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APSCOM/2009_ VMDELGADO

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Attractiveness of Hydropower Project in the Philippines: The Public-Private Partnership

Victor M. Delgado Jr#1, Maria Luisa M. Delgado *2

#National Power Corporation Quezon City, Philippines

[email protected]*National Power Corporation

Quezon City, Philippines [email protected]

ABSTRACT:The National Power Corporation's (NPC) experience in quickly resolving the power crisis that hit the country during the late 80's and early 90's can be largely attributed to the involvement of private enterprise in putting in place a number of power plants to support NPC's existing but aging plants.

This initial success has prompted NPC to adopt a policy of tapping private capital for implementing generation projects identified in the Power Development Plan, with the view that ODA funding can be best utilized to implement the needed backbone transmission lines of the country. This also fits well with the government's long term plans of eventually leaving generation projects to private sector.

The merits of hydropower as an alternative power source have long been recognized by NPC due to the unique benefits it offers. Aside from being indigenous and renewable, it is cheap source of energy in the long run considering its long useful life and low operational cost. And above all, its contribution to perform regulating function for the power grid because of its inherent technical characteristics makes it more desirable.

The Build-Operate-Transfer (BOT) arrangement is, however, difficult for a hydropower project. Unlike a thermal alternative, the characteristics of a hydro do not sit well with the BOT structure. The challenges, therefore, are adapting the unique characteristics of hydropower to this arrangement, and developing a firm process by which NPC can encourage private developers to risk their capital.

This paper will present the incentives the Government of the Philippines offered to the private investors who are willing to take the risk of developing renewable energy, particularly hydropower, in the context of BOT scheme. Likewise it will present the initiatives of the government of the Philippines is doing in order to further promote the development of renewable energy.

I. INTRODUCTION

NPC was tasked by the government to develop all the rivers and streams in the country for power generation purposes until

1987 when the government virtually lifted its monopoly in the development of power generation with the passage of Executive Order 215 (EO 215), the predecessor of the BOT Law. However, only few private investors took advantage and avail the incentives offered by the EO 215. For the likes of hydropower projects, despite of long tradition of its development in the country, it did not encouraged to mobilize the same level of interest for the private sector as compare to the thermal IPPs in spite of the privileges the government offers for its development.

Private participation in the power sector is not a new concept for the National Power Corporation (NPC). Prior to the enactment and the implementation of Republic Act 9136 known as “The Electric Power Industry Reform Act of 2001” (EPIRA) the government had already initiated reforms and tapped private sector’s capital to provide the additional capacity needed to cope with the country’s increasing demand for electricity. Legislations were passed to encourage the private sector to participate in providing the needed investments to finance the construction of new power plants. Foremost with this is the passage of the Build-Operate-Transfer Law (BOT) which was used by the government as vehicle to attract private investors, both local and foreign, to finance the needed investment in the power sector.

The power industry under the BOT Law turns out to be a premier investment opportunity in the Philippines. Both local and foreign investors emerged as partners of NPC in constructing thermal power plants to finally end the crippling power crisis in the 90’s. This marked the emergence of the Independent Power Producers (IPPs) in the country, which in year 2003 accounts to about 58%1 equivalent to 7,400 MW of the total generating capacity of NPC. To date, there were seven (20) IPP contracts (1,900 MW) that were concluded and turned-over to NPC. Of the total 41 IPP contracts of NPC, there were three hydropower plants with combined capacity of 555 MW that were contracted by NPC under the BOT law.

The difference between the previous legislations concerning the power sector with EPIRA is that NPC is allowed to contract the power produced by the IPPs, whereas under the new law, other than prohibiting NPC to purchase power from new IPPs, the new law will eventually relinquish the

1 NPC Data – 2003 Annual Report


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government’s role to the private sector and thus relieving the government the responsibility of providing funds to finance new power plants.

The passage of EPIRA paved the way for a market driven industry that will introduce competition in the generation sub-sector. The EPIRA doesn’t call for a fully deregulated power industry. Only the generation and supply will be deregulated (Figure 1) while the distribution and transmission will continue to be regulated by the ERC.

The new law calls for the selling of all NPC’s generation asset to broaden the ownership base and promote competition in the generation sub-sector. Except for the Agus and Pulangi hydroelectric power plant of NPC located in Mindanao, all hydroelectric plants of NPC will be privatized.

EPIRA is promoting total competition. Competition will start upon the privatization of NPC’s generation assets. The more important aspect of the EPIRA is the opportunity for the private investors to build new power plants to meet the future electricity demand. According to the Department of Energy 2005-2014 Philippine Energy Plan, the country will need a total of 9,225 MW of new capacity additions to meet the projected electricity demands in the next ten years.

