Strategy for gross national happiness (sgnh) Annexures to the Main Document

8.1.4 To meet the increasing demand for electricity within the country, the unmet and rapidly growing demand in India, the competing opportunities in India and Nepal, Bhutan has to mobilize quickly to attract the required amount of private investment in hydropower development to achieve the targeted capacity addition. Otherwise, we will continue to waste the opportunity of utilizing one of our most valuable and renewable natural resources. The comparatively fast, relatively low-cost and successful implementation of the Chhukha and Tala Projects indicate some inherent advantages that Bhutan possesses in development of hydropower projects. We need to capitalize on these comparative advantages before we lose them.

8.1.5 The intentions of involving and expediting private investment in hydropower development are clearly reflected in the Electricity Act of Bhutan 2001. However, the fact that no private investment has occurred till date would indicate that additional policies and capacity building is required. To approve investment within six months of inviting offers, additional policies and legislations, institutional capacity strengthening is critical. To be able to tender, evaluate, award, monitor and eventually take over the projects developed by private investor, restructuring and augmentation of the DoE and Bhutan Electricity Authority (BEA) is essential to facilitate private investment.

8.1.6 Due to inadequate domestic capital, and not to crowd out investment in other equally important sectors, FDI will be required to achieve the level of timely investment in hydropower development. Anticipating such a requirement even way back in 2001, the Royal Government has incorporated this aspect in the Electricity Act of Bhutan 2001⁴⁰. Since the primary purpose is to accelerate hydropower development, the investment climate has to be made sufficiently attractive to draw investors to the Kingdom, especially in view of competing opportunities in Nepal and India.

8.1.7 Given the cordial relations between Bhutan and India, large potential for export of Bhutanese power to India and existence of resource capacities in the Indian private sector, it is expected that almost all private external investment in hydropower development might be from India. With this basic assumption and reality, the policy on IPP has to be targeted to attract investment mainly from India.

8.1.8 Investment plans worth US $100⁴¹ billion by NTPC, Reliance Energy, Tata Power and others and global giants like ABB, Alstrom and GE have been finalized for the power sector in India. Power equipment manufacturers in India are ramping up capacities to meet the increasing demand.

8.2.1 The location and terrain of Bhutan provides both advantages and disadvantages to the development of hydropower. While the terrain is the reason for the nation being blessed with 30,000 MW of hydropower potential, it also provides challenges in providing access to all the potential project sites, increasing transportation and execution time.

8.2.2 With eastern and north-eastern India not developing at the same pace as other regions of that country, Bhutan’s location makes it far away from the load centers of India. This increases delivery costs of electricity and puts us at a disadvantage in comparison to Nepal and the western Himalayan states of India. However, our projects are better placed physically while compared to the huge potential in the north eastern states of India.

8.2.3 The relatively fast and economical completion of Chhukha and Tala hydroelectric projects are proof of the comparative advantages that Bhutan provides to project development. These are:

• 
  Timely and transparent decisions accorded by a compact and efficient government;
  
• 
  No political interference in the management of the projects;
  
• 
  Quick environmental and other clearances;
  
• 
  Good law and order situation provided to the project activities;
  
• 
  Non-existence or minimal corruption; and
  
• 
  Exemption of taxes and duties.
  

5. 
   The success of hydropower development in Bhutan is contingent on the growth of India’s economy and its steady need for huge amounts of electrical energy. Electricity production in India 2006 was 630.6 billion units against 2,500 billion units for China and 3,979 billion units for USA⁴³. For the Indian economy to grow to the level of China, and to eventually reach the standards of USA, India needs to add huge capacities in electricity production.
   
6. 
   In the long run, if multi-lateral cooperation takes off in South and South-east Asia, there could be market for Bhutan’s hydropower beyond India.
   
7. 
   As the level and concern of pollution in India grows, clean energy may become attractive and essential even at a premium. Coal based thermal power plants pollute air and poses problem of ash⁴⁴ disposal in particular while thermal plants in general require huge quantities of water. While nuclear power appears to be an attractive alternative in India, the level of “not in my backyard” opposition could determine its real success.
   
8. 
   The Indo-US Nuclear deal has attracted serious interest in development of nuclear power generation business in India that, on a conservative scale, will be worth more than US$ 9 billion over the next five years⁴⁵. CEA, GoI has projected that nuclear energy will account for 35% of total power generated in India by 2050.
   
