HYDROPOWER IN NEPAL FROM DEVELOPERS' AND GENERAL INVESTORS' PERSPECTIVE.

As we all know, Nepal has immense opportunity in hydropower generation. So it is pointless to mention the hydro potential every now on then when it is known to all of us. In my previous post, I mentioned the barriers related to hydropower generation. I largely blamed the existing PPA rates. (Why hydropower development is slow in Nepal despite huge potential?) 



In this post, I will write something from developers’ and general investors’ perspective. And to me, hydropower is going to be a next disaster for general investors if a "Regulatory Body" is not established soon. This is what I speculate in near future. And there are plenty of valid reasons for my argument.

Hydropower is emerging as a game changer in Nepalese economy. A lot of things have been said in this regard. No other industry in Nepal is so promising other than hydropower. So, it is obvious for an ordinary citizen to be interested in investing their hard earned money in hydropower. The trust in hydropower companies is also due to the fact that the established hydropower companies are distributing the guaranteed return. The higher performance and valuation of listed hydropower companies in Nepal Stock Exchange (NEPSE) is the basis for understanding the return prospect.

Having said that; constructing hydropower in Nepal has become an expensive affair these days. 

Cost required to reach PPA Level
Normally, it takes about three to five years of licensing before actual construction takes place. The survey license fee is not that cheap. The annual applicable fees for the survey license are as follows.

1 to 5 MW                                           NRs. 1 million                         

5 to 10 MW                                         NRs. 2 million

10 to 25 MW                                       NRs. 3 million

25 to 100 MW                                     NRs. 4 million

100 MW to 500 MW                           NRs. 5 million

More than 500 MW                             NRs. 6 million

Then, there are fees related to PPA, Grid Connection, Consultant Fees, Admin expenses, Staff expenses, travelling expenses and so on. On top of that, there are lots of agencies in Nepal that need to be taken care of.

In an average, NRs. 2 to NRs. 5 million per MW is needed to bring a project to PPA level. 

Now what happens?
As soon as the project reaches to PPA level, the developer will have only three options. 1) Outright sale to foreign investors 2) Drop the project completely, and 3) Construct the project anyway.

The first option is never going to happen in the present situation. This is because Government of Nepal has not been able to provide assurance to foreign investors (Dollar PPA and Sovereign Guarantee). 

The second option is not possible for many developers as certain amount of money is already involved. Thus, the developers will be left with only option, i.e."Construct the project anyway" 

However, it is not an easy task to construct a project. Let's find out the challenges developers have to face. 

1) Debt Arrangement.
Arranging funds for constructing hydropower is never an easy task. Hydropower in Nepal is constructed in 30:70 model in general. This means, 30 percent of the total project cost will be equity investment and the balance 70 percent will be raised through bank financing. 

Unfortunately, the total banking capacity of Nepal has the ability to finance not more than 300 MW (in total at best) at present. In addition, there are plenty of pipeline projects competing for the financial closure. Financing is one of the main hurdles.

Project financing in Nepal is relatively a new concept. Matching funds are problematic. Since our Nepalese banks collect major deposits for short periods of one to two years only, it is very difficult for them to finance a fixed rate for entire loan tenure of 10 to 15 years for hydropower projects. Therefore, floating interest rates are offered to minimize the risk on the part of the financiers, which leaves the developer with a higher risk. 

2) Banks will charge a hefty interest rate and do the safe landing
Bank is generally safe in regards to hydro lending. The first reason is because of the fundamental difference in risk between debt and equity. 

Second, the project financing concept is relatively new concept as I said earlier. No banks in Nepal will finance the projects just by looking how financially viable the project is. Banks will always look for the Net Worth of the developers. They ask Personal Guarantee (PG) covering the entire loan amount backed by the Net Worth (This is the NRB's requirement). No matter how good the project is or how well experienced the developing team is, project will not get bank financing unless there is enough  PG to cover the entire loan backed by the Net Worth (even if the developers have required equity). This is a huge risk for developers.

The third reason is the clause no 37 (RIGHT ASSIGNMENT OF AGREEMENT) in the PPA document. It states, "Nepal Electricity Authority NEA may transfer the rights, claims or obligation of the developing company to the Bank or Financial Institution providing loan to the Company, makes request to NEA showing the reason that the Company has failed in the fulfilling the obligation toward the Bank or the Financial Institution under the Loan Agreement". Further it says that the Bank and Financial institution can transfer the rights, claims or obligation of the Company to the third person or organization or any corporate. Also, NEA may make payment of the loan, interest or any other obligation from the amount payable to the Company, to the lead Bank or the Financial Institution directly if such request is made by such Banks or Financial Institution. 

This will give relief to the lending institutions. Also, the technical nature (Q40%) and the existing PPA rates in Nepal somehow support the interest and principal payment. Around 60 to 90 percent of the total revenue will be enough to pay the bank/financial institution’s installments (principal plus interest). And, when I say interest rate, it is quite huge. Banks charges interest rate as high as high 14% which makes many hydropower projects unable to distribute dividends to shareholders at all. 

3) Arrangement of equity

Banks ask developers to inject the required equity at first (in some case 100 percent of the total equity) in order to get debt funding (70 percent of the total project cost).

There is an option of IPO for the developers which is restricted to 49% of the total issued capital. This means, developers have to put at least 51% of the total equity upfront from their pocket.

Many developers can not even invest the required equity. Hence, the developers will seek for other promoters. (Ordinary investors should take developers’ claim about the profitability of hydropower with a pinch of salt. :p). The real developers will just act as a fund manager. In return, they will charge sweat equity.

Developers' intention

Above are the hurdles for arranging the fund for constructing project. Developers have to go through so many challenges such as

i) They have to compete with so many developers for the financial closure since Nepali banks have a limited credit capacity
ii) Banks charge insanely high and floating interest rate.
iii) Banks require Personal Guarantee (PG) which puts developers at a huge risk
iv) In many cases, banks require 100 percent upfront equity. 

In addition to above challenges, we are all aware of local problems, political risk, foreign exchange risk, labour problems and so on during construction of the project. 

In short, the developers have to go through so many uncertainties and risks. On top of that, developers know that there is no one to look after them due to lack of regulatory body in hydropower construction. 

This will encourage developers to throw out everything to get their sweat, blood and money back with a premium. Short term benefits will allure the developers rather than attaining the long term goals. The amount the developers siphon off during construction is quite significant. It it so huge that the profitability of the project suffers badly.

So I, personally, believe that the hype hydropower projects have created in Nepalese market will suffer ultimately if concerned authorities do not take this matter seriously. General investors will eventually realize that they are in a sinking ship. By the time general investors know the fact; the developers will get away with a huge chunk of shares/benefits.

In order to prevent such situation, I believe there must be a regulatory body. This is the first and foremost requirement. Without regulatory body, it is in the hands of developers to manipulate the project cost according to their liking. Therefore, the regulatory body should intervene the procurement of materials (especially steel and cement), Hydro-mechanical equipment, Electro-mechanical equipment and overall management of the project. This will ensure transparency. 

In addition, general investors should do their homework regarding the management and technical aspect of the projects before making an investment. Herd mentality that exists among Nepali investors should be stopped right away.