With the passage of the EPIRA, it can be assumed that private investment will be the only source of capital to finance the future power requirements of the country. However, it is worthwhile to note that NPC’s experienced in contracting private power prove that building thermal power plant is more attractive than the development of hydroelectric power 2 .Figure 2 shows the total share of hydropower plants built under the public-private partnership.

In the development of hydropower project, the more challenging part is its ability to attract financing. Investments of private hydropower projects are mainly base on a non-recourse project financing, where the security is essentially the project itself. This raises very serious issues as the risks associated with this type of plant have a direct bearing on its ability to raise the needed funds. And all these risks when factor-in makes hydropower less attractive when evaluated in the short run against thermal generation and appear to be a more expensive option; even it is economically attractive and competitive in real term. In the long run, hydropower can be very competitive especially when an existing hydropower plant has already paid-up the loan invested on it. Hydro generation has always in a better position in terms of dispatch in any types of market.

The deregulation of the power sector spouse by EPIRA opens the opportunity for the private sector to own, operate and sell their own power to consumers at their true cost. Part of the privatization concept is the sell out of NPC’s generation assets. Selling of NPC’s hydropower plant will serve as catalyst on the future of the privatization of NPC assets since hydropower plants is much easier to operate and maintain, with all infrastructure provided and can produce electricity at

2 Prior to the EPIRA private development including BOT and other variants has produced a ratio of 1MW hydro for every 12 MW thermal

a very low cost as compared with other types of plant. Owning an existing hydropower plant maybe easier but constructing a “Greenfield” project is entirely different and require tedious process.

II. GOVERNMENT INITIATIVES IN ATTRACTING HYDROPOWER INVESTORS: THE PUBLIC PRIVATE PARTNERSHIP

NPC's experience in quickly resolving the power crisis that hit the country during the late 80's and early 90's can be largely attributed to the involvement of private developers in putting in place a number of power plants to support NPC's existing but aging plants.

This initial success has prompted NPC to adopt a policy of tapping private capital for implementing generation projects identified in its Power Development Program, with the view that Official Development Assistance (ODA) funding, the source of most of NPC capital, can best be utilized to implement the also needed backbone transmission lines of the country. This also jibes well with the government's long term plans of eventually leaving generation projects to private investors.

The merits of hydropower as an alternative power source have long been recognized by NPC due to unique benefits it offers. Aside from being indigenous and renewable, it is cheap source of energy in the long run considering its long useful life and low operational cost. And above all, its contribution to perform regulating function for the power grid because of its inherent technical characteristics makes it more desirable.

Until 2001 when a new hydropower was commissioned under the BOT law, for 20 years, however, no new hydropower projects have been built, although a few have always been listed in the NPC Power Development Program as candidate plant for implementation.

The BOT arrangement is, however, difficult for a hydropower project. Unlike a thermal plant, the characteristics of a hydropower do not sit well with the BOT structure. The challenges, therefore, are adapting the unique characteristics of hydropower to this-arrangement, and developing a firm process by which NPC can encourage private developers to risk their capital.

NPC’s success of attracting private capital into the implementation of hydropower projects depends to a large extent on a number of factors. Among these are: o The legal framework that was put in place to be able to

address various legal issues involved; o The available incentives to investors; o The viability of the hydropower projects offered and the

role of the projects in the power system; o The transparency of the tendering process backed by a

clear and well-crafted bidding rules; o The allocation of risks to the different players in the

market; o Relevant pricing structure to set the pricing limits for the

project.


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III. INCENTIVES OFFERED BY NPC TO ATTRACT PRIVATE INVESTORS

The existing legislative and regulatory support system is considered as a significant incentive that proponents took advantage to pursue their bid for NPC's BOT projects. Lenders also consider this incentive as a critical factor before deciding to make investments on these projects.

The BOT Law prescribed the investment incentives available to project proponents for projects authorized under the law. Applicable incentives for NPC's BOT projects come in the form of: o Government support for proponents registered with the

Board of Investments (BOI) as provided under the Omnibus Investment Code of 1987, the applicable incentive offered by the government during that time;

o NPC’s direct support such as cost sharing; and o Other Government support such as credit enhancements

and minimum-off-take provisions.

A. Government Support

The initial success of implementing the BOT Law to provide the needed additional power that solves the power crisis during the early 90’s prompted NPC to be more creative in finding ways to encourage private sector to join in the BOT implementation of hydropower projects. In August 1994, NPC offered several hydroelectric power projects for private sector’s participation under the BOT Law. However, the bidding failed to attract the same level of acceptance to private investors as compared to the response of the private sector in the thermal (oil-based and coal) projects offered by NPC.

