Workshop on the Changing Face of Electricity Markets in the Mekong River Basin

Hosted by WWF Indochina and the Mekong River Commission Phnom Penh, Cambodia January 28-29, 2003

Session II: Implications for Hydroelectricity Development

Can large hydro survive the transition to competitive power markets? This is a fundamental question facing the global dam-building industry. Particularly given the advantages of gas-fired combined cycle plants, which can be built wherever power is needed without the cost of long distance transmission, or the extraordinary social upheaval and environmental damages that large hydro dams have brought to the Mekong region.

My starting point for this talk today is that large hydro dams are not competitive. I will review what the hydro industry and longtime dam financiers have to say about that. I’ll look at some trends in hydro and gas-fired power development in the region. I’ll go through some of the key reasons why private investors prefer gas-fired combined cycle plants to large hydro dams and why utilities and their financiers still want to build more large hydro dams even though they are neither cheap nor reliable. And finally, I’ll touch on some fundamental changes required in the way electricity investment decisions are made so that millions more people in this region can very soon begin to benefit from alternatives to large hydro dams, starting with gas-fired combined cycle plants but leading to wider applications of renewable energy technologies.

1.The Gas-Fired Threat to Large Hydro in the Mekong Region

In the Mekong region, the most commercially successful and cost-competitive alternative to large hydro dams are the high-efficiency gas turbines and combined cycle gas turbine plants (that is, one gas turbine coupled with a steam turbine) fuelled with natural gas.

International dam financiers know it, the dam building companies and utilities know it, and aid-backed hydro consultants know it, though they still promote them: large dams are last century’s technology. In August 1998, the hydro industry’s journal, International Water Power & Dam Construction, published an unusually gloomy article entitled “The gas-fired threat to SE Asian hydro power.” Reporting on an Asian Development Bank and Asian Economic Cooperation meeting, the article concluded that large hydro was looking “no more socially or environmentally viable than nuclear energy.” Citing World Bank figures, the article said that for countries like Thailand, large hydro imports were uncompetitive with gas based on price, public desirability, and because of the added economic value of using gas in on-site cogeneration plants favoured by industrial consumers. It concluded that the availability of abundant and low-cost natural gas in the Mekong region would render many large-scale hydro export projects in the planning stages “uncompetitive.”

A year later, Asian Development Bank hydro consultants, UK-based Halcrow, repeated much the same message in their assessment of Mekong hydro projects on the drawing board. Halcrow wrote that the Electricity Generating Authority of Thailand (EGAT) considers combined cycle gas turbine plants – with their high operating efficiency and relatively low operating costs – “to be the most competitive option for Thailand at the present time.” Halcrow explains in more detail: “considering both fixed and variable costs, CCGT [combined cycle gas turbine] plant offers the lowest-cost long-term alternative to imports for supply at intermediate and high load factors, [simple cycle] gas turbines might be more competitive for low-load factors. And still more explanation: “the most likely alternative to additional hydroelectric capacity is some combination of peaking and load-following plant . . . a 75:25 mix of CCGT and GT plant would perform satisfactorily over a wide range of operating load factors while offering considerable flexibility in dispatch.”

While that 1999 study acknowledged the advantages of combined cycle plants for meeting future demand, the fact is that EGAT has already been successful in employing combined cycle technology to meet its double-digit growth in electricity demand through the 1980s and early 1990s. Development of offshore gas fields in the Gulf of Thailand in the 1980s led to rapid expansion of gas-fired combined cycle plants. Of Thailand’s total installed generating capacity, which is roughly three times that of Vietnam and serves almost 100 percent of the population, about 70 percent comes from gas-fired combined cycle plants, both large-scale (700-MW range) and small-scale (50-200 MW).

The last hydro dam built by EGAT, and financed by the World Bank, was the much-protested Pak Mun dam in 1994. The Bank declined financing for Vietnam’s Dai Ninh dam in 1998, reportedly over concerns about resettlement and the dam’s environmental impacts. Similarly, the Asian Development Bank withdrew from financing Vietnam’s Se San 3 dam project in 2000, reportedly over Electricity of Vietnam’s mishandling of downstream environmental and public safety concerns (a project that Canadian utility Hydro-Quebec had once expressed interest in building in partnership with Electricity of Vietnam). The only major hydro project in the region completed with ADB financing in the last decade was the US$280 million 210-MW Theun Hinboun project in Lao PDR in 1996. Theun-Hinboun was developed by Nordic hydro companies, and with Nordic aid, as a less damaging and less costly alternative to the larger Nam Theun 2 dam proposed further upstream.

In Vietnam, state owned Electricity of Vietnam Corporation is investing heavily in new hydro projects in the central highlands, even though the central government’s 2001 master plan aims to reduce the country’s dependence on large hydro and move to a fossil fuel-dominant power system over the next decade.

Vietnam gets about half its power supply from large hydro dams, which means that power consumers suffer frequent drought-induced blackouts and power shortages especially during the dry season. In drier years, some reservoirs produce almost no power at all. In 1998, for example, Vietnam’s largest hydro plant, the 1920-MW Hoa Binh, was producing just 10 percent of its capacity.

But now that natural gas is becoming available, many energy experts predict a boom in combined cycle plant investment will follow and say that southern Vietnam’s electricity needs could be met now with existing supplies.

The first onshore delivery of natural gas came to Vietnam in 1995 and a second pipeline is expected to start delivering gas in 2003. Unocal also plans to bring gas onshore to Vietnam from the Gulf of Thailand by 2005 while PetroVietnam claims to be finding new commercially viable gas fields every year.

In the Mekong delta, the World Bank, the Asian Development Bank, and the Japanese government are backing the multi-billion-dollar Phu My industrial complex, which includes a string of 700-MW combined cycle plants. The plants will be fuelled with natural gas from a field jointly developed by PetroVietnam and Petronas from Malaysia, and delivered through a 300-kilometre pipeline financed by the Japanese government.

Vietnam also has enormous untapped potential for smaller scale combined cycle plants to serve its large industrial consumers that require large amounts of heat and power (i.e., electronics manufacturers, pharmaceutical companies, agricultural processing industries, etc.).

2.Large Hydro Is Uncompetitive

Given these trends in the region, what is now apparent to the hydro industry and longtime financiers, the World Bank and the ADB, is that large hydro cannot compete, at least not without special subsidies and powers conferred upon dam builders to externalize certain costs and, most critically, to override the rights of citizens to decide whether they want their rivers dammed for power production, and what, if any, costs are acceptable to them.

Without subsidies and special powers, commercial investors won’t put their money into large hydro dams in the region. ADB hydro consultants, Norconsult, noted in their 1995 ‘subregional energy study,’ that private investors would need to sell their hydro dam output for between 6 and 8 US cents per kilowatt-hour in order to generate a commercially acceptable rate of return. But what they are more likely to get from prospective buyers, such as EGAT, is about 4 US cents per kilowatt-hour since this is roughly equivalent to the avoided cost for a new combined cycle plant for EGAT or Electricity of Vietnam. At that price, dam builders will need public subsidies to defray their costs, if they want to attract private investors and appear to ‘compete’ with gas-fired power producers.

The Mekong River Commission recognized this in its 2001 hydro development strategy prepared by the Mekong Secretariat in Phnom Penh. It noted the context for hydropower planning in the region today had changed due to “the cost-competitiveness of combined cycle alternatives where relatively inexpensive natural gas is available.” It noted “new challenges in hydropower financing with less available public funding and hesitation by the private sector.”

3.Private Investors Prefer Less Risky Options

For private investors, investing in combined cycle plants rather than large hydro dams makes far more economic sense.

Less Capital Cost

Combined cycle plants can be built for one-third to one-half the capital cost of a large hydro dam. For example, Electricity of Vietnam spent about US$1 billion building the 720-MW Yali Falls dam; a consortium led by Electricite de France (EdF) is hoping to raise US$1.1 billion for a 1070-MW hydro dam in Lao PDR. Meanwhile, EdF financed and built the 715-MW Phu My 2.2 gas plant for under US$480 million.

Shorter Lead Times

It took EVN eight years to build Yali while a typical 700-MW combined cycle plant can be installed and running in under two years. Plants can also be built in 50-100 MW units, adding on to better match demand growth using smaller add-on units as needed thereby reducing the risk of over-investment.

Less Financial Risk/Uncertainty

Dams are notoriously prone to cost overruns. Because they take longer to build, they are susceptible to changes in interest rates and the cost of capital while under construction; they are vulnerable to geological uncertainties, and delays and cost increases related to environmental reviews, resettlement problems, and court challenges.

Greater Reliability

Gas-fired combined cycle plants can be operated to more than 90 percent reliability year-round with reliability guaranteed by the equipment suppliers in a longterm service contract with the project owners/operators. Large hydro in the tropics tends to be over-designed and operate at full capacity for only a few months of the year. Because dams cannot guarantee reliability to the same high level as combined cycle plants, the value of the electricity from dams is worth less to the purchaser, which means the price is often set below actual cost.

4. Why Do Mekong Utilities and Donor Agencies Still Promote Large Hydro As Cheap?

Large hydro dams are still favoured by state owned utilities because of the way they have traditionally been allowed to manage the capital and operating costs of their projects.

Capital Costs Not Reflected in Price

Traditionally, state utilities, such as EVN, have not carried dam construction capital or interest costs of borrowing on their books, and the price of electricity is set too low to recover those costs. EVN’s Hoa Binh dam cost US$2 billion to build but EVN carries only about $100 million on its books. In Lao PDR, much of the capital cost, as well as maintenance and refurbishment for the largest and oldest hydro dam, Nam Ngum, was financed by Japan.

Water is Considered a ‘Free’ Fuel

Water –the fuel that is used to drive the turbines –has traditionally been considered free and unlimited by utilities in this region. Competing uses and the rights of competing users are not recognized.

With no capital costs on their books, and no fuel costs, utilities like EVN calculated their operating costs for hydro as less than one cent per kilowatt-hour. Compare that to the 4 to 5 cents EVN now has to pay thermal suppliers, and hydro looks like a very good deal from the point of view of the utility.

Value of Hydropower Inflated

International hydro consultants and utilities in the region have wrongly assumed the value of the power produced from a dam is simply the maximum available tariff times the average output. But this defies international standards for deciding the value of a power plant  its value in terms of its profitability and its efficiency. The real value of power from a power plant is determined using the concept of firm power and the actual output a dam can reliably produce every year over a number of years.

Firm Power is the amount of power that can be made available at any one particular time during the year, immediately upon demand, and with very high reliability. Hydro dams in the tropics typically have very low firm power capacity. EGAT for example defines firm power at its dams as the lowest month’s production over a ten-year span.

Cost of Backup Power Excluded

With a hydro-dominant power system as in Vietnam, it becomes very expensive to have sufficient firm power to meet demand, according to power economists at Harvard University. This is because of the length of the dry season and the need to install backup generators to produce electricity when it is needed. Backup usually means diesel-fired generators, which can cost 10 to 15 US cents per kilowatt-hour to run.

So, for example, if EVN wanted to guarantee 1350 MW of firm power, it would need to build a 1900-MW hydro dam and then install 780 MW of backup generation to operate during the dry season. Or it could build a 4500-MW dam  almost the capacity of one of the dams EGAT wants to build on the Salween River  in order to get a firm capacity of 1350-MW year round.

In effect, building large hydro is a costly and inefficient strategy for expanding power supply because it means excess and underused capacity for several months of the year. This increases the cost of the overall system as backup plants sit idle (and not recovering capital) when hydro dams are working in the wet season.

Environmental and Social Costs Externalized

Studies prepared for the World Bank- and hydro industry-sponsored World Commission on Dams found that dam builders have routinely underestimated and externalized social and environmental costs. Both the World Bank and the ADB have criticized utilities for this practice yet it continues to be the norm, particularly in Vietnam, and despite growing demands from citizens that dam builders take full responsibility for the costs and liabilities of their projects.

5.How Does Power Planning and Investment Decision Making Need to Change?

For large hydro projects in the Mekong region to be considered attractive to investors, a fair deal for power consumers, and acceptable to riparian communities, the old utility practice of hiding costs and risks associated with large hydro, and appealing for public subsidies to make large dams appear economically viable, must end.

As the Mekong River Commission 2001 strategy paper states: “Hydropower should be developed in the context of a true least-cost expansion of power, where the full range of options and their associated costs, direct and indirect, are taken into account and assessed on a level basis.”

To do this, however, requires structural reform of the power industry in each Mekong country. For the purpose of discussion, I have outlined a few fundamental changes that should occur to improve the quality of hydro projects proposed and the quality of power generation investment decision making in general:

Introduce competitive procurement and legally binding licensing procedures for power producers. This means introducing open and competitive bidding for potential power suppliers, combined with rigorous public review procedures to ensure public acceptability and affordability. Potential suppliers would be legally obliged to declare all costs and risks honestly and accurately, prior to securing financing, and with full liability for any hidden or unforeseen costs and risks. To do this, governments must be persuaded that transparency would lead to better investment decisions, would prevent hidden costs and surprises, and would encourage much-needed investment in the region.

End government guarantees for power investors and producers. The financial risk and burden of uncertainty in electricity demand, costs, and fuel prices should be placed on power plant investors and their customers, not on government and taxpayers. This shift would encourage investment in smaller-scale, less-risky power plants that do not require government guarantees, and do not impose huge financial burdens on governments when demand growth is slower than projected.

Depoliticize the industry. To protect citizens and consumers from monopoly abuse and political power deals, governments need to have an electricity regulatory body at arms length from power producers, accountable to parliaments/national assemblies but with the authority to enforce rules and standards. Governments in the region are perversely preoccupied with accommodating the needs of foreign investors or confusing the electricity industry with an employment or social development agency that can be used to create jobs or direct investment into under-developed regions  when the real objective of the government should be to set clear rules that balance the interests of consumers and investors, with those of society at large. The economic regulator of the industry should ensure that prices charged by generators are fair/reflect true costs and risks; ensure that consumers have some way to provide feedback about service and standards, and have recourse when needed. The environmental regulator of the industry should ensure that power producers meet the highest environmental standards and respect citizens’ property rights. Building this regulatory capacity in the region is arguably one of the most neglected and least understood areas of power sector reform and yet critical to setting the industry on a firm setting for a sustainable electricity future.

Large hydro subsidies must end. International financiers, such as the World Bank and the Asian Development Bank, should stop subsidizing hydro development and encourage open and fair competition among suppliers. If these agencies must have a role, it would be to assist governments in setting the new rules and legal framework for a publicly regulated and competitive power supply market, without interfering in investment decisions. Thank you and I look forward to your comments and questions. References are available upon request from the author at grainneryder@nextcity.com

Grainne Ryder, Policy Director, Probe International
Toronto, Canada
https://journal.probeinternational.org/