Dams Financing

118
Thematic Review Economic and Financial Issues III.2 Trends in the Financing of Water and Energy Resources Projects Final Version: January 2001 Prepared for the World Commission on Dams (WCD) by: Per Ljung With inputs from Chris Head and Hilary Sunman Secretariat of the World Commission on Dams P.O. Box 16002, Vlaeberg, Cape Town 8018, South Africa Phone: 27 21 426 4000 Fax: 27 21 426 0036. Website: http://www.dams.org E-mail: [email protected]

Transcript of Dams Financing

Thematic Review Economic and Financial Issues III.2

Trends in the Financing of Water and Energy Resources

Projects

Final Version: January 2001

Prepared for the World Commission on Dams (WCD) by:

Per Ljung

With inputs from Chris Head and Hilary Sunman

Secretariat of the World Commission on Dams P.O. Box 16002, Vlaeberg, Cape Town 8018, South Africa

Phone: 27 21 426 4000 Fax: 27 21 426 0036. Website: http://www.dams.org E-mail: [email protected]

Trends in the Financing of Water and Energy Resource Projects ii

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Disclaimer This is a working paper of the World Commission on Dams - the report published herein was prepared for the Commission as part of its information gathering activity. The views, conclusions, and recommendations are not intended to represent the views of the Commission. The Commission's views, conclusions, and recommendations will be set forth in the Commission's own report. Please cite this report as follows: Ljung, P., Head, C., Sunman, H. Trends in the Financing of Water and Energy Resources Projects, Thematic Review III.2 prepared as an input to the World Commission on Dams, Cape Town, www.dams.org. The WCD Knowledge Base This report is one component of the World Commission on Dams knowledge base from which the WCD drew to finalize its report �Dams and Development-A New Framework for Decision Making�. The knowledge base consists of seven case studies, two country studies, one briefing paper, seventeen thematic reviews of five sectors, a cross check survey of 125 dams, four regional consultations and nearly 1000 topic-related submissions. All the reports listed below, are available on CD-ROM or can be downloaded from www.dams.org Case Studies (Focal Dams) • Grand Coulee Dam, Columbia River Basin, USA • Tarbela Dam, Indus River Basin, Pakistan • Aslantas Dam, Ceyhan River Basin, Turkey • Kariba Dam, Zambezi River, Zambia/Zimbabwe • Tucurui Dam, Tocantins River, Brazil • Pak Mun Dam, Mun-Mekong River Basin,

Thailand • Glomma and Laagen Basin, Norway • Pilot Study of the Gariep and Van der Kloof

dams- Orange River South Africa

Country Studies • India • China

Briefing Paper • Russia and NIS

countries

Thematic Reviews • TR I.1: Social Impact of Large Dams: Equity and

Distributional Issues • TR I.2: Dams, Indigenous People and Vulnerable

Ethnic Minorities • TR I.3: Displacement, Resettlement,

Rehabilitation, Reparation and Development

• • TR II.1: Dams, Ecosystem Functions and

Environmental Restoration • TRII.1: Dams, Ecosystem Functions and

Environmental Restoration • TR II.2: Dams and Global Change • TR III.1: Economic, Financial and Distributional

Analysis • TR III.2: International Trends in Project Financing

• TR IV.1: Electricity Supply and Demand Management Options

• TR IV.2: Irrigation Options • TR IV.3: Water Supply Options • TR IV.4: Flood Control and Management Options • TR IV.5: Operation, Monitoring and

Decommissioning of Dams • • TR V.1: Planning Approaches • TR V.2: Environmental and Social Assessment for

Large Dams • TR V.3: River Basins � Institutional Frameworks

and Management Options • TR V.4: Regulation, Compliance and

Implementation • TR V.5: Participation, Negotiation and Conflict

Management: Large Dam Projects

• Regional Consultations � Hanoi, Colombo, Sao Paulo and Cairo • Cross-check Survey of 125 dams

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects iii

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Acknowledgements This paper is one of 17 thematic papers being prepared as input into the WCD process. Per Ljung was the lead writer. Chris Head contributed most of Chapter 5 and Hilary Sunman most of Chapter 3. Manrique Rojas, Bruce Aylward and Sarah Porter contributed by collecting and analysing data on financing trends for the paper. Lily Donge and Chaminda Rajapakse also contributed to data collection and analysis. A number of individuals and organisations responded to the Commission�s invitation to provide views and insights on this topic from a stakeholder perspective. A list of these submissions is provided in Appendix 2. John Besant-Jones and Donal O�Leary provided valuable comments on a �work in progress� draft that was placed on the WCD website prior to the April 2000 WCD Forum meeting. A number of constructive comments on the formal review draft (placed on the WCD website on May 24, 2000) were received from the following members of the review panel: John Besant-Jones Bob Crick Janak Karmacharaya Ruth Meinzen-Dick Peter Bosshard Shripad Dharmadhikary Steve Rothert The lead writer has endeavoured to respond to all comments received by the closing date and takes responsibility for any remaining errors or omissions. The WCD Secretariat has reproduced the full text of the review panel comments in Appendix 3 in order to ensure that all views are available to stakeholders in the debate and that the process is fully transparent.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects iv

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Financial and in-kind Contributors: Financial and in-kind support for the WCD process was received from 54 contributors including governments, international agencies, the private sector, NGOs and various foundations. According to the mandate of the Commission, all funds received were �untied�-i.e. these funds were provided with no conditions attached to them.

• ABB

• ADB - Asian Development Bank

• AID - Assistance for India's Development

• Atlas Copco

• Australia - AusAID

• Berne Declaration

• British Dam Society

• Canada - CIDA

• Carnegie Foundation

• Coyne et Bellier

• C.S. Mott Foundation

• Denmark - Ministry of Foreign Affairs

• EDF - Electricité de France

• Engevix

• ENRON International

• Finland - Ministry of Foreign Affairs

• Germany - BMZ: Federal Ministry for Economic

Co-operation

• Goldman Environmental Foundation

• GTZ - Deutsche Geschellschaft für Technische

Zusammenarbeit

• Halcrow Water

• Harza Engineering

• Hydro Quebec

• Novib

• David and Lucille Packard Foundation

• Paul Rizzo and Associates

• People's Republic of China

• Rockefeller Brothers Foundation

• Skanska

• SNC Lavalin

• South Africa - Ministry of Water Affairs and

Forestry

• Statkraft

• Sweden - Sida

• IADB - Inter-American Development Bank

• Ireland - Ministry of Foreign Affairs

• IUCN - The World Conservation Union

• Japan - Ministry of Foreign Affairs

• KfW - Kredietanstalt für Wiederaufbau

• Lahmeyer International

• Lotek Engineering

• Manitoba Hydro

• National Wildlife Federation, USA

• Norplan

• Norway - Ministry of Foreign Affairs

• Switzerland - SDC

• The Netherlands - Ministry of Foreign Affairs

• The World Bank

• Tractebel Engineering

• United Kingdom - DFID

• UNEP - United Nations Environment

Programme

• United Nations Foundation

• USA Bureau of Reclamation

• Voith Siemens

• Worley International

• WWF International

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects v

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Executive Summary The Setting During the 1990s, dramatic changes occurred in the manner infrastructure facilities in the developing world1 are financed, built and operated. Strapped for financial resources and realizing that infrastructure bottlenecks hampered economic growth, governments started to change their roles from service providers to regulators and facilitators of private investments. Thus, there is now a global trend towards liberalization and greater reliance on market forces and competition as a way of improving the quality of infrastructure services while lowering the cost to the consumers. New entrants are being allowed in areas previously reserved for the public sector. The monolithic state owned utilities are being �unbundled� and privatised. Companies from both industrialised and developing countries have responded rapidly to the new opportunities and have invested heavily in both greenfield projects and in buying and improving privatised utilities. Commercial lenders have adapted the �project finance� model previously reserved for foreign exchange earning mining and hydrocarbon projects to fit projects getting their revenues in local currencies. Private investments in infrastructure projects increased eight-fold from 1990 to reach $120 billion in 1997. For the decade as a whole, private infrastructure investments in developing countries were close to $600 billion. Purpose of the Review Paper Very little of this money was devoted to the construction of dams. Indeed, while infrastructure investments in developing countries expanded rapidly during the 1990s, it appears that fewer dams are being constructed now than in the 1980s. To explain these contradictory trends, this thematic review paper seeks to:

• Describe recent international trends in financing for water and energy resources projects, focusing on dams and the associated non-dam options.

• Highlight the main features of the project financing approaches and models that are emerging in different regions and settings.

• Review the key implications relevant to the mandate of the World Commission on Dams (WCD). A basic premise of the report is that all infrastructure projects�whether public or private�should be economically viable and social and environmental impacts should to the extent possible be avoided, minimised and mitigated. Investments in Dams and Public Sector Financing During the 1990s, annual investments in large dams in developing countries were in the order of $22-31 billion, or slightly less than half of the total investments in water related infrastructure.2 Some $12-18 billion were devoted to the construction of hydropower plants, $8-11 billion to irrigation reservoirs and a couple of billion dollars to water supply and flood control dams. Industrialized countries appears to have invested $7-10 billion in hydropower and $3-5 billion in dams built for other purposes. Total annual investment in large dams in the 1990s was therefore on the order of $32-46 billion. Considering the rise and fall of the pace of dam-building over the last half-century, an estimate of total expenditure during this period on large dams is $2 trillion. The multilateral and bilateral development agencies have traditionally been a major source of financing for large dam projects in developing countries. Over the last decade, however, overall aid flows have declined in real terms and most donors have expanded the share of their assistance devoted to social sectors and quick disbursing non-project lending. Greater awareness of the social and

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects vi

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

environmental consequences of large dams has made most donors reluctant to finance projects that involve dam construction and resettlement. The Asian Development Bank, for example, has not financed an irrigation reservoir since 1989. Its lending for power paints an equally striking picture. In the 1970s, 28% of its power sector lending was for the construction of hydropower plants. In the 1990s, this share had fallen to less than 8%. Although the decline in lending for dam projects by the World Bank and the other regional development banks has been somewhat less drastic, the basic picture is similar. There are a number of reasons why this decline has occurred:

• Environmental and social (�safeguard�) policies have become more explicit and comprehensive.

• Internal review processes have been strengthened (the World Bank, for example, has appointed an external Inspection Panel which can review the compliance by staff and managers with the Bank�s policies and procedures).

• Lending policies, especially in the power sector, seek to promote reform and encourage governments to bring in the private sector.

• Greater emphasis is being placed on sound macro-economic policies and reduction in poorly targeted subsidies (for example, the large subsidies typically associated with public sector canal irrigation schemes).

• Country strategies focus more on poverty alleviation and environmentally sustainable development, which has increased the emphasis on energy efficiency, renewable energy sources as well as involvement of the beneficiaries in small scale infrastructure projects such as rural water supply and irrigation management.

At present, the donor community appears to be providing only around $2.5 billion a year (on average) for dam related projects (i.e. about 8% of total dam finance). This compares with peak levels of financial assistance that reached over $4 billion (in 1998 prices) during the late 1970s and early 1980s. Export credit agencies (ECAs) in aggregate provide greater amounts of funding for developing countries than the World Bank and the regional development banks together. Although some of the ECAs can provide financing for local costs, the bulk of their loans and guarantees support exports of goods and equipment. The amount of imported equipment installed in irrigation and water supply dams is minor. In most developing countries, however, imported generating equipment amounts to around 30% of the total investment cost in hydropower.3 Based on fragmented data from a few agencies and considering the needs of imported equipment, it can safely be assumed that the ECAs annually provide less than $1.5 billion for various types of dams in developing countries. State-owned utilities, government departments and agencies provide more than four-fifths of the needed funds. However, all indications are that, in real terms, the amount provided by public agencies has declined since the 1980s. There are several reasons for this trend:

• Macro-economic stability and reducing budget deficits have become key concerns for public policy makers. At the same time, greater emphasis is being placed on social sector expenditures, especially for health, nutrition and education. This means that less funding is available for infrastructure investments.

• Since the 1970s, the financial performance of many power utilities has declined and their ability to finance investments utilising their own resources has correspondingly declined. Although this trend is being reversed, self-financing is still difficult and, for the reasons given above, governments are no longer able to provide as large contributions to investments. Since the cost of thermal generation has declined more rapidly than the cost of hydropower development, there has also been a shift in the investment programs towards thermal generation.

• Cost recovery has always been a major issue in surface irrigation schemes. Typically, water charges cover little more than the O&M cost of the schemes (reportedly, there are cases where the

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects vii

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

charges are even less than the cost of collection). Thus, financing for irrigation dams and related canal infrastructure has traditionally been provided by the treasuries who nowadays have less ability to do so. Furthermore, there is widespread disillusionment with the performance of canal schemes�in terms of efficiency of water use, water logging and salinity, and the high cost per beneficiary. As a result, greater emphasis is placed on groundwater development and improving the performance of existing schemes.

• Tariffs for urban water supply and sewerage schemes typically cover only one-third of the cost of providing the services. Governments find it increasingly difficult to provide the resources that are needed to keep up with a rapid pace of urbanisation.

Faced with these financial constraints, governments have turned to the private sector to get help in improving the performance of the previously state-owned utilities and in mobilising the needed financing for both dams and non-dam options. Nature and Implications of Infrastructure Reforms In the power sector the reform process involves a number of elements: corporatisation of the utility, reform of the legal framework, establishing a regulatory authority, encouraging independent power producers (IPPs), �un-bundling� the main utility and selling off its generation and distribution assets. The pace and sequencing of reforms varies significantly with Latin America having advanced the furthest. Most countries are moving towards the following structure: a number of mostly privately owned generating companies that compete based on price; a private or state-owned national grid company responsible for high voltage transmission; a number of privately owned regional distribution companies that operate as regulated local monopolies; and a regulatory authority. Especially in Asia, the first entry of the private sector has been through IPPs that are special purpose companies established to build, own and operate power plants. Such schemes are often referred to as BOO (�build-own-operate�) projects. In many cases, the private company is required to transfer ownership of the plant to the state utility at the end of a 20-30 year concession period (thus, the acronym BOT which stands for �build-operate-transfer�). A number of issues have arisen as a result of the reforms related to: impact on the poor and on energy efficiency and pre-commercial emerging technologies; the sequencing of reforms and governments� ability to regulate the sector; corruption and nepotism; staff reductions and employment security; and loss of sovereignty and societal control over key development assets. Arising out of these concerns is a set of recommendations that can be summarised as follows:

• As power sector restructuring proceeds, there is an increased need for a more elaborate and articulate sector policy. The power sector needs to be treated within the framework of an overall energy policy which deals with issues such as import and export of energy (taking into account the emergence of regional gas and power grids) and the development of indigenous and renewable energy sources. The power sector policy also needs to address rural electrification, establish guidelines for the regulator and develop instruments to influence the behaviour of the enterprises in the sector. Policymaking has to be a continuous, transparent process where all stakeholders are given a voice. It cannot be a �one-shot� exercise carried out by foreign consultants. At present, most developing countries lack this capability and the multilateral and bilateral donors have an important role in building up local capabilities through training and technical assistance.

• While the government still owns the vertically integrated utility, societal objectives can be directly incorporated in the utility�s investment program. Similarly, when the private sector role is limited to greenfield projects operating under long-term contracts with the utility, broader social and environmental concerns can be incorporated into the solicitation/bidding process. In a decentralised system, policies and regulatory frameworks that determine the playing field for different options and the institutional capacity for developing and enforcing regulations assume a

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects viii

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

paramount role in ensuring that societal objectives are met and that the projects are financially viable from the developer�s perspective.

• Environmental and social/resettlement issues need to be explicitly�and transparently�incorporated into the process that grants concessions to private operators. Criteria and guideline in this respect are emerging from other WCD thematic reports.

• In power generation, tariffs should account for not only the premium value of energy supplied during peak demand periods but also the value of the ancillary benefits that hydropower can provide for system management.

• A special policy framework, streamlined approval processes and simplified power purchase agreements are needed to encourage local entrepreneurs to invest in small scale hydropower projects.

• Related to other options, the government should rely primarily on general incentives such as import duties and taxes in addition to environmental and social impact regulations.

• Some form of public-private partnership is virtually always required for multi-purpose schemes and might be justified for different types of dams and non-dam options to ensure that societally beneficial schemes offer a competitive risk/rate of return relationship to private capital. The form of partnership is likely to vary from case to case, but schemes like the Casecnan irrigation-cum-power generation project in the Philippines show that appropriate solutions can be developed.

