NEPAL > A quick guide for hydropower investors in Nepal

On August 27, 2014 by Santosh Thapa

The next big thing in Nepali capital market and overall economy is hydropower. The new entrants in Nepal Stock Exchange (NEPSE) are mostly hydropower companies. There will be at least 16 hydropower companies within two years. Currently, there are 6 listed hydropower companies in NEPSE.

With plenty of hydropower companies in the IPO pipeline, general investors may have trouble choosing the right company. As a part of investors awareness program, I believe this is the right time for me to write something about ‘what to look for’ while investing in hydropower companies. (Please view UPCOMING HYDROPOWER IPO IN NEPAL AND LESSON LEARNED FROM THE RECENT IPOs. to find out how many hydropower companies are in the IPO pipeline)

As we all know, hydropower is a pure science. When certain amount of water hits a turbine with a certain force, the amount of electricity to be produced is known. It is scientifically proven. And the generated electricity when multiplied by the Power Purchase Agreement (PPA) rate, then the total revenue for an entire period is known. Basically, this is how hydropower business works.

Sometimes, the so called ‘simple calculation’ fails and hydropower business is no exception. Below are the key things that should be taken into consideration while investing in hydropower companies.

1) Developers:- The reputation of developers is not so good in the present context. This is largely due to the absence of regulatory body in hydropower. No wonder, cost manipulation during construction is a common problem that exists in Nepal’s hydro. Many developers seem to be attracted by short term benefit. Thus, general investors should be more careful regarding the developers. Try to go for the developers with a good track record.

2) Management:- As I said earlier, hydropower business is a pure science. But the success and failure of the company largely depends upon its management. Whenever there is human involvement, synergy could be positive or negative. In real world, 1+1 is not always 2 as studied in old school days. Sometimes it could be more than 2 or less than 2. Hence, strong management with a diverse experiences/qualification is the ‘must’ in hydropower companies.

3) Project Location:- The project isolated from human settlement with all necessary infrastructures is an ideal project. This will help to reduce the competition arising from other usage of water e.g. Drinking water/Irrigation versus water for electricity generation. Although scheduling of water use to suite the situation has to be agreed by both project management and affected Village Development Committees beforehand, the competition may arise even after construction. To avoid this situation, project in isolated area is more preferable.

4) Catchment Area:- It is an area of land where surface water from rain and melting snow come to the project dam. In the context of Nepal, the catchment area with substantial area in the Himalayas (snow covered) is considered to be good. Those rivers with source from snow capped regions is called snow-fed river and is considered to be good for hydropower generation. This ensure decent amount of water during dry season.

5) Plant Load Factor (PLF):- The ratio of average loaded output to the installed capacity of the plant is called plant load factor. Almost all the projects in Nepal are run off the river (RoR) project. That means, no hydropower project will run in full installed capacity throughout the year. PLF is the percentage at which the hydropower plant operates compared to its full capacity. It represents the amount of electricity produced by the project. Currently, project with 60% or above PLF is considered to be acceptable. The general rule of thumb is ‘higher, the better’.

6) PPA rates and Project Cost:- PPA rates and project cost per MW alone will not give you the clear profitability picture as both are the relative terms. The current standard PPA rate for the projects below 25 MW is NPR 4.80 per kWh during wet season (8 months) and NPR 8.40 per kWh during dry season (4 months). Previously, it was NPR. 4.0 per kWh during wet season (8 months) and NPR 7 per kWh during dry season (4 months). Further before, it was 3.90 per kWh during wet season (8 months) and NPR 5.52 per kWh during dry season (4 months).

There are projects where PPA rate is 3.90 per kWh during wet season and NPR 5.52 per kWh during dry season and still giving handsome returns to its investors. That is because the cost of constructing project was also low.

The important factor here is to understand the relationship between the PPA rate and cost per MW. I have highlighted the ideal range in the following table.

PPA Rates Cost per MW
NPR 4.80 and NPR 8.40 PR 150-180 million
NPR 4 and NPR 7 NPR 120-160 million
NPR 3.90 and NPR 5.52 NPR 100-120 million

The above table is considered to be ideal. However, the general rule of thumb is ‘higher PPA rates with lower cost per MW’

7) Electro-Mechanical Equipment:- The recent experiences in Nepal’s hydro have forced me to keep this heading as one of the benchmarking technique. The reputation of Chinese machines these days are not so good. Chinese electro-mechanical equipment does not deliver efficiency which will directly hit the revenue stream. On top of that, the project has to pay penalty to NEA when it fails to supply less the 80 percent of the contract energy. Likewise, regular breakdown of the machinery is not unusual. These are common problems for most of the hydropower companies in Nepal that have installed Chinese machinery.

Alternatively, European machines like Andritz and Voith have a good reputation in the market.

8) Future Projects:- Hydropower project in Nepal is constructed under BOOT model. At the end of 30 years, the project has to be handed over to government. Thus, company with intention of constructing only one project should be avoided at all cost. Company holding multiple hydropower licenses is the ‘must’ for any investors.

9) Company’s Financial Plan:- This heading is more like a personal preference. Companies that provide regular dividend tends to have higher share price. I am always against the aggressive dividend policy. I believe, company should focus on developing new projects through its own resource rather than issuing right share. Issuing share means additional burden to company. (Please view Dividend policy to make hydropower projects more profitable. for further understanding). Typically, if a company adopts tight dividend policy then a hydropower project will have enough money to construct another same size project every five year. And those who maintain reserves tend to have higher share price in the long run, for e.g. Chilime Hydropower Company Limited.