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Even when countries have a wealth of untapped hydropower potential available, why can it still remain a challenge to entice financial investors to become involved? Suzanne Pritchard investigates recent developments in Pakistan and the work of the �鶹��Ƶ working group looking at finance and risks.

Spirits were high at the inauguration of the 84MW New Bong Escape hydropower project, on 15 July this year. Pakistani Prime Minister Nawaz Sharif, who was elected in May partly on promises to fix persistent power cuts in the 180-million people country, attended the ceremony in person. “We need sufficient power for our industry, schools, hospitals and other sectors” he said, adding that the project was a milestone in the country’s history and would pave the way for similar projects.

New Bong Escape is indeed a milestone: it is the first private hydroelectric power plant in Pakistan. More projects are in the pipeline, including the 147 MW Patrind project.

Waqar Ahmad Khan, CEO of the independent power producer Star Hydro Limited (SHPL), and a member of �鶹��Ƶ, discussed investment and risks at the last World Congress in Malaysia.

“As far as Pakistan is concerned it has a relatively long history in independent power projects,” Star Hydro’s CEO explained. “It also has a long history in developing hydro power projects. Even in the 1900s small hydro schemes were set up here, and when Pakistan became independent in 1947, it started working on larger projects.

"Unfortunately,” Khan adds, “from the 1980s onwards progress in the hydropower sector has been very slow, and there has been a slight shift to thermal power. But despite all the challenges and difficulties, independent power projects (IPPs) have enjoyed a relatively safe investment climate in Pakistan.”

IPPs currently provide about a third of power generation in Pakistan. This has been achieved through wide-ranging reforms of the country’s energy sector, with assistance from the Asian Development Bank (ADB) and the World Bank since the 1990s. The public sector alone could not provide the required investment to promote much needed electric power development, and so the government restructured and opened up the energy sector to attract private capital.

The need for additional power supplies in Pakistan has been described as a matter of utmost urgency. Energy deficits have been a major barrier to economic growth in the country, and such shortages have been estimated at over 4,200MW during peak demand.

Investment in new generation has fallen behind expectations, while power demands continue to rise with ever increasing occurrences of power shortages across urban centres. In addition the problem has been heightened by the country’s increasing dependency on oil imports, with its associated price escalation and volatility.

“Pakistan needs to develop projects to bridge the generation gap but at the same time thermal projects are expensive to run, and the cost of electricity is going up. So it is looking for ways to generate energy economically. It needs to diversify resources from thermal power and gas projects to hydropower,” Khan commented.

To help with this shift the government has initiated a new policy which allows a 17% rate of return on the equity that an investor will spend on a hydropower project. “This is a very, very attractive rate of return,” Khan admits. “Under the policy guidelines the government has also guaranteed concessionary arrangements and agreements.”

New investors in hydropower

With such incentives and significant hydropower potential remaining untapped in Pakistan, surely private investors are snapping up the opportunities? “There is potentially 50-70,000MW of hydro potential here. However the frustration,” Khan laments, “is that even though the investment framework is established, and tested, the challenge remains in financing these hydro projects in Pakistan.

"There are quite a few IPPs already operating in the private sector but, apart from New Bong Escape, the hydropower sector hasn’t seen any major activity in the past.” Khan hopes that the recent progress of the Patrind hydropower project will attract more investors in the country.

The 147MW run-of-river Patrind hydropower facility is to be constructed between the Kunhar and Jhelum rivers, near Muzaffarabad in Pakistan. Under a build-own-operate-transfer basis, and after completion of a four-year construction period, the project is scheduled to start producing electricity for the country’s National Grid in December 2016.

“We completed financial closure in December 2012,” he says, proudly adding, “this is currently the largest private sector financing for renewable energy in Pakistan.” Financial closure for the project was very much dependent upon Star Hydro Power raising finances amounting to US$247M from the Asian Development Bank, the International Finance Corporation (IFC - the lending arm of the World Bank), along with the Korean Investment Bank.

Due to non-payment of government subsidies, power distribution companies have been unable to fulfil obligations to generating companies, which adds a commercial risk to the whole endeavour" – Waqar Ahmed Khan, CEO, Star Hydro Limited

The Patrind project is a milestone for a consortium of companies from the Republic of Korea: it marks the country’s first investment in Pakistan’s hydropower sector. Star Hydro Project Limited is a special purpose vehicle which has been created to implement the hydro project. It comprises Korea Water Resource Corporation (K-Water) and Daewoo Engineering & Construction Company, also of Korea.