• Most private investors in power schemes in the developing world have been responsible in meeting internationally acceptable standards for environmental mitigation. In most cases, they have acquired the land for their facilities through open market purchases and provided proper compensation to the former owners.4 There is also an emerging �best practice� adopted by some project sponsors in providing economic and social development programs for the people living in the vicinity of the facility. In the case of hydropower development, however, both private and public sector schemes have proven to be highly controversial and a number of high schemes have been stopped. A major reason for this is the general lack of widely accepted norms for minimisation and mitigation of environmental and social impacts of dam projects. It is likely that most developers in power facilities would conform to any guidelines that emerge from the WCD process since doing so would reduce project risks and increase the likelihood that the project can be financed at reasonable terms. However, private companies are likely to find it difficult, if not impossible, to acquire large tracts of land and resettle hundreds or thousands of families. They (and their financiers) are likely to insist that the government provide the land with no encumbrances�prior to start of construction. Given that the land acquisition and resettlement process for public sector projects usually isn�t completed until the filling of the reservoir is about to occur, this will significantly increase the time required for the development of major hydropower projects in the private sector.

• Lenders and project sponsors have realised that long-term power purchase contracts will not necessarily protect them against political and economic shocks like in Indonesia and Pakistan. This means that increased emphasis is given to the economics of the project (�low cost producer�) and the regulatory framework. The main implication of this is that countries without a proper regulatory framework are less likely to be able to mobilise private financing for power projects.

In the water and sanitation sector the basic approach rarely involves straight out divestiture. Rather, the most common approach is to have a private operator take over management and operation of an existing system and assume responsibility for future investments for expansion and quality improvements. For larger cities, the emerging model is to divide the service area into two concessions in order to get �competition by comparison.� In essence, however, the concessions are regulated monopolies. As in power, Latin America is leading the way in water sector reform. A number of greenfield projects for major facilities like water or sewerage treatment plants and long-

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects ix

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

distance water conveyance have also been built as BOO/BOT schemes. The key implications and recommendations related to the restructuring trends in the urban water and sanitation sector are:

• Given that the responsibility for rural water supply in most countries is separate from that for urban water supply, the impact of private concessions for urban water supply and sewerage on rural consumers is negligible. Indeed, as the urban concessions reduce the need for subsidies, the privatisation process might even give governments an opportunity to focus more financial and technical resources on rural water and sanitation schemes.

• Urban water supply and sanitation is a more heterogeneous service than, for example, power supply. Especially in the large cities in low income countries, only a small fraction of the population is served through house connections and those households lucky enough to have a connection tend to get water only a few hours a couple of times a week. Others are served through public standpipes. Many urban dwellers, if not the majority, buy water from vendors, tanker trucks or have their own wells. On the sanitation side, typically even a much smaller number of households are connected to the sewerage system, and only a small share of the sewerage is properly treated. Thus, a regulator has to be able not only to determine the appropriate tariff level for different types of service but also to provide the right kind of balance between environmental, social and commercial objectives.

• Unfortunately, because privatisation has been done on a city-by-city basis, the need for a proper regulatory regime has often been neglected. Given the very direct impact that a regulator�s and concessionaire�s actions have on the quality of life in urban neighbourhoods, the need for transparent regulation � and popular participation in the process � is probably greater in the water supply and sanitation sector than in the power sector, and greater and more difficult in developing countries than in industrialised countries. Consequently, it is essential to develop the regulatory regime prior to any privatisation transaction.

• Even if they don�t involve building dams, the construction of urban water and sewerage facilities can be very disruptive and involve significant land acquisition and resettlement. Thus, major water and sewerage works should be subject to similar environmental and social guidelines and approval processes as dams.

Large-scale irrigation schemes serving smallholders are rarely financially viable and often fall short of physical and economic targets. Consequently, they are likely to remain a government financed and managed activity. The reforms in the irrigation sector are thus focusing on involving the project beneficiaries in the design (still rare) and operation and maintenance of the schemes. The approaches followed are very similar to those adopted for small-scale infrastructure facilities described below. Private companies owning major estates producing flowers, fruits, vegetables or other cash crops have occasionally built dams to provide year-round irrigation. Since irrigation represents a much greater consumptive use than hydropower and water supply, the issues related to riparian rights (and social/economic equity) are critical. This implies the need for a transparent concession process. Flood control is almost a textbook example of a �public good� and basically falls within the purview of governments. Conceptually, there is a switch in focus from flood control to flood management. There are a few isolated cases, as under the private infrastructure initiative in the UK, where the private sector has been brought in to build and maintain flood control facilities. The structure of such projects is most akin to long term lease agreements where the government defines where, when and how a facility will be built and pays a fee for the service. Such �private� facilities should be reviewed, approved and monitored along the same lines as publicly owned facilities. The changing role of governments, however, is not limited to private sector participation in the financing, construction, operation and ownership of large-scale infrastructure facilities as described above. An equally fundamental shift is occurring in the development of small-scale infrastructure facilities in rural areas and in poorer neighbourhoods in cities and towns.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects x

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

It has been clear for a long time that participation by beneficiaries and grass roots institutions is critical for the long-term success of many types of development projects, especially small-scale infrastructure schemes in rural areas. All over the world, NGOs have worked with local communities and put in place mechanisms that ensure both that the poorest segments of the population benefit and that the results are sustainable. Until the early 1990s, most governments continued a top down, army type of approach to the development of renewable energy sources, village water supply, irrigation management and similar activities. The multilateral development banks and many bilateral donors found it difficult�if not nearly impossible�to reach down to the grass-roots level. Over the last decade, however, many governments have redesigned their rural development and squatter upgrading programs and the donor community has found ways of working with NGOs and designing projects that fully involve the local community and project beneficiaries. While both governments and donors have a long way to go, the movement is certainly in the right direction. The modalities vary significantly from one case to another depending on the type of development activity being undertaken, the strength of government and civic institutions, culture and local traditions. It is beyond the scope of this paper to review these approaches and to make recommendations. However, several successful examples and recommendations are provided in the various options papers prepared for the WCD and in documents such as the World Bank�s Participation Sourcebook. A couple of issues are especially relevant in the context of the present paper:

• These grassroots activities need to be explicitly incorporated into the relevant national sector policies.

• The relationship between local community initiatives and the programs of utility companies needs careful consideration by governments, regulators and concessionaires. There are numerous questions that must be addressed. How do community groups working on improving urban squatter settlements interact with the water utility? What kind of financial and technical support should be provided by the utility? Are the concession contracts for regional electricity distribution companies expressed in such a way that NGO sponsored village electrification programs are prohibited? There are many more questions�many of which cannot be anticipated when the �rules-of-the-game� are established for privatised utilities. This means that there has to be a transparent, highly participatory regulatory process for dealing with this kind of issues as they arise.

Implications of the Project Finance (Non- or Limited Recourse) Model The preferred way of financing private infrastructure schemes in the developing world is �project finance.� This means that the repayment of the financing relies on the cash flow and the assets of the project itself rather than on the strength of the sponsor�s balance sheet. The risks (and returns) are borne not by the sponsor alone but by the different participants in the projects. Non-recourse financing implies that the lenders to and investors in the project do not have any direct recourse to the sponsors, for example through loan guarantees. Although creditors� security include the assets being financed, these assets tend to be illiquid and of limited value as collateral. Thus, the lenders rely on the operating cash flow generated by the project. Sometimes, lenders have limited recourse to the sponsors. Such recourse often involves some form of pre-completion guarantee by the sponsors. In either case, the project needs to be carefully structured to ensure lenders that it is economically, technically, environmentally feasible and that it is capable of servicing the debt under most reasonable scenarios. Crucial to the successful structuring of a project financing is the identification and mitigation of risks. These risks are allocated among the project participants through a comprehensive set of legal documents, usually referred to as the �security package.� In projects following the BOO/BOT model, a long-term off-take agreement with a government entity that buys the output, is typically a central part of the security package. An implementation agreement (or concession

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects xi

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

contract) defines the rights and obligations of both the government and the concessionaire. Some of the critical elements in most implementation agreements are the government�s commitments to:

(i) make up for any shortcomings in the performance of the public agency that buys the output;

(ii) make foreign exchange available for debt service and repatriation of profits;

(iii) protect the concessionaire against political force majeure events and changes in taxation and law.

Project finance deals tend to be highly leveraged with debt typically accounting for 70-80% of total financing. Thus, the driving forces in the risk minimisation process are not the project sponsors but the commercial lenders. There are many cases where the sponsors have negotiated one set of contracts with the government and the lenders have come in and insisted on changes that implied that the government had to assume greater risks. The reason for this situation is that project sponsors get rewarded through returns on their investment of 15-20% after adjustment for inflation while lenders have to work with a small margin of 2-3% over the cost of capital (with no upside potential). Thus, while they will respond to small increases in project and/or country risks through upward adjustments in the spread over LIBOR and/or shortening of the maturities, there very soon comes a point where they rather not lend than take the risk. One basic fact in the project finance business is that a project�s credit rating cannot exceed the creditworthiness of the host country unless some form of credit enhancement is provided. This means that projects in countries with a Standard & Poor�s credit rating lower than BBB- (or the equivalent from other credit rating agencies) will find it extremely difficult to mobilise the required financing. To overcome this difficulty, financing packages in most countries with limited creditworthiness will include political risk guarantees from export credit agencies or from multilateral agencies like MIGA or �partial risk guarantees� from the World Bank and the regional development banks.5 Although such guarantees can cover a broad range of risks, the* one that the commercial lenders are almost universally concerned about is the availability of foreign exchange for debt service. Although the B-loan6 program of IFC and corresponding programs at other development banks don�t formally provide protection against a government�s failure to make foreign exchange available for debt service, most bank regulators in industrialised countries regard B-loans as having a de facto preferred creditor status. This means that in most developing countries, the participation of official agencies in one form or another is imperative. This participation can take the form of:

• Equity investments and A and B-loans from IFC and the private sector arms of the regional development banks;

• Guarantees from MIGA;

• Partial risk guarantees from the World Bank and the regional development banks;

• Loans from the World Bank and the regional development banks (either directly to the project company with a repayment guarantee from the government or channelled through the government), and

• Loans and/or guarantees from export credit agencies. Another risk that the commercial lenders have been very concerned about is the market or off-take risk. In the vast majority of all infrastructure projects, governments or government agencies either buy the output (as when an IPP sells power to the state-owned utility) or decide on the price (as in the case of privatised water utilities). They also have a number of ways in which they can directly or indirectly influence the number of units produced and/or sold. Thus, in the absence of a transparent regulatory framework with a good track record, the lenders insist that the security package include a long-term off-take agreement (such as a power purchase agreement).

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects xii

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Project risk is usually greatest during the construction phase. Thus, virtually all greenfield projects are built with fixed-price, date certain turnkey contracts. There are severe penalties for delays and deficiencies in quality and the technical performance of the plant. Dam projects are inherently more susceptible to cost over-runs and delays and therefore more risky than other types of infrastructure projects serving similar purposes. Added to the traditional construction risks is the potential for delays and cost overruns due to environmental and resettlement issues. Other things equal, this means that lenders will shy away from hydropower and other projects involving dam construction. Consequently, most successfully financed hydropower projects are of the run-of-river type with more limited social and environmental impacts. A greater flexibility in the structuring of hydropower transactions is gradually emerging with sponsors agreeing to take some construction risks by providing stand-by financing. Some power buyers are also agreeing to adjust tariffs to compensate for delays and cost increases due to unforeseen construction problems. Issues that have surrounded limited recourse financing of infrastructure projects, and especially power generation projects, include:7

• An over-reliance on foreign borrowings is making additional claims on a country�s foreign exchange earnings and jeopardises its creditworthiness. This is in no way inherent in the project finance approach but rather a result of the host country�s underdeveloped credit market or the private sector being crowded-out by excessive government borrowings. Indeed, most project sponsors and the foreign lenders would like to see as much as possible of the financing provided by domestic banks and equity investors. Malaysia is one of the countries with the largest amount of money invested in private infrastructure projects and local banks have provided much of the financing.

• Governments have assumed too great contingent liabilities through the guarantees provided in the implementation or concession agreements. However, if government agencies had undertaken the same investments, the government�s direct and indirect liabilities probably would have been even higher. The real issue is the failure of governments to properly account for the contingent liabilities in their own foreign exchange management strategy.

• The cost of the power (or other output produced by the project) is too high due to the high cost of commercial financing. Implicit in this argument is typically the assumption that concessional financing would have been available. Given the policies of the donor community described above, it is not at all certain that concessional financing would be available for power generation projects.8 Furthermore, the soft terms are intended to benefit the borrowing country. Most donors would argue that such funds should be on-lent to the utilities on commercial terms (with the treasury using the �spread� to help finance urgently needed social programs).9 If the utility itself sought commercial financing, in most cases the terms would be no better and possibly worse than those obtained by properly structured BOO/BOT projects. (Many governments also provide hidden subsidies to the utilities through equity contributions on which they require no returns.)

Private hydropower facilities (and other dam projects) involve greater up-front costs than comparable non-dam projects. Adopting WCD�s recommendations on an appropriate environmental and social framework for the construction of dams will likely add to these up-front costs. However, compliance with WCD recommendations will certainly indicate that a dam project has a wider social and environmental acceptance than a non-compliant project. Thus, a compliant project should be less risky (in terms of completion risk, etc) and therefore the likelihood that it will be financed is enhanced. It also suggests the possibility that the risk minimisation could lead to slightly lower financing costs (e.g. through lower interest rates, better bond rating, lower insurance costs, etc).10 The net effect of higher up-front costs but lower project risk will vary on a case-by-case basis.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects xiii

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

It needs to be noted, however, that this effect will be additional to the existing issue that is raised by the distinction between financial and economic analyses of profitability (for which see the Thematic Review III.1 on Financial, Economic and Distributional Analysis). Economic analysis may be used to identify the most attractive option from the standpoint of the national economy (including its social and environmental effects) but there is no guarantee that the top project will be the most financially attractive project, or that it will be financially viable.11 This is a result of two factors: (1) the difference between the financial and economic benefits of water and energy services and (2) the difference between the social/environmental impact of the project as viewed through either the economic valuation of these impacts or the financial costs/benefits of internalising these through available mitigation and financial mechanisms. As part of the process, then, there is a need for a partnership between private developers and the government to ensure a �financeable� allocation of costs and risks. Otherwise, projects that meet society�s objectives � whether they are dam or non-dam alternatives � may go un-funded in favour of projects that meet the narrower criteria of financial viability. This is especially important in the case of multi-purpose projects in view of the low levels of cost recovery from irrigation and water supply consumers and zero cost recovery from flood control beneficiaries. In most cases, commercial lenders go through a comprehensive due diligence process that covers not only the financial aspects of a project but also all its technical, economic and environmental aspects. They are also ready to support programs aimed at promoting economic and social development in the area around the project. Most important, however, is the fact that any prudent lender will seek to minimise the risks of delays and cost overruns (as well as the possible abandonment of the project). Thus, it is likely that they will voluntarily support improved criteria and guidelines for project development if this makes dam projects less controversial. Conclusion and Recommendations There is a global trend towards greater private sector participation in power development and water supply and sanitation. Combined with adaptation of a traditional project finance approach to suit infrastructure projects, this has resulted in a massive inflow of private debt and equity financing for power, water supply and sanitation schemes in developing countries. This has enabled developing countries to extend the coverage and quality of services beyond what would otherwise have been possible. However, for this development to be socially acceptable, economically beneficial and sustainable, government policy making and the regulatory framework need to be strengthened. The reforms at sector level need to be supported by sound macro-economic policies and strengthening of domestic capital markets. The social and environmental impacts of private sector energy and water resource projects that involve the construction of dams pose serious challenges for governments, sponsors and lenders. Some of these challenges are the same as those posed by public sector dam projects, others are unique to private sector projects. Detailed recommendations on the governance structure required for socially and environmentally sustainable development have been presented in most of the thematic review papers. Thus, the following recommendations focus on the specific issues related to private ownership and financing of large-scale water resource projects:

• The fundamental principle should be that the same governance structure applies to both public and private sector projects. This means, for example, that a dam built by the irrigation department should be subject to the same criteria and scrutiny as a dam for a private sector hydropower project.

• Environmental and social/resettlement issues need to be explicitly�and transparently�incorporated in the process that grants concessions to both private and public operators.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects xiv

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

• Options assessments should be the responsibility of the government. Issues like hydro versus thermal generation or demand side management versus new generation are fundamental policy issues and should not be dealt with in the context of an individual project.

• Basin planning and broad definition of projects should be the responsibility of the government. Water is a valuable resource to the nation and only the government can decide on the optimal use of this resource.

• Assessments of alternatives should be the responsibility of the entity proposing a given project. In the context of a dam project, this might involve analyses of alternative dam locations, configuration of the generating plant, etc.

