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Secretariat of the World Commission on Dams P.O. Box 16002, Vlaeberg, Cape Town 8018, South Africa Phone: 27 21 426 4000 Fax: 27 21 426 0036. Website: http://www.dams.org E-mail: info@dams.org
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Disclaimer
This is a working paper of the World Commission on Dams - the report published herein was prepared for the Commission as part of its information gathering activity. The views, conclusions, and recommendations are not intended to represent the views of the Commission. The Commission's views, conclusions, and recommendations will be set forth in the Commission's own report. Please cite this report as follows:
Ljung, P., Head, C., Sunman, H. Trends in the Financing of Water and Energy Resources Projects, Thematic Review III.2 prepared as an input to the World Commission on Dams, Cape Town, www.dams.org.
Country Studies
India China
Briefing Paper
Russia and countries NIS
Thematic Reviews
TR I.1: Social Impact of Large Dams: Equity and Distributional Issues TR I.2: Dams, Indigenous People and Vulnerable Ethnic Minorities TR I.3: Displacement, Resettlement, Rehabilitation, Reparation and Development TR II.1: Dams, Ecosystem Functions and Environmental Restoration TRII.1: Dams, Ecosystem Functions and Environmental Restoration TR II.2: Dams and Global Change TR III.1: Economic, Financial and Distributional Analysis TR III.2: International Trends in Project Financing
TR IV.1: Electricity Supply and Demand Management Options TR IV.2: Irrigation Options TR IV.3: Water Supply Options TR IV.4: Flood Control and Management Options TR IV.5: Operation, Monitoring and Decommissioning of Dams TR V.1: Planning Approaches TR V.2: Environmental and Social Assessment for Large Dams TR V.3: River Basins Institutional Frameworks and Management Options TR V.4: Regulation, Compliance and Implementation TR V.5: Participation, Negotiation and Conflict Management: Large Dam Projects
Regional Consultations Hanoi, Colombo, Sao Paulo and Cairo Cross-check Survey of 125 dams
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Acknowledgements
This paper is one of 17 thematic papers being prepared as input into the WCD process. Per Ljung was the lead writer. Chris Head contributed most of Chapter 5 and Hilary Sunman most of Chapter 3. Manrique Rojas, Bruce Aylward and Sarah Porter contributed by collecting and analysing data on financing trends for the paper. Lily Donge and Chaminda Rajapakse also contributed to data collection and analysis. A number of individuals and organisations responded to the Commissions invitation to provide views and insights on this topic from a stakeholder perspective. A list of these submissions is provided in Appendix 2. John Besant-Jones and Donal OLeary provided valuable comments on a work in progress draft that was placed on the WCD website prior to the April 2000 WCD Forum meeting. A number of constructive comments on the formal review draft (placed on the WCD website on May 24, 2000) were received from the following members of the review panel: John Besant-Jones Bob Crick Janak Karmacharaya Ruth Meinzen-Dick Peter Bosshard Shripad Dharmadhikary Steve Rothert The lead writer has endeavoured to respond to all comments received by the closing date and takes responsibility for any remaining errors or omissions. The WCD Secretariat has reproduced the full text of the review panel comments in Appendix 3 in order to ensure that all views are available to stakeholders in the debate and that the process is fully transparent.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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ABB ADB - Asian Development Bank AID - Assistance for India's Development Atlas Copco Australia - AusAID Berne Declaration British Dam Society Canada - CIDA Carnegie Foundation Coyne et Bellier C.S. Mott Foundation Denmark - Ministry of Foreign Affairs EDF - Electricit de France Engevix ENRON International Finland - Ministry of Foreign Affairs Co-operation Goldman Environmental Foundation Zusammenarbeit Halcrow Water Harza Engineering Hydro Quebec Novib David and Lucille Packard Foundation Paul Rizzo and Associates People's Republic of China Rockefeller Brothers Foundation
Skanska SNC Lavalin South Africa - Ministry of Water Affairs and Forestry Statkraft Sweden - Sida IADB - Inter-American Development Bank Ireland - Ministry of Foreign Affairs IUCN - The World Conservation Union Japan - Ministry of Foreign Affairs KfW - Kredietanstalt fr Wiederaufbau Lahmeyer International Lotek Engineering Manitoba Hydro National Wildlife Federation, USA Norplan Norway - Ministry of Foreign Affairs Switzerland - SDC The Netherlands - Ministry of Foreign Affairs The World Bank Tractebel Engineering United Kingdom - DFID UNEP United Nations Environment Programme United Nations Foundation USA Bureau of Reclamation Voith Siemens Worley International WWF International
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects
Executive Summary
The Setting During the 1990s, dramatic changes occurred in the manner infrastructure facilities in the developing world1 are financed, built and operated. Strapped for financial resources and realizing that infrastructure bottlenecks hampered economic growth, governments started to change their roles from service providers to regulators and facilitators of private investments. Thus, there is now a global trend towards liberalization and greater reliance on market forces and competition as a way of improving the quality of infrastructure services while lowering the cost to the consumers. New entrants are being allowed in areas previously reserved for the public sector. The monolithic state owned utilities are being unbundled and privatised. Companies from both industrialised and developing countries have responded rapidly to the new opportunities and have invested heavily in both greenfield projects and in buying and improving privatised utilities. Commercial lenders have adapted the project finance model previously reserved for foreign exchange earning mining and hydrocarbon projects to fit projects getting their revenues in local currencies. Private investments in infrastructure projects increased eight-fold from 1990 to reach $120 billion in 1997. For the decade as a whole, private infrastructure investments in developing countries were close to $600 billion. Purpose of the Review Paper Very little of this money was devoted to the construction of dams. Indeed, while infrastructure investments in developing countries expanded rapidly during the 1990s, it appears that fewer dams are being constructed now than in the 1980s. To explain these contradictory trends, this thematic review paper seeks to: Describe recent international trends in financing for water and energy resources projects, focusing on dams and the associated non-dam options. Highlight the main features of the project financing approaches and models that are emerging in different regions and settings. Review the key implications relevant to the mandate of the World Commission on Dams (WCD).
A basic premise of the report is that all infrastructure projectswhether public or privateshould be economically viable and social and environmental impacts should to the extent possible be avoided, minimised and mitigated. Investments in Dams and Public Sector Financing During the 1990s, annual investments in large dams in developing countries were in the order of $2231 billion, or slightly less than half of the total investments in water related infrastructure.2 Some $12-18 billion were devoted to the construction of hydropower plants, $8-11 billion to irrigation reservoirs and a couple of billion dollars to water supply and flood control dams. Industrialized countries appears to have invested $7-10 billion in hydropower and $3-5 billion in dams built for other purposes. Total annual investment in large dams in the 1990s was therefore on the order of $3246 billion. Considering the rise and fall of the pace of dam-building over the last half-century, an estimate of total expenditure during this period on large dams is $2 trillion. The multilateral and bilateral development agencies have traditionally been a major source of financing for large dam projects in developing countries. Over the last decade, however, overall aid flows have declined in real terms and most donors have expanded the share of their assistance devoted to social sectors and quick disbursing non-project lending. Greater awareness of the social and
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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environmental consequences of large dams has made most donors reluctant to finance projects that involve dam construction and resettlement. The Asian Development Bank, for example, has not financed an irrigation reservoir since 1989. Its lending for power paints an equally striking picture. In the 1970s, 28% of its power sector lending was for the construction of hydropower plants. In the 1990s, this share had fallen to less than 8%. Although the decline in lending for dam projects by the World Bank and the other regional development banks has been somewhat less drastic, the basic picture is similar. There are a number of reasons why this decline has occurred: Environmental and social (safeguard) policies have become more explicit and comprehensive. Internal review processes have been strengthened (the World Bank, for example, has appointed an external Inspection Panel which can review the compliance by staff and managers with the Banks policies and procedures). Lending policies, especially in the power sector, seek to promote reform and encourage governments to bring in the private sector. Greater emphasis is being placed on sound macro-economic policies and reduction in poorly targeted subsidies (for example, the large subsidies typically associated with public sector canal irrigation schemes). Country strategies focus more on poverty alleviation and environmentally sustainable development, which has increased the emphasis on energy efficiency, renewable energy sources as well as involvement of the beneficiaries in small scale infrastructure projects such as rural water supply and irrigation management.
At present, the donor community appears to be providing only around $2.5 billion a year (on average) for dam related projects (i.e. about 8% of total dam finance). This compares with peak levels of financial assistance that reached over $4 billion (in 1998 prices) during the late 1970s and early 1980s. Export credit agencies (ECAs) in aggregate provide greater amounts of funding for developing countries than the World Bank and the regional development banks together. Although some of the ECAs can provide financing for local costs, the bulk of their loans and guarantees support exports of goods and equipment. The amount of imported equipment installed in irrigation and water supply dams is minor. In most developing countries, however, imported generating equipment amounts to around 30% of the total investment cost in hydropower.3 Based on fragmented data from a few agencies and considering the needs of imported equipment, it can safely be assumed that the ECAs annually provide less than $1.5 billion for various types of dams in developing countries. State-owned utilities, government departments and agencies provide more than four-fifths of the needed funds. However, all indications are that, in real terms, the amount provided by public agencies has declined since the 1980s. There are several reasons for this trend: Macro-economic stability and reducing budget deficits have become key concerns for public policy makers. At the same time, greater emphasis is being placed on social sector expenditures, especially for health, nutrition and education. This means that less funding is available for infrastructure investments. Since the 1970s, the financial performance of many power utilities has declined and their ability to finance investments utilising their own resources has correspondingly declined. Although this trend is being reversed, self-financing is still difficult and, for the reasons given above, governments are no longer able to provide as large contributions to investments. Since the cost of thermal generation has declined more rapidly than the cost of hydropower development, there has also been a shift in the investment programs towards thermal generation. Cost recovery has always been a major issue in surface irrigation schemes. Typically, water charges cover little more than the O&M cost of the schemes (reportedly, there are cases where the
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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charges are even less than the cost of collection). Thus, financing for irrigation dams and related canal infrastructure has traditionally been provided by the treasuries who nowadays have less ability to do so. Furthermore, there is widespread disillusionment with the performance of canal schemesin terms of efficiency of water use, water logging and salinity, and the high cost per beneficiary. As a result, greater emphasis is placed on groundwater development and improving the performance of existing schemes. Tariffs for urban water supply and sewerage schemes typically cover only one-third of the cost of providing the services. Governments find it increasingly difficult to provide the resources that are needed to keep up with a rapid pace of urbanisation.
Faced with these financial constraints, governments have turned to the private sector to get help in improving the performance of the previously state-owned utilities and in mobilising the needed financing for both dams and non-dam options. Nature and Implications of Infrastructure Reforms In the power sector the reform process involves a number of elements: corporatisation of the utility, reform of the legal framework, establishing a regulatory authority, encouraging independent power producers (IPPs), un-bundling the main utility and selling off its generation and distribution assets. The pace and sequencing of reforms varies significantly with Latin America having advanced the furthest. Most countries are moving towards the following structure: a number of mostly privately owned generating companies that compete based on price; a private or state-owned national grid company responsible for high voltage transmission; a number of privately owned regional distribution companies that operate as regulated local monopolies; and a regulatory authority. Especially in Asia, the first entry of the private sector has been through IPPs that are special purpose companies established to build, own and operate power plants. Such schemes are often referred to as BOO (build-own-operate) projects. In many cases, the private company is required to transfer ownership of the plant to the state utility at the end of a 20-30 year concession period (thus, the acronym BOT which stands for build-operate-transfer). A number of issues have arisen as a result of the reforms related to: impact on the poor and on energy efficiency and pre-commercial emerging technologies; the sequencing of reforms and governments ability to regulate the sector; corruption and nepotism; staff reductions and employment security; and loss of sovereignty and societal control over key development assets. Arising out of these concerns is a set of recommendations that can be summarised as follows: As power sector restructuring proceeds, there is an increased need for a more elaborate and articulate sector policy. The power sector needs to be treated within the framework of an overall energy policy which deals with issues such as import and export of energy (taking into account the emergence of regional gas and power grids) and the development of indigenous and renewable energy sources. The power sector policy also needs to address rural electrification, establish guidelines for the regulator and develop instruments to influence the behaviour of the enterprises in the sector. Policymaking has to be a continuous, transparent process where all stakeholders are given a voice. It cannot be a one-shot exercise carried out by foreign consultants. At present, most developing countries lack this capability and the multilateral and bilateral donors have an important role in building up local capabilities through training and technical assistance. While the government still owns the vertically integrated utility, societal objectives can be directly incorporated in the utilitys investment program. Similarly, when the private sector role is limited to greenfield projects operating under long-term contracts with the utility, broader social and environmental concerns can be incorporated into the solicitation/bidding process. In a decentralised system, policies and regulatory frameworks that determine the playing field for different options and the institutional capacity for developing and enforcing regulations assume a
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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paramount role in ensuring that societal objectives are met and that the projects are financially viable from the developers perspective. Environmental and social/resettlement issues need to be explicitlyand transparently incorporated into the process that grants concessions to private operators. Criteria and guideline in this respect are emerging from other WCD thematic reports. In power generation, tariffs should account for not only the premium value of energy supplied during peak demand periods but also the value of the ancillary benefits that hydropower can provide for system management. A special policy framework, streamlined approval processes and simplified power purchase agreements are needed to encourage local entrepreneurs to invest in small scale hydropower projects. Related to other options, the government should rely primarily on general incentives such as import duties and taxes in addition to environmental and social impact regulations. Some form of public-private partnership is virtually always required for multi-purpose schemes and might be justified for different types of dams and non-dam options to ensure that societally beneficial schemes offer a competitive risk/rate of return relationship to private capital. The form of partnership is likely to vary from case to case, but schemes like the Casecnan irrigation-cumpower generation project in the Philippines show that appropriate solutions can be developed. Most private investors in power schemes in the developing world have been responsible in meeting internationally acceptable standards for environmental mitigation. In most cases, they have acquired the land for their facilities through open market purchases and provided proper compensation to the former owners.4 There is also an emerging best practice adopted by some project sponsors in providing economic and social development programs for the people living in the vicinity of the facility. In the case of hydropower development, however, both private and public sector schemes have proven to be highly controversial and a number of high schemes have been stopped. A major reason for this is the general lack of widely accepted norms for minimisation and mitigation of environmental and social impacts of dam projects. It is likely that most developers in power facilities would conform to any guidelines that emerge from the WCD process since doing so would reduce project risks and increase the likelihood that the project can be financed at reasonable terms. However, private companies are likely to find it difficult, if not impossible, to acquire large tracts of land and resettle hundreds or thousands of families. They (and their financiers) are likely to insist that the government provide the land with no encumbrancesprior to start of construction. Given that the land acquisition and resettlement process for public sector projects usually isnt completed until the filling of the reservoir is about to occur, this will significantly increase the time required for the development of major hydropower projects in the private sector. Lenders and project sponsors have realised that long-term power purchase contracts will not necessarily protect them against political and economic shocks like in Indonesia and Pakistan. This means that increased emphasis is given to the economics of the project (low cost producer) and the regulatory framework. The main implication of this is that countries without a proper regulatory framework are less likely to be able to mobilise private financing for power projects.
In the water and sanitation sector the basic approach rarely involves straight out divestiture. Rather, the most common approach is to have a private operator take over management and operation of an existing system and assume responsibility for future investments for expansion and quality improvements. For larger cities, the emerging model is to divide the service area into two concessions in order to get competition by comparison. In essence, however, the concessions are regulated monopolies. As in power, Latin America is leading the way in water sector reform. A number of greenfield projects for major facilities like water or sewerage treatment plants and longThis is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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distance water conveyance have also been built as BOO/BOT schemes. The key implications and recommendations related to the restructuring trends in the urban water and sanitation sector are: Given that the responsibility for rural water supply in most countries is separate from that for urban water supply, the impact of private concessions for urban water supply and sewerage on rural consumers is negligible. Indeed, as the urban concessions reduce the need for subsidies, the privatisation process might even give governments an opportunity to focus more financial and technical resources on rural water and sanitation schemes. Urban water supply and sanitation is a more heterogeneous service than, for example, power supply. Especially in the large cities in low income countries, only a small fraction of the population is served through house connections and those households lucky enough to have a connection tend to get water only a few hours a couple of times a week. Others are served through public standpipes. Many urban dwellers, if not the majority, buy water from vendors, tanker trucks or have their own wells. On the sanitation side, typically even a much smaller number of households are connected to the sewerage system, and only a small share of the sewerage is properly treated. Thus, a regulator has to be able not only to determine the appropriate tariff level for different types of service but also to provide the right kind of balance between environmental, social and commercial objectives. Unfortunately, because privatisation has been done on a city-by-city basis, the need for a proper regulatory regime has often been neglected. Given the very direct impact that a regulators and concessionaires actions have on the quality of life in urban neighbourhoods, the need for transparent regulation and popular participation in the process is probably greater in the water supply and sanitation sector than in the power sector, and greater and more difficult in developing countries than in industrialised countries. Consequently, it is essential to develop the regulatory regime prior to any privatisation transaction. Even if they dont involve building dams, the construction of urban water and sewerage facilities can be very disruptive and involve significant land acquisition and resettlement. Thus, major water and sewerage works should be subject to similar environmental and social guidelines and approval processes as dams.
Large-scale irrigation schemes serving smallholders are rarely financially viable and often fall short of physical and economic targets. Consequently, they are likely to remain a government financed and managed activity. The reforms in the irrigation sector are thus focusing on involving the project beneficiaries in the design (still rare) and operation and maintenance of the schemes. The approaches followed are very similar to those adopted for small-scale infrastructure facilities described below. Private companies owning major estates producing flowers, fruits, vegetables or other cash crops have occasionally built dams to provide year-round irrigation. Since irrigation represents a much greater consumptive use than hydropower and water supply, the issues related to riparian rights (and social/economic equity) are critical. This implies the need for a transparent concession process. Flood control is almost a textbook example of a public good and basically falls within the purview of governments. Conceptually, there is a switch in focus from flood control to flood management. There are a few isolated cases, as under the private infrastructure initiative in the UK, where the private sector has been brought in to build and maintain flood control facilities. The structure of such projects is most akin to long term lease agreements where the government defines where, when and how a facility will be built and pays a fee for the service. Such private facilities should be reviewed, approved and monitored along the same lines as publicly owned facilities. The changing role of governments, however, is not limited to private sector participation in the financing, construction, operation and ownership of large-scale infrastructure facilities as described above. An equally fundamental shift is occurring in the development of small-scale infrastructure facilities in rural areas and in poorer neighbourhoods in cities and towns.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects
It has been clear for a long time that participation by beneficiaries and grass roots institutions is critical for the long-term success of many types of development projects, especially small-scale infrastructure schemes in rural areas. All over the world, NGOs have worked with local communities and put in place mechanisms that ensure both that the poorest segments of the population benefit and that the results are sustainable. Until the early 1990s, most governments continued a top down, army type of approach to the development of renewable energy sources, village water supply, irrigation management and similar activities. The multilateral development banks and many bilateral donors found it difficultif not nearly impossibleto reach down to the grass-roots level. Over the last decade, however, many governments have redesigned their rural development and squatter upgrading programs and the donor community has found ways of working with NGOs and designing projects that fully involve the local community and project beneficiaries. While both governments and donors have a long way to go, the movement is certainly in the right direction. The modalities vary significantly from one case to another depending on the type of development activity being undertaken, the strength of government and civic institutions, culture and local traditions. It is beyond the scope of this paper to review these approaches and to make recommendations. However, several successful examples and recommendations are provided in the various options papers prepared for the WCD and in documents such as the World Banks Participation Sourcebook. A couple of issues are especially relevant in the context of the present paper: These grassroots activities need to be explicitly incorporated into the relevant national sector policies. The relationship between local community initiatives and the programs of utility companies needs careful consideration by governments, regulators and concessionaires. There are numerous questions that must be addressed. How do community groups working on improving urban squatter settlements interact with the water utility? What kind of financial and technical support should be provided by the utility? Are the concession contracts for regional electricity distribution companies expressed in such a way that NGO sponsored village electrification programs are prohibited? There are many more questionsmany of which cannot be anticipated when the rules-of-the-game are established for privatised utilities. This means that there has to be a transparent, highly participatory regulatory process for dealing with this kind of issues as they arise.
Implications of the Project Finance (Non- or Limited Recourse) Model The preferred way of financing private infrastructure schemes in the developing world is project finance. This means that the repayment of the financing relies on the cash flow and the assets of the project itself rather than on the strength of the sponsors balance sheet. The risks (and returns) are borne not by the sponsor alone but by the different participants in the projects. Non-recourse financing implies that the lenders to and investors in the project do not have any direct recourse to the sponsors, for example through loan guarantees. Although creditors security include the assets being financed, these assets tend to be illiquid and of limited value as collateral. Thus, the lenders rely on the operating cash flow generated by the project. Sometimes, lenders have limited recourse to the sponsors. Such recourse often involves some form of pre-completion guarantee by the sponsors. In either case, the project needs to be carefully structured to ensure lenders that it is economically, technically, environmentally feasible and that it is capable of servicing the debt under most reasonable scenarios. Crucial to the successful structuring of a project financing is the identification and mitigation of risks. These risks are allocated among the project participants through a comprehensive set of legal documents, usually referred to as the security package. In projects following the BOO/BOT model, a long-term off-take agreement with a government entity that buys the output, is typically a central part of the security package. An implementation agreement (or concession
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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contract) defines the rights and obligations of both the government and the concessionaire. Some of the critical elements in most implementation agreements are the governments commitments to: (i) (ii) (iii) make up for any shortcomings in the performance of the public agency that buys the output; make foreign exchange available for debt service and repatriation of profits; protect the concessionaire against political force majeure events and changes in taxation and law.
Project finance deals tend to be highly leveraged with debt typically accounting for 70-80% of total financing. Thus, the driving forces in the risk minimisation process are not the project sponsors but the commercial lenders. There are many cases where the sponsors have negotiated one set of contracts with the government and the lenders have come in and insisted on changes that implied that the government had to assume greater risks. The reason for this situation is that project sponsors get rewarded through returns on their investment of 15-20% after adjustment for inflation while lenders have to work with a small margin of 2-3% over the cost of capital (with no upside potential). Thus, while they will respond to small increases in project and/or country risks through upward adjustments in the spread over LIBOR and/or shortening of the maturities, there very soon comes a point where they rather not lend than take the risk. One basic fact in the project finance business is that a projects credit rating cannot exceed the creditworthiness of the host country unless some form of credit enhancement is provided. This means that projects in countries with a Standard & Poors credit rating lower than BBB- (or the equivalent from other credit rating agencies) will find it extremely difficult to mobilise the required financing. To overcome this difficulty, financing packages in most countries with limited creditworthiness will include political risk guarantees from export credit agencies or from multilateral agencies like MIGA or partial risk guarantees from the World Bank and the regional development banks.5 Although such guarantees can cover a broad range of risks, the* one that the commercial lenders are almost universally concerned about is the availability of foreign exchange for debt service. Although the Bloan6 program of IFC and corresponding programs at other development banks dont formally provide protection against a governments failure to make foreign exchange available for debt service, most bank regulators in industrialised countries regard B-loans as having a de facto preferred creditor status. This means that in most developing countries, the participation of official agencies in one form or another is imperative. This participation can take the form of: Equity investments and A and B-loans from IFC and the private sector arms of the regional development banks; Guarantees from MIGA; Partial risk guarantees from the World Bank and the regional development banks; Loans from the World Bank and the regional development banks (either directly to the project company with a repayment guarantee from the government or channelled through the government), and Loans and/or guarantees from export credit agencies.
