
Source: Overview of Power Sector - 12th Plan and Beyond, Central Electricity Authority


Table 3: Estimated Total Fund Requirement for Generation & Transmission during 12th Plan


Generation
4950.83
Transmission
2400
Distribution
4000
Total Fund Requirement
11350.8
(All figures in Billion Rupees)
Note: The calculation assumes a US $ to Rupee conversion rate of Rs.45

Source: Overview of Power Sector - 12th  Plan and Beyond, Central Electricity Authority


Scenario of Hydro Power Project Financing in India


Background: India’s critical need for power


Severe power shortage is one of the greatest obstacles to India’s development. Over 40 percent of the country’s people most living in the rural areas do not have access to electricity and one-third of Indian businesses cite expensive and unreliable power as one of their main business constraints.

India’s energy shortfall of 10 percent (rising to 13.5 percent at peak demand) also works to keep the poor entrenched in poverty. Power shortages and disruptions prevent farmers from improving their agricultural incomes, deprive children of opportunities to study, and adversely affect the health of families in India’s tropical climate.

Poor electricity supply thus stifles economic growth by increasing the costs of doing business in India, reducing productivity, and hampering the development of industry and commerce which are the major creators of employment in the country.

Hydropower Scenario in India


According to India’s Central Electricity Authority (CEA), India has a hypothetical hydropower potential of 148,700 MW. Actual capacity stood at 508 MW at independence, and at 38,206.40 MW in July 2011. At times, hydro had a share of more than 50% both in generating capacity and actual generation. This has since gone down to less than 21%. As India’s main problem is a lack in peaking power, the authorities would like to increase the hydro share within the power mix to 40%.

India’s Northern region accounts for 36% of existing hydropower capacity, and the Southern region, for 34%. Expansion is primarily planned in the North-Eastern region (the Brahmaputra-Barak basin, with 48% of the country’s hypothetical hydropower potential), and the Northern region (the Ganga basin, with 36% of the undeveloped potential). Of the 98 projects which CEA identified as the first priority for further development in 2001, 52 are located in the Brahmaputra and 20 in the Ganga basin.



Hydro Projects Proposal as per current 11th Five year Plan:


The status of Hydro projects totaling to 16,553 MW included in the 11th Five Year Plan is as under:

·         14,431 MW (87%) are under construction;

·         1,537 MW (9.5%) have been accorded concurrence by CEA/State Government and are awaiting investment decision/work award;

·         585 MW (3.5%) the DPR is ready and concurrence of CEA/State Government is awaited.

·         Besides capacity addition, a strong inter-state and inter-regional transmission system has also been planned not only to evacuate the planned generation capacity but also to provide open access for transfer of power from surplus to deficit areas.

Availability of Financial Market Instruments in Indian Hydro Project Financing



India Financial Market helps in promoting the savings of the economy - helping to adopt an effective channel to transmit various financial policies. The Indian financial sector is well-developed, competitive, efficient and integrated to face all shocks. In the India financial market there are various types of financial products whose prices are determined by the numerous buyers and sellers in the market. The other determinant factor of the prices of the financial products is the market forces of demand and supply. The various other types of Indian markets help in the functioning of the wide India financial sector.

Features of Indian Financial Markets


o   India Financial Indices - BSE 30 Index, various sector indexes, stock quotes, Sensex charts, bond prices, foreign exchange, Rupee & Dollar Chart

o     Indian Financial market news

o Stock News - Bombay Stock Exchange, BSE Sensex 30 index, S&P CNX-Nifty, company information, issues on market capitalization, corporate earnings statements
o   Fixed Income - Corporate Bond Prices, Corporate Debt details, Debt trading activities, Interest Rates, Money Market, Government Securities, Public Sector Debt, External Debt Service

o   Foreign Investment - Foreign Debt Database composed by BIS, IMF, OECD,& World Bank, Investments in India & Abroad
o   Global Equity Indexes - Dow Jones Global indexes, Morgan Stanley Equity Indexes Currency Indexes - FX & Gold Chart Plotter, J. P. Morgan Currency Indexes
o   National and Global Market Relations Mutual Funds  

