Power Trading Gridlock
Fresh efforts to usher in competitive power market to face wheeling constraint
By Keshav Gautam & Madan Lamsal
With the growing energy crisis, at least the hydropower sector should be buoyant. But that is not happening and the country is facing a severe power crunch with the load shedding period extended to five hours each day and this period is expected to further increase during the coming months. Very little additional investment is flowing into this sector though there are many licenses issued for mini, micro and small hydroelectricity projects. Also the foreign investors who had come to Nepal during the last decade have not increased their investment. The American investor in the 36 MW Bhote Koshi Power Project has already divested from Nepal. Only formalities are pending for this disinvestment. And the Norwegian investor in the Khimti Power Project is making any further investment. Rather it is reported to have signed PPA in India to invest in a power project there.
It is not that the power companies are not earning profit. Even the state-owned Nepal Electricity Authority (NEA) is making a cash profit though its accounting profit may be negative. But the companies are distributing this profit as hefty dividend instead of reinvesting it.
The general tendency is to blame the security situation for this. But despite the security problems, it is possible to invest in some small projects as a number of such projects from Nepali investors are being commissioned. Therefore, given the experience that foreign investors already had in Nepal, they could have kept on investing on such small projects at least. Clearly, they were not happy with the government’s way of implementing the policies and rules that had initially attracted them.
Rent Seeking Class
Nepali investors have received license for developing various small hydropower projects, but most are not developing them. While the general perception is that they are not developing these projects because they are not getting the capital, in reality they are just sitting on the licenses and waiting for some financier/developer to come to them prepared to pay a premium for the license. Not surprisingly, most of these licenseholders are politicians.
Bundling & Unbundling
To address the problems experienced in this sector, the government is about to issue some ordinances which the workers of the state-controlled Nepal Electricity Authority (NEA) and some specialists of the electricity sector are opposing. While the representatives of the private sector independent power producers—IPPs are of the view that the principles underlying the new ordinances are valid ones, they say the details of the provisions are not sufficient.
The crux of the matter is the provision to unbundle the NEA into separate entities for power generation, transmission, distribution and engineering services. While the workers are criticising this step for the obvious vested interest that it will reduce their union strength, some experts of the power sector are critical of it on the grounds that it is being introduced on the coaxing of the international donors whereas it was the same donors who had earlier coaxed the government to bundle the separate power companies and regulatory bodies of the past into a single NEA. The IPPs say the unbundling is a must in order to create a market mechanism to govern the electricity sector. Vesting so much regulatory powers with the same agency that is also controlling generation and distribution of power is simply illogical, they say.
But the idea of market mechanism in electricity is not well-marketed in Nepal and is probably the reason why the idea of unbundling is getting tough opposition (see box for in page 31 how such a market operates).
Faulty Mindset
Though exactly what the proposed laws contain as the new provisions is still a secret, the IPPs say even the previous law wasn’t that bad. That is why some foreign investors had come and invested in Nepal’s hydropower sector. But the implementation of the law was not according to the spirit. It was spoiled by the bureaucracy, they claim.
As one example of the wrong implementation of the spirit of the law, the IPP say the Department of Electricity Development (DED) was not developed as a powerful agency. Though the department was designated as the single window from where the IPPs were supposed to receive all the necessary services from the government, it was not so in practice. The recommendations of the DED were rejected by the senior clerks of the revenue offices.
Nord Pool: Model of Electricity Market
The Nordic electricity market (Nord Pool) is the first multi-national (regional) electricity market in the world. It is globally regarded as a model market. Senior vice-president of Nord Pool Consulting AS, Dr Per Christer Lund, explains the working of Nord Pool:
Back in the 1950s, Norway consisted of a number of municipalities that were loosely interconnected. Each municipality was responsible for its own electricity generation. In 1991 during the political discussions on introducing a new Electricity Act it was decided to set up an electricity market so that the municipalities could trade power. At the time of deregulation in 1991, we liberalised generation. Also distribution and retail prices is deregulated so that there is competition. In 1996 Sweden joined in, and by 2000 the entire Nordic and Scandinavian countries except Iceland became a part of this market.
Almost 100 per cent of Norway’s power is hydro. So in winter when the water is frozen, there is no generation. During those months we import electricity from the surrounding countries: Denmark, Finland Sweden, Germany. The power goes into the common market. So we are capacity surplus but energy deficit.
The transmission capacity is partly owned by municipal power companies and partly by the state-owned grid company. The tariff is fixed. So one can buy from any generator but the transmission tariff is the same.