“K-Water has been working outside of Korea for the past 14 years or so,” Khan says, “but it’s not been investing in projects, only providing technical services in the hydro power and water sector. It’s a recent phenomenon since 2009 when they started to look outside and invest in countries other than Korea.”

“Pakistan was the first destination for South Korea as far as their investment was concerned,” says Waqar Ahmad Khan. “Patrind is basically the first major investment project taken outside of Korea and we’re beginning to write our own success story.”

Securing financing was not a given. Khan points to a variety of problems which have deterred private investment in the country’s much needed hydropower development. These include political instability; security fears in relation to the war on terror; plus investor reluctance to commit to large infrastructure projects with long construction periods and their inherent geological, social and environmental risks.

“Micro economic issues also mean that there is still this question of what we call circular debt,” Khan continues. “Due to non-payment of government subsidies, power distribution companies have been unable to fulfil obligations to generating companies, which adds a commercial risk to the whole endeavour. All these things have come at a time when the country needs investment in this sector but, when looking at the risks, most investors still do not find it attractive enough and are unwilling to come and invest in Pakistan.”

The role of development banks

The assistance of international investors and development banks was key. “When we presented our case to them I think we struck a chord with their mandate to help develop a country like Pakistan which needs hydropower. Our background and technical and financial strength,” Khan adds, “were perhaps the key factors which prompted these organisations to lend a sizeable sum of the project cost.”

IFC believes its involvement in the Patrind project will send a valuable and positive signal to international lenders and investors; just as Pakistan plans to add additional generating capacity on an IPP basis. ADB also considers that its financial assistance was indispensible.

The bank’s long term financing enabled the project to achieve financial closure; something which it believes would have been difficult only using commercial sources under the country’s present financial and political environment.

“ADB was instrumental in this project,” says Takeo Koike, principal investment specialist at the bank. “Our key rationale is to support the development of power in Pakistan. Power shortages are one of the biggest problems in the country and we are trying to mitigate this and help diversify power resources. Hydro is an area where Pakistan has potential and we wanted to expand our activities in this sector.

“We have been working with the Korean Investment Bank in other countries,” Koike continues to explain, “and based on our discussions with them, we started to talk about Patrind.”

It’s a dual process: we assist private sector involvement and we are also working with the government to provide a better environment for investment.” – Takeo Koike, principal investment specialist, Asian Development Bank

ADB’s justification for becoming involved in the Patrind hydropower scheme hinged on the fact that the project will expand, strengthen and stabilise the country’s energy supplies. The use of indigenous water supplies will not only produce affordable hydroelectricity and reduce reliance on expensive oil imports, it will also decrease greenhouse gas emissions.

In addition to creating job opportunities for local people during and after construction, ADB also believes its active participation in the project will reassure other sponsors and lenders.

By facilitating debt financing ADB can help co-ordinate the project financing. “What we are trying to do is fill up the funding gap in terms of volume,’ Koike said. “The banking market cannot solve all financial needs for this type of project and local banks cannot commit for such a long duration. There are international banks operating in Pakistan, but they are not participating in long-term financing either. ADB can still provide financing for this type of infrastructure investment, and based on our networks, we hope to bring in other debt financing as well.”

By acting as a catalyst for hydropower projects like Patrind, ADB believes it can inspire confidence in investors. The bank hopes that its previous experience of working in the Pakistani energy sector, as well as its role in mitigating risk, solving problems and catalysing financial resources, will help promote interest in countries such as Pakistan.

Yet, in spite of the fact that he considers the country to have a good international framework for investors, Koike admits that investor confidence is still very weak.

“We cannot resolve all the issues that Pakistan is facing,” he says, “but we are talking to the government to encourage sector reform. It’s a dual process: we assist private sector involvement and we are also working with the government to provide a better environment for investment.”

Assessing the Investment Climate for Climate Investments was the title of a recent World Bank research working paper. Published in September 2012, the study focused on clean energy investments across South Asia and stressed that supportive policies are needed to lower investment risk, and create a more favourable environment in emerging markets.

Although a number of private companies praised the efforts of the government of Pakistan in creating an attractive environment for renewable energy producers, they have called for more effective implementation of existing laws and regulations, along with greater transparency.

The report continues to identify other barriers to investment in Pakistan. There is the need to reduce administrative costs and have a speedier, less political process of obtaining project approvals. Cost-effective access to both land and equipment is also described as being critically important and can be a serious constraint to investment.

Furthermore international institutions are urged to develop a political and security risk guarantee mechanism to promote more confidence and stop driving away potential investors.