·         Forex and Bullion

  
Role of Multinationals in Indian Hydro Project Financing

 It will be evident from the reading of the case studies that the role of the multilateral development banks has, in most cases, been essential for the success of the projects. Furthermore, that the assistance that such banks provide can come in a number of forms. Their potential role in assisting the financing of private hydropower projects can be through the use of loans, equity investments and/or guarantee instruments, which are described below in the following ascending order of dependence on public sector support:

1.        Loans/equity investments to the private partner,

2.        Partial Risk Guarantees (covering government undertakings),

3.        Partial Credit Guarantees (to extend the maturity of debt financing), and

4.        Loans to governments and other public entities.

  
Government of India Initiative in Hydropower Development


To boost economic growth and human development, one of the Government of India’s top priorities is to provide all its citizens with reliable access to electricity by 2012. To ensure that the uncovered 40 percent of Indian homes get electricity by 2012, and to serve rising demand from those already being served by the power grid, the government estimates that the country will need to install an additional 100,000 Mega Watts (MW) of generating capacity by 2012, expanding grid-based generation to about 225,000 MW. Given that India added about 23,000 MW during the last 10th Five Year Plan of 2002-2007, this will be quite a quantum jump.

The Government of India has decided to acquire an increasing portion of this additional power from the country’s vast untapped hydropower resources, only 23 percent of which has been harnessed so far. India’s energy portfolio today depends heavily on coal-based thermal energy, with hydropower accounting for only 21 percent of total power generation. The Government of India has set the target for India’s optimum power system mix at 40 percent from hydropower and 60 percent from other sources.

The main features of the Government of India policy on hydro power development are as follows:

                    i.      Additional budgetary financial support for ongoing and new hydro projects under Central Public Sector Undertakings.
                  ii.      Basin-wise development of hydro potential – comprehensive Ranking studies for 399 schemes.
                iii.      Advance action for capacity addition – 10 year ahead of execution Emphasis on quality of survey & investigations

                iv.      Resolution of inter-state issues on sharing of water and power. Renovation, Modernization & Uprating of existing hydro stations

                  v.      Promoting small and mini hydel projects – 25 MW and below now fall into category of “non conventional” qualifying for benefits.

                vi.      Simplified procedures for clearances by Central Electricity Authority; Electricity Act 2003 further liberalises this.
2.      Rationalization of hydro tariff by allowing premium on sale rate during peak period

                                                              i.      Realistic estimates of completion cost considering new development on geological front during execution.
3.      Promoting hydel projects in joint venture

4.      Selection of developer through MOU/Bidding route

                                                              i.      Govt. support for land acquisition, resettlement and rehabilitation, catchment area development, etc.

                                                            ii.      Some of the measures announced by; Govt. of India have already been introduced which include simplified procedures for transfer of techno-economic clearances, streamlining of clearance process and introduction of three-stage clearance approach for development of hydro projects in Central Sector/Joint Ventures, etc.

                                                          iii.      The Central Electricity Regulatory Commission has approved 5% hydro development surcharge on annual fixed charges for central hydro power generation

Funding Scenario of Hydro Power Projects in India


Hydro Project financing in India, as in many other countries of the Asian region, has not been an easy task. However, following the new initiative taken by the Indian Government to help create an additional 50,000MW installed hydro capacity by the year 2012, things have started to look up. At present, power projects (including hydropower schemes) in India are supposed to be funded from the following sources:

Through NHPC and other central utilities, the government provides the equity capital of central sector power projects. The government also offers a range of other incentives to promote the development of power projects

State governments and utilities contribute the equity capital of state sector projects. They conclude power purchase agreements with IPPs, and offer escrow accounts and other guarantees as securities.

Investors from India and abroad are supposed to provide the equity of private sector projects. In central, state sector or private projects, equity usually needs to cover 30% of project costs.

Once the equity has been secured, PFC and Indian development finance institutions extend rupee loans for the debt-financing of central, state sector and private power projects. Increasingly, Indian commercial banks and other financial institutions also provide debt funding to power utilities and individual projects. Domestic lenders usually cover about 40% of the project cost. In some cases, they also extend foreign currency loans. Export credit agencies, some bilateral institutions and numerous international commercial banks extend loans (or guarantees) to cover the foreign currency debt of power projects, which usually amounts to about 30% of project cost.