The experience provides NPC an indicator on how hydroelectric power projects should be packaged to attract private investors. NPC came out with a concept that should tailor-fit a BOT arrangement specifically for hydropower projects to stimulate the private sector’s interest and generate the same level of enthusiasm it got for its thermal power projects.

As a result, the government provided some support mechanism as follows that encourage international lenders to provide funding to hydropower projects:

1) Fiscal Incentives: The original proponents of the hydropower project offered by NPC for BOT implementation, Bakun (70 MW) and San Roque (345 MW), being consortia composed of multi-national companies including Philippine companies acceded into corporations organized under Philippine Laws before being registered with the BOI as pioneer firms. Both projects exceed the 30-MW minimum installed capacity for a power generating facility to be considered as a pioneer enterprise. Having satisfied all other requirements of the BOI, the proponents benefited in the following incentives: o Six-year income tax holiday from the start of commercial

operation (non-pioneer generating facilities will be

entitled to a four-year tax holiday) o Additional deduction from the Taxable Income for Labor

Expenses; o Exemption from Contractor's Tax; o Simplification of Customs procedures; o Unrestricted use of consigned equipment; o Employment of Foreign Nationals; o Tax Credit for Taxes and Duties on raw materials; and o Access to Bonded Manufacturing/Trading Warehouse.

2) Government Guarantee: In order for the project to be more attractive to private sector participation, NPC through the help the Department of Finance grants a Government Performance Undertaking. Such guarantee doesn’t in anyway make the government pay the debt entered into by the project proponent. Under the Government Performance Undertaking, the government is giving guarantee that all financial obligations carried by NPC under the Power Purchase Agreement will carry the full faith and credit of the Government for a the duration of the Cooperation Period3.This further enhances the bankability of the project.

B. NPC’s Direct Support

Direct support means that NPC provides certain indirect equity in the project. NPC bears part of the pre-investment and capital expenses necessary for the implementation of the project. These expenses include:

Completed Feasibility Study; Site and Other Land, Including Relocation of the would

be affected families; Transmission Lines and Access Infrastructure;

1) Feasibility Studies: NPC recognizes the difficult challenges in offering hydropower development projects for bidding on the basis of pre-feasibility studies only. Under these circumstances, bidders will expect big rewards for assuming the risk of technical and financial viability, and the resulting bids will be excessively high. To address this issue, NPC created a policy requiring that projects offered for bids are backed by full feasibility studies prepared by NPC. Long before this policy was adopted however, NPC has been conducting full studies for its projects except that numerous unsolicited proposals have been received as a result of the Government's new direction allowing the private sector to own power generating facilities. In all hydropower projects offered by NPC for BOT implementation, NPC provided all related studies concerning the project.

2) Relocation, Resettlement and Compensation: NPC undertakes the relocation, resettlement and compensation of households directly affected by its generation and transmission line projects. Households are given the option to

3 Cooperation Period is the fixed term (25-years) given by NPC to Hydropower BOT proponents operate and maintain before the said plant is transferred to NPC


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accept the standard housing units in NPC's resettlement sites plus financial assistance for relocation and compensation, or to accept an equivalent financial assistance. The resettlement program includes community development and livelihood program.

3) Land, Easements and Right's of-Way: Among the responsibilities of NPC in the contract arrangement is to provide the necessary lands and rights of way at no costs to the proponent of the project. It includes the land, easements and rights-of-way for the project's permanent and temporary structures including borrow and spoil disposal areas. All necessary instruments are executed such that the proponent may use the project site for the purpose of financing and refinancing the cost of constructing and maintaining the power plant.

Although this practice is common to all NPC’s BOT projects, in order of magnitude NPC’s exposure in the development of hydropower projects is larger compare to thermal projects especially if it involves building huge dam with bigger capacity and reservoir. Such was the case in building San Roque Multi-purpose Project wherein NPC allocated a huge amount of money to acquire the necessary lands in building the associated infrastructure of the project.

4) Provision of Transmission Line: The associated transmission line is part of NPC's responsibility under the PPA, with a guarantee that the line would be in place at the latest six months before the target completion date of the first generating unit.

NPC however reserves the option to allow the proponent to undertake financing and construction of the transmission line under a separate contract. Under this setup, NPC will define the origin and the terminal points of the line, the proponent will determine the route and construct the line according to NPC's design standards.

5) Provision of Access Roads: Due to the complexity of the location of the hydropower projects, access road became one of the major associated infrastructure works integral to its operation and requires considerable amount of money to develop. In order to lessen the cost of the tariff to be offered by the bidders, the access to the project site was made part of NPC responsibility. Another reason is that site access infrastructure can be more effectively implemented as a turn-key contract independent from the BOT contract for the power facilities. Funding can be accessed from traditional lenders under easier terms as compared if the costs were included in debt component of the BOT contract.