Another risk that the commercial lenders have been very concerned about is the market or off-take risk. In the vast majority of all infrastructure projects, governments or government agencies either buy the output (as when an IPP sells power to the state-owned utility) or decide on the price (as in the case of privatised water utilities). They also have a number of ways in which they can directly or indirectly influence the number of units produced and/or sold. Thus, in the absence of a transparent regulatory framework with a good track record, the lenders insist that the security package include a long-term off-take agreement (such as a power purchase agreement).
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Project risk is usually greatest during the construction phase. Thus, virtually all greenfield projects are built with fixed-price, date certain turnkey contracts. There are severe penalties for delays and deficiencies in quality and the technical performance of the plant. Dam projects are inherently more susceptible to cost over-runs and delays and therefore more risky than other types of infrastructure projects serving similar purposes. Added to the traditional construction risks is the potential for delays and cost overruns due to environmental and resettlement issues. Other things equal, this means that lenders will shy away from hydropower and other projects involving dam construction. Consequently, most successfully financed hydropower projects are of the run-of-river type with more limited social and environmental impacts. A greater flexibility in the structuring of hydropower transactions is gradually emerging with sponsors agreeing to take some construction risks by providing stand-by financing. Some power buyers are also agreeing to adjust tariffs to compensate for delays and cost increases due to unforeseen construction problems. Issues that have surrounded limited recourse financing of infrastructure projects, and especially power generation projects, include:7 An over-reliance on foreign borrowings is making additional claims on a countrys foreign exchange earnings and jeopardises its creditworthiness. This is in no way inherent in the project finance approach but rather a result of the host countrys underdeveloped credit market or the private sector being crowded-out by excessive government borrowings. Indeed, most project sponsors and the foreign lenders would like to see as much as possible of the financing provided by domestic banks and equity investors. Malaysia is one of the countries with the largest amount of money invested in private infrastructure projects and local banks have provided much of the financing. Governments have assumed too great contingent liabilities through the guarantees provided in the implementation or concession agreements. However, if government agencies had undertaken the same investments, the governments direct and indirect liabilities probably would have been even higher. The real issue is the failure of governments to properly account for the contingent liabilities in their own foreign exchange management strategy. The cost of the power (or other output produced by the project) is too high due to the high cost of commercial financing. Implicit in this argument is typically the assumption that concessional financing would have been available. Given the policies of the donor community described above, it is not at all certain that concessional financing would be available for power generation projects.8 Furthermore, the soft terms are intended to benefit the borrowing country. Most donors would argue that such funds should be on-lent to the utilities on commercial terms (with the treasury using the spread to help finance urgently needed social programs).9 If the utility itself sought commercial financing, in most cases the terms would be no better and possibly worse than those obtained by properly structured BOO/BOT projects. (Many governments also provide hidden subsidies to the utilities through equity contributions on which they require no returns.)
Private hydropower facilities (and other dam projects) involve greater up-front costs than comparable non-dam projects. Adopting WCDs recommendations on an appropriate environmental and social framework for the construction of dams will likely add to these up-front costs. However, compliance with WCD recommendations will certainly indicate that a dam project has a wider social and environmental acceptance than a non-compliant project. Thus, a compliant project should be less risky (in terms of completion risk, etc) and therefore the likelihood that it will be financed is enhanced. It also suggests the possibility that the risk minimisation could lead to slightly lower financing costs (e.g. through lower interest rates, better bond rating, lower insurance costs, etc).10 The net effect of higher up-front costs but lower project risk will vary on a case-by-case basis.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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It needs to be noted, however, that this effect will be additional to the existing issue that is raised by the distinction between financial and economic analyses of profitability (for which see the Thematic Review III.1 on Financial, Economic and Distributional Analysis). Economic analysis may be used to identify the most attractive option from the standpoint of the national economy (including its social and environmental effects) but there is no guarantee that the top project will be the most financially attractive project, or that it will be financially viable.11 This is a result of two factors: (1) the difference between the financial and economic benefits of water and energy services and (2) the difference between the social/environmental impact of the project as viewed through either the economic valuation of these impacts or the financial costs/benefits of internalising these through available mitigation and financial mechanisms. As part of the process, then, there is a need for a partnership between private developers and the government to ensure a financeable allocation of costs and risks. Otherwise, projects that meet societys objectives whether they are dam or non-dam alternatives may go un-funded in favour of projects that meet the narrower criteria of financial viability. This is especially important in the case of multi-purpose projects in view of the low levels of cost recovery from irrigation and water supply consumers and zero cost recovery from flood control beneficiaries. In most cases, commercial lenders go through a comprehensive due diligence process that covers not only the financial aspects of a project but also all its technical, economic and environmental aspects. They are also ready to support programs aimed at promoting economic and social development in the area around the project. Most important, however, is the fact that any prudent lender will seek to minimise the risks of delays and cost overruns (as well as the possible abandonment of the project). Thus, it is likely that they will voluntarily support improved criteria and guidelines for project development if this makes dam projects less controversial. Conclusion and Recommendations There is a global trend towards greater private sector participation in power development and water supply and sanitation. Combined with adaptation of a traditional project finance approach to suit infrastructure projects, this has resulted in a massive inflow of private debt and equity financing for power, water supply and sanitation schemes in developing countries. This has enabled developing countries to extend the coverage and quality of services beyond what would otherwise have been possible. However, for this development to be socially acceptable, economically beneficial and sustainable, government policy making and the regulatory framework need to be strengthened. The reforms at sector level need to be supported by sound macro-economic policies and strengthening of domestic capital markets. The social and environmental impacts of private sector energy and water resource projects that involve the construction of dams pose serious challenges for governments, sponsors and lenders. Some of these challenges are the same as those posed by public sector dam projects, others are unique to private sector projects. Detailed recommendations on the governance structure required for socially and environmentally sustainable development have been presented in most of the thematic review papers. Thus, the following recommendations focus on the specific issues related to private ownership and financing of large-scale water resource projects: The fundamental principle should be that the same governance structure applies to both public and private sector projects. This means, for example, that a dam built by the irrigation department should be subject to the same criteria and scrutiny as a dam for a private sector hydropower project. Environmental and social/resettlement issues need to be explicitlyand transparently incorporated in the process that grants concessions to both private and public operators.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Options assessments should be the responsibility of the government. Issues like hydro versus thermal generation or demand side management versus new generation are fundamental policy issues and should not be dealt with in the context of an individual project. Basin planning and broad definition of projects should be the responsibility of the government. Water is a valuable resource to the nation and only the government can decide on the optimal use of this resource. Assessments of alternatives should be the responsibility of the entity proposing a given project. In the context of a dam project, this might involve analyses of alternative dam locations, configuration of the generating plant, etc. The greatest benefits of private participation in infrastructure are generally derived from competition. Bidding/competition is also the best way of minimizing the potential for corruption. The competition in the case of power generation can take two different forms: If the country still is in the early stages of reforming the power sector, IPP sponsors can be selected based on the lowest tariff that would be part of a long-term power purchase agreement (for thermal generating projects this is an increasingly commonand generally successfulpractice). If, however, the host country has introduced a competitive power market, the project sponsors would be free to build their plants at any cost but would have to compete with other plants once in operation. In the context of hydropower projects, this process would be modified somewhat in order to ensure that the consumers and/or government gets the maximum benefits of the competition12: o o Case 1IPPs with long-term power purchase agreements: Potential developers would submit bids on the lowest (average or levelised) tariff they would require. Case 2Competitive power market: The potential developers would bid for the right to develop the site. This could take the form of a royalty or an agreed profit sharing formula.
There is a need for public-private partnerships in the development of dams in order to mitigate the unique risks and ensure that the externalities associated with such projects are adequately accounted for. Each dam project is unique and, thus, the sharing of risks, costs and benefits needs to be tailored to the specific nature of each project. The host government should assume the responsibility for feasibility studies and preliminary designs. Thermal power plants are increasingly becoming standardised and the cost varies little from site to site. Each hydropower project, however, is unique and tailored to the specific site. The cost depends primarily on the sites hydrology, topology and geology and can easily vary by a factor of 2 or 3 from one site to the next. Thus, without detailed soil, geological and hydrological investigations, no developer can estimate the cost with any reasonable degree of accuracy. The uncertainty will be reflected in the very high bids. Since the investigations are costly and time consuming, it doesnt make sense to have each potential bidder carry out all the surveys and prepare a feasibility study. Rather, this should be the responsibility of the relevant government agency. The feasibility study should be carried out by a reputable international consulting firmideally with guidance from an advisory panel, possibly comprising the short listed bidders. The host government should carry out the environmental assessment and prepare the mitigation and resettlement plans prior to inviting the private sector. These activities require extensive studies and public participation. The risk to the developers is minimized if the whole approval process has been completed before bids are requested. Governments need to retain responsibility for land acquisition and resettlementunless it is on a minor scale. Lenders will probably insist on the land being handed over to the project company, free of encumbrances, prior to the first draw-down on the loans. The dealings between the host government and the private developer(s) have to be transparent. The development of dam projects involves politically sensitive social and environmental issues
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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and requires a closer co-operation between private sponsors and government agencies than other infrastructure projects. To ensure the long-term sustainability of the contractual (project) structure, the selection of the private developer has to be competitive and transparent. The same need for transparency applies to subsequent negotiations of contract conditions related to risk and cost sharing. It is essential to establish an appropriate tariff regime for hydropower projects. The basic purpose of (and economic justification for) dam projects is to change the availability of water/power over the time. Tariffs based purely on energy output fail to properly compensate hydropower projects for their ability to meet daily, weekly and annual peak demands. Such tariffs tend to create a bias in favour of thermal and run-of-the-river schemes. As a minimum, the tariff structure should include both a capacity and an energy component. Ideally, the tariff should be differentiated to allow for peak pricing and reflect the value of the ancillary benefits that hydropower can provide for system management. The international development agencies and ECAs should review their lending policies related to dams and adopt the recommendations of the Commission. A consistent handling of environmental and social issues related to dams is imperative. Project developers (in collusion with the host government) should not be able to shop for the least restrictive lending conditions. However, the policy changes should go one step beyond adopting policies that are consistent with the expected recommendations by the Commission. The private sectors bias against hydropower and other water resource projects means that there is potentially a greater role for multilateral and bilateral donors in making up for financial shortfalls. Participation by the multilateral development banks can also provide additional safeguards in ensuring proper handling of social and environmental issues.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Contents
Acronyms ................................................................................................................................xix 1
1.1 1.1.1 1.1.2 1.2
2
2.1 2.2 2.2.1 2.2.2 2.2.3 2.3 2.3.1 2.3.2 2.4 2.5 2.6
3
3.1 3.2 3.2.1 3.2.2 3.2.3 3.2.4 3.2.5 3.3 3.3.1 3.3.2 3.3.3 3.3.4 3.3.5 3.3.6 3.4 3.4.1 3.4.2 3.4.3 3.4.4 3.5
4 The Emergence of New Financing Instruments for Large-Scale Private Sector Water and Energy Resource Projects ...................................................................................36
4.1 4.2 4.3 The Basic Principles of Project Finance ...................................................................................... 36 The Structure of A Limited Recourse Transaction...................................................................... 37 Key Issues Related to Limited Recourse Financing .................................................................... 39
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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5
5.1 5.1.1 5.1.2 5.1.3 5.1.4 5.1.5 5.1.6 5.1.7 5.2 5.3 5.4 5.4.1 5.4.2 5.4.3 5.4.4
6
6.1 6.2 6.3 6.4
7
7.1 7.1.1 7.1.2 7.1.3 7.1.4 7.1.5 7.2 7.2.1 7.2.2 7.2.3 7.2.4 7.2.5 7.3 7.3.1 7.3.2 7.4
References ................................................................................................................................70 Appendix I: List of Contributing Papers to the Thematic Review III.2 Trends in the Financing of Water and Energy Resource Projects ............................................................73 Appendix II: Submissions for Thematic Review III.2........................................................74 Appendix III: Comments Received for Thematic Review III.2.........................................76 Annex 1: Asian Development Bank Financing Trends .....................................................92
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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List of Tables
Table 3.1. Estimated Hydropower Production (1973-96) and Installed Capacity in 1996 ................... 18 Table 3.2. Regional Growth in Hydropower Capacity ......................................................................... 18 Table 3.3. Estimated Annual Global Investment in Dams During the 1990s ....................................... 20 Table 3.4. Bilateral Aid Flows to Two Sectors Including Dams .......................................................... 20 Table 3.5. World Bank Lending for Power, Irrigation and Water and Sanitation, 1970-99 ................. 21 Table 3.6. Annual Financial Flows for Dam Projects from Aid Donors, 1995-99 ............................... 24 Table 3.7. Current Sources of Financing for Dams in Developing Countries. ..................................... 31
List of Figures
Figure 2.1. A Stylised Model of the Emerging Power Sector Structure in Developing Countries......... 6 Figure 2.2. Progress on Power Sector Reform in 115 Developing Countries......................................... 7 Figure 2.3. Regional Progress on Power Sector Reform ........................................................................ 8 Figure 2.4. Investments in Private Power Schemes, 1990-97................................................................. 9 Figure 2.5. Water and Sewerage Schemes with Major Private Sector Investments, 1990-97 .............. 12 Figure 3.1. Construction of Dams per Decade...................................................................................... 17 Figure 3.2. Total bilateral aid flows to the hydro-electric power sector ............................................... 21 Figure 3.3. Inter-American Development Bank Financing for Large Dams ........................................ 23 Figure 3.4. Asian Development Bank Financing for Large Dams, 1968 to 1999................................. 23 Figure 3.5. Bilateral and Multilateral Aid Donor Financing for Dam Projects, 1950 to 1999 ............. 24 Figure 3.6. Financial Flows of Private and Official Capital for Developing Countries ....................... 25 Figure 3.7. Private Capital Flows to Developing Countries ($ billion) ............................................... 26 Figure 3.8. Regional Patterns of Private Capital Flows (Average 1998-99 in $ billion) ...................... 26 Figure 3.9. Trends of Private Sector Investment for Infrastructure ...................................................... 27 Figure 3.10. EXIM Bank Financing...................................................................................................... 29 Figure 4.1. Security Package for a Power Project................................................................................. 37 Figure 5.1. Private Hydropower Plants Reaching Financial Closure, 1994-2000 ................................ 42 Figure 6.1. Large Scale Renewable Energy Projects Built by the Private Sector, 1994-2000,MWs... 58
List of Boxes
Box 2.1. The High Cost of Non-performing Public Utilities.................................................................. 4 Box 2.2. Corruption and Infrastructure Development .......................................................................... 10 Box 3.1: A Culture to Lend?................................................................................................................. 32 Box 4.1: Project Finance Risks ............................................................................................................. 38 Box 4.2: Is Private Power More Costly?............................................................................................... 40 Box 5.1: Murphy's Law and the Mandate of the WCD ........................................................................ 52 Box 7.1: What is the Future for Private Capital Flows? ....................................................................... 66
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Acronyms
ADB AfDB BOO BOT CCGT EBRD ECA EIB EXIM FAO GW GWh IBRD ICOLD IDA IDB IEA IFC ILA IPP JEXIM kWh LIBOR MAF MDB MIGA MW NGO OECD O&M OPIC PV TWh USEXIM WCD Asian Development Bank African Development Bank Build-operate-own Build-operate-transfer Combined cycle gas turbine European Bank for Reconstruction and Development Export credit agency European Investment Bank Export-Import Bank of the United States Food and Agriculture Organization of the United Nations Gigawatt (109 Watt) Gigawatt-hour (109 Watt-hour) International Bank for Reconstruction and Development International Commission on Large Dams International Development Agency Inter-American Development Bank International Energy Agency International Finance Corporation International lending agency Independent power producer Export-Import Bank of Japan Kilowatt-hour (103 Watt-hour) London interbank offer rate Mean annual flow Multilateral development bank Multilateral Investment Guarantee Agency Megawatt (106 Watt) Non-governmental organization Organization for Economic Co-operation and Development Operation and maintenance Overseas Private Investment Corporation (US) Photovoltaics Terrawatt-hour (1012 Watt-hour) Export-Import Bank of the United States World Commission on Dams
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
1.1.1 Objectives
The general purpose of this paper is to provide a strategic overview of infrastructure financing issues as a contribution to the debate on dams and the WCD process. The paper has three main objectives: 1. To describe international trends in infrastructure financing and sources of financing for water and energy resources projects, focusing on dams and options to dams (i.e. alternative approaches for providing services such as electricity generation, irrigation, water supply, flood management, etc.). 2. To highlight the changing context and main features of the financing approaches/models emerging in different regions and settings (to help illustrate emerging good practices for different types of development schemes). 3. To review the implications relevant to the WCD mandate and the dams debate in the sustainability context. This includes the influences of the changing project finance climate on the policy, regulatory, planning and decision-making practices, options assessment, roles and responsibilities, and other practices in the water and energy resource field further into the project cycle of dams (i.e. construction, operation, monitoring etc.) which impact on sustainability. A basic premise of the report is that all infrastructure projectswhether public or privateshould be economically viable and social and environmental impacts should to the extent possible be avoided, minimised and mitigated.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
The pace of reforms and, especially, the host countrys creditworthiness has a major impact on the willingness of commercial lenders to provide financing for dams and other infrastructure projects. What does this imply for the poorest countries in Africa and Asia? Another issue relates to the possible impact of financing trends on policies for development of indigenous energy resources. Countries generally wish to develop their indigenous resources for electricity generation, whether they are fossil fuel, hydro, geothermal or other renewable energy resources. The extent to which project financing trends can in practice, reinforce or override government policies to develop indigenous resources is an issue of increasing concern. The range of financing models for large-scale projects that are being explored today for governmentprivate and wholly private sector ventures is a key consideration in how hydro projects and non-dam options for the services may be financed in future. Multi-purpose projects pose particular challenges if they are to be fully financed by private sector. Given the financing trends, an important issue will be the extent to which financing is available for irrigation, water supply and other water and energy services either separately, or as part of multi-purpose project developments. In parallel, an important concern will be the amount of money available for government-community, and local initiatives for financing small-scale approaches and options, as well as stakeholder participation in the larger projects developed in their community areas. The influence that project financing trends for dams and options may have on policy, planning and decision-making processes are key issues. This is in respect to the roles and responsibilities of the newly formed regulatory bodies, line ministries, the utilities and the private sector participants in water and energy resources projects. There are implications concerning the degree to which project financing considerations impact on the evolving participatory decision making-processes and decision-making roles. Many of the new project financing approaches, particularly those for dams are complex and involve considerable negotiation on a case-by-case basis. This raises important issues relating to capacity building in developing economies for the new roles. The learning curve, experience and time factors are important considerations in negotiating sustainable outcomes.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
supply, which reduces growth and employment generation. Lovei and McKechnie (2000) report on a World Bank sponsored study which revealed that power outages in Bangladesh cost about $1 billion a year and reduce GDP growth by about half a percentage point. Similar results have been reported for Pakistan and India. This chapter describes the trends towards liberalisation and greater reliance on market forces, allowing new entry, encouraging competition, unbundling monolithic state owned utilities and privatisation, etc. It will also describe the institutional and regulatory models that have emerged in different regions and sectors. The purpose of the chapter is not to argue for or against private participation in infrastructure development but to provide a proper context for the subsequent discussion of financing trends and methods. In simple terms, the reforms involve: (i) the application of commercial principles to the provision of services; (ii) introduction of competition largely through some form of privatisation and opening up many infrastructure activities to new entrants; and (iii) involving users more in the design and operation of infrastructure facilities. These changes have been facilitated by technological innovations, an improved understanding of how governments can regulate private infrastructure providers to ensure that the benefits of reform accrue to the consumers, and the development of new financing tools. Of the areas of concern to the Commission, the reforms have been most rapid and far reaching in the power sector.13 Reforms are also under way in the water supply and sanitation sector. Large-scale irrigation projects have been--and are likely to be--affected to a much lesser extent. Large-scale flood control schemes will certainly remain in the public sector in the future (although some limited forms of private participation are emerging). New approaches in terms of involving the beneficiaries and community groups are enhancing the sustainability of small-scale infrastructure facilities in both urban and rural areas and, thus, making many of the non-dam options more viable.
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
Figure 2.1. A Stylised Model of the Emerging Power Sector Structure in Developing Countries
Government Policy
Regulator
Transmission Company
Greenfield IPPs
Marketing Companies
Customers
Power sector reform comprises a number of different elements aimed at increasing competition and accountability and mobilisation of financial resources for system expansion and service quality enhancement. The main elements are: Corporatisation and commercialisation of the government power entity to increase autonomy and management accountability; Revision of the legal framework to allow new entry and private ownership as well as encourage competition in generation and/or distribution; Creation of a transparent regulatory framework and establishment of an autonomous regulatory body (or providing for the separation of the governments policy and regulatory functions as a step towards the creation of an independent regulator); Within the overall legal and regulatory framework, establish policies and procedures for licensing of private greenfield investments in generation, transmission and distribution. Most commonly, such investments have taken the form of independent power producers (IPPs); and Unbundling of the state-owned utility company and divestiture of generating, transmission and distribution assets. Typically, the transmission system and hydropower plants (especially if they also provide releases for irrigation schemes) are the last to be privatised.
