Hydro Power Pricing In Nepal

Hydropower Pricing in Nepal Indra Kumar maharjan [email protected]

Hydropower Pricing in Nepal Indra Kumar Maharjan [email protected]

Introduction Energy is an essential commodity for the users and the pricing this energy is a very complex issue. It can be found in books that price is determined in a competitive market in the long run and supply and demand in the short run. Also, cost of producing it plays a crucial role in determining its price. In hydropower projects the ownership also governs the price charged by the utility to the final consumer i.e. Tariff. The private sector can only consider the unit cost of generation including operation and maintenance cost along with some profit based on market condition and government policies for setting up the tariff. On the other hand the government sector needs to consider social issues and consumers’ purchasing power along with other benefits for setting up the tariff. Looking at the global electricity market, two types of pricing methods have been used. In the past electricity prices were average-cost based. The tariff level was determined from financial targets set by the government, regulatory body, or the utility itself, using historic costs from the utility’s accounting books. The tariff structure ensured each consumer paid his own share of the average cost of supply, e.g. as determined by how much of the system capacity and fuel each consumer class used on average. But these pricing gives less information about future financial resources needed for increasing electricity requirements or new consumers. Marginal-cost pricing overcomes this important defect. In marginal-cost pricing past or ‘sunk’ costs are not significant; only uncommitted costs incurred because of additional demands provide the correct ‘signal’ to consumers. These are the investment and running costs incurred when consumers demand more. Marginal-costs are usually related to extra increment of 1 kW or 1 kWh of electricity demand. Both types of pricing have the same tariff components but different numerical values. The tariff components are namely; 1. 2. 3. 4.

Capacity (kW) charge, related to system peak demand. Management, operating and maintenance charges Fuel (kWh) charges, related to system fuel costs Connection and metering charges

Capacity charge plus the fixed part of management, operating and maintenance charge are directly related to capacity or kW. Similarly fuel charges and variable part of management, operating and maintenance charge are ‘energy related’. Connection and metering charges is consumer related. Marginal cost tariffs are calculated according to the same consumer classes as average-cost tariffs, basically residential, commercial and industrial.

ii

In conclusion we can say that the pricing of the electricity is done with consideration of capacity, energy and consumer related charges. Load management and spot pricing must be done in accordance with marginal-cost tariffs to achieve the financial goals. Marginal- cost tariffs can be costly to administer and need to have a consumer response. They are most suited to direct application for the developed countries for large consumers. In developing countries and small consumers, the capacity charge is usually incorporated into the energy charges to make the tariff easier to understand and implement. In poor countries there may be a low ‘lifeline’ price for special consumers using very little electricity but who would be unable to sustain life without that small quantity. In Nepal, 80 rupees is charged for 20 units. For effective tariff making, the contribution from the three disciplines namely commercial, accounting and economist approach should be considered. Another important point that must be remembered is that electricity is a ‘premium’ fuel. Therefore conserving and optimizing usage of energy applies especially to electricity. Because electricity cannot be stored, except at prodigious cost, and in order to produce and use it more efficiently it is important to improve the overall load factor of the system and so optimize generating station production through load management. Load management results in lower costs to the utility which can be reflected in tariffs charged to consumers. A tariff encouraging the continuous use of system should be developed. Load management can be effectively done through appropriate pricing of electricity. Tariffs with some form of spot pricing have been in use for some time. Spot pricing has been offered as a surcharge during periods of likely plant shortage. Spot pricing established for the first time a true ‘market place’ enabling consumers and producers to adjust demand and price simultaneously. It is workable whether a utility is publicly or privately owned, centrally or locally owned/controlled. Hydropower pricing in Nepal The price of electricity is fixed by Tariff Fixation Committee (TFC) formed under the Electricity Act 2049BS (1990 AD). According to the section 17 in the act, it is said that TFC shall fix the electricity tariff and other charges on the basis of the rate of depreciation, reasonable profit, mode of operation of the plant, changes in consumer’s price index, royalty etc. It is also said that TFC shall categorize the type of consumer and fix the tariff accordingly for each category. Similarly in section 18, it is mentioned that for those generators with isolated distribution shall be entitled to fix the electricity tariff and other charges for the electricity distributed. It is also mentioned that the tariff may be so fixed that all investments made on electricity generation, transmission or distribution is paid back in average of 25 years by deducting the depreciation cost and a dividend of 25% on share capital earned.