C. Other Government Support Mechanism

These support mechanisms offered by the government is an incentive given to make BOT power projects more attractive to the large lending institution more so with hydropower whose primary source of generation depends on the

climatological factor that posed unwanted risk. Below are the following support mechanisms:

1) Guaranteed Capacity Payment: NPC guarantees payments to the Proponent as part of the Capital Recovery Fees irrespective of the actual output through a secured long-term PPA. In such arrangement the proponent is guaranteed of minimum payments every month. The guaranteed capacity payment is standard for all NPC IPP contracts to have some form of fixed capacity or capital recovery payment to IPP proponents to ensure that the proponent is able of repaying their project debt and meet their interest obligation in timely manner.

2) Multiple Currency Tariff: One of the key issues in the financing of hydropower projects is its bankability and its ability to pay its loans in such a short period of time matching its loan tenor which is usually foreign currency denominated. Although hydropower required high civil works content that are available locally, there is virtually no funding available that can be sourced from any local banks to finance such portion of the work. In such a case the proponent has no recourse but to source its fund through any available ILA’s willing to finance offering commercial interest rates.

Hydropower is highly capital intensive and in consequence a very large proportion of the tariff during the debt servicing period is attributable to capital charges. This is a marked contrast to thermal IPP plants where fuel and operation costs constitute perhaps 75% of the tariff. In order to address such risk, NPC allowed IPP to propose tariff using foreign currency depending on the source of their financing. Tariff structures are based upon in two forms with Capital Recovery Fee (CRF) and Operating Fee (OMF).

3) Taxes and Similar Fees: NPC is responsible for the payment of taxes, fees, duties, charges and other levies including input VAT on importation of equipment imposed by the GOP or any agency or instrumentality to which the Proponent have acquired in relation to the project. Likewise NPC shouldered the payment of real estate taxes and assessments rates and other charges relative to the structures and improvements in the power plant.

4) Buy-out Provision in the Contract: The contract set-out in the PPA defines circumstances and provisions for a Buy-out whereby NPC will pay lump sum payment to the Proponent in lieu of a continued contractual relationship. The lump sump payment provides a reasonable rate of return to the investment made by the proponent. This provision in the PPA gives significant comfort to the Proponent to protect them from the possibility that events attributable to changes in Philippine law would diminish the value of their investment.

5) Force Majeure: The risk of force majeure in the contract attributable within the control of the government will not relieved NPC from payment of all its obligations under the PPA. In such a case the Proponent is assures of continued revenue whether the event affects NPC or the Proponent.


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IV. RISK SHARING ALLOCATION IN PRIVATE-PUBLIC PARTNERSHIP

In a successful public-private partnership, project risks and responsibilities are assigned to the entity that is best able to manage them. It has been proven by NPC in its own BOT projects. The private sector is generally better at managing commercial risks and responsibilities such as those associated with construction, operation and financing. However in order for the project secure financing, public participation is required in areas such as acquisition of rights-of-way, political risk and market risk. This is what NPC has applied to attract private sector participation in its entire project offered under the BOT law.

Table 1 shows the summary of risks identified by NPC and the allocation of the risks the way that they are treated in the PPA. It shows how NPC tried to mitigate the risks to make the project bankable by: o Taking on the risk directly, i.e. currency and market o Sharing the risk with the proponent, i.e. hydrology and

ECC

V. HYDROPOWER DEVELOPMENT IN THE PHILIPPINES:BEYOND NPC

In the Philippines, the emergence of new hydropower plant that provide an impact to the grid was attributed to the government’s effort to attract the private sector’s support to finance its power development expansion program.

The deregulation of the electric power industry is still in the early stage of development. The legal framework lay down by the government through the enactment of the EPIRA is one of the reasons why the trend towards privatization of generation sector will prosper. But the question is whether private sector will invest their money on hydroelectric power. There are more than 10,000 MW (Figure 3-5) of hydropower potential in the Philippines waiting for the needed financing to start its turbine running. But a number of factors may inhibit private developer specifically the number of risks that are associated and to some extent inherent with it.

On balance, hydropower development will likely experience modest increase in each share in the generation mix due to the fact that EPIRA is in full support for the utilization of indigenous and new and renewable energy resources. However, the inhibiting factors probably will not allow for a dramatic transformation in funding more hydropower plants.

Transferring hydropower development coupled with all the associated risks into the hands of private sector will render hydropower projects in a very difficult situation. There is no assurance that hydropower will be one of the top three alternative plants that the private investors will chose in building future additional capacities. Judging from the way the private investors regarded their participation in the NPC BOT projects, private investors main focus is the project’s financial viability. This means that the project must have a clear and certain source of revenues that will be sufficient (a)

to service the project debt over the terms of the various loans and (b) to provide reasonable return on equity which is commensurate with the type of development and risks the investors will take.

In the case of the BOT projects entered by NPC, investors are assured of their revenue which is normally covered by a long term Power Purchase Agreement (PPA), 25 years in the case of hydropower, since NPC guaranteed to purchase all electricity produced by the power plant with a minimum off-take even though they fall short on the required delivery provided the operations is within the guaranteed parameters. This will not be the case anymore as the EPIRA law prohibits NPC to incur any new obligations to purchase power through bilateral contacts with any generation companies or suppliers4.

Based on the experience of NPC with private developer, there area certain factors which may contribute to outweigh the benefits of developing hydropower project because of the risks associated in its development. However, though it may vary to a certain magnitude, hydropower development involved costs and different risks that make it more costly and difficult to finance on a private basis alone, particularly when compared to equivalent thermal projects (i.e. coal or oil fired thermal plant). These are the risks and challenges that the investors of new hydropower will face under the EPIRA.

All private infrastructure development carries certain common risks beyond the control of project developer (i.e. political risk, currency exposure, force majeure, etc) but hydropower is perceived as posing particular difficulties in a number of areas relating to project definition, risk, financing and regulations.

Financing hydroelectric power projects is very challenging. More often, only state owned public utilities and some other large utility companies can afford to develop large hydropower projects. The reason is not because the lack of possible sites for development nor financial support but rather the costs it carries in relations with the risks associated in its development.

NPC’s experience gave an indication on the contributing factors that may affect the hydropower’s viability. These are considered risks that may vary depending on the site and size of the project. If these are not properly managed, the viability of hydropower project will be greatly affected which may turn hydropower to be an unattractive option for private power producers. These risks which are considered higher in hydro than in thermal will apparently deter the private sectors from investing in hydropower projects. This may lead to the direction of more thermal and less hydro regardless of whether there are more promising hydro potential sites.

VI. ASSOCIATED PROBLEM AND RISK IN DEVELOPING HYDROPOWER PROJECT

The following are brief discussions on the possible problems and risks identified during the implementation of

4 Section 47j, Chapter V of Republic Act No. 9136 and Section 7b, Rule 23 of the IRR of Republic Act No. 9136


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hydropower projects in the Philippines under the auspices of public-private partnership.:

A. High Development Cost

It is inherent in the development of hydropower project to undergo very tedious pre-construction activities. The fact that hydropower development is distinct with each other because of its very site-specific nature made it impossible to define a project with a degree of certainty without significant expenditures in the studies involving in-depth site investigation works. Typically, under the traditional public sector arrangement, the state utility usually spent the costs associated with it during the initial stage of the feasibility study. The conduct of full-blown feasibility study is usually secured through Official Development Assistance financed by multi-lateral lending agencies. However, there are some cases that state utility can seek grants to finance the conduct of the feasibility study. 5 Notwithstanding, the conduct of the feasibility study doesn’t guarantee that the project is viable. More often these costs are treated as sunk costs in project development. NPC’s data shows that the conduct of the feasibility study for 52 sites for NPC’s small hydropower projects program costs $8 million. However, among the 11 projects offered by NPC for BOT implementation only two projects have produced results.

In the same way, private projects have to internalize their upfront costs and very seldom that private projects are afforded with grants in the conduct of feasibility study. These include transaction expenses for legal, financial and due diligence services; they also include engineering costs, technical and environmental consulting fees and etc. These carrying costs are generally much higher for hydropower than for thermal power plant. As an indication, on the average the carrying costs for the candidate hydropower projects, including financing charges, were 45% compared with 25% to 30% for a thermal project.6

The cost of a hydropower project ($/kW) is typically 100 to 200 percent more than a thermal powerplant. Being a highly capital intensive, its consequence therefore resulted to a very large proportion of the tariff during the debt-servicing period is attributable to capital charges. This is a marked contrast to thermal IPP plants where fuel and operation and maintenance costs constitute perhaps 75% of the tariff.

The danger of having longer construction period exposed the developer to higher financial risk and to some extent resulted to cost overruns.

For a private developer, it cannot afford to expose itself for such considerably high cost overrun without factoring its effect in the tariffs. Tariffs have to be heavily front-loaded to meet debt service obligations and to preserve its financial viability. These adversely affect the perception of hydropower as an investment. There will be imbalanced in the

5 USAID financed the Feasibility Study for Liangan Hydropower Project in Lanao del Norte, Philippines. 6 Head, Chris – Financing of Private Hydropower Projects, 2000

competitiveness of hydro being uncompetitive in the short term and over competitive in the longer term.