A recent survey of 115 developing countries by the World Bank (Bacon, 1999) reviews how far different aspects of power sector reform have progressed. The results are summarised in Figure 2.2.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
0
Source: Data from Bacon (1999)
10
20
30
40
50
Politically, the most acceptable way of introducing private ownership in the power sector has been through construction and operation of new generating plants, commonly referred to as independent power producers (IPPs). IPPs are special purpose companies established to develop, own and operate power plants. These schemes sell power to the main utility under long-term contracts. In 1987, Turkey15 was the first developing country to enact a law governing the establishment of buildoperate-transfer (BOT) projects. Under the BOT model a developer gets a long-term (typically 2030 years) concession to build and operate an infrastructure project. At the end of the concession period, the ownership of the project is handed over to the state-owned utility (or to some other government entity). The developer also mobilises the financing, typically using a project finance approach (see Chapter 4). As private ownership has become more acceptable, many countries have switched to a build-own-operate (BOO) model where there is no obligation to transfer ownership to the government at the end of the concession period.16 BOO/BOT schemes have been the predominant form of private participation in Asia. The initial IPPs in the Philippines, Pakistan and other pioneering countries were negotiated deals between the project sponsors and the government. The agreed tariffs and the resulting returns to the investors were also high (typically 20% or more). The negotiations and the mobilisation of finance could take several years.17 Gradually, tariffs have declined (in part due to falling prices for generating equipment) and the development process has been shortened considerably as standard approaches have evolved. However, the lack of transparency in the negotiating process has been the source of many debates and has occasionally led to costly delays as new governments have refused to honour agreements entered into by their predecessors.18 This has led project sponsors to realise that they need to be able to demonstrate that the contract was fair and that they are low cost producers of electricity. Similarly, government officials were seeking a way of protecting themselves against accusations of corruption and ensuring that the country received the best possible deal. Thus, in the mid-1990s, many governments started to invite competitive tenders for IPP projects. The bidding process has increased transparency and resulted in lower power tariffsperhaps by as much as 20-25% (Albouy and Bousha, 1998). The IPPs sell power to the state-owned utilities under long-term contracts that are fairly rigid. The experience from those industrialised countries that have spearheaded power sector reform has shown that significant efficiency gains can be achieved by introducing a competitive power market where the lowest bidders get dispatched. Thus, the price would change hour by hour and at each time the most efficient generating plants would be operating. Generating facilities that supply power directly to the grid based on the variable spot price (i.e. without long-term power purchase agreements) are referred
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
to as merchant plants. Project sponsors and commercial lenders are willing to finance merchant plants only in countries where the state-owned utility has been unbundled and most assets have been sold to the private sector and the regulator has established a track-record in terms of fairness and transparency. So far only relatively few merchant plants have been built in developing countries (the first one was in Chile a few years ago). However, as power sector reform continues, these plants are likely to become more common.
Latin America South Asia Europe & C Asia East Asia & Pacific M. East & N. Africa Sub-Saharan Africa
0
Source: Bacon (1999)
20
40
60
80
100
Reform Indicator
East Asia: The performance of the existing state-owned utilities was perceived as being less of a problem than the mobilisation of additional financial resources for system expansion (to meet power demands that were growing at unprecedented rates). Thus, the emphasis in East Asia was on attracting foreign investors and lenders for the construction and operation of greenfield generation projects. Some 57% of all LDC investments in BOO/BOT generating projects were made in East Asia in the period up to 1997. South Asia: Political resistance against restructuring and privatisation has been strongalthough some reforms are under way. It has, however, been much easier to gain acceptance for private investments in greenfield generating projects. Eastern Europe and Central Asia: The major problems in this region were inefficient production and use of energy. Thus, after a slow start, the restructuring process has taken hold and privatisation of
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
unbundled utilities has accelerated. Virtually all of the greenfield projects have been concentrated in Turkey. Middle East and North Africa: Private participation in the power sector has so far been limited, but BOO/BOT schemes are becoming more common. Sub-Saharan Africa: The initial involvement of the private sector in Africa regions power sector took the form of management contracts. Recently, increased emphasis is given to restructuring and outright privatisation as well as greenfield generation projects. The investments that have been mobilised through private greenfield projects and privatisations in different regions are summarised in Figure 2.4 below. Figure 2.4. Investments in Private Power Schemes, 1990-97
US$ Billion 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 Latin America East Asia
Greenfield
South Asia M East & N Africa Sub-Saharan Africa
Divestiture
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
10
stronger. The power sector needs to be treated within the framework of an overall energy policy which deals with issues such as import and export of energy (taking into account the emergence of regional gas and power grids) and the development of indigenous and renewable energy sources. The power sector policy also needs to address rural electrification, establish guidelines for the regulator and develop instruments to influence the behaviour of the enterprises in the sector. The sequencing of reformswhere the private sector is brought in before the governments regulatory capacity has been built upis a problem that has emerged in a number of countries. An extension of this issue is the question whether the general culture and the overall legal framework are supportive of objective and transparent regulation. There is an obvious role for the donor community in providing training and technical assistance to build-up the regulatory capacity in developing countries. Most private investment in power generation in developing countries has taken the form of IPPs that sell power at a predefined price. There is no adjustment in the tariff based on the day or the time when power is supplied. This means that there is an in-built bias in favour of base-load plants. A move towards a more competitive power market and the introduction of merchant plants is likely to make the construction of peaking plants more attractive. Since hydropower plants are ideally suited for peaking, this trend is likely to make hydropower investments more attractive to private investors than they are at present. There have been widespread allegations regarding corruption and nepotism in the award and negotiation of contracts/concessions for private operators (see Box 2.2). While many of these allegations have been politically motivated and few have been proven, it is likely that a number of such cases have occurred. The evolving best practices in terms of minimising such cases involve open, competitive bidding for concessions based on pre-defined contracts, independent regulation and a transparent process with public participation at all stages. (It should be noted, however, that the countries where corrupt awards of concessions have taken place probably are the same countries where corruption also occurs in normal procurement and that this might be a significant factor contributing to the poor performance of public sector entities.) Box 2.2. Corruption and Infrastructure Development In recent years, the negative impact of corruption on social and economic development has been clearly documented. Unfortunately, corruption seems to be especially common in the areas of concern to WCD. According to the Bribe Payers Survey commissioned by Transparency International (TI), corruption is most endemic in public works contracts and construction. Power (including petroleum and energy) is ranked as number three of nine business sectors. (For further details see TIs web site: www.transparency.org). As a number of well published scandals in industrial countries demonstrate, corruption is in no way a problem that is limited to developing countries. Indeed, in TIs most recent tabulation of the Corruption Perception Index, a number of developing countries are ranked higher (i.e. as being less corrupt) than some developed countries. There is also little doubt that unethical business practices of many firms from OECD countries contribute to corruption in the developing world. The donor community has responded to this problem in a variety of ways. Aid is increasingly linked to measures aimed at reducing corruption and increasing transparency in public sector decision making. Capacity building is one of the elements in the donors strategy and making aid conditional on concrete measures to reduce corruption is another. In parallel, the industrialized countries are seeking to stop their own firms from paying bribes. Prior to 1998, only the United States Foreign Corrupt Practices Act of 1977 prohibited national firms from bribing officials of governments overseas. By criminalising international bribery, the Act also ended the tax-deductibility of bribes paid by U.S. firms to foreign public officials. Significant
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
11
advances were made in replicating this effort outside the U.S. when, in December 1997, member governments of the OECD agreed on the text of a Convention on Combating Bribery of Foreign Public Officials in International Business Transactions. This convention has been a landmark achievement, reflecting changing sentiments in the international community that efforts to reduce corruption must operate in capital-exporting countries as well as in developing economies. As of August 2000, twenty-three countries had ratified the convention. Unfortunately, some OECD members have signed but still not ratified the convention. There have been a number of accusations regarding corruption and nepotism in private infrastructure projects. While few cases have been proven, there clearly is a need to minimise the scope for such practices. The starting point is a transparent process for approving and negotiating the security packages for private infrastructure projects. Competitive bidding for the concessions will also reduce the scope for corruption. Other safeguards are provided by the due diligence process carried out by international lenders and the practice of employing reputable international firms auditing the project accounts. As in all sectors, there are legitimate concerns among the employees regarding staff reductions and unemployment. Over time, a number of strategies have been developed to deal with these issues. These involve, inter alia, establishing a consultative process, giving employees a stake in the privatised entity through equity participation, various types of golden handshakes (financed out of the sales proceeds or with donor support) and/or employment guarantees. Some of the objections raised are more ideological in nature and concern the divestiture of public assets (selling the crown jewels) as well as objections to foreign ownership of strategic assets and reduced sovereignty. In part, this is an issue that only can be resolved through the political process. In part, however, it is also an empirical questionor rather a whole series of questions such as: Does privatisation lead to efficiency gains, and do these efficiency gains ultimately benefit the consumers? Do private operators give adequate attention to equity issues and expansion of service to low income groups? Do developing countries have the capacity to properly regulate the privatised entities? There are a few often-quoted studies that show initial efficiency gains and service quality improvements. These studies are, however, rather anecdotal in nature. The long-term benefits of utility privatisation in a developing country setting still remain to be proven or disproved.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Figure 2.5. Water and Sewerage Schemes with Major Private Sector Investments, 1990-97
Latin America East Asia & Pacific Europe & C. Asia Sub-Saharan Africa M. East & N. Africa South Asia
0 10 20 30 40
Number of Schemes
Source: Silva, Tynan and Yilmaz (1998)
There is little scope for achieving significant efficiency gains by introducing competition in water collection and water or sewerage treatment. Piped water supply and sewerage networks are basically natural monopolies (although they face competition from private wells and tubewells, water vendors and individual sanitation solutions). This has meant that unbundling along the lines adopted in the power sector is not an attractive solution. Rather, the approach generally has been to treat the system in small towns and medium-sized cities as one unit. In very large cities, there is often an attempt to introduce yardstick competition (or competition by comparison) by breaking up the existing utility into a couple of regional parts, with the different parts managed by separate entities. Private participation can take a number of forms: Operation and management contracts are intended to improve the performance of loss-making public utilities while leaving the government responsible for new investments. These contracts usually include performance incentives for the private operator. Most of these contracts have been in Africa. Lease contracts represent an expanded role for the private sector over the shorter-term O&M contracts. The government remains owner of all the facilities but the private company employs the staff and has full responsibility for all aspects of the operation including tariff collection. The company pays a fee to the government for the lease. Concession where the private sector takes over the management and operation of an existing system but also assumes the responsibility for future investments for network expansion and quality improvements. Roughly half of all water and sanitation schemes with private participation are of this type, accounting for 80% of all private investments in the sector. Argentina has been in the forefront of the reforms along these lines with an aggregate investment commitment of over $6 billion. Most of the concessions are located in Latin America although a couple major ones are located in East Asia. Greenfield projects are relatively numerous but individually small. They involve construction and financing of discrete facilities like water or sewerage treatment plants or major water conveyance schemes. They account for some 30% of all projects with private participation and one-sixth of the private investments in financial terms. Most of the greenfield projects take the form of buildown-transfer (BOT) projects. As with power, most BOT projects have been built in East Asia (and especially in China). Straightforward divestitures (privatisations) are rare. Only a handful has been made so far.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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In the power sector, virtually all of the private investments went into greenfield projects or divestitures, while these kinds of transactions are relatively rare in the water and sanitation sector. Another noteworthy difference between the two sectors is the degree of market concentration. In power, the top ten developers together have less than 40% of the total market. In the water and sanitation sector, however, one company was involved in 28 of 97 transactions during the 1990-97 periodand these were generally the largest transactions that together accounted for more than 60% of all private investments in water supply and sanitation (Silva, Tynan and Yilmaz, 1998).
2.3.2 Emerging Issues Related to Reform in the Water and Sewerage Sector
The concerns expressed regarding the reform process in the urban water and sanitation sector are similar to those related to power sector reform. However, privatisation in the water and sewerage sector is more controversial.19 Many argue that access to water to meet basic human needs is a fundamental right that should not be subject to private profit motives. Most cities in the developing world have large informal settlements that are not served by public services. Local community initiatives play an important role in upgrading these settlements and providing basic water and sanitation services. Many governments regard such initiatives with hostility and the state-owned water utilities often refuse to collaborate. There is a widespread suspicion among NGOs that private operators are going to be even less responsive to the needs of the poor and to community based programs. Unfortunately, because privatisation has been done on a city-by-city basis, the need for a proper regulatory regime has often been neglected. However, given the very direct impact that a regulators and concessionaires actions have on the quality of life in urban neighbourhoods, the need for transparent regulationand popular participation in the process--is probably greater in the water supply and sanitation sector than in the power sector. Regulation is more complex in developing countries than in industrialised countries where regulation tends to focus on price/tariffs and a relatively narrow set of service indicators. In the major cities in the low income countries, only a small fraction of the population is connected to the pipe network and most of them get water only a few hours a day a few days a week. The great majority of households are supplied through public standpipes, water vendors or their own wells. Under such circumstances, extending and improving serviceat affordable pricesare major regulatory concerns that require difficult trade-offs. Given that the responsibility for rural water supply in most countries is separate from that for urban water supply, the impact of private concessions for urban water supply and sewerage on rural consumers is negligible. Indeed, as the urban concessions reduce the need for subsidies, the privatisation process might even give governments an opportunity to focus more financial and technical resources on rural water and sanitation schemes.
2.4 Irrigation
Irrigation is the main user of water in developing countries and most dams have been built to serve canal schemes. Many of the canal schemes have failed to provide the quality of water supply (in terms of quantity, timeliness and reliability) that is needed for growing high value cash crops or achieving high yields from traditional food and fodder crops and existing schemes increasingly suffer from water logging and salinity problems (Dahwan, 1998, Postel, 1999 and Silliman & Lenton, 1991). Further, evaluations by multilateral agencies of their irrigation portfolios reveal considerable appraisal optimism, with a significant number of projects falling below an acceptable rate of return.20 These and other shortcomings of canal irrigation schemes are principally due to inadequate maintenance, management deficiencies, and inappropriate on-farm water management.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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The average financial returns to canal irrigation are quite modest and vary considerably from one farmer to the next.21 Water charges are typically set very low (presumably to reflect the level of returns accruing to the most marginal farmers rather than the returns to the average farmer). In many cases the water charges dont even cover the annual O&M cost. Groundwater irrigation represents a noticeable contrast to most canal schemes. The private sector (individual farmers and groups or co-operatives as well as corporations) has long invested heavily in groundwater development and usually achieves excellent financial returns. However, subsidies for groundwater development may well have led to unsustainable levels of groundwater withdrawals (Postel 1999). The tradition of paying little for irrigation water supplied from state-sponsored schemes22 has meant that private investors essentially have no interest in building and operating canal irrigation schemes serving hundreds, if not thousands, of smallholders. Consequently, there are few canal irrigation schemes supplied from privately built dams anywhere in the world. During the colonial era, there were some private schemes built to supply water for large plantations. These were, however, rare exceptions. With the improvement in trade and transport logistics, some producers in developing countries have been able to successfully enter the global market for fruits, vegetables and flowers. The large estates that typically produce for the export market primarily rely on groundwater as the source of their irrigation water. There are, however, a small number of dams and associated irrigation networks that are being built by private estates such as Agro Guayabito A.S. in Peru.23 The development of privately owned canal schemes is often complicated by the issue of water rights. Irrigation is a large net user of water (rather than a temporary borrower) and the use of water by one farmer precludes the use of this quantity (with adjustment for return flows) by another. Although there often are conflicts between hydropower generation and irrigation, the riparian issue is much more contentious in the case of irrigation than in the cases of hydropower generation (especially if the scheme has little or no storage) and water supply.24 Building on the approaches developed for IPPs, there have been a couple of isolated cases where the government has sought to reap the benefits of the of private sectors competence in construction management and operation of projects also in the irrigation sector. One example of this approach is the Casecnan project in the Philippines.25 Barring a few exceptions along the lines just described, large-scale irrigation development is likely to remain primarily a responsibility of governments. The reforms under way in a number of countries with large surface irrigation schemes have therefore focused on improving water distribution and water use by directly involving the farmers in the operation and management of the schemes. Farmers participation can take a number of forms26 but increasingly farmers groups or autonomous irrigation units take on the administrative as well as financial responsibilities for O&M. In some cases, this also involves recovery of a part of the capital cost, either in cash or through labor contributions.
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Dams are virtually never built primarily to facilitate navigation. However, navigation has been classified as a secondary benefit in about 5% of the multipurpose dams. These benefits are rarely quantified. Like flood control, navigation is basically a public good and will not in itself attract private capital. For some issues related to financing of multipurpose dams see Section 5.4.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
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5000
4000
Industrialized Countries
Projection
3000
1998 Register
2000
Projection
1000
Developing Countries
1998 Register
1950s
1960s
1970s
1980s
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Table 3.1. Estimated Hydropower Production (1973-96) and Installed Capacity in 1996 Production Production 1973 1996 TWh TWh OECD countries 911 1,344 Non OECD 374 1,173 Total 1,285 2,517 Source: see Annex A. Data on capacity from IEA. Increment 1973-96 TWh 433 799 1,232 Capacity 1996 GW 376 333 709
Table 3.2 shows a tentative breakdown of hydropower capacity by region. By 1996, 19% of global capacity was in Latin America, while Asia (including China) accounted for 15%. Growth in hydropower capacity in was much stronger in non-OECD countries. While in OECD countries as a whole installed capacity increased by 1.7% per year, in the rest of the world the average increase was 5.1% and within this total was dramatic growth of 7% per year in China and Latin America, and nearly 5% in Asia (excluding China). Table 3.2. Regional Growth in Hydropower Capacity
Region Former USSR Eastern Europe China Asia Latin America Africa Middle east Total non OECD OECD Total Installed capacity GW (1996) (1) 61 14 53 46 138 17 4 333 376 709 % of total capacity, 1996 9 2 8 7 19 2 1 47 53 100 Growth in installed capacity, 1973 to 1996, % per year (2) 2.5 % 2.3 % 7.1 % 4.6 % 7.4 % 3.4 % 5.9 % 5.1 % 1.7 % 3.0 % Hydro as % of total power generation in 1997 17.6 % 24.5 % 16.8 % 16.7 % 75.5 % 15.2 % 5.0 % 24.0 % 15.1 % 18.4 %
Notes: (1) Derived from IEA data (2) Derived from IEA data. Totals may not add due to rounding
However, there are indications that the growth of hydropower generation in developing countries has declined over the last couple of decades. During the 1970s, the growth rate was over 6%, during the 1980s around 4% and slightly less than 3% since 1990.32 This implies that the new addition to hydropower capacity during the 1990s has been only about 8.0-8.1 GW per year. Applying the unit cost described above gives an estimate of annual hydropower investments in developing countries in the range of $12 billion to $18 billion during the 1990s. This is consistent with the figure provided by Briscoe (1998).
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
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estimate is about $5,000 and the high about $8,000 per hectare. Adjusting these figures for inflation gives a range of $20-30 billion, which is consistent with Briscoes estimate. It has been estimated that 40% of the irrigation investments in both India and the Philippines are made by private farmers for groundwater development. In Pakistan, the private sector share is as high as 70%. However, Pakistan with its deep aquifer in the Indus basin and its old canal schemes that provide additional recharge, is probably on the extreme high end for ground water development among the major irrigation countries. Thus, taking 40-50% as typical, and using the above figures on total investments, this would give annual investments in canal irrigation of $13-18 billion.33 There are roughly 200 million hectares of irrigated land in developing countries at present. India accounts for about 28% of this area. However, the country accounts for almost two-fifths of the annual growth in the irrigated area. During the first part of the 1990s, annual public sector expenditures on irrigation in India were around $5 billion per year, with most spent on dams and canal irrigation. Adjusting this figure for inflation and assuming that all developing countries, on average, expand their irrigated area in a manner similar to that in India, would give global expenditures on canal irrigation in the order of $15 billion. However, the cost of construction is low in India and the cost of canal schemes is lower than in most other countries (see Jones, 1995). Thus, $15-18 billion per year might be the most reasonable estimate for public investments in canal irrigation in developing countries (excluding on-farm investments). The percentage of cost of an irrigation scheme that is devoted to the construction of the reservoir varies considerably from case to case: for small canal schemes, the reservoir can easily account for four-fifths of the cost; in very large schemes, this share might fall to one-fifth. The average is probably somewhere between 50% and 60%, which would imply that annual investments in irrigation dams in developing countries during the 1990s was in the range of $8-11 billion.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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The figures in Table 3.3 include generating equipment in the case of hydropower and ancillary structures for other types of dams (but not canal systems for irrigation or distribution systems for water supply).
The international flows are reasonably well documented and clear trends in infrastructure financing are evident. The domestic investments are much harder to assess however.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
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Figure 3.2. Total bilateral aid flows to the hydro-electric power sector
1.4 1.2 ($ billion in current prices) 1 0.8 0.6 0.4 0.2 0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Source: OECD CRS Database
While official aid flows may be significant in some sectors, over the past decade the total bilateral flow to hydropower and agricultural water resources is between $1 and 2 billion per year. Given the discussion above, it is reasonable to assume that no more than one-third of the loans and grants for agricultural water resources are for dams. This would give a total bilateral flow of less than $1.1 billion per year as compared with total dam investments (in non-OECD countries) of $22-31 billion.
Between 1970 and 2000, the World Bank financed 110 hydropower projects with a capacity of 35,000MW. The value of these loans is estimated at about $25 billion in todays terms. However, hydropower lending peaked in the 1980s and there has been a sharp decline in recent years. For fiscal years 1995-99, the World Bank has made only six loans for hydropower projects, two of which involved the construction of new dams: Ertan in China (FY96) and Gilgel Gibe in Ethiopia (FY98).34
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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In addition, the World Bank has financed a couple of projects that include mini- or micro-hydropower plants. The World Banks lending for irrigation development peaked around 1980 and has steadily declined from about $2 billion twenty years ago (in present value terms) to less than $500 million in the fiscal year that ended in June 1999. At the same time, there has been a shift in emphasis from support of new canal schemes to improvements to existing schemes through rehabilitation and better water management. The decline in lending for water supply and sanitation has been less pronounced. Still, in real terms, the lending is down by more than one-third since the peak in the late 1970s. In total, over the 1995-99 period, the World Bank provided about $550 million per year for projects involving the construction of new dams and $520 million for projects that included components for the rehabilitation and refurbishment of existing dams. In many, if not most, of the projects, the dam components (as defined by the World Bank to include civil works for the dam and cost of land acquisition) were only minor parts of the projects. Thus, in the 16 projects that supported the construction of new dams, the dam components accounted for only one-sixth of both the total project cost and the loan amount. In the 32 projects supporting rehabilitation and/or improving the safety of dams, the dam component accounted for less than one-tenth of the investment cost and the loan amount. If only lending for the dam components is counted, the average falls to $134 million per year.35 By implication other project components such as electricity generating equipment, canal works, resettlement, watershed management and even components that are simply part of a larger multipurpose loan constitute a large portion of the total project cost. The Inter-American Development Bank (IDB) lent $9.4 billion for dams between the early 1960s and late 1990s, to projects with a total investment cost of $38 billion. The dam construction activities supported by IDB peaked about two decades ago and have declined drastically since then. While in 1982, for example, construction were on-going on 45 dams financed by IDB, this figure had fallen to 10 dams in 1999. (See Figure 3.2 below.) The bank made no loans for hydropower in the second half of the 1990s. During the second half of the 1990s, the annual amount of financing for dams is estimated to be around $200 million.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Figure 3.3. Inter-American Development Bank Financing for Large Dams 7,000 6,000
($ millions, 1998 prices)
5,000 4,000 3,000 2,000 1,000 0 1960-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94 1995-99
Energy
Irrigation
Water Supply
Other
The Asian Development Bank has also curtailed its dam construction activities in recent years (see Figure 3.4). For example, it has not financed an irrigation dam since 1989.36 Its lending for hydropower paints an equally striking picture. In the 1970s, hydropower projects accounted for 28% of its lending for power. In the 1990s, this share had fallen to less than 8%. Decline for water supply was similar: in the 1970s, the share of dam projects was 21% and in the 1990s, less than 5%. Thus, in the latter half of the 1990s, annual lending for dam projects has been around $100 million. Appendix 4 to this paper provides a set of charts on the trends in ADBs financing of large dams and alternative water and energy investments, as well as trends in co-financing of dams that ADB has financed. Figure 3.4. Asian Development Bank Financing for Large Dams, 1968 to 1999
1,000 900 800 US$M, 1998 prices 700 600 500 400 300 200 100 1968-74 1975-79 1980-84 1985-89 1990-94 1995-99 Hydro Dams Irrigation Dams Water Supply
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Other Development BanksEBRD, EIB, AfDBAccount for a smaller lending volume in support for dams than the bilaterals, World Bank, ADB and IDB. Figure 3.5 summarises available data for commitments on dam projects from these sources, including data from EBRD and AfDB. The graph reveals that lending from these sources peaked at around $4.4 billion per year in 1980-84 and has dropped steadily to approximately $2.4 billion per year in 1995-99. On this basis total financing provided by aid agencies and development banks for dams since 1950 comes to $125 billion. Figure 3.5. Bilateral and Multilateral Aid Donor Financing for Dam Projects, 1950 to 1999
25 EBRD /6 AfDB /5 ADB /4 15 IDB /3 Bilateral /2 10 World Bank /1
20
0 1950- 1955- 1960- 1965- 1970- 1975- 1980- 1985- 1990- 199554 59 64 69 74 79 84 89 94 99
4
Source: 1Sklar and McCully (1994 eco029) and World Bank (2000a), 2OECD (2000), 3IDB (1999), Lagman (2000), 5AfDB (1998), 6EBRD (1996; 1999; 2000a; 2000b).
