Turnitin Originality Report

Financing Hydel Power Projects by Mr. Ahad Khan Cheema

From Individual Research Paper (21st SMC)

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ID: 818178060

Word Count: 8532

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John Briscoe. "The Financing of Hydropower, Irrigation and Water Supply Infrastructure in
Developing Countries", International Journal of Water Resources Development, 12/1/1999
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paper text:
IRP FIRST DRAFT FINANCING HYDEL POWER PROJECTS IN PAKISTAN -
POTENTIAL AND CHALLENGES Presented by: Ahad Khan Cheema, PAS Faculty Advisor:
Mr. Ahmar Elahi INTRODUCTION Statement of the Problem Pakistan is one of few countries
that possess large hydroelectric (hydel) potential a coveted form of energy due to its
insignificant generation cost and long life. It is estimated that more than 40,000 MW of power
generation capacity can be installed on our water resources. Yet, despite energy shortage,
partially driven by unsustainable generation costs using imported fossil fuels, only 15% of this
hydroelectric potential has been harnessed so far. In order to exploit Pakistans hydel resources
productively, huge investments are needed. The current state of our economic development does
not easily allow us the fiscal space in our public budgets to undertake this huge enterprise,
despite the clear and obvious benefits of hydroelectric power generation. Certainly, with the
given tax structure and tax-to-Gross Domestic Product (GDP), enough public financing is not
available to finance all of the available large hydroelectric potential a desirable goal keeping in
view that fossil fuel import will continue to put huge burden on Pakistans balance of trade. In an
attempt to replicate the relative success of attracting private capital to thermal power generation
under various independent power producer policies, the Government of Pakistan has made

several attempts to 2attract overseas investment, and to facilitate tapping the domestic

capital market to raise local financing for power projects. Steps such as

offering 2internationally competitive terms, an attractive framework for domestic

investors, simplification of procedures, and steps to create and encourage a domestic

corporate debt securities market have been taken but limited response has been noted. In

fact, prior to the China-Pakistan Economic Corridor (CPEC), any discussion of non-public
financing of large dams had been conspicuously absent. The absence of private investment on
hydropower, despite clear knowledge of its fundamental economic benefits, is now a well-
recognised global problem. Private financing in the power sector has established a clear

preference for 1low-risk projects that are not capital-intensive, with short

construction times and quick returns in effect thermal power projects, and

preferably gas-fired plants (though Chinese investors prefer coal-based power plants due
to their familiarity with them). While the 1private sector has completely taken over the

role of developing new power stations (as was the case in Pakistan till very recently),

globally the private sector is only building one megawatt (MW) of hydropower for each 40
megawatts of fossil-fuel thermal plants it establishes. This is despite international consciousness

about 1global warming and an urgency to find clean renewable sources of energy. In

Pakistans context, it is imperative to develop a sustainable model for financing hydropower

whether through private financing or public financing built on top of a robust strategy that
leads to the development of all of the available hydroelectric potential within the next 30 years.
Review of Literature Hydropower, being the worlds largest source of renewable and affordable
energy accounts for approximately 7billion GWh per year, only 25% of potential, in developing
countries. Due to the high risks, frequent delays and cost overruns hydropower projects have
historically been financed pre- dominantly from public funding in the developing world.
Briscoe1 in his paper looks at the trend of World Bank lending and highlights that a marked
decline in lending for hydropower over the course of the 1990s occurs with hydropower lending
falling by about 25% as a share of Bank lending of the approximately $20 billion lent annually.
This was primarily the result of environmental pressures on the WB and other multilateral
agencies however, what is interesting is that this decline was mirrored by a parallel shift in
hydropower sector spending by developing countries themselves that preferred to use own
resources to fund these projects and instead submitting projects to the World Bank that were
more political palatable to Western countries2. The private sector, during the early 1990s, on
the other hand started to show interest in funding hydroelectricity with The International Finance
Corporation (the private sector arm of the World Bank) approving financing for seven private
hydroelectric power projects between 1990-19953. This was consistent with the overall trend in
private sector involvement in hydropower which exhibited interest in not only development of
new capacity but also in buying, rehabilitating and operating existing hydroelectric plants as seen
especially in Brazil 1 John Briscoe, The Financing of Hydropower, Irrigation and Water Supply

Infrastructure in Developing Countries, 3International Journal of Water Resources

Development, (1999), 3http://dx.doi.org/10.1080/07900629948718. 2 Ibid. 3 J.

Besant-Jones, Attracting Finance for Hydroelectric Power, 4World Bank Group, FPD

Energy Note No. 3,4http://www.worldbank.org/html/fpd/energy/energynotes. and other

Latin American countries4. There is no doubt that private sector will have to play the leading role
in power sector, with leading energy thinkers even predicting that 90% of power financing in
future will come from the private sector5. But the question remains how the private sector views
investments in hydropower with the high number of risks, many inherent in the geographical,
hydrological and geological tailoring that each individual hydropower project requires, the
answer would be warily. However, Trembath6 argues that in contrast to developed countries for
developing countries a very strong factor for any private financier is the substantial market
growth potential. Conducive legal and regulatory environments make some markets more

structured and therefore less risky to invest not only money but also effort in bringing 3a

project to the stage where it can be costed by a developer and introduce adesirable

level of certainty. This certainty is a necessity according to him because even relatively

simple projects entail complex sets of partnerships7. Hydropower at present stands at a

crossroads with the advocates of the Consequences for Hydro Financing Hydropower and `The
New Energy Economy portraying, and rightly so, hydropower as an indigenous, renewable,
non-polluting and long-lived peak energy resource more deserving of foreign investment than
many thermal projects which when based on imported equipment and fuel are no more than a
long-term contract for the import of electricity8 while on the other hand environmental interest
groups and the anti-dam lobby attack hydropower, particularly large projects due to the
environmental and social implications of such dams9. Furthermore, competition from alternative
energy sources, such as the natural gas-fueled combustion engine becoming a dominant
technology for producing electricity is posing further challenges for attracting private finance for
hydropower. With its economic and physical characteristics practically the opposite of those of
hydro projects it is 4 A.A.,Churchill, Meeting hydros Financing and Development Challenges
in Large Dams: Learning from the Past, Looking at the Future, Proceeding of a workshop held
in Gland, Switzerland (Gland, IUCN), (1997), A.A.,Churchill, Hydropower. a new business or
an obsolete industry?, in Large Dams: Learning from the Past, Looking at the Future,
Proceedings of a workshop held in Gland, Switzerland (Gland, IUCN), (1997). 5 Barnevik
Trembath, Constraints To Hydropower Development In A Privatizing Sector, 4World

