The Chief Executives of Banks, Financial Institutions and Mutual Funds
Reg: Non-viability of hydropower projects in North-East India – a caution on lending
In the last few months, a rash of hydropower projects have been revived in the states of the North-East, particularly in Arunachal Pradesh. These projects are driven by the private sector and public-private partnerships.
This letter contends, in brief, that the hydropower projects in the North-East being proposed are entirely unviable, unless heavily subsidised during project implementation and operation (through artificially-induced premium pricing over its lifetime). The objective of writing this open letter is to caution the banks, financial institutions and mutual funds that invest in India’s infrastructure sector against investing in hydropower projects in the current energy scenario, and more specifically against investing in such projects in the North-East, due to the high, unacceptable risks
involved and financial unviability.
The concomitant larger national interests of this open letter are to caution against further non-performing asset creation in this sector and prevent further deterioration in the health of the State Electricity Distribution Companies (‘discoms’).
In brief, the argument against hydropower is listed below. The letter lists links to articles and reports from credible sources to back up the key points being made herein.
- Supply equal to, or exceeding demand in the foreseeable future: Over the next decade, the growth of solar, wind and efficiency investments for the energy sector, the commissioning of under-construction thermal and hydro projects, plus improved efficiency and plant load factors of existing thermal plants will match demand for energy, by all reasonable, realistic estimates. In the last eighteen months itself, power generation has exceeded demand, with peak power shortage being 0.7%. This supply glut will continue well into the decade, with the market for energy likely to remain saturated. The surplus is being driven particularly by the ramp-up in solar energy capacity, which is likely to continue. In 2019-20 alone, for instance, a cumulative capacity of 9.39 Gigawatt of solar energy has been installed (www.ieefa.org).
- Attractive pricing of solar energy (including solar-led energy for round-the-clock supply, at a 40-60% discount to thermal and hydropower): The exponential improvement in the efficiency of wind power and solar technology and reduction in raw material costs has meant that the price of solar modules has fallen 80% over just the past eight years, while the efficiency of wind turbines has increased to about 40%, from 25% just a few years ago. Consequently, winning bids at reverse auctions for energy sale are in the range of Rs. 2.44 to Rs. 2.60 per unit.
In a very recent reverse auction in May 2020 for the supply of 400 Megawatts by Solar Energy Corporation of India, the winning bid for round-the-clock power supply was Rs. 2.90 per unit (with 3% annual escalation) that would, over 15 years, have a levelized cost of Rs 3.55 to 3.60 per unit. The generation is expected to be led by solar energy but will include peak power supply through a combination of generation sources that include idle thermal capacity (Report in Mercom India).
Further, while storage technology today is expensive, at about Rs. 8 crores per Megawatt, it will see exponential efficiency improvement and price declines over the next five years due to scale and innovations that are currently underway. Mckinsey & Company predicts that “The total cost of energy-storage systems should fall 50 to 70 percent by 2025 as a result of design advances, economies of scale, and streamlined processes”. This substantially negates the justification for hydropower as the source of peak power requirements and the demand for energy from hydropower at higher tariffs is likely to be heavily impacted as a result.
- Financial Unviability of hydropower projects: Our analysis of one project, Etalin Hydropower (3097 Megawatts), confirms financial unviability; as the promoter company for this project, Jindal Power, has no earlier experience in hydropower, we have considered operating metrics from NHPC – a PSU mini-ratna – to aid in comparison, after appropriate considerations for scale and efficiency, and determined cash flows over the loan life-cycle of 23 years (5 years of moratorium on loan repayment and 18 years of subsequent loan servicing).
Note: In this financial analysis, we have not considered a glacial or seismic event, the financial impact of which could be debilitating, both for the project and the lenders. More on this in the next point.
In essence, at the end of 23 years, our analysis shows cumulative negative cash flows, despite a highly favourable levelised tariff of Rs 4.32 per unit. Over 70% of the estimated revenue generation will go towards debt servicing, which indicates poor debt service coverage. At the opportunity tariff available today for round-the-clock power supply, the project will be unable to even service the loan.
- Real & present risks of a geological accident: There are two serious, and entirely underestimated, risks in having hydroelectric projects in the Himalaya in general (Arunachal Pradesh, in particular) as detailed below:
Risk of landslides, mountain slippage and seismic activity: Serious accidents during the construction and operational life of hydropower projects in the Western and Eastern Himalaya have been common. For instance, there have been landslides, heavy soil erosion and damage to houses and property near the site of the Teesta III project in Sikkim in recent years. These are often triggered by underground blasting and tunnelling for hydropower projects, and by forest destruction. The June 2013 flooding in Uttarakhand damaged at least 10 large hydropower projects in operation and under construction. A study by the Institute of Earth and Environmental Sciences, University of Potsdam, Germany, estimated that at least 25% of hydropower projects in the Indian, Nepalese and Bhutanese Himalaya are likely to face severe damage from quake-triggered landslides.
