DAM CONSTRUCTION AND OPERATION
ACQUISITIVE INVESTORS CORPORATION (AIC)
Integrative Economics Limited
Jon Carling, Stella Edochie
Margaret Ellis & Julius Kareba
Within the framework of its national economic development strategy, the government of Nigeria is taking steps to improve electricity generation and supply in the local economy and has therefore issued a brief for the tender of bids for the construction and operation of a dam, which will be built primarily to supply electricity to the city of Lagos, the commercial capital of Nigeria.
The project is envisaged against the background of a wide gap in electricity services over the years, mainly due to the inability of the now dismantled state monopoly, the National Electric Power Authority (NEPA), in maintaining the electricity infrastructure and adequately meet customer demand, which was estimated at 10,000MW in 2005 and is projected to double by the year 2010. The unreliable and deficient supply, is a major infrastructural limitation for the country. It is estimated that only 36% of Nigerians have access to electricity, almost all of them in urban areas.
In response to the government’s invitation for private sector participation in the construction of the hydro-electric dam, a prospecting company, Acquisitive Investors Corporation, hereafter referred to as AIC, has contracted our services, that of Integrative Economics Limited, (IE Ltd), to investigate the possibility and provide advise on the economics of building the dam on the Benue River in the Ondo State.
The remainder of this report and the appendages, therefore represent the findings and recommendations of our company to AIC, in respect of the Ondo State Dam project.
Brief Components – roles and responsibilities.
The brief presented by the Nigerian government, outlined specific responsibilities for itself and the successful private company in the construction and maintenance of the dam and these are detailed below.
Responsibilities – Private Company
the successful company will bear the full costs of construction and operation of the dam over the life of the project, as well as any related compensatory costs resulting from the establishment of the dam.
the company will be able to recover the costs of the project and be the sole beneficiary of the revenue generated by the dam over its period of operation.
the private entity will operate the dam project entirely for the benefit of Nigeria and is therefore prohibited from exporting electricity or other related products resulting from the operation, as the country has high un-met demands for such products.
Responsibilities – Nigerian Government
the land will be made available at no cost to the company, in line with the Nigerian government’s normal practice for these kinds of projects.
the government will establish a regulator to ensure that the operator of the dam follows normal legal and financial practices.
the government will also oversee the pricing policy to ensure that increases in the rate for the provision of electricity and water, do not surpass the ceiling of 1% per annum.
will generally regulate the operator’s charging policies.
This report provides a potential solution and recommends that AIC proceed with its bid based on the following reasons:
the proposal offers significant private net benefits to AIC
the proposal also offers positive social net benefits to Nigeria
the proposal provides additional electricity to Lagos, and irrigation to the Ose Region, both of which would then experience positive indirect and induced effects.
The relatively smaller size of the proposed dam, follows the recommendations of the World Commission on Dams, (WCD), that smaller dams tend to be more efficient and cost-effective than larger ones. The proposal has the following features:
17 meter high dam over the River Benue in the Ose region of the Ondo State, approximately fifty miles from the city of Lagos
reservoir constructed in the Benue Valley, with a capacity of 350 million cubic metres
three turbines, with combined annual production of 1250 GigaWatts, and the potential to increase output by up to 50%
electricity supplied direct to the city of Lagos along newly constructed transmission lines
construction of the Dam is expected to take five years, after which it will operate for 45 years and then require to be decommissioned, at cost to the operating company.
the communities targeted to benefit directly from the dam will be the people and businesses of Lagos, who will receive all of the project’s electricity, as well as the farming community of Ose, which will benefit from increased irrigation with the water generated by the project.
establishment of the dam will require the re-housing of 1500 households, occupying an area of land of approximately one square kilometre each and will also disturb existing fishing patterns in the Ose Region, at a likely cost of $1.43 million a year.
10,000 workers will be employed for the first five years of the project and the subsequent operation and maintenance of the dam will require a labour force of 1,400 persons.
The next few sections of this report look at the benefits and costs to the successful operator, and the external costs and benefits engendered by the project. The report then concludes with an appraisal of the net social benefit.
If the AIC is to proceed with this project and operate it successfully in private and social terms, they can expect to have further opportunities to operate dams in Nigeria, and throughout those parts of Africa where electricity is scarce and land requires irrigation. Whilst it is not possible to attach values to these benefits, AIC will be well aware of the kudos that a successful project can provide.
In terms of the project itself, the construction of a dam in the Ondo State should provide annual revenue of $62.5 million per year (at current prices) from the sale of electricity, assuming that the plant runs at planned capacity and a price per kilowatt hours of $0.05. For water, the supply to the agriculturally intense Ondo State was calculated to generate revenue of $15.2 million a year at current prices, and also projected to rise by 1% per year thereafter. The total revenue from water and electricity supply should therefore amount to some $4388 million per year. In order to understand the net present value of that revenue, we have applied a discount rate of 11% to the revenue figures. The rate of 11% was used following advice from the World Commission on Dams which suggests that a high discount rate (typically 8-12%) will allow for the risks inherent in a project of this sort. Having applied the discount rate to the $488 million revenue stream, we calculate that the Net Present Value (NPV) of the internal benefits of this project is around $505 million. Later in this report, we will show how higher discount rates can affect the private net benefits of this proposal, and also look at the effects of different sales volumes of electricity and water.
The project will inevitably be capital-intensive at first, as the initial costs of construction and compensation will need to be met before any revenue is generated by the project. As the dam operates, there will be costs around operation and maintenance, and costs to allow for the extra noise and pollution caused by the dam.
The initial costs will all feature in the first five years of the project, during which time the dam will be constructed. We anticipate the following costs:
initial design and environmental studies : $1million
costs of building and machinery materials : $23.35 million
labour costs : $139.74 million
relocation of residents of the Benue Valley : $22.5 million
The detailed spreadsheet, submitted with this report, provides a further breakdown of these costs.
Once in operation, we anticipate that the operation and maintenance costs of the dam to be around $4.05 million in the first year of electricity generation. This assumes an annual inflation rate of 6%, in line with the current rate in Nigeria. We have provided sensitivity analysis around this in the accompanying spreadsheet. There will also be an annual environmental cost of around $1m in the first year of operation, we expect to be able to negotiate a constant cost of £1m per annum over the lifetime of the project.
Finally, there will be decommissioning costs to take into account, for which we have allowed $7million in the final year of operation.
The private costs total some $1100 over the lifetime of the project. Applying the same 11% discount rate as we did to the private benefits of the project, we arrive at a NPV for the private costs of $210 million.
Is the project likely to be profitable?
Our calculations show that, using a discount rate of 11% and subtracting the private costs from the private benefits, the net private benefit of this project to AIC would amount to around $295 million. That is a significant margin and we recommend that AIC considers bidding to the Government to undertake the project, in the knowledge that it should be in the company’s interests to do so.
However, we are aware that the Government will need assurances that any tenders for this project have considered the interests of the Nigerian society as a whole, and that such external benefits and costs have been calculated.
The next few sections of this report look at those costs and benefits of the proposal which are external to the operating company.
The electricity generated from the Dam will all be supplied to the city of Lagos, some fifty miles away. Lagos is the economic centre of Nigeria and is looking for further growth, but the opportunities to grow are limited by a number of factors, electricity supply being key amongst them. Large companies interested investing in Nigeria have been known to decide against making their investments, due to the inadequate and unreliable electricity supplies. It should be noted that supplying electricity to Lagos will have direct benefits for residents and companies there, but there will also be significant indirect and induced effects. Clearly, as new investment develops, there should be benefits in the supply chains of the new plants or services, and there will also be more money in the pockets of workers in those companies, all of which will benefit the local economy.
A further series of external benefits will accrue to the people of the Ose region, who will be able to access water to irrigate their land. We anticipate that agricultural productivity will grow by 30% in the region in the each of the first five years of the dam’s operation, as farmers will be able to grow crops all year round, and have costed the benefits of this at $0.3 million in the first year of the Dam’s operation. In subsequent years, we estimate that the increase in productivity will drop to 10% each year. Once again, the benefits of irrigation will not just be direct ones: farmers will be able to make more profit, and some of them may decide to use that profit to establish other businesses, either in the region or perhaps in the city, and there will also be indirect effects through a need for greater supplies, and induced effects through the power to purchase more. Indeed, as the farms become more profitable and some people move away from farming, some of the ‘disguised’ unemployment that exists in the rural areas should reduce, thereby enhancing efficiency gains further. There are some 145,000 residents in Ose region, and each can expect a better quality of life as a result of the dam’s ability to generate irrigation.
IE Ltd would be happy to use its Input/Output and Computable General Equilibrium economic models to demonstrate the effects of different scenarios on the Nigerian economy, at an additional consultancy cost to AIC.
The external costs of the project relate to the eco-system and the loss of land in the Benue Valley. Changes to the eco-system would mainly relate to the loss of river fishing, downstream of the dam. We estimate that 10% of the fishing area will be lost, equivalent to a loss of $1.43 million value of fish, from the point at which the dam begins construction. We have allowed for an inflationary increase in each of the fifty years, resulting in a total external cost of some £414million.
Loss of land is an external cost, which we have valued at $10,000 for each of the 1500 households that will need to re-locate as part of the project. That will be a one-off external cost, amounting to a total of $15million.
Totalling the two identified external costs gives a total of some $430million over the lifetime of the project, before any discount rate is applied.
Overall Cost/Benefit Analysis of the Project
The Government will wish to know that the social net benefit of the project is positive. To understand this, we have calculated the social costs and social benefits of the project and subtracted the former from the latter.
The social costs are the combination of the private and external costs, taking into account inflation (6% pa) and the 11% discount rate. These total $253million over the fifty years.
The social benefits are, similarly, the combination of the private and external benefits, again taking into account inflation and the discount rate. Those total $517 million over the lifetime of the project, even before the indirect and induced effects are taken into account.
Subtracting costs from benefits gives a net social benefit of around $263 million. We believe that the Government will regard this as a significant benefit, and it shows that the project will be beneficial to Nigerian society, as well as being a highly worthwhile undertaking for AIC.
Our recommendation is that AIC should proceed with the proposal for this project, but the company should be aware of potential differences in the outcome of the cost-benefit analysis under varying economic conditions and economic assumptions derived from the sensitivity analysis.
The results of these assumptions are enumerated below and more details of these are provided in the accompanying spreadsheet.
Higher costs of construction
Adding to the costs of construction by up to 40% would still generate a positive private net benefit of $240million, and a net social benefit of $210 million.
Higher costs of operation and maintenance
We assumed an annual inflation rate of 6% over the fifty years of the project, broadly in line with the current rate in Nigeria. If that rate were to double, the project would still have a positive private net benefit, but a higher rate still perhaps to 18 or 24%, would result in negative private net benefit. Whilst it is impossible to predict inflation fifty years ahead, inflation over 12% is unusual and we would recommend that concerns about much higher inflation than at present should not prevent the project from proceeding from the point of view of AIC Ltd. The social net benefit would be positive unless inflation were to average around 12% for the lifetime of the project. The Government will need to take a view on how likely it is that the social net benefits would be negative in the light of this analysis.
Assuming an increase in the cost of labour or supplies over that period by up to three times current levels would still generate positive private and social net benefits.
Decrease in volume of electricity
A reduction in output of up to 40% over the lifetime of the project would still generate positive private and social net benefits.
Increase in volume of electricity
The plant will have a theoretical capacity to generate 50% more power than the level costed for in this report. Assuming that such output was generated, for the lifetime of the project would clearly increase both the private and social net benefits, to a maximum level around 70% higher for both the private and social net benefits.
ncrease in the discount rate
We noted above that the discount rate used in this report is relatively high, at 11%, reflecting the potential risks in a project of this sort – dams, especially larger ones, do not always generate the benefits expected, hence our report plans for power output around two thirds of potential. However, it may be worth considering the different levels of private and social net benefits deriving from different discount rates. We calculate that using a discount rate of up to 21% will still generate positive private and social net benefits, but that to go higher, perhaps to 25%, will generate negative net benefits.
We conclude that under most scenarios, the private and social net benefits would be positive. We would add that a plant generating only 66% of potential output has scope for offsetting increased costs with increased revenue, and that for those reasons it would be in the interests of AIC and the Government to proceed with this proposal.
Case Studies, Secretariat to World Commission on Dams; Final Reports, November 2000.
Brazil: Tucuruí Hydropower Complex, Tucuruí Hydropower Complex.
Pakistan: Tarbela Dam and related aspects of the Indus River Basin.
Thailand: Pak Mun Dam, Mekong River Basin.
Turkey: Aslantas Dam and related aspects of the Ceyhan River Basin.
U.S.A: Grand Coulee Dam and the Columbia Basin Project
Zambia and Zimbabwe: Kariba Dam.
Federal Bureau of Statistics, Nigeria; Statistical Factsheet, November 2006
Mulera, M.K. ‘‘Our Energy-Rich Dark Continent’’; The Daily Monitor, Kampala, Uganda, November 5th 2007.
World Commission on Dams; ‘Dams and Development, A New framework for Decision-Making’; November 2000.
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