Banks Energy Week, Washington, DC, (1314 March 1997). 6 Ibid. 7 O. Ulfsby,

Project Financing Of Hydropower Projects In Developing Countries: some issues worth

discussion, 4World Banks Energy Week, Washington, DC, (1314 March 1997). 8 John

Briscoe, The Financing of Hydropower, Irrigation and Water Supply Infrastructure in

Developing Countries, 3International Journal of Water Resources Development (1999),

http://dx.doi.org/10.1080/07900629948718 9 David M. Rosenberg, Patrick McCully, and

Catherine M. Pringle, GlobalScale Environmental Effects of Hydrological Alterations, Bio
Science, (September 2000). a far more attractive option; low relative capital costs, shorter
construction times and greater degree of accuracy in predicting output albeit higher fuel and
operating costs. Coming to the actual financing methodology it has been seen that for larger
projects there has been little private sector financing without substantial involvement of
governments and international agencies which have co-financed and assumed some of the risks
in such projects by not only providing partial risk guarantees but also funding project preparation
and upstream sector planning activities. Trembath10 notes that traditional financing by
governments and via bilateral and multilateral banks addressed most of these difficulties by
financing development costs credits, technical assistance loans and project preparation facilities.
Similarly, he notes that uncertainties associated with construction were addressed to a certain
extent by price variation clauses and by a `schedule of rates form of contract that passed the risk
of unknown conditions, as much as possible, to the owner of the project. With the support of
their governments these owners shouldered the responsibility for any cost overruns with presence
of maturities and grace periods accommodating the longer construction and payback periods. The
author further notes that these arrangements were not free from moral hazards because the party
best able to diversify the risk was the one bearing the risk which was usually the government in
case of hydropower development. More recently the narrative of the Word Bank has shifted
towards investments in hydropower projects in developing countries; after having declined
funding for hydropower for almost a decade. This shift has mainly occurred as a result of the
realization that multipurpose hydropower development brings about a significant number of
benefits for the poor which range from provision of electricity, managing water resources
efficiently and support of water dependent activities11. However, his realization is accompanied
with the acknowledgement that the private sector must play a critical role in the development of
hydropower as the financing requirements of large projects are higher than the funds available
with the public sector, including the World Bank. Thus, the Bank is working with not only with
developing country governments but also the private sector and civil society organizations for
planning and executing hydropower projects that increases the environmental, financial and
social success of these projects. Participation by private sector not only brings financing
possibilities by also additional skills in procurement, project management and financial 10
Barnevik Trembath, Constraints To Hydropower Development In A Privatizing Sector, World
Banks Energy Week, Washington, DC, (1314 March 1997). 11 World Bank, Building a
Sustainable Hydropower Partnership, (2008). management, operations and maintenance skills
etc. Furthermore, a new aspect that the World Bank is exploring are the financial benefits of low
carbon generation Between 2005 and 2007, carbon credit was extended to 15 WBG projects
valuing US$110 million. Increasingly, the carbon market is accessed by larger projects in both
the private and public sectors12. Though, as seen above, the development of hydropower
requires greater participation of the private sector in development, operation and management
but at the same time it will also require continued and significant support and involvement of
social development assistance to help set internationally accepted standards on planning,
designing, construction and operation of these dams as mandated by the World Commission on
Dams13. This will also provide private sector investors some degree of security with respect to
political risk by means of partial-risk guarantees as well as facilitating power sharing and sale
agreements across borders14. Coming to the case of Pakistan there is a dearth of scholarly work
on the subject of hydropower financing. A recent study by the Islamabad Chamber of Commerce
and Industry15 (n.d.) has concluded that there are multiple barriers that prevent investments in
the energy sector and specifically hydropower; high inefficiencies, unrealistic power tariff, low
payment recovery etc. the report further highlights that under the government had planned run-
of-river hydro projects under the Power Policy 2002 for adding 4,325MW of electricity to the
grid and even though funds were released timely there have been delays in completion of all
projects almost. In fact, between 2000 to 2011 only 1,450MW Ghazi Barotha and Mangla Dam
raising projects have been completed in which Mangla is not being utilized due to land
resettlement issues. Furthermore, the report finds that under new hydropower project
management the time for setting up hydro projects has been reduced significantly yet the
concerned authorities in Pakistan still cite long construction periods as an argument. Citing
example of India it highlights that 520 MW Omkareshwar project on the Narmada River has
been completed in four years whereas small hydropower projects are being completed within
approximately 20 to 22 months. 12 Ibid. 13 World Commission on Dams, Dams and
Development: A New Framework for Decision-Making Earth scan, (2000). 14 C. Sadoff and D.
Grey, Beyond the River: The Benefits of Cooperation on International Rivers, Water Science &
Technology, Vol. 47, No. 6, pp. 9196, IWA Publishing (2003). 15 Islamabad Chamber of
Commerce and Industry, ICCI, An Overview of Electricity Sector In Pakistan Available from
www.icci.com.pk. The government of Pakistan has drafted a Mega Hydel Power Policy in 2016
which it hopes will remove some of the bottlenecks to private investment. Though it has
previously given hydel power policies in 1995, 2002, 2013 and 2015 but they have not been
successful with only one project of 84 MW materializing the last 20 years. Under the new policy,
broadly, it is envisaged that WAPDA will conduct the feasibility study, prepare detailed
engineering design, conduct environmental impact assessment, acquire land and resolve
resettlement issues, provide road access and security, liaison with the government departments
and get tariff approved from the National Electric Power Regulatory Authority (NEPRA)16.
The policy anticipates that these activities, which are the most time consuming and expensive,
when done by WAPDA before the project is opened for international competitive bidding with
encourage greater participation by the private investors. Similarly, rather than awarding projects
on tariff bidding basis, which normally leads to delays and cost escalation, the new policy
proposes that bidding be held on completion time basis. This strategy has not yet been tested
anywhere in the world, however, the Government is confident it will yield better results because
the investor would have greater incentives to complete the project earlier they will be able to
sell power earlier and thus secure additional revenue and get guaranteed number of extra years of
operations with higher return on equity17 (Kiani, 2016, p.1). Significance and Scope of Study