• The greatest benefits of private participation in infrastructure are generally derived from competition. Bidding/competition is also the best way of minimizing the potential for corruption. The competition in the case of power generation can take two different forms: If the country still is in the early stages of reforming the power sector, IPP sponsors can be selected based on the lowest tariff that would be part of a long-term power purchase agreement (for thermal generating projects this is an increasingly common�and generally successful�practice). If, however, the host country has introduced a competitive power market, the project sponsors would be �free� to build their plants �at any cost� but would have to compete with other plants once in operation. In the context of hydropower projects, this process would be modified somewhat in order to ensure that the consumers and/or government gets the maximum benefits of the competition12:

o Case 1�IPPs with long-term power purchase agreements: Potential developers would submit bids on the lowest (average or �levelised�) tariff they would require.

o Case 2�Competitive power market: The potential developers would bid for the right to develop the site. This could take the form of a royalty or an agreed profit sharing formula.

• There is a need for public-private partnerships in the development of dams in order to mitigate the unique risks and ensure that the externalities associated with such projects are adequately accounted for. Each dam project is unique and, thus, the sharing of risks, costs and benefits needs to be tailored to the specific nature of each project.

• The host government should assume the responsibility for feasibility studies and preliminary designs. Thermal power plants are increasingly becoming standardised and the cost varies little from site to site. Each hydropower project, however, is unique and tailored to the specific site. The cost depends primarily on the site�s hydrology, topology and geology and can easily vary by a factor of 2 or 3 from one site to the next. Thus, without detailed soil, geological and hydrological investigations, no developer can estimate the cost with any reasonable degree of accuracy. The uncertainty will be reflected in the very high bids. Since the investigations are costly and time consuming, it doesn�t make sense to have each potential bidder carry out all the surveys and prepare a feasibility study. Rather, this should be the responsibility of the relevant government agency. The feasibility study should be carried out by a reputable international consulting firm�ideally with guidance from an advisory panel, possibly comprising the short listed bidders.

• The host government should carry out the environmental assessment and prepare the mitigation and resettlement plans prior to inviting the private sector. These activities require extensive studies and public participation. The risk to the developers is minimized if the whole approval process has been completed before bids are requested.

• Governments need to retain responsibility for land acquisition and resettlement�unless it is on a minor scale. Lenders will probably insist on the land being handed over to the project company, free of encumbrances, prior to the first draw-down on the loans.

• The dealings between the host government and the private developer(s) have to be transparent. The development of dam projects involves politically sensitive social and environmental issues

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects xv

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

and requires a closer co-operation between private sponsors and government agencies than other infrastructure projects. To ensure the long-term sustainability of the contractual (project) structure, the selection of the private developer has to be competitive and transparent. The same need for transparency applies to subsequent negotiations of contract conditions related to risk and cost sharing.

• It is essential to establish an appropriate tariff regime for hydropower projects. The basic purpose of (and economic justification for) dam projects is to change the availability of water/power over the time. Tariffs based purely on energy output fail to properly compensate hydropower projects for their ability to meet daily, weekly and annual peak demands. Such tariffs tend to create a bias in favour of thermal and run-of-the-river schemes. As a minimum, the tariff structure should include both a capacity and an energy component. Ideally, the tariff should be differentiated to allow for peak pricing and reflect the value of the ancillary benefits that hydropower can provide for system management.

• The international development agencies and ECAs should review their lending policies related to dams and adopt the recommendations of the Commission. A consistent handling of environmental and social issues related to dams is imperative. Project developers (in �collusion� with the host government) should not be able to �shop for the least restrictive lending conditions.� However, the policy changes should go one step beyond adopting policies that are consistent with the expected recommendations by the Commission. The private sector�s bias against hydropower and other water resource projects means that there is potentially a greater role for multilateral and bilateral donors in making up for financial shortfalls. Participation by the multilateral development banks can also provide additional safeguards in ensuring proper handling of social and environmental issues.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects xvi

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Contents Acronyms ................................................................................................................................xix

1 Introduction and Issues Overview .................................................................................1 1.1 Introduction ...................................................................................................................................1 1.1.1 Objectives ......................................................................................................................................1 1.1.2 Structure, Scope and Approach .....................................................................................................2 1.2 Issues Overview.............................................................................................................................2

2 The Changing Role of Governments in Water and Energy Resource Development 4 2.1 General trends and principles ........................................................................................................4 2.2 The Power Sector...........................................................................................................................5 2.2.1 The Reform Process in the Power Sector ......................................................................................5 2.2.2 Regional Patterns ...........................................................................................................................8 2.2.3 Emerging Issues Related to Power Sector Reform........................................................................9 2.3 Water Supply and Sewerage........................................................................................................11 2.3.1 The Reform Process in the Water and Sewerage Sector .............................................................11 2.3.2 Emerging Issues Related to Reform in the Water and Sewerage Sector .....................................13 2.4 Irrigation ......................................................................................................................................13 2.5 Flood Control and Navigation .....................................................................................................14 2.6 Small Scale Projects ....................................................................................................................15

3 Financing Statistics, Trends and Policies of International Financial Institutions...16 3.1 Introduction .................................................................................................................................16 3.2 Dam Investments .........................................................................................................................16 3.2.1 Trends in Dam Construction........................................................................................................16 3.2.2 Value of Investments in Dams: Hydropower ..............................................................................17 3.2.3 Value of Investments in Dams: Irrigation....................................................................................18 3.2.4 Value of Investments in Dams: Water Supply and Flood Control ..............................................19 3.2.5 Annual Global Investment in Dams ............................................................................................20 3.3 Sources of funds ..........................................................................................................................20 3.3.1 Bilateral development assistance.................................................................................................20 3.3.2 Multilateral Flows........................................................................................................................21 3.3.3 International Private Sector Investments .....................................................................................24 3.3.4 Export credit agencies..................................................................................................................28 3.3.5 Domestic Private Sector Financing of Dams...............................................................................29 3.3.6 Domestic Public Sector Financing for Dams...............................................................................30 3.4 Policies and Instruments of International Financial Institutions..................................................31 3.4.1 The Policy Frameworks of the Multilateral Development Banks ...............................................31 3.4.2 The Policy Frameworks of Bilateral Donors and ECAs..............................................................33 3.4.3 Emerging Instruments for Support of Public and Private Dam Projects .....................................33 3.4.4 The Outlook for Lending by the Multilateral Development Banks.............................................34 3.5 Implications .................................................................................................................................35

4 The Emergence of New Financing Instruments for Large-Scale Private Sector Water and Energy Resource Projects ...................................................................................36 4.1 The Basic Principles of Project Finance ......................................................................................36 4.2 The Structure of A Limited Recourse Transaction......................................................................37 4.3 Key Issues Related to Limited Recourse Financing ....................................................................39

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects xvii

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

5 Issues and Emerging Practices in the Financing of Dams .........................................41 5.1 Hydropower Dams.......................................................................................................................41 5.1.1 Overview .....................................................................................................................................41 5.1.2 Trends in the Regulatory Environment........................................................................................43 5.1.3 Trends in Project Financing.........................................................................................................46 5.1.4 Future Roles for the Public Sector in Hydropower development ................................................49 5.1.5 Influence of Financing on Project Selection................................................................................49 5.1.6 Constraints and Opportunities .....................................................................................................50 5.1.7 Key Issues Arising from New Approaches to Project Financing ................................................51 5.2 Water Supply Dams.....................................................................................................................53 5.3 Irrigation and Flood Control Dams..............................................................................................53 5.4 Multipurpose Dams .....................................................................................................................54 5.4.1 Overview .....................................................................................................................................54 5.4.2 Main Considerations....................................................................................................................54 5.4.3 Trends in the Development of Multipurpose Schemes................................................................55 5.4.4 Key Issues Arising.......................................................................................................................56

6 Issues and Emerging Practices in the Financing of Non-Dam Options....................57 6.1 Large Scale Energy Projects (Grid Connected)...........................................................................57 6.2 Non-Grid Connected Energy Options..........................................................................................58 6.3 Demand Side Management Options ............................................................................................59 6.4 Small Scale Water Supply and Irrigation Options.......................................................................59

7 Synthesis: Implications of Financing Trends for the Debate on Dams ....................61 7.1 The Changing Pattern of Dam Financing ....................................................................................61 7.1.1 Multilateral Development Banks (MDBs)...................................................................................61 7.1.2 Bilateral Donor Agencies ............................................................................................................61 7.1.3 Export Credit Agencies (ECAs) ..................................................................................................61 7.1.4 Developing Country Governments ..............................................................................................61 7.1.5 The Private Sector........................................................................................................................62 7.2 Implications of Present Trends ....................................................................................................63 7.2.1 Impact on Consumers ..................................................................................................................63 7.2.2 Macro-Economic Impact .............................................................................................................63 7.2.3 Impact on State-Owned Utilities .................................................................................................64 7.2.4 Impact on the Use of Indigenous Energy Resources ...................................................................64 7.2.5 Impact on the Use of Renewable Energy Resources ...................................................................64 7.3 The Outlook for the Financing of Dams and their Options .........................................................65 7.3.1 Official Development Assistance ................................................................................................65 7.3.2 Private Investments in Dams and Options to Dams ....................................................................66 7.4 Summary Recommendations .......................................................................................................66

References................................................................................................................................70

Appendix I: List of Contributing Papers to the Thematic Review III.2 Trends in the Financing of Water and Energy Resource Projects ............................................................73

Appendix II: Submissions for Thematic Review III.2........................................................74

Appendix III: Comments Received for Thematic Review III.2.........................................76

Annex 1: Asian Development Bank Financing Trends .....................................................92

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects xviii

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

List of Tables Table 3.1. Estimated Hydropower Production (1973-96) and Installed Capacity in 1996 ...................18 Table 3.2. Regional Growth in Hydropower Capacity .........................................................................18 Table 3.3. Estimated Annual Global Investment in Dams During the 1990s .......................................20 Table 3.4. Bilateral Aid Flows to Two Sectors Including Dams ..........................................................20 Table 3.5. World Bank Lending for Power, Irrigation and Water and Sanitation, 1970-99 .................21 Table 3.6. Annual Financial Flows for Dam Projects from Aid Donors, 1995-99 ...............................24 Table 3.7. Current Sources of Financing for Dams in Developing Countries. .....................................31 List of Figures Figure 2.1. A Stylised Model of the Emerging Power Sector Structure in Developing Countries.........6 Figure 2.2. Progress on Power Sector Reform in 115 Developing Countries.........................................7 Figure 2.3. Regional Progress on Power Sector Reform ........................................................................8 Figure 2.4. Investments in Private Power Schemes, 1990-97.................................................................9 Figure 2.5. Water and Sewerage Schemes with Major Private Sector Investments, 1990-97 ..............12 Figure 3.1. Construction of Dams per Decade......................................................................................17 Figure 3.2. Total bilateral aid flows to the hydro-electric power sector ...............................................21 Figure 3.3. Inter-American Development Bank Financing for Large Dams ........................................23 Figure 3.4. Asian Development Bank Financing for Large Dams, 1968 to 1999.................................23 Figure 3.5. Bilateral and Multilateral Aid Donor Financing for Dam Projects, 1950 to 1999 .............24 Figure 3.6. Financial Flows of Private and Official Capital for Developing Countries .......................25 Figure 3.7. Private Capital Flows to Developing Countries ($ billion) ...............................................26 Figure 3.8. Regional Patterns of Private Capital Flows (Average 1998-99 in $ billion) ......................26 Figure 3.9. Trends of Private Sector Investment for Infrastructure ......................................................27 Figure 3.10. EXIM Bank Financing......................................................................................................29 Figure 4.1. Security Package for a Power Project.................................................................................37 Figure 5.1. Private Hydropower Plants Reaching Financial Closure, 1994-2000 ................................42 Figure 6.1. Large Scale Renewable Energy Projects Built by the Private Sector, 1994-2000,MWs...58 List of Boxes Box 2.1. The High Cost of Non-performing Public Utilities..................................................................4 Box 2.2. Corruption and Infrastructure Development ..........................................................................10 Box 3.1: A Culture to Lend?.................................................................................................................32 Box 4.1: Project Finance Risks .............................................................................................................38 Box 4.2: Is Private Power More Costly?...............................................................................................40 Box 5.1: Murphy's Law and the Mandate of the WCD ........................................................................52 Box 7.1: What is the Future for Private Capital Flows? .......................................................................66

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects xix

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Acronyms ADB Asian Development Bank AfDB African Development Bank BOO Build-operate-own BOT Build-operate-transfer CCGT Combined cycle gas turbine EBRD European Bank for Reconstruction and Development ECA Export credit agency EIB European Investment Bank EXIM Export-Import Bank of the United States FAO Food and Agriculture Organization of the United Nations GW Gigawatt (109 Watt) GWh Gigawatt-hour (109 Watt-hour) IBRD International Bank for Reconstruction and Development ICOLD International Commission on Large Dams IDA International Development Agency IDB Inter-American Development Bank IEA International Energy Agency IFC International Finance Corporation ILA International lending agency IPP Independent power producer JEXIM Export-Import Bank of Japan kWh Kilowatt-hour (103 Watt-hour) LIBOR London interbank offer rate MAF Mean annual flow MDB Multilateral development bank MIGA Multilateral Investment Guarantee Agency MW Megawatt (106 Watt) NGO Non-governmental organization OECD Organization for Economic Co-operation and Development O&M Operation and maintenance OPIC Overseas Private Investment Corporation (US) PV Photovoltaics TWh Terrawatt-hour (1012 Watt-hour) USEXIM Export-Import Bank of the United States WCD World Commission on Dams

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 1

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

1 Introduction and Issues Overview

1.1 Introduction

Faced with severe budget constraints and mounting social expenditures during the 1990s, most governments in developing countries have curtailed their investments in infrastructure. At the same time, overall aid flows have declined and multilateral and bilateral development agencies have expanded the share of their financial assistance devoted to social sectors and to quick disbursing non-project lending. A major paradigm shift, however, is under way which is changing the way infrastructure facilities are owned, operated and financed. Governments are increasingly building up their ability to regulate the infrastructure sectors while divesting assets and/or encouraging the private sector to build and operate new facilities. The paradigm shift has been most dramatic in developing countries. Changing perceptions among international investors and commercial banks to emerging market risks combined with the introduction of regulatory reforms and privatisation programs have led to a virtual explosion of private investments in power and water supply schemes, so far primarily in the middle income countries. The approach to developing and operating small-scale infrastructure facilities is also changing. Governments are increasingly involving the beneficiaries in the planning, design, implementation, operation and financing of rural energy and water supply schemes and urban slum upgrading programs�often with the help of NGOs that help organise community groups. These trends will have important implications for water resource development and the construction of dams over the next two decades. This background paper for the World Commission on Dams reviews these trends and makes recommendations on how governments and the international community best can steer the process for the common good. 1.1.1 Objectives The general purpose of this paper is to provide a strategic overview of infrastructure financing issues as a contribution to the debate on dams and the WCD process. The paper has three main objectives:

1. To describe international trends in infrastructure financing and sources of financing for water and energy resources projects, focusing on dams and options to dams (i.e. alternative approaches for providing services such as electricity generation, irrigation, water supply, flood management, etc.).

2. To highlight the changing context and main features of the financing approaches/models emerging in different regions and settings (to help illustrate emerging good practices for different types of development schemes).

3. To review the implications relevant to the WCD mandate and the dams� debate in the sustainability context. This includes the influences of the changing project finance climate on the policy, regulatory, planning and decision-making practices, options assessment, roles and responsibilities, and other practices in the water and energy resource field further into the project cycle of dams (i.e. construction, operation, monitoring etc.) which impact on sustainability.

A basic premise of the report is that all infrastructure projects�whether public or private�should be economically viable and social and environmental impacts should to the extent possible be avoided, minimised and mitigated.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 2

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

1.1.2 Structure, Scope and Approach The paper is structured as follows: Chapter 2 describes the changing roles of governments in the development of energy and water resources. It first reviews the reasons why the traditional public sector approaches are being modified to encourage the corporate private sector as well as project beneficiaries, community groups and NGOs to take on a greater responsibility for infrastructure services. Second, it describes the emerging structures and regulatory regimes for the power and water supply sectors. Third, it looks at the growing emphasis on community participation in the development of small scale, geographically disbursed energy and water supply schemes that often are alternatives to the construction of dams. Chapter 3 analyses recent trends in the financing of dams and related infrastructure facilities. The main emphasis is on international capital flows from the World Bank, the regional development banks, bilateral donors, export credit agencies as well as the rapidly growing flows from commercial lenders. Chapter 4 describes in detail the new instrument--�limited recourse finance� or �project finance�--that is used for the financing of large scale, privately owned energy and water resource projects. Chapter 5 presents the issues and emerging practices in the financing of dams, with the emphasis placed on hydropower and multi-purpose schemes. Chapter 6 looks at the issues and emerging practices in the financing of non-dam options. The discussion is basically divided into two parts: the first looks at the financing of large-scale projects (especially power generation projects); the second, at the financing of small-scale energy and water supply projects. Chapter 7 draws the conclusions from the preceding discussion and makes a number of recommendations relevant to WCD�s mandate.