As per the world standard, the cost of hydroelectric plant varies depending on the size of the power plant. Large-scale hydroelectric plants are usually $800 – 1000/kW, medium sized hydroelectric plants are $1,000 – 2,000 $/kW and mini hydroelectric plants are between $2,500 – 4,000 $.kW7.

B. Difficulty in the Approval Process

The approval process for the development of hydroelectric project is very challenging. Before a detail investigation for a possible site is conducted, developer should secure permits from appropriate government agencies to enter into the area, which becomes more complicated if the site falls under the so-called National Integrated Protective Areas. Usually in the case of state owned utilities like NPC, this can be easily addressed because it can always invoke the government to government arrangement. However, for a private developer they are required to present the project to a public forum and convinced the locality on the nature of the project before a permit is granted.

Hydropower development needs to secure water permit 8

from the National Water Resources Board (NWRB). Approval process becomes easier if the subject Project doesn’t have any applicant that is in conflict with the hydro developer application. However, it took will time if there are other applicants who has an interest other than for power generation and in such a case it is being deliberated by the NWRB to evaluate whose greater benefits the water rights will serve.

7 Li, Francis, “Alternatives to Dam Building for Power Production”, The International Journal on Hydropower and Dams, Vol. 8, 2001

8 Water permit is the privilege granted by the Government of the Republic of the Philippines; to appropriate, divert, and use water for all water related projects.


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C. Long Gestation Period

Unlike other fossil-based power plants wherein the capacity is pre-determine before the feasibility study is conducted, hydroelectric power need to undergo an intensive study to determine the potential capacity of a particular potential site. Feasibility study of fossil-based power plants takes an average of 8 months to complete. Upon completion of the feasibility study, definite design and pre-construction activities will follow that will takes additional 18 months on the average before the detailed design and construction activities started. Depending on the project size, it will take 4 to 6 years from pre-feasibility study to project implementation phase before a certain project is realized, excluding the construction period that usually takes a minimum of 4 years.

D. Potential Conflict between the Interests of the System and Private Developer

It is to the best interest of all concern stakeholders when development of a particular river basin will takes into account its optimum development. However, problem arises when the projects are selected and defined by the developer without regard to the overall requirements of the system and the optimal development of the river basin. There is a natural tendency for developers to select the configuration that will provide the lowest risks and highest returns, irrespective of the fact that it may well represent an underutilization of the site, for example by creating a base load run-of-river scheme where a storage project might be possible or to some extent a multi-purpose project. And generally speaking, the private developer will likely opt for the project that suits his objectives rather than the requirement of the system. This will pose a serious problem that should be addressed as early as pre-construction stage.

Unlike thermal power projects, which can be built and operated essentially in isolation, an individual hydropower scheme has to be seen in the broader context of the river basin planning where there may be multiple water usage and other hydropower projects to be considered. Most of the large NPC hydropower plants in Luzon are multi-purpose projects. Its purpose basically is to avail the optimum benefits it can derive from the particular river basin. Other than for power generation, it can be a source for irrigation, water supply and flood control structures.

Generally, water is regarded as property owned by the estate and should ensure that its usage is properly allocated in each broader context. Since water is owned by the estate, water use regulation is necessary to rationalize the utilization, development, conservation and protection of the nation’s water resources. Regulation of water use is governed within the context of the Water Code of the Philippines.

Prior to the enactment of EPIRA NPC prepared the feasibility study in coordination with other agencies involved in the water development. More often, most of NPC’s hydropower development program has an irrigation

component in the overall river basin planning. In some cases, in the basic economic analysis multi-purpose project is more desirable as benefits are maximize as compare to a single purpose project.

In the context of private development, this may pose a number of specific regulatory issues that arise from the fact that hydro entails the exploitation of unique natural resources and the development may not be fit to the overall private development concept. Unlike in the government’s developmental point of view where the utmost consideration is macro-economic viability, it may not be the perspective of private developer. And therefore such conflict should be properly addressed before any complications arise whenever the private sector decided to enter in the development of hydropower resources.

E. High Construction Risk

While most hydropower projects of any size will take four to five years to construct, a typical gas fired projects requires less than two years or less than four years for other types of thermal power plants. The longer construction period increases the interest and equity required during construction. However, the late start to the revenue stream also adds to the perception of project risk, and in turn increases the risk premium in the financing charges.

During construction stage, the principal construction risk in hydro projects arises from the site’s geological conditions. This covers a wide range of technical problems concerning the safety of the structures and which way can have a major influence on both the schedule and final cost.

Other risks associated to construction arise due to the inherent difficulty of the site conditions that poses logistical problems and oftentimes vulnerable to unwanted risk. This problem is associated to its location oftentimes located in the remote areas, river valleys and across the mountain range.