Hydropower has the cheapest generation cost, but so far Pakistan is unable to harness this form
of power generation in any substantial way. Since the construction of the Tarbela Dam, not a
single big hydropower project has been carried out during the last 40 years, except Ghazi
Barotha. As a result, two-thirds of the countrys electricity is produced from fossil fuels, and just
one-third from hydro. Development of hydropower is a significant objective because it is an
intergenerational resource due its long design life of 100 years. This means that a strong
established base of hydropower can drive the national development agenda for multiple
generations. Rather such 16 NEPRA, Tariff Determination: Bulk Supply Tariff for WAPDA
Hydroelectric, (20015-16). http://www.nepra.org.pk/Tariff/WAPDA/2015/TRF-312 WAPDA
Determination.PDF 17 Khaleeq Kiani, Policy for mega hydropower projects finalized, The
Dawn News, 11 May, 2016, Available from https://www.dawn.com/news/1257546 power can
serve as the backbone for the overall socio-economic development in the long- term.
Hydropower is recognised as a superior form of energy generation as it is fueled by water a
clean fuel source that doesnt pollute the air like power plants that burn fossil fuels, such as
coal or natural gas. More importantly, since the water cycle is driven by the sun, it is costless and
therefore inflation-free. It is for this reason that Tarbela and Mangla, set up by the previous
generation, is providing electricity to this generation at negligible rates (around Rs. 1/kWh) and
play a key role in keeping power affordable for the lowest social strata (Table 1). In Pakistans
particular case, being a domestic source of energy, substantially increasing hydroelectric powers
share in the total energy mix will increase energy independence as reliance on international fuel
sources decrease. The energy generated through hydropower relies on the water cycle, which is
driven by the sun, making it a renewable power source, making it a more reliable and affordable
source than fossil fuels that are rapidly being depleted. In addition to a sustainable fuel source,
hydropower efforts produce a number of benefits, such as flood control, irrigation, and water
supply. Given the undisputed financial and economic merits of hydropower, the nations inability
to develop its hydel potential is a cause for serious concern. This makes any investigations or
studies examining the financing bottleneck of hydroelectric power generation, such as this one,
of great national importance. It may be noted that storage based hydroelectric schemes also
provide many other benefits most importantly flood control, irrigation, and water security for a
primarily agrarian country like Pakistan but also drinking water supply, navigation, recreation,
tourism and aquaculture, and opening of avenues for development of remote and backward areas.
However, this study will focus only on harnessing the hydroelectric potential and not the
ancillary benefits of establishing dams. The scope of this study, therefore, is the examination of
hydel potential in Pakistan, historical performance in development of this potential, existing
development plans and vision, funding structure of existing hydropower structures, Government
of Pakistans funding strategy for future hydropower stations and dams, bulk hydel tariff and the
framework for its determination, challenges and difficulties of accessing financing -- globally as
well as specifically for Pakistan, risks assumed by financiers (or those that deter financing),
reasons and measures to mitigate some of the problems, policy options for establishing a robust
financing framework for large dams and integrated strategy for developing all large hydel
potential within the next 30 years. Methodology This paper adopts a straightforward
methodology to derive a sustainable financing structure for development of all large hydropower
potential within 30 years. First known gaps in financing of hydel are reviewed, then the list is
filtered for gaps affecting large dams or hydropower structures, before rigorous analysis is
carried out to determine which gaps are applicable to Pakistan. Based on the aforesaid, a
hypothetical counterfactual is constructed to examine if addressing these known gaps would
enable financing of hydropower development smoothly and sustainably in Pakistan. Finally, this
examination is used to determine the mode of financing required for constructing large dams and
an integrated financing solution is proposed for the development of all large hydel potential
within 30 years. SECTION I 1.1 Primer Hydroelectric power is the energy derived from
flowing water. This can be from rivers or from man-made installations, where water flows from a
high-level reservoir down through a tunnel and away from a dam. Turbines placed within the
flow of water extract its kinetic energy and convert it to mechanical energy. This causes the
turbines to rotate at high speed, driving a generator that converts the mechanical energy into
electrical energy. The amount of hydroelectric power generated depends on the water flow and
the vertical distance (known as head) the water falls through. Hydroelectric projects are of
three main types: storage schemes, run-of-river schemes and pumped storage. In storage
schemes, a dam impounds water in a reservoir that feeds the turbine and generator, which is
usually located within the dam itself. Run-of-river schemes use the natural flow of a river, where
a weir can enhance the continuity of the flow. Both storage and run-of-river schemes can be
diversion schemes, where water is channelled from a river, lake or dammed reservoir to a remote
powerhouse, containing the turbine and generator. Pumped storage incorporates two reservoirs.
At times of low demand, generally at night, electricity helps pump water from the lower to the
upper basin. This water is then released to create power at a time when demand, and therefore
price, is high. Although not strictly a renewable energy (because of its reliance on electricity),
pumped storage is very good for improving overall energy efficiency. This paper only considers
storage schemes and run-of-river schemes a as pumped storage is a hybrid model and generally
in its infancy for large-scale power production. Hydropower plants have a long life those built
50 to 100 years ago are still operating today. In fact, hydropower is the most proven, efficient,
flexible and reliable source of electricity based on more than a hundred years of experience.
Upgrades and refurbishment can readily extend lifetime of plants which contribute to the low
cost of electricity from hydropower as well as their capacity (by 5 to 20%). While hydropower
is a well proven and mature technology, it is still advancing and expanding its scope of
application, for example by developing cheaper technologies for small-capacity and low-head
applications so as to enable the exploitation of smaller rivers and shallower reservoirs.
Hydrokinetic technologies are being developed that do not require a hydraulic head but extract
energy from water flows in rivers and waterways. As per global benchmarks, construction costs
for new hydropower projects are usually less than USD 2 million/MW for large scale hydro (>
300 MW), and USD 2 to 4 million/MW for small- and medium-scale hydro (< 300 MW) (Table
2). Unfortunately, the initial investment needs for each project differs and must be studied
individually due to the unique nature of each hydropower project. Parameters affecting
investment costs and the return on investment include the project scale, which can range from
over 10,000 MW to less than 0.1 MW; the project location; the presence and size of reservoir(s);
