Micro Hydro ; Cost and Financial Profitability

A Micro Hydro

The Cost Per Kilowatt Installed

In the examples examined in the five countries, the capital cost of micro hydro plants, limited to shaft power, ranged from US$714 (Nepal, Zimbabwe) to US$1,233 (Mozambique). The average cost is US$965 per installed kW which is in line with the figures quoted in some studies. The installed costs for electricity generation schemes are much higher. The installed cost per kW ranged from US$1,136 (Pucará, Peru) to US$5,630 (Pedro Ruiz, Peru) with an average installed cost of US$3,085. The data for the complete sample and detailed summary of the financial analyses of the 16 sample projects is provided in the annex to this report.

An important observation is that the cost per installed kilowatt is higher than the figures usually cited in the literature. This is partly due to the difficulty analysts have in establishing full costs on a genuinely comparative basis. A significant part of micro hydro costs can be met with difficult to value labour provided by the local community as ‘sweat equity’. Meaningful dollar values for local costs are difficult to establish when they are inflating and rapidly depreciating relative to hard currencies. In addition, there is little consistency in the definition of boundaries of the systems being compared, for instance, how much of the distribution cost, or house wiring, is included, how much of the cost of the civil works contribute to water management and irrigation, and so forth. In this study very great care was taken to produce estimates of the actual costs on a rigorously comparable basis. It is for example of paramount importance to distinguish between schemes limited to mechanical power only and schemes which include electricity generation. 

As with any de-centralised energy supply system, the comparison of actual costs at the ‘micro’ level of individual plants can also be misleading. Successful programmes require investments in the systems necessary for training, repair, and marketing. The critical issue is that these tasks exhibit substantial economies of scale in that the cost per micro hydro plant installed falls as the number of plants increases. Comparisons based on average costs will therefore be strongly influenced by the number of plants built.

Estimates of these ‘macro’ costs associated with developing and supporting a programme – sometimes referred to as “system overhead costs” are also difficult to establish, particularly as many of the costs associated with Research and Development and the training of engineering workshops are ‘sunk costs’ which took place over many years.

Cost per KW including transmission

Wide Variation in Costs

The variations in capital costs have a number of explanations. While common-sense suggests that micro hydro is likely to experience some economies of scale in the size of each plant, this cannot be concluded from this particular sample. The main explanation appears to lie in the wo types of project, namely: schemes designed to provide mechanical power for productive activities such as agro-processing; and schemes for which the bulk of the production is to supply electricity for domestic end-uses and services. The investment cost for mechanical power is relatively low (US$714 to US$1,233), as there are no transmission lines, connections, or generator. The lowest cost per kilowatt installed were found in Gorkhe, originally built to supply mechanical power, Svinurai, Chifotu and Elias which supply mechanical power only.

Electricity generation schemes, as expected have a higher installed cost per kW. there are also some differences between countries and even within the same country which might be explained by the following parameters:

• Site characteristics;Transport to site (in Nepal transport is said to constitute 25% of total costs16)
• The labour content, and the wide variation between the cost of labour in the countries studied
• Standards
• Sizing (municipal plants in Peru were often over sized); and
• Transmission and distribution costs.

A major conclusion can be drawn from this: Costs are highly site specific, are controllable with good management, proper sizing and appropriate standards. Two other issues emerge from this analysis of costs. In addition to the costs identified here for supplying energy, all systems also require substantial investment in end-use technologies to make the supplied energy useful. Furthermore, a major advantage of micro hydro is that it can be built locally at considerably less cost than it can be imported18, and the costs of local manufacture can be reduced still further by developing local engineering capabilities and advisory services. For instance in Sri Lanka imported turbine generating sets up to 100 kW cost approximately Rs.50,000 to Rs.150,000 (US$700-US$2,000) per kW, while the local manufacturers are now capable of delivering them at Rs.10,000 to Rs.15,000 (US$140-US$200) per kW, with marginally reduced turbine efficiencies.

How Do the Costs of Hydro Compare with Other Options?

