Hydropower Pricing in Nepal

Indra Kumar maharjan

indramaharjan@gmail.com
 Hydropower Pricing in Nepal
Indra Kumar Maharjan
indramaharjan@gmail.com

Introduction

Energy is an essential commodity for the users and the pricing this energy is a very complex
issue. It can be found in books that price is determined in a competitive market in the long
run and supply and demand in the short run. Also, cost of producing it plays a crucial role in
determining its price. In hydropower projects the ownership also governs the price charged
by the utility to the final consumer i.e. Tariff.

The private sector can only consider the unit cost of generation including operation and
maintenance cost along with some profit based on market condition and government
policies for setting up the tariff. On the other hand the government sector needs to consider
social issues and consumers’ purchasing power along with other benefits for setting up the
tariff.

Looking at the global electricity market, two types of pricing methods have been used. In the
past electricity prices were average-cost based. The tariff level was determined from financial
targets set by the government, regulatory body, or the utility itself, using historic costs from
the utility’s accounting books. The tariff structure ensured each consumer paid his own share
of the average cost of supply, e.g. as determined by how much of the system capacity and
fuel each consumer class used on average. But these pricing gives less information about
future financial resources needed for increasing electricity requirements or new consumers.
Marginal-cost pricing overcomes this important defect.

In marginal-cost pricing past or ‘sunk’ costs are not significant; only uncommitted costs incurred
because of additional demands provide the correct ‘signal’ to consumers. These are the
investment and running costs incurred when consumers demand more. Marginal-costs are
usually related to extra increment of 1 kW or 1 kWh of electricity demand. Both types of
pricing have the same tariff components but different numerical values. The tariff
components are namely;

1. Capacity (kW) charge, related to system peak demand.

2. Management, operating and maintenance charges
3. Fuel (kWh) charges, related to system fuel costs
4. Connection and metering charges

Capacity charge plus the fixed part of management, operating and maintenance charge are
directly related to capacity or kW. Similarly fuel charges and variable part of management,
operating and maintenance charge are ‘energy related’. Connection and metering charges is
consumer related. Marginal cost tariffs are calculated according to the same consumer classes
as average-cost tariffs, basically residential, commercial and industrial.

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In conclusion we can say that the pricing of the electricity is done with consideration of
capacity, energy and consumer related charges. Load management and spot pricing must be done
in accordance with marginal-cost tariffs to achieve the financial goals.

Marginal- cost tariffs can be costly to administer and need to have a consumer response.
They are most suited to direct application for the developed countries for large consumers.
In developing countries and small consumers, the capacity charge is usually incorporated
into the energy charges to make the tariff easier to understand and implement.

In poor countries there may be a low ‘lifeline’ price for special consumers using very little
electricity but who would be unable to sustain life without that small quantity. In Nepal, 80
rupees is charged for 20 units.

For effective tariff making, the contribution from the three disciplines namely commercial,
accounting and economist approach should be considered.

Another important point that must be remembered is that electricity is a ‘premium’ fuel.
Therefore conserving and optimizing usage of energy applies especially to electricity.
Because electricity cannot be stored, except at prodigious cost, and in order to produce and
use it more efficiently it is important to improve the overall load factor of the system and so
optimize generating station production through load management. Load management results
in lower costs to the utility which can be reflected in tariffs charged to consumers. A tariff
encouraging the continuous use of system should be developed. Load management can be
effectively done through appropriate pricing of electricity.

Tariffs with some form of spot pricing have been in use for some time. Spot pricing has been
offered as a surcharge during periods of likely plant shortage. Spot pricing established for the
first time a true ‘market place’ enabling consumers and producers to adjust demand and
price simultaneously. It is workable whether a utility is publicly or privately owned, centrally
or locally owned/controlled.

Hydropower pricing in Nepal

The price of electricity is fixed by Tariff Fixation Committee (TFC) formed under the
Electricity Act 2049BS (1990 AD). According to the section 17 in the act, it is said that TFC
shall fix the electricity tariff and other charges on the basis of the rate of depreciation,
reasonable profit, mode of operation of the plant, changes in consumer’s price index, royalty
etc. It is also said that TFC shall categorize the type of consumer and fix the tariff
accordingly for each category.

Similarly in section 18, it is mentioned that for those generators with isolated distribution
shall be entitled to fix the electricity tariff and other charges for the electricity distributed. It
is also mentioned that the tariff may be so fixed that all investments made on electricity
generation, transmission or distribution is paid back in average of 25 years by deducting the
depreciation cost and a dividend of 25% on share capital earned.

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Similarly in section 21, it is written that the rate of electricity purchased from independent
power producers (IPP) shall be determined on the basis of fixed percentage of avoided cost
or an addition to the generation cost or fixed percentage of average tariff of Nepal
Electricity Authority.

