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EVALUATION OF ECONOMIC RENT OF HYDROPOWER: A CASE OF NEPAL

Tika R. Limbu, Student Member IEEE Ram M. ShresthaSchool of Information Technology and Electrical Engineering Energy ProgramUniversity of Queensland Asian Institute of Technology, PO Box 4

St. Lucia, QLD-4072 Klong Luang, Pathumthani 12120, Thailand.Email: tlimbu@itee.uq.edu.au Email: ram@ait.ac.th

AbstractLike any other natural resources, hydro resources that are capable of generating electricity at cheaper cost giverise to economic rent. Nepal possesses huge amount of such cheaper hydro resources which is far in excess ofthe domestic demand. The existing rents levied by the governments are not found to address the potential valueof resources. In this study hydro rent is calculated for two types of hydropower projects: (i) domestic demandoriented project and (ii) large and export oriented project. In doing so, the study uses the concept of hydro rent asa measure of cost savings achievable by the use of hydro resources over the least cost alternatives. The WASP-III+ optimisation software developed by IAEA has been used to derive two least cost generation expansion plansi.e. one with and the other without the nominated hydro resource. The difference in the costs of two plans givesthe rent of the hydro resource.

Key Words

Hydropower, opportunity cost, economic rent, generation expansion plans, least cost.

1.0 INTRODUCTION

The rise in the oil price globally has increased thesignificance of other energy resources such as coalor hydropower. However, unlike the oil producingcountries that are benefited by earning higherrevenues arising from the increase in oil prices, theowner of hydro resources are not able to generatesimilar revenues out of it [1]. So, [2] argued that it

is necessary to base public water resourcesdevelopment or reallocation decisions on estimatedsynthetic market prices or shadow prices. The

principal concept underlying the estimation ofshadow prices is the amount a rational user of

publicly supplied goods would be willing to pay.

For hydro sites, the prices obtained from thedevelopers through the competitive auction would

be the proper measure of the present value of allfuture annual hydro rents [2, 3]. In fact hydro siteswould be developed to the extent that they allowthe producers of electricity to reduce costs. It is this

cost saving that represents the rent that would beattributable to a particular site if it has no otheralternative use [3]. Export price could also be ameasure for a true opportunity cost [3], [4].

When there is no competitive auction of hydroresources or component export price, an estimateof the economic rent of hydropower should bemade based on its opportunity cost and on the basisof the surplus generated by it. According to [4] in along run efficient equilibrium condition,opportunity cost of a hydropower resource would

be equal to the marginal cost of obtaining

additional electricity (for instance from new

hydropower plants, or gas power plants or importetc). This is a long run marginal cost approach andthe economic rent is determined as the residualvalue i.e. long run marginal cost of electricity lessthe cost of hydroelectricity.

[1] mentioned that ideal estimate of hydro rentshould be based on the difference in costs of the

two least cost plans i.e. with and without hydroresources. However, there are different underlyingassumptions on the opportunity cost of hydropowerand evaluation of hydro rents. The value of hydrorent depends crucially upon those assumptions suchas the construction of the alternative used to replacehydropower etc.

[3] evaluated the hydro rent by measuring the costdifference in providing the electricity from thehydro sources and from the thermal and/or nuclearsources for the case of Canadian utilities. Similarly,[1] evaluated the rent of the same hydro facilities of

those utilities by comparing the cost of all thermaloption (mix of coal fired, gas turbine and nuclear)with the cost of existing hydrothermal facilities.Besides, there are studies by [2], [5], [6] and [7] onthe valuation of hydropower. All of them haveassumed the opportunity cost of hydroelectricity to

be the cost of electricity based on the bestalternative thermal power technology.

The studies on the evaluation of hydropower rentfor the Canadian utilities vary widely in terms ofthe assumptions on the costs of alternativetechnologies to the hydro resources, which gave

rise to different values of hydro rents. Further, the

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methodologies used by these studies are notdesigned to capture the dynamic nature of the valueof the hydro resources. Rather, they are based onleast cost alternatives within a static framework.Clearly, these assumptions ultimately do not lead

to the optimal results [8].

The weakness of the approaches in [1] and [3] toevaluate the potential hydro resource rent for theexisting hydropower plant of Canada is theassumption in finding the alternative technologiesfor replacing the hydropower [9]. Differences intheir assumptions produced different results andsuch differences pose problems when the estimatesare used to assess tax policies.

Hence, it has been realised that there is a need for amore accurate and rigorous methodology that could

capture the factors affecting the value of rents aswell as the characteristics of the power system suchas demand, reliability, load pattern etc.

2.0 POWER SECTOR IN NEPALNepal has several potential hydropower sites.These hydro sites are said to have the combined

potential of generating 43,000 MW ofhydroelectricity a large part of which can be usedmainly for meeting the export demand.

However, the installed capacity of Nepal as yet isjust over 600 MW - one of the lowest in South

Asia. Only around 22% of the population haveaccess to grid electricity. As the demand of energyis rising at 10% per annum, the 10 thNational Plan(2002-2007) aims to increase the installed capacityto 842 MW by the end of the plan period serving55% of the population and raising the per capitaconsumption to 100 kWh [11].

3.0 METHODOLOGY

In this study the hydro rent is measured by thedifference in the total cost of two generationexpansion plans, a base plan (with an identifiedhydro project) and alternative plan (without a

hydro project). The difference of the two is the costsaving in the presence of low cost hydro resource,defined here as the economic surplus or theeconomic rent arising from hydro production.This methodology is also defined as a detailedmethod or system expansion method to calculateavoided cost of the system [12].

Total system cost and corresponding generationcapacity additions for the generation expansion

plan of Nepal Power System for the planninghorizon are optimised with WASP-III+ software,which uses probabilistic production cost simulation

and dynamic programming to reach the least cost

solution against the given constraints and thecharacteristics of power system using theinformation on the set of optimal plants, theirearliest available year, expected energy generation

by each category of plant in the load duration curve

and their year of selections etc.

3.1 Methodology to Calculate Hydro Rent

3.2 Total Cost Function

Objective functions of optimisation in WASP-III+,

includes the following expression:Bj= [Ijt Sjt+ Fjt+Ljt+Mjt+Ojt]Bjis the objective function of the expansion planI = Capital investment costS = Salvage value of investment costsF = Fuel cost for operationL = Fuel Inventory costsM = Non fuel operation and maintenance costO = Cost of energy not servedt = Time in years 1, 2,.TT = Length of the study period(I, S, F, L, M and O are all discounted values.)

3.3 Calculation of Hydro Rent (USc/kWh)The ratio of the present value of the system costsaved by the selected hydro project to the presentvalue of the energy contributed by the plant givesthe per unit surplus due to the project and is termedas per unit rent of the project.

Let the total cost or objective function value of thebase case plan with hydro plant, discounted to theyear 1995 (base year of study) is TC1and the totaldiscounted cost of the alternative plan (i.e., theone without the hydro plant), is TC2. Let r be thediscount rate and total energy contributed by the

hydro plant to the system in year i be Ei.

Existing andcandidate

plant data

Data of hydrowhoserent to

be studied

Optimal system planwithout Hydro plant

Optimal system planwith Hydro plant

Optimal system cost

Without Hydro plant = TC1Optimal system costwith Hydro plant = TC2

Economic Surplus = TC = (TC1-TC2)

Original systemload shape and

load forecast

Hydro rent/kWh = TC/Discounted incremental energycontribution by the Hydro plant during the planning year

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Then, the average per unit surplus generated =Present value of the cost difference of expansion

plans/ Present value of energy contributed by thehydro plant during the planning horizon.