the use of the power supplied for base or peak load or both; environmental and social impact;
and possible other benefits alongside power production, such as flood control, irrigation, fresh
water supply, etc. Finally, the way in which a project is financed is also a key factor in assessing
its cost and returns. 1.2 Landscape of Hydel Power in Pakistan 1.2.1 Potential Pakistans has vast
hydropower potential of about 60,000 MW, of which approximately 40,000 MW has been
studied in detail and is well documented, while the remaining is based on rough estimates. Figure
1 presents categorization of hydropower potential in terms of available basins, rivers, and small
hydel potential sites available in the country. The Indus River Basin contains almost 75% of all
hydropower potential in Pakistan. Within this, large-scale hydro potential is estimated to be
41,720 MW (Table 3) while small- and medium-scale hydro is estimated to be 868 MW.
Naturally, not all of the available potential is suitable for exploitation given the environmental
and social effects of hydropower projects, which must be carefully considered. However, by
following an integrated approach in managing water resources, planning hydropower
development in co-operation with other water-using sectors, and taking a full life-cycle approach
to the assessment of the benefits and impacts of projects, Government of Pakistan has
documented the projects in Table 3 as suitable for development. 1.2.2 Performance Despite being
a water-rich country, in its approximately 70 years of existence, Pakistan has only been able to
utilize 11% or about 6,595 MW of its hydro-electric potential. Installed hydropower stations as
identified in Table 4 is distributed as follows: 3,767 MW in Khyber- Pakhtunkhwa, 1,698 MW in
Punjab, 1,036 MW in Azad Jammu and Kashmir and 93 MW in the Gilgit-Baltistan. Hydropower
development in the Indo-Pak subcontinent started in 1925, with the construction of the Renala 1
MW hydropower station in modern-day Pakistani Punjab. After a decade, the 1.7 MW
Malakand-I hydropower station was built, which was later upgraded to 20 MW capacity.
Subsequently, in 1953, the 20 MW Dargai hydropower station was commissioned. At the time of
independence, Pakistan inherited a very small power base of 60 MW capacity for its 31.5 million
population. At the time of creation of the Water and Power Development Authority18 in 1958,
the countrys total hydel potential capacity was enhanced to 119 MW. In 1960, Pakistan and
India signed the Indus Waters Treaty a water-distribution treaty brokered by the World Bank
(then the International Bank for Reconstruction and Development). According to this agreement,
control over the three "eastern" rivers the Beas, the Ravi and the Sutlej was given to India,
while control over the three "western" rivers the Indus, the Chenab and the Jhelum to
Pakistan (see Figure 2). To operationalize this, canals and storage dams were constructed to
divert waters from the western rivers and replace the eastern river supply lost by Pakistan.
Pakistans entitlement of 142 MAF (Indus 93, Jhelum 23 and Chenab 26) of water utilisation led
to the construction of 240 MW Warsak, 1,000 MW Mangla and 3,478 MW Tarbela hydropower
projects. All treaty-related works were financed by India and World Bank- arranged external
financing in the form of grants and loans through an Indus Basin Development Fund Agreement;
a treaty entered into by and between Australia, Canada, Germany, New Zealand, the United
Kingdom, the United States, the International Bank for Reconstruction and Development and
Pakistan. In the 57 years since, Pakistan has not even been able to double the installed
hydroelectric power generation capacity. While in recent year the failure to build dams is due to
an absence of political consensus, historically the principal driver has been lack of financial
resource mobilisation. 18 The Pakistan Water and Power Development Authority (WAPDA) is a
statutory body, which was established through an Act of Parliament in February 1958 (WAPDA
Act 1958) under a special statute on the pattern of Tennessee Valley Authority for integrated and
rapid development and maintenance of water and power resources of the country. WAPDA is an
autonomous body having an owner, a board and management structure. WAPDA is wholly
owned by Government of Pakistan (GoP) through Ministry of Water and Power, however, the
governance structure of WAPDA is different than that of a corporate entity. The Authority
consists of a Chairman and three (3) member one for each wing (Water, Power and Finance),
who are designated as Managing Directors of respective wing. The Government of Pakistan
appoints the Chairman and Members of the Authority for the given tenor of the post. The General
Managers of different functional departments report directly to the Members of their respective
wings. Under Section-8 of WAPDA Act 1958, the WAPDA Authority is mandated for preparing
and execution of schemes of irrigation, water supply, power generation, and flood control,
prevention of water logging and salted lands and inland navigation with the approval of the
Government of Pakistan. WAPDA Water Wing undertakes schemes for development of dams,
water channels drainage and other projects as are awarded to it by federal, provincial or local
governments. WAPDA Power Wing was unbundled in eight distribution, four generation and one
transmission and despatch company in 1998. Following that WAPDA is responsible for
operation, maintenance, up-gradation and expansion of its in-operation hydel power stations and
construction of new projects for generation of power using hydel sources on build, own and
operate (BOO) basis. 1.2.3 Future Plans Development of hydel power projects, or rather lack of,
has remained an integral part of the national conversation. At various stages, effort has been
made by multiple regimes to build political consensus but the long gestation period of the
projects along with the seemingly unsurmountable financial challenge have undermined such
efforts. Inevitably, the seriousness with which such projects are pursued has always been held
hostage to the question that no one has an answer to: Where will the money come from?. That
being said, there has been no let-up in the study and development of project documents from the
technical side (Table 5). As of now about projects with hydro-electric potential of 5,000 MW are
ready for execution while those amounting to a little under 28,000 MW are at various stages of
study. More importantly, large hydel projects and their sites have been clearly identified (Table 6
and Figure 3) and there is reasonable consensus on the validity of their potential. This paper will
focus on developing a financing mechanism for these large projects. Very recently, discussions
regarding the development of two large hydel projects --Dasu (4,320 MW) and Diamer-Bhasha
(4,500 MW) have picked up steam and serious effort is being made by WAPDA to arrange
funding for their execution. 1.3 Sources of Funding 1.3.1 Within Pakistan As discussed earlier in
Section 2.2.2, the substantial portion of financing for existing hydel installed base arrived in the
form of grants and loans from foreign countries as part of a greater geopolitical settlement
between India and Pakistan. Since then, however, further investment (including the maintenance
and rehabilitation of existing structures) has largely been made through public funds (in the form
of budgetary grants like the Public Sector Development Programme) and WAPDA-generated
resources (available through their Authority Fund19). 19 WAPDAs Authority Fund is a
legislated account that primarily comprises: a. loans and grants obtained from the federal and
provincial governments b. sale proceeds of WAPDA bonds c. loans obtained by the Authority