1.2 Issues Overview

One central issue with respect to the WCD mandate is where the changes in project financing may lead, in terms of the likely availability of financing for dams and non-dam options, and the regional differences. Specifically, what sources of financing can be anticipated for supply and demand management options for water and energy services in the future? A related issue is how the policies and practices of international financing institutions (IFIs) are responding to changes in the market place, and to what extent these changes reflect sustainable development practices in the water and energy resource sectors. This includes financing for larger scale projects of a centralised nature, and project financing for smaller scale rural and community based water and energy initiatives. Power sector restructuring and de-regulation are increasingly global phenomenon, though the direction and rate of change is country-specific and motivated by different factors. The extent to which the trends in the availability of financing influence the types of projects that are developed (e.g. thermal versus hydro generation options; large versus medium and smaller scale projects; supply side versus demand side options), are increasingly important issues. Related to this issue is the way in which hydro and thermal alternatives and demand-side options are valued in electricity system planning and investment decision-making, and in isolated and rural settings.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 3

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

The pace of reforms and, especially, the host country�s creditworthiness has a major impact on the willingness of commercial lenders to provide financing for dams and other infrastructure projects. What does this imply for the poorest countries in Africa and Asia? Another issue relates to the possible impact of financing trends on policies for development of indigenous energy resources. Countries generally wish to develop their indigenous resources for electricity generation, whether they are fossil fuel, hydro, geothermal or other renewable energy resources. The extent to which project financing trends can in practice, reinforce or override government policies to develop indigenous resources is an issue of increasing concern. The range of financing models for large-scale projects that are being explored today for government-private and wholly private sector ventures is a key consideration in how hydro projects and non-dam options for the services may be financed in future. Multi-purpose projects pose particular challenges if they are to be fully financed by private sector. Given the financing trends, an important issue will be the extent to which financing is available for irrigation, water supply and other water and energy services either separately, or as part of multi-purpose project developments. In parallel, an important concern will be the amount of money available for government-community, and local initiatives for financing small-scale approaches and options, as well as stakeholder participation in the larger projects developed in their community areas. The influence that project financing trends for dams and options may have on policy, planning and decision-making processes are key issues. This is in respect to the roles and responsibilities of the newly formed regulatory bodies, line ministries, the utilities and the private sector participants in water and energy resources projects. There are implications concerning the degree to which project financing considerations impact on the evolving participatory decision making-processes and decision-making roles. Many of the new project financing approaches, particularly those for dams are complex and involve considerable negotiation on a case-by-case basis. This raises important issues relating to capacity building in developing economies for the new roles. The learning curve, experience and time factors are important considerations in negotiating sustainable outcomes.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 4

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

2 The Changing Role of Governments in Water and Energy Resource Development

2.1 General trends and principles

The post-war era saw an unprecedented growth in global prosperity enabled by massive investments in all types of infrastructure. In developing countries alone, the annual investment level approached $200 billion in the mid-1990s. However, the expansion was generally not matched by a similar improvement in service quality. Low tariffs, inadequate bill collection, insufficient maintenance, misallocated investments, unresponsiveness to users and technical inefficiencies were increasingly acknowledged as major problems. The resulting poor performance of infrastructure enterprises, however, represented only the tip of the iceberg. The main concern was the impact on economic growth and poverty alleviation (see Box 2.1). Around 1990, governments in developed as well as developing countries started to realise that the problems were rooted in the monopolistic nature and bureaucratic structure of the institutions and the incentives facing infrastructure providers. Thus, faced with ever growing demand and constrained resources (in part due to a failure to recover the real cost of providing the services from the users), governments started to change their roles from being service providers to being facilitators of private investments and regulators. Box 2.1. The High Cost of Non-performing Public Utilities

The poor performance of most state-owned infrastructure enterprises in developing countries has been amply documented. For example, the World Development Report 1994, which was titled �Infrastructure and Development,� documented the problems of insufficient maintenance, misallocated investments, unresponsiveness to users, and technical inefficiencies (World Bank, 1994). A few of the indicators presented in the report were that only about 60% of the generating capacity in developing countries was available at a given time, compared to best practice of over 80%. Most water supply systems lost one-third of their water and some as much as half, compared to best practices of less than one-sixth. The overall efficiency of water use in most canal irrigation schemes was only 25-30% with 40-45% being reasonable in well maintained and operated systems. The report estimated that the direct cost of these inefficiencies was close to $40 billion a year for the electricity and water supply sectors alone (including railways and roads brought the total to around $55 billion). In addition, the report documented the fiscal burden of not recovering the full cost of the users: tariffs in the power sector covered only about 60% of the cost and in the water supply sector the revenues were less than one-third of the cost of supply. For power and water supply the total fiscal cost was estimated at around $110 billion. When the deficits of railways were added, the total amounted to $123 billion. The cost, however, goes far beyond the direct budgetary impact. Fiscal constraints have meant that the amount of new investments has been limited and, with few exceptions, it is the poor who have to do without government services. Numerous studies have shown how people in low-income urban areas pay five to thirty times as much for water from vendors than the better-off pay for tap water. The poor, especially in rural areas, have to rely on alternative energy sources at a higher cost than electricity. The justification for subsidies is usually that the service has to be �affordable to the poor.� In virtually all cases, however, utility subsidies are poorly targeted and benefit the wealthier more than the poor (World Bank, 1994). Also the indirect cost of subsidies tends to fall disproportionately on the poor. In Bangladesh, for example, budget transfers to the two main power companies amounts to about $100 million per year, more than the government�s expenditures on health (Lovei and McKechnie, 2000). The beneficiaries of these subsidies are the relatively affluent 16% of the population that have electricity service. The poor (and the population at large) also suffer from the macro-economic impact of poor electricity

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 5

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

supply, which reduces growth and employment generation. Lovei and McKechnie (2000) report on a World Bank sponsored study which revealed that power outages in Bangladesh cost about $1 billion a year and reduce GDP growth by about half a percentage point. Similar results have been reported for Pakistan and India. This chapter describes the trends towards liberalisation and greater reliance on market forces, allowing new entry, encouraging competition, �unbundling� monolithic state owned utilities and privatisation, etc. It will also describe the institutional and regulatory models that have emerged in different regions and sectors. The purpose of the chapter is not to argue for or against private participation in infrastructure development but to provide a proper context for the subsequent discussion of financing trends and methods. In simple terms, the reforms involve: (i) the application of commercial principles to the provision of services; (ii) introduction of competition largely through some form of privatisation and opening up many infrastructure activities to new entrants; and (iii) involving users more in the design and operation of infrastructure facilities. These changes have been facilitated by technological innovations, an improved understanding of how governments can regulate private infrastructure providers to ensure that the benefits of reform accrue to the consumers, and the development of new financing tools. Of the areas of concern to the Commission, the reforms have been most rapid and far reaching in the power sector.13 Reforms are also under way in the water supply and sanitation sector. Large-scale irrigation projects have been--and are likely to be--affected to a much lesser extent. Large-scale flood control schemes will certainly remain in the public sector in the future (although some limited forms of private participation are emerging). New approaches in terms of involving the beneficiaries and community groups are enhancing the sustainability of small-scale infrastructure facilities in both urban and rural areas and, thus, making many of the non-dam options more viable.

2.2 The Power Sector

2.2.1 The Reform Process in the Power Sector The objective of power sector reform typically is to create an industrial structure that maximises the scope for competition, innovation and efficiency gains. This requires that the typical monolithic, state-owned utility be broken up in parts, a process commonly referred to as �unbundling.� In power generation, this involves the establishment of a number of autonomous producers that compete based on price. Electricity distribution is in many respects a natural (regional) monopoly and, thus, it is usually impractical to have several suppliers (networks) serving the same area. The approach in this case is to introduce �competition by comparison.� This involves dividing the country into a number of concession areas with one distribution company in each. The regulatory authority then compares the performance of the various companies and sets individual tariffs and targets for each company based on an assessment of �best practices� and potential service improvements and cost savings. In an integrated system, it tends to be impractical to break-up the transmission network and it usually remains as one corporate�public or private�entity. There is a need for a central dispatch function, which typically rests with the transmission company. In small countries with low electricity consumption, unbundling is sometimes regarded as impractical although it is becoming more common.14 The market structure that most countries are moving towards is captured in Figure 2.1. Some industrialized countries are gradually introducing competition at the retail level. This involves transforming not only the transmission company but also the regional distribution companies into common carriers that transport the electricity (for a fee) from the generating plants to the consumers. In this case, marketing companies buy the power at the wholesale level and sell it to the consumers.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 6

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 2.1. A Stylised Model of the Emerging Power Sector Structure in Developing Countries

Government Policy

Regulator

Transmission Company

Hydropower Generating Cos

ThermalGenerating Cos

GreenfieldIPPs

RegionalDistribution Cos

MarketingCompanies Customers

Power sector reform comprises a number of different elements aimed at increasing competition and accountability and mobilisation of financial resources for system expansion and service quality enhancement. The main elements are:

• Corporatisation and commercialisation of the government power entity to increase autonomy and management accountability;

• Revision of the legal framework to allow new entry and private ownership as well as encourage competition in generation and/or distribution;

• Creation of a transparent regulatory framework and establishment of an autonomous regulatory body (or providing for the separation of the government�s policy and regulatory functions as a step towards the creation of an independent regulator);

• Within the overall legal and regulatory framework, establish policies and procedures for licensing of private greenfield investments in generation, transmission and distribution. Most commonly, such investments have taken the form of �independent power producers� (IPPs); and

• Unbundling of the state-owned utility company and divestiture of generating, transmission and distribution assets. Typically, the transmission system and hydropower plants (especially if they also provide releases for irrigation schemes) are the last to be privatised.

A recent survey of 115 developing countries by the World Bank (Bacon, 1999) reviews how far different aspects of power sector reform have progressed. The results are summarised in Figure 2.2.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 7

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 2.2. Progress on Power Sector Reform in 115 Developing Countries

0 10 20 30 40 50Percent of Countries Undertaking Reform

Distribution Divested

Restructuring

Regulator

Corporatization

Generation Divested

Indep Power Producers

Legal Reform

Source: Data from Bacon (1999)

Politically, the most acceptable way of introducing private ownership in the power sector has been through construction and operation of new generating plants, commonly referred to as �independent power producers� (IPPs). IPPs are special purpose companies established to develop, own and operate power plants. These schemes sell power to the main utility under long-term contracts. In 1987, Turkey15 was the first developing country to enact a law governing the establishment of �build-operate-transfer� (BOT) projects. Under the BOT model a developer gets a long-term (typically 20-30 years) concession to build and operate an infrastructure project. At the end of the concession period, the ownership of the project is handed over to the state-owned utility (or to some other government entity). The developer also mobilises the financing, typically using a project finance approach (see Chapter 4). As private ownership has become more acceptable, many countries have switched to a �build-own-operate� (BOO) model where there is no obligation to transfer ownership to the government at the end of the concession period.16 BOO/BOT schemes have been the predominant form of private participation in Asia. The initial IPPs in the Philippines, Pakistan and other pioneering countries were negotiated deals between the project sponsors and the government. The agreed tariffs and the resulting returns to the investors were also high (typically 20% or more). The negotiations and the mobilisation of finance could take several years.17 Gradually, tariffs have declined (in part due to falling prices for generating equipment) and the development process has been shortened considerably as standard approaches have evolved. However, the lack of transparency in the negotiating process has been the source of many debates and has occasionally led to costly delays as new governments have refused to honour agreements entered into by their predecessors.18 This has led project sponsors to realise that they need to be able to demonstrate that the contract was fair and that they are low cost producers of electricity. Similarly, government officials were seeking a way of protecting themselves against accusations of corruption and ensuring that the country received the best possible deal. Thus, in the mid-1990s, many governments started to invite competitive tenders for IPP projects. The bidding process has increased transparency and resulted in lower power tariffs�perhaps by as much as 20-25% (Albouy and Bousha, 1998). The IPPs sell power to the state-owned utilities under long-term contracts that are fairly rigid. The experience from those industrialised countries that have spearheaded power sector reform has shown that significant efficiency gains can be achieved by introducing a competitive power market where the lowest bidders get dispatched. Thus, the price would change hour by hour and at each time the most efficient generating plants would be operating. Generating facilities that supply power directly to the grid based on the variable spot price (i.e. without long-term power purchase agreements) are referred

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 8

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

to as �merchant plants.� Project sponsors and commercial lenders are willing to finance merchant plants only in countries where the state-owned utility has been unbundled and most assets have been sold to the private sector and the regulator has established a track-record in terms of fairness and transparency. So far only relatively few merchant plants have been built in developing countries (the first one was in Chile a few years ago). However, as power sector reform continues, these plants are likely to become more common. 2.2.2 Regional Patterns The sequencing and pace of reform varies significantly from one country to another. However, there are some clear regional patterns that emerge from the study by Bacon (1999). Based on the number of countries that had undertaken various reform steps, the author calculated regional �reform indicators.� These indicators are presented in Figure 2.3. Another World Bank study analyses the amount and purpose of private investments in the power sector (Izaguirre, 1998). Together, these two studies give the following picture of private involvement: Latin America: This region (led by Chile) pioneered power sector restructuring and privatisation in the developing world. It was driven by the concern about the low efficiency of state-owned utilities. This was combined with a desire to mobilise foreign equity capital to help reduce the region�s heavy debt burden. During much of the 1990s, the need for new investments to increase capacity was relatively limited. Thus, up to 1997, Latin America accounted for 67% of the investment in privatised power utilities but less than 10% of the investments in BOO/BOT type generation projects. Figure 2.3. Regional Progress on Power Sector Reform

0 20 40 60 80 100

Reform Indicator

Sub-Saharan Africa

M. East & N. Africa

East Asia & Pacific

Europe & C Asia

South Asia

Latin America

Source: Bacon (1999) East Asia: The performance of the existing state-owned utilities was perceived as being less of a problem than the mobilisation of additional financial resources for system expansion (to meet power demands that were growing at unprecedented rates). Thus, the emphasis in East Asia was on attracting foreign investors and lenders for the construction and operation of greenfield generation projects. Some 57% of all LDC investments in BOO/BOT generating projects were made in East Asia in the period up to 1997. South Asia: Political resistance against restructuring and privatisation has been strong�although some reforms are under way. It has, however, been much easier to gain acceptance for private investments in greenfield generating projects. Eastern Europe and Central Asia: The major problems in this region were inefficient production and use of energy. Thus, after a slow start, the restructuring process has taken hold and privatisation of

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 9

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

�unbundled� utilities has accelerated. Virtually all of the greenfield projects have been concentrated in Turkey. Middle East and North Africa: Private participation in the power sector has so far been limited, but BOO/BOT schemes are becoming more common. Sub-Saharan Africa: The initial involvement of the private sector in Africa region�s power sector took the form of management contracts. Recently, increased emphasis is given to restructuring and outright privatisation as well as greenfield generation projects. The investments that have been mobilised through private greenfield projects and privatisations in different regions are summarised in Figure 2.4 below. Figure 2.4. Investments in Private Power Schemes, 1990-97

0.05.0

10.015.020.025.030.035.040.045.0

US$ Billion

Latin America

East Asia

South Asia

Europe & C Asia

M East & N Africa

Sub-Saharan Africa

Divestiture

Greenfield

Source: Data from Izaguirre (1998)

2.2.3 Emerging Issues Related to Power Sector Reform A number of concerns have arisen out of the reform process. First, the move towards commercialisation of the power sector has raised questions regarding the ability of the poor to pay higher prices for power. While this is a serious concern, there are a couple of mitigation factors. The present direct and indirect subsidies tend to benefit the richer consumers much more than consumers with lower incomes and electricity consumption (World Bank, 1994). The lack of internal mobilisation of investment resources due to the low financial viability of most state-owned utilities and a shortage of general government funds for the sector have limited funding for system expansion. This has meant that most of the poor in developing countries are not connected to power grids but have to rely on more costly alternative energy sources. Thus, the advocates for reform argue that greater efficiencies from private management and competition as well as increased investments will over the medium and long-term benefit the poor. A related concern is that the commercialisation of the sector will lead to a reduced attention to energy efficiency programs and pre-commercial emerging technologies. This is definitely a possible outcome that needs to be countered by well-articulated sector policies, a system of incentives and careful and foresighted regulation. Until recently, government policy making has essentially been limited to determining the one and five year investment programs for the state-owned utility, i.e. the policies were rather narrow and implicit rather than explicit. Subsequently, they have also encompassed the basic approaches and time-schedules for various restructuring actions. However, as restructuring proceeds and decision-making in the power sector becomes more decentralised, the need for a more articulate policy becomes