With these provisions in hand we have three methods of tariff fixation namely; Cost plus
Pricing, Avoided Cost Pricing and Fixed percentage of retail tariff.

Cost plus pricing is the simplest way of pricing the electricity. In this approach the
generator fixes the price of electricity based on its average cost of generation plus a certain
net profit margin. Hence the price largely depends upon the cost to produce electricity.
Hydropower pricing is basically a function of the costs of the hydropower project. Costs of a
hydropower project consists of four parts- associated costs, induced costs, external costs and
opportunity cost of water. Costs of a hydropower project occur during two distinct time
frames; construction and operation phase. The costs that are associated with the need to
produce hydropower such as preparatory works, civil works, electrical and mechanical
equipment, transmission and substation, engineering, management and administration and
operation and maintenance cost comes under associated cost. The costs needed to mitigate
adverse impacts produced by the project during the construction phase to the society; nature
and environment are termed as induced cost. The costs occurred for construction of
infrastructure like roads, rural electrification, transmission lines that may not be directly
linked to the projects are considered as external cost. Generally no external costs occur during
operation phase except for watershed management. Beside all this a cost assigned for the
forgone opportunity for other uses of water as irrigation is taken as opportunity cost. Since the
water is not consumed by hydropower plant, this is often neglected. Along with all these
cost, a natural resource use cost called Royalty is also charged by the government. Two types
of royalty have been defined by Hydropower Development Policy 2001 namely Capacity and
Energy Royalty based on capacity and energy generated respectively.

The cost of the hydropower project can be reduced to some extent with the implementation
of Multi-purpose project. This means that the same project can be used for irrigation, flood
control, navigation and recreation and hydropower. The costs occurred is shared by the
different projects based on the benefits and costs occurred or costs only. But benefit
assessment is considered as the complex process with lots of discrepancy as it is very
difficult to quantify the benefits. Benefits may be of direct type such as capacity benefits or
indirect type as land enhancement benefits and secondary benefits as employment benefits,
public benefits and disbenefits. Distribution of benefits is also a complex process.

Avoided cost is defined as the cost of producing the power through the next alternative
technology like thermal whose cost has been avoided. This type of cost is not linked with
production efficiency and is not related to the actual cost of production. This is basically
based on the cost that the buyer will avoid and is difficult to estimate in context of cross
border trade. The avoided cost price is usually used to reap the net benefit from
technological change in hydropower generation.

Fixed percentage of retail tariff approach ignores actual cost of production like the cost
occurred in generation, transmission, distribution etc. It sets a certain percentage of retail

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tariffs and fixes the price. This is usually implemented in setting price for electricity
purchased from IPP’s by NEA.

The tariff in Nepal is very high and dull. The main reason for such high tariff in Nepal is
because of high per unit (kW) cost of hydro-power plants that are developed in the country (i.e.,
high cost of supply), especially the larger ones with public funding. This high cost of supply
of electricity is mainly due to the need for importing construction materials (e.g., steel) and
equipment, the inability of the local contractors to take up significant construction work
volume and the inability to mobilize local finances and thus the reliance on hard currency
loans. Furthermore, large hydro-power plants in Nepal are implemented under bilateral or
multilateral donor aid with the preconditions (tied aid) that the generating equipment, accessories
and the main contractor be from the donor countries. Small hydro-power plants are more
cost effective due to use of local finances and local contractors in larger proportion.

Another reason for high tariff is due to ‘cost-plus pricing’ approach used to fix the tariff. Cost-
plus pricing is good for the developers as it guarantees a minimum profit but it does not
encourage reduction in generation cost and thus the tariff. It may even lead to power
generation with high costs for higher profit and vice versa, as profit margin is estimated as a
certain percentage of the total costs.

Hence the focus should be to ensure that the consumer end tariff is affordable, and to
continue to increase supply of electricity to the general population. The tariff should be
smart and sensitive and should also contribute to load management. The country should
come out of the cost plus pricing mindset and to develop a mechanism which rewards
efficiency. This will only contribute to sensitive and smart tariff for any category of
consumers and developers.

Reference

 Berrie, T. W. Power System Economics, IEE Power Engineering Series, ISBN 0-

906048-88-5
 Shrestha, Ratna Sansar. Financing and Economics of Power Systems Lecture notes,
Kathmandu University.
 Gautam, Upendra and Karki, Ajoy. Hydropower Pricing in Nepal, Developing a
Perspective, Jalsrot Vikas Sanstha (JVS), Anmanager, Kathmandu, Nepal, 2004
 Karki, Ajoy and Shrestha, B. ‘Micro-hydropower in Nepal: Access to Electricity for
Isolated Rural Population in the Hills and Mountains’, International Energy Journal,
Special Issue, vol. 3, No.2, December 2002.