with general sanctions of the government Such expenditures are often supported by grants and
loans from bilateral and multilateral agencies (such as the World Bank, Asian Development
Bank, Islamic Development Bank) and friendly nations in the Gulf and European Union (Table
7). Germany, for example, is providing support in Keyal Khwar (128 MW), Harpo (35 MW) and
the rehabilitation of Warsak Dam (243 MW). The upgrade and refurbishment of old generating
units and allied equipment of Mangla (to increase generating capacity from 1,000 MW to 1,300
MW) is planned to be carried out with the support of USAID. Ongoing hydel projects such as
Golen Gol (106 MW), Tarbela 4th Extension (1,410 MW) and Keyal Khwar (122 MW) are also
being financed by the Government of Pakistan equity supported by foreign relent loans from the
Saudi Fund, OPEC Fund, Kuwait Fund, Kfw, World Bank, IDA & IBRD. Other than these
primary modes of financing, recent years has seen WAPDA reach out to commercial lenders
(both local and international) for its hydel projects, keeping in view their revenue generating
nature. Hydel projects, which have attracted such form of financing are Jinnah (96 MW),
Neelum-Jhelum20 (969 MW), Dasu21 (4,320 MW portion) and Diamer- Bhasha (4,500 MW).
However, loans for these were raised against sovereign guarantees and/or balance sheet and
assets of WAPDA, rather than against the projects themselves. In March 2017, WAPDA secured
financing of Rs. 144 billion for Dasu a consortium of major local banks led by Habib Bank
Limited (HBL) by far being the biggest single loan agreement for any public sector entity in
the history of Pakistan. For Dassu, the WAPDA is also venturing into a fresh previously-untested
form of financing for hydroelectric power projects international capital markets. While
Pakistan occasionally raises foreign exchange through international bond offerings the last one
being the 10-year bond of $500 million floated in the international Euro bond market in
September 2015 at a d. foreign aids and loans obtained from the IBRD, ADB and other
international donor agencies on such terms and conditions as may be approved by the
government e. Sale of power 20 Neelum Jhelum is being implemented by WAPDA through a
special purpose vehicle (SPV), which has injected equity of Rs.45.8 billion. Equity investment in
Neelum Jhelum was done through different means, including taking credit of Rs. 19 billion from
local banks. Financial close was achieved in May 2016 after signing loan agreements with
Chinese Exim Bank and a consortium of 16 local banks led by National Bank of Pakistan
underwritten by Government of Pakistan through Rs. 100 billion worth of 10-year Sukuk
(Islamic bonds). 21 Against partial credit guarantee of $210 million provided by World Bank and
a counter-guarantee to the banks provided by the Government of Pakistan coupon rate of 8.25
per cent22. WAPDA has already received firm approval from the Economic Coordination
Committee (ECC) to raise $350 million for 10 years, backstopped by a portion of World Banks
credit guarantee of $460 million available for commercial financing. Discussion is also
underway to raise another $500 million as well23. It must also be noted that Pakistan has also
seen some initial response from private investors for taking the lead in development of small
hydropower projects as independent power producers (IPPs). The first such project was the New
Bong Escape (84 MW) that was set up under the 1995 Hydropower Policy of the Government of
Pakistan and started operations in March 2013. Since then it has remained the sole hydel IPP
commercially operating in Pakistan. However, a recent uptake of investor interest manifesting
itself in the form of the under construction hydel projects Patrind (147 MW) and Gulpur (102
MW) promises to end this distinction. Other projects in the pipeline are at initial stages of project
development. Since the announcement of CPEC, strong Chinese interest has also resulted in
private financing of large projects such as Karot (720 MW) and Suki Kinari (870 MW)
although since these investors are Chinese state-owned entities, such capital injection does not
offer a true test of the marketability of Pakistani large hydel projects amongst private investors.
1.3.2 Global Experience Globally, power sector deregulation leading to the dismantling of the
monolithic state power utilities and the move toward private ownership of generation,
transmission and distribution has whittled the appetite to use public sources of finance for power
generation (whether hydel or otherwise). This is largely due to recognition that power projects
are revenue generating and financially stable enough to readily attract private financing.
However, this evolution has had a negative effect on development of hydroelectric power -- as
traditional public sources of finance have dried up, they have not been replaced in equal measure
by private funds. In consequence, the world is experiencing a sharp decline in greenfield hydro
projects. While it may be argued that this decline is only due a transitory situation, partway
between the old system and full deregulation and the situation would be very different when
there is 22 Communicated by the Ministry of Finance to be twice oversubscribed
(https://www.dawn.com/news/1209263) 23 https://tribune.com.pk/story/1406569/pakistan-likely-
float-500m-bonds-fund-dasu-project/ no longer a state-backed utility to enter into long-term
offtake agreements and to undertake the project definition studies at present, the financing of
private infrastructure on a nonrecourse basis, where the security is essentially the project itself,
relies on the ability of the project to generate stable revenue. This is done by long term purchase
contracts offered by the off taker using a pre-defined tariff based either on energy alone, or on a
capital recovery plus operating costs formula (alternately known as capacity payments) similar to
that used for thermal independent power producers. In the proceeding section, therefore, we
examine the tariff structure of hydel in Pakistan to develop a basic understanding of the revenue
stream available for financing of hydropower projects on nonrecourse basis. 1.4 Hydel Tariff in
Pakistan 1.4.1 Tariff Regime All electricity tariffs in Pakistan are determined by an autonomous
regulator knows as the National Electric Power Regulatory Authority (NEPRA) established
through the enactment of the Regulation of Generation, Transmission and Distribution of Electric
Power Act, 1997, which became effective on 13 December, 1997. Tariff once determined by
NEPRA and notified by the Government of Pakistan remains valid until the same is revised by
NEPRA. 1.4.2 Bulk Hydel Tariff (for WAPDA) Although WAPDA predates NEPRA, it is
mandated as per Section-31 of the Act to get its power services tariff determined from NEPRA.
Accordingly, WAPDA gets its tariff determined for bulk hydel supply (and not per project24)
from time to time the current applicable tariff was determined by NEPRA for FY 2015-16.
NEPRA determines the bulk supply tariff in two components fixed charge and variable charge
for recovery of annual revenue requirements. Whereas hydel related charges i.e. Net Hydel Profit
(NHP) under Article 161(2) of the Constitution to the provinces, water usage charges to Azad
Jammu and Kashmir and the 24 Although at Para # 106 of its determination dated 13th
November 2015, NEPRA directed WAPDA to ensure that its next tariff petition was based on the
individual stations with detailed breakup of power projects supported by assumptions/basis duly
certified from a reputable audit firm. Indus River System Authority (IRSA)25 levy are allowed
