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Global Issues Affecting Hydro Development: What Does the Future Hold?

By Chris Head

Future hydroelectric development is likely to be affected by three global issues: meeting a growing demand for electricity in developing countries; managing multiple uses of a finite water supply; and advancing the prospects of hydropower as a source of hydrogen.

The hydropower industry is looking healthier than it has for a long time. As a result of high oil prices in combination with concern over global warming, attention is being focused on hydropower as one of the few commercially viable, renewable energy resources that can have a significant effect on the global energy scene. Furthermore, international financing institutions are acknowledging that harnessing indigenous energy and water resources lies at the heart of the development process in many countries, and that maybe they overreacted to the anti-dams lobby in the 1990s by withdrawing support from hydro projects.

All of this is very positive, but the present situation is not without its challenges. The industry is still adjusting to the idea that hydropower is, increasingly, becoming a private sector obligation – and there is still not much enthusiasm from the private sector to take on large or risky projects. Financing remains a serious obstacle in many countries, with the fully private build-own-operate-transfer (BOOT) model proving difficult to apply to hydro. The future probably lies with public-private partnerships (PPPs) that use a mix of public and private funding. However, there is no single prescriptive solution, and each PPP has to be tailored to suit the circumstances.

Furthermore, we are still struggling to achieve a responsible balance between the world’s increasing demands for power and water, and the apparent resistance to almost any new water resources development by certain members of the non-governmental organization (NGO) community. In recent years a calmer and more rational debate has ensued, but in some countries the situation has reached the point where power planners are contemplating building thermal power stations using imported fossil fuels, because it is too difficult to get a license to develop their abundant indigenous hydro resources.

An industry in transition

Before we can speculate on the future, we need to examine where our industry has been and where it is now. Today, the power industry is in transition in many parts of the world. The idea of a publicly-owned power utility providing all the functions of generation, transmission, and distribution has, in many locations, given way to open market arrangements. Such an arrangement involves separating the three functions into independent companies that trade with each other under the vigilant eye of a regulator. This market model has given rise to the concept of an independent power producer (IPP) selling electrical power to the grid under a BOOT or build-own-operate (BOO) concession granted by the government.

The financing of these independent power stations is usually based on long-term power purchase agreements. However, in the developing world, this approach has been hampered by the fact that many utilities are not financially robust enough to be regarded as creditworthy offtakers. To overcome the problem, multilateral development banks have shifted their stance toward being “facilitators” of private financing, in addition to being direct sources of public funding. They’ve introduced a new range of financing instruments (guarantees) intended to induce the private sector to invest in areas in which it had previously feared to tread.

As a result of these structural changes, the public sector in many countries has stepped back and waited for private companies to come forward and finance the next generation of power stations. But while the BOOT/ BOO formula worked well for thermal power stations – at least until the financial crises that rocked Asia and South America in the late 1990s – it has proved to be less suitable for hydropower. Many private hydro concessions have been signed, but relatively few projects have reached fruition. And, along the way, there have been a number of expensive failures.

To compound matters, the situation was made more difficult in the 1990s when the international financing community came under sustained attack from a small but vociferous anti-dams lobby. This attack made the financing community shy away from all projects that might prove controversial, irrespective of the merits. With a few notable exceptions, most public financiers effectively embargoed dam projects for a decade, and private sector bankers mostly followed suit. In the meantime, many developing countries suffered and complained bitterly, but to no avail.

Then, in 2000, the World Bank signalled its intention to “re-engage” with the financing of water resources projects, including dams, subject to certain safeguards. This was a huge step forward. Some still will argue that the pendulum is too far in the one direction, with the minimum criteria for acceptability set so high that, at best, it seriously delays projects and, at worst, it is an effective deterrent. However, most people would agree that we are now a more responsible industry, and the important thing is that the international financing community is firmly back in the hydro business.

That, in summary, is the recent history against which we now judge the prospects for the future. The past 15 years have brought about many changes, to which the industry has responded. Now, let us look at likely drivers of change in the future.

Issue 1: Demand and resources

We should start by recognizing the new hydropower business is based on a finite resource, and that most of the undeveloped potential lies in Africa, Asia, and South America, as illustrated in Figure 1. Fortunately, this coincides with the fact that the growth in demand for electricity is highest in these areas of the world, driven by the combined influences of population growth and increased access to electricity.


Figure 1: Worldwide, the technically feasible undeveloped hydroelectric potential (red) is highest in Asia, South America, and Africa. The developed quantity of each region is shown in blue.
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Take, for example Brazil, a wakening giant of an economy which already has more than 70,000 mw of hydropower installed, and vast untapped potential. The South American country is experiencing growth in electrical demand of more than 5 percent per annum, equivalent to about 3,000 mw a year. Although electricity demand is increasing at about twice the growth rate of the economy, per-capita consumption is still only one-third of that in Western Europe. In other words, there is still room for significant growth in the system before the demand levels off as it has in more mature economies.

Much of that growth in Brazil will be supplied by water power. Brazil is one of the four “BRIC” countries (the others being Russia, India, and China) that forecasters expect to be the rising economies over the next 50 years. All four countries exhibit the same combination of rapidly growing demand for electricity and vast untapped hydro resources. India and China, the new economic superpowers of Asia (each with populations in excess of 1 billion), are both experiencing gross domestic product (GDP) growth at three times that of the developed world. Yet in per-capita terms, their income and energy consumption is very small, suggesting that they will continue to be heavily committed to harnessing their vast hydropower resources for many years to come.

Other countries with stronger economies elsewhere in Asia and South America are experiencing similar growth in demand for electricity, and most of them have hydro resources. Many also have emerging capital markets that will progressively reduce their dependency on international funds when it comes to financing future projects.

On the other hand, the poorer countries, many of them in Africa, will remain heavily dependent on hard currency financing. This situation creates a high exchange rate risk, which, ultimately, has to be borne by the consumer. Private developers also want higher returns for working in risky environments. It is a cruel irony that countries at the bottom of the economic pile often end up paying the most for their electricity. They need to develop their indigenous hydro resources to build their economies, but are too poor to finance the infrastructure to start the process. Catch 22 with a vengeance!

Issue 2: More multipurpose projects

In his book, Water: The Fate of Our Most Precious Resource, Marq de Villiers writes: “The trouble with water – and there is trouble with water – is that they’re not making any more of it.”1 As de Villiers rightly points out, the same water is constantly being recycled within our sealed biosphere, yet mankind’s dependence on it is increasing all the time. Water-stressed regions in the world are growing rapidly; many river basins are under severe pressure. These physical constraints often translate into political pressures, especially where there are different regions or nations sharing the same water resources.

In a perfect world, river basins would be developed and managed as unified entities. In reality, this seldom happens for both historic and political reasons. As the pressure on water resources grows, the only logical response is better management of the finite resource available. And this means placing more emphasis on multipurpose projects.

Apart from the necessity of optimizing the use of water resources, multipurpose projects have several advantages. They attract wider support and tend to face less opposition than single-purpose (hydropower) projects and, most important, they should be easier to finance because there is a prospect of attracting money from multiple sources based on the non-power benefits they create.

Unfortunately water resources projects tend to exhibit a gap between economic and financial viability. A multipurpose project can be economically viable when the wider benefits are weighed against the wider costs, but all too often the same project can look financially weak when viewed as a commercial proposition. The reason for this is simply that, in the past, the non-power benefits have been assumed to be free. Worst still, even the power benefits tend to have been underestimated because most market models fail to put a value on ancillary services.

In the commercially accountable and competitive environment under which hydro now operates, it is clearly illogical to expect a multipurpose project to be financed on its power benefits alone. We need to find channels through which the non-power beneficiaries can contribute their share. However, in many cases, it will not be possible to monetize the benefits. The only solution will be to subsidize the project through concessionary financing to fill the gap between economic and financial viability. This is the role of the international financing agencies, who traditionally are “the lenders of last resort.”

In the future, we can expect to see more multipurpose projects based on financing models that capture the monetary value of these wider benefits. And, whenever a prospective hydro project can be converted into a multipurpose scheme, it will increase its chances of success.

More international cooperation

History shows that hydropower projects are remarkably resilient when it comes to operating across political divides – provided it is in the interest of all parties. The Kariba Dam on the Zambezi River, which straddles the boundary between Zambia and Zimbabwe, continued to supply power to both countries from 1965 to 1979 when the border was closed and a state of open hostility existed. Further downstream, the 2,040-mw Cahora Bassa hydro project in newly independent Mozambique traded power with what was then apartheid South Africa, at least until the power line was blown up. Governments at totally opposite ends of the political spectrum of will cooperate on international river basins when it is necessary. And, in the future, it will become increasingly necessary.

In the past, the difficulty of obtaining international agreement on transboundary river basins seriously inhibited development. International financiers would not contemplate becoming involved with any project without the agreement of the riparian states. As this was often difficult to obtain, frequently nothing happened.

However, a wind of change is blowing; new moves are being made to increase international cooperation over the use of shared water resources. An example is the Nile Basin Initiative sponsored by a group of international donors led by the World Bank. This initiative is an ambitious program aimed at all of the riparian states cooperatively using the waters of the Nile to achieve economic and social development, as well as water security, over a large area of Africa. Hydropower is expected to play an important part in the program.

We shall almost certainly see more cooperative agreements of this sort in the future, and they will release for development projects that previously have been impossible to move forward.

Issue 3: the wild card: hydropower to hydrogen

When one looks far enough into the future, the wild card must surely be what is becoming known as “H-to-H” (hydropower to hydrogen). Vehicles powered by hydrogen offer the prospect of emissions-free transport, without atmospheric pollution. Buses and cars powered by hydrogen are already in service on an experimental basis, and vast sums of money have been spent on developing hydrogen fuel-cell technology. But hydrogen is not an energy source; it is only a carrier. The full benefits of the hydrogen economy will only be achieved if hydrogen can be produced from renewable sources. Most hydrogen today is made from hydrocarbons, so unless we can change this, the underlying problems of global warming and security of supply remain.

Hydropower can produce hydrogen through electrolysis, and it is better suited for this purpose than most other renewables. H-to-H looks increasingly competitive as a source of hydrogen in the face of rising oil prices. The difficulty is location. The world is full of stranded hydro assets, untapped potential at remote sites mainly in countries that cannot develop or use the resource themselves. Other countries may be prepared to pay a high price for renewable energy, but the hydrogen has to be transported and stored. The technology exists, but it needs to be scaled up, and the costs and economics will remain uncertain until more detailed studies are undertaken.

If the product of hydropower can be turned into a commodity that is internationally tradable for hard currency irrespective of where it is produced, it would mark a new era for our industry. It also could dramatically change the fortune of some of the poorer countries of the world, including those shown in Figure 2 on page 26, that happen to have hydro resources far in excess of their domestic requirements.


Figure 2: Several countries have a large technically feasible surplus of hydroelectric potential (red), which could be used to generate hydrogen. By and large, these countries are very poor. Current production in each country is shown in blue.
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A few back-of-the-envelope calculations will illustrate the point. Let’s assume that a hydro-rich country, such as one of those featured in Figure 2, develops two-thirds of its hydroelectric potential specifically for the purpose of hydrogen production and receives a royalty of, say, 15 percent of the commodity price for the electricity. Table 1 shows the positive economic effect such a royalty could have (as a percentage of the country’s GDP as well as a percentage of current exports). As shown in the table, royalties from the sale of hydroelectricity as a commodity for hydrogen production could substantially boost the economies of some of the world’s poorest countries. One may argue with the specific assumptions used in this example, but the overall message, and the potential, is very clear.

Click here to enlarge image

What other technology offers the opportunity to tackle the problemsofglobal warming, energy sustainability, atmospheric pollution, and global poverty simultaneously?

Conclusions

Financing of hydro projects will continue to be dependent on a mix of private and public money. Projects must be attractive to a wide range of affected people to get public money, and they must be financially viable to attract private money.

To encourage public support, more attention needs to be given toward demonstrating and quantifying the wider economic benefits of hydro. In addition, there has to be an increased emphasis on multipurpose and international aspects of hydroelectric developments.

Finally, using hydropower to produce hydrogen offers the prospect of being able to develop some of the world’s stranded hydro assets. It may sound far-fetched, but so did the idea of mobile telephones just 20 years ago! s

Mr. Head may be reached at Chris Head & Associates, East Weald, Ashford Road, Tenterden, Kent
TN30 6LX United Kingdom; (44) 1580-763552; E-mail: chris_head@btopenworld.com

Note

1 de Villiers, Marq, Water: The Fate of Our Most Precious Resource, McClelland & Stewart, Toronto, Ontario, Canada, 2003.

Chris Head is an independent consultant specializing in the contractual, commercial, and regulatory aspects of hydropower and water resources management.

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