Apart from direct funding, the central government has started to offer a series of incentives to encourage the development of power projects:

  • The government exempts bonds for the infrastructure sector, particularly PFC bonds, from taxes.
  • In 1995, the government granted tax holidays of ten years and an exemption from import tariffs for so-called mega-projects of more than 1,000 MW (in the thermal sector) or 500 MW (in the hydro sector). It also extended guarantees to seven private hydropower projects.
  • In 1997, the government started to provide an interest subsidy of 4% for PFC loans for priority projects (including the completion of power projects, missing transmission links etc.) under the Accelerated Generation & Supply Programme. The Power Ministry believes that this programme has been effective in helping states to complete projects, and would like it to be funded also under the Tenth Plan.
  • Under the Accelerated Power Development Programme, the government contributes grants and loans for the renovation and modernization of existing power plants and distribution networks.
  • Host state governments receive a free share of 12% of the power produced by central hydropower projects in their territory.

Project financing Issues in Indian Hydro Power Projects



The key issues in the financing of private hydropower projects are bankability and affordability. Although the operating costs of hydro are minimal and the project life almost infinite, there are multiple cost-related factors that make hydro difficult to finance on a private basis, particularly when compared to equivalent thermal projects. These include the following:

High Capital Costs. The specific cost of a hydro power station (Rs. In Billion /MW) is typically

 0.06 to 0.07 compared to 0.04 to 0.05 for a thermal power station, depending upon the site characteristics and the type of thermal plant. This gap widens when private financiers require

fixed price EPC contracts, because the contingency that has to be priced in for hydro is much higher than for thermal power projects. Furthermore private development invariably implies higher equity returns and higher interest costs so that the capital-intensive nature of hydro is magnified relative to its thermal competitor. For thermal projects capital charges may constitute less than half of the tariff. Therefore the consequences of using private capital are diluted; but for hydropower, where capital charges dominate annual costs, the impact of higher capital charges is much more pronounced.

High Front-End Costs. All private projects have to internalize their front-end costs. These include transaction expenses for legal, financial and due diligence services; they also include engineering costs, technical and environmental consulting fees, environmental mitigation and the developer's own expenses. These "soft costs" are generally much higher for hydro than for thermal plants (it is generally 45 percent compared with 25 to 30 percent for a typical thermal project) because of the longer time that hydro takes to prepare for private financing and its greater complexity.

Long Construction Period. Most hydro projects of any size will take four to five years to construct. This is to be compared to less than two years for a gas-fired power station, or three to four years for other types of thermal power station. The longer construction period increases the interest and equity returns during construction (considered above as a component of "soft" costs). However, the late start to the revenue stream also adds to the perception of project risk, and in turn increases the risk premium in the financing charges.
Limited Availability of Export Credit Financing. The high civil work content of most hydro schemes severely limits the availability of export credits. Generally the ECA (Export Credit Agency) element will be no more than one-third of the direct project costs, which may be only 20 percent of the total funding requirement. In contrast the majority of the finance for thermal power stations is in the form of ECA credits. The low proportion of ECA funding for hydro not only increases the financing gap, but it also makes it more difficult to raise commercial funds, which are usually piggybacked onto ECA loans. Where commercial loans are available they are often expensive and of short tenor-unless extended by Partial Guarantees.
Mismatch of Loan Tenor and Asset Life. For both thermal and hydropower projects the tenor of available ECA credits and commercial loans is considerably less than the asset life. For thermal projects, loans may extend for up to 12 years from the commissioning date, compared to an asset life of perhaps 20 years. The accelerated repayment required is reflected in higher initial tariffs than would be the case if the project were publicly financed. For hydropower projects, the effect is exacerbated, since loan tenors are the same while asset life is conventionally assumed to be 50 years or longer.
Peak and Base-load Plant. Most hydro plants are intended to operate in the medium to upper range of the load curve, while many thermal IPPs are operated at high capacity factor near base-load. In practice this makes it misleading to compare energy costs without recognizing that the value of mid-range and peak energy is usually significantly higher than baseload generation. Tariff comparisons should always be on the basis of the quality of the energy supplied, which is reflected by the position it occupies in the load-duration curve and the ancillary support services it provides.