9. 
   With the private sector aggressively investing in the power sector in India, capacity addition within the country may pick up to a level to meet its growing demand for electricity. This may make import of hydropower from Bhutan, with availability varying greatly with the seasons, unnecessary or unattractive unless we are able to move rapidly to have the first-mover advantage and fill the demand and supply mismatches in India before the opportunity is lost forever.
   
10. 
    India’s desire to have a thermal hydro generation mix of 60:40 is with the purpose of thermal generation, including nuclear, meeting the base load and the hydro to meet the daily peaks. Therefore, hydro generation from large reservoirs would become the need of the day as India’s power sector grows. Because of our own need for greater firm power, and the growing realities of Indian power sector, we need to find the means to develop reservoir schemes. The run of the river schemes in Bhutan provide 68%⁴⁶ of the annual generation during the four monsoon months, making such schemes suitable for only daily peaking during the winter months. With the same monsoon season across the kingdom, the generation pattern of all run of the river schemes would be similar, making these unsuitable for seasonal peaking power.
    
11. 
    With tremendous investment taking place in India in the power sector, both in the public and private sectors, there could be resource crunches – financial, human resources, material, machinery and equipment. Unless Bhutan moves quickly to develop its potential in hydropower, we could find ourselves crowded out of this business. Even during the construction of Tala Project, delays in deliveries were experienced because the production capacities of the manufacturers were not available because of demand out pacing supply. Experienced and skilled manpower, especially in hydropower construction, can also become a factor for projects not being picked for development. In the mid-1990s, leading firms like Siemens and GE would not even quote a price because their backlog was so long⁴⁷. Currently manufacturers like BHEL in India are also sitting on order backlogs as long as three years prompting the Ministry of Power, GOI to even consider setting up an additional PSU for manufacturing power equipment.
    
12. 
    The present institutions managing the power sector in Bhutan are not geared to manage both the magnitude and the schedule of investment envisaged for hydropower development in the country. This needs immediate focus and time bound strengthening.
    
13. 
    Before committing to investment and payment in hard currency, impacts on the nation’s economy and finances need to be carefully examined. Countries like Philippines, Mexico, Argentina and a whole lot of others have experienced severe difficulties in their payment obligations and electricity tariff for allowing dollar denominated investment in electricity sector⁴⁸.
    
14. 
    Under the defined assumptions, summary of the financial analysis in Table 7.12 indicate that hydropower projects can be developed in Bhutan by private investors at competitive electricity tariff.
    

2. 
   Policy Guidelines
   

1. 
   Since 34% of the investment fund is being targeted through IPP, it is essential that IPP projects be promoted immediately, for which, an IPP policy needs to be adopted using the following policy guidelines:
   
2. 
   The DoE has already received a TA from ADB for development of Hydropower Policy which would also cover policies concerning private sector participation in hydropower development. While issues concerning private investment in hydropower would be comprehensively addressed under this TA, the areas that need to be addressed are enumerated below.
   
3. 
   The development of hydropower projects is capital intensive with long pay back period. Hydropower projects are also subject to risks like encountering poor geology in underground works, lack of control of “fuel delivery”, etc. These realities need to be factored in the policies through proper risk-sharing mechanisms so that investors are adequately safeguarded. The broad outline of the issues that need to be addressed in the policies to facilitate private investment in hydropower development are presented in the following sections.
   

4. 
   Royalty/Free Energy
   
   1. 
      For being accorded the privilege of utilizing the natural resource of the country, the state shall be compensated by payment of royalty⁴⁹ from the energy generated by the hydropower stations. Based on the Indian experience of IPPs providing 12% of generated energy to the state government⁵⁰, royalty at 15%⁵¹ of generation at bus bar for run of the river schemes will be levied, with payment to be either in energy or in cash as it may be convenient to the government. Jaiprakash Associates Limited (JAL) has signed MOU with Arunachal Pradesh for execution of two projects, where free power for the first ten years is 12% and then 15-15.5% thereafter⁵². Because reservoir schemes provide added benefits such as recreational facilities, waterways, fisheries, etc., the rights of which will remain with the state, royalty for such projects could be different from run off the river schemes.
      
   2. 
      The other option for deciding on the amount of royalty could be through competitive bidding. This will ensure that the relative advantages of different projects are factored in by the investors and yet ensure a reasonable return to the state. To protect the interest of both the state and the investor, mechanism has to be built into the royalty payment structure; royalty is defined on design generation with allowance for auxiliary consumption capped, minimum royalty payment is defined so that the state receives payment even during circumstances when the producer is unable to market their energy and royalty is based on actual generation when shortfalls are on account of hydrological reasons.
      

5. 
   Ownership & Financing
   
   1. 
      The Electricity Act of Bhutan 2001 requires the construction of electricity supply facilities by private parties to be executed through competitive bidding. Pursuant to this requirement and for obtaining the best offers, the 7 projects identified for development through private capital need to be tendered out through competitive bidding, with tendering management and approvals to be accorded by the regulatory authority (BEA)⁵³ and the government (DoE). Both agencies need to be strengthened to cater to these requirements. The development of such projects will be under Build Operate and Transfer (BOT) mechanism, with the transfer of assets to the state to occur after 30 years of commercial operation⁵⁴.
      
   2. 
      To be able to achieve the targeted generation capacity by 2028, 100% FDI need to be allowed for hydropower development. The government, through its investment agencies, can retain an option to participate as an equity partner in the venture. Present FDI policy has to be amended to include investment in Indian rupees and to permit 100% ownership. Conditions for repatriation of profits, especially in hard currency, for projects where some liability is in hard currency, need to be addressed in the IPP policy in consultation with concerned ministries and agencies.
      
   3. 
      For projects that do not perform to projections, for reasons beyond their control, the BEA may provide extension to the BOT duration for a period not exceeding 5 years. Under such circumstances, the original contract shall be renegotiated. At the end of the BOT duration, the IPP shall hand over all installed assets, including inventory items and O&M manpower, to the state. To ensure viability of the project as a vibrant continuing concern, all rights to existing contracts shall be transferred to the state or its authorized agency. However, the projects shall be handed over without any residual obligations. It is expected that there will be substantial differences in service rules and benefits between the IPP and DGPC, which on behalf of the state would be taking over the projects, which need to be appropriately addressed at the time of transfer.
      

6. 
   Taxes
   
   1. 
      To encourage investment in the sector and to make the projects competitive, investors need to be provided with tax breaks and holidays. During the construction stage, customs and sales tax be exempted for material and equipment utilized for construction of the project⁵⁵. To provide at least a level playing field, duration and type of tax holidays need to be provided in line with those provided to IPPs in hydropower in India and Nepal. PIT and BEA fees will be paid as per the existing norms in the country. Levy of CIT, on actual or notional profits, after the tax holiday and imposition of a turnover tax need to be addressed in detail in the IPP policy to be developed by DoE.
      
   2. 
      As per the existing arrangement on the domestic sale and export to India of electricity, no taxes and duties shall be levied on the sale of electricity.
      

7. 
   Power Purchase Agreement (PPA)
   
   1. 
      As per the Electricity Act 2001, PPAs are not subject to tariff regulations which will allow the IPPs to trade their power in the market facilitated by the recent open access in the Indian transmission grid and promotion of spot market.
      
   2. 
      A well formulated, transparent and predictable PPA will be the only basis which will attract private capital in hydropower development. Therefore, it is crucial that the government is either a direct party to the PPA or a proactive facilitator. Provided that the investment environment is made really competitive, it is anticipated that some investors will utilize some of the projects as captive plants to wheel energy to manufacturing bases outside Bhutan or arrange their own PPA. Where investors are unable to arrange their own PPA for export of energy, the cooperation agreement signed between Bhutan and India on 28^th July 2006 can be used by Bhutan to arrange off take of energy from IPPs for export to India through PTC. To provide comfort to IPPs and that the state shall not resort to “obsolescing bargain”⁵⁶, government may accept that all disputes with the IPPs, especially with regard to state guaranteed PPA, are subject to international arbitration norms.
      
   3. 
      While there are inherent risks in the government committing to purchase all energy produced by the IPPs, especially with the IPPs owning about 27%⁵⁷ of generation by 2028, the domestic demand⁵⁸ projected to increase to 1,201⁵⁹ MW by 2028 may require the government to bear such risks. Capacity addition of 10,000 MW by 2028 assures firm power of only 1,860 MW and may therefore require the royal government to be engaged, in one manner or the other, in the PPA with the IPPs for making energy available for the domestic market – especially during the lean river inflow period in winter. Therefore, the royal government has to retain the first right for power purchase from the IPPs while awarding contracts.
      

8. 
   Foreign Exchange
   
   1. 
      It is possible that investors from third countries would be interested in participating in hydropower development in the kingdom, especially if they are able to arrange their own PPA or if state guarantee can be provided for off take of their production.
      
   2. 
      Also to encourage the most efficient equipment and the latest technology, Indian and Bhutanese IPPs may make part of their investment in foreign exchange. Investors who arrange their own PPA will be required to factor their foreign currency obligation risks in their PPA and for cases where the state or its agency is the power purchaser, the currency fluctuation risks will have to be borne by the state.
      
   3. 
      Since IPPs have experienced difficulties in staying afloat during devaluation of the local currency when their PPA has been arranged in local currency and governments have encountered severe fiscal imbalances and crisis when having committed to cover currency fluctuations risks, the magnitude of transaction and risks need to be carefully assessed while permitting investment in hard currency or when PPAs are arranged in such currencies. Based upon prevailing or forecasted conditions, the government can hedge such risks and also negotiate for part of the payment for export of electricity in hard currency⁶⁰. Subsection 49.1 (vi) of Part 4 of the Electricity Act of Bhutan 2001 requires the preparation and publication of clear mechanism for currency convertibility and remittances.
      

9. 
   Land Acquisition and Other Infrastructure
   
   1. 
      All land required by IPPs will be acquired by the government⁶¹ and leased to them for the duration of the BOT. Since the project ownership would be transferred to the government at the end of the BOT term, the government will bear all costs of land acquisition. This will include the land required for providing access roads, colonies and storage sites. Resettlement, though to be arranged by the government, costs would have to be included in the project cost.
      
   2. 
      Acquisition of land, clearances from NEC, DoF, etc. should be initiated concurrently with preparation of the DPR of the projects and all such activities should be completed on completion of the DPR. Thus, clearances and acquisitions should be completed along with the DPR. Procedures of land acquisition and various clearances shall be defined by the related agencies. When DPR is ready all clearances are ready.
      
   3. 
      Transmission networks, to optimize resources, will be developed by the transmission licensee, currently BPC, up to the border for export projects. A summary of the new roads and transmission lines required for the projects is provided in the table below.
      

Table 8.3: New Transmission Lines and Roads for IPP Projects

4. 
   Regulated wheeling charges will have to be paid by the power producer.⁶² Beyond the border, the IPP which arranges its own PPA will be responsible for acquiring the transmission capacity. However, to make the investment in hydropower projects as attractive as possible, the government could leverage its bilateral relationship with India to facilitate transmission capacity addition in India for evacuation of power from projects in Bhutan.
   
5. 
   Two power stations of 750 MW each are being developed on Tawangchhu in Tawang District of Arunachal Pradesh⁶³, which adjoins the districts of Trashi Yangtse and Trashigang in Bhutan. These two projects are estimated to generate 6,636.50 MU in a 90% dependable year. Since this energy would need to be evacuated to West Bengal and beyond, there would be common interest to India and Bhutan if this power could be evacuated through shorter transmission lines through Bhutan. Since we could use these transmission lines to piggy back our own production from Kholongchhu, this possibility needs to be seriously examined. Wheeling of 1,500 MW and 6,636.50 MU would bring Nu. 830 million in annual revenue to BPC, even at current wheeling charge of Nu. 0.125 per unit.
   
6. 
   Six of the projects to be offered to private investors require construction of roads more than 40 km per project. Leaving these to the IPPs may not only discourage them in picking up these projects, but also increase project costs and delay the completion of the projects. Where road access are planned to be provided near these sites in the Road Sector Master Plan 2007-27, the construction of these roads need to be initiated by the government in advance of project implementation.
   
7. 
   All expenses related to environment protection and mitigation will be at the cost of the project.
   

10. 
    Risks and Guarantees
    
    1. 
       There are risks associated with both the construction and operation of hydropower stations. The possible risks and their allocation and mitigation are indicated in the table below: