Absolutely needed

It is the duty of government to provide basic infrastructures like electricity to its citizens. When government struggles to do so and invites private investors to join hands, it is absolutely necessary to reward them properly. Expectation of healthy profits by private sector is very natural.

The prevailing PPA rate, however, is not that attractive. It does not offer even reasonable profits. To find out the required PPA rates, let's do some comparisons first.

NRs. 3.90 per kWh during wet season and NRs. 5.52 per kWh during dry season were offered in the late nineties. The current PPA rates are NRs. 4.80 per kWh during wet season and NRs. 8.40 per kWh during dry season. 

From late nineties to now, the prices of construction materials like cement, steel, sand, aggregate and so on are more than double. The wage rate, price of land and fuel have increased exponentially. Anyone in this country with basic knowledge of construction business knows the reality. In addition, the USD exchange rate has already crossed 100 Rupees mark.  

From this standpoint, the current PPA rate is peanuts. 

One may argue that NEA had a policy to buy energy from the projects designed at Q65% then. Now it is Q40%. Project generates more energy in the latter case while the size of project structures and E&M will also increase to accommodate the increasing design discharge (installed capacity will be higher). Although the benefit obtained by such change in design parameter outweighs the increasing cost stream, it is not that significant.

The recently completed projects can be taken as instances. Forget about the returns to their investors, many companies are incurring losses every year.

One of the main reasons for the low return is the mismatch between the completion cost and the PPA rates. The cost constructing hydropower projects these days is skyrocketing.

Details	Lower Modi-1	Naugarh gad	Siuri Khola	Ankhu Khola
MW	9.9	8.5	5	8.4
COD	2012	2015	2012	2013
Cost per MW in crores	21.4	16.5	18.5	28

*Since private sector is mainly involved in small hydropower project, I mentioned projects up to 10 MW only. 

By analyzing the recent per MW cost of the completed projects and the energy produced by them, I did a calculation to find out the minimum required PPA rate. Certainly, I have made some logical assumptions.

Assumptions and justifications

a) Per MW cost = NRs. 21.5 crores 

The average cost per MW of the recently completed (above mentioned) projects is NRs. 21.1 crores. For analysis purpose, I have take NRs. 21.5 crores. 

b) PLF = 60% 

The typical nature of Nepali hydropower projects designed at Q40%

c) Expected Equity IRR = 20 percent. This is the minimum threshold for any investor in the present context.

d) All other applicable parameters and currently used model for hydropower construction are applied. You can view the detail assumptions and parameters here. 

Findings

My finding suggests that the PPA rates should be NRs. 7.07 per kWh (flat rate) to ensure the minimum expected EIRR assuming the current offered incentives. (detail calculation can be found here). This means, increment of 33.40 percent in the existing PPA rates. 

Justifications

a) Still the proposed PPA rate is below the average selling price of NEA, i.e. NRs. 8.04 per unit.

b) This PPA rate comes closer to what other countries are offering. For instance, Sri Lanka offers roughly about NRs. 12.32 per kWh (flat here). (Although our PPA rate still seems significantly low, it is necessary to understand other factors. Average PLF in Sri Lanka is very low as compared to Nepal, i.e., 40% in Sri Lanka)

In addition to 33.40 percent increment in the existing PPA rates, the following things are absolutely needed for private sector.

1) Continuation of “Take or Pay” PPA:- No investor will invest without this clause. It is simple as that.

2) 45% compensation:- The standard PPA allows developers to claim only 5 percent of the revenue loss if NEA fails to construct the transmission line on time. The compensation amount is not enough to pay the bank's interest. Also, why should a developer suffer when NEA fails to perform its duty? This sort of irrational clause is principally wrong in the world of business. This has to be increased to at least 45% like in ‘super six projects’. 

3) At least 9 escalations:- To mitigate the soaring inflation and the floating interest offered by domestic banks, at least 9 compounded escalation is required like NEA owned projects through its subsidiary companies. 

4) In case of strikes:- You cannot make private investor to suffer from their (politicians) stupid strikes. Developer should be able to claim compensations in case of strikes like Upper Karnali Hydropower Project (900 MW).

5) 100 percent VAT exempt:- Currently, NRs. 50 lakhs per MW is offered by the government as VAT subsidy. This should be 100 percent.