Risk and Funding Opportunities in Indian Hydro Power Projects

 Local financing of infrastructure projects has been very limited in many developing countries because of the immature state of the domestic financial markets. Where such financing is available, interest rates are usually too high to make projects affordable. For these reasons it is likely that for the foreseeable future most private hydropower projects will continue to be financed using offshore funds, as in the case studies.

While the international banks traditionally provide the major share of offshore project debt under an ECA umbrella with maturities of up to 14 years, commercial bank loan maturities for developing country projects can be very short (3-7 years) without multilateral cover. In addition, lending banks normally expect loan principal amortization to start soon after completion of the project with equal semiannual installments. Such repayment terms, aggravated by short maturity periods, result in high debt service requirements in the initial years of operation.

The use of international capital markets to access long-term institutional funds has been explored by private power companies, and project finance bonds have been used, principally in refinancing situations. However, compared to commercial banks, familiarity with nonrecourse project finance debt is still limited among bond investors, and their appetite has been seriously blunted by the recent financial turmoil in parts of the developing world. In consequence capital markets remain wary of infrastructure project financing in emerging economies. Official support mechanisms, such as export credit insurance and multilateral guarantees, are available to reduce these problems. Their main advantage is to reduce project risks and therefore lower the required interest rate, and to reschedule
and extend the tenor of commercial debt beyond what would be available under purely commercial arrangements. This can be particularly valuable in the case of hydropower projects where the terms of the debt impact particularly heavily on tariff levels. The effect that improvement in the debt terms, through longer maturities and lower interest rates, has on required tariff levels.

Required returns on equity are closely linked to the perception of risks. Where the project is structured in a manner that passes most of risks outside the control of the sponsor to the utility or the host government, and where the legal, regulatory and institutional environment ensure the contractual rights of project financiers, the sponsor will accept lower equity returns, possibly as low as 15 percent a year. In contrast, a high risk project would probably not attract equity investors at all, or the investors will demand returns higher than 25 percent a year. Among the candidate projects, the actual returns on equity lie between these two extremes, generally averaging around 20 percent a year. There is no established pattern for risk allocation in private hydro projects and the accepted norms are still emerging, driven largely by what is required to achieve financing. However Table 10 gives a summary of the main risks and an indication of the way that they are tending to be allocated in a number of countries as the market develops.

The arrangements shown reflect the level of risk assumption that generally needs to be assumed by the public sector to make a project bankable. It will be seen that the public sector increasingly has to bear many of the risks that they did under the traditional utility-led implementation arrangements, and this is likely to remain a feature of most medium-to-large privately financed hydro developments for the foreseeable future. This obviously raises some fundamental questions regarding the rationale behind the practice of developing new hydropower stations in the private sector if the public sector still carries much of the risk

Table 4: Normal Risk Sharing Arrangements for Hydro Projects in India

Type of Risk
Risk Taker
Hydrology Risk

temporary deficits
Usually PC, but sometimes access to GV  funds. Insurable
long-term deficits
GVIUT increasingly assuming this risk. Not insurable
flood damage (construction)
Generally CO risk unless force majeure, or insurance
flood damage (permanent works)
risk. Insurable
Construction Risk

changes in quantities/cost overruns
Depends on reason. Either CO, PC or shared
unforeseen ground conditions
Increasingly borne by the UT or shared.

Partly insurable
delayed completion
Normally CO risk, but some exposure by PC
Performance Risk

equipment
Plant supplier or turnkey contractor
project performance
CO, and possibly PC
transmission
Usually the responsibility of the UT
Environmental Aspects Risk

permitting land acquisition/resettlement
PC or, by preference, UT GV/UT
Market Risk

market risk
Usually UT through take-or-pay
dispatch
Obligation and right of the UT
Force Majeure Risk

continued debt servicing
Generally obligation on the UT to maintain payments
rehabilitation costs
Principal exposure on the UT (increased tariff) and insurers
Political Risk

obligations of utility
GV obligation often backed by political risk insurance
changes in law
GV obligation often backed by political risk insurance
changes in tax
GV obligation often backed by political risk insurance
Financial Risk

increase financing costs
Generally passed to UT in the tariff, or absorbed by PC
exchange rate
Generally passed to UT, backed by GV
cost escalation
Usually reflected in tariff during construction and by limited tariff escalation thereafter
  
Indian Government Initiatives in Funding Hydro Power Projects5


Indian Government has taken a number of measures in recent years to accelerate hydropower development (of special relevance to private developers are the preparation of a shelf of well investigated projects, which could substantially reduce risk perceptions), streamlining of the clearance procedures, the provisions of open access and trading as per Electricity Act 2003, etc. Efforts are also being made to make long-term debt available. As mentioned in Section V, PFC is now giving loans to private sector hydropower projects for up to 70% of the project cost with a maximum repayment period of 20 years with a moratorium for construction period plus 6 months.23 In January 2004, MOP constituted an inter-institutional group (IIG) of FIs with an objective to expedite the financial closure of private sector power generation projects and to address last-minute issues impeding project development and financing. The members of IIG are the State Bank of India (SBI), Industrial Credit and Investment Corporation of India Limited (ICICI), Industrial Development Bank of India (IDBI), Life Insurance Corporation (LIC), PFC and Infrastructure Development Finance Company (IDFC). Since its formation, 11 projects with an aggregate capacity of 4,001.8 MW have achieved financial closure. Currently, six projects with an aggregate capacity of about 7,532 MW are under IIG’s consideration.

State-level Initiatives

The hydro-rich states like Uttaranchal, Himachal Pradesh and Sikkim have taken a number of initiatives in recent years to promote a balanced growth of public and private sector projects These are briefly discussed below.
Uttarakhand: The key features of the government of uttarakhand’s policy are (a) potential hydro projects identified by the government of Uttaranchal are advertised for international competitive bids;
(b) bids are invited over a minimum premium, payable upfront to the government of uttarakhand, at the rate of Rs.5 crores per project; (c) projects are allocated to bidders making the highest bid over and above the upfront minimum premium; (d) projects are allocated for an initial period of 45 years on a build-own-operate-and-transfer basis; (e) the developers of the project have the right to sell the power outside the state; no agency of the state will guarantee purchase of power; and (f) 12% of electricity generated is to be made available free of cost to the state during entire life of the project.

Himachal Pradesh: The key features of the policy of Himachal Pradesh are (a) selection of developer on MOU route for projects up to 100 MW and based on international competitive bidding route for projects above 100 MW; (b) no clearances from CEA for projects selected on competitive bidding route for projects costing up to Rs2,500 crores; (c) secondary energy rate to be at par with primary energy, (d) premium on peak power, and (e) 100% foreign equity permitted on the automatic approval route provided it does exceed Rs1,500 crores. Also for projects above 100 MW installed capacity, the government has reserved the right of equity participation up to 49% on a selective basis.

Sikkim: In order to expedite hydropower development through private sector participation in the State, the government of Sikkim has formed the Sikkim Power Development Corporation Ltd (SPDCL), to facilitate joint venture projects between a private power developer and the government. For SPDCL-promoted projects and as per the MOU signed between the Sikkim government and a private power developer, 12% free power would be made available to the State and the private power developer would be permitted to sell its entire balance power directly to needy states or through power trading agencies, whichever way they would like to sell. In all SPDCL-promoted joint venture projects, the government’s equity participation ranges from a minimum of 10% to a maximum of 49%.


Investment Incentives for Investors in Hydro Power Projects


Below is a summary of the incentive package for both domestic and foreign investors:


All companies will be allowed a debt-equity ratio of 4-to-1.

  • The companies will be allowed to raise a 20 percent minimum of the outlay through public issues.
  • The promoter`s contribution should be at least 11 percent of the total outlay, with a ceiling of 40 percent from Indian public financial institutions. To ensure that the private entrepreneurs bring in additional sector resources, they must obtain 60 percent of their contribution from sources other than public financial institutions.
  • For both licensee and generating companies, up to 100 percent foreign equity participation will be permitted for projects set up by foreign private investors.
  • The import of equipment for power projects by foreign investors will be permitted in cases where foreign suppliers extend concessional credit.
  • To safeguard return on investment against a possible power demand shortage, private generating companies will be allowed to sell power under a two-part tariff structure. This will be based on operational norms and optimal plant load factor (PLF)--an important indicator of the plants` operational efficiency. The PLF will be prescribed by the Central Electricity Authority (CEA), the central government`s advisor to the Department of Power on technical and economic matters.
  • The rate of depreciation will be periodically announced by the central government.

The specific incentives for the licensees are:

  • A license duration of 30 years in the first instance and subsequent renewal for 20 years, instead of 20 and 10 years, respectively, prior to the amendment;
  • a 5 percent return rate in place of the previous 2 percent above the RBI (Reserve Bank of India) rate;
  • capitalization of interest at actual cost during construction instead of the previous 1 percent above RBI rate; and
  • Special grants to meet debt redemption obligations.

Conclusion

Indian Power System has not been developed in a required manner and need hydropower potential development on fast track basis. The exorbitant fund requirement to meet the gigantic challenge cannot be met with the budgetary support of Centre/State Governments. A co-operation between government and private sector is essentially required to develop projects in a time bound manner. To facilitate smooth execution of the project it is necessary that government policy should be such that the private sector finds easy approach in handling development of hydro sites since for individual developers, tackling various agencies for seeking clearances/information would be difficult.

Need has been recognized for accelerated hydropower development in India. 80% of the existing hydro potential is still unharnessed. Hydro Power Projects are still in a state of evolution, with the process proving to be slow and expensive. Small projects will continue to be developed, but there is a danger that interest will falter in the larger projects if prospective developers continue to be faced with high upfront costs and long gestation periods, with only limited prospects of success.

Following points can be summersied as concluding comments on Scenario of Hydro Power Project financing in India
  1.   India’s power generation capacity has expanded rapidly since independence. Even so, the growth of generation could not keep up with demand. The country has a power shortage of 8% on average, and of 11% at peak times. Power supply is unreliable and of poor quality, and many rural communities have no access to electricity.
  2.  .      India’s per capita electricity consumption of 750 kWh per year is very low by international standards. Even at this level, the lack of generating capacity is not the main problem. Power in India is produced, transmitted, distributed and consumed inefficiently.
  3.    Encouragement of the further development and use of financing mechanisms that will facilitate the flow of private capital into hydro.
  4.    A large amount of investment capital is created in India. Traditionally, it has been the role of the country’s development finance institutions to make such capital available to industry and infrastructure utilities in the form of long-term loans.
  5.    Due to fundamental problems and environmental & regulatory hurdles financial institutions seem to go through a certain cycle of hope and disillusionment regarding power, and particularly hydropower, projects in India.
  6.    The multilateral development banks have completely withdrawn from directly funding hydropower projects in India due to problem of fungibility.
  7.       Only Multilateral agencies like World Bank (WB), Asian Development Bank (ADB) and Pension funds; which are called as a long term investors, are willing to finance Hydro projects having GOI guarantees.
  8.       Encourage the availability of longer-term finance at low cost from international sources, including ECAs, and through the use of credit enhancement mechanisms such as the World Bank Partial Risk and Partial Credit Guarantees;
  9.  Foster a regulatory framework that is responsive to the needs of hydro, which includes a willingness on the part of governments to assume certain project risks that cannot easily be accommodated by the private sector;
  10.  Ensure that the deregulation process recognizes that most hydro can only be financed on the basis of a long-term PPA signed with a credible offtaker and backed by a sovereign or similar guarantee;.  It will be necessary to develop Hydro Power Project structures that involve a risk-sharing formula that is both bankable and cost-effective in terms of minimizing construction costs and the resulting tariffs. 
  11.   Coordination of financial support (loans/guarantees) by the various multilateral/bilateral development banks and ECAs concerned with private hydro developments

In conclusion, Hydro Power Project sector is currently fragmented and without a clear sense of direction needs a better-coordinated approach to what is inevitably a major exercise in public-private partnership. The role of the multilateral and bilateral development banks is changing. It may have diminished in the context of thermal power generation, but it remains as crucial as ever in the hydro sector if the challenge of attracting required finance is to be adequately met.

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