iii

Similarly in section 21, it is written that the rate of electricity purchased from independent power producers (IPP) shall be determined on the basis of fixed percentage of avoided cost or an addition to the generation cost or fixed percentage of average tariff of Nepal Electricity Authority. With these provisions in hand we have three methods of tariff fixation namely; Cost plus Pricing, Avoided Cost Pricing and Fixed percentage of retail tariff. Cost plus pricing is the simplest way of pricing the electricity. In this approach the generator fixes the price of electricity based on its average cost of generation plus a certain net profit margin. Hence the price largely depends upon the cost to produce electricity. Hydropower pricing is basically a function of the costs of the hydropower project. Costs of a hydropower project consists of four parts- associated costs, induced costs, external costs and opportunity cost of water. Costs of a hydropower project occur during two distinct time frames; construction and operation phase. The costs that are associated with the need to produce hydropower such as preparatory works, civil works, electrical and mechanical equipment, transmission and substation, engineering, management and administration and operation and maintenance cost comes under associated cost. The costs needed to mitigate adverse impacts produced by the project during the construction phase to the society; nature and environment are termed as induced cost. The costs occurred for construction of infrastructure like roads, rural electrification, transmission lines that may not be directly linked to the projects are considered as external cost. Generally no external costs occur during operation phase except for watershed management. Beside all this a cost assigned for the forgone opportunity for other uses of water as irrigation is taken as opportunity cost. Since the water is not consumed by hydropower plant, this is often neglected. Along with all these cost, a natural resource use cost called Royalty is also charged by the government. Two types of royalty have been defined by Hydropower Development Policy 2001 namely Capacity and Energy Royalty based on capacity and energy generated respectively. The cost of the hydropower project can be reduced to some extent with the implementation of Multi-purpose project. This means that the same project can be used for irrigation, flood control, navigation and recreation and hydropower. The costs occurred is shared by the different projects based on the benefits and costs occurred or costs only. But benefit assessment is considered as the complex process with lots of discrepancy as it is very difficult to quantify the benefits. Benefits may be of direct type such as capacity benefits or indirect type as land enhancement benefits and secondary benefits as employment benefits, public benefits and disbenefits. Distribution of benefits is also a complex process. Avoided cost is defined as the cost of producing the power through the next alternative technology like thermal whose cost has been avoided. This type of cost is not linked with production efficiency and is not related to the actual cost of production. This is basically based on the cost that the buyer will avoid and is difficult to estimate in context of cross border trade. The avoided cost price is usually used to reap the net benefit from technological change in hydropower generation. Fixed percentage of retail tariff approach ignores actual cost of production like the cost occurred in generation, transmission, distribution etc. It sets a certain percentage of retail

iv

tariffs and fixes the price. This is usually implemented in setting price for electricity purchased from IPP’s by NEA. The tariff in Nepal is very high and dull. The main reason for such high tariff in Nepal is because of high per unit (kW) cost of hydro-power plants that are developed in the country (i.e., high cost of supply), especially the larger ones with public funding. This high cost of supply of electricity is mainly due to the need for importing construction materials (e.g., steel) and equipment, the inability of the local contractors to take up significant construction work volume and the inability to mobilize local finances and thus the reliance on hard currency loans. Furthermore, large hydro-power plants in Nepal are implemented under bilateral or multilateral donor aid with the preconditions (tied aid) that the generating equipment, accessories and the main contractor be from the donor countries. Small hydro-power plants are more cost effective due to use of local finances and local contractors in larger proportion. Another reason for high tariff is due to ‘cost-plus pricing’ approach used to fix the tariff. Costplus pricing is good for the developers as it guarantees a minimum profit but it does not encourage reduction in generation cost and thus the tariff. It may even lead to power generation with high costs for higher profit and vice versa, as profit margin is estimated as a certain percentage of the total costs. Hence the focus should be to ensure that the consumer end tariff is affordable, and to continue to increase supply of electricity to the general population. The tariff should be smart and sensitive and should also contribute to load management. The country should come out of the cost plus pricing mindset and to develop a mechanism which rewards efficiency. This will only contribute to sensitive and smart tariff for any category of consumers and developers. Reference    

Berrie, T. W. Power System Economics, IEE Power Engineering Series, ISBN 0906048-88-5 Shrestha, Ratna Sansar. Financing and Economics of Power Systems Lecture notes, Kathmandu University. Gautam, Upendra and Karki, Ajoy. Hydropower Pricing in Nepal, Developing a Perspective, Jalsrot Vikas Sanstha (JVS), Anmanager, Kathmandu, Nepal, 2004 Karki, Ajoy and Shrestha, B. ‘Micro-hydropower in Nepal: Access to Electricity for Isolated Rural Population in the Hills and Mountains’, International Energy Journal, Special Issue, vol. 3, No.2, December 2002.

v