Arunachal Pradesh is categorised as Zone V (at maximum risk) in the mapping of seismic zones in India and there is recent history of numerous quakes above 5 on the Richter, including one with its epicentre in the Mishmi hills that killed at least 4,800 people.
A study by a geographer specialising in the geology of the region states that “Extreme rainfall events in 2015-2016 completely destroyed villages downstream from the Dibang, in Lower Dibang district. Hydroelectric dams on such rivers can significantly exacerbate the problem.” (Chintan Sheth)
Risks from glacial melt and lakes: The report by Chintan Sheth, in its assessment of Etalin Hydro also states that “The risk of such projects upstream closer to glaciers and glacial lakes, is extremely high due to the unpredictable nature of the volume and flow rate during glacial lake outburst floods.” Even if the dam acts as an effective barrier, the energy release in the downstream flow increases rapidly, posing grave risks to populations living downstream. As a further – and more recent example - it was reported that, during the monsoons of 2019, a cloud burst in Sikkim forced the release of water at the Teesta Dam III project site, resulting in flooding and washing away of road and bridge infrastructure, and severely damaging a number of villages. As hydropower projects have a purported life of 50 to 70 years, these risks and the unintended consequences of any seismic or glacial event are unacceptably high.
- Project delays and inordinate gestation period: A hydropower project in Arunachal Pradesh will, realistically, take eight to ten years or more to be operational, after considering terrain, monsoon activity and the clearance of forest cover. In the case of the proposed Etalin hydropower project, the user agency itself estimates a minimum of 7 years and, for long-gestation hydropower projects, delays are the norm, not the exception. What is more, projects that were revived in recent months (after being announced years ago) have been delayed for a variety of reasons outside project management control, including strong protests by local communities.
Such a gestation period should be unacceptable for lenders, particularly since the future pricing is likely to be way above market price and the demand scenario uncertain: the market for energy in 2030 or beyond cannot, with the best of analyses, be projected with any degree of certainty and it is vital to be flexible and nimble in choice of technology, rather than get locked in to a further quarter century of energy pricing from 2030 (as will be the case with any hydropower project that is now approved in Arunachal).
- Non-compliance with standard social governance norms and negative impacts on downstream riparian states: Hydropower projects in India have a notoriously poor record of protecting the local communities and their livelihoods. These communities therefore legitimately, fear displacement with poor rehabilitation or serious collateral damage to livelihoods. The Lower Subansiri project, for instance, began in 2005 and was due to be operational in 2010, but is still stuck for the above reason and is now incurring an estimated loss of Rs. 100 million (Rs 10 crore) every single day.
As far as states are concerned, these projects have significant and unaccounted trans-boundary impacts that range from flooding and associated crop damage, loss of fishing livelihoods of those living downstream and several other, often unintended, effects. In many of these projects, lower Assam is likely to be most impacted. It is our contention that hydropower projects in the North East do not pass even the most basic tests of social responsibility checklists that financial institutions and bondholders seek from their borrowers/investee companies.
- Hydropower projects will lead to further deterioration in discom finances: As discussed earlier, the Etalin hydropower project analysed over its life cycle shows cumulative negative cash flows, despite a highly favourable levelised tariff of Rs 4.32 per unit. Considering trends in energy innovation and future pricing, by 2030, when the project is operational, the pricing of Rs 4.32 per unit is likely to render the project a stranded asset. Indeed, recently the CEO of Jindal Power himself expressed doubts about project viability stating that, “In the current situation, the project doesn’t look like an attractive investment in view of the huge investment. Further, it is a large project and we feel we’ll struggle to find long-term buyers for the entire capacity but policy support from the government can make the project viable and draw investors.”
If, as the company CEO suggests, the Government supports the project by mandating a Power Purchase Agreement at the levelized price of Rs 4.32, we estimate an implicit subsidy (considering current opportunity options available) of about Rs. 11,480 crores.
There is a high possibility that discoms might reverse their commitment to purchase power at premium prices, as has been evidenced in the offtake process of the Teesta III project, where some states have refused to buy high-cost energy. As you are aware, the condition of India’s State Electricity Distribution Companies is abysmal. The outstanding dues from the discoms to generators, as of December 2019, was INR 88,177 crores and the Government has been forced to support them in the recent financial reforms package announced in May 2020.
This is ultimately funded by the taxpayer, as will be the case with artificially-set premium power tariffs that seem to be the only way for a hydropower project to be viable. Equally, private hydropower players are, and will continue to be, heavily impacted with high Accounts Receivables, resulting in defaulting of interest and principal repayment to the banking sector.