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 10

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

stronger. The power sector needs to be treated within the framework of an overall energy policy which deals with issues such as import and export of energy (taking into account the emergence of regional gas and power grids) and the development of indigenous and renewable energy sources. The power sector policy also needs to address rural electrification, establish guidelines for the regulator and develop instruments to influence the behaviour of the enterprises in the sector. The sequencing of reforms�where the private sector is brought in before the government�s regulatory capacity has been built up�is a problem that has emerged in a number of countries. An extension of this issue is the question whether the general culture and the overall legal framework are supportive of objective and transparent regulation. There is an obvious role for the donor community in providing training and technical assistance to build-up the regulatory capacity in developing countries. Most private investment in power generation in developing countries has taken the form of IPPs that sell power at a predefined price. There is no adjustment in the tariff based on the day or the time when power is supplied. This means that there is an in-built bias in favour of base-load plants. A move towards a more competitive power market and the introduction of merchant plants is likely to make the construction of peaking plants more attractive. Since hydropower plants are ideally suited for peaking, this trend is likely to make hydropower investments more attractive to private investors than they are at present. There have been widespread allegations regarding corruption and nepotism in the award and negotiation of contracts/concessions for private operators (see Box 2.2). While many of these allegations have been politically motivated and few have been proven, it is likely that a number of such cases have occurred. The evolving �best practices� in terms of minimising such cases involve open, competitive bidding for concessions based on pre-defined contracts, independent regulation and a transparent process with public participation at all stages. (It should be noted, however, that the countries where corrupt awards of concessions have taken place probably are the same countries where corruption also occurs in normal procurement and that this might be a significant factor contributing to the poor performance of public sector entities.) Box 2.2. Corruption and Infrastructure Development

In recent years, the negative impact of corruption on social and economic development has been clearly documented. Unfortunately, corruption seems to be especially common in the areas of concern to WCD. According to the �Bribe Payers Survey� commissioned by Transparency International (TI), corruption is most endemic in �public works contracts and construction.� �Power (including petroleum and energy)� is ranked as number three of nine business sectors. (For further details see TI�s web site: www.transparency.org). As a number of well published scandals in industrial countries demonstrate, corruption is in no way a problem that is limited to developing countries. Indeed, in TI�s most recent tabulation of the �Corruption Perception Index,� a number of developing countries are ranked higher (i.e. as being less corrupt) than some developed countries. There is also little doubt that unethical business practices of many firms from OECD countries contribute to corruption in the developing world. The donor community has responded to this problem in a variety of ways. Aid is increasingly linked to measures aimed at reducing corruption and increasing transparency in public sector decision making. Capacity building is one of the elements in the donors� strategy and making aid conditional on concrete measures to reduce corruption is another. In parallel, the industrialized countries are seeking to stop their own firms from paying bribes. Prior to 1998, only the United States� Foreign Corrupt Practices Act of 1977 prohibited national firms from bribing officials of governments overseas. By criminalising international bribery, the Act also ended the tax-deductibility of bribes paid by U.S. firms to foreign public officials. Significant

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 11

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

advances were made in replicating this effort outside the U.S. when, in December 1997, member governments of the OECD agreed on the text of a �Convention on Combating Bribery of Foreign Public Officials in International Business Transactions.� This convention has been a landmark achievement, reflecting changing sentiments in the international community that efforts to reduce corruption must operate in capital-exporting countries as well as in developing economies. As of August 2000, twenty-three countries had ratified the convention. Unfortunately, some OECD members have signed but still not ratified the convention. There have been a number of accusations regarding corruption and nepotism in private infrastructure projects. While few cases have been proven, there clearly is a need to minimise the scope for such practices. The starting point is a transparent process for approving and negotiating the security packages for private infrastructure projects. Competitive bidding for the concessions will also reduce the scope for corruption. Other safeguards are provided by the due diligence process carried out by international lenders and the practice of employing reputable international firms auditing the project accounts. As in all sectors, there are legitimate concerns among the employees regarding staff reductions and unemployment. Over time, a number of strategies have been developed to deal with these issues. These involve, inter alia, establishing a consultative process, giving employees a stake in the privatised entity through equity participation, various types of �golden handshakes� (financed out of the sales proceeds or with donor support) and/or employment guarantees. Some of the objections raised are more ideological in nature and concern the divestiture of public assets (�selling the crown jewels�) as well as objections to foreign ownership of strategic assets and reduced sovereignty. In part, this is an issue that only can be resolved through the political process. In part, however, it is also an empirical question�or rather a whole series of questions such as: Does privatisation lead to efficiency gains, and do these efficiency gains ultimately benefit the consumers? Do private operators give adequate attention to equity issues and expansion of service to low income groups? Do developing countries have the capacity to properly regulate the privatised entities? There are a few often-quoted studies that show initial efficiency gains and service quality improvements. These studies are, however, rather anecdotal in nature. The long-term benefits of utility privatisation in a developing country setting still remain to be proven or disproved.

2.3 Water Supply and Sewerage

2.3.1 The Reform Process in the Water and Sewerage Sector Reforms in the urban water and sanitation sector have been slower and much more modest than in the power sector. Governments have been reluctant to bring in private owners and operators, in part because water is treated as a social rather than economic good. Because of this, tariffs have generally covered only about one-third of the real cost of supplying water. The lack of financial viability of water and sanitation utilities has reduced the interest of the private sector in buying existing utilities or to invest in greenfield facilities. Still, there is a growing trend towards greater private participation. According to a study conducted by the World Bank, the private sector invested around $25 billion in almost 100 water and sewerage schemes in developing countries between 1990 and 1997 (Silva, Tynan and Yilmaz, 1998). The regional distribution of these schemes is shown in Figure 2.5.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 12

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 2.5. Water and Sewerage Schemes with Major Private Sector Investments, 1990-97

0 10 20 30 40

Number of Schemes

South Asia

M. East & N. AfricaSub-Saharan Africa

Europe & C. Asia

East Asia & PacificLatin America

Source: Silva, Tynan and Yilmaz (1998)

There is little scope for achieving significant efficiency gains by introducing competition in water collection and water or sewerage treatment. Piped water supply and sewerage networks are basically natural monopolies (although they face �competition� from private wells and tubewells, water vendors and individual sanitation solutions). This has meant that �unbundling� along the lines adopted in the power sector is not an attractive solution. Rather, the approach generally has been to treat the system in small towns and medium-sized cities as one unit. In very large cities, there is often an attempt to introduce yardstick competition (or �competition by comparison�) by breaking up the existing utility into a couple of regional parts, with the different parts managed by separate entities.

Private participation can take a number of forms: • Operation and management contracts are intended to improve the performance of loss-making

public utilities while leaving the government responsible for new investments. These contracts usually include performance incentives for the private operator. Most of these contracts have been in Africa.

• Lease contracts represent an expanded role for the private sector over the shorter-term O&M contracts. The government remains owner of all the facilities but the private company employs the staff and has full responsibility for all aspects of the operation including tariff collection. The company pays a fee to the government for the lease.

• Concession where the private sector takes over the management and operation of an existing system but also assumes the responsibility for future investments for network expansion and quality improvements. Roughly half of all water and sanitation schemes with private participation are of this type, accounting for 80% of all private investments in the sector. Argentina has been in the forefront of the reforms along these lines with an aggregate investment commitment of over $6 billion. Most of the concessions are located in Latin America although a couple major ones are located in East Asia.

• Greenfield projects are relatively numerous but individually small. They involve construction and financing of discrete facilities like water or sewerage treatment plants or major water conveyance schemes. They account for some 30% of all projects with private participation and one-sixth of the private investments in financial terms. Most of the greenfield projects take the form of build-own-transfer (BOT) projects. As with power, most BOT projects have been built in East Asia (and especially in China).

• Straightforward divestitures (privatisations) are rare. Only a handful has been made so far.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 13

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

In the power sector, virtually all of the private investments went into greenfield projects or divestitures, while these kinds of transactions are relatively rare in the water and sanitation sector. Another noteworthy difference between the two sectors is the degree of market concentration. In power, the top ten developers together have less than 40% of the total market. In the water and sanitation sector, however, one company was involved in 28 of 97 transactions during the 1990-97 period�and these were generally the largest transactions that together accounted for more than 60% of all private investments in water supply and sanitation (Silva, Tynan and Yilmaz, 1998). 2.3.2 Emerging Issues Related to Reform in the Water and Sewerage Sector The concerns expressed regarding the reform process in the urban water and sanitation sector are similar to those related to power sector reform. However, privatisation in the water and sewerage sector is more controversial.19 Many argue that access to water to meet basic human needs is a fundamental right that should not be subject to private profit motives. Most cities in the developing world have large informal settlements that are not served by public services. Local community initiatives play an important role in upgrading these settlements and providing basic water and sanitation services. Many governments regard such initiatives with hostility and the state-owned water utilities often refuse to collaborate. There is a widespread suspicion among NGOs that private operators are going to be even less responsive to the needs of the poor and to community based programs. Unfortunately, because privatisation has been done on a city-by-city basis, the need for a proper regulatory regime has often been neglected. However, given the very direct impact that a regulator�s and concessionaire�s actions have on the quality of life in urban neighbourhoods, the need for transparent regulation�and popular participation in the process--is probably greater in the water supply and sanitation sector than in the power sector. Regulation is more complex in developing countries than in industrialised countries where regulation tends to focus on price/tariffs and a relatively narrow set of service indicators. In the major cities in the low income countries, only a small fraction of the population is connected to the pipe network and most of them get water only a few hours a day a few days a week. The great majority of households are supplied through public standpipes, water vendors or their own wells. Under such circumstances, extending and improving service�at affordable prices�are major regulatory concerns that require difficult trade-offs. Given that the responsibility for rural water supply in most countries is separate from that for urban water supply, the impact of private concessions for urban water supply and sewerage on rural consumers is negligible. Indeed, as the urban concessions reduce the need for subsidies, the privatisation process might even give governments an opportunity to focus more financial and technical resources on rural water and sanitation schemes.

2.4 Irrigation

Irrigation is the main user of water in developing countries and most dams have been built to serve canal schemes. Many of the canal schemes have failed to provide the quality of water supply (in terms of quantity, timeliness and reliability) that is needed for growing high value cash crops or achieving high yields from traditional food and fodder crops and existing schemes increasingly suffer from water logging and salinity problems (Dahwan, 1998, Postel, 1999 and Silliman & Lenton, 1991). Further, evaluations by multilateral agencies of their irrigation portfolios reveal considerable �appraisal optimism,� with a significant number of projects falling below an acceptable rate of return.20 These and other shortcomings of canal irrigation schemes are principally due to inadequate maintenance, management deficiencies, and inappropriate on-farm water management.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 14

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

The average financial returns to canal irrigation are quite modest and vary considerably from one farmer to the next.21 Water charges are typically set very low (presumably to reflect the level of returns accruing to the most marginal farmers rather than the returns to the average farmer). In many cases the water charges don�t even cover the annual O&M cost. Groundwater irrigation represents a noticeable contrast to most canal schemes. The private sector (individual farmers and groups or co-operatives as well as corporations) has long invested heavily in groundwater development and usually achieves excellent financial returns. However, subsidies for groundwater development may well have led to unsustainable levels of groundwater withdrawals (Postel 1999). The tradition of paying little for irrigation water supplied from state-sponsored schemes22 has meant that private investors essentially have no interest in building and operating canal irrigation schemes serving hundreds, if not thousands, of smallholders. Consequently, there are few canal irrigation schemes supplied from privately built dams anywhere in the world. During the colonial era, there were some private schemes built to supply water for large plantations. These were, however, rare exceptions. With the improvement in trade and transport logistics, some producers in developing countries have been able to successfully enter the global market for fruits, vegetables and flowers. The large estates that typically produce for the export market primarily rely on groundwater as the source of their irrigation water. There are, however, a small number of dams and associated irrigation networks that are being built by private estates such as Agro Guayabito A.S. in Peru.23 The development of privately owned canal schemes is often complicated by the issue of water rights. Irrigation is a large net user of water (rather than a temporary �borrower�) and the use of water by one farmer precludes the use of this quantity (with adjustment for return flows) by another. Although there often are conflicts between hydropower generation and irrigation, the riparian issue is much more contentious in the case of irrigation than in the cases of hydropower generation (especially if the scheme has little or no storage) and water supply.24 Building on the approaches developed for IPPs, there have been a couple of isolated cases where the government has sought to reap the benefits of the of private sector�s competence in construction management and operation of projects also in the irrigation sector. One example of this approach is the Casecnan project in the Philippines.25 Barring a few exceptions along the lines just described, large-scale irrigation development is likely to remain primarily a responsibility of governments. The reforms under way in a number of countries with large surface irrigation schemes have therefore focused on improving water distribution and water use by directly involving the farmers in the operation and management of the schemes. Farmers� participation can take a number of forms26 but increasingly farmers groups or autonomous irrigation units take on the administrative as well as financial responsibilities for O&M. In some cases, this also involves recovery of a part of the capital cost, either in cash or through labor contributions.

2.5 Flood Control and Navigation

Flood control is almost a textbook example of a �public good� and basically falls within the purview of governments. There are a few isolated cases, as under the private infrastructure initiative in the U.K., where the private sector has been brought in to build and maintain flood control facilities. The structure of such projects is most akin to long term lease agreements where the government defines where, when and how a facility will be built and pays a fee for the service.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 15

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Dams are virtually never built primarily to facilitate navigation. However, navigation has been classified as a secondary benefit in about 5% of the multipurpose dams. These benefits are rarely quantified. Like flood control, navigation is basically a public good and will not in itself attract private capital. For some issues related to financing of multipurpose dams see Section 5.4.

2.6 Small Scale Projects

The changing role of governments, however, is not limited to private sector participation in the financing, construction, operation and ownership of large-scale infrastructure facilities as described above. An equally fundamental shift is occurring in the development of small-scale infrastructure facilities in rural areas and in poorer neighbourhoods in cities and towns. It has been clear for a long time that participation by beneficiaries and grass roots institutions is critical for the long-term success of many types of development projects, especially small-scale infrastructure schemes in rural areas. All over the world, NGOs have worked with local communities and put in place mechanisms that both ensure that the poorest segments of the population benefit and that the results are sustainable. Until the early 1990s, most governments continued a top down, army type of approach to the development of renewable energy sources, village water supply, irrigation management and similar activities. The multilateral development banks found it difficult�if not nearly impossible�to reach down to the grass-roots level. Over the last decade, however, many governments have redesigned their rural development and squatter upgrading programs and the donor community has found ways of working with NGOs and designing projects that fully involve the local community and project beneficiaries. While both governments and donors have a long way to go, the movement is certainly in the right direction. The modalities varies significantly from one case to another depending on the type of development activity being undertaken, the strength of government and civic institutions, culture and local traditions. It is beyond the scope of this paper to review these approaches and to make recommendations. However, a number of successful examples and recommendations are provided in the various options papers prepared for the Commission. A wealth of information on this topic can be found on the website27 of the Participation Group at the Institute for Development Studies, Sussex. A couple of issues are especially relevant in the context of the present paper:

• These grassroots activities need to be explicitly incorporated into the relevant national sector policies.

• The relationship between local community initiatives and the programs of utility companies needs careful consideration by governments, regulators and concessionaires. There are numerous questions that must be addressed. How do community groups working on improving urban squatter settlements interact with the water utility? What kind of financial and technical support should be provided by the utility? Are the concession contracts for regional electricity distribution companies expressed in such a way that NGO sponsored village electrification programs are prohibited? There are many more questions�many of which cannot be anticipated when the �rules-of-the-game� are established for privatised utilities. This means that there has to be a transparent, highly participatory regulatory process for dealing with this kind of issues as they arise.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 16

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

3 Financing Statistics, Trends and Policies of International Financial Institutions

3.1 Introduction

Over the last decade, significant changes have occurred in the financial environment for developing countries. In part fuelled by the reforms described in the previous chapter, private financing for infrastructure facilities has overtaken the flows from bilateral and multilateral donors. One of the outcomes of the evolving policies of donors and budget constraints faced by most governments is that less public funding is available for the construction of dams. The private sector has not stepped in to make up for the shortfall in public funding. Rather, hydropower plants account for only about 5% of the generating capacity being added through private investments in developing countries. As a result, dam construction appears to have slowed down significantly over the 1990s. The aim of this chapter is to review the broader financial trends � and the forces behind them � and to assess their impact on the financing of dams and options to dams.