separately at the rates determined by Council of Common Interest (CCI) as a pass-through
charge, the tariff is determined as follows: Annual Revenue Requirement = *Return on
Regulatory Asset Base + Depreciation Expenses + O&M + Ijara Rental - Other Income [+/-]
prior period adjustments for regulatory revenue gaps. *The Regulatory Assets Base for tariff
purpose includes: a. Average Net value of Operating Assets at historical cost b. Average Capital
Works In Progress NEPRA allows return on Regulatory Assets by including return on the actual
incurred capital cost of the project going forward towards completion at the actual weighted
average cost of capital (WACC) with 17% return on equity. The return varies based on WACC
and average level of regulatory assets base. Under this mechanism, electricity consumer pays
Return on Assets (ROA), covering Interest During Construction (IDC) and Return on Equity
during Construction (ROEDC) during construction phase26. This special mechanism is designed
to facilitate WAPDA in reducing the financing required for the capital-intensive hydropower
projects with long construction periods (since such amount is not included as part of the
financing) while building equity that it can then inject at the stipulated ratio. 1.4.3 Tariff for
Hydel IPPs Tariff for IPPs comprises the Capacity Purchase Price (CPP) which is the fixed
component and the Energy Purchase Price (EPP) which is the variable cost. Both are determined
using a transparent formula. For the CPP, this formula relies on: 25 Indus River System
Authority (IRSA) was created in 1992 to implement the historic Water Apportionment Accord
agreed among the provinces in 1991 26 This arrangement is different from standard treatment of
IDC and ROEDC under IPP regime where these are accumulated and compounded during
construction phase and subsequently recovered from consumers through levelised tariff during
the term of the Power Purchase Agreement (PPA). a. project debt payments (inclusive of interest
principal) b. return on equity c. fixed element of the operating and maintenance cost. d. insurance
cost for the plant e. foreign exchange risk insurance cost which is the cost of hedging the loans
against foreign exchange risk For the EPP, the formula relies on: a. fuel cost which is notified by
the government for use of water b. variable element of the operating and maintenance cost Tariff
can either be determined upfront by the NEPRA done when soliciting private investment for
identified projects or settle through negotiations, where an IPP submits an unsolicited proposal.
NEPRA determines the tariff in consultation with the IPP, the power purchaser, and other
stakeholders (including public views through open hearings) while taking the technical and
financial parameters in to account: a. Technical the net energy available for the sale determined
after taking into account electrical efficiency, auxiliary loads, transformation efficiency and plant
availability (determined judiciously, taking into account suitable provisions for anticipated
maintenance and forced outages) b. Financial debit-equity ratio, internal rate of return or return
on equity (as notified by the Government of Pakistan), interest on loan (whenever a floating
interest rate regime is adopted, loans are indexed to change in relevant benchmark interest rates,
such as KIBOR for local loans and LIBOR for foreign loans, capital cost, and the operation and
maintenance cost27 (ICCI Report, p.16-17). To mitigate the currency risk, the tariff is
determined in US dollar terms. 27 Islamabad Chamber of Commerce and Industry, ICCI, An
Overview of Electricity Sector In Pakistan Available from www.icci.com.pk. SECTION II 2.1
Peculiarities of Hydel Power Projects As discussed in Section 2.3.2, global experience has
demonstrated that hydel power, especially large projects, is unable to compete with thermal
power for private investment despite its desirability. This section examines the peculiar nature of
hydel power projects that forms a naturally barrier or deterrent to the capitalist who is simply
looking for a return on his investment. Almost always financiers understand hydel projects to be
highly site-specific, capital- intensive with uncertain future revenue stream. Table 8 lists a basic
comparison between hydropower projects and thermal projects. 2.1.1 Risks Hydropower projects
are capital intensive with higher initial capital costs compared to equivalent thermal power
station. For an investor, whose first preference is to diversify in the hopes of seeking stability in
returns, investing in hydropower generally means committing and exposing a larger amount of
capital to the risk profile of a single project. And by definition, hydropower projects pose a
higher risk than thermal projects. No two dams are similar their site-specific nature makes
construction heavily dependent on geological factors. Experience has shown that construction is
long and uncertain, highly susceptible to design changes mid-construction, and more often than
experiences inflated costs by the time of completion. Such uncertainty therefore has to be built
into the financing requirement at the start to ensure project completion. In this respect, there are
strong analogies to be drawn with the oil and gas industry, and with mining. Both of these are
high-risk enterprises, but they are also high-reward because of the monopolistic nature of their
product. Hydro does not enjoy the same protection because of its need to compete with other
totally different forms of power generation (that are low risk), but it is likely to follow the same
path toward balance sheet financing by large companies with the necessary resources. In addition
to their risk of project construction itself, the success of hydropower projects is dependent on
social and environmental safeguards hydropower projects have historically become identified
with poor standards of social and environmental implementation. While improvements have been
made in these areas, investors still remain concerned over the risk of delays caused by protest by
non-governmental or other interest groups. Pakistans own history with hydropower has seen a
lot of politics attached to specific projects relocation, sub-national disputes, water sharing
formulae, etc. affecting the sponsors ability to guarantee projects and/or resolve problems. The
biggest impact of such risk is seen on ability to complete land acquisition, especially for storage
structures. Overall, this risk weighs adds on substantially to the country risk when evaluating
investment potential of hydropower projects. On top of that, hydropower projects carry a
hydrological risk output is essentially unpredictable subject to river flows and broader water
management constraints. In Pakistans case, the peculiar nature of river control between India
and Pakistan renders this risk even beyond the control of the sponsor or guarantor and places the
issue firmly in the centre of geopolitical risks. Yet even with the hydrological risk involved,
hydropower projects are essentially viewed as projects with a high front end risk profile, i.e. the
risks are also frontloaded in a project. Developers therefore need a long period of operation
(which is comparatively lower risk in comparison) to counter the high levels of risk encountered
during construction28. This is not surprising, considering that hydropower projects have a life of
100 years and such long-life projects have commensurately intensive development. 2.1.2
Financing Constraints Financiers regularly compare hydropower projects with thermal power
parks when making investment decisions on a $/MW basis (100 to 200 percent higher than
thermal). Even governments when making public financing decisions for power investment