Or; Average rent/kWh = (TC2 TC1 )/Ei/(1+r)i

= TC/Ei/(1+r)i

3.4 Input Data and Assumptions

Planning horizon of 21 years i.e., 2005 to 2025 isconsidered in the study. The base year of study

being 1995, all the input costs are 1995 based, andall costs are discounted to this year at the annualrate of 10% (which is the opportunity cost ofcapital in Nepal) in the base case [13]. The LOLPvalue of 5 days/year and minimum reserve marginof 10% is taken. No more energy purchase fromIndia after year 2005 is assumed in the base case.Cost of energy not served is assumed USc 31/kWh

[13]. Similarly, the foreign cost componentescalation is supposed to take place at the rate of2.7 % per annum and the local cost component by6% per annum [13]. The Load forecast for the

Nepal Power system used in the study is as givenin Appendix-1.

3.5 Resource Rent in the Domestic Market

The hydro project considered in the domesticmarket scenario is Upper-Arun hydro project(335 MW Run-of-River type), which is a least costcandidate in the generation expansion planinventory for domestic demand [13].

In the base case or business as usual case, allthe existing and committed hydro and thermal

plants of the inventory (Appendix-2) areconsidered available. The different cases andscenarios made are presented in the Table 1.System plans with and without Upper-Arunhydro plant are derived to meet the existing andfuture demand under a given load growth patternfor the planning horizon.

3.6 Resource Rent in the Export Market

To evaluate the hydro rent with power exportscenario, optimisations of generation expansion

plans are made with and without Kali-Gandaki-2(660 MW Storage) project.

Table: 1. Descriptions of Case Studies:

Cases Descriptions

Case-I The business as usual case where hydroand thermal candidates are considered toobtain expansions plans with and withoutUpper-Arun hydro project assuming nofuel price escalation during the planninghorizon.

Case-II An all thermal case: Candidate plants areall of thermal type except Upper Arun

hydro project and the expansions planswith and without Upper Arun are derivedassuming no fuel price escalation duringthe planning horizon.

Case-III An all thermal fuel price escalation case:

Same as Case II except that annual fuelprice rise by 10% is considered during theplanning horizon.

Case-IV A business as usual + fuel price escalationcase: Same as in Case-I and except thatfuel price escalation by 10% per annum isconsidered during the planning horizon.

Case-V A High demand case: It is same as Case-Iexcept that it includes an export demand of2000MW from year 2011.

Case-VI A power export case with all availablehydro and thermal candidate plants;expansion plans derived with and without

Kali-Gandaki-2 hydro project; and no fuelprice escalation assumed during theplanning horizon.

4.0 RESULTS AND CONCLUSIONSIn this study, hydro rent of two projects, one fordomestic market and another for the export marketare calculated separately as the opportunity costsare different in the two markets.

4.1 ResultsTable 2: Upper-Arun for Hydrothermal Cases:

S.No. Descriptions Case-I Case-IV Case-V

1 Upper Arunonline year

2015 2013 2011

2 System Costwith UpperArun=TC1(MU$)

501.86 499.60 1469.94

3 System CostwithoutUpper Arun=TC2(MUS$)

518.92 532.18 1485.18

4 Saving due

to UpperArun = TC1-TC2(MUS$)

17.06 32.58 57.79

5 IncrementalUpper Arun

Energy = EGWh (1995)

2761.18 2653.94 6290.98

6 SpecificRent of theProject

=TC/E(USc/kWh

0.62 0.89 0.92

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Table 3: Upper Arun Rent if all Thermal Cases:

S.No. Descriptions Case-II Case-III

1 Upper Arun online year 2017 2017

2 Cost with Upper Arun= TC1(MU$)

1214.08 1258.36

3 Cost without UpperArun = TC2(MU$)

1251.19 1300.97

4 Saving due to UpperArun = TC1-TC2

= TC (MU$)

37.16 42.61

5 Incremental Energy of

Upper Arun = E GWh(1995)

2023.37 2023.37

6 Specific Rent of the

Project = TC/E(USc/kWh

1.83 2.11

Table 4: Kali Gandaki 2 Rents in Export Scenario.S.No. Descriptions Case-VI

1 Kali Gandaki-2 online year 2011

2 Total System Cost with KaliGandaki-2 = TC1(MU$)

1469.94

3 Total System Cost withoutKali Gandaki 2 = TC2(MU$)

1527.73

4 Saving due to Kali Gandaki 2

= TC1-TC2= TC (MU$)

57.79

5 Incremental Energy of Kali

Gandaki 2 = E GWh (1995)

2290.98

6 Kali Gandaki-2 Hydro Rent

= TC/E (USc/kWh

0.92

4.2 ConclusionsIn Case-I the rent of the hydropower is evaluated atits opportunity of providing electricity fromoptimal mix of new hydropower or coal fired

plants or Gas turbine plants or imports. This is thecost a utility would have to incur in the absence ofUpper Arun project in the system. The value ofhydro rent in the Case-I is found to be 0.618USc/kWh, which is 22% of the cost of energygeneration from Upper-Arun project.

Similarly, in Case-IV, where the fuel price is

assumed to escalate by 10% per annum, theopportunity cost of hydropower would be higher.The rent in this Case is found to be USc 0.89/kWh.This amounts to 32% of the cost of electricitygeneration. As expected, the rent increases with thefuel price of the thermal alternatives.

In CaseV where the level of demand is higher(assuming the 2000 MW export of power to take

place from year 2011), the rent is found to be USc0.92/kWh. The result shows that the opportunitycost of project will be higher at the higher demandlevel.

In Case-II with all thermal based alternativegeneration sources, the value of hydro rent in thedomestic market assuming no escalation in fuel

price is USc 1.83/kWh, which is 66% of the perunit cost of generation of hydropower. If the pricesof fuels are assumed to escalate by 10% per annum(Case-III), the rent would go as high as USc2.11/kWh. Compared to the cost of hydro energygeneration, this value comes out to be as high as76% of the per unit cost of generation.

From the results of generation expansion planningwith and without the Kali Gandaki-2 Project in theCase-VI, the total cost saved by the project is foundto be 57.78 MU$ (1995 base) and per unit of costsaved is USc 0.92/kWh. This value is 15% of the

per unit generation cost of the Project.

0

0.2

0.4

0.6

0.8

1

USc/kWh

Base Case Fuel Price +10%

Cases

Figure: 2. Hydro Rent (Usc/kWh) for all Thermal Cases

To verify the results, another study of the hydrorent based on the revenue from export of electricity(which is also the opportunity cost of hydropowerof Nepal) was carried out (Appendix-3). Hydrorents evaluated from this method are found to besimilar.

4.3 Limitations of StudyIn the study of potential hydro resource rent above,no costs of externalities (in terms of timber, fishand recreational activity losses), implications toenvironment and nor the possible gains (in terms ofirrigation, flood control, navigation and outdoor

activities) are considered.

0

0.1

0.2

0.3

0.4

0.5

0.60.7

0.8

0.9

1

USc/kWh

Base Case Fuel Price +10% High DemandCases

Figure: 1. Hydro Rent (Usc/kWh) for Hydro Thermal Cases

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4.4 Sensitivities of Hydro Rente a ions on the

n the Case-I (Figur:3), the value of hydro rent is

he study shows that hydro rent is very sensitive to

.0 APPENDICES

recast of Nepal

MW

Ther re many underlying assumptalternative technologies of hydropower that makesthe value of economic rent different [1]. Factorslike discount rate, fuel price and demand level are

considered in the study for sensitivity analyses.Sensitivity of the rent to the discount rate isanalysed by carrying out the analysis with discountrates 8%, 10% and 12%.

IUSc 0.34/kWh at discount rate of 8%, USc0.62/kWh at 10% and USc 0.80/kWh at 12%. Theresults show that the hydro rent is very sensitive tothe discount rate.

Tthe demand. With the given demand level and set

of existing and candidate plants, large hydropowersuch as Kali Gandaki-2 project does not yield anyrent in the domestic market. However, when exportmarket is assumed available, the project wouldgenerate a rent of USc 0.61 /kWh, which is 10% ofthe unit electricity generation cost of the project.But Upper-Arun hydro project one of the optimal

plants to meet the domestic demand yields rent ofUSc 0.62 /kWh in the domestic market, which is22% of the unit generation cost of the project.

Similarly, hydro rent is found to be site specific(cost of transmission), highly sensitive to changes

in the price of fuel and the level of demand that areresponsible for the price of electricity. With theincrease in price of fuel by 10%, hydro rent wouldincreases by as high as 43%.

5

Appendix: 1. System Load Fo

Year Load Forecast GWh Load Forecast

2004 2300.0 525.1

2005 2502.2 571.3

3006 2701.9 616.9

2007 2922.1 667.1

2008 3150.0 719.2

2009 3376.8 771.0

2010 3637.4 830.5

2011 3913.7 893.5

2012 4205.4 960.1

2013 4513.7 1030.5

2014 4839.6 1104.8

2015 5184.5 1183.72016 5549.7 1267.1

2017 5936.6 1355.4

2018 6346.8 1449.0

2019 6781.9 1548.4

2020 7243.6 1653.8

S [13].

ppendix: 2.(a) Costs of Thermal Plants

e: [13], [1

ppendix:2(b) Technical details of Thermal plantsT

ource:

A

Sourc 5].

Aechnical GT

12.MS LS

Character 5 DO DOMU LT GT C

150 20C

150

MinimumOperation MW

410 10 15 10 0 78 37.5

MaximumWOperation M

12.5 20 30 20 50 120 150

Heat Ratekcal/kWh

307.5 0 5 0 5217 196 212 307 2923 2146

Domestic FuelCost(USc/106kcal)

673 673 673 642 673 673 0

Foreign FuelCost(USc/106kcal)

2769 2763 2769 1145 2769 2769 1138

Fuel Type 1 1 0 3 1 1 5

SpinningReserve

20 10 10 10 20% 15 10

Forced OutageRate

20 20 20 20 20% 20 12

ScheduledMaintenancDays

e37 40 40 40 37 40 35

Maintenanceclass size MW

12.5 20 30 20 50 20 150

Fixed O&M(USc/kWh)

2.8 5.1 6.3 5.3 2.6 3.5 0.761

VariableO&M

Wh(USc/k )

2.6 2.6 2.6 2.6 2.6 2.6 4.17

Source: [13]

ppendix: 3 Rent based on Export Revenuethe

(M )

IDC % Constr

AIn this, hydro rent is the difference betweenexport value and the cost of producing electricityfrom hydro resource. For this, average long runmarginal cost of electricity supply in the Indian gridis taken as the reference. The total long run

marginal cost of electricity supply at consumers

Plants Local Foreign PlantCostUS$

Cost(M )US$

Life uctionYears

GT12.5 6.1136.5 689.7 15 1.5

MSDO 6 11 10.05 54.25 20 0.02 2.5

LSDO 87.0 1656.0 25 11.9 3.0

MULT 6 1 10.15 209.25 20 0.02 2.5

GT50 31.75 603.25 20 6.11 1.5

C120 42.25 802.25 15 11.92 3.0

C150 358.1 888.5 25 15.63 4

Figure: 3. Sensitivity to Discount Rates

00.10.20.30.40.50.60.70.80.9

8 10 12Discount Rate %

Sc/U

kWh

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level in India is IRs 1.27/kWh for off-peak, IRs.2.01/kWh for partial peak and IRs. 3.52/kWh for

peak period [14].

Annual LRMC of capacities for generation,

eak-load

able: 5.LRMC of Peak Energy in India

e:[15]

onsidering the export revenue per kWh equal to

.0 REFERENCESenkins,

" Ministry

[2]l

[3] ges, and A. Scott,

[4] jotta,itation

-

[5] lio, "Evaluation offor a

m,"

[6] "The Economic

hn

Hopkins Press 1966.

[7]gement," George

[8]f Nepal," in

ute

[9]dro-Electriques au

[10]ns Inc., 1987.

Kathmandu,

[12]

s Experience."IEEE Transactions989.

[13]

[14]ent through

nt 226-

[15] ral

.0 BIOGRAPHIESE. (Elect.) in 1988 from

n ersity of Roorkee, India and M.Eng. (Energy

D.r

lect.) fromreceived a

transmission and distribution are IRs 3609/kW,936/kW and 835/kW respectively. The energy costis IRs 0.81/kWh for peak and IRs. 0.63/kWh foroff-peak and the discount rate of 10% with planteconomic life of 25 years are considered.Based on the above LRMC for supplying pat different level of supply in Indian system iscomputed as shown in Table 5.

T

Exchange Rate: IRs./US$ (1995) = 31.12, Sourc

Cthe LRMC of the Indian Power System at thegeneration level, hydro rent accruable from KaliGanadaki-2 at 10% discount rate would be USc0.61/kWh (cost of Kali-Gandaki-2 at the discountrate of 10% is USc/kWh = 6.138).

6[1] R. C. Zuker and G. P. Z

"Hydroelectric Rent of Canada.,of Supply and Services, Canada. 1984.R. Young and S. L. Gray, "EconomicValue of Water Concepts and EmpiricaEstimates." National Water Comission,800 North Quincy Street., Allington,Verginia 22203. 1972.J. T. Bernard, G. E. Brid"An Evaluation of the Potential CanadianHydroelectric Rents," University of

British Columbia, 1982.E. S. Amundsen and S. T"Hydroelectric Rent and PrecipVariability,"Energy Economics, pp. 8191, 1993.G. E. CastiHydroelectric Energy BenefitsPredominantly Thermal Power SysteU S Office of the Water Research andTechnology 1977.H. G. Van der Tak,Choice Between Hydroelectric andThermal Power Developements," Jo

R. K. Davis, "Pricing and Efficiency inWater Resources ManaWashington University, 1971.T. R. Limbu, "Evaluation of EconomicRent of Hydropower: A Case o

Energy Program. Bangkok: Asian Institof Technology, 1998.J. T. Bernard, "Taxation des ResourcesNaturelles et Rentas HyCanada,"L'actualite Economique, Revued'analyse Economique, vol. 66, pp. 421-443, 1990.A. Randall,Resource Economics: JohnWily and So

[11] S. Dhakal, "Whither Power Sector," inSpot Light Weekly, vol. 23.

Total LRMC/kWhSupplyLevel

Capital(IRs/kWh)

Energy(IRs/kh) (IRs) (USc)

Generation 1.289 0.81 2.099 6.75

H V Level 2.040 0.81 2.850 9.16

L V Level 2.709 0.81 3.519 11.31

2004.A. Shalaby, "Avoided Costs; Ontario

Hydro'on Power Systems, v. 4, p. 147-157, 1"A Report on System Planning Studies andInvestment Program," Nepal ElectricityAuthority, Kathmandu 1996.P. V. Srinivasan and B. S. Reddy,"Electricity Demand MangemPricing, Scopes and Options (Repri1996)." Indira Gandhi Institute ofDevelopement Research, New Delhi 1997."Fourth National Power Plan," CentElectricity Authority, New Delhi 1997.

7

Tika Ram Limbuobtained B.

ivUEconomics & Planning) in 1998 from Asian Institute ofTechnology (AIT), Bangkok. At present he is doing Ph.at ITEE in University of Queensland. He has worked ove14 years in Nepal Electricity Authority.

Ram M. Shresthareceived his B.Eng. (Eniversity of Baroda, India in 1973. He alsoU

B.L. from Tribhuvan University, Nepal in 1977. HisMaster and Ph.D. degrees are from the AIT in 1982 and1986 respectively. At present he is a Professor of EnergyEconomics at School of Environment, Resources andDevelopment of AIT. He is a member of AmericanEconomic Association, and International Association forEnergy Economics. He serves as an Associate Editor ofEnergy-The International Journal and Energy Economicsand as a member of the Editorial Advisory Board ofInternational Energy Journal. He is a Co-author of "Bio-Coal: Technology and Economics", Regional EnergyResource Information Canter, AIT, Bangkok, 1991 and"Energy Policies in Asia: A Comparative Study,McGraw-Hill, Singapore 1987. He is a recipient of theBest Paper Award from International Association forEnergy Economics in 1991.

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