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Lessons to be Learned – Hydropower Industry

With more than 6,000 MW PPA concluded projects, the hydropower sector is certainly going to be
the next big thing in Nepal. The predetermined revenue for 30 years of operation along with the
successful completion of projects by the pioneer hydropower companies has opened up an avenue
for hydropower investment. One of the main reasons for the growing interest in this sector is the
fixed return. Unlike other businesses where future earning is hard to predict, hydropower revenue is
almost guaranteed.

The surge in hydropower development is also due to the fact that the Government of Nepal has
prioritized the hydropower sector. Nepal is planning to achieve a double-digit economic growth
within the next decade, and to achieve the prosperity target, the energy sector will have a leading
role to play.

A lot of new policies have been introduced by Government of Nepal recently in order to attract
investment such as introduction of PPA rates for PRoR & storage projects, PPA rate determination
mechanism for projects over 100 MW capacity through negotiations and revision of tariffs for RoR
projects where projects are now entitled to get 6 months dry energy rate after meeting certain
conditions as opposed to 4 months dry rate for all RoR projects.

Although the revenue prospect of hydropower is fairly secured, financial arrangement is still like a
mountain to climb. Banks generally shy away from making investment decisions because of the
longer gestation period and so many perceived risks associated during construction/generation of
hydropower projects.

Things are about to change now. Commercial banks have to invest 10 percent of the total loan in the
energy sector by mid-July 2024, according to monetary policy 2020/21. This compulsory requirement
is almost two times its current exposure of about 5%. While this provision has given some reliefs to
developers, some banks are treating it as an additional burden.

The experience of banks in hydropower is not so good. Cost manipulation, cost and time overrun,
fake equity claim, selection of in-house contractor/supplier, inferior structures, and low energy
generation in actual compared to the contract energy are some bad experiences faced by the banks.
These problems are so acute in some projects that few banks are now struggling to recoup their
interest and principal. More than 25 hydropower projects developed by independent power
producers are ‘sick’ as they have either failed to service their debts or are reeling under financial
crisis, according to Independent Power Producers’ Association, Nepal (IPPAN).

With the introduction of a new compulsory lending provision, commercial banks are now in pressure
to increase their exposure although hydropower is not their cup of tea. We have already seen the
effect of this provision. Banks with lower base rates are now encouraging developers to swap loans
from other banks which have a higher base rate. However, swapping hydro loans will not be
sufficient to meet the overall target of commercial banks. There is no choice but to increase the
hydro lending in new projects.

Learning from the past experiences is the way to go. The above mentioned barriers faced by the
bank can largely be reduced if banks adopt the right approach. One way is to appoint the
consultants, both technical and financial, during construction. Hydropower projects are exposed to
more risks during construction as compared to operational projects.

Banks do hire third party technical and financial consultants during construction. However, the
remuneration of those consultants are paid by the developers. When the developers pay the

consultants, it is quite obvious that the consultants will write reports/recommendations by
protecting the interest of developers.

Banks are missing the fundamental issues here. Typically, 70 to 75 percent of the total project cost is
financed by banks and financial institutions. Banks need consultants who see the projects from the
banks’ eyes, not the developers, and this will only happen if banks pay the consultant fees.
Having consultants working for banks will be beneficial to tighten the screws. Cost manipulation and
fake equity injections will be largely minimized. Also, the quality of work will be assured since the
technical consultants will verify the lab test results and check if the construction is done as per the
required standards.

The sooner the banks realize the need for consultants to safeguard their investment, the better.
Otherwise, the same story will continue. Save now and suffer later.

Author: Santosh Thapa

Santosh Thapa is the engagement manager at Invest & Infra. He is a seasoned business and finance
consultant with more than 12 years of experience, including significant experience in hydropower,
transport and capital markets. He has extensive experience in financial analysis, feasibility study,
capital raising, negotiation, due diligence, etc for developers in more than two dozen projects. He
holds an MBA in University of Wales, United Kingdom. He is a thought leader and regularly blogs on
issues related to hydropower, foreign investment, policies, etc.

Author: santosh thapa

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