cannot wholly escape from such a comparison. What financial analysis fail to (or cannot) account
for are the unremunerated benefits of hydropower projects such as grid stabilisation, water
storage, flood control, provision of access roads, and establishment of fish habitats or centres of
tourism. While these may be significant benefits to a country, the value of these benefits may not
accrue to a private 28 J. Plummer, Options Assessment for Structuring and Financing new
Hydropower in PNG, 2011, Available from www.ppiaf.org/sites/ppiaf.org/
les/publication/PNGconceptNov.pdf. developer. Thus, economic viable projects do not seem to
be visible from a purely financing perspective. So far, this challenge of transferring ancillary
benefits to the sponsor has restricted wholesale private investment in large hydel projects. To
complicate matters further, hydel projects have a long lifecycle and are often financially viable or
digestible only over a long tenor. This excludes a large portion of investors, whose appetite is
restricted to single generation investments (i.e. the 30-year band seen in most public-private
partnership projects). Even the standard tenor of loans from commercial banks (i.e. 10-years for
IPPs) is often found to be too short for recovery of the high capital costs. Longer tenor financing
up to 20 years is only available from bilateral or multilateral agencies. Hydropower projects also
have a longer gestation period site surveys, water flow studies, environmental and social
compliance, political consensus, land acquisition, relocation, and many other activities with
indefinite timelines precede the actual construction which place a huge stress on financiers
ability to keep capital committed for a project prior to financial close. If financial close is
achieved early on, the commitment charges only add to other substantive soft costs like interest
over the longer construction period, burdensome environmental impact assessment, project
preparation requirements (regulatory as well as financing-related) and contingencies to cover
risks. Finally, hydropower projects also lose out on another avenue of financing that is often seen
in thermal power projects suppliers credit or export credits. While hydropower projects are
capital intensive, a high proportion of costs are spent on local content such as civil works. This
limits the scope of export credit agencies, which are mandated to only support content from their
own countries. 2.2 Case studies 2.2.1 Dasu The Dasu hydroelectric power project, one of the
major schemes currently being executed by Wapda, is being partly funded by the World Bank
through International Development Assistance (IDA) of $588 million along with credit guarantee
of $460 million. 2.2.2 Neelum Jhelum SECTION III 3.1 Policy Options: Private, Public-
Private Partnership or Public? Before venturing forth into a policy discussion regarding the
financing of hydropower projects, it may be useful to discuss the issue of public versus
private. It would be a misconception to shydropower project can be either totally private or
totally public. Almost every project in the world requires the participation of both public and
private sectors in some form or the other. As an example, a privately funded hydel IPP must
liaise with both the federal as well as the provincial government on a range of legal and
regulatory issues. It is very difficult for a private operator to implement a project without the
support and cooperation of the public sector. Similarly, a publicly funded and executed project
will generally involve procurement and contracting or subcontracting to the private sector.
However, for the purposes of this paper, the public policy option will refer to projects largely
developed with public funding; private will refer to projects largely developed with private
funding (equity and debt) and public private partnership will refer to projects which use a
framework to distribute risks between the public sector on a commercial basis. 3.2 Private
Funding Pakistan has been suffering from power shortfall for about a decade now despite a
robust IPP framework that was established as early as 1992. Even though more than 40 private
operators have set up thermal power plants since then, the size and scale of these investments
demonstrate Pakistans limitations in attracting large investments. Excluding public-sector power
projects that were later privatized29, the largest greenfield project set up though private equity
was also the first Hub Power (1,292 MW) set up back in 1994. From then on, investment
appetite has been limited to a maximum size of 600 MW. In comparison, baseload shortfall
touched 10,000 MW. Even with policies offering attractive return on equity upwards of 20%
(through guaranteed internal rate of return of 16-17%), private investors have been generally shy
of injecting big money in the power sector. Common reasons given are country risk, general
political instability, judicial activism, poor track 29 Kot Addu Power Company Limited
(KAPCO) has a gross installed capacity of 1,638MW. record of contract enforcement and poor
cash flows due to financial mismanagement30.This is not to say that investor outlook will
change in the medium term as recent activity under CPEC has led to some bigger investments by
Chinese state-owned enterprises (among which are two 1,320 MW coal power plants and two 7-
800 MW hydel power projects). So far, this paper has discussed the challenges faced in the
financing of hydel power projects but these challenges have been assessed in the context of
readily available private sector financing for thermal power projects. Given that Pakistan has
remained in investment deficit for thermal power plants as well, it would not be prudent policy to
rely on investor sentiment changing so rapidly as to allow establishment of large hydel projects
as purely private ventures (given the challenges faced in better established markets). The next
section examines steps that can be taken to improve the investment environment by increasing
the share of risk participation of the public sector and developing an optimum regulatory
framework to make hydel power investment compete with thermal power. 3.3 Public-Private
Partnership Based on the review of peculiarities of hydel power projects carried out in Section
3.1, it is clear that the regulatory framework for hydro cannot be the same as for thermal projects.
As hydel projects have a wider public interest element, they require greater public support.
Specifically, large projects, which are the focus of this paper, which have strong multipurpose
benefits, would only be able to attract private investment under some form of public- private
partnership. Of need is the development of a risk-sharing formula that is both bankable (by
reducing uncertainty) and cost-effective in terms of minimizing construction costs (reducing
capital outlay) and the resulting tariffs. 3.3.1 Construction cost Following the uptick of private
financing of power projects, there has been a strong move towards engineering, procurement and
construction (EPC) contracts instead of unit cost contracts (commonly known as rate or BOQ
contracts in Pakistan) in an effort to insulate the sponsor from construction risk (and subsequent
price impact). However, serious contractual 30 Circular debt, which currently stands in excess of
Rs. 400 billion, has introduced great instability in payments to IPPs. difficulties are being noted
in hydro projects where geological discoveries during construction have made projects non-
feasible for the contractors to work on. This has resulted in a reversal in trend and newer
contracts put some risk-sharing between the contractor and sponsor. To prevent projects from
