Opening the Door to India’s Small Hydro Capacity

Despite significant opportunities and evident demand, development of small hydropower projects in India is beset with challenges. But mechanisms can be adopted that could secure a major slice of its huge potential.

By David Appleyard

With its large population of rural poor who lack access to electricity from the grid, a peak load deficit estimate at about 10%, and rapid (albeit recently slowed) economic growth, India needs power.

A good deal of attention has been focused on the development of small hydropower capacity, deemed projects with a nameplate rating of 25 MW or less. There is significant potential in the country for hydropower development on this scale. Figures from the responsible agency, the Ministry of New and Renewable Energy (MNRE), estimate the potential for power generation in India from such plants at more than 15,000 MW.

Recognizing that small hydropower projects can play a critical role in improving the overall energy scenario of the country and in particular that for remote and inaccessible areas, the ministry’s aim is that at least half of the hydro potential in the country is harnessed over the next decade and that the installed capacity of small hydro facilities should be about 7,000 MW by the end of 12th Five Year Plan in 2017. The economy of India is based in part on planning through its five-year plans, which are developed, executed and monitored by the Planning Commission of India. The 11th Five Year Plan completed its term in March 2012.

Overall, MNRE is targeting a capacity addition of 30,000 MW during the 12th Five Year Plan period from various renewable energy sources.

In total, 967 small hydro projects with an aggregate capacity of 3,632 MW had been installed in India by the end of April 2013, with 24 states announcing a policy to invite private sector bodies to set up projects. In addition, 281 small hydro projects with a total capacity of 1,061 MW are under construction.

During the 11th Five Year Plan, a capacity of 1,419 MW of small hydro was added, while 536 MW was accumulated in the 10th Five Year Plan.

MNRE says it is providing central financial assistance to set up small/micro hydro projects both in the public and private sectors, while financial support is also given to state governments for the identification of new potential sites — including surveys and the preparation of detailed project reports — and renovation and modernization of old projects.

From 2012 to 2013, INR1.6 billion (US$28 million) of funding was released under the Small Hydro Power (SHP) Programme, with the largest amounts going to states such as Arunachal Pradesh, Himachal Pradesh, Jammu & Kashmir and Uttarakhand. Predictably, most of the potential is in Himalayan states, as river-based projects, and in other states on irrigation canals.

The ministry says the main focuses of the SHP program are to: lower the cost of equipment, increase reliability and set up projects in areas that give the maximum advantage in terms of capacity utilization.

According to MNRE, its SHP program is now essentially being driven by private investment, and it finds that projects are normally economically viable and that the private sector is showing lot of interest in investing in SHP projects.

Driving private investment

However, given the vast potential and obvious drivers for demand, the experience on the ground would appear to be rather more challenging. So why has India been so hesitant when it comes to execution?

Shedding light on this theme, attendees at the HydroVision India Conference and Exhibition in May heard from Anchit Gupta, director of business development at Focal Energy, which invests in, owns and manages a portfolio of renewable energy projects in the hydroelectric, biomass, wind and solar sectors. Gupta offered his perspectives on the issue of financing of hydropower plants.

Construction work is proceeding on several small hydro projects in India, with still others in the pipeline for future development.
Construction work is proceeding on several small hydro projects in India, with still others in the pipeline for future development.

When considering investing in development of a hydropower facility, Gupta explains, a good partner with honesty and integrity is the most important element, together with projections and adequate contingencies within the project plan.

However, the cost of debt and the interest rate on capital is a major influence, and Gupta says that even though the company is an equity investor, it is capital rates the group focuses on, rather than equity returns. He says this is the most pressing issue for renewable energy and infrastructure development in India.

He continues by presenting a typical example of a project deal with a debt:equity ratio of 70:30, a typical interest rate of 14% and a repayment period of eight years. In this case, “around 22% of total project cost in the first year is outflow to service debt. Most projects are not generating that kind of cash flow in the first few years. That is one of the most pressing issues for renewable energy in India,” he says.

He also adds that a realistic assessment of revenue is critical, saying: “One of the challenges [is that] projects are more often than not over-advertised, with under-estimation of revenue project costs and over-estimations of energy production potential. We have a benchmark for a 30% haircut, and so far we been spot on. You could say that Indian developers are consistently inconsistent in over-estimating generation potential.”

Small dams like this one in India show considerable promise in meeting the need for electricity, as long as proper support mechanisms are adopted.
Small dams like this one in India show considerable promise in meeting the need for electricity, as long as proper support mechanisms are adopted.

Giving a developer’s perspective, Nikhil Jaipurkar, a partner with Shimla, India-based hydropower consultancy firm and developer Strategic Consulting Group also points to a number of challenges, such as lack of regulatory support and clarity regarding various project permits and clearances. Jaipurkar says this in turn leads to extended development timelines and cost overruns, and this challenge is the one where proactive government at the state and central level can make a difference.

Jaipurkar also points to a lack of professional developers, especially at the smaller scale, and lower level of understanding on the part of the project participants, resulting in sub-optimal solutions. This is a point echoed by Gupta, who addresses the changing nature of small hydro developers by saying there is a need to overcome the family business approach, as well as small developers accepting that experts can come in, and that standards need to change.

Gupta says, “Most plan so that everything is going to be perfect, but we say not everything will be perfect, you need to plan for contingencies. Working with a long-term partner, some say, ‘Initially it was very hard for us, but now we see the value of this approach.'”

Considering some of the technical issues, Jaipurkar argues that reliable hydrology data for smaller streams is not available and correlations are being used from larger rivers, which may not be accurate. Developers and investors, he says, “do not always have the technical competence, intent or patience to measure actual flow data for two years, two lean seasons at least.” Thus, he adds, hydrology is almost always a ‘guesstimate’ and is an open risk for the project’s power generation. Many commissioned SHPs are facing low actual peak load factors as a result, he says, and are finding problems servicing debt.

Gupta, too, points out that project valuations can be an issue in the small hydropower sector. “The other challenge we face is the valuation expectations by developers. They expect they’re going to get the same valuations as projects they may hear about in the market,” he says, adding, “Our approach focuses on a very thorough and aggressive due diligence process. For example, developers may say, ‘The tariff is going to be increased in two months.’ Well, we can wait for two months and see what happens. Whatever is there and can be supported is what we rely on.”

Giving further insights into the company’s due diligence process, Gupta explains, “We also look at other projects, not just in our portfolio but also other projects that we have looked at and decided not to invest in, to give us a benchmark for evaluating the opportunity we have come across. When we look at projections, we always include a safety margin, such as the 30% haircut on generation. We also know that there are enough projects available for us to invest in, and if we walk away we don’t sweat it.”

Jaipurkar also notes a propensity to increase the estimation of potential generation capacity, thus selecting sub-optimal design characteristics. Jaipurkar notes that in some cases this has seen viable projects at a smaller scale becoming non-viable at a larger scale.

On financing, Jaipurkar says, “Even if the project is fully permitted and is shovel-ready, finance from banks is dwindling. The power sector is on the negative list for many banks, as is the broad infra sector, and many have got their power sector exposure to the maximum.

“Financing from government. bodies like IREDA, comes with its own set of issues and delays. Banks are demanding more and more collateral to back the lending, which for many SHP developers is not easy to get. At the same time, interest rates are high and tariffs, especially in Himachal Pradesh, are low.”

He also points to challenges in the Renewable Energy Certificates (REC) market: “Right now the REC market is stagnated, with supply outstripping demand by six to seven times. Many developers had looked at the REC market a year back, with hopes of getting a higher revenue realization for their projects. The price was coming to around INR3.7/kWh, as compared to the FIT of INR3/kWh. But now with the RECs remaining unsold for more than a year, their hopes are dashed. Most developers today are totally against the REC route due to the uncertainties associated with the REC price and also its availability after year 2017.”

A call for government action

Jaipurkar calls for a proactive stance to be taken by the government and various departments, for instance, by imposing penalties for inordinate permitting delays and setting tariffs at a level that is attractive for developers to invest and obtain their required return.

He argues that the subsidy for SHP should be increased and the mechanism to deliver the subsidy should be revised. This subsidy should be available to the developer to reduce their equity requirement, Jaipurkar says.

Dalip Dua, managing director at Krishna Hydro Projects Pvt. Ltd., based in Dehradun, India, tells HRW-Hydro Review Worldwide that accelerated financing is indeed one of the biggest challenges facing Indian hydropower development currently and that long-term debt at reasonable interest rates from institutional investors, such as pension or insurance funds — as is found in Europe and the USA for instance — with 12 to 15 years tenure is required.

“The principle challenges are like risk guarantees, power off-take agreements and price variation payments from delays in project[s],” says Dua.

Dua also calls for stronger government intervention, arguing that projects that are facing problems could be developed on a public-private partnership (PPP) principal, in which the government could have partnership of 26% for five years of the project. “This will enable the developers to overcome the principle challenges,” he says.

In terms of attracting foreign investment to small hydropower projects in India, Gupta highlights a fundamental issue, saying, “It is a challenging business not just because it is a business but because the regulatory environment keeps changing from time to time.”

And, like Dua, he also notes that the prospect of lower interest rates for capital projects in India needs foreign investors.

With the general consensus highlighting a number of significant challenges, perhaps typically Indian, there was also a general note of optimism. Gupta, for example, expanded on the positive aspects, concluding: “There is a big need for foreign capital looking for credible income generating assets. And there are huge capital needs for infrastructure projects in India. I believe there is the groundwork for creating win-wins.”

Dua also concludes on a positive note. He says a small hydro mission of 5,000 MW for the purposes of Indian energy security should be announced, “which should be funded through a ‘NTPC: Fossil Fuel Power Generator,’ thus capturing carbon balancing by ‘Federal Government Initiative.'”

Whether or not this becomes a reality, Dua believes there is an “assured future of small hydropower in India.”

David Appleyard is chief editor of HRW-Hydro Review Worldwide.

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