Investment In Hydropower Sector, Nepal

Nov. 27, 2023, 10:01 a.m.

Abstract

Hydroelectricity is a clean and reliable source of electricity, and it is well-suited to meet the growing demand for electricity.

Only 5% of total hydroelectricity potential has been harnessed so far in Nepal [4].  With investment from both private and public sectors, this number could go upwards.

This research investigates into the investment scenario, prospects and challenges in Hydropower sector of Nepal. Investors need access to information before taking decisions on their investments. This paper can be of help to them.

 

 

Introduction

 

Nepal, lying in the heart of the Himalayas, has an abundance of water resources, making it a destination for investment in the hydropower sector. With its vast river networks and diverse topography, Nepal holds immense potential for harnessing hydropower as a clean and sustainable source of energy. As the demand for electricity continues to rise, both domestically and in the South Asian region, investing in Nepal's hydropower sector presents a lucrative opportunity for both domestic and international investors.

Only a fraction of Nepal's hydropower potential has been tapped so far. The country's government has recognized the significance of developing its hydropower resources to meet its growing energy needs, reduce dependency on imported energy, and promote economic growth. Consequently, Nepal has created a favorable investment climate by introducing policies, regulations, and incentives that aim to attract private and foreign investors into the hydropower sector.

 

Methodology

This term paper has been prepared by heavy amount of internet research. Reports from organizations and articles from different publications are referenced.

 

Findings and Discussion

 

Broader Economic Conditions

 

Nepal’s broader economic conditions are not looked as very favorable. Indicators such as high inflation can discourage investment. The Economist has marked Nepal as failing/failed state [11]. This is not a good sign towards attracting foreign investment.

 

Resource Curse Turnaround

When it comes to hydro, Nepal used to have suffered from resource curse for a very long period of time when all the potential went unused [9]. This unused potential has been a big loss for the Nepalese people. Nepal used to suffer heavy power shortages in the past although it has been resolved these days largely attributed to the leadership of Kulman Ghising [10].

 

Market Size and Potential

 

The market demand for electricity is ever increasing. The total energy consumption in Nepal was 589 PJ in 2019. It increased to 626 PJ in 2021, despite the slump in 2020 due to covid to 566 PJ [5]. We can say that the demand for energy is ever increasing.

Nepal expects to export a lot of hydroelectricity to India in the near future. India, as a rapidly developing country with one of the highest GDP growth rates among large countries will be needing to get its hand on all kinds of energy resources. Nepal’s hydroelectricity could fulfill some of its demand. Hydroelectricity consists of only small portion of total energy consumption. Most of the energy consumption is sourced from fossil fuels. As the world moves towards more greener energy source, hydroelectricity along with others sources such as solar energy can play an important role.

As of 2019, 85% of the world's energy needs are met by burning fossil fuels [7]. If the world is to move towards clean and safe energy, hydroelectricity potential must be properly harnessed.

 

 

Electricity consumption in Nepal

 

The electricity consumption remains very low in Nepal. As per a report by the Ministry of Energy, Water Resources and Irrigation, the per capita electricity consumption in Nepal is 350 units [1]. For comparison, the world’s average is 3081 units [2]. The Nepal government plans to rapidly increase electricity consumption per capita to 700 units by 2026[3]. In Nepal, traditional methods of energy have been dominant sources, however, renewable energy sources, especially hydroelectricity, are quickly grabbing their share. By 2021, the share of the highest used fuel, traditional biomass, has decreased to 66% from 87% in 2009[5]. Residential sector is the biggest consumer of electricity sitting at 44%, while industries come at second, sitting at 37% [4]. This is opposite to the rest of the world where the industries consume nearly double energy compared to households (42% against 26%) [6]. This can be explained by the fact that Nepal has a very small industrial sector.

 

Exporting to India

Some progress has been made towards exporting energy to India from Nepal [21]. Few years ago, Nepal had to import energy from India. Since the export price is very low, there have been voices from some entrepreneurs that if they receive electricity at the same price as India gets, they can profitably invest that into industries in Nepal creating many job opportunities and enhancing the economic status of Nepal. Nepal has also taken some initiatives towards exporting electricity to Bangladesh [23]. However, under rules India has established, it cannot buy energy from Nepal that is linked to Chinese investment or involvement, be it equipment, workers, or subcontractors [30]. India’s such takes can hamper hydro development in Nepal and discourage Chinese investors from taking part.

 

Exporting to Bangladesh

Beyond India, Nepal and Bangladesh have shown interests in trading electricity. That requires permissions from Indian government to build transmission lines over its land. Lately, some positive progress has been made towards that direction. "An agreement has been reached for power trade with Bangladesh via Indian territory. Indian Prime Minister Modi has said India will import 10,000 MW of electricity in the next 10 years. It has created an environment to export power produced from different hydropower projects including Upper Tamakoshi" [31]. However, this is yet to materialize. If this becomes successful, it would be a big advantage for hydro investors in Nepal.

 

The Monopoly of Nepal Electricity Authority

 

NEA is the sole distributor of hydroelectricity in Nepal. Despite long periods of inefficiencies from NEA, the monopoly status has gone unchallenged by intellectuals, political will and even private sector. Nepal Infrastructure Bank (NIFRA) has stated its intentions towards entering this energy distribution market by working on Transmission Line Projects [14], but its success is far away. The monopoly status has very important implications in a number of different ways that are very relevant to the investors.  Adding to the monopoly status, as a governmental bureaucratic organization, NEA tends to be very risk averse which causes it to be sluggish in taking actions. Many have called for private sector involvement calling present condition of NEA monopoly (a single buyer market) a hindrance. Such a paradigm shift in the energy sector is also called for now to attract more private sector investment in power generation [12].

 

Private Sector Investment

Pursuing the privatization process, in 2003, the Government of Nepal handed over majority ownership and management control to private investors on public-private partnership model [28]. Nepal’s move towards privatization and liberalizations came with a lot of challenges and did not go very smooth. It still faces a lot of challenges.

 

 

Nepali Stock Market and hydroelectricity

A few years ago, many hydroelectricity companies were trading well below their IPO price of Rs 100. Some of them went as low as Rs 49 [15]. This kind of price was disheartening to the investors to say the least. However, the sector has now made a comeback and has managed to give a good market price to the early investors. As of July 2023, Hydroelectricity sector forms the second largest in terms of total market capitalization just behind Commercial banking and above Microfinance sector [24]. This shows that Nepali stock market investors are fairly positive towards future prospects of Hydropower.

 

35 years of license

Nepal government gives only 35 years of ownership rights to the Hydro companies, after which it will take over. The companies should manage to finish the project and reap the profits during that timeframe. Sometime the time period is extended for 15 more years [16].

 

17% profit Limit [17]

Hydropower developers have been barred from taking more than 17 per cent profit. If the profit made by any hydropower project is higher than 17 per cent, it will be managed by reducing the rate agreed upon in the power purchase agreement (PPA). The government can effectively leverage the monopoly status of Nepal Electricity Authority to enforce this rule.

 

 

Foreign Investment

According to NRB’s research, the electricity generation sector, particularly hydropower sector in Nepal has been emerging as a preferred sector for FDI in recent years. The latest survey shows that 27.5 percent of FDI stock and 36.4 percent of total paid-up capital is in this sector. Moreover, hydropower sector has also attracted other sources of external financing such as foreign loans in addition to FDI [22].

 

Going Green

Around the world, there has been a financing towards going all electric in order to minimize the effects of fossil fuel carbon emissions [25]. Going green refers to adopting environmentally friendly practices and making choices that have a positive impact on the environment. This can include reducing waste, conserving energy, and using sustainable resources. It is important to go green in order to mitigate the negative effects of climate change and protect our planet for future generations. This is good news for hydropower investors in Nepal and around the world. The governments will be subsidizing and giving tax breaks to clean vehicles, which will result in more demand for hydroelectricity. During the budget announcement for the fiscal year 2078/79, the Nepal government announced that it is abolishing excise duty tax on electric vehicles (EVs) alongside reduced custom duty. This is a welcome respite for individuals and companies planning to go electric [26]. However, in the latest budget, tax rates on entry level electric vehicles have been increased again [27].

 

Tax Reliefs [16]

The corporate tax break is worth 20%. For the first ten years of operation, the income tax holiday incentive is completely exempt. For the next five years, there will be a 50% exemption. If the project is a public company, an additional 15% tax break is available. Import of machinery and equipment qualifies for a 100 percent VAT exemption. On the purchase of machinery and equipment, there is no VAT to be paid. Customs benefit– A 1% customs duty is levied on construction equipment imported into the country. Losses can be carried through for a period of up to 12 years. Such reliefs from government are intended to encourage hydropower investments in Nepal. This is a positive sign for investors as well as all the Nepalese people.

 

 

Politics and Bureaucracy

The main challenge in Nepal is the political and bureaucratic vested interests that align with neither the people nor the hydroelectricity investors. The bureaucratic system of Nepal is very slow and full of corruption. The Nepalese political thinking generally has a negative attitude towards profit seeking adventures, especially the big investors. This attitude is also manifested by the overwhelming representation of economically leftist political parties in Nepalese parliament. Nepal’s weak rule of law environment, ethnic tensions are also a big problem in Nepali politics which hinder overall development of industries.