The experience on privately funded IPP hydropower projects of NPC shows that projects can be delivered on time and others ahead of schedule and within budget under strict contractual arrangement. Bakun and San Roque are two of NPC’s IPP hydropower projects that are constructed under EPC contract whose schedule completion dates is ahead than its target completion in the contract.

F. Hydrological Risk

Hydrological risk lies outside the control of any of the parties in any type of contract arrangement. Furthermore, the assessment of project hydrology necessarily has to be based on historical data, which can be highly vulnerable in its reliability. The methodical approach to hydrology has been to assume that, in statistical terms, historic flow patterns would be replicated in the future. This is a very standard procedure in the hydropower project analysis.

There are three main types of hydrological risk that will matter:

The risk of flood damage;


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Short term production deficit in case of dry years below the long-term average; and

Energy production deficits due to unreliable assessment of the average hydrology, or subsequent changes in the hydrological regime.

The significance of the above risks will vary from project to project, but all have bearing on the security and viability of any private investment.

Hydrology has a direct impact on the energy production of the hydropower project as to fuel of different types is to thermal power plants. In a private hydropower undertaking this is a notable concern, as the developer will carry the hydrological risk. In a public-private type of arrangement, such risk can be mitigated through an off-take arrangement.

G. Environmental Issues

Concerns on issues regarding environmental preservation became a sensitive issue especially to large hydropower development. Lenders and guarantors alike are highly stimulated on environmental issues, and they invariably require that a project meets not only local environmental permitting but also international norms as defined by large International Lending Agencies (ILAs).

In such a case, for hydropower schemes, the environmental issues are quite sensitive that can pose a problem during the approval process. It can be complex and varies substantially between projects. Large hydropower schemes tend to be sensitive if they involved resettlement or the loss of rare habitat. Therefore securing of Environmental Compliance Certificate requires a thorough study and is very time consuming and expensive business and sometimes represents an unwelcome risks and delays as far as private developer is concerned. The cost of environmental mitigation is invariably borne by the developer and the project.

H. Financing Constraints

The public-private arrangement imbued by the BOT program of NPC produced results in terms of the successful financing of power projects in the Philippines. In the case of hydropower, although several projects had been lined-up for BOT undertaking, only a couple of projects has put into place. Below are factors that private investors seem will affect the financial viability of hydropower projects:

1) Long Payback Periods: On the average, investment cost for NPC’s hydropower plant is recovered within 8 to 10 years period of operation. Considering that NPC’s funding source came from multilateral financing with concessional terms, recovery of investment would be much longer if the developer will source their fund from commercially available financing terms. Although the economic life of hydropower plant is longer which can last over 50 years, it would not be desirable for a private developer to wait 10 or more years before they can get back their investment.

An analysis made for NPC’s hydropower IPPs shows that the developer’s investment can be recovered within 5 years of operation. This is because their revenue is secured through long-term agreement with NPC. In the hydropower projects implemented through the BOT Law, market risk is assumed by NPC and payments are secured by a government guarantee. With the new structure under EPIRA, private owners will look for their own customers and in effect taking the market risk.

2) Foreign Exchange Exposure: As compared to thermal projects, a hydropower project contains relatively high proportion of local civil work costs. This cost can be difficult to estimate because they can be subject to high and unpredictable local cost escalation. Despite the large local civil cost content there was virtually no locally source debt, with nearly all of the financing in foreign currency. Such a case is very evident not only with hydropower but almost all NPC IPPs. However, NPC’s IPPs are secured in the payment of foreign currency since their tariff is structured is such a way that their Capital Recovery Fee is guaranteed to receive foreign currency payment. In other words in the contract entered into by NPC with its hydropower IPP, foreign exchange risk is shouldered by NPC. It would be more desirable if the local component can be financed in local currency, thereby removing some of the foreign exchange exposure. In the case of NPC’s hydropower IPP’s, Bakun and San Roque Hydropower Projects were financed using foreign offshore funds but they are secured by long term contracts where most of the payments where paid in foreign currency.

Without a guaranteed market that will assume the foreign exchange risk, private developer will shoulder the currency risk in the event that the power generation and supply are fully deregulated. NPC can no longer enter into contract with any IPPs as provided by law. It only means that hydropower developer doesn’t anymore luxury to contract NPC into long term agreement. In such a case, hydropower developer will lose the guarantee issued by the Republic of the Philippines in favor of IPP in terms of the long-term power purchase contract with NPC. Private developers will look for each respective market and have to compete with the open market being promoted by the EPIRA. There is no guarantee that the developer can enter into long term bilateral agreement from its customer that will pay in foreign currency.

VII. CONCLUSIONS

As the Philippines are about to begin the new era of the electric power industry, hydropower being one of the most notable contributor of affordable, clean and reliable energy source faces new challenges whether it will continue and expand its historical importance. The challenge to those who are willing to expand the ownership of hydropower through construction of new “Greenfield” projects will be to overcome the following factors: o Withdrawal of government incentives for hydropower; o Uncertain future power purchase arrangements; o Environmental challenge;


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o Host community resistance; o Financing including foreign exchange exposure; and o Construction and operational risk. The BOT program of NPC is attributed on successful

partnership between NPC, other government agencies, projects sponsors and project lenders. As a result of government support available, commercial banks have been prepared to take project risk thereby providing a substantial source of capital for the projects. Complete removal of these supports would result in (a) smaller entrepreneurial investors being forced out of the industry, (b) less financial support (debt) for hydro projects, (c) only companies with large balance sheets able to participate, and (d) ultimately higher power rates through less innovation.

The success of the private sector involvement in the development of these two hydropower projects can be attributed to the following factors: o The government’s initiative in providing the minimum

needed works which are very important for the private investors to jumpstart the implementation process to bring in private financiers. Preparatory works like the provision of feasibility study, site selection and field investigations were provided by NPC.

o The allocation of project risks and responsibilities inherent with private hydro development were assigned to the public or private entity that is best able to manage them. Market risk was NPC’s responsibility and specially in the case of acquiring right of way and factors associated with social and political issues that require government intervention should be handled by public sector.

o The experience of NPC in handling private power undertakings and NPC’s learning curve in developing hydropower projects. Prior to the tendering of these two projects, NPC has already implemented several private power undertakings under the BOT law and was able to tailor fit the requirements of hydropower development, which is completely different from thermal plants. Primarily, NPC allows the contractor to allocate the recovery of its capital by giving a premium to the energy that will be generated during peak period. This is very evident in the determination of the tariff, wherein the price of power generated during peak period is higher than the off-peak period. The capital recovery fee is based on the peak energy delivered by the power plant.

o The government support through incentives given to the hydropower developers of San Roque and Bakun to achieve optimum benefits.

oThe future arrangement of privatizing fully the hydropower development is a challenge not only to the private investors but also to the government on whether this kind of arrangement will remain viable. The objective of privatization and the EPIRA, as well, is for the country to have a continuous supply of affordable power and a balance energy mix. This will only be realized in the future if hydropower will continue its existence.

The chances of the continued development of hydropower in the Philippines will rely on the government’s effort to push for its development and extend assistance. Government assistance is an absolute necessity as it involves not pure power alone but likewise other usage of water to the best interest of the people. There are responsibilities that the government must acknowledge and be willing to address for hydropower to prosper in the future.

Table 1 Allocation of Identified Risk under the PPA

Identified Risk NPC/ Govt

Private /

Proponent

Remarks

Development Cost * * NPC prefers the feasibility study and all the pre-con activities while private proponent takes care of the development during the bidding process.

Hydrology

temporary deficits

* *

long-term deficits * **

Hydrology risks are associated with generation and have direct impact on the cash flow of the project.

flood damage (construction)

**

flood damage (permanent work)

**

Flood damages are insurable risk and can be recovered by the Proponent.

Construction Risk changes in

quantities/cost overruns

* **

unforeseen ground conditions

**

delayed completion

**

In the usual P/P NPC is prepared to take part of the risk by considering higher project cost estimate. In the long run most of the risk is being shouldered by the Proponent

Performance Risk

Equipment ** Project

Performance **

Equipment and project performance are risks associated in the operation of the plant.

Transmission **

Transmission line is always a government responsibility

Environmental Aspects

Permitting * *

Land acquisition/resettlement

**

Environmental management plan

* *

In the usual P/P both shares responsibility in the permitting as developer and proponent of the plant.


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Market

Market Risk ** Dispatch * *

In the usual P/P NPC absorbs all the risk as the proponent is guaranteed of the market. Over the off-take agreement Dispatch is a risk shared by both party.

Figure 1. New Structure of Electric Power Industry under EPIRA

LEGEND: Oversight Regulation Coordination Ownership

Policymaking Operation Supervision Competitive Regulated

Figure 2. Total Share of Hydropower in Public-Private Partnership

Hydro19%

Geothermal11%

Gas17%

Coal28%

Oil25%

Figure 3. Hydropower Potentials in Luzon

Figure 4. Hydropower Potentials in Visayas

E R C PSALM CORP

N P C

D O E

J C P C

W E S M

GENCOs

SPUG

Suppliers/ Aggregator DUs

PU EC

TRANSCO

N E A

INDUSTRY PARTICIPANTS


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Figure 5. Hydropower Potentials in Mindanao

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