The price of electricity consists of three components. The transmission tariff, fixed by the government through the regulator and the cost of energy, not fixed at all, constitutes a third each of the price. And the remaining third is taxes. The cost of energy varies and it is here that the generators compete.
You have a number of options for procuring and selling power. You can sell it on a long-term basis, or you can decide one day ahead what you want to sell the next day in the Day Ahead Market. That is the Nord Pool spot market. I am willing to sell so much of electricity at a given price for each hour, the next day.
You have the price quotes on an hourly basis. There are 24 quotes in a day. You may have different prices at different levels. When the supply and demand match, it becomes the market clearing price. And of course this price varies from one hour to another.
Power market and financial market
Prices can be very volatile, very uncertain. To reduce risks, market participants enter into financial contracts that hedge risks, with derivative products. So Nord Pool operates two different spot markets: one is the typical spot market for power and another for the financial derivatives. These are traded on Nord Pool. The power spot market is regulated by the electricity regulator and the financial market by the security regulator. Contracts can be between any one.
However, households do not actually enter into the picture. It is distributors, industrial companies, or traders who want to arbitrage on electricity prices. There are about 100 retailers and they are all listed on the internet. I can log on to the net and check their prices for electricity on a daily basis and buy from any of them. Of course, I can’t change my retailer every day; but it’s possible to change it on a weekly basis. The contracts can be for a month; you can have a peak and off-peak contract. There are various types of contracts used by retailers to attract customers.
The physical generation of power is about 380 terrawatt hours which is 380 million megawatt hours. The amount of electricity traded on the derivatives market is about 2,000 million megawatt hours. That is about seven times more than the power generated. So the peak volume of trade is on the derivatives market.
Derivatives contract are typically for delivering one MW for one week at a fixed price. The pay off is the difference between the contract price and the underlying actual price. The derivatives contract tends to be traded at the price the market players believe will be the spot market price.
A national power market would facilitate the exchange of surplus power from one region to a deficit region. It would ensure that the transmission channels are efficiently utilised and it will help in price discovery. If the generators charge high prices the consumers won’t buy. There will be no deal.
(Courtesy: The Economic Times)
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The new ordinances being promulgated are to implement the new Hydropower Policy of 2001 which was brought out after extensive interactions with the private sector. But at the last stage, the private sector was not consulted and the policy came out without incorporating some crucial suggestions of the private sector. For example, though it was agreed with the private sector that there would be a 15-year tax holiday and uniform royalty for all types of hydropower projects, these were changed in the final document that was announced. As the new ordinances are to implement the same policies, they are not going to contain these facilities. Hence the dissatisfaction of IPPs.
As the focus of the new policy is to attract further investment in the hydropower sector and regulate the electricity sector, the Nepal Electricity Regulation Commission Ordinance will be promulgated simultaneously with the Electricity Ordinance. The next focus is on unbundling the NEA. The internal homework was started in the NEA for this purpose about three years ago. As a result, generation, transmission, distribution and engineering divisions have already been set up in NEA which can easily be converted into separate companies soon after the Ordinances are issued. However, there is a catch. All four entities will be reporting to the same board. The private sector is opposed to that idea as it would essentially retain the present situation in the market.
To reach the ultimate goal of multiple buyers and sellers of electricity, certain things have to be done first. The major one is commercialisation of NEA’s different entities. The second is to take out the transmission line of electricity from NEA’s control and ensure that everyone has open and non-discriminatory access to it. But for this the NEA Act too has to be amended. However, that is being delayed.
Risks & Returns
Nepal’s current situation has increased the risks level for foreign investors. Still when compared to the opportunities, these risks are less, say the IPPs. “The logic is that though the risks are high, many of them can be hedged or insured,” says Dr. Sandip Shah, President of the Independent Power Producers of Nepal (IPPAN). Though most of the existing power projects are not insured against various risks, the insurance companies are capable of providing such covers.
When foreign investors come to a country they look at a number of things. First: the availability of raw material, in this case water, which is available in plenty due to the perennial rivers. And the topography offers opportunity to develop power projects in so many locations.
Second is the labour law. And the new labour law that is about to be promulgated soon is said to be much conducive for investment than the existing one.
Third is the market. Though the market for power within Nepal is considered small, the fast growing Indian economy offers the market opportunity. But there is a caveat. To tap the Indian market, there has to be robust power transmission line between the two countries and a power trading agreement has to be concluded. Unfortunately, power is something that cannot be smuggled across taking advantage of the open border.