 

Free Electricity

The government plans to grant free electricity to households who consume up to 50 units per month during the rainy season and 30 units during the winter season. In a move towards reducing reliance on cooking gas, the government has also announced a gradual shift towards electricity as an alternative energy source [13]. Such freebies, however, can have negative impacts on profit seeking investment. Politicians often have incentives to promise free stuff for which the citizens eagerly show support. However, someone has to pay for it, and in case of electricity, it will be the Hydropower investors.


Shareholders’ political voting power

Certain percentage of shares of any hydropower companies must be reserved for locals [18] for which the locals apply very excitedly. They apply shares for each member of their family including their children. This means each of the hydropower companies must have few lakhs of local shareholders in village areas. The entire sector as a whole may have a rough estimation of over 50 lakhs of small shareholders. This is an immense political voting power and, in the future, the hydro investors as a whole can effectively create enough political pressure to cause favorable policy changes towards their investment returns.

 

 

Black Money in Hydro

Black money refers to money that is earned through illegal means or hidden from the government in order to evade taxes. It is often associated with underground economies, such as bribery, corruption, tax evasion, and money laundering. Few years ago, during the finance minister-ship of Janardan Sharma, the government enabled hydro investment to have no background checks for it source. This has made hydro sector a heaven for settling the corruption wealth in Nepal. “The government will not seek sources for investments made in the areas of nationally important hydropower projects, international airports, infrastructure projects like underground highways, cement factories, steel factories, agriculture-based businesses, tourism, businesses that create employment for more than 300 Nepalis and production-based businesses that use more than 50 percent of domestic raw materials until April 12, 2024,” according to the new provision in the Financial Act 2021-22 [19]. This will have negative effects on normal Hydro investors as the black money is not necessarily seeking profit. The downward pressure on normal investors can become immense.

 

 

Vulnerability to Climate Change
 

Vulnerability to climate change refers to the extent to which a particular system, such as a community or ecosystem, is susceptible to the adverse impacts of climate change. This vulnerability can vary depending on a range of factors, including geography, socio-economic conditions, and existing levels of resilience. In the next decade, Himalayan glaciers are expected to lose between 10-30% of their masses [8]. Activities such as this will not only drastically reduce the base flow available to hydropower projects, but that there will be more landslides and glacial outbursts. This will cause an increase in operational costs and loss of revenue from plant stoppages. It is generally very difficult to exactly predict which hydropower plants will be most affected by climate change activities. So, investors are better off all plants will be facing these problems.

 

Nuclear Energy as Competing Energy Source

Any investor must take into account the potential competing energy sources. Nuclear energy, which has largely been suppressed taking nuclear risk into account is slowly seeing an uptick of interest around the world. As the engineering and technology advances are made, it is becoming possible to produce safe nuclear-powered energy. Such produced energy would become extremely cheap, effectively making the Hydro Energy too cumbersome and expensive to maintain. Nuclear plants have relatively small land requirements. While hydro power relies on the availability of water resources and suitable locations for dams, nuclear power plants can be built virtually anywhere. Plus, the energy wars will further push countries to produce their own cheap nuclear energy at scale. The nuclear power is starting to be seen as highly reliable, clean, affordable, efficient and sustainable [20].

 

 

Other Competing Energy Sources

There are several competing energy sources to hydro. One such source is solar energy, which utilizes sunlight to generate electricity through the use of photovoltaic panels. Solar energy has the advantage of being abundant and clean, with no harmful emissions associated with its use. Another alternative to hydro is wind energy. Wind turbines capture the kinetic energy from the wind and convert it into electricity. Wind energy is also clean and renewable, but its availability is dependent on wind patterns and may require specific geographical conditions. Geothermal energy is another viable competitor to hydro. This energy source utilizes heat from beneath the Earth's surface to generate electricity. Geothermal energy is reliable and emits minimal greenhouse gases, making it an attractive option for sustainable energy production. Additionally, bioenergy, derived from organic matter such as biomass, can be used as an alternative to hydro. Biomass can be burned to produce heat or converted into biofuels for electricity generation. These are an overall competing source of energies. While at current stage, they may not possess much hreat to hydro business, an investor must look at improvements made in technology of these energies because such technology improvements can drastically change equations.

 

Conclusion

           

While there is a lot of untapped potential in Hydroelectricity sector in Nepal, an investor seeking profit must do careful analysis before investing. There are good reasons behind why there has been so little progress in this sector in Nepal in the past. Although there seems to be more optimistic view lately, hydropower investment is still subject to many risks and uncertainties that are way beyond the control of any individual investor or an investment institution. The arguments in favor of investing in Nepal are the increasing demand, somewhat favorable tax reliefs, but there are equally important potential risks as discussed in the Findings and Discussion section.

 

References:

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