3.2 Dam Investments

3.2.1 Trends in Dam Construction There are no overall statistics on financial flows for dams as such and, consequently, a picture must be developed by pulling together a range of information from various sources that may or may not be internally consistent. The objective is to develop a plausible picture of historic financial patterns, current changes in patterns and assess the implications for dams in the future. One starting point is to look at dam construction over the past twenty years, and see first of all changes and trends in types, numbers and locations of dams and then to try to work backwards to the financing implications for the existing dams. The largest source of financing for dams is the domestic public sector. Unfortunately, little work has been done in the past to document these investments. International financial flows are well documented by the OECD, and for bilateral aid flows there is robust information on the amount of money spent on different dam related investment activities in various regions. While there is a changing pattern with private flows increasing relative to the total, these flows still appear minuscule relative to the total level of investments that have been made in dams over the past 20 years. Figure 3.1 below summarises the number of dams constructed in developing and industrialised countries since 1950. The ICOLD data suggest a steady growth up to around 1980 when the trend appears to have turned around. Although the data for the 1990s is incomplete, the rapid decline in recent years is clear (and consistent with data on financing flows presented later in this chapter).28 The level of investment in dams is likely to have declined as well, although it is not clear the extent to which decline in finance for dams is causal or reflecting other changes. There has been no thorough assessment of the total value of investments in dams. Briscoe (1998), drawing on the World Bank�s extensive data on private and public investments, has made the most comprehensive assessment of developing countries� investments in dams and water related infrastructure (although not for dams alone). He estimated that the total annual value of investment for hydropower was around $15 billion; for water supply and sanitation, $25 billion; and for irrigation and drainage, around $25 billion. The following sections seek to develop more specific estimates for dams alone, excluding associated infrastructure in electricity and water conveyance and distribution.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 17

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 3.1. Construction of Dams per Decade

0

1000

2000

3000

4000

5000

6000

1950s 1960s 1970s 1980s 1990sSource: ICOLD Database, 1998 Projected Total

Industrialized Countries

Developing Countries1998 Register

1998 Register

Projection

Projection

3.2.2 Value of Investments in Dams: Hydropower On the hydro side, the level of investment can be derived from analysis of the cost per MW capacity. The WCD Thematic Review Paper IV.1 on Electricity Supply and Demand Management Options gives a range of $500 to $2,000 per kW for run-of-river plants and $1,000 to $5,000 per kW for large storage projects. Head (1999) quotes figures for the cost per kW of hydropower dams as being between $1,000 and $3,000. An analysis of investments in 44 dam projects financed by IDB since 1970 indicate an investment cost per kW capacity broadly between $500 and $2,000.29 The IDB figures are appraisal estimates, i.e. ex ante. Adjusting them for likely cost overruns and delays, gives a range of $750 to $3,000.30 There is a remarkable consistency between these figures. It may be reasonable to take a figure at the higher end of the range and assume a cost per MW of between $1.50 and $2.25 million. (Equipment account for about 30% of the total investment cost per MW.) By 1996 the global installed capacity of hydropower was 709 GW according to the International Energy Agency (IEA). The four developing countries with the largest installed capacities in 1996 are Brazil (51 GW), China (48 GW), Russia (44 GW) and India (21 GW). Global hydropower generation according to IEA was 2,517 TWh in 1996, of which developing countries (i.e. non-OECD) accounted for 47%. Assuming that the plant factors were the same in both OECD and non-OECD countries, this would give an installed capacity of about 333 GW in developing countries. The WCD Thematic Review Paper IV.1 quotes a global figure31 of 655 GW installed capacity of which developing countries accounted for 333 GW or 51%. The results of this analysis are shown in the following tables. Table 3.1 shows estimated global hydropower production for the 1973-1996 period. It is interesting to note the shift in emphasis from investment in OECD countries to non-OECD. In 1973, the OECD countries accounted for 71% of the generation but the non-OECD countries accounted for almost two-thirds of the increase between 1973 and 1996.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 18

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Table 3.1. Estimated Hydropower Production (1973-96) and Installed Capacity in 1996

Production 1973

Production 1996

Increment 1973-96

Capacity 1996

TWh TWh TWh GW OECD countries 911 1,344 433 376 Non OECD 374 1,173 799 333 Total 1,285 2,517 1,232 709 Source: see Annex A. Data on capacity from IEA. Table 3.2 shows a tentative breakdown of hydropower capacity by region. By 1996, 19% of global capacity was in Latin America, while Asia (including China) accounted for 15%. Growth in hydropower capacity in was much stronger in non-OECD countries. While in OECD countries as a whole installed capacity increased by 1.7% per year, in the rest of the world the average increase was 5.1% and within this total was dramatic growth of 7% per year in China and Latin America, and nearly 5% in Asia (excluding China). Table 3.2. Regional Growth in Hydropower Capacity Region

Installed capacity GW (1996) (1)

% of total capacity, 1996

Growth in installed capacity, 1973 to

1996, % per year (2)

Hydro as % of total power generation in

1997 Former USSR 61 9 2.5 % 17.6 % Eastern Europe 14 2 2.3 % 24.5 % China 53 8 7.1 % 16.8 % Asia 46 7 4.6 % 16.7 % Latin America 138 19 7.4 % 75.5 % Africa 17 2 3.4 % 15.2 % Middle east 4 1 5.9 % 5.0 % Total non OECD 333 47 5.1 % 24.0 % OECD 376 53 1.7 % 15.1 % Total 709 100 3.0 % 18.4 % Notes: (1) Derived from IEA data (2) Derived from IEA data. Totals may not add due to rounding However, there are indications that the growth of hydropower generation in developing countries has declined over the last couple of decades. During the 1970s, the growth rate was over 6%, during the 1980s around 4% and slightly less than 3% since 1990.32 This implies that the new addition to hydropower capacity during the 1990s has been only about 8.0-8.1 GW per year. Applying the unit cost described above gives an estimate of annual hydropower investments in developing countries in the range of $12 billion to $18 billion during the 1990s. This is consistent with the figure provided by Briscoe (1998). 3.2.3 Value of Investments in Dams: Irrigation Reliable data on investments in dams and canal irrigation are relatively scarce. Since the purpose of this chapter is to estimate the overall order of magnitude, a couple of approximate calculations will be presented. Briscoe (1998) estimates that annual investments in irrigation in developing countries are of the order of $25 billion per year. The Global Water Partnership (1999) estimates that total water related investments amount to $75 billion, of which irrigation and water supply & sanitation account for $30 billion each. It is difficult to identify within this the proportion of the total attributable to dams. Certainly, this includes all the investments associated with public sector irrigation and drainage, and most of the private investments in groundwater. According to FAO data, the irrigated area in developing countries increased by 3.1 million hectares annually between 1993 and 1998. A review by Jones (1995) of 191 completed irrigation projects financed by the World Bank provides two different estimates of the construction cost. The low

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 19

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

estimate is about $5,000 and the high about $8,000 per hectare. Adjusting these figures for inflation gives a range of $20-30 billion, which is consistent with Briscoe�s estimate. It has been estimated that 40% of the irrigation investments in both India and the Philippines are made by private farmers for groundwater development. In Pakistan, the private sector share is as high as 70%. However, Pakistan with its deep aquifer in the Indus basin and its old canal schemes that provide additional recharge, is probably on the extreme high end for ground water development among the major irrigation countries. Thus, taking 40-50% as typical, and using the above figures on total investments, this would give annual investments in canal irrigation of $13-18 billion.33 There are roughly 200 million hectares of irrigated land in developing countries at present. India accounts for about 28% of this area. However, the country accounts for almost two-fifths of the annual growth in the irrigated area. During the first part of the 1990s, annual public sector expenditures on irrigation in India were around $5 billion per year, with most spent on dams and canal irrigation. Adjusting this figure for inflation and assuming that all developing countries, on average, expand their irrigated area in a manner similar to that in India, would give global expenditures on canal irrigation in the order of $15 billion. However, the cost of construction is low in India and the cost of canal schemes is lower than in most other countries (see Jones, 1995). Thus, $15-18 billion per year might be the most reasonable estimate for public investments in canal irrigation in developing countries (excluding on-farm investments). The percentage of cost of an irrigation scheme that is devoted to the construction of the reservoir varies considerably from case to case: for small canal schemes, the reservoir can easily account for four-fifths of the cost; in very large schemes, this share might fall to one-fifth. The average is probably somewhere between 50% and 60%, which would imply that annual investments in irrigation dams in developing countries during the 1990s was in the range of $8-11 billion. 3.2.4 Value of Investments in Dams: Water Supply and Flood Control Data in the World Development Report on infrastructure (World Bank, 1994) indicate that during the early to mid 1990s, infrastructure investments in developing countries were around $200 billion of which water and sanitation accounted for about one-sixth. This is very consistent with the estimate of $30 billion provided by the Global Water Partnership (1999). There is no such thing as a typical water supply scheme for a city. The sources of water and their location vary enormously from one city to another. However, some guidance can be provided by an analysis of ADB�s lending portfolio. Over the last three decades, ADB has made loans amounting to $5.4 billion (in 1998 terms) for water supply and sanitation projects. About 9% of that amount was spent on water supply dams. However, over the 1990s, the percentage has fallen to less than 5%. Using the latter figure, would give an annual investment of around $1.5 billion in dams built for water supply. A cross-check on this figure can be derived from ICOLD�s statistics on dams. About 7% of all the single purpose dams in developing countries are built for water supply and one-third of all multi-purpose dams have water supply as one of the objectives. However, single purpose water supply dams tend to be smaller than dams built for other purposes and water supply tend to account for a relatively minor share of the total investment in multi-purpose dams. Thus, the above estimate seems reasonable. About three percent of all dams built in developing countries have flood control as their single purpose. Slightly over one-third of the multi-purpose dams have flood control as a stated objective. As noted in WCD Thematic IV.4 �Flood Control and Management Options,� there is now a switch in emphasis from structural to management interventions. Thus, it seems reasonable to assume that annual investments in flood control dams are in the range of $0.5-1.0 billion.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 20

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

3.2.5 Annual Global Investment in Dams This rather rough and ready assessment then suggests that annual investment for dams in developing countries is in the range of $22-31 billion. Investment in hydro dams in OECD countries is of the order of $7-10 billion per year and $3-5 billion for other purposes. Bringing these broad-brush figures together, the total annual investment in dams during the 1990s seems to be of the order of $32-46 billion per year, of which developing countries account for about two-thirds. Considering the rise and fall of the pace of dam-building over the last half-century, an estimate of total expenditure on large dams during this period is $2 trillion. Table 3.3. Estimated Annual Global Investment in Dams During the 1990s

$ billion Developing Countries

Developed Countries

Total

Dams for hydro power 12-18 7-10 19-28 Dams for irrigation 8-11 Dams for water supply 1.5 3-5 13-18 Dams for flood control 0.5-1.0 Total 22-31 10-15 32-46 The figures in Table 3.3 include generating equipment in the case of hydropower and ancillary structures for other types of dams (but not canal systems for irrigation or distribution systems for water supply).

3.3 Sources of funds

The possible sources of investment funds for dams for all purposes are:

• Loans and grants from bilateral and multilateral sources;

• Public sector investments in country;

• International private sector investments, and

• Private sector investments in country. The international flows are reasonably well documented and clear trends in infrastructure financing are evident. The domestic investments are much harder to assess however. 3.3.1 Bilateral development assistance Analysis of the bilateral flows show that, in practice, these are a very small component of total investments. Table 3.4. Bilateral Aid Flows to Two Sectors Including Dams

($ billion in current prices) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Hydro-electric power plants 0.5 1.0 0.5 1.2 0.4 0.7 0.8 1.3 1.2 0.8 0.6 Agricultural water resources 0.5 0.5 0.4 0.5 0.5 0.2 0.4 0.5 1.0 0.5 0.5 Source: OECD CRS database

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 21

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 3.2. Total bilateral aid flows to the hydro-electric power sector

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

($ b

illio

n in

cur

rent

pric

es)

Source: OECD CRS Database While official aid flows may be significant in some sectors, over the past decade the total bilateral flow to hydropower and agricultural water resources is between $1 and 2 billion per year. Given the discussion above, it is reasonable to assume that no more than one-third of the loans and grants for agricultural water resources are for dams. This would give a total bilateral flow of less than $1.1 billion per year as compared with total dam investments (in non-OECD countries) of $22-31 billion. 3.3.2 Multilateral Flows Data on multilateral flows are more fragmented since DAC/CRS statistics do not break down multilateral flows (nor indeed private sector flows) by purpose. Thus, the lending for dam projects by the multilateral development agencies must be derived from a detailed analysis of their lending portfolios. In real terms, the World Bank�s lending for power, irrigation and water supply & sanitation has declined from about $6.6 billion per year in the early 1980s to about $3.6 billion during the last half of the 1990s. Table 3.5. World Bank Lending for Power, Irrigation and Water and Sanitation, 1970-99

Sector 1970-74 1975-79 1980-84 1985-89 1990-94 1995-99 Power 10.5 13.1 18.2 18.6 12.5 10.0 Irrigation 4.4 10.0 9.3 6.3 5.3 4.2 Water & Sanitation 2.8 6.1 5.4 5.2 5.8 3.9 Source: World Bank (1994) and various annual reports Notes: (in $ billion per 5-year period, in real 1998 dollar terms) Between 1970 and 2000, the World Bank financed 110 hydropower projects with a capacity of 35,000MW. The value of these loans is estimated at about $25 billion in today�s terms. However, hydropower lending peaked in the 1980s and there has been a sharp decline in recent years. For fiscal years 1995-99, the World Bank has made only six loans for hydropower projects, two of which involved the construction of new dams: Ertan in China (FY96) and Gilgel Gibe in Ethiopia (FY98).34

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 22

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

In addition, the World Bank has financed a couple of projects that include mini- or micro-hydropower plants. The World Bank�s lending for irrigation development peaked around 1980 and has steadily declined from about $2 billion twenty years ago (in present value terms) to less than $500 million in the fiscal year that ended in June 1999. At the same time, there has been a shift in emphasis from support of new canal schemes to improvements to existing schemes through rehabilitation and better water management. The decline in lending for water supply and sanitation has been less pronounced. Still, in real terms, the lending is down by more than one-third since the peak in the late 1970s. In total, over the 1995-99 period, the World Bank provided about $550 million per year for projects involving the construction of new dams and $520 million for projects that included components for the rehabilitation and refurbishment of existing dams. In many, if not most, of the projects, the �dam components� (as defined by the World Bank to include civil works for the dam and cost of land acquisition) were only minor parts of the projects. Thus, in the 16 projects that supported the construction of new dams, the dam components accounted for only one-sixth of both the total project cost and the loan amount. In the 32 projects supporting rehabilitation and/or improving the safety of dams, the dam component accounted for less than one-tenth of the investment cost and the loan amount. If only lending for the dam components is counted, the average falls to $134 million per year.35 By implication other project components such as electricity generating equipment, canal works, resettlement, watershed management and even components that are simply part of a larger multipurpose loan constitute a large portion of the total project cost. The Inter-American Development Bank (IDB) lent $9.4 billion for dams between the early 1960s and late 1990s, to projects with a total investment cost of $38 billion. The dam construction activities supported by IDB peaked about two decades ago and have declined drastically since then. While in 1982, for example, construction were on-going on 45 dams financed by IDB, this figure had fallen to 10 dams in 1999. (See Figure 3.2 below.) The bank made no loans for hydropower in the second half of the 1990s. During the second half of the 1990s, the annual amount of financing for dams is estimated to be around $200 million.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 23

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 3.3. Inter-American Development Bank Financing for Large Dams

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

1960-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94 1995-99

($ m

illio

ns, 1

998

pric

es)

Energy Irrigation Water Supply OtherSource: IDB, 1999.