It is our contention that, instead of providing subsidies to the power-generation value chain, Government policies that encourage power conservation and saving (such as versions of ‘surge pricing’ during peak hours), reduction in distribution losses and efficient utilisation of existing energy infrastructure should be immediately actioned. Energy conservation technologies are known to generate significantly higher project returns over life-cycles than generation. In addition, roof-top solar – with the innovative idea of solar cities powered by rooftop solar mooted by the Honourable Prime Minister on numerous occasions - and the PM-KUSUM scheme launched by the Ministry of New and Renewable Energy (MNRE), Government of India, could be two of a number of energy technology and policy innovations in the coming decade, turning energy economics on its head.
Hydropower has played a useful role in meeting India’s past energy needs, but such projects in the North-East have a high probability of financial failure and of triggering natural disaster. Such an impact will cascade through the system, as is currently the case with discoms.
For all the above reasons, this communication urges your institution/fund to redouble your due-diligence and take appropriate funding decisions to protect the investor community and the lending ecosystem in the country and abroad.
This open letter has been written as a summary of detailed deliberations between a group of concerned Indian professionals with domain expertise in banking, energy investments and energy economics.
1. Energy supply-side projections have been detailed in the report titled ‘The Price of Plenty’ – by Prayaas (Energy Group), arguably the most credible independent team analysing the energy sector.
Surplus power here to stay
Today, more and more industrial consumers are migrating away from distribution companies and directly obtaining power from generators of their choice. Additionally, renewable energy capacity, which is not usually backed down, is growing rapidly with falling prices. Therefore, surplus power with distribution companies is bound to grow and substantial thermal capacity will be backed down in the near future.
Already, several recently commissioned plants are being backed down across states. In fact, distribution companies in Gujarat and Maharashtra have even projected backing down of power plants that are yet to be commissioned in the coming years. It is safe to say that many of the
recently contracted plants are being built only to be backed down.
Unless urgent attention is given to the management of surplus power, it will join the ranks of excessive transmission and distribution losses and excessive cross subsidies as one of the intractable, long standing problems before the electricity distribution sector in India.
May 30, 2017. Report accessed on May 20th , 2020
The major reason for the sustained surplus power is quite simply the massive capacity addition in the past decade, justified on the basis on high anticipated demand growth.
Great expectations and their consequences
In the past decade, India has seen a significant addition of thermal power capacity – of about 132 gigawatts. This is 1.64 times the installed capacity in 2007. Much of the capacity addition in the past decade was justified on the basis of high projected demand growth. Most State Electricity
Regulatory Commissions have regulations to ensure power procurement is based on realistic demand forecasting by distribution companies.
However, distribution companies rely on medium-term and long-term demand estimates of the Central Electricity Authority, published as part of the Electric Power Survey every five years.
Over the decades, Central Electricity Authority projections have continually over-estimated demand by 30% to 40% for long-term projections. Due to revisions every five years, the demand projections are regularly tempered, but future demand is still based on unrealistically high
June 2nd, 2017. Report accessed on May 20th 2020.
2. Who Would Still Fund a New Coal Power Plant in India? Report by the Institute for Energy Economics and Financial Analysis. May 2020. Report accessed on May 19 th 2020.
3. https://mercomindia.com/renew-power-seci-round-clock-renewable-tender/ May 8th, 2020. Report accessed on May 21st , 2020.
4. Mckinsey & Co: The new rules of competition in energy storage by David Frankel, Sean Kane, and Christer Tryggestad. April 2018.
5. Report by Institute of Earth and Environmental Science, University of Potsdam, PotsdamâGolm, Germany, quoted in Down to Earth. Report accessed on May 21st 2020.
6. The August 15, 1950 earthquake measured 8.6 on the Richter scale, and killed at least 4,800 people and devastated north-eastern India as well as a large part of Tibet had its epicentre at the Mishmi hills in Lohit district of Arunachal Pradesh.
Data collated from the US Geological Survey and the Incorporated Research Institutions for Seismology (IRIS) shows that the region has witnessed numerous quakes above 5 on the Richter scale since 1900. The number would go up if quakes below that intensity were considered.
7. Study by Mr. Chintan Sheth, a professionally-qualified geographer specialising in the region around the Dibang valley (where India’s largest hydroelectric project is now at approval stage).
The study notes that “Arunachal Pradesh and specifically Dibang valley are part of a seismically active geological region. The mountain building process is ongoing and excessive strain is building up between geological layers. Earthquakes relieve this strain periodically, however, there are cases wherein large earthquakes do not completely relieve this strain, and are followed by an even larger earthquake. Arunachal has been victim of such an earthquake in 1950 that was preceded by a large earthquake in 1947 that did not release enough strain. The April 2015 Gorkha earthquake that killed 9000 people was also one such earthquake that did not release enough strain. It is anyone’s guess where the next great earthquake is expected to strike in the Himalayas.”