The picture seems quite favourable to micro hydro. When bringing improved energy services to poor people is the priority, the focus moves to the type of energy services they require and their locations. If minimum lighting is the only energy end-use required in remote locations, photovoltaics may be the main alternative, being cheaper than dry cell batteries, and capable of producing a better light than kerosene. Where falling water is available, micro hydro compares well with photovoltaics. In Peru the cost of 50-Watt systems (modules, regulator, battery, 3 lamps, other components and installation) is said to be $1,02020. In South Africa it is currently suggested that the unsubsidised delivered cost of Solar Home systems is approximately US$625 for a 50 Watt system (including battery, controller, wiring and 4 lights), giving a US$10/month break even cost using money at 14% real. This is equivalent to about $12,500 per kW and would therefore appear to be much more expensive than the cost of the most expensive electricity from micro hydro. Fossil fuels (particularly kerosene) will remain the main alternative to biomass fuel for poor people, as it can be purchased in the tiny quantities and for the small sums of money that are most consistent with poor people’s cash availability. Micro hydro, like many other decentralised renewable energy options, are characterised by high initial capital costs (certainly higher than diesel systems) which are offset to some extent by relative low recurrent costs. This means that ‘entry costs’ are likely to be beyond the reach of poor people, even if the lifetime costs of these options is lowest.
Diesel is the real bench-mark against which micro hydro has to be judged. One of the outstanding features of micro hydro is that under the right conditions it can provide the power (both electric and shaft power) to secure livelihoods through the use of electric motors and other equipment for production. Here the picture is mixed. A comparison with diesel generator sets carried out in Peru shows that micro hydro was the least cost option at the sample sites. It is even more beneficial if the impact on the environment over the lifetime of the project is included. However, the results depend on the cost of transporting the fuel and the cost of capital. A study conducted in Nepal by New Era revealed that five out of the 25 micro hydro plants were not economically viable because diesel generating sets were operating in the vicinity.
In Sri Lanka the cost of diesel generation is estimated to be about US$1,000 per kilowatt installed .However, the lack of trained technicians to provide regular maintenance is currently a major obstacle to their further penetration into the rural environment. Even so, some several thousands electric generators of less than 75 kVA were imported into Sri Lanka in 1996 at a cost of over $10 million. In practice the crucial factor is likely to be the availability and cost of transporting the fuel, and the extent to which the price of diesel (and the system on which it is transported) is subsidised.

Micro Hydro can be Financially Profitable
The profitability of the sample projects was measured using both an internal rate of return (IRR) and a return on capital invested. The consulting firm, London Economics (LE), was contracted to design a simple spreadsheet model to generate and test the profitability of the schemes and to assess the quality of the resulting data.

• Two types of IRR were calculated:In the first calculation all the income is taken into consideration (grants, subsidies etc.). This is the real return of the investment made by the owner. But with this method, schemes that were able to attract a high level of subsidy or grant will have a very high return. When a loan is taken up, the repayment is made according to the agreement with the financial intermediary, usually a bank.
• In the second case, it has been assumed that grants and subsidies are covered by soft loans. This indicator shows what the IRR would be in the case where subsidies and grants are in effect replaced by soft financing facilities.

The two indicators are important because they reflect prevailing and future situations.All IRR were calculated after financing. When a scheme was almost entirely financed by grants and subsidies, it has been assumed that the scheme was financed by a soft loan, at rates which vary between the countries in which the plant is located. The IRR were calculated in current and constant US dollars. Assumptions were made about what the inflation rate would be for the lifetime of those schemes that were implemented only recently . Experience across the study countries shows a wide range of financial profitability and some interesting common features. The microanalysis reveals that there are plants that can be run profitably without subsidy. These are the projects with a constant price rate of return of more than 8%. These plants are Seetha Eliya (12.4%), Barpak (17%), Atahualpa (20.5%) Yumahual (14%) and Svinurai (20%), plus possibly the two mechanical plants in Mozambique. All these tend to be the plant installed initially or solely to produce mechanical power for a profitable end-use such as milling. Where plants are used exclusively for electric lighting, operating costs can usually be covered by electricity sales, but the capital costs will have to be subsidised by grants.
The analyses in current prices inevitably have higher IRR than those in constant prices. This is because tariff setting is often very poor and therefore the price of electricity is not being adjusted to keep pace with the rate of inflation. An important conclusion of the review is, therefore, that the financial return of many of the projects could have been improved considerably if the tariffs had been adjusted merely to keep level with inflation. This is particularly the case in Seetha Eliya in Sri Lanka and Svinurai in Zimbabwe.

 

IRR without subsidy

At a more fundamental level, variation in financial performance of the projects reviewed was due to variation in load factor. High load factors were achieved in schemes supplying mechanical power or electricity to motors rather than those installed primarily for lighting. Lighting for 4-5 hours a day can theoretically give maximum plant factors in the order of 0.15 to 0.20. This is indeed the typical plant factor for many micro hydro plants examined. In Nepal 90 % of the schemes are supplying mechanical power. These schemes have a better profitability and can be financially sustainable in remote locations.
The micro hydro industry appears, therefore, to be faced with a particularly difficult paradox. Most of the financially viable installations provide mechanical power to productive enterprises, but the main demand from consumers in a number of countries appears to be for electric lighting.
Micro hydro is therefore most likely to be profitable or at least financially self-sustaining, where there is:a high load factor (the actual consumption as a proportion of total possible generation),

• a financially sustainable end-use,
• costs are contained by good design and management, and
• effective management of the installations, including the setting and collection of tariffs that keep pace with inflation.