The Asian Development Bank has also curtailed its dam construction activities in recent years (see Figure 3.4). For example, it has not financed an irrigation dam since 1989.36 Its lending for hydropower paints an equally striking picture. In the 1970s, hydropower projects accounted for 28% of its lending for power. In the 1990s, this share had fallen to less than 8%. Decline for water supply was similar: in the 1970s, the share of dam projects was 21% and in the 1990s, less than 5%. Thus, in the latter half of the 1990s, annual lending for dam projects has been around $100 million. Appendix 4 to this paper provides a set of charts on the trends in ADB�s financing of large dams and alternative water and energy investments, as well as trends in co-financing of dams that ADB has financed. Figure 3.4. Asian Development Bank Financing for Large Dams, 1968 to 1999

-

100

200

300

400

500

600

700

800

900

1,000

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

US$

M, 1

998

pric

es

Hydro Dams

Irrigation Dams

Water Supply

Source: Lagman (2000)

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 24

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Other Development Banks�EBRD, EIB, AfDB�Account for a smaller lending volume in support for dams than the bilaterals, World Bank, ADB and IDB. Figure 3.5 summarises available data for commitments on dam projects from these sources, including data from EBRD and AfDB. The graph reveals that lending from these sources peaked at around $4.4 billion per year in 1980-84 and has dropped steadily to approximately $2.4 billion per year in 1995-99. On this basis total financing provided by aid agencies and development banks for dams since 1950 comes to $125 billion. Figure 3.5. Bilateral and Multilateral Aid Donor Financing for Dam Projects, 1950 to 1999

0

5

10

15

20

25

1950-54

1955-59

1960-64

1965-69

1970-74

1975-79

1980-84

1985-89

1990-94

1995-99

US$

Bill

ions

, 199

8 pr

ices

EBRD /6

AfDB /5

ADB /4

IDB /3

Bilateral /2

World Bank /1

Source: 1Sklar and McCully (1994 eco029) and World Bank (2000a), 2OECD (2000), 3IDB (1999), 4Lagman (2000), 5AfDB (1998), 6EBRD (1996; 1999; 2000a; 2000b). Overall, official flows for dam projects for the most recent five year period can be summarised as follows: Table 3.6. Annual Financial Flows for Dam Projects from Aid Donors, 1995-99

Development Agency Annual Amount ($ billion) Bilateral donors 1.0 billion World Bank 1.1 billion Asian Development Bank 0.1 billion Inter-American Development Bank 0.2 billion Other Multilateral Agencies N/A. (probably less than 0.2 billion) Total around 2.5 billion Note: Includes expenditure on new dams (including associated infrastructure, mitigation programs and ancillary structures) and refurbishment/rehabilitation of existing dams. 3.3.3 International Private Sector Investments Overall Trends in Private Capital Flows DAC statistics show the total value of international private sector flows. Figure 3.6 compares private financial flows with official aid flows for developing countries over twenty years and demonstrates the relative shift between the two.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 25

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 3.6. Financial Flows of Private and Official Capital for Developing Countries

$-$20,000$40,000$60,000$80,000

$100,000$120,000$140,000$160,000

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

Year

US$

(Milli

ons)

Total Net OfficialFlowsTotal Net PrivateFlows

Source: DAC Database 1978-1997 Figure 3.6 describes the private flows on a �net� basis, i.e. debt repayments are deducted from the disbursements. Furthermore, foreign direct investments are excluded. In assessing the impact of private capital flows on new investment projects in developing countries, it is more appropriate to look at the gross capital flows. Thus, Figure 3.7 describes the gross private capital flows since 1990. A couple of features are especially noteworthy. First, equity flows�both foreign direct investments and portfolio investments�have grown in importance: in 1990, equity accounted for roughly one-quarter of the total private flows; in 1999, this share had risen to over half of the total. Second, equity flows have continued to grow, albeit at a more modest rate, over the last couple of years. A major part of the increase in recent years can be explained by privatisation of state-owned utilities. (World Bank, 2000b) Third, after a expansion of lending in the up to 1997, commercial banks and other private lenders have become much more cautious following the Asian crisis. Thus, total private sector lending to developing countries fell by more than one-third between 1997 and 1999 and lending to private clients without public sector guarantees was more than cut in half over the same period.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 26

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 3.7. Private Capital Flows to Developing Countries ($ billion)

0

50

100

150

200

250

300

350

400

450

1990 1993 1994 1995 1996 1997 1998 1999 Public & Public Guaranteed Debt Private Non-Guaranteed Debt Foreign Direct Investments (net) Portfolio Equity Investments

Debt Flows

Equity Flows

Source: World Bank (2000b) Figure 3.8. Regional Patterns of Private Capital Flows (Average 1998-99 in $ billion)

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

SS Africa South Asia M East & N Afr E Europe & C A East Asia Latin America

Public & Publ Guar Debt Non Guaranteed Debt Foreign Direct Investments Portfolio Equity

Source: World Bank (2000b)

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 27

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

The private flows are, however, very concentrated. Very little of the private capital has found its way to Sub-Saharan Africa and South Asia. Indeed, on a per capita basis, the inflows to South Asia are far below those to other regions. Middle income countries account for four-fifths of total private flows to developing countries. China accounts for almost two-thirds of the flows to low income countries, with India receiving about one-third of the remainder. Thus, only about five percent of total private flows have gone to all other low-income countries in Africa and Asia. Private Investments in Dams and Other Infrastructure For reasons that are discussed elsewhere in this report, private infrastructure investments in developing countries have increased eightfold from 1990 to reach $120 billion in 1997. As can be seen from Figure 3.9, there was a decline in 1998 following the Asian crisis. (Although details are not available, the indications are that the decline continued in 1999.37) For the decade as a whole, the investments were close to $600 billion. Telecommunications was the sector that first attracted large private investments, followed by power. During the 1990s, a total of $131 billion was invested in private power schemes, of which $73 billion (56%) was for greenfield generation projects. Private investments in transport infrastructure (toll-roads, ports, airports and railways) have also been significant. As discussed in Chapter 2, private investments in water and sanitation have been slower to materialise and much lower in money terms. Figure 3.9. Trends of Private Sector Investment for Infrastructure

0

20

40

60

80

100

120

140

1990 1991 1992 1993 1994 1995 1996 1997 1998

Water & San.TransportEnergyTelecoms

There has been some private sector interest in hydro investments. The International Finance Corporation played a catalytic role by approving financing for 7 private hydroelectric power projects between 1990 and 1995. Most of these were small � between 10 to 73 MW but one was a large 450 MW run of the river project. Based on unpublished figures from the World Bank�s database on private infrastructure, Briscoe (1998) estimated that about 12% of private power investments between 1990 and 1995 were devoted to hydropower projects. Another World Bank study estimates that hydropower accounted for 7% of the capacity of private power projects that reached financial closure over the 1994-96 period (Izaguirre, 1998). For large projects with limited recourse financing, the share of hydropower was estimated at 5% in terms of installed capacity. These capacity figures would imply that, in financial terms, hydropower would account for around 10% of total private investments in power generation. The World Bank�s database, however, is believed to include some projects that have been postponed or cancelled. Thus, these figures should be regarded as upper limits.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 28

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Rojas and Aylward (2000) have analysed the information on power projects in the Projectware database.38 According to their analysis, green-field power generation projects (in developing countries) with a total investment cost of $69.1 billion reached financial closure between 1994 and the end of the first quarter of 2000. Hydropower projects accounted for $6.2 billion or 9.0% of the total. While this database includes some public sector projects that have obtained commercial financing, most of the projects are privately owned and operated. Rojas and Aylward�s figures also indicate that the capacity of the hydropower projects that have reached financial closure was 4,200 MW or about 5.8% of the capacity of the projects in the database. A different picture emerges from a study by Cambridge Energy Research Associates (CERA, 1997), which suggests that in 1996, the portion of hydro in total IPP closings was only 1.5% in capacity terms. The same study suggests that for the 1991-96 period, hydro accounted for 2.5% of the capacity of new privately funded projects. The latter figure would imply that that only about 5% of total private power generation investments were devoted to hydropower schemes. These estimates give a range of private hydropower investments of $0.5-1.1 billion per year for the 1990s. Overall, private investments in water supply and sanitation have been modest compared to the investments in the power sector. Most of these investments have been devoted to network improvements and some water and sewerage treatment facilities. No significant investments in dams appear to have been undertaken so far. While the private sector has invested major amounts in groundwater development, little money has been spent on dam projects. A couple of multi-purpose projects with irrigation components have been built on a BOT basis. Private companies owning major estates producing flowers, fruits, vegetables or other cash crops have occasionally built dams to provide year-round irrigation. In aggregate terms, however, these investments are minor compared to private investments in hydropower. 3.3.4 Export credit agencies Export Credit Agencies (ECAs) played a significant role in the boom in private sector financing for infrastructure during the 1990s. The export-import banks of Canada, France, Germany, Italy, Japan, the UK and the US (the so-called G7 ECAs) supported between them more than $300 billion in exports to developing countries between 1994 and 1996. This was slightly more than was provided by the World Bank and regional development banks together. This support reflected the growing number of privately led business projects indicated in Figures 9-12. The energy sector has been a substantial recipient of such flows, but they have mainly been investments in thermal power plants, partly reflecting the larger volume of thermal power plants and the higher equipment component in such projects. The ECAs play an important role in limited recourse transactions in all countries with less than an investment grade credit rating. Thus, they appear to have been part of the financing packages for most of the private hydropower transactions. In terms of support for public sector projects, the ECAs have been quite liberal in financing equipment purchases for the electro-mechanical plant at hydropower plants. Some of the ECA supported projects (such as the public sector Three Gorges Dam in China and the proposed private sector Ilisu hydropower project in Turkey and Maheshwar in India) have proven to be quite controversial. Consequently, some of the ECAs are reluctant to provide aggregate figures on their financing of dams and an overall picture must be pieced together with fragmented data. Although some of the ECAs can provide financing for local costs, the bulk of their loans and guarantees support exports of goods and equipment. The amount of imported equipment installed in irrigation and water supply dams is minor. In most developing countries, however, imported

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 29

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

generating equipment amounts to around 30% of the total investment cost in hydropower.39 Based on fragmented data from a few agencies and considering the needs of imported equipment,40 it can safely be assumed that the ECAs provide significantly less than $1.5 billion annually for various types of dams in developing countries. It appears that the most active ECAs in providing support for dam (and especially hydropower) projects are those from Canada, Germany, Japan and Switzerland. The Export-Import Bank of the US (USEXIM) can provide financial support for hydropower and other water resource projects, although demand for finance for these has declined in the past decade. The USEXIM together with OPIC, also from the US, are widely regarded as having the most stringent social and environmental requirements among the ECAs. While the USEXIM has lent significant sums for hydro dams, the peak year was 1989 and lending has been much lower since (see Figure 3.10). It is also interesting to note that lending for hydropower considerably outweighs lending for irrigation dams � this pattern is consistent among all the financing institutions. Figure 3.10. EXIM Bank Financing

$0

$20

$40

$60

$80

$100

$120

$140

$160

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

($ m

illio

ns, c

urre

nt p

rices

)

Investments in hydroelectric projects Investments in irrigation projects 3.3.5 Domestic Private Sector Financing of Dams Virtually all infrastructure services derive their ultimate revenues in local currencies. Where obligations to suppliers or providers of debt and equity are denominated in foreign currencies, the project or utility is exposed to convertibility, transfer and exchange rate risks. Since foreign investors and lenders generally are unwilling to bear these risks, these are typically shifted to the government and/or to consumers. For example, most green-field power generation projects have their tariffs linked to the US dollar and the government guarantees the availability of foreign exchange for debt service and expatriation of profits. This makes it desirable to maximise the domestic content in infrastructure projects (provided that the quality doesn�t suffer unreasonably) and to mobilise as much of the financing as possible from

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 30

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

domestic sources. This is especially the case for dam projects that tend to have a large civil works component. In industrialised countries, there is a long history of mobilising part of the funds needed for new state-owned infrastructure facilities through bond issues. In the hydropower field, good examples are the provincially owned hydropower corporations in Canada and the Tennessee Valley Authority in the US. During the 1990s, a number of state-owned utilities in Asia were partially privatised through public equity offerings. These utilities have subsequently operated on a commercial basis and have financed part of their expansion programs through bank loans, bonds and sale of equity. Today, utility shares account for about one-fifth of the stock market capitalization in Malaysia and Thailand. However, even some of the fully state-owned power companies, such as WAPDA in Pakistan, have mobilized funding by issuing bonds on the domestic capital market. Far too often, however, state-owned utilities have poor financial performance and cannot access funding from the private sector. The privatization of utilities in Latin America took a different course from that followed in East Asia. The major objectives in most Latin American privatizations were to reduce government foreign currency debt and to quickly improve the performance of the utilities. Thus, the basic approach was to sell controlling stakes to foreign corporations that assumed operating responsibilities. Greenfield projects in power generation have been financed predominantly through offshore equity and debt, with relatively few exceptions. Most projects in Thailand and Malaysia were sponsored by local industrial groups and financed primarily with local bank loans. In Chile, the pension funds have been major investors in infrastructure projects. Gradually, however, domestic bank loans are used for the financing of new power investments in other Latin American countries. Most large hydropower projects have been financed predominantly with overseas bank loans or with support from the multilateral development institutions. One of the few exceptions is the Ita project in Brazil that has mobilized about $400 million from the Brazilian National Development Bank. The $103 million debt for the Bakun project in the Philippines was originally underwritten by a consortium of local banks but was subsequently partially syndicated to a group of foreign banks. Of special interest, however, is the emergence of smaller hydropower projects in countries such as Armenia, India and Sri Lanka. In the case of Armenia and Sri Lanka, the size of the projects in the order of 1 MW while the size in India is more than ten times as large. What is notable about these projects are that they are small enough for local entrepreneurs to mobilize the equity and for domestic banks to provide all of the debt. 3.3.6 Domestic Public Sector Financing for Dams There are very little data on dam financing available on a country-by-country basis. It is worth noting though that the vast majority of funds for investment in dams are generated in-country. As Briscoe notes, developing countries spend about $250 billion per year on infrastructure investment and about 90% of this are financed through government tax revenues � or loans taken out by governments. Foreign financing has contributed to varying degrees with greater contribution in Latin America, China and south East Asia. Of the (tentative) $22-31 billion invested in dams each year in developing countries, about four-fifths is financed directly from the public sector. The overall financing pattern that emerges from the analysis in the previous sections is summarised in Table 3.7.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 31

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Table 3.7. Current Sources of Financing for Dams in Developing Countries.

Source of Funds Approximate Amount Share of Financing Bilateral & Multilateral Donors 2.5 billion 7-10% Export Credit Agencies <1.5 billion 5-7% Private Sector (local & foreign) 0.5-1.1 billion 2-5% Government Agencies & State-Owned Utilities 17-27 billion 78-86% Total Investment in Dams 22-31 billion 100%

3.4 Policies and Instruments of International Financial Institutions

3.4.1 The Policy Frameworks of the Multilateral Development Banks As noted above, there has been a general pattern among international donors to move from direct investments in infrastructure and capital projects to social programs. Although they are independent and adopt their own policies, there is a large degree of commonality in their policies and strategies. The key reasons why lending for dams by development banks has declined are: 1. Environmental and social (�safeguard�) policies have become more explicit and comprehensive.

In the case of the World Bank41, the key safeguard policies concerning dams are:42

• Environmental Assessment (always required for large dams);

• Natural Habitats;

• Cultural Property;

• Indigenous People;

• Involuntary Resettlement;

• Forestry;

• Safety of Dams; and

• Projects on International Waterways;

2. Internal review processes have been strengthened (the World Bank, for example, has appointed an external Inspection Panel which can review the compliance by staff and managers to the Bank�s policies and procedures);

3. Lending policies, especially in the power sector, seek to promote reform and encourages governments to bring in the private sector;

• IFC and the private sector �windows� of the regional development banks have expanded their activities during the 1990s and give priority to infrastructure projects;

• New instruments�especially partial risk guarantees�have been adopted to support private investments;43

4. Greater emphasis is being placed on sound macro-economic policies and reduction in poorly targeted subsidies (for example, the large subsidies typically associated with public sector canal irrigation schemes);

5. Country strategies focus more on poverty alleviation and environmentally sustainable development, which, inter alia, has led to:

• An increased emphasis on energy efficiency and renewable energy sources;

• Projects designed to involve the beneficiaries in the design, construction and operation of small-scale infrastructure projects such as rural water supply;

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 32

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

• A greater focus on rain-fed farming in remote and less developed regions;

• A realisation that large-scale canal irrigation has generally been less effective than small-scale schemes and farmers need to be involved in irrigation management.

6. Evaluations of lending operations supporting dam projects are mixed:

• In some cases, it has been difficult (if not impossible) to ensure that the borrower has adhered to the lending agency�s safeguard policies;

• Cost overruns have been more serious than in the case of non-dam projects meeting the same purpose;44

• While on the average, it appears that the construction delays are about the same for dam and non-dam projects,45 the dam projects can sometimes experience extreme delays.46

Box 3.1: A Culture to Lend?