Then comes the financing. This is another area where the problems lies, say the IPPs. Nepali banks are not allowed project financing under the existing guidelines of the central bank. Even collateral financing is a problem, they say, as the hydroelectricity is still not accorded the priority sector status. Though the list of the priority sector includes energy, it covers all the energy related industries including the production of bulbs and switches. Thus the list is not specific to hydroelectricity. And the other problem is with the single borrower limit. Even five or six banks forming a consortium cannot finance more than about Rs. 100 million for a project, which is peanut for even a medium sized hydropower project. Therefore, some IPPs are now planning to issue debentures targeting the remittances. However, as the sustainability of remittances is suspect, it may not be enough to develop power projects to meet the annual growth projection of the electricity demand.
That leaves the international market as the only option to raise the finance. But due to the country risk perception about Nepal in the international market and the lack of independent country rating about Nepal, there needs to be either government guarantee or guarantee from the buyer to attract the investor. There is a single buyer right now (NEA) but no international lender would be ready to provide the finance against the guarantee of NEA when it looks at NEA’s balance sheet.
Therefore, the next option is tapping the capital and money market of India. And this possibility is fortunately real. Shah says Indian bankers are interested in investing in Nepal’s hydropower projects. Though there are certain restrictions from the Reserve Bank of India (RBI) on investing abroad, that is not a big issue, he says, citing that a lot of Indian investment is going to China or other countries and RBI has not posed hurdles in that.
Moreover, though the country has no international credit rating, project rating can be done by Indian rating agencies like CRISIL so that finance can be raised from the Indian capital market too.
The next issue of concern for foreign investors is currency conversion. But again, as Shah says, there has been no problem for repatriation of profit from Nepal.
These are solid points in favour of Nepal, he concludes. Nepal can market itself among the potential foreign investors by making use of these facts.
Export or Domestic Consumption
The market issue is one of the major points of debate in Nepal’s hydroelectricity sector. While some people view that as power is a raw material and no country can hope to develop itself by exporting raw material only and thus the idea of exporting power is not in the long-run interest of the country, the others give example of Bhutan which has recorded a tremendous increase in its per capita income by exporting power.
Still more important is the logic that the power price will be lower if the project is developed with a view to export to India. The reason is the load factor. The peaking power demand in India is during the summer when the Nepali rivers have more water flow and power demand in Nepal is low. If the project is developed for the local market only, it has to be designed at lower capacity keeping in mind the lower flow of water in those rivers during the winter when the local market has peaking energy demand. Thus the turnover of the project will be higher if the target market is India. That reduces the average unit cost of electricity. Therefore, if this strategy is adopted the techno-economically feasible power generation capacity will be much higher than 44,000 MW that is presently estimated, says Gyanendra Lal Pradhan, Chairman of the executive committee of Butwal Power Company, which owns a couple of hydropower projects and is developing a number of others.
However, power export should be through the national grid and not directly from the power house, he suggests. If the export is through the national grid, the country will be able to use the power it needs and the excess can be exported while at the same time it will be possible to import it when there is deficit in the country’s generation. If the export is straight from the power house, Nepal will not be able to use power generated from such project, says Pradhan.
But for the export market to be realised, there has to be a power trading agreement between the two countries. Presently Nepal has a power exchange agreement and that should be replaced by a power trading agreement. Though such an agreement is already finalised between the two countries, it is still pending as it has not been ratified by the Nepali Parliament. However, the private sector people say, such agreement should not need parliamentary ratification, therefore the delay is being caused for no reason. The constitution requires the ratification for treaties related with sharing water, not for the treaty to sell the electricity which is like any other product, such as vegetable ghee or carpet.
Wheeling problem
Whether decision makers will listen to that logic is still doubtful. However, even if they do, or even if the parliament is reconvened and the treaty is ratified, Nepal-India power trade will still face a roadblock. The transmission line between the countries does not have the capacity to wheel the projected load of power trade.
The wheeling problem is present not just for export. So far, each new power project has its own transmission line to connect it to the national power grid. As the transmission line cost adds to the total project cost, the cost of the power produced tends to be higher than what it should be. Moreover, the present 132 KV lines are not sufficient for the system and thus they are causing a lot of technical leakage of the power transmitted. The suggestion of the private sector is to have 250 KV lines connecting the potential power project sites or river basins up to the Indian border close to the Indian power centres. If this happens and the national transmission grid is made easily accessible to all as provided for in the proposed ordinances, potential projects would be picked up by interested developers much faster. But the NEA is still stretching 132 KV lines. This is sheer waste of resources, say the IPPs.
But will the proposed ordinances really help in expanding and upgrading the power transport network is still anybody’s guess.