Overall, official flows for dam projects for the most recent five year period can be summarised as follows: Table 3.6. Annual Financial Flows for Dam Projects from Aid Donors, 1995-99 Development Agency Annual Amount ($ billion) Bilateral donors 1.0 billion World Bank 1.1 billion Asian Development Bank 0.1 billion Inter-American Development Bank 0.2 billion Other Multilateral Agencies N/A. (probably less than 0.2 billion) Total around 2.5 billion Note: Includes expenditure on new dams (including associated infrastructure, mitigation programs and ancillary structures) and refurbishment/rehabilitation of existing dams.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Figure 3.6. Financial Flows of Private and Official Capital for Developing Countries
$160,000 $140,000 US$ (Millions) $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $78 80 82 84 86 88 90 92 94 19 19 19 19 19 19 19 19 19 19 96
Total Net Official Flows Total Net Private Flows
Year
Source: DAC Database 1978-1997 Figure 3.6 describes the private flows on a net basis, i.e. debt repayments are deducted from the disbursements. Furthermore, foreign direct investments are excluded. In assessing the impact of private capital flows on new investment projects in developing countries, it is more appropriate to look at the gross capital flows. Thus, Figure 3.7 describes the gross private capital flows since 1990. A couple of features are especially noteworthy. First, equity flowsboth foreign direct investments and portfolio investmentshave grown in importance: in 1990, equity accounted for roughly onequarter of the total private flows; in 1999, this share had risen to over half of the total. Second, equity flows have continued to grow, albeit at a more modest rate, over the last couple of years. A major part of the increase in recent years can be explained by privatisation of state-owned utilities. (World Bank, 2000b) Third, after a expansion of lending in the up to 1997, commercial banks and other private lenders have become much more cautious following the Asian crisis. Thus, total private sector lending to developing countries fell by more than one-third between 1997 and 1999 and lending to private clients without public sector guarantees was more than cut in half over the same period.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Source: World Bank (2000b) Figure 3.8. Regional Patterns of Private Capital Flows (Average 1998-99 in $ billion)
180.0 160.0 140.0 120.0 100.0 80.0 60.0 40.0 20.0 0.0
SS Africa South Asia M East & N Afr E Europe & C A East Asia Latin America
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The private flows are, however, very concentrated. Very little of the private capital has found its way to Sub-Saharan Africa and South Asia. Indeed, on a per capita basis, the inflows to South Asia are far below those to other regions. Middle income countries account for four-fifths of total private flows to developing countries. China accounts for almost two-thirds of the flows to low income countries, with India receiving about one-third of the remainder. Thus, only about five percent of total private flows have gone to all other low-income countries in Africa and Asia. Private Investments in Dams and Other Infrastructure For reasons that are discussed elsewhere in this report, private infrastructure investments in developing countries have increased eightfold from 1990 to reach $120 billion in 1997. As can be seen from Figure 3.9, there was a decline in 1998 following the Asian crisis. (Although details are not available, the indications are that the decline continued in 1999.37) For the decade as a whole, the investments were close to $600 billion. Telecommunications was the sector that first attracted large private investments, followed by power. During the 1990s, a total of $131 billion was invested in private power schemes, of which $73 billion (56%) was for greenfield generation projects. Private investments in transport infrastructure (toll-roads, ports, airports and railways) have also been significant. As discussed in Chapter 2, private investments in water and sanitation have been slower to materialise and much lower in money terms. Figure 3.9. Trends of Private Sector Investment for Infrastructure
There has been some private sector interest in hydro investments. The International Finance Corporation played a catalytic role by approving financing for 7 private hydroelectric power projects between 1990 and 1995. Most of these were small between 10 to 73 MW but one was a large 450 MW run of the river project. Based on unpublished figures from the World Banks database on private infrastructure, Briscoe (1998) estimated that about 12% of private power investments between 1990 and 1995 were devoted to hydropower projects. Another World Bank study estimates that hydropower accounted for 7% of the capacity of private power projects that reached financial closure over the 1994-96 period (Izaguirre, 1998). For large projects with limited recourse financing, the share of hydropower was estimated at 5% in terms of installed capacity. These capacity figures would imply that, in financial terms, hydropower would account for around 10% of total private investments in power generation. The World Banks database, however, is believed to include some projects that have been postponed or cancelled. Thus, these figures should be regarded as upper limits.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Rojas and Aylward (2000) have analysed the information on power projects in the Projectware database.38 According to their analysis, green-field power generation projects (in developing countries) with a total investment cost of $69.1 billion reached financial closure between 1994 and the end of the first quarter of 2000. Hydropower projects accounted for $6.2 billion or 9.0% of the total. While this database includes some public sector projects that have obtained commercial financing, most of the projects are privately owned and operated. Rojas and Aylwards figures also indicate that the capacity of the hydropower projects that have reached financial closure was 4,200 MW or about 5.8% of the capacity of the projects in the database. A different picture emerges from a study by Cambridge Energy Research Associates (CERA, 1997), which suggests that in 1996, the portion of hydro in total IPP closings was only 1.5% in capacity terms. The same study suggests that for the 1991-96 period, hydro accounted for 2.5% of the capacity of new privately funded projects. The latter figure would imply that that only about 5% of total private power generation investments were devoted to hydropower schemes. These estimates give a range of private hydropower investments of $0.5-1.1 billion per year for the 1990s. Overall, private investments in water supply and sanitation have been modest compared to the investments in the power sector. Most of these investments have been devoted to network improvements and some water and sewerage treatment facilities. No significant investments in dams appear to have been undertaken so far. While the private sector has invested major amounts in groundwater development, little money has been spent on dam projects. A couple of multi-purpose projects with irrigation components have been built on a BOT basis. Private companies owning major estates producing flowers, fruits, vegetables or other cash crops have occasionally built dams to provide year-round irrigation. In aggregate terms, however, these investments are minor compared to private investments in hydropower.
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generating equipment amounts to around 30% of the total investment cost in hydropower.39 Based on fragmented data from a few agencies and considering the needs of imported equipment,40 it can safely be assumed that the ECAs provide significantly less than $1.5 billion annually for various types of dams in developing countries. It appears that the most active ECAs in providing support for dam (and especially hydropower) projects are those from Canada, Germany, Japan and Switzerland. The Export-Import Bank of the US (USEXIM) can provide financial support for hydropower and other water resource projects, although demand for finance for these has declined in the past decade. The USEXIM together with OPIC, also from the US, are widely regarded as having the most stringent social and environmental requirements among the ECAs. While the USEXIM has lent significant sums for hydro dams, the peak year was 1989 and lending has been much lower since (see Figure 3.10). It is also interesting to note that lending for hydropower considerably outweighs lending for irrigation dams this pattern is consistent among all the financing institutions. Figure 3.10. EXIM Bank Financing
$160 $140 ($ millions, current prices) $120 $100 $80 $60 $40 $20 $0 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Investments in hydroelectric projects Investments in irrigation projects
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domestic sources. This is especially the case for dam projects that tend to have a large civil works component. In industrialised countries, there is a long history of mobilising part of the funds needed for new stateowned infrastructure facilities through bond issues. In the hydropower field, good examples are the provincially owned hydropower corporations in Canada and the Tennessee Valley Authority in the US. During the 1990s, a number of state-owned utilities in Asia were partially privatised through public equity offerings. These utilities have subsequently operated on a commercial basis and have financed part of their expansion programs through bank loans, bonds and sale of equity. Today, utility shares account for about one-fifth of the stock market capitalization in Malaysia and Thailand. However, even some of the fully state-owned power companies, such as WAPDA in Pakistan, have mobilized funding by issuing bonds on the domestic capital market. Far too often, however, state-owned utilities have poor financial performance and cannot access funding from the private sector. The privatization of utilities in Latin America took a different course from that followed in East Asia. The major objectives in most Latin American privatizations were to reduce government foreign currency debt and to quickly improve the performance of the utilities. Thus, the basic approach was to sell controlling stakes to foreign corporations that assumed operating responsibilities. Greenfield projects in power generation have been financed predominantly through offshore equity and debt, with relatively few exceptions. Most projects in Thailand and Malaysia were sponsored by local industrial groups and financed primarily with local bank loans. In Chile, the pension funds have been major investors in infrastructure projects. Gradually, however, domestic bank loans are used for the financing of new power investments in other Latin American countries. Most large hydropower projects have been financed predominantly with overseas bank loans or with support from the multilateral development institutions. One of the few exceptions is the Ita project in Brazil that has mobilized about $400 million from the Brazilian National Development Bank. The $103 million debt for the Bakun project in the Philippines was originally underwritten by a consortium of local banks but was subsequently partially syndicated to a group of foreign banks. Of special interest, however, is the emergence of smaller hydropower projects in countries such as Armenia, India and Sri Lanka. In the case of Armenia and Sri Lanka, the size of the projects in the order of 1 MW while the size in India is more than ten times as large. What is notable about these projects are that they are small enough for local entrepreneurs to mobilize the equity and for domestic banks to provide all of the debt.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Table 3.7. Current Sources of Financing for Dams in Developing Countries. Source of Funds Bilateral & Multilateral Donors Export Credit Agencies Private Sector (local & foreign) Government Agencies & State-Owned Utilities Total Investment in Dams Approximate Amount 2.5 billion <1.5 billion 0.5-1.1 billion 17-27 billion 22-31 billion Share of Financing 7-10% 5-7% 2-5% 78-86% 100%
2. Internal review processes have been strengthened (the World Bank, for example, has appointed an external Inspection Panel which can review the compliance by staff and managers to the Banks policies and procedures); 3. Lending policies, especially in the power sector, seek to promote reform and encourages governments to bring in the private sector; IFC and the private sector windows of the regional development banks have expanded their activities during the 1990s and give priority to infrastructure projects; New instrumentsespecially partial risk guaranteeshave been adopted to support private investments;43
4. Greater emphasis is being placed on sound macro-economic policies and reduction in poorly targeted subsidies (for example, the large subsidies typically associated with public sector canal irrigation schemes); 5. Country strategies focus more on poverty alleviation and environmentally sustainable development, which, inter alia, has led to: An increased emphasis on energy efficiency and renewable energy sources; Projects designed to involve the beneficiaries in the design, construction and operation of small-scale infrastructure projects such as rural water supply;
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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A greater focus on rain-fed farming in remote and less developed regions; A realisation that large-scale canal irrigation has generally been less effective than small-scale schemes and farmers need to be involved in irrigation management. In some cases, it has been difficult (if not impossible) to ensure that the borrower has adhered to the lending agencys safeguard policies; Cost overruns have been more serious than in the case of non-dam projects meeting the same purpose;44 While on the average, it appears that the construction delays are about the same for dam and non-dam projects,45 the dam projects can sometimes experience extreme delays.46
Box 3.1: A Culture to Lend? Many critics argue that the World Bank is driven by a culture to lend, implying that the quantity of lending is more important than the quality or development impact of the projects it finances. Many World Bank staff members would agree. Indeed, an internal task force headed by former World Bank Vice President Willie Wapenhans forcefully made the same point (World Bank, 1992). However, the Banks current President is consistently stressing the importance of quality while down-playing quantitative lending targets. There are a number of indications that he is serious (as were his predecessors) and that the culture is slowly changing: A Quality Assurance Group (created in the mid-90s and located in the Presidents Office) reviews the quality of the Banks lending operations in real time rather than ex post as the Operations Evaluations Department. An independent Inspection Panel created in 1993 to provide an independent forum to private citizens who believe that they or their interests have been or could be directly harmed by a project financed by the World Bank. The Panel reviews the compliance of staff and managers to the Banks policies and procedures. The Banks Country Strategy Papers for low income countries are not only discussed in draft form with the concerned government but also with civil society groups. After extensive reviews by the Board, the finalized Country Strategy Papers are published on the Banks web site. This is in sharp contrast with the situation two decades ago when these documents were not even seen by the government or by the Executive Directors on the Banks Board. Summaries of all proposed lending operations as well as the complete Project Appraisal Documents are also available to the general public on the web site. This makes the Banks decision making regarding its lending operations more transparent. Most safeguard policies (on environmental and social issues) have been gradually strengthened. Similarly, the Bank has increasingly sought to involve the target population in project design and implementation and NGOs are emerging as development partners (albeit, the Bank still has a long way to go in this area.)
Finally, the overall lending level of the World Bank has gradually declined in real terms for more than a decade (in spite of a burst of quick disbursing lending in the aftermath of the Asian crisis). In the fiscal year that ended on June 30, 2000, the overall lending of the World Bank ($15.3 billion) was the lowest in nominal terms since 1985 and in real terms (i.e. after adjustment for inflation) the lowest since 1974.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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3.4.3 Emerging Instruments for Support of Public and Private Dam Projects
There are great similarities in the lending policies and instruments among the multilateral development banks. Often, but in no way always, the World Bank Group is taking the lead in adopting new instruments or policies. Thus, for ease of presentation, this section focuses on the World Bank Group. The World Bank Group consists of four main parts: The International Bank for Reconstruction and Development (IBRD) lends to governments or to private or public sector entities (with a government repayment guarantee) at a quasicommercial interest rate. IBRD mobilises the bulk of its resources by placing bonds on the international capital markets. All middle-income and a couple of low-income countries (China, India and Pakistan) are eligible to borrow from IBRD. The International Development Agency (IDA) provides long-term, soft loans to governments in low-income countries. Grants from the industrialised countries provide most of IDAs resources. IDA can lend only to governments, not to government agencies or private enterprises. The International Finance Corporation (IFC) is the private sector arm of the World Bank Group. It provides equity and debt to private companies that invest in developing countries. Its lending terms are commercial. IFC cannot accept government repayment guarantees for its loans (which IBRD requires). The Multilateral Investment Guarantee Agency (MIGA) provides political risk insurance for private investments in developing countries. The insurance can be provided for both debt and equity investments.
In the early 1990s, IBRD developed a number of instruments to help mobilise funding from the private sector for development projects. The two main vehicles that are used today are: Partial credit guarantees are used to mobilise commercial loans for public sector projects. Such guarantees have been used to mobilise commercial bank loans for state-owned utilities in China and Jordan. Due to IBRDs commitment to cover part of a potential default by the borrower,
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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these commercial loans have longer maturities and lower interest rates than what would be possible otherwise. Partial risk guarantees are used to help mobilise financing for private infrastructure projects in countries with a credit rating that is below investment grade. A partial risk guarantee protects the commercial lenders in the case of default by the project company due to certain political events.47
Until a year ago, partial risk guarantees could be provided only to countries eligible for IBRD loans. Subsequently, on a pilot basis, guarantees can now also be provided to IDA countries. Guarantee operations are subject to the same environmental and social policies as regular World Bank loans. In order to bring in additional commercial financing in countries with marginal credit rating, IFC has started a program of B-loans. B-loans are syndicated loans where IFC is the lender on record. Although the B-loan program of IFC doesnt formally provide protection against a governments failure to make foreign exchange available for debt service, most bank regulators in industrialized countries regard B-loans as having a de facto preferred creditor status. Although the structure of the regional development banks is simpler than that of the World Bank group, they have the same basic features:48 They lend to most governments on quasi-commercial terms (similar to IBRD); They have soft or concessional windows for lending to low-income countries; They have private sector windows that can provide equity and debt for private sector projects; They can provide partial risk guarantees like IBRD and B-loans like IFC.
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moved from the pilot stage to full-scale applications. Thus, while, for example, the World Bank doesnt have any generation project in its published project pipeline, it has around two dozen projects in the lending pipeline that focus on the development of renewable energy sources or on enhancing energy efficiency. This trend is expected to continue over the next decade.
