The Hindu Business Line : Small hydro-power projects — The SPV model can be electrifying

A LARGE number of hydro-power development projects with the potential to generate 25 MW each — categorised as small hydros — have been identified in many States. There is a concentration of such potential in Himachal Pradesh, Uttaranchal, the North-Eastern States and Sikkim, identified by nodal agencies such as Himurja (HP), Jal Vidyut Nigam (Uttaranchal), Neepco (North Eastern Electric Power Corporation Limited) and the State Electricity Boards.

The aggregate potential in this category is estimated at 1,500 MW. Many of these projects have been allotted by the State governments under a bidding process to private promoters. Against the number of projects identified, those actually implemented or under implementation constitute just about 15 per cent. A variety of factors are responsible for this slow progress.

The present system of project allotment through open bids does not differentiate between bidders who are keen to actually implement the project and those who bid and hold on to the allotment indefinitely.

The rather low entry cost of Rs 5-10 lakh per MW allows participants with the minimal financial means to enter the fray, particularly in the 1-3 MW range. Often, such bidders look to sell the project allotted and exit with some cash gains.

Sometimes, the bidder suffers from the lack of execution capability. There is inadequate knowledge and experience of executing such a project in hilly terrain and the perceived execution risks inhibit many bidders. For some, the project is an unrelated diversification outside their core activity. Remoteness of the project location and distance from the usual place of business are deterrents, especially for South-based bidders. There are also instances of projects being held up for want of power evacuation infrastructure.

In several cases where the actual generation potential is found to be lower than estimated, the project has been abandoned. Concerns over long-term viability due to the high project cost, fixed rate PPAs with no review provisions, water royalty levied as free power deliverable to the SEB, at 12-18 per cent of generation, and project cost escalations may have led to stalling of projects with marginal viability.

Financial closure delays and collateral or other conditionalities imssposed by the lenders have affected specific projects. The involvement and guidance of the State-level nodal agencies in the implementation of the projects is limited to `monitoring'.

There are no incentives either, from the State, for timely completion of the project. In such a situation, it is no wonder that the actual power generated from small hydro projects is insignificant and that much of the realisable potential remains untapped.

Hydro-power: Benefits

Hydro-power generation is well-established technologically across the globe in diverse geo-physical conditions. It is the cleanest, non-polluting mode of production of electrical energy. The project capacities in hydros range from less than 1 MW to hundreds of MW. With no raw material and feedstock costs, and utilising a renewable natural resource, the hydro-power sector has the inherent advantage of lowest cost of generation.

Small and medium hydro power stations are collectively major sources of power supply in many countries in Europe, Canada, the US, Brazil and South-East Asia. In India, successful execution of smaller hydro capacities has been demonstrated under the UNDP and also by a handful of successful IPPs.

Hydro-power projects up to 25 MW capacity are eligible for substantial cash subsidy from the Ministry of Non-Conventional Energy Sources. Project income is exempt from tax for ten years. Hydro projects automatically qualify for carbon credits under the Clean Development Mechanism supported by the Kyoto Protocol and similar Emission Reduction Funds.

These projects have a long concession period of about 40 years and provide a perennial stream of revenue to the investors. The new National Electricity Policy under contemplation would most likely further incentivise hydel power generation and place a stronger thrust on this sector. The entry of the private sector into power trading would push up the demand for hydel generation for its cost advantage and higher trading spreads.

The SPV approach

Towards facilitating expeditious and economical implementation of small hydro projects and realising the huge generation potential, what are the benefits of setting up special purpose vehicles (SPVs) for taking up development of small hydro projects in contiguous geographical areas. The SPV functions as a joint implementation platform for the promoters, investors and lenders to the projects taken up.

The SPV implements the respective projects on behalf of all the stake-holders and, after the project is completed and the commercial generation of power from the project stabilises, it exits from the project. The SPV may also itself bid for new projects identified in its area of operation and implement them on a BOO/BOOM basis (see Diagram).

Funding the SPV

An SPV is usually constituted as a joint stock company. It raises equity and debt funds from the market for financing the projects. The funds raised are allocated project-wise in its books. The SPV can handle a number of projects together but should delineate the financial and physical status of each for due transparency and to enable project monitoring by lenders and investors.

Apart from ordinary equity capital or common stock, the SPV may also issue project-specific preference shares to such investors who may choose to invest in any specific project. The SPV shall issue a Pass Through Certificate to such preference investor specifying his holding in the project(s).

The preference shares shall carry an agreed rate of dividend and lock-in period. The SPV shall raise the required debt funds from FIs, banks and from international financial institutions, leveraging the aggregate equity.

Entry into projects

An SPV may enter into a new project, either as the principal bidder or in consortium with others. In respect of projects already bid for and allotted to promoters, the SPV may either buy out the promoters' stake or co-participate in the project along with the promoters, with the approval of the lenders and other stake-holders. The SPV may also take up execution of projects on behalf of promoters/IPPs, or on a BOT, BT or turnkey contract basis.

Exit from projects

An SPV should exit from a project after its completion and commissioning, as per the agreed mode of implementation. In BOOM/BOO or owned projects, after the project is completed and commercial generation of power is stabilised, a detailed valuation of the assets and liabilities of the completed and running project can be undertaken, discounting future cash flows anticipated, for arriving at the sale price.

The SPV should invite competitive bids for takeover of the assets and liabilities of the project by intending buyers and decide on the terms.

The SPV may also offer for sale the equity invested in any completed project to intending investors, at a premium based on the valuation of the project. The completed projects would be attractive for investors buying up or into them as they will already be generating power and cash flows.

The investors in the SPV will be rewarded with dividend/bonus from the premium earned on sale/transfer of the projects or the equity, apart from regular dividends from projects in operation.

Advantages of SPV model

The SPV approach would effectively address the present systemic deficiencies and other problems retarding the development of small hydro projects. The collective setting envisaged in the SPV model can bring about advantages of scale and professional expertise to project execution. Implementing a string of small projects together under a unified set-up would be cost-effective. The input costs, both civil and electro-mechanical, could be economised considerably. Materials and machinery can be sourced at lower cost.

Implementation time would decrease substantially, and logistics would be far smoother. Uniformity in design and material standards will ensure better quality of work and enhance efficiency in generation.

The SPV can afford to engage manpower of excellent technical quality for project investigation, supervision and management. The project execution risks can be minimised.

Superior and higher technologies can be adapted. Project implementation can be achieved faster with all the resources and expertise at the command of the SPV.

FIs, banks and international developmental agencies, as well as power sector institutions — Power Finance Corporation, PTC India (earlier Power Trading Corporation), Power Grid Corporation and National Hydroelectric Power Corporation — would be interested in funding the SPV by way of debt and also some equity, as project implementation and credit risks would be less than in direct lending to individual IPPs.

Since the SEBs and State governments shall be major beneficiaries of the SPV model of small projects development, their support and involvement in the strategy is expected to be forthcoming, as in expediting the land and environmental clearances for the projects and power evacuation arrangements.

The proposition, it is earnestly believed, will generate keen interest among the promoters, stakeholders and agencies concerned with the development of small hydro-power projects.

They could come together and form an SPV company for implementation of the identified projects.

Services of a competent investment/merchant banker could be enlisted for mobilising equity and debt funds. Project management could be entrusted to a team of qualified and experienced professionals.

The SPV approach is the best course for achieving expeditious implementation of small hydro projects and realising the substantial power generation potential available in this sector.

(The author is a former General Manager of SBI. He can be contacted at: rvpkesan@hotmail.com. The views expressed are author's own and do not necessarily reflect those of any of the entities or agencies concerned.)

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