Why hydropower needs a push

Despite being an important and cheap source of clean and renewable energy, hydropower's share in India's energy mix has been declining

Hydropower has clear economic, social and systemic advantages. Fuelled by water, it is clean and renewable compared to fossil fuels. It is among the cheapest sources of energy. It can be operated for base loads as well as peak loads. Hydro projects have enormous socio-economic benefits for local populations and surrounding areas. Worldwide, at least 66 countries generate more than half of their power from hydro. In neighbouring Bhutan it accounts for 40 per cent of exports and 25 per cent of GDP. 

Yet, hydropower is neglected in India — of the total potential of 142 Gw, capacity created is only 45 Gw. The private sector has been averse to investing in hydropower (its share is under 10 per cent) and lenders are reluctant to lend. In the last three five-year plans hydropower capacity addition was a meagre 17 Gw. New capacity likely to be added by 2022 is about 11 Gw, but construction is not progressing on schedule. 

Most hydropower projects in India are stressed owing to neglect by governments and other stakeholders; thermal power projects, by contrast, are stressed despite governmental support. Unfortunately, the policy, regulatory, financing and implementation frameworks have not measured up to the distinctive characteristics and complexities of hydropower projects. Hydropower lost out first to coal-based capacity, and then to wind and solar power capacity. Government policy for the resurrection of hydro projects has languished for more than two years.

A case often made out against hydropower is its high generation cost of Rs 5.5-6.5 per unit, compared to discoms' average procurement price of Rs 3-3.5 and the newly discovered tariff of Rs 2.5-3.5 for wind and solar power. This assertion, though correct, ignores the reality that hydropower’s high generation cost is primarily due to unusually high cost over-runs. Interest on debt during construction often constitutes 30-40 per cent of the project cost. Free power given to state governments as royalty, high soft costs (because of risks and complexities) and high financing charges add to this cost. These cost elements are controllable. Further, on a comparable basis, the social cost of solar and wind power according to Economic Survey 2016, is Rs 11 per unit. In any case, in the longer run, the world over hydropower is the cheapest source of energy, apart from its direct and indirect economic benefits. Bhakra power, for example, currently costs less than 30 paisa per unit.

India’s hydropower potential has been estimated at 142 Gw, but capacity created so far is only 45 Gw

The need for hydropower, independent of its cost, is undisputed for system integration. The proposed addition of 175 Gw of renewable power by 2022 will lead to significant grid integration, balancing and adequacy cost. To fulfil India’s Intended Nationally Determined Contribution (INDC) and reduce its carbon imprint, an additional hydro capacity of 35 Gw will be needed by 2027. However, capacity under construction is only 11 Gw. A holistic approach addressing policy, regulatory, financing, infrastructure and implementation issues in hydropower is therefore urgently needed.

The first and foremost challenge is to avoid time and cost over-runs caused by lack of infrastructure and difficulties faced in land acquisition, resettlement and rehabilitation. These projects are in hilly and difficult terrain. State governments are better-placed to acquire land, develop local infrastructure, obtain environmental and forest clearances, and resolve resettlement and rehabilitation issues. State governments should develop entire river basins and then award hydro projects upstream and downstream. This will cut initial capital costs and facilitate timely implementation, eliminating the root cause of high generation costs. The experience of solar park development, bringing together the Union government, state governments and local implementation agencies for integrated infrastructure development, should be replicated. If this is done, it may not be difficult to source debt and equity funding from domestic and foreign sources. The joint venture approach followed so far has not been very successful. In many cases, the government has not given its equity contribution or has delayed it.

The financing requirements of hydropower projects are different from those of wind/solar projects and, therefore, need a different approach. Hydro projects invariably suffer time and cost over-runs of up to 100 per cent or more. Currently, more than 11 Gw of projects are languishing with cost over-runs exceeding Rs 500 billion. Lenders ignore hydropower projects’ distinctive requirements and projects thus remain under-funded. To avoid such situations, lenders should ascertain contingencies such as geological surprises or local uncertainties and assess their financial impact.

The debt sanction should then be in two parts — part one involving debt sanction for project cost under normative conditions, and part two covering debt sanction to meet contingencies. Such two-part funding, in vogue in other countries, would safeguard the project from uncertainty and delays presently being encountered by hydro projects in obtaining debt later. Further, debt should have a tenor of 30-35 years and should be back-loaded, since hydro projects typically have a life of more than 50 years. Capital costs should be allowed to be recovered over the life of the project. Development of a market for long-term bonds and institutions like infrastructure debt funds would further facilitate cost reduction through refinancing, once the project is operational and free from most risks.

It is impractical for hydropower projects to sign power purchase agreements before financial closure since these projects have long gestation periods and costs remain indeterminate until commissioning is near. Lenders are, therefore, wary of off-take risk and do not encourage lending. The government needs to ensure, as stated in the Tariff Policy 2016, procurement of at least 60 per cent of power at normative cost. In addition, hydro projects irrespective of their size should be treated as renewable power and a separate purchase obligation prescribed. This would help in promoting the market for hydropower.

Hydropower’s share in India’s energy mix is declining. However, it is an important and cheap source of clean and renewable energy. With mounting stress in existing hydro projects and ambitious targets for additional wind and solar power, which are uncertain, the government needs to be more pro-active at every stage of development of hydropower, as in the case of solar power. Further delay would hurt the power sector as a whole.   

The writer is former MD & CEO, PTC India Financial Services