3.5 Implications
The implications of this discussion seem to be that: Overall financing of dam based projects has slowed down substantially since the heyday of the 1970s and 1980s. In part this reflects the global shift away from public sector financing to partnership and deregulated private sector investment. Dam based projects whether for irrigation, water supply or hydropower - offer less attractive financial conditions for private sector investors than non-dam alternatives.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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4 The Emergence of New Financing Instruments for Large-Scale Private Sector Water and Energy Resource Projects
4.1 The Basic Principles of Project Finance
The preferred way of financing private infrastructure schemes in the developing world is project finance. This means that the repayment of the financing relies on the cash flow and the assets of the project itself rather than on the strength of the sponsors balance sheet. The risks (and returns) are borne not by the sponsor alone but by the different participants in the projects. There are two basic types of project finance: non-recourse and limited recourse project finance. Non-recourse financing implies that the lenders to and investors in the project do not have any direct recourse to the sponsors, for example through loan guarantees. Although creditors security include the assets being financed, they tend to be illiquid and of limited value. Thus, the lenders rely on the operating cash flow generated by the project. Limited recourse financing allows the lenders and equity investors some recourse to the sponsors. Such recourse often involves some form of pre-completion guarantee by the sponsors. In either case, the project needs to be carefully structured to ensure lenders that it is economically, technically, and environmentally feasible and that it is capable of servicing the debt under most reasonable scenarios. Crucial to the successful structuring of a project financing is the identification and mitigation of risks. These risks are allocated among the project participants through a comprehensive set of legal documents, usually referred to as the security package. The security package achieves two things: (i) it allocates risks to the parties that best can manage those risks; and (ii) it ensures the long-term commitment of the parties to the project. Figure 4.1 illustrates the basic structure of the security package for a power project. The key agreements in the security package are: The Implementation Agreement (IA) or Concession Agreement sets out the conditions under which the project company can operate. It also sets out the governments obligations to the project company. Typically, it protects the company against changes in law and taxation and against certain political force majeure events. Depending on country conditions, it might also have provisions related to the availability of foreign exchange for debt service and profit remittances and convertibility of the local currency. The Guarantee Agreement (GA) commonly covers the governments undertaking to ensure that various state-owned entities (especially the power purchaser) fulfill their obligations. The Power Purchase Agreement (PPA) between the (state-owned) utility and the project company covers, inter alia, the long-term commitment by the utility to buy power at a pre-defined price. It also defines a number of technical and financial undertakings by both parties. The tariff typically is divided into two parts: a capacity charge (that guarantees the project company sufficient revenues to service the debt even if the plant is not dispatched) and an energy charge. Generally, the tariff formula includes indexation for general inflation, devaluation and changes in fuel costs. The Fuel Supply Agreement (FSA) between a coal, gas or oil supplier and the project company defines the terms and conditions for long-term sales of the fuel in question.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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The Turn Key Construction Contract (TKC) typically provides for a fixed price and includes severe penalties in case completion is delayed. In most cases, the contractor is also responsible for designs and procurement of all equipment. The Operation and Maintenance Agreement (O&MA) is entered into with a company that has acknowledged expertise in operating power plants. Although such contracts tend to have shorter duration than the FSA and PPA, they typically covers the period while the bulk of the loans are being repaid. Like the TKC, the O&MA includes significant penalties for the O&M contractor in case he fails to meet the agreed performance targets. The Loan Agreements (LA) are entered into with the lenders. For larger projects (say, over $100 million) the loans tend to be syndicated to a group of banks. The loans typically have maturities of 10-12 years, with repayment starting shortly after the planned start of commercial operation. Most commercial bank loans have a floating interest rate, which provides for a spread over the 6-months LIBOR. Depending on the creditworthiness of the country where the project is located and the risk profile of the project, the spread over can vary between 1% and 4%. The Inter-Creditor Agreement (ICA) defines the relationships between the different lenders. It covers, inter alia, the procedures for handling an eventual default by the project company. Figure 4.1. Security Package for a Power Project
Cabinet/ Government GA
Regulatory Authority
PPA
State-owned Utility
FSA
PROJECT
COMPANY
LA ICA LA
Turnkey Contractor
Project Operator
Equity Investors
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sub-ordinated debt). For most thermal power projects, this has typically resulted in a demand by the lenders that the equity provided by the sponsors and other investors should cover at least 25% of the cost of the project (including interest during construction). Since equity is more expensive than debt, the desire to have the most competitive tariff for the power sold, will result in the equity being as close to what the lenders regard as the minimum acceptable. Box 4.1: Project Finance Risks Identification and mitigation of risks are at the core of limited recourse financing for infrastructure projects. Of course, every project is different and it is not possible to compile an exhaustive list of risks or to rank them according to importance. What is a major risk in one project might be negligible in another. The risks are also very different for different participants in a project. What might look like a major risk to the project sponsor/developer might not concern the government or the lenders. The nature of the risks also changes over time as the project moves from early planning stage through construction and commercial operation to eventual decommissioning. Lenders and developers typically make a distinction between commercial and political risks. The former cover risks that are a natural part of doing business such as construction of the plant and its efficient operation, market prospects and interest rates fluctuations. Political risks have traditionally included such events as insurrections, major strikes and expropriation. However, in the project finance context, political risks are seen much more broadly and typically cover all factors that are directly controlled by the government or strongly influenced by government actions or in-actions. Thus, political risks include the availability and convertibility of foreign exchange, changes in law, timely approvals and issuance of permits and licenses, the contractual performance of government owned entities. The borderline between commercial and political risks is often fuzzy and varies from case to case. Typically, the risks are classified depending on the stage of the project. The financiers of a project would be concerned about the following risks: Development risks. The process from project concept to financial closure can be long and cumbersome. The detailed feasibility study might demonstrate that the project isnt viable or lenders might consider macro-economic conditions too risky for long-term loans. However, bureaucracy and slow approval processes and drawn-out negotiations of the key contracts are the most common obstacles that seriously impact the viability of the projectassuming that the basic policy and regulatory framework doesnt change during the development phase. In India, for example, after more than five years of negotiations, only two of eight fast track projects have reached financial closure. The risks at this stage are taken by the project sponsors. Construction risks. These are almost universally mitigated through a fixed-price, date certain design and construction contract. Thus, the turnkey contractor assumes most of the risks. However, there are residual risks that affect the sponsors and lenders such as those due to foreign exchange and interest rate movements and a variety of political force majeure risks. Operating risks. The proper operation of the plant is ensured through warranties by the equipment supplier/turnkey contractor and through an O&M contract with an experienced operator. The availability of fuel is ensured through a long-term contract with a reliable supplier. Most critical, however, is the off-take risk that in the case of power plants typically is mitigated through a long-term contract with a state-owned utility. The risks associated with economic factors outside the project companys control are typically passed on to the state-owned utility (and the final consumers) by linking the tariff to an index that includes general inflation, devaluation and changes in fuel costs. The next major issue that needs to be tackled is the risk of cost overruns. Although the principle is to have a fixed price construction contract, there are always factors that can legitimately increase the
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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construction cost (such as exchange rate movements, interest rate changes and unforeseen foundation problems) or delay completion. To deal with this problem, it is common to require the sponsors to give a commitment to increase their equity contribution. Similarly, the lenders often make a commitment to provide a limited increase in the loan amount. These contingent funding amounts are usually referred to as stand-bys. The stand-bys typically range between 5% and 10% of the base financing. The real challenge, however, is that a project never can have a credit rating which is higher than the country where it is located. Thus in most countries with a credit rating which is below investment grade,49 commercial banks will be reluctant to take the risk of the host country running out of foreign exchange. This means that there often is a need to seek insurance cover from one or several of the ECAs. Since ECA coverage is linked to the export of equipment, the sourcing of equipment is often determined by which ECA is willing to provide cover to projects in the host country. Given the limitations on ECA support, there is often a need to seek financing from IFC or one of the regional development banks. In addition, other risk mitigating vehicles are sought, such as B-loans and partial risk guarantees from the World Bank and the regional development banks. The commercial risks are partly mitigated by the lenders through the debt-service limits. In addition, the lenders seek to spread the risk through syndication. Local currency expenditures typically make up part of the cost. This means that it is prudent to also mobilise local debt, wherever feasible. In short, the financing package for a major infrastructure project in a low income country tend to be highly complex, involving a number of commercial banks, a couple of ECAs and one of the IFIs.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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using the spread to help finance urgently needed social programs). If the utility itself sought commercial financing, in most cases the terms would be no better and possibly worse than those obtained by properly structured BOO/BOT projects (see Box 4.2). Box 4.2: Is Private Power More Costly? A frequent comment in the discussion of private power generation is that it is too expensive and that the existing state-owned utility can generate power more cheaply. This argument deserves careful scrutiny since it is commonly the result of faulty assumptions and incomplete (or biased) analysis. The first key assumption is that the plant will be built for the estimated cost and completed as planned. However, as Bacon et al (1996) demonstrated, most power plants experience both delays and cost over-runs. Their review of 135 generation projects indicated that the average project experienced a cost over-run of 21% and the completion date slipped by 36%. Taking into account the interest during construction, the combined effects of the slippages, these two factors increased the capital cost of the projects by one-third. The second key assumption is that the plant will be operated according to best practices. However, as noted by the World Bank, poor maintenance means that the typical public sector generating plant in developing countries is available for operation only about 60% of the time as opposed to more than 80% of the time under best practices. Thus, cost over-runs, completion delays and operating problems often results in capital costs (per kWh of energy produced) that are 50-100% higher than estimated at the sanctioning stage. IPPs are typically built with fixed-price, date-certain construction contracts, which means that the tariff will not be adjusted if there are construction delays and/or cost over-runs. Similarly, a failure to meet the plant availability targets typically results in penalties to be paid to the power purchaser who, thus, doesnt have to absorb the cost of poor operation and maintenance. The comparison of private and public sector power generation is often biased through implicit subsidies in the financing of state-owned facilities. Frequently public sector entities are provided credit on very favorable terms either from the government or from commercial banks due to treasury guarantees or lending directives. Any lending terms (in terms of interest rates and maturities) that are better than those that can be obtained by private sector entities (with similar creditworthiness) represent subsidies to the utility and should be removed before any cost comparisons. Basically, government owned utilities and well-structured IPPs should be able to access commercial debt on similar terms. Many governments also provide equity to state-owned entities on which they earn little or no return. Again, this represents a subsidy that tends to obscure the real cost of power development. Theoretically, the target return on governments equity investments should reflect the opportunity cost of government revenues, which would tend to vary from country to country. On the whole, however, it would tend to be higher in developing than in industrialized countries. A reasonable order of magnitude for the return on equity would be 10-15%. For example, Vattenfall AB, the big Swedish state-owned power company, earned a 12% return on equity during the second half of the 1990s. IPP investors, however, typically require higher returns on their equity. In general the returns are 16-20%. For IPPs with a debt-equity ratio of 3:1, the higher target return increases the annual capital cost by around one-sixth. In short, any comparison of the cost of power generated by public and private plants must be done carefully and take into account the actual operating performance.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Sub-Saharan Africa
Asia
Latin America
200
400
600
800
1,000
1,200
1,400
1,600
MW of Installed Capacity
Source: Projectware database (Rojas and Aylward, 2000)
In parallel with these private sector initiatives, there remain many hydro projects being built by publicly owned utilities in countries like China, India and Iran. At present these represent by far the larger proportion of hydro projects under construction, but the trend is towards public funding becoming scarcer and it is likely that when the present tranche of projects is completed, it will not be replaced at the same level as before. Irrespective of whether projects are being developed in the public or private sector, the environmental issues are looming larger and taking a more central role than in the past. Whereas twenty years ago the Environmental Assessment (EA) for a prospective hydro project would occupy perhaps one chapter in the Feasibility Report, it is now invariably a separate report, often with detailed supporting annexes and usually undertaken by an independent party. Many, but not all, countries would require the studies to be undertaken to World Bank or similar guidelines, and most international consultants in the sector would expect to work to these standards. This does not avoid contentious issues, but it ensures that they are identified and thoroughly investigated in advance of any final commitment to the project. As a result the more recent projects have generally been subjected to a much more thorough environmental screening process than previously. The trends discussed in the previous chapters and the increasing environmental concerns give rise to a number of interrelated issues that are explored in this section of the report. Character of Hydropower Plants A central feature of the issues to be explored here is the uniqueness of each hydropower site, and the importance of developing that site for the optimal national benefit (i.e. for utility purposes) consistent with acceptability amongst local stakeholder groups. These objectives are encapsulated in the emerging criteria for hydropower projects in a number of countries, which require that they should be: Economically viable Environmentally sustainable Acceptable to the local community.52
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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To appreciate the first point it is necessary to understand the differences between basic types of hydro project, and the quality of electricity that they can produce. They are: Run-of-river projects have no reservoir and generate only on the natural, unregulated river flow. These projects have relatively minor environmental impact, other than the depletion of river flows between the intake and powerhouse on tunnel schemes. However due to the lack of storage they produce relatively low value base load energy, and offer few of the ancillary benefits inherent in a storage project (e.g. load following, spinning reserve, energy standby). Storage projects have the flexibility to adjust output to meet system requirements. They are used to store energy and service the high-value peak of the load curve. Most importantly they are more responsive in terms of load following frequency control and emergency standby than any other form of generation. In summary storage projects produce higher quality electricity, but at the cost of generally raising more environmental concerns over such issues as loss of land, population displacement and changed flow patterns. The distinction between these two types of scheme is not absolute. Some run-of-river schemes can have very limited storage (e.g. hourly) and reservoirs for storage schemes can provide everything from daily to seasonal regulation. For example in Southern Africa it is not unusual to find reservoirs which can hold three times the mean annual flow (MAF) whereas in South-East Asia, with its more regular rainfall pattern, typical storages might be the equivalent of three to six months' MAF.
Early attempts by some governments to attract private investment to the hydro sector on the basis of an ill-formulated regulatory framework and unclear risk allocation proved a failure. The private sector response to such overtures was poor because of concerns over: Perceived high commercial risks, particularly in terms of uncertain energy production and high exposure to completion risk due to the nature of the works. Delays and heavy costs involved in feasibility studies and obtaining the necessary permits. Possible late interference and unforeseen costs or delays arising from environmental and resettlement issues, and problems with land and water rights.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Difficulty in financing projects with a large local civil works content and long payback periods.
It became evident that if private investors are to be attracted to fund hydro projects, the public sector has to be prepared to assume some of the risks, and to play a much larger role in the project than for thermal IPPs. Furthermore, there are key issues to be resolved regarding the interface between the public and private partners if the project is to be developed and operated in a way that realizes the full potential of the site. In general, private hydro schemes are on a BOT basis (build, operate, transfer) with the scheme eventually reverting to the state-owned utility at the end of the concession period. Under such arrangements, it is natural that the private concessionaire will take a shorter-term, narrower perspective that may be in conflict with the broader interests of the host government and the utility. For example, most private hydro projects are being promoted as run-of-river schemes because financiers and guarantee agencies are reluctant to become involved with storage projects due to concerns over environmental problems and negative publicity. In consequence there is a tendency to develop run-of-river schemes irrespective of whether the site might be better developed as storage project yielding higher quality electricity and possible multipurpose benefits. Other problems can arise when it comes to the operation of existing storage schemes, where a private operator will naturally try to adopt a reservoir release policy to maximise the returns from the sale of electricity. Under a power pool system there will be a tendency for all hydro schemes with storage to bid into the peak of the load curve where the higher price is obtained, but this can result in an unacceptable pattern of river flows downstream and may be in conflict with other requirements. The regulatory framework therefore has to address, on the one hand, the need to induce the private sector to participate in an area in which it is not particularly comfortable, and on the other hand provide the necessary checks and balances to ensure that the wider and longer-term national and local interest is being preserved. A key issue with which many governments are struggling is the method of awarding hydro concessions in a manner that meets certain basic obligations, namely that: The site is developed in an optimal manner, not only for the power system but also for multipurpose use where appropriate; The selection of the concessionaire, and the setting of tariff levels, meet adequate standards of public accountability; A sensible balance is achieved between the benefits that the state receives and the support that it provides. The project meets adequate environmental criteria, and is acceptable to the local population. The engineering, operation and maintenance of the project are consistent with public safety requirements and maximising the project life.
The World Bank study already mentioned, examined trends in the regulatory environment for in about seven countries at various stages of development. All have been trying to promote privately financed hydro with varying degrees of success, and tuning their regulatory approach accordingly. The current position can be briefly summarised as follows: Lao PDR. Legislative reform has been focussed on encouraging foreign investment for the development of export projects as Lao's hydro resources are far in excess of its domestic demand. Two projects have reached the construction stage and a third (Nam Theun II) is still under planning following a delay of several years while the environmental impact was reviewed.53 There is no BOT legislation as such. Each project has been directly negotiated on a tripartite basis between the developer, the government and EGAT, the Thai utility. The government is expected to benefit as a
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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shareholder using concessionary ADB lending to purchase its shares and from royalty payments and tax revenues. Potential export revenues will form a significant part of GNP. Nepal. Nepal also has hydropower resources far in excess of its domestic requirements. Like Lao it has been traditionally dependent on concessional financing, but the New Industrial Policy of 1992 opened the door to private financing. To date there have been two privately funded hydro projects (36 MW and 60 MW) aimed at the domestic market. Both have been directly negotiated and depend heavily on support from international lending agencies (ILAs). The trend is now towards encouraging competitive bidding for the next generation of domestic projects, and reviewing the way forward on larger export projects. Philippines. The government and the utility (NPC) have modified the regulatory framework considerably following a poor response by the private sector to earlier rounds of BOT hydro bidding. Despite many attempts and a large number of projects being offered to the private sector, there are only three BOT hydro projects actually under construction. Negotiations on a number of others are being blighted by the reluctance of the utility to enter into further power purchase agreements pending full privatisation of NPC. There have been no public sector hydro projects for many years. Turkey. The position is similar to the Philippines in that there much effort has resulted in very little action on the ground. Despite favourable risk sharing arrangements from the viewpoint of the private developer, and the "award" of about 80 BOT hydro concessions, only a handful of projects are under construction. One of these is the 600 MW Birecik project that is reported to have taken eight years to negotiate. There is growing recognition that the private hydro program in Turkey is stalling due to bureaucracy and financing problems. India and Pakistan. Both countries have tried, largely unsuccessfully, to attract private finance to the hydropower sector, and both have recently issued new policy guidelines which lay more emphasis on state participation in private projects, particularly in terms of project preparation, environmental permitting and support with financing. Much emphasis is being placed on the sharing of commercial risks and the provision of sovereign guarantees for the underwriting of power off-take agreements. Brazil. Currently undergoing deregulation of the power sector, with accompanying legislation to encourage private generators. The regulatory framework is based upon a competitive bidding process that varies according to the size of project. To date most of the activity has focused on the sale of existing assets, but there are a small number of new quasi-private hydro schemes in progress, many involving the local utility company in partnership with private industries. As will be seen from the above, the picture is unclear and changing. No standard regulatory model has emerged for hydro projects, but in general terms the trend is in the following directions: In most cases utilities are assuming production risk (i.e. payments are not dependent on river flows) and sharing some of the construction risks. The public sector is increasingly recognising that the feasibility study and project definition are public responsibilities, and that it is anyway advantageous to retain them in the public sector. Similarly EA studies and the resulting mitigation/resettlement plans have to be carried out by the public sector before the private sector becomes involved. The host government has to be prepared to back the utility's payment obligations with sovereign guarantees. Political risk cover and funding support mechanisms are needed from the ILAs whose role is central to the success of most privately financed hydro projects.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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In conclusion the public sector in the form of the host government, the utility and the ILAs will continue to have a strong influence on any new hydro projects irrespective of whether they are developed in the private or the public sector.
As the civil works are largely local costs, a significant proportion of the total project funding could be sourced in local currency if it was available, and would return immediate benefits to the local economy. In contrast most thermal power stations have a very high percentage of equipment, which is usually imported, and the foreign exchange component can reach over 80%. In the past it has been difficult to exploit this advantage in the developing world, because of limitations on local capital resources and the fact that the scale of the works is usually beyond the capability of local firms. In practice hydro projects, especially in low-income countries, have therefore also had a large foreign exchange component, generally by the multilateral development banks or bilateral donors. Twenty years ago, a major portion of public sector hydro project in the developing world was financed by donor agencies, but in more recent years there has been a tendency for this type of financing to be restricted to the civil works leaving the remainder to be funded through export credits.54 In addition to providing finance, most export credit agencies (like the USEXIM, ECGD, Hermes and Coface) offer insurance cover for certain types of risk in support of their own exporters. ECA funding is more readily available than straight commercial lending and at somewhat easier terms that sit partway between commercial credits and loans provided by the international development banks like IBRD and ADB. Hydropower projects have long gestation periods and economic lives and are capital intensive. Whereas the cost of energy from thermal stations has a major fuel component that is common to both public and private sector projects, the cost of energy from a hydro plant is totally dominated by the overall cost of the works including finance. Thus, the declining availability of government funding and long-term loans or grants from the donor community has a significant impact on the development of hydropower projects and alternative means for meeting the growing energy demand in developing countries. The ways in which a hydropower project can be financed depends on its size and whether it rests in the public or private sector. Broadly speaking the options are as follows: Public Sector Public sector projects are typically financed from either central government funds or by the utility on the strength of its balance sheet, which normally implies corporate borrowing. Depending on the country concerned it might still be possible to mobilize debt from one or other of the ILAs, although this is a diminishing source of funds (see Chapter 3). More creditworthy borrowers in the developed world will often raise money on the bond markets. Public sector financing will undoubtedly remain an option in a number of countries where the power utility still is state-owned, and in those areas of the world where the necessary legislative framework is not in place. However it has to be recognised that the global trend in the financing of infrastructure projects, including power, is inexorably towards increasing dependence on private investment.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Although a project may initially be publicly funded, it is possible to introduce private finance at a later stage by selling or leasing a completed project. In general an existing hydro asset is an attractive investment provided the power off-take position could be secured. In countries like China, the public sector is either borrowing on the strength of existing hydro assets or selling equity in them. However this approach is clearly only viable if there is sufficient public sector funding available in the first place to implement the project. Private Sector Financing for Large Projects Private sector projects are generally financed as stand-alone IPPs created specifically for the purpose of developing, owning and operating the project. Whereas thermal power projects are generally of the BOO type, most hydropower schemes are eventually transferred back to the state or the utility, and the concession is therefore granted on a BOT basis. Hydropower projects are riskier than thermal power projects and, thus, debt/equity ratios for hydro projects are typically in the region 70%/30%. For thermal power projects with their high equipment content, the traditional source of debt has been the export credit agencies. However for the typical hydro project ECA credits are unlikely to account for more than 30% of total project cost. With equity accounting for perhaps another 30%, this leaves 40% of the overall project cost including financing to be sourced from elsewhere as follows: Sponsor's equity ECA credits Commercial loans or ILAs Total 30 % 30 % 40 % 100 %
Unless the host country has a well developed financial market and/or an investment grade credit rating, this gap is usually too large to be filled by commercial loans and experience has shown that for the larger projects ILA support is usually needed. Amongst the projects examined in the recent World Bank study (Head, 1999) the ILAs were seen to have acted in a number of roles, including: surrogate lenders (i.e. through the host government) direct lenders equity holders providers of technical assistance guarantors.
In general, private financing is only sustainable with support from the host government and within a security package that often requires sovereign guarantees (see Chapter 4) Some of the international power developers are assembling portfolios of projects located in a single country. So far, these holdings generally have not been consolidated into a single corporate entity. However, as privatisation of existing generating plants is progressing and more green-field projects are being built, such consolidation is likely to occur. This offers some hope that the project finance approach will gradually be replaced by a corporate finance approach, which would facilitate the mobilisation of long-term debt. An intermediate approach has been adopted by a few developers who have pooled the debt of several projects and issued bonds with the revenue stream from the pooled projects as security. Private Sector Financing for Smaller Projects One of the difficulties with the financing of large-scale hydro projects is that in most developing countries, local capital markets are too under-developed to finance a major share of the civil works
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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component. This, of course, has led to developers seeking international financing and, thus, putting additional strain on the balance-of-payments of the host country. Consequently, it is encouraging to find that local entrepreneurs in some developing countries have shown an interest in the development of small hydro projects. Such projects can range from a couple of hundred kW to perhaps 10 or 20 MW. (The upper limit largely depends on the ability of local banks to provide long-term financing). Armenia, for example, has established an independent regulatory authority and restructured the power sector. The units of the formerly state-owned monopoly have not yet been divested. However, private entrepreneurs have invested in 13 small hydropower plants that now produce about one percent of the countrys electricity. Similarly, with the help of an IDA credit, Sri Lanka has encouraged private investments in small hydro plants (with capacities ranging between a couple of hundred kW to a couple of MW). Over the last three years 13 projects have been built with an aggregate capacity of 12 MW. Local banks are presently considering loan applications for projects with a total capacity of 16. (The IDA funds are channelled through local banks at commercial interest ratesalthough at somewhat longer maturities than would normally be available.) India also seems to be on the verge of rapid development of small hydropower plants (although the size range is higher than in Sri Lanka and Armenia). Besides reducing the balance of payment impact of hydropower development, these small-scale projects tend to be fairly inexpensive (in Sri Lanka the cost ranges from $800 to $1,300 per kW) and have short gestation period. Furthermore, the social and environmental impacts tend to be limited. Politically, these small-scale projects with local owners are often more acceptable than large projects with foreign owners. One pre-requisite for this type of small-scale development is that the government has an efficient approval process and use simple, standardised power purchase contracts with an uncomplicated and transparent tariff formula. Public-Private Partnerships Many types of hydro project are proving to be difficult to finance entirely in the private sector, and yet traditional sources of public funding are no longer available. The solution to this problem may well be a combination of public and private funding, with the public sector providing in effect the minimum needed to bring the private financiers to the table. This can be achieved in a number of ways: Hybrid Projects where the project is effectively divided into separately financed public and private elements. For example, the public sector can finance the dam structure and the private developers can be responsible for the powerhouse. This approach is most common in multi-purpose projects, such as the San Roque project in the Philippines. Another variation on the same approach is when a private developer retrofits the powerhouse associated with an existing publicly owned dam. Lease-Purchase Arrangements under which public money in injected into the project in the form of lease-purchase payments during the construction phase to reduce the amount of private funding required. This has the effect of reducing the amount of private finance needed (and overall cost of the project) making it more affordable and bankable. Under both of these arrangements ownership and effective control of the project remain in the hands of the (public sector) utility. To date there is little actual experience of implementing projects under these arrangements (although similar approaches have been used extensively for other types of infrastructure).
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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and wider interests of the state in achieving the optimum development of the site, but such conflicts can exist. There is a tendency on the part of private developers to avoid multi-purpose projects because of: the perceived complications of dealing with a number of government departments representing the different water-user interests; the lowor non-existentrevenues from purposes other than power generation, and the fact that most multi-purpose projects involve storage. Projects on international rivers are relatively rare because of the reluctance of international organisations like the World Bank to become involved unless there are water-sharing agreements endorsed by the affected riparian states.
In terms of environmental impact assessments, and the subsequent mitigation measures, the outcome is not significantly influenced by the approach to project financing, because the international banking community, ECAs and the major commercial lenders are all moving towards adopting a consistent approach which is to require studies to internationally acceptable guidelines before they will even consider a project for financing.