Many critics argue that the World Bank is driven by a �culture to lend,� implying that the quantity of lending is more important than the quality or development impact of the projects it finances. Many World Bank staff members would agree. Indeed, an internal task force headed by former World Bank Vice President Willie Wapenhans forcefully made the same point (World Bank, 1992). However, the Bank�s current President is consistently stressing the importance of quality while down-playing quantitative lending targets. There are a number of indications that he is serious (as were his predecessors) and that the culture is slowly changing:

• A Quality Assurance Group (created in the mid-90s and located in the President�s Office) reviews the quality of the Bank�s lending operations in �real time� rather than ex post as the Operations Evaluations Department.

• An independent Inspection Panel created in 1993 to provide an independent forum to private citizens who believe that they or their interests have been or could be directly harmed by a project financed by the World Bank. The Panel reviews the compliance of staff and managers to the Bank�s policies and procedures.

• The Bank�s Country Strategy Papers for low income countries are not only discussed in draft form with the concerned government but also with civil society groups. After extensive reviews by the Board, the finalized Country Strategy Papers are published on the Bank�s web site. This is in sharp contrast with the situation two decades ago when these documents were not even seen by the government or by the Executive Directors on the Bank�s Board.

• Summaries of all proposed lending operations as well as the complete Project Appraisal Documents are also available to the general public on the web site. This makes the Bank�s decision making regarding its lending operations more transparent.

• Most safeguard policies (on environmental and social issues) have been gradually strengthened. Similarly, the Bank has increasingly sought to involve the target population in project design and implementation and NGOs are emerging as development partners (albeit, the Bank still has a long way to go in this area.)

Finally, the overall lending level of the World Bank has gradually declined in real terms for more than a decade (in spite of a burst of quick disbursing lending in the aftermath of the Asian crisis). In the fiscal year that ended on June 30, 2000, the overall lending of the World Bank ($15.3 billion) was the lowest in nominal terms since 1985 and in real terms (i.e. after adjustment for inflation) the lowest since 1974.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 33

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

3.4.2 The Policy Frameworks of Bilateral Donors and ECAs Most bilateral development agencies follow policies and strategies that are similar to those of the multilateral agencies (although the emphasis varies from one agency to the other). The issues raised by NGOs relate less to their written social and environmental policies as such than to perceived weak monitoring and enforcement mechanisms. Even the Swedish and Norwegian development agencies that are often regarded as two of the leaders on environmental and social issues, have been criticised for being unduly influenced by their domestic hydropower industries (see Usher 1997 eco026). The export credit agencies are still in a transition process from the time when they exclusively helped finance exports for private industrial plants and equipment for state-owned infrastructure facilities. As they have become more involved in the financing of private infrastructure projects, they have generally adopted more stringent environmental and social/resettlement policies. USEXIM and OPIC have been in the lead in strengthening these policies. Export-Import Bank of Japan (JEXIM) is also a leader in this respect (in part due to its dual role as an ECA and a bilateral development agency). Still, a number of ECAs are widely seen as having weak policies and lax enforcement. Indeed, there is a strong suspicion among environmental groups that many project developers �shop around� for ECA support and seek support from those institutions that have the least stringent environmental requirements. Some countries with more strict environmental policies for their ECAs also complain about unfair competition from those with more lax policies. As a result, OECD�s �Working Party on Export Credits and Credit Guarantees� has been given the mandate to exchange environmental information and to develop common approaches to handling environmental issues. 3.4.3 Emerging Instruments for Support of Public and Private Dam Projects There are great similarities in the lending policies and instruments among the multilateral development banks. Often, but in no way always, the World Bank Group is taking the lead in adopting new instruments or policies. Thus, for ease of presentation, this section focuses on the World Bank Group. The World Bank Group consists of four main parts:

• The International Bank for Reconstruction and Development (IBRD) lends to governments or to private or public sector entities (with a government repayment guarantee) at a quasi-commercial interest rate. IBRD mobilises the bulk of its resources by placing bonds on the international capital markets. All middle-income and a couple of low-income countries (China, India and Pakistan) are eligible to borrow from IBRD.

• The International Development Agency (IDA) provides long-term, soft loans to governments in low-income countries. Grants from the industrialised countries provide most of IDA�s resources. IDA can lend only to governments, not to government agencies or private enterprises.

• The International Finance Corporation (IFC) is the private sector arm of the World Bank Group. It provides equity and debt to private companies that invest in developing countries. Its lending terms are commercial. IFC cannot accept government repayment guarantees for its loans (which IBRD requires).

• The Multilateral Investment Guarantee Agency (MIGA) provides political risk insurance for private investments in developing countries. The insurance can be provided for both debt and equity investments.

In the early 1990s, IBRD developed a number of instruments to help mobilise funding from the private sector for development projects. The two main vehicles that are used today are:

• Partial credit guarantees are used to mobilise commercial loans for public sector projects. Such guarantees have been used to mobilise commercial bank loans for state-owned utilities in China and Jordan. Due to IBRD�s commitment to cover part of a potential default by the borrower,

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 34

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

these commercial loans have longer maturities and lower interest rates than what would be possible otherwise.

• Partial risk guarantees are used to help mobilise financing for private infrastructure projects in countries with a credit rating that is below investment grade. A partial risk guarantee protects the commercial lenders in the case of default by the project company due to certain political events.47

Until a year ago, partial risk guarantees could be provided only to countries eligible for IBRD loans. Subsequently, on a pilot basis, guarantees can now also be provided to IDA countries. Guarantee operations are subject to the same environmental and social policies as regular World Bank loans. In order to bring in additional commercial financing in countries with marginal credit rating, IFC has started a program of �B-loans.� B-loans are syndicated loans where IFC is the lender on record. Although the B-loan program of IFC doesn�t formally provide protection against a government�s failure to make foreign exchange available for debt service, most bank regulators in industrialized countries regard B-loans as having a de facto preferred creditor status. Although the structure of the regional development banks is simpler than that of the World Bank group, they have the same basic features:48

• They lend to most governments on quasi-commercial terms (similar to IBRD);

• They have �soft� or concessional windows for lending to low-income countries;

• They have private sector windows that can provide equity and debt for private sector projects;

• They can provide partial risk guarantees like IBRD and B-loans like IFC.

3.4.4 The Outlook for Lending by the Multilateral Development Banks Support for Dam Projects The long-term lending trends described in the previous sections are likely to continue. They are reflections of slowly evolving paradigms of development economics and of the political mandate of their main shareholders. Thus, the overall lending levels are unlikely to increase in real terms. Investments in basic infrastructure facilities are likely to continue their downward slide. The private sector will be counted upon to play a growing role in the provision of electricity, municipal and industrial water supply and sanitation. However, the financing of dams by the multilateral agencies has declined to quite a low level. In part, this decline in lending for dams has been due to internal uncertainty about the acceptability of dams. If the WCD process leads to the wide acceptance of environmental and social guidelines for the construction of dams, this internal uncertainty (and the resulting reluctance to process operations involving dam construction) will be reduced. This could result in a modest increase in support for dam construction by the multilateral agencies. If this is the case, the bilateral agencies are likely to follow in the same footsteps. The overall increase, however, is unlikely to be very large. Government budgets will certainly remain the dominant source of financing for dams, with the private sector potentially taking on a greater role. Support for Non-Dam Options During the 1990s the multilateral and bilateral lending agencies have increasingly focused on poverty alleviation and environmentally sustainable development. With this has come a renewed focus on energy efficiency and renewable energy sources. While renewable energy projects become a part of the lending portfolios about a decade ago, the initial projects were essentially of a pilot nature aimed at testing not only technological packages but also delivery mechanisms. By now, these projects have

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 35

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

moved from the pilot stage to full-scale applications. Thus, while, for example, the World Bank doesn�t have any generation project in its published project pipeline, it has around two dozen projects in the lending pipeline that focus on the development of renewable energy sources or on enhancing energy efficiency. This trend is expected to continue over the next decade.

3.5 Implications

The implications of this discussion seem to be that:

• Overall financing of dam based projects has slowed down substantially since the heyday of the 1970s and 1980s.

• In part this reflects the global shift away from public sector financing to partnership and deregulated private sector investment. Dam based projects � whether for irrigation, water supply or hydropower - offer less attractive financial conditions for private sector investors than non-dam alternatives.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 36

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

4 The Emergence of New Financing Instruments for Large-Scale Private Sector Water and Energy Resource Projects

4.1 The Basic Principles of Project Finance

The preferred way of financing private infrastructure schemes in the developing world is �project finance.� This means that the repayment of the financing relies on the cash flow and the assets of the project itself rather than on the strength of the sponsor�s balance sheet. The risks (and returns) are borne not by the sponsor alone but by the different participants in the projects. There are two basic types of project finance: non-recourse and limited recourse project finance. Non-recourse financing implies that the lenders to and investors in the project do not have any direct recourse to the sponsors, for example through loan guarantees. Although creditors� security include the assets being financed, they tend to be illiquid and of limited value. Thus, the lenders rely on the operating cash flow generated by the project. Limited recourse financing allows the lenders and equity investors some recourse to the sponsors. Such recourse often involves some form of pre-completion guarantee by the sponsors. In either case, the project needs to be carefully structured to ensure lenders that it is economically, technically, and environmentally feasible and that it is capable of servicing the debt under most reasonable scenarios. Crucial to the successful structuring of a project financing is the identification and mitigation of risks. These risks are allocated among the project participants through a comprehensive set of legal documents, usually referred to as the �security package.� The security package achieves two things: (i) it allocates risks to the parties that best can manage those risks; and (ii) it ensures the long-term commitment of the parties to the project. Figure 4.1 illustrates the basic structure of the security package for a power project. The key agreements in the security package are: The Implementation Agreement (IA) or Concession Agreement sets out the conditions under which the project company can operate. It also sets out the government�s obligations to the project company. Typically, it protects the company against changes in law and taxation and against certain political force majeure events. Depending on country conditions, it might also have provisions related to the availability of foreign exchange for debt service and profit remittances and convertibility of the local currency. The Guarantee Agreement (GA) commonly covers the government�s undertaking to ensure that various state-owned entities (especially the power purchaser) fulfill their obligations. The Power Purchase Agreement (PPA) between the (state-owned) utility and the project company covers, inter alia, the long-term commitment by the utility to buy power at a pre-defined price. It also defines a number of technical and financial undertakings by both parties. The tariff typically is divided into two parts: a capacity charge (that guarantees the project company sufficient revenues to service the debt even if the plant is not dispatched) and an energy charge. Generally, the tariff formula includes indexation for general inflation, devaluation and changes in fuel costs. The Fuel Supply Agreement (FSA) between a coal, gas or oil supplier and the project company defines the terms and conditions for long-term sales of the fuel in question.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 37

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

The Turn Key Construction Contract (TKC) typically provides for a fixed price and includes severe penalties in case completion is delayed. In most cases, the contractor is also responsible for designs and procurement of all equipment. The Operation and Maintenance Agreement (O&MA) is entered into with a company that has acknowledged expertise in operating power plants. Although such contracts tend to have shorter duration than the FSA and PPA, they typically covers the period while the bulk of the loans are being repaid. Like the TKC, the O&MA includes significant penalties for the O&M contractor in case he fails to meet the agreed performance targets. The Loan Agreements (LA) are entered into with the lenders. For larger projects (say, over $100 million) the loans tend to be syndicated to a group of banks. The loans typically have maturities of 10-12 years, with repayment starting shortly after the planned start of commercial operation. Most commercial bank loans have a floating interest rate, which provides for a spread over the 6-months LIBOR. Depending on the creditworthiness of the country where the project is located and the risk profile of the project, the spread over can vary between 1% and 4%. The Inter-Creditor Agreement (ICA) defines the relationships between the different lenders. It covers, inter alia, the procedures for handling an eventual default by the project company. Figure 4.1. Security Package for a Power Project

ICA

(PED-NDFC)IC

Cabinet/Government

PromotionalAgency

RegulatoryAuthority

State-ownedUtility

FuelSupplier

TurnkeyContractor

ProjectOperator

PROJECTCOMPANY

ProjectSponsors

SeniorLenders

SubordinatedLenders

EquityInvestors

IA

FSA

TKC

O&MCSA

LA

LA

GA

PPA

4.2 The Structure of A Limited Recourse Transaction

The basic principle in limited recourse finance is that the project�s cash flow provides the assurance to lenders that they will be repaid. This means that the debt-service ratio is of critical importance. The minimum acceptable level for this ratio depends on the risk profile of the project. The main variable that can be used to ensure an adequate debt-service ratio is the amount of equity (and quasi-equity or

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 38

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

sub-ordinated debt). For most thermal power projects, this has typically resulted in a demand by the lenders that the equity provided by the sponsors and other investors should cover at least 25% of the cost of the project (including interest during construction). Since equity is more expensive than debt, the desire to have the most competitive tariff for the power sold, will result in the equity being as close to what the lenders regard as the minimum acceptable. Box 4.1: Project Finance Risks

Identification and mitigation of risks are at the core of limited recourse financing for infrastructure projects. Of course, every project is different and it is not possible to compile an exhaustive list of risks or to rank them according to importance. What is a major risk in one project might be negligible in another. The risks are also very different for different participants in a project. What might look like a major risk to the project sponsor/developer might not concern the government or the lenders. The nature of the risks also changes over time as the project moves from early planning stage through construction and commercial operation to eventual decommissioning. Lenders and developers typically make a distinction between commercial and political risks. The former cover risks that are a natural part of doing business such as construction of the plant and its efficient operation, market prospects and interest rates fluctuations. Political risks have traditionally included such events as insurrections, major strikes and expropriation. However, in the project finance context, political risks are seen much more broadly and typically cover all factors that are directly controlled by the government or strongly influenced by government actions or in-actions. Thus, political risks include the availability and convertibility of foreign exchange, changes in law, timely approvals and issuance of permits and licenses, the contractual performance of government owned entities. The borderline between commercial and political risks is often fuzzy and varies from case to case. Typically, the risks are classified depending on the stage of the project. The financiers of a project would be concerned about the following risks: Development risks. The process from project concept to financial closure can be long and cumbersome. The detailed feasibility study might demonstrate that the project isn�t viable or lenders might consider macro-economic conditions too risky for long-term loans. However, bureaucracy and slow approval processes and drawn-out negotiations of the key contracts are the most common obstacles that seriously impact the viability of the project�assuming that the basic policy and regulatory framework doesn�t change during the development phase. In India, for example, after more than five years of negotiations, only two of eight �fast track� projects have reached financial closure. The risks at this stage are taken by the project sponsors. Construction risks. These are almost universally mitigated through a fixed-price, date certain design and construction contract. Thus, the turnkey contractor assumes most of the risks. However, there are residual risks that affect the sponsors and lenders such as those due to foreign exchange and interest rate movements and a variety of political force majeure risks. Operating risks. The proper operation of the plant is ensured through warranties by the equipment supplier/turnkey contractor and through an O&M contract with an experienced operator. The availability of fuel is ensured through a long-term contract with a reliable supplier. Most critical, however, is the off-take risk that in the case of power plants typically is mitigated through a long-term contract with a state-owned utility. The risks associated with economic factors outside the project company�s control are typically passed on to the state-owned utility (and the final consumers) by linking the tariff to an index that includes general inflation, devaluation and changes in fuel costs. The next major issue that needs to be tackled is the risk of cost overruns. Although the principle is to have a fixed price construction contract, there are always factors that can legitimately increase the

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 39

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

construction cost (such as exchange rate movements, interest rate changes and unforeseen foundation problems) or delay completion. To deal with this problem, it is common to require the sponsors to give a commitment to increase their equity contribution. Similarly, the lenders often make a commitment to provide a limited increase in the loan amount. These contingent funding amounts are usually referred to as �stand-bys.� The stand-bys typically range between 5% and 10% of the base financing. The real challenge, however, is that a project never can have a credit rating which is higher than the country where it is located. Thus in most countries with a credit rating which is below investment grade,49 commercial banks will be reluctant to take the risk of the host country running out of foreign exchange. This means that there often is a need to seek insurance cover from one or several of the ECAs. Since ECA coverage is linked to the export of equipment, the sourcing of equipment is often determined by which ECA is willing to provide cover to projects in the host country. Given the limitations on ECA support, there is often a need to seek financing from IFC or one of the regional development banks. In addition, other risk mitigating vehicles are sought, such as B-loans and partial risk guarantees from the World Bank and the regional development banks. The commercial risks are partly mitigated by the lenders through the debt-service limits. In addition, the lenders seek to spread the risk through syndication. Local currency expenditures typically make up part of the cost. This means that it is prudent to also mobilise local debt, wherever feasible. In short, the financing package