Cash Generating End-Uses

It is a truism to say that MHP is likely to be more financially viable if the electricity generated can be used to supply power to a profitable cash generating enterprise. The use of a single mill for a few hours per day can clearly raise plant load factors substantially. Furthermore the choice of end-uses can have a profound effect on extending the benefits of micro hydro to households that cannot be connected directly to the system, either for reasons of cost or location. Such end-uses range from street lighting, access to public television, battery charging centres, to mills and other forms of agro processing. However, the studies show that such enterprises are often difficult to develop. Combining new micro hydro installations with new income generating enterprises that have a daytime use for hydro electricity in remote locations is difficult, not least because local markets are small and isolated.
In discussions of this review in Sri Lanka, for instance, both practitioners and policy makers were united in expressing their extreme scepticism about the creation of such enterprises. They argued that:

• Attempts to create electricity using enterprises in the past have tended to increase social tensions within the village and within the management of the Electricity Consumer Societies that own the hydro plant. It is seen as offensive that the public asset of water is being used to increase the power and wealth of an individual.
• Community-owned enterprises, such as rice mills, have often been too large in relation to the local small and isolated market, too costly in relation to the capital available in the village and too difficult to manage in relation to the managerial capacities in the village. It is to assume away the problems of underdevelopment to assume that such enterprises will start up spontaneously after the arrival of electricity.
• The support for small and micro enterprises that is offered in Sri Lanka is said to be limited and could not be assumed to be available to people or groups setting up businesses to use micro hydro plants.

Mechanical energy for grain milling from a micro hydro plant

Similar problems have been experienced about community-owned enterprises in Nepal, particularly where villages contain a wide range of castes However there have been notable exceptions, particularly in Nepal and Peru were particular entrepreneurs have not only invested in micro hydro, but they have sold power to their neighbours and started up a number of businesses.

Links To The Grid

Sales to the grid represent a special case of cash generating end-uses. Sales, when power is in excess, could provide a better load and the potential for reliable cash flow. The opportunities for selling to the grid are likely to be more feasible at the ‘mini’, however, than the ‘micro’ hydro scale. In one case in Sri Lanka the high returns to one of the plants (Seetha Eliya) was a consequence of the high value imputed to the electricity from the micro hydro plant. The plant provided electricity to the Tea Estate where otherwise only expensive and unreliable power from the grid would be available. In the case of Peru (Yumahual), the high return is due to the opportunity cost from of electricity generated by a diesel generator. The cost per kWh from genset is usually quoted at around 18 US cents per kWh. Of course with such a cost it is likely that the investor would have opted for other options.
In Sri Lanka the Ceylon Electricity Board (CEB) introduced the small Power Purchase Agreements (PPAs) in 1996, and specified the prices they would pay for energy from grid connected small power producers with generation capacities of up to 10 MW. These prices are set by the CEB on the basis of their avoided costs. Consequently the prices vary according to the time of the year and the availability of water in large hydro reservoirs. These prices do not reflect the environmental costs and benefits from small hydro development. The profitability of this option clearly depends on the regulatory framework and the price that the utility is prepared to pay. In 1999 the prices offered for the dry season were 4.6 US cents per kWh and in the wet season 3.9 US cents per kWh. This would appear to be in line with the average cost of production of a properly run micro hydro plant and with a significant load factor. Proximity to the grid nonetheless poses its own problems. For many rural people the presence of grid electricity puts the purpose of a hydro plant into doubt. In Sri Lanka it is feared that where an Electricity Consumer Society (ECS) is near enough to the grid to make the necessary connections the ECS members will abandon the MH power and buy directly from the grid at a price that currently is below the cost of production. Similarly in Nepal a study carried out in 1998 found that 38% of the 60 micro hydro plants reviewed were located within 10 km of the grid (particularly in the Central Development Region) and this had an adverse effect on their business.
Uncertainty about when the grid will arrive in a village, often as a result of politicians making false promises prior to elections, considerably increases the risk of investing in a micro hydro plant. Such risks could be reduced by government or the utility developing a clear plan for grid extension, and making it publicly available. Similarly where the private sector is involved in extending central grids near to existing micro hydro plants, it will be important to have a regulatory framework that requires the grid to buy power from the hydro plant at a reasonable price, or buy the plant at its depreciated value.
In Sri Lanka it is estimated that in general micro hydro will not be financially viable if the national grid is available within 4 km to 5 km. The cost of grid extension is currently estimated at US$7,200 per km of primary distribution lines.

Making the ‘Profitable’ Social is Easier than Making the ‘Social’ Profitable!
A clear lesson that emerges from the review at this stage is that projects that start out primarily
with social objectives find it very difficult to add on profitable end-uses. Micro hydro
investments envisaged at the outset as primarily supplying power to a business venture can
more easily add on the provision of a social service such as lighting, or power for schools or
health clinics.

Best practices regarding Micro Hydro