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The withdrawal of public sector funding from infrastructure projects in general, and power in particular because it is perceived to be commercially viable in its own right. The reluctance of private investors to engage in projects that have long lead times, heavy frontend expenditure, a high risk profile and long payback periods. The problems of financing projects with a relatively low import content and a high proportion of local civil works costs, often in countries with a low credit rating and immature capital markets. The financing problem is exacerbated by the reluctance of many ILAs and commercial bankers to become involved with projects that they think might become controversial. Developers themselves are naturally tending to opt for the easiest projects, which do not necessarily reflect the optimal development of the site or the project that the system most requires. The lack of a clear regulatory framework and a mature, proven model for the private financing of hydropower projects is also inhibiting progress. The price of projects is being increased by the risk sharing mechanisms and contract arrangements imposed by bankers, and by the cost of raising private finance. When combined with the relatively short payback period this often results in unacceptably high tariffsespecially in the early years--which cannot compete with the thermal alternative. The comparison with thermal plant is further distorted by the fact that hydro is increasingly required to internalise its environmental mitigation and social costs (e.g. resettlement) whereas in most countries there is no carbon tax or similar charge levied for the environmental impact of fossil-fuel generation.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Box 5.1: Murphy's Law and the Mandate of the WCD Murphys Law (anything that can go wrong, will go wrong) is the basic premise on which project finance is based. The Eurotunnel, the largest project financing in recent times, resulted in losses amounting to many billions of dollars for both equity investors and lenders. In simple terms, the problems were delays, cost overruns and overoptimistic revenue projections. The lessons learnt from this experience are now reflected in the security package for infrastructure projects in developing countries. Fixed-price, date-certain turnkey construction contracts are aimed at limiting the construction risk for the financiers. Similarly, the off-take agreements (for example, power purchase agreements) seek to ensure that the state-owned utility will buy a reasonable amount of the output and pay a fair price. Besides the obvious technical/engineering risks (geology and hydrology) that large dam projects pose, the environmental and social issues related to the construction of dams increase the risk to lenders and equity investors. Basically, project financiers see these as political completion risks that can delay and increase the cost of the project and ultimately make it into a failure. The starting point in any due diligence process carried out by commercial lenders is the question: Does this project meet all legal and regulatory requirements? This leads to a number of more specific questions: Does the sponsor have legal title and unencumbered access to the land? Does the project meet all environmental requirements of the government? Does the project meet all safety requirements? Has the project received all required clearances and licenses?
A negative answer to any of these or similar questions means that the project will not be financed. Difficulties arise when the answer is ambiguous. This is rarely the case in energy and water resource projects such as thermal power plants that do not involve the construction of dams. In the case of dam projects, however, the social and environmental impacts are much wider and few developing countries have norms and procedures that are unambiguous and acceptable to the affected people. This, of course, is why dam projects tend to be highly controversial. Under these circumstances, commercial lenders are unlikely to take the completion risks. Broad acceptance of a clear set of the criteria and guidelines such as those that are expected to emerge from the Commission - and the incorporation of these in national resettlement and environmental policies will reduce the ambiguity and, thus, the perceived risks to investors and lenders. While the adoption of such criteria and guidelines might increase the cost of individual projects (and reduce the investors return), this will be outweighed by the risk mitigation impact of the guidelines. Consequently, the forthcoming WCD guidelines are likely to be an attractive alternative to business as usual for reputable developers and lenders. A related issue is raised by the distinction between financial and economic analyses of profitability (see Thematic Review III.1 on Financial, Economic and Distributional Analysis). Economic analysis may be used to identify the most attractive option from the standpoint of the national economy (including its social and environmental effects) but there is no guarantee that the top project will be the most financially attractive project, or that it will be financially viable.58 This is a result of two factors: (1) the difference between the financial and economic benefits of water and energy services and (2) the difference between the social/environmental impact of the project as viewed through either the economic valuation of these impacts or the financial costs/benefits of internalising these through available mitigation and financial mechanisms. As part of the process, then, there is a need for a partnership between private developers and the government to ensure a financeable allocation of costs and risks. Otherwise, projects that meet societys objectives whether they are dam or non-dam alternatives may go un-funded in favour of projects that meet the narrower criteria of financial
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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viability. Since the divergence between economic and financial results will vary from project to project, there is a need for governments to be flexible in their support and adjust it based on the individual situation. As far as the "big dams" debate is concerned, the other issues arising from the new approaches to project financing can be summarised as follows: There is a need for clarity in the consultation and environmental permitting processes, which should be undertaken by the host government (or its utility) before the involvement of the private sector. These are issues better handled at government level and well in advance of any moves to project implementation. The host government (or its utility) has to retain control over the definition of the project to ensure it returns maximum economic benefits to the country consistent with acceptability at the local level. Again this is not principally an issue for the private sector. A balanced approach is needed in evaluating the benefits and costs of specific hydro projects, bearing in mind that the alternative will almost certainly be to build another power station elsewhere. The costs of feasibility studies, resettlement, if carried out by the concerned government, should generally be paid for or be reimbursed by the concessionaire.
In summary hydro is too valuable a potential source of generation to ignore, but care has to be taken to ensure that it is sensitively developed with more consultation and care than has often been the case in the past. Host governments need to understand that private money will follow the most favourable projects, and that if hydro is to fall into this category much has to be done to build confidence in the process by which schemes are processed, permitted, financed and constructed.
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fundamental shift to financing occurring in the irrigation sector as in the power industry, at least at the present time. Large-scale private irrigation projects supplied from dams tend to be centrally managed estates growing high value cash crops. A good example is Agro Guayabito A.S. that grows tomatoes and asparagus for export in the desert north of Lima, Peru. The estate is supplied with irrigation water from a dam built and owned by the company. Besides $8 million from IFC, domestic investors and banks raised $28 million in financing for the project. Experience has shown that flood control is usually difficult to justify as the sole reason for building a large dam, and typically it tends to be treated as an (often un-quantified) additional economic benefit to be added to the overall benefits of a dam whose primary function is power generation or irrigation. In the operation of such a dam there is often a trade-off to be achieved between the interests of flood attenuation which requires the reservoir level to be held down at certain times of the year so that buffer storage is available, and the irrigation/hydropower interest which will generally be seeking to maintain a full reservoir for security of supply. It is not unusual to find that the provision of flood attenuation storage in the reservoir can only be achieved by sacrificing some of the hydropower benefits, which may well represent a larger overall economic loss but a socially justified position.
With the exception of electricity generation and (sometimes) water supply, the above functions tend to fall within the "non-commercial" category as far as the provision of storage is concerned. That is to say that it is relatively unusual for a dam to be promoted primarily for flood control, recreation or fish breeding, although these may be useful spin-offs. In summary therefore the financing of multipurpose dams tends to hinge around the primary functions of hydropower, irrigation and water supply.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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From the government's viewpoint, the regulatory issues are more severe than for hydro alone, because a multipurpose project can exercise control over a large area of the river basin in terms of determining downstream flow patterns and water availability. The situation is complicated because of the necessity to protect not only the position of existing projects but also the rights of future projects yet to be developed. In these circumstances water rights issues, always sensitive at the best of times, loom particularly large because no government can afford to commit itself for a long period to methods of reservoir operation that it may subsequently wish to change. Yet to the private owner the limits within which he is free to operate the reservoir and use water will be crucial to the income of the project and the profitability of his investment. Against this background it is not surprising that there have been very few privately financed multipurpose schemes. One of the few exceptions is the Casecnan Transfer Project in the Philippines. In this case, a private company is building a 26 km long tunnel that will carry water to irrigate 50,000 ha on the Luzon Island (as well as produce 400 GWh per year of hydropower). The National Irrigation Authority of the Philippines will buy both the bulk water supplies and the power under long-term contracts. Besides the potential efficiency gains, the real attraction of such a scheme, from the governments point of view, is budgetary. If the public agency faces a budget constraint that limits its ability to invest, it can replace an up-front expenditure with a long-term contract where it in essence pays for the construction with what is akin to a lease payment. Another example, also from the Philippines, is the San Roque Hydroelectric Project, with a planned capacity of 345 MW. The project will also provide irrigation water for 87,000 ha and some flood control benefits. It is estimated that 49% of the benefits will be derived from power generation, 40% from irrigation and the balance from water quality improvements and flood control. The National Power Corporation (NPC) will buy the power. NPC has obtained a $400 M loan from JEXIM that will be passed on to the sponsors (in essence to cover the cost of the dam attributed to the non-power benefits). The sponsors have obtained equity and commercial debt to cover the balance of the $1,100 M construction cost. The San Roque Power Corporation will be paid for the non-power benefits of the dam through the power tariff.59
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all water-related developments in a catchment that provides most of the country's power and irrigation potential, and the water supply to the capital Nairobi. However TARDA only implements multipurpose projects, leaving single purpose projects to the government agencies concerned. This pattern is being repeated elsewhere for the large multipurpose projects, although in practice there is, as for hydro, a significant downturn in new starts, due to: The withdrawal of traditional sources of public sector funding, particularly for large dam projects. The complexity of launching multipurpose projects in the private sector (regulatory issues). The relative unattractiveness of most multipurpose projects to private investors because they often depend upon accruing "benefits" from a number of water-users, most of whom will not be creditworthy. The fact that following privatisation, the power and water utilities are no longer able or interested in promoting projects that are not immediately beneficial to their core activities. Most significant multipurpose projects involve large storage reservoirs that are facing increasing opposition on environmental grounds.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Figure 6.1. Large Scale Renewable Energy Projects Built by the Private Sector, 19942000,MWs
2,500
2,000
1,500
1,000
500
0
Latin America Asia E Europe & C Asia M East & N Africa Sub-Saharan Africa
Nuclear power plants in developing countries have so far been built only by government owned entities (with quasi-commercial export financing). Given the construction risks and the environmental issues involve, it is highly unlikely that commercial lenders will contemplate financing such projects.
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households have solar PV systems than are connected to the power grid. NGOs started the program in the 1980s but it became commercial in the 1990s, with about 20,000 units sold per year. An estimated 15% of the units are sold through hire-purchase arrangements and commercial banks and rural savings and credit co-operatives are showing interest in financing solar PV systems. At a different level, IFC and the international investment community are showing interest in renewable energy. IFC is participating in two global investment vehicles supporting investments in developing countries: The Solar Development Corporation supports solar PV system technology for non-grid applications. The corporation can provide debt, equity and quasi-equity to a broad range of actors, such as local assemblers/system integrators, distributors, retailers, energy service companies, financial intermediaries and NGOs. The Renewable Energy and Energy Efficiency Fund provides equity and debt to enterprises investing in grid connected and non-grid connected schemes requiring funding of between $1 million and $50 million.
Thus, gradually, a support system is evolving that covers small- and large-scale renewable energy technologies, mobilising resources from households, community groups, NGOs, governments, local entrepreneurs as well as international energy companies and investors. This is likely to lead to an acceleration of the adoption of sustainable energy projects.
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The greater challenge occurs when the schemes serves a group of families, for example a village or a squatter settlement in a city. Participation by beneficiaries and grass roots institutions is critical for the long-term success of most schemes of this type. Thus, increasingly governments and donors are adopting approaches that build on grassroots initiatives. In the IDA sponsored Community Water and Sanitation Project in Sri Lanka, for example, local NGOs help develop schemes in collaboration with community groups that contribute part of the funding and assume the responsibility for operation and maintenance. The schemes are subsequently presented to a committee with both government and NGO representatives, which approves funding for the schemes based on their merit. A number of similar programs exist in Latin America, Africa and Asia. They are commonly called social funds or rural infrastructure funds. When properly designed and tested on a pilot scale prior to full implementation, they can be effective vehicles for meeting basic infrastructure needs in rural areas and in low-income urban neighbourhoods.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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The dam lobby remains strong in many developing countries, but it is facing a growing domestic resistance to the construction of new dams and, especially, the resulting resettlement of large numbers of people. The construction of publicly financed dams appears to be on a downward trend, mostly due to the difficulties of mobilising the required resources.
The greatest financing difficulties occur in low-income countries with below investment grade credit ratings: o o o About four-fifths of all private investments have been directed to middle income countries. China has received roughly two-thirds of the flows directed to low-income countries, with India accounting for approximately one-third of the remainder. Thus, all other low-income countries have in aggregate received only about 5% of the private capital flows to developing countries.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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However, projects in some of the poorest and least creditworthy countries (Laos, Nepal, Bangladesh) demonstrate that financing can be mobilised if: o o o The policy framework is appropriate with reasonable tariffs, The security package (i.e. the contractual allocation of risks and rewards) is properly structured, and Multilateral development banks and ECAs provide either loans or guarantees limiting the lenders risks associated with foreign currency availability and convertibility.
A promising development is the emerging interest by local entrepreneurs and commercial banks in investing in small scale (100,000 kW to 10 MW) hydropower projectsprovided the contractual framework is simple and the tariff formula provides reasonable returns commensurate with the risks.
In the medium and long-term, low-income households (that presently have to make alternative and more costly arrangements for meeting their water and energy needs) are likely to benefit from private investments in system expansion. Similarly, in the medium term, all consumers are likely to benefit from improved quality of service. (There is overwhelming evidence that when reforms have been undertaken in a proper manner service quality has improved rapidly.)
The macro-economic impact of new financing techniques for greenfield power investments depends on how the without private investments scenario is defined: o Power shortages are costly.65 If the host country has been experiencing severe shortages, private investments in power generation can have significant multiplier effects, both through relieving constraints on industrial growth and encouraging new investments in other sectors.66 If private power investments have been required to keep pace with rapid growth in demand, the macro-economic impact has most likely been beneficial.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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In the aftermath of the Asian crisis, it appears that a couple of countries might have invested too heavily in power generation creating a surplus capacity. However, this is primarily due the unanticipated decline in demand rather than over-expansion compared to reasonable growth projects when the projects were initiated.67 If the cost paid for power is artificially inflated and new greenfield construction exceeds any reasonable projections, private generating investments can definitely contribute to macro-economic problems. It has been argued that this was the case in Indonesia.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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projects. They and the host country governments have developed ways of working with NGOs and community groups in developing small-scale energy and water supply projects. International investors are also finding renewable energy projects attractive as indicated by two recent initiatives: o o The Solar Development Corporation that supports solar PV system technology for nongrid applications in developing countries. The Renewable Energy and Energy Efficiency Fund that provides equity and debt to enterprises investing in grid connected and non-grid connected schemes requiring funding of between $1 million and $50 million.
7.3 The Outlook for the Financing of Dams and their Options
7.3.1 Official Development Assistance
Development assistance has been on a gradual decline throughout the 1990s and there are no signs that this decline is going to be reversed. There is a similar decline in the share that is being devoted to infrastructure. The paradigm shift described in this report does not only affect the developing countries but also the industrialised nations. Thus, the donor community is likely to continue to support (through policy advice, lending and loan conditionality) an expanding role for the private sector in the provision of infrastructure facilities. The donor community is likely to continue to emphasise environmentally sustainable development focusing on delivering basic economic and, especially, social (i.e. health and education) services to the poorest segments of the population. Given these basic trends and assuming there is a broad consensus on international norms for the handling of resettlement and environmental issues, the outlook for development assistance for dams and alternatives to dams can be summarised as follows: o Private sector hydropower dams will be supported through the various instruments that the development agencies have to their disposal. The amount of support from multilateral and bilateral agencies is likely to increasealthough not dramatically. Most development agencies are likely to stay away from single purpose hydropower schemes built by state-owned utilities. The disillusionment with large-scale irrigation projects goes beyond the issues related to dam construction70 and, thus, no major reversal in the downward trend for donor financing of big canal schemes is likely. Dams for water supply will continue to be supported on a modest scale. It is less clear how the donor community will respond to requests for support of large multi-purpose dams. There is clearly role to play for both governments and official development agencies in such projects. Ceteris paribus, if international best practices are applied to the planning and implementation of multi-purpose projects, the donors should be more willing to provide financing than they are today. However, this might be offset by the reluctance to support large-scale canal irrigation schemes. Donor support for energy efficiency and renewable energy projects is likely to continue to increase, although it is likely to account for no more than a couple of percent of the total volume of development assistance.
o o
o o
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Box 7.1: What is the Future for Private Capital Flows? During the 1990s, developing countries experienced a major surge in private capital flows that helped sustain the boom in private infrastructure investments. Seen in a historical perspective, this surge was not unique. Since the middle of the 18th century, there have been at least three other periods when private capital flows to emerging markets expanded rapidly. The first major surge took place from around 1870 to the outbreak of World War I, with much of the capital taking the form of bond financing for railroads and other infrastructure facilities. The second was the post-World War I boom that lasted until the Great Depression. The third followed the 1973 oil price shock and lasted until the 1982 Mexican crisis. The boom of the 1990s was similar to the earlier expansion periods in terms of its size (relative to the economies of the borrowing countries) and its close relationship with rapid growth and technological progress. A striking difference, however, is the much greater importance of equity flows during the 1990s. The three previous episodes were punctuated by currency and financial instability in the capital receiving countries, and eventually ended in global political or financial crisis. The rapid expansion in private sector lending to developing countries during the 1990s came to an abrupt halt following the financial crises in East Asia and Russia. In net terms (i.e. disbursements less principal repayments) private long-term debt flows fell to $47 billion in 1999, less than one-third of the level in 1996. Foreign direct investments, however, have continued to grow and reached an unprecedented $192 billion 1999. Private infrastructure projects in developing countries tend to be highly leveraged and, thus, mostly dependent on debt financing. The World Bank (2000b) projects a gradual recovery in long-term private sector lending between
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2000 and 2002. Foreign direct investments are expected to grow at a more modest pace than in the past decade. In terms of the longer-term outlook, the World Bank concludes: The next decade may well se another capital boom to emerging markets, accompanied again by high volatility of capital flows. Within this overall trend of growing private power investments, there will be a move away from IPPs with long-term power purchase agreements towards merchant plants that sell on a wholesale market. This is going to lead to premium prices being paid for power produced during peak demand periods. This, in turn, will make hydropower projects with storage more attractive to private investors. The potential switch towards reservoir projects will depend on the regulatory regime that is put in place (related not only to tariffs but also to the environmental clearance process and to the approach taken for dealing with land acquisition and resettlement).
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Case 2Competitive power market: The potential developers would bid for the right to develop the site. This could take the form of a royalty or an agreed profit sharing formula.
There is a need for public-private partnerships in the development of dams in order to mitigate the unique risks and ensure that the externalities associated with such projects are adequately accounted for. Each dam project is unique and, thus, the sharing of risks, costs and benefits needs to be tailored to the specific nature of each project. The host government should assume the responsibility for feasibility studies and preliminary designs. Thermal power plants are increasingly becoming standardised and the cost varies little from site to site. Each hydropower project, however, is unique and tailored to the specific site. The cost depends primarily on the sites hydrology, topology and geology and can easily vary by a factor of 2 or 3 from one site to the next. Thus, without detailed soil, geological and hydrological investigations, no developer can estimate the cost with any reasonable degree of accuracy. The uncertainty will be reflected in the very high bids. Since the investigations are costly and time consuming, it doesnt make sense to have each potential bidder carry out all the surveys and prepare a feasibility study. Rather, this should be the responsibility of the relevant government agency. The feasibility study should be carried out by a reputable international consulting firmideally with guidance from an advisory panel, possibly comprising the short listed bidders. The host government should carry out the environmental assessment and prepare the mitigation and resettlement plans prior to inviting the private sector. These activities require extensive studies and public participation. The risk to the developers is minimized if the whole approval process has been completed before bids are requested. Governments need to retain responsibility for land acquisition and resettlementunless it is on a minor scale. Lenders will probably insist on the land being handed over to the project company, free of encumbrances, prior to the first draw-down on the loans. The dealings between the host government and the private developer(s) have to be transparent. The development of dam projects involves politically sensitive social and environmental issues and requires a closer co-operation between private sponsors and government agencies than other infrastructure projects. To ensure the long-term sustainability of the contractual (project) structure, the selection of the private developer has to be competitive and transparent. The same need for transparency applies to subsequent negotiations of contract conditions related to risk and cost sharing. It is essential to establish an appropriate tariff regime for hydropower projects. The basic purpose of (and economic justification for) dam projects is to change the availability of water/power over the time. Tariffs based purely on energy output fail to properly compensate hydropower projects for their ability to meet daily, weekly and annual peak demands. Such tariffs tend to create a bias in favour of thermal and run-of-the-river schemes. As a minimum, the tariff structure should include both a capacity and an energy component. Ideally, the tariff should be differentiated to allow for peak pricing and reflect the value of the ancillary benefits that hydropower can provide for system management. The international development agencies and ECAs should review their lending policies related to dams and adopt the recommendations of the Commission. A consistent handling of environmental and social issues related to dams is imperative. Project developers (in collusion with the host government) should not be able to shop for the least restrictive lending conditions. However, the policy changes should go one step beyond adopting policies that are consistent with the expected recommendations by the Commission. The private sectors bias against hydropower and other water resource projects means that there is potentially a greater role for multilateral and bilateral donors in making up for financial shortfalls. Participation by the multilateral
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development banks can also provide additional safeguards in ensuring proper handling of social and environmental issues.