such adverse mid-construction cost escalation, Government of Pakistan should bear the full cost
of project definition and take only those projects to market that are adequately prepared, based
upon detailed technical studies and site investigation, with a clear contractual framework and
security package already in place. Well defined projects, accompanied by robust site studies are
most likely to get the best EPC prices and least likely to have mid-construction crises. In addition
to the above, the government would also have to bear the risk of unforeseen geological
conditions (with adequate financing in place to prevent mid-construction delays), keeping in
view that private investor would be unable to pass on such risk to the EPC contractor and would
be deterred if contingent financing has to be arranged to handle escalation in costs. 3.3.2 Land,
relocation and environment Given the well-entrenched political dimension of hydropower
projects, Government of Pakistan has to take on all external risks related to the success of the any
project that is to be undertaken. These include the acquisition of land (especially important,
given that it has eminent domain) and any resettlement, as well as getting environmental permits.
Although global practice has been to leave the main responsibility of acquiring environmental
permits to the sponsors, this is not an area in which the private sector is comfortable given the
long delays and expenses that can be incurred. Keeping in view that environmental clearance is a
public responsibility, environmental and social due-diligence should be done prior to project
announcement and all permits should be put in place by the government before the private sector
becomes involved. 3.3.3 Hydrology In Pakistans particular case hydrological risk is the most
severe due to the unique nature of river distribution between India and Pakistan (as discussed in
Section 2.2.2) and one that is arguably beyond even the control of the sovereign. Even otherwise,
hydrology is always an inherent risk in hydel projects as design is always based on the
assumption that, in statistical terms, rivers would follow historic flow patterns when in fact rivers
demonstrate high variability. Add risk of geopolitical interference in river flows to the increasing
concern over long-term changes in the global weather patterns, and it is likely to become a strong
deterrent to private investment. Thus, for any private financing to take place, comfort has to be
built around the hydrology risk. This can be done by adding certainty to the revenue stream of
the power producer, either by: (a) defining the tariff in terms of capacity payment only, or (b)
guaranteeing a minimum number of kWhs to be purchased regardless of production. Lastly,
keeping in view the long life of the project, the term of the offtake agreement with the power
purchaser may also be increased to 50 years instead of the usual 30 so that the power producer
has a longer period over which the river can behave in the predicted fashion 3.4 Public
Expenditure Executing large hydropower projects can lead to significant economic benefits well
in excess of the financial benefits. But given that even governments are challenged to monetise
these benefits, it is unrealistic to expect private operators to do so. From a national perspective,
the decision to develop a project should be based on the economic gain to the country rather than
a decision as to whether the private sector would be willing to develop it. As noted in the
previous section, certain aspects that affect development of large hydroelectric power projects
such as the political, environmental, social and hydrological risk can never be absorbed by a
private investor on a per project basis. Inevitably, the government has to underwrite these risks
for attracting any private capital. If then, project development and a substantial portion of risks
related to large hydel projects is to be picked up by the public sector, and only the challenge of
raising finances (repayment of which, too, through the tariff is underwritten by the sovereign
guarantee) and getting the dam constructed is being transferred to the private sector, an
examination is required to determine if the WACC being offered by such investor (~20% return
on equity and ~6% commercial financing rates on say 70:30 debt-equity ratio) can be replaced by
a cheaper arrangement. The government has its disposal many avenues of raising capital using its
own balance sheet, i.e. sovereign guarantee, assets, revenue generation, etc. These are (in terms
of components of hydel projects): a. Local financing (for civil work) b. Export credits (for
electro-mechanical) c. Development funding (for project preparation, environment & social
clearance, project finance) d. International commercial banks e. International capital market
bonds (long tenors) f. Local Islamic bonds (sukuk) g. Credit enhancement (through
donor/multilateral agencies) h. Unbundling of water storage costs for recovery through
agricultural taxes, land development, water charges i. Carbon credits and/or other green setoff
initiatives j. Privatisation of publically financed power projects From Section 2.3.1 of this paper,
it is clear that Pakistan has had success in accessing such capital at various times for different
projects. The only challenge then remaining is to develop a sustainable and self-contained
cascading model for development of all large hydropower plants. Pakistan is fortunate enough to
have at its disposal reasonable installed capacity of hydel power that has been dependably
providing energy (on average 31,500 GWh per year recently) for several decades. This energy,
currently sold at Rs. 1.2 or $0.01 per kWh, well below the average generation price of Rs. 13.5
or $0.13 per kWh provides a huge opportunity for securitization of a revenue stream and clean
ring-fencing of hydropower development. As discussed at the start of the paper, hydel power
serves as an intergenerational transfer of wealth the exceptionally low energy prices seen today
are the result of investment by a previous generation (even if in the form of political settlement).
Given that this generation has hugely benefited from such investment, it is only equitable for it to
invest in a similar manner for providing cheap and clean energy to the next generation. The bulk
hydel kWh is an ideal conduit for this investment. Figure 4 represents the findings of a
rudimentary financial model in which the entire large hydel potential is developed in 30 years in
a cascading manner by raising finances from the 30-year international bond market. Such bonds
are floated in three tranches ($29.4 billion in year 2018, $23.2 billion in 2022 and $12.3 billion
in year 2028). These result in the development of large hydel projects in the sequence presented
in Figure 5. The interest payment (est. at 10% for simplicity) and 1/30th part of the principal is
ploughed back using the bulk hydel tariff, which decreases with time as more hydel projects
come online. For the next ten years, the consumer sustains a $0.12/kWh unit rate for hydel
(which is below existing average basket price and similar to the tariff being determined for new
thermal plants), after which the unit rate drops to $0.06/kWh by 2034. The simple model does
not assume any interest rate gains from on the principal amount ploughed back and held till the
bond coupons mature, nor does it take into account increased hydel generation due to projects
under construction (Neelum-Jhelum and Tarbela-IV Extension). CONCLUSION ? In total
consideration, achieving max potential early is better than deferred action unlike mineral
resources ? Potential of any water flow gone into sea is wasted and non-recoverable
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