The way the World Bank Group approaches hydropower has changed and the lessons learned from this re-engagement are informing those undertaking large projects – especially in emerging economies.
By Meike van Ginneken
In the past decade, hydropower development has picked up after a sharp decrease in the 1990s. The late 1990s was characterized by escalating debates over large dams. At the World Bank, our investments in hydropower declined by 90% between 1992 and 2002. However, globally, between 2005 and 2011, newly installed hydropower capacity just outpaced new generation capacity from all other renewables combined. This growth was driven by hydropower development in Asia, especially in China.
The political discourse on hydropower has also changed over the past decade. The environmental movement has broadened its focus from local environmental issues to global issues like climate change. Middle income countries, especially the governments of Brazil, Russia, India, China, and South Africa (BRICS), are increasingly financing hydro and have become more assertive in advocating infrastructure development. The World Bank Group supports sustainable and responsible hydro projects of various sizes and types, depending on local need.
The potential for hydropower is arguably highest in Africa. On one hand, the stakes are high as only one third of Africans has access to modern energy. On the other hand, the opportunities are enormous as only 8% of Africa’s vast hydro potential is developed. This is lower than any other continent. Hydro can light up Africa.
Sustainability front and center
Environmental and social sustainability have made considerable progress in the past decade with a number of international guidelines developed to measure the sustainability of hydropower projects, such as the IHA’s Hydropower Sustainability Assessment Protocol
Implementing environmental and social management plans during construction and after commissioning has often proven harder than writing them. The hydropower community should continue to learn and to incorporate lessons from what works in practice. And while know-how for responsibly managing environmental and social impacts has improved considerably, the challenge is always in applying this consistently and efficiently.
The standing of hydropower suffers from real and perceived pre-construction and construction delays. A review by some academics at the University of Oxford on cost overruns attracted attention recently but it’s important to remember that most of the hydropower projects which now generate 16% of the world’s electricity are “no regret” investments. Hydropower projects often deliver benefits beyond predictions. For example – Itaipu, a hydropower project jointly constructed by Brazil and Paraguay, is highlighted in the Oxford paper. There were indeed cost overruns. It took 11 years between signing the treaty that originated the project in 1973 and the first power being generated in 1984. But the benefits have been enormous. Itaipu generated nearly 100 TWh in 2013 – providing 72% of the power used in Paraguay and 17% in Brazil. In constant dollars, revenues generated from the project amount to nearly six times the actual cost of construction. The two governments have shared about $10 billion in royalties. This is why political leaders and policy analysts in Brazil agree that Itaipu was a very good investment.
Still, cost overruns and delays continue to be a concern for large infrastructure projects including hydropower. This is often due to over-optimistic and outdated cost and construction time estimates. But often, lack of government capacity and resources to drive projects forward is a serious cause of escalating cost and project duration.
The 2012 commissioning of the 250 MW Bujagali project on the Nile in Uganda was a milestone as it was the first full-scale private hydro project in Sub-Saharan Africa. Bujagali is a success but coming to financial close on a complex project financing structure with multiple public and private sources of financing – with overlapping requirements – took a long time. In 2002, the Ugandan President Museveni told Reuters: “I am not happy because a project that should have taken two years has taken seven years to start.”
Since Bujagali’s financial close in 2007, no other large scale privately financed hydropower project has come to financial close in Sub-Saharan Africa. Given hydro’s investment profile, it comes as no surprise that private financing for hydropower has lagged compared to investments in thermal generation. Firstly, hydropower is capital intensive with construction accounting for up to 80% of total project costs. Secondly, the normal economic life of a hydropower project is far longer than that of a thermal generation plant. Thermal plants are standardized and pose few surprise risks. Hydropower plants are site specific and pose geological and hydrological risks that need to be shared by private developers and governments.
Large hydropower has traditionally been developed with cheap public money and, as a result, offtakers and policy makers have come to expect very low generation costs. Private developers and financiers require commercial rates of return. In developing countries, loan maturities are often limited to five to 10 years. Given the high capital expenditure of hydropower, the cost of capital has a strong impact on the production costs. Take the case of the 147 MW Adjarala Hydroelectric Project on the Mono River between Togo and Benin. With a concessional financing package, the levelized generation cost would be below 7 US cents/kWh. Purely commercial financing would nearly triple that unit cost.
Higher unit costs of hydropower will have to be anticipated if governments want to increase the pace of hydro development using private financing. At the same time, the cost of commercial financing could be brought down through risk mitigation instruments and combining public and private financing. In most cases, levelized unit costs of hydropower beat other technologies even if the costs of commercial financing are reflected.
At present, most concessionaires sell their energy exclusively to one state-owned utility. However, the number of projects which sell energy to industrial users or export power to neighboring countries is growing. This could enhance the attractiveness of hydropower for private financiers going forward. Hydropower is already an important source of revenue for countries like Lao PDR, Nepal, and Bhutan.
The rapid expansion of the mining industry can be a game changer for hydropower in Africa. Historically, mines have developed cheap hydropower resources for self-supply – leaving households in the dark or paying for more expensive sources of energy. The World Bank Group promotes grid based arrangements in which mines sell into the grid, co-invest in the grid, or mines serve as anchor demand for independent power producers. Hydropower capacity that could be developed through grid-based arrangements with the mining industry in Sub-Saharan Africa (excluding South Africa) is estimated at 3–5 GW by 2020.
Non-traditional financiers – such as Brazil, China, and India – often seem attractive to government officials frustrated about the high cost of privately-financed projects and the time-consuming arrangements needed to set up projects financed by international financial institutions.
Some interesting findings are emerging from an on-going review being undertaken by the Cooperation in International Waters in Africa (CIWA) program at the World Bank on the role of China and Brazil as new financers of major water infrastructure in Africa. The review identified 17 hydropower projects between 2000 and 2013 that received some level of finance from Chinese banks. When complete, these projects will add nearly 7 GW of power. The total cost of these projects is about $13 billion, of which roughly half is coming from Chinese financiers.
Preliminary results debunk some of the myths circulating about Chinese-financed hydropower in Africa. For instance, Chinese hydropower financing does not extensively use resource-backed financing in exchange for future mining revenue flows. Contrary to what many people think, several Chinese-financed projects have an international engineering consultancy firm overseeing construction by a Chinese contractor. The analysis indicates that projects backed by non-traditional financiers face many false starts and delays.
All in all, the financial news is mixed. Too many hydropower projects have suffered from false starts. Doing better in the future will require a push to develop hydropower-specific models to attract private financing. It will also require finding streamlined structures for mixing and matching various sources of project financing – including Western and non-traditional financiers.
In the past two decades, hydropower has shifted from an engineering-dominated sector to a more holistic business model. This broadening of the hydropower business has been at the core of the hydropower renaissance. However, this move to a more integrated approach could over time risk diluting attention to engineering aspects and to physical sustainability.
The physical sustainability of assets depends on the quality of design and construction, as well as on the operation and maintenance of infrastructure after commissioning. Technical quality starts at the design phase. Quality construction only happens after comprehensive project preparation.
The World Bank Group has expanded its role in support of project preparation. The bank is, for instance, providing technical assistance to the preparation of the 4,800 MW Inga 3-BC project in the Democratic Republic of Congo. By supporting studies according to international standards, we will help to improve the quality of the project and reduce cost overruns and delays later on.
While the technical quality of construction of the new generation of hydro projects have generally been good, we have noticed some exceptions in which governments awarded a contract but failed to adequately monitor progress. Widespread use of fixed price engineering, procurement and construction (EPC) contracts has increased the visibility of governments and developers on costs but these contracts require strong independent oversight and control.
Operation and maintenance of hydropower infrastructure will gain urgency as new projects come on-line. In Sub-Saharan Africa, most hydropower projects coming on-line in the coming years are publicly owned and financed with support from donors and non-traditional financiers. New asset management models need to be developed and rolled out as these new dams are commissioned.
Hydropower development has changed. The sector is starting to establish a track record on environmental and social sustainability. This will need to be accompanied by a push to develop hydropower specific models to attract private financing. As we embrace the new integrated approach to hydropower, attention to the physical sustainability of hydropower assets should also be deepened.
Meike van Ginneken is practice manager, energy, for West and Central Africa for the World Bank Group. Article adapted from keynote speech at HydroVision International 2014, watch video at http://bit.ly/1EMQfIv, starting at 1:06:50.