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References
AfDB (African Development Bank). 1998. Review of the Bank's Experience in the Financing of Dam Projects, African Development Bank, Operations Evaluation Department. Albouy, Yves and Reda Bousba. 1998. The Impact of IPPs in Developing CountriesOut of the Crisis and into the Future. Viewpoint 162. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Bacon, Robert. 1999. A Scorecard for Energy Reform in Developing Countries. Viewpoint 175. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Bacon, Robert W., John E. Besant-Jones and Jamshid Heidarian. 1996. Estimating Construction Costs and Schedules: Experience with Power Generation Projects in Developing Countries. World Bank Technical Paper 325, Energy Series. Washington, D.C. Dhawan, B. D. 1998. Indias Irrigation Sector: Myths and Realities. Indian Journal of Agricultural Economics. Vol. 53 (1) Jan-March Briscoe, John. 1998. The Financing of Hydropower, Irrigation and Water Supply Infrastructure in Developing Countries. Mimeo. World Bank, Washington, D.C. Crousillat, Enrique. 1998. Developing International Power Markets in East Asia. Viewpoint 143. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. EBRD (European Bank for Reconstruction and Development), 1996, Latvian Hydropower Plants Receive EBRD Financing, press release, 29 April, London, European Bank for Reconstruction and Development, http://www.ebrd.com/english/opera/PRESSREL/PR1996/30APR29.HTM. EBRD, 1999, EBRD Signed and Approved Projects in Slovenia: as at 31 December 1999, London, European Bank for Reconstruction and Development, http://www.ebrd.com/english/opera/COUNTRY/Slovproj.htm. EBRD, 2000a, EBRD Activities in Azerbaijan: EBRD Signed Projects in Azerbaijan, London, European Bank for Reconstruction and Development, http://www.ebrd.com/english/opera/COUNTRY/AZERACHT.HTM. EBRD, 2000b, EBRD Signed Projects in Georgia: as at 30 June 2000, London, European Bank for Reconstruction and Development, http://www.ebrd.com/english/opera/COUNTRY/Georproj.htm. Estache, Antonio and Martin Rodriguez-Pardina. 1997. The Real Possibility of Competitive Generation Markets in Hydro SystemsThe Case of Brazil. Viewpoint 106. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Gray, R. David and John Schuster. 1998. The East Asian Financial CrisisFallout for Private Power Projects. Viewpoint 146. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Head, Chris. 1999. Financing of Private Hydropower Projects. Final Draft Report. Mimeo. The World Bank, Washington, D.C.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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IDB (Inter-American Development Bank). 1999. IDB's Dam-Related Projects (1960-1999), unpublished, Inter-American Development Bank, Washington DC. Izaguirre, Ada Karina. 1998. Private Participation in the Electricity SectorRecent Trends. Viewpoint 154. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Izaguirre, Ada Karina. 2000. Private Participation in Energy. Viewpoint 208. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Jones, William I. 1995. The World Bank and Irrigation. A World Bank Operations Evaluation Study. Washington, D.C. Lagman, Anneli. 2000. Database of ADB Large Dams, unpublished, Asian Development Bank, Manila. Lovei, Laszlo and Alastair McKechnie. 2000. The Costs of Corruption for the PoorThe Energy Sector. Viewpoint 207. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. OECD (Organisation for Economic Co-operation and Development), 2000. Development Assistance Committee International Development Statistics: Online Databases, Paris, Development Assistance Committee, Organisation for Economic Co-operation and Development, http://www.oecd.org/dac/htm/online.htm O'Leary, Donal T., Jean-Pierre Charpentier, and Diane Minogue. 1998. Promoting Regional Power TradeThe Southern African Power Pool. Viewpoint 145. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Postel, Sandra. 1999. Pillars of Sand: Can the Miracle Last? WW Norton. Washington, DC. Roger, Neil. 1999. Recent Trends in Private Participation in Infrastructure. Viewpoint 196. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Rojas, Manrique & Bruce Aylward. 2000. Summary of Preliminary Analysis of Private Sector Financing for Current and Pipeline Power Projects. Contributing paper to the World Commission on Dams Thematic Review III.2, WCD: Cape Town. Silliman, J. and Roberto Lenton. 1985. Irrigation and the Land Poor, Paper for the International Conference on Food and Water, Texas A and M University, College Station, TX. Silva, Gisele, Nicola Tynan, and Yesim Yilmaz. 1998. Private Participation in the Water and Sewerage SectorRecent Trends. Viewpoint 106. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Sklar, L., McCUlly, P. 1994. Damming the Rivers: The World Bank's Lending for Large Dams, Working Paper 5, Berkeley, International Rivers Network, WCD Submission eco029. Sunman. 2000. Financing Statistics, Trends and Policies of International Financial Institutions. Contributing Paper to the World Commission on Dams Thematic Review III.2, WCD: Cape Town. Ulfsby, yvind. 1997. Project Financing of Hydropower Projects in Developing Countries. Paper presented at the World Bank Energy Week. Mimeo. World Bank, Washington, D.C. White, Wayne. 2000. A Review of the Power Purchase Agreement between the Republic of the Philippines National Power Corporation and a consortium constituting the San Roque Power
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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Corporation Concerning the Construction and Operation of the San Roque Multipurpose Project, Foresight Associates, Acton, Massachusetts, WCD Submission eco019. World Bank. 1992. Effective implementation: Key to development impact. Report of the Portfolio Management Task Force, Washington, DC. World Bank. 1994. World Development Report 1994: Infrastructure for Development. New York: Oxford University Press. World Bank. 2000a. Database on Active Dam Projects: Unpublished Database. The World Bank, Washington, D.C. World Bank. 2000b. Global Development Finance 2000. The World Bank, Washington, D.C.
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Appendix I: List of Contributing Papers to the Thematic Review III.2 Trends in the Financing of Water and Energy Resource Projects
Note: Materials from these contributing papers were incorporated directly into the text or annexes or provided necessary background information for the author(s) of the thematic. Chris Head Chris Head Hilary Sunman Hydropower Dams Multipurpose Dams Financing Statistics, Trends and Policies of International Financial Institutions
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Bosshard, Peter ECO027 Sklar, Leonard and McCully, ECO029 Patrick Matsumoto, Satoru ECO031 White, Wayne Bond, Patrick Ulfsby, Oyvind Kochendorfer-Lucius, Gudrun Dr Colajacomo, Jaroslava Bosshard, Peter ECO032 ECO033 ECO035 ECO037 ECO039 ECO040
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Millan, Jaime Moore, Deborah Moore, Deborah Rich, Bruce Rich, Bruce Moore, Deborah and Sklar, Leonard Whitten, Patience Boscolo, Marco Bristol, Michael Rich, Bruce Eggen, Oyvind
ECO043 ECO044 ECO045 ECO046 ECO047 ECO048 ECO049 ECO050 OPT115 ECO064 ECO068
The Future of Large Dams in Latin America and the Caribbean: IDB's Energy Strategy for the Region Dams and Export Finance Agencies: Need for Evaluation within the WCD Work Programme Many World Bank Projects Haunted by Grand Delusions Smile on a Child's Face: From the Culture of Loan Approval to the Culture of Development Effectiveness Established Common Elements of International Good Practice For Environmental Assessment - Background Memorandum Reforming the World Bank's Lending for Water: the Process and Outcome of Developing a Water Recource Management Policy What Does Financial Engineering Have to Do with Environmental Protection Chapter 13 Emerging Carbon Market and the Role of Central America Developing Power Sector in the GMS Region (Date: 2000) Race to the Bottom Private Benefit, Public Risk: Theun-Hinboun Power Project as an Example
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* Refers to the comments that were received after the June 26, 2000 deadline.
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Evaluation Department of the World Banks review of cost and schedule performance of power generation projects. OED had no input to this exercise, which was done by three staff members in other departments as a personal interest and published under the title Estimating Construction Costs and Schedules: Experience with Power Generation Projects in Developing Countries as Word Bank Technical Paper No. 325. Id be grateful if you would ensure that this attribution is corrected.
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The central question of this Thematic Review is the role of the state in financing dams. In a very general statement (in the ES), the RD remarks that there is a "need for public-private partnerships in the development of dams in order to mitigate the unique risks and ensure that the externalities associated with such projects are adequately accounted for". Like many other NGO observers, I believe that the involvement of the state is a necessary (even if obviously not sufficient) condition for the avoidance, minimization or mitigation of social and environmental costs in infrastructure projects. So I would certainly agree with the government side of the above equation. Towards the end of the ES and the SR, the author reveals his own interpretation of state involvement in dam projects. In the ES, he states: "Once criteria and guidelines for economically, socially and environmentally acceptable development of dams have emerged from the WCD process, these should be adopted by the international development agencies for both lending and guarantee operations. The existence of such guidelines should allow the international donor community to expand lending for sound dam projects where a participation of the public sector is justified." And the SR maintain: "The declining ability of governments to finance infrastructure projects and the private sector bias against hydropower and other water resource projects have meant that an increasing number of socially beneficial, environmentally benign and economically attractive dam projects remain undeveloped. Multilateral and bilateral donors can play an important role in making up for the financial shortfalls as well as encouraging proper handling of social and environmental issues." Obviously, both of these statements are totally unbased and unacceptable. In order to assess them, it is necessary to touch on the question of development effectiveness (a question which the WCD, inspite of its mandate, has so far consistently shied away from): * I believe that social and environmental impacts should be avoided, minimized or mitigated in any and all infrastructure projects. Doing so can make such projects socially and environmentally acceptable - which is different from being socially beneficial or environmentally benign. * Infrastructure projects which meet the minimum criteria of social and environmental acceptability should make economic sense, and should not be subsidized by the (host or donor) state. * The (host or donor) state should only subsidize projects which, beyond simply being acceptable, have a positive development value for poor social groups or regions - e.g. for rural electrification schemes which are identified through a democratic option assessment process. The statements and recommendations of the RD contradict this perspective of dams and development effectiveness: * In the ES, the author states that "the donor community has found ways of working with NGOs and designing projects that fully involve the local community and project beneficiaries". While this statement might be true for some sectors, it is certainly not true for dam building. The impression arises that it is simply being made in order to prepare the ground for the concluding call for state subsidies for dams. * In the following paragraph, the ES claims that "a number of successful examples [of projects fully involving the local community and project beneficiaries] and recommendations are provided in the various options papers prepared for the Commission". Even without having read all the options papers, I very much doubt that this statement is correct. Again this comes across as the wishful thinking which is needed for the concluding call for state subsidies. * As quoted above, the SR then conclude: "The declining ability of governments to finance infrastructure projects and the private sector bias against hydropower and other water resource projects have meant that an increasing number of socially beneficial, environmentally benign and
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economically attractive dam projects remain undeveloped. Multilateral and bilateral donors can play an important role in making up for the financial shortfalls as well as encouraging proper handling of social and environmental issues." With the twisting of evidence which NGOs have well documented, some WCD case studies might claim that certain dam projects have been socially and environmentally acceptable. I would strongly question however whether the global review - or the author of the DR can identify one single large dam which is "socially beneficial, environmentally benign and economically attractive". * Again as quoted above, the ES concludes: "Once criteria and guidelines for economically, socially and environmentally acceptable development of dams have emerged from the WCD process, these should be adopted by the international development agencies for both lending and guarantee operations. The existence of such guidelines should allow the international donor community to expand lending for sound dam projects where a participation of the public sector is justified." The term "sound" presumably means economically attractive and socially and environmentally acceptable. Acceptability is a minimum requirement for any project to go ahead, but is not a sufficient requirement for (host or donor) state subsidies. Otherwise, since only acceptable projects should go ahead, the state would need to subsidize all infrastructure projects. As long as the knowledge base cannot identify any dams which are "socially beneficial, environmentally benign and economically attractive", the call for expanding state subsidies is therefore totally unwarranted. Conclusion: My impression is that even in the era when social and environmental costs could simply be externalized to the affected communities and the environment, most large dams did not make economic sense. If in the future, all external costs are indeed to be internalized, the economic and financial viability is even more out of reach. So purely private funding for large dams will not materialize. And except for the theoretical case where disadvantaged affected communities opted for a large dam as a socially beneficial development project, state subsidies are not justified. So this Thematic Review should simply state that private finance for large dams will not materialize, and should refrain from proposing recommendations which are based on wishful thinking from a dam builder's perspective.
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First Objective: Trends in Financing The first of these has been done adequately. Of course, there are some gaps in information where it has been made clear that these will be filled in later, but it is not likely that the new information will change the substantial conclusions of the financing trends. Second Objective: Features of the Project Financing and Various Models The second objective, namely to highlight the main features of the financing approaches, and the models that are emerging is covered only partly. In terms of the features, the fact that large dam projects are a high risk propositions and that the financial returns accrue on longer term has been brought out clearly (and repeatedly). This is a very important feature of the financing of large dams. While the risks are analysed and indeed most of the recommendations in Conclusion recommend essentially that these should be taken up by the Government the paper fails to note that this is what is already being done. At least the experience in India is that the agreements are being so structured that virtually all the risks financial, political, force majuare, hydrological etc are taken up by the state (or ECAs of other countries). In spite of this, the participation of the private sector is limited and they are looking for even more concessions. The features of irrigation project have been covered well and as has been pointed out, it is unlikely that the mode of ownership and financing will change as far as irrigation projects are concerned. Third Objective: Implications of Present Trends In terms of the third objective, however, the paper has failed to analyse what the implications are vis-vis the issues covered in the Mandate of the WCD. In fact, the Paper has turned out to be a paper on how to ensure that private funding is made available for large dams. This is clear from the Conclusions as stated in the ES, which are nothing but a series of recommendations related to making it easier for private sector financing of dams. (barring a couple of recommendations which say that social and environmental issues need to be incorporated in the process that grants concessions, and that Governments need to undertake initiatives to encourage development of alternatives to dams on a sustainable basis.) The Summary Recommendations also show the same approach. This aim of the Paper is re-confirmed from the statement (Page 57 of Report, Summary Recommendations): The declining ability of governments to finance infrastructure projects and the private sector bias against hydropower and other water resource projects have meant that an increasing number of socially beneficial, environmentally benign and economically attractive dam projects remain undeveloped. This is an astounding statement. There is no basis shown for such a statement. It would be useful if the authors could mention a few large dams that are socially beneficial, environmentally benign and economically attractive. The key features and implications of the financing trends that remain unexplored or explored inadequately include (even though these issues have been identified and set out in sections 1.2): Implications of current trends in financing for ensuring proper EIA, SIA and proper implementation of the social and environment safeguard measures and the resettlement and rehabilitation.
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The implication of the financing trends for the development of the alternatives whether the privatisation will encourage or discourage development and implementation of non-dam alternatives for water and energy. It is repeatedly stated that several measures will be required to make the financing of large dams attractive to private sponsors. However, the implications of these measures like counter guaranteees, escrow coverage, elimination of cross subsidies, high cost of power etc. is not discussed at all. These are intrinsically related to the development effectiveness of large dams the central mandate of WCD. To give an example, it has been shown, based on official figures and studies, that the Maheshwar Hydel Power Project (400 MW, on river Narmada, India, fully private sector, project promoters S. Kumars of India, equity holder include Ogden Energy, USA, Siemens, ABB, and seeking support of Hermes Export Credit guarantees) will result in power that is so costly that the current billings of the state utility (Madhya Pradesh Electricity Board) will barely be enough to cover the purchase of power and hence even the payment of salaries of staff would suffer. The project (with a few other IPPs) has the potential to make the utility go bankrupt. The project has recently been given escrow cover. Another implication is that the utility will have to abandon the single point connection scheme which today provides domestic lighting to the poorest and most backward of the people in the state. In general the issue of what will happen to supply of power to poor people and consumers with low paying ability has not been addressed. It is brought out very effectively in the paper that the hydro projects are high-risk projects. However, from this, the paper directly jumps to how there is a need for sharing of these risks and how the same may be shared by the Government and how the projects may be made more attractive to the private developers. However, this is not a correct approach. If the projects are high risk, then it does not automatically follow that assumption of the risks by the Governments will be the best option. There was a need to examine, critically, whether it would be better for the Government to assume these risks and make feasible these hydro projects, or would it be better for the Government to develop, encourage and implement non-dam options? Will the private sector be more responsible, responsive and accountable to the local people, and for ensuring social and environmental sustainability? This is a very crucial issue as in case after case, it has been found that the private sector is far less responsible and accountable compared to the public sector (whose own record is certainly not glorious). The paper discusses the risks for the private developers and how to minimise these; it also talks about the how the Government should share most of these risks; however, there is no discussion whatsoever of the risks to the affected people and who will share these.
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and the role of the private sector sponsors is nowhere even near meeting internationally acceptable standards. The example of Nam Theun II given by the authors of the papers also shows a lack of appreciation of the environmental issues. It is stated in endnote 48: Nam Theun II has been a controversial project on environmental grounds, but it is worth noting that a portion of the project revenues will be directed specifically for the protection of the Nakai Plateau where the scheme is located. It is argued that without such measures the existing environment would be substantially destroyed within a relatively short period of time, and that although the project submerges 450 km2 (about 40%) of the plateau most importantly provides the means for protecting the upstream catchment area which comprises some 3,500 km2 of primary forest. The developer will contribute $1 million/year over 30 years towards the management of this forest which is of outstanding international significance in terms of its bio-diversity, in addition to meeting the direct environmental mitigation costs arising from the project. If this is what the authors of the paper mean by private developers meeting international standards, then one can offer no comments. It is somewhat equivalent to saying that the Amazon forest would be depleted and degraded in any case, so let us allow a company to log away 40% of it and this will help pay for protecting the remaining 60%. This approach confuses the cause and effect (if the existing environment is under threat of destruction, then what needs to be done is to identify the reasons for the same and address those, not allow 40 % to be submerged by a dam which then will presumably pay partly for protection of the remaining one.). B. Page viii- ix of ES: Consequently, most successfully financed hydropower projects are of the run-of-river type with limited social and environmental impacts. It is not clear whether the terms run-of-river and limited social and environmental impacts are used interchangeably. There is no guarantee that run-of-river schemes will have limited impact. Some of the most controversial projects, and those with massive social and environmental impact have been the run-of-river schemes. For example, the Pak Mun dam in Thailand, and the Maheshwar Hydel Project in India. Indeed, while there is some correlation between the size and the impact of the project, this is by no means a fixed equation. Private developers will be attracted towards projects with lesser financial risks which is their main concern, and not to schemes with lesser social and environmental impacts. This is all the more so because the way financing is being structured (and this is also the recommendation of the paper) is that the Government, the public sector, the utilities are taking up all the (financial) risks. Regarding the social and environmental impacts, in most cases the liability of these remains undefined, or vaguely defined. C. Page x of ES: In most cases, commercial lenders go through a comprehensive due diligence process that covers not only the financial aspects of a project but also all its technical, economic and environmental aspects. They are also ready to support programs aimed at promoting economic and social development in the area around the project. Thus, it is likely that they will voluntarily support improved criteria and guidelines for project development. Again, it is not clear as to what has been the basis to draw this conclusion. Experience has shown that the commercial lenders are concerned only about their (recovering) their lending, and since this is in most cases covered by some sort of guaranteees, there is virtually no risk to them, and they are hardly bothered about the other aspects of the project. To give again the example of Maheshwar Hydel Power Project, the equipment supply to the project is to come from Siemens of Germany, and was to be financed by (then) BayrischeVeriense Bank, now the Hypoverience Bank. (Spelling subject to
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correction). This was to be covered with an EC guarantee from Hermes (ECA for Germany), which had already extended a in principle guarantee to the project. It was only when the affected people got organised under the Narmada Bachao Andolan and started raising various issues that this situation changed. After a campaign on the Hermes guarantee, Hermes realised that they had not looked at many of the issues, many of the ground realities had been wrongly reported to them, and so it suspended the Guarantees about 2 years ago which have till date not been re-instated. It may be mentioned that this is a very rare occurrence and normally in principle guarantee is virtually a final guarantee. Further, the commercial lender, Bayerischeverience Bank even refused to answer the letters written by the affected peoples organizations, namely NBA, and when ultimately contacted and forced to discuss (on the phone) took a stand that they were not concerned about the social and environmental impact since their lending was fully covered by the Hermes guarantee. (this was at the time when the in principle guarantee was still in place). This is the general approach demonstrated by the commercial lenders, and certainly consistent with their general interests. It is thus highly unlikely that they will voluntarily support any new (and hopefully stronger) guidelines laid down by the WCD, especially since their commercial risks are normally fully covered. It may be pointed out that today, even the ECAs do not have uniform guidelines and NGOs and peoples movements have to make a herculean effort to get them to introduce even the minimum and common standards. (US ECA is one rare exception). The point about commercial lenders, or even project sponsors being ready to support programs aimed at promoting economic and social development in the area around the project also needs to be looked into in more carefully. Normally, such efforts are nothing but superficial measures, opening a school here, or a temple there, or at best a hospital, done more to white-wash their role in destroying the livelihoods, environment and culture of the area. D. Page ii, ES: Strapped for financial resources and realizing that infrastructure bottlenecks hampered economic growth, governments started to change their roles from that of a provider of services to being a regulator and a facilitator of private investments. If the paper is discussing the reasons for the change in financing of infrastructure projects and the trend towards privatisation, one important reason is the pressure form international financial institutions like the WB and IMF. This pressure, at the behest of the private capital interests globally have played an important role in the changing trends, and it is important to recognise this. This is essential since there is a lot of opposition to the role being accorded to the private sector and it is by no means likely that this trend will not see a reversal, or at least strong and continuing opposition. E: Page iii, ES Since the 1970s, the financial performance of many power utilities has declined and their ability to finance investments utilising their own resources has correspondingly declined. Although this trend is being reversed, self-financing is still difficult and, for the reasons given above, governments are no longer able to provide as large contributions to investments A very important criticism of the policies for privatisation (at least in India) has been that the inability of the public institutions to finance projects using their own resources has been largely due to the restrictions imposed on them by the political leadership for example provision of electricity to agricultural consumers at rates far below generation cost. If the public sector is given the same terms as the private (PPAs signed with an assured rate of return on equity, assured purchase of power at previously decided rates which are fixed for the duration of the operation of the project, assumption of the risks by the Government rather than the project, counter guarantees and escrow facilities,
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preferred supplier status i.e. their plant will be the last to be backed down, deemed generation facility i.e. if the power cant be purchased due to surplus in the grid, even then the project would be paid for the power ) if all these are provided to the public companies, there is not reason why they too will not be able to run the plants at a profit and finance their own expansion. Critiques of this kind are growing in India and could have an impact on the financing and the kind of facilities being provided to the private sector. F. Page ix, ES The cost of the power (or other output produced by the project) is too high due to the high cost of commercial financing. Implicit in this argument is typically the assumption that concessional financing would have been available. Given the policies of the donor community described above, it is not at all certain that concessional financing would be available for power generation projects. The high cost of power in such projects is not only due to the higher cost of financing, but also due to loaded PPAs which guarantee excessive rates of returns, cost padding (since the normal way of calculating cost of power is a cost plus approach), such skewed terms accorded to the private concerns presumably for a consideration. Lack of transparency has not helped the matters. G. Page 29, Emergence of New Financing Instruments In either case, the project needs to be carefully structured to ensure lenders that it is economically, technically, environmentally feasible and that it is capable of servicing the debt under most reasonable scenarios. This kind of concern about risks of lenders, promoters etc. find place in the report at several places, but the need to structure (or choose a dam / non-dam alternative) so as to assure affected people and the environment does not find the same importance. H. Page 34 chap. 5, Current situation Despite this the international lenders and guarantee agencies have come under a lot of pressure from groups who appear to be lobbying against hydropower in general, sometimes without regard to the specific characteristics of individual projects or the environmental cost of alternatives. What is the basis of this statement? The critiques of the affected people and NGOs are among the most studied and it is not only unfair but ridiculous to make such statements which try and demean the opposition to large dams. I. Page 34, Character of Hydropower Plants Run-of-river projects have no reservoir and generate only on the natural, unregulated river flow. These projects have relatively minor environmental impact, other than the depletion of river flows between the intake and powerhouse on tunnel schemes.
This assumption that R-o-R plants are low impact is not correct and has already been pointed out above. J. Page 36, Trends in Regulatory Environment Under a power pool system there will be a tendency for all hydro schemes with storage to bid into the peak of the load curve where the higher price is obtained, but this can result in an unacceptable pattern of river flows downstream and may be in conflict with other requirements This is a very important point and particularly relevant from the point of view of the Criteria and Guidelines that WCD will develop.
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K. Page 39 In general private financing is only sustainable with support from the host government and within a security package that often requires sovereign guarantees (see Chapter 4) This is a very important conclusion, and one of the most important significant facts about private sector financing of large hydro. What remains to be analyzed in the paper however, is whether it is worth it for the host Government to provide such a security package (which involves great costs financial, social, environmental ) or it would be better to go for alternatives.
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5. The concept of avoided cost has been widely accepted in calculation of the benefit of a power station. The economic analysis of hydropower project should be done in the basis of full life time of a project, which automatically takes into consideration the operation and maintenance requirements, adopting the principal of avoided cost 6. While there are legitimate environmental and social concerns created by development of water resources project, which need to be addressed properly and adequately, there are cases when these concerns are overblown out of proportion and cross all the boundaries of reality. Yet, because of effective networking of such campaign, the innocent project becomes a victim. Hence, if WCD guidelines are complied with by developers of hydropower projects, there must be the obligation for such concerned groups to stop opposing just for opposition. The WCD guideline should create two-way contract. This will encourage the private investors to participate in the hydropower development.
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Section 2.4 on irrigation is quite strongly negative with very little supporting evidence. Statements like It is well documented that few of these schemes provide the quality of water supply that is needed for growing high value cash crops or achieving high yields from traditional food and fodder crops. are too strong, and require citations for support. A thorough review of World Bank funded irrigation projects by Jones (1995) gives a rather different picture: weighted by size, 84% of irrigation projects had satisfactory ratings, which was higher than for the agricultural sector as a whole. Furthermore, larger projects were significantly more likely to have satisfactory ratings, which is different from the implications of this section. Groundwater may have more private investment by individual farmers, but this has also been heavily subsidized, especially through cheap energy policies. The final paragraph of section 2.4 is not quite accurate. Water rights are important for any type of use. Power generation may technically be a non-consumptive use, but if water is released for power generation at times when it is not needed for downstream water uses, then it effectively consumes the water. Irrigation, on the other hand, may consume a large portion of the water, but if it is during the rainy season when the water would otherwise run to the sea, it is less of a loss to the system. The paper makes a very important point that electricity charges should have peak and off-peak rates: so also water use should be treated differently for peak and off-peak periods. Municipal and industrial uses, which require reliable water supplies year-round have much higher storage requirements (and therefore incur higher costs and water losses) than wet-season irrigation. Although it was not in the terms of reference, it would have been good if the paper had also dealt with the implications of different types of financing for the management and incentives for management of systems. Small and Carruthers make a very persuasive case for financially autonomous irrigation agencies (as opposed to traditional government agencies) because, they argue, the need to collect revenue from the farmers will introduce incentives for a client service orientation among agency staff. Although this does not appear to happen in every case, different forms of financing create different accountability. Projects financed by the government, MNCs, or local contributions will differ in who they are accountable to, how they are accountable, and how that is translated into incentives for staff. There is an assumption that private financing will create efficiency, but perhaps would only create incentives to serve those who can afford it. Greater attention to these issues would be valuable. Finally, both the TOR and the paper assume that thermal power plants will be more desirable than hydropower in many cases. However, hydro not only has the advantages of being able to adjust to peak loads, but it also does not emit carbon. If attention to global climate change becomes serious in the next few decades (which is quite likely), then hydropower generation could once again become more attractive. The paper makes a real contribution to the discussion of the future of dams, and I look forward to the final version. References: Jones, William I. 1995. The World Bank and Irrigation. Operations Evaluations Study. Washington DC: World Bank.
Small, L.E. and I. Carruthers. 1991. Farmer-Financed Irrigation: The Economics of Reform. Cambridge, MA: Cambridge University Press in association with the International Irrigation Management Institute.
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competitive wholesale power market, but this type of deal would be unfinanceable in developing countries until both the capital and power markets were properly developed. (iii) page vi, second bullet: try "heterogenous" for "multi-dimensional"? (iv) Flood control - page vi: the UK example cited here is similar to tolling arrangments that have been used for the first IPPs in highly risky countries for foreign investments in infrastructure, such as in Philippines in the early 1990s and recently in Cote d'Ivoire. Tolling involves the investor constructing and operating the plant, and passing electricity produced in its plant to order from fuel supplied on the account of the off-taker. (v) Implications of Project Finance (Non- or Limited Recourse) Model - page viii, second para.: it's worth adding that these observations apply because typical project-financed deals in developing countries are undertaken with a high degree of gearing - say 70% loans/30% equity, and the lenders have no potential to increase their earnings in the way that equity holders do, whereas both face a potential loss of earnings. (vi) Same as point v, fourth para. Note that IFC and its counterparts also take equity stakes. (vii) Same as point v, last para. The issue here is that the absence of credible anti-monopoly regulation of the wholesale power market is compensated by regulation through the legal system by means of the project contracts, which is unwieldy and inflexible but much better than nothing. (vii) page ix, first para.: the suggestion that lenders will shy away from hydropower needs to be more clearly qualified than here because IFC and its counterparts have lent for hydropower. (viii) page ix, third bullet point: the interest rate spread between donor lending terms and on-lending terms is needed as payment for the loan repayment guarantee that the state treasury usually provides. (ix) Generally, the paper does not address some of the innovative ways to share construction risks for privately-financed dams that have been adopted by clients and sponsors, which are worth mentioning. (x) Likewise, the issue of relative contributions to debt servicing from muti-users of dam services needs to be highlighted, in view of the low levels of cost recovery from irrigation and water supply users and zero cost recovery from flood control beneficiaries. In practice, therefore, hydropower has usually the been the main source of cost recovery, but this is no longer possible generally in competitive wholesale power markets. This situation may explain the increased difficulty in financing multi-purpose dam projects.
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appear as useful and constructive as the approach provided below, which leaves to the author of the TOC the option of how best to integrate into the TOC any of the following comments or suggestions. 1) As an overall comment, lending institutions usually refer to the term Project Finance to mean Limited Recourse Financing or that specific type of financial support formulated to respond to the requirements of projects having private ownership (such as independent power producers IPPs) and structured as a Build-Own Transfer (BOT) or Build Own-Operate Transfer (BOOT) undertaking. I believe that the TOC of the paper should address this point by providing separate sections that describe and explain the specific finance issues and trends that are attributable to the different types of project ownership structures and their respective financial risks. 2) First, the overall financing issues and trends associated with hydro and water resource projects should be addressed in a broad context. Many of the major elements that impact decisions by international lending institutions to support water and hydroelectric projects transcend the differences associated with the various financial programs offered to provide support for specific ownership schemes. For example, some lending institutions require environmental and social impact evaluations for all hydro or water resource projects, irrespective of how the project is structured. To what degree is the repayment term of lending institutions a function of amount of financing provided for the project? Do certain financial institutions offer financing incentives (as does Ex-Im Bank, for example) for hydroelectric projects in recognition of their status as a renewable energy source? 3) Second, financing issues and trends attributable to straightforward sovereign risk hydro and water resource projects should be addressed separately. Can one expect a net increase or a decline in the demand for financing of new publicly owned hydro and water projects? (One may expect that due to the very large investments associated with large dam projects, such as the mammoth Three Gorges project, such projects would remain in the public or sovereign-risk domain.) What are the responses and trends of lending institutions to projects having conventional public ownership? Are elements of financial support, such as the length of repayment terms, readily adjustable to the needs of projects in this category? Is mixed credit or concessionary support for such projects declining, with financial support expected to come from Export Credit agencies or multilateral lending institutions? 4) Third, the specific issues and trends associated with hydro and water resource projects requiring actual project finance (or limited recourse financing) should be addressed. These cover the category of privately owned projects that include the IPPs with BOT/BOOT ownership schemes. What are the mechanisms or trends that could encourage financial institutions to assume the unique risks associated with supporting privately owned hydro and water resource projects?. How are export credit agencies (ECAs) and IFIs responding? What are they identifying as the risks, and are these consistent with the general perception of the owners risks? What is a generally accepted debt-to-equity ratio for a hydro project, and is it similar to the ratios of projects in other sectors? How do lending institutions address the currency transfer risks inherent in hydro projects? 5) Forth, the specific issues and trends associated with lending institutions risk assessments of hydroelectric projects, as opposed to conventional thermal power projects, should be addressed. For example, are the advantages (if identified) of hydroelectric projects, in contrast to thermal power projects requiring fuel supply agreements (and the associated risks related to such agreements), taken into account by lending institutions? Are risk advantages acknowledged for independent power producers that exploit hydroelectric potential with no fuel supply risk? Do lending institutions recognize this apparent advantage? What is the bond market for hydro projects and are there any trends for accessing this source of capital? Is the predictability of revenue (a function of hydrology) the real issue or risk facing lending institutions, as opposed to
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the perceived issue of length of construction? If so, what are the mechanisms being devised by project sponsors, public utilities and lenders to mitigate this risk? 6) Finally, as a general observation, Ex-Im Bank does not view the tenor or term of ECA loans as representing a particular obstacle to the financing of hydroelectric projects. For limited recourse financing projects, a more likely obstacle would be reflected in the ability to quantify risks that are a function of natural phenomena, such as rainfall and hydrology. Also, hydro and water resource projects have a higher percentage of host country or local costs to foreign exchange costs (for imported equipment and services) than is the case for IPP thermal power plants. This may impact the appetite of international lending institutions (especially ECAs) to provide adequate support of such projects. 7) It is important that the role or mission of the various types of lending institutions be explained in this paper, together with the trends associated with their support for hydro and water resource projects. Also, is the OECD (or even the WTO) expected to impact the way that ECAs and other lending institutions address the environmental and social impact of hydro and water resource projects? Are private lending institutions, especially those that have signed onto the UNEP Environmental Framework Agreement, expected to show greater sensitivity to the environmental issues associated with hydro and water resource projects? To what degree is the review or evaluation of the environmental and social impacts of large dams, hydro and water resource projects evolving to encompass issues that were not deemed particularly relevant or important in the past? What is the impact that NGO intervention has on the decision-making policies of lending institutions? To what degree are lending institutions acknowledging the importance of recognizing all of the stakeholders associated with water and hydro projects and following through to solicit input from these identified stakeholders? 8) How transparent are the policies of lending institutions with respect to the broad spectrum of both financial and environmental/social issues that are generally acknowledged to be attributable to hydro and water resource projects? Does the transparency of a lending institutions policies in this arena impact its ability or willingness to support controversial large dams or water resource projects?
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This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
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ADB Financing: Water Supply Dams vs. NonReservoir Water Supply Projects
US$M, 1998 prices 1,600
Water Supply Dams Water Supply
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80%
60%
40%
20%
ADB Commercial
Multilateral Borrower-financed
Note: This chart shows the levels of co-financing in dams to which ADB has committed funds.
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Endnotes
1
This thematic review paper focuses on developing countries for several reasons: (i) most dam projects to be built in the future are likely to be located in developing countries; (ii) the changes in financing practices have had and are likely to have the most dramatic impact in developing countries; and (iii) industrialised countries typically have a stronger tradition of regulating dam projects than developing countries. 2 There are no overall statistics on financial flows for dams and, consequently, a picture must be developed by pulling together a range of information from various sources that may or may not be consistent. 3 The countries in Asia and Latin America with the largest hydropower systems have a welldeveloped domestic manufacturing capacity for most types of turbines, generators, and transformers, etc. Thus, the import content in their hydropower schemes is fairly low. 4 When problems have arisen, it has usually been cases where the government was the formal owner but squatters lived on or derived their living from the land. While proper resettlement and reasonable compensation to ensure that the affected people at least can maintain their living standards is the international norm, some governments and private companies have found it difficult to handle some cases. 5 The recent decision by the World Bank to also offer guarantees for projects in the poorest and least developed countries makes this instrument much more important as a facilitating instrument for private infrastructure investments. (Previously guarantees could only be offered for projects in middle income countries and a couple of the more creditworthy low-income countries.) It deserves to be noted that partial risk guarantees provided by the World Bank and the regional development banks are covered by the same guidelines social and environmental guidelines as loans. 6 B-loans are syndicated loans for which IFC is the lender on record. A-loans are direct loans from IFC. 7 Often the arguments for or against limited recourse finance actually concern private ownership of infrastructure facilities and the process of sector reform and privatisation. This set of issues is dealt with in the previous sections of this summary. 8 The World Bank, for example, is presently holding back any lending to the Power Development Board in Bangladesh while it is ready to support two private power plants through loans and/or partial risk guarantees. 9 In the case of lending on quasi-commercial terms (for example IBRD loans), the spread is often justified by the repayment guarantee that the state treasury provides to the lending agency. 10 While most commercial lenders set the interest rate and repayment period for a project based on its risk profile, the variations are relatively minor. The assessment of risks primarily influences the lenders decision regarding whether to support the project or not. Sponsors and equity investors are, however, likely to adjust their target return on equity based on the perceived level of risks. 11 Note that the use of Multi-Criteria Analysis in place of the standard Cost-Benefit Analysis does not change this situation: the project preferred by society in either case may not be financially viable per se for the reasons mentioned in the text. 12 The concept of bidding for the right to develop hydropower projects is controversial. Some experienced developers argue that not even competitive bidding for the selection of the EPC/turnkey contractor is appropriate (Ulfsby, 1997) 13 However, telecommunications was the sector where liberalization occurred first and it is the sector that has attracted the largest amount of private investments to developing countries. This process was and still is driven by exceptionally rapid technological innovation, falling costs and the virtual disappearance of economic barriers to entry. 14 The success of the rural electricity co-operatives in Bangladesh, for example, shows that even very small distribution entities can be managed extremely well. Improved methods for dispatch also makes it quite feasible to operate a system with a number of small, independent generators.
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15
However, it took almost a decade before all legal and political issues were resolved and the Turkish BOT program moved ahead. 16 A number of variations of the BOT/BOO model have been used, for example, repair-operatetransfer (ROT) where a private party finances the repair of a facility, operates it for a number of years to recover the cost and subsequently hands it back to the utility. Other variations include build-lease-transfer (BLT) where a private party finances and builds a facility, leases it to the utility and subsequently transfers ownership. 17 In the case of the 1,200 MW Hub power project, the process took more than five years before construction started in late 1993. 18 The most publicised case is the Dahbol generation project in India. A number of private power projects in Pakistan have recently been forced to re-negotiate for the same reason. 19 A striking example of this was the great divide at the World Water Forum, held in the Hague in March 2000, between NGOs and trade unions on one side and the representatives from governments, international organisations and corporations on the other. 20 A review by Jones (1995) of 110 World Bank financed gravity irrigation projects showed that these schemes had, on average, an estimated economic rate of return of 14% at the time of loan closing (i.e. when the World Bank stopped its disbursements but typically prior to full completion of the works). However, for a more limited sample of projects for which an assessment was made after the schemes had been in operation a few years, the economic rate of return was in the order of 9% - that is below the 10% typically considered as the minimum criteria for economic viability. 21 Farmers at the head-reaches tend to get a good water supply while those near the edges tend to get only a sporadic supply. The tail-enders usually suffer more from the negative externalities (water logging and salinity) due to over-irrigation in the higher lying head-reaches. Thus, some tail-enders might actually see declining incomes after a canal scheme has been built. 22 Low water charges are often justified by references to important secondary benefits from irrigation, and as the US example clearly demonstrates (see the WCD Grand Coulee Case Study), heavy subsidies for canal water are not limited to developing countries. 23 See section 3.3.3 for further details. 24 In part this is because the ultimate beneficiaries of hydropower tend to be the electricity consumers while in the case of irrigation water for a large private estate, the main beneficiary is the owner of the estate. 25 See section 5.4.2 for further details. 26 See WCD Thematic Review IV.2 on Assessment of Irrigation Options. 27 The URL for the site is: http://www.ids.ac.uk/ids/particip/ 28 The data is from ICOLDs 1998 register of large dams. Assuming a two-year lag in data reporting, the data for the 1990s would represent about 60% of the completions during the decade. This would imply a completion rate in the developing world of about around 200 dams per year. Extrapolating to the end of the decade, this would give a total for the 1990s of around 2,000 damsor about 70% of the level during the 1980s. The same calculation for industrialized countries would give a total of about 1,400 for the decade. 29 Analysis of IDB database in Sunman (2000). 30 The actual overrun of the large dams in the IDB project list was 45%, roughly equal to the overall overrun for a sample of 250 large dams of 54% found in the WCD Thematic Review III.1 Financial, Economic and Distributional Analysis. 31 From World Atlas, 1998. 32 This declining trend is also borne out by the financing flows from the multilateral development institutions. IDBs support for dam construction peaked around 1982. Between 1973 and 1985, the IDB was investing in over 20 hydropower dams at any one time. By the late 1990s this had fallen to less than 5. 33 A check on the magnitude of investments in canal irrigation can be provided by the following calculation: Globally, about 36% of the irrigated area is supplied from dams (estimate provided by the WCD Secretariat). According to the analysis by Jones (1995) surface irrigation is approximately
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twice as high as the cost for pump irrigation. This would imply that canal irrigation (relying on dams) would account for 53% of the aggregate investment cost for irrigation. 34 The other loans were for: repair of the generating facilities at Selingue in Mali (FY96); construction of the run-of-river Ghazi-Barotha in Pakistan (FY96) which relies on regulated releases from Tarbela; installation of generating facilities at the existing dam at Manantali to serve Mali, Mauritania and Senegal (FY97); installation of pumped storage facilities at Tongbai in China (FY00). 35 See http://www.worldbank.org/html/extdr/pb/dams/factsheet.htm for further details. 36 Although it is reported that 2 irrigation dams are in the ADB pipeline. 37 The World Bank (Izaguirre, 2000) estimates that private investments in power and natural gas transmission facilities in developing countries fell from a peak of $46 billion in 1997 to $25 billion in 1998 and only $15 billion in 1999. 38 The Projectware database is created and managed by Capital DATA, a joint venture company between Euromoney Publications Plc and Computasoft Ltd. The Projectware database is updated quarterly. 39 The countries in Asia and Latin America with the largest hydropower systems have a welldeveloped domestic manufacturing capacity for most types of turbines, generators, and transformers, etc. Thus, the import content in their hydropower schemes is fairly low. 40 Countries like Brazil, China and India with major hydropower programs have well developed equipment manufacturing capabilities. 41 The regional development banks have generally moved in parallel with the World Bank and their policies are in most respects the same. 42 The full text of the relevant World Bank policies are available on the Banks web-site: www.worldbank.org 43 In February 2000, the World Bank had no loans for state-owned power plants in its lending pipeline. However, it had under active consideration four partial risk guarantees to support private power plants. 44 A review of World Bank projects by Bacon et al. (1996) of 71 hydropower projects and 64 thermal power projects approved between 1965 and 1986 showed an average cost overrun of 30% for the former versus 11% for the latter. See the WCD Thematic III.1 for a larger database on cost overruns. 45 This experience which is contrary to common wisdom is probably due to the fact that dam projects typically approved later in the project cycle. (Most agencies usually approve dam projects first when the contracting has been completed.) 46 For example, the Yacyreta project in Argentina-Paraguay whose first loan was approved by IDB in 1979 is still unfinished. 47 In the case of power generation projects, the typical set of political risks that the lenders are protected against are: (i) breach of contract by government entities; (ii) availability and convertibility of foreign exchange; (iii) changes in law (including tax law); (iv) political force majeure events. Normal construction, operating and natural force majeure risks are not covered but have to be born by the project sponsor. 48 The European Bank for Reconstruction and Development (EBRD) is somewhat different than its older cousins. It has, inter alia, a mandate to allocate at least 50% of its lending to private enterprises. 49 BBB- by Standard & Poors or equivalent by any of the other rating agencies. 50 Often the arguments for or against limited recourse finance actually concern private ownership of infrastructure facilities and the process of sector reform and privatisation. This set of issues is dealt with in the previous sections of this summary. 51 The World Bank, for example, is presently holding back any lending to the Power Development Board in Bangladesh while it is ready to support two private power plants through loans and/or partial risk guarantees. 52 At a minimum, this would require that the local population would have a voice in the process and that the standard of living of the affected community would be at least as high after construction of the project through appropriate compensation and rehabilitation measures.
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The timing of the project remains uncertain due to the slump in power demand in Thailand following the Asian crisis. 54 However, under the umbrella of the OECD, the bilateral donors have severely reduced their use of mixed credits (i.e. when development aid is combined with ECA financing) for commercially viable projects. The reason is that it was viewed as giving an unfair advantage to those suppliers that could easily persuade their aid agencies to co-finance projects. Single purpose hydropower projects are generally be regarded as commercially viable. Thus, ECAs generally co-finance projects with the multilateral institutions rather than with the aid agency from the same country. 55 The World Bank is presently processing its first partial risk guarantee for a private hydropower project, the 200 MW Bujagali Hydropower Project on the Nile River in Uganda. The project, which follows the BOT model, is sponsored by AES Corporation of the US. 56 Nam Theun II has been a controversial project on environmental grounds, but it is worth noting that a portion of the project revenues will be directed specifically for the protection of the Nakai Plateau where the scheme is located. It is argued that without such measures the existing environment would be substantially destroyed within a relatively short period of time, and that although the project submerges 450 km2 (about 40%) of the plateau most importantly provides the means for protecting the upstream catchment area which comprises some 3,500 km2 of primary forest. The developer will contribute $1 million/year over 30 years towards the management of this forest which is of outstanding international significance in terms of its biodiversity, in addition to meeting the direct environmental mitigation costs arising from the project. 57 According to press reports, the Malaysian government has taken over responsibility for the Bakun project and is studying options for its implementation. Preliminary site work appears to be underway. 58 Note that the use of Multi-Criteria Analysis in place of the standard Cost-Benefit Analysis does not change this situation: the project preferred by society in either case may not be financially viable per se for the reasons mentioned in the text. 59 For a critique of the PPA for this project see White (2000 eco019). 60 Efficacy means that the subsidy reaches those for whom it is intended (i.e. minimizing errors or inclusion and exclusion). 61 Sector efficiency means that the subsidy is structured in such a way that it encourages provision of services at least cost (taking into account externalities). 62 Cost-effectiveness means that the subsidy achieves its social goals at the lowest program cost while providing incentives to businesses to serve the target groups. 63 Most consumers in developing countries tend to buy cigarettes one-by-one although they would save buy buying a full package of cigarettes. The same way of adapting to budget constraints is displayed in most of their buying habits. This means, inter alia, that most households are willing to pay a higher monthly cost for electricity (or water) if they can avoid an up-front connection fee. 64 Frequently, small and medium sized businesses would be looking for payback periods of 24 months or less when investing in new equipment. 65 For example, the power shortages (reflected in load-shedding, blackouts and burn-outs) in Pakistan around 1995 were estimated to cost the economy around $900 million a year. A recent World Bank sponsored study revealed that energy shortages in Bangladesh in the late 1990s cost about $1,000 million and reduce GDP growth by about half a percentage point (Lovei & McKechnie, 2000). 66 There is little doubt, for example, that the successful BOT program in the Philippines played a significant role in restoring growth in the mid-1990s. 67 It should be noted that power shortages are much costlier to the economy than a similarly sized surplus. Thus, it makes economic sense to err on the high side than on the low side when planning for generation system expansion. 68 If the subsidized capital costs, implementation delays and the low operational efficiencies in most state-owned generating facilities are taken into account, the tariffs paid to IPPs are in most cases lower than the real cost of the utilitys own cost of generation. 69 WAPDA in Pakistan is a good example of how these pressures led the utility to improve its operational performance.
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission
Thematic III.2 Trends in the Financing of Water and Energy Resource Projects,
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The concerns of the donors include: (i) the inequitable growth that occurs due to the high expenditures benefiting relatively few people; (ii) the relatively low economic returns due to inefficient water use in the absence of functioning water users organizations; (iii) negative environmental impacts from waterlogging and salinity (and to some extent the use of agro-chemicals). 71 The concept of bidding for the right to develop hydropower projects is controversial. Some experienced developers argue that not even competitive bidding for the selection of the EPC/turnkey contractor is appropriate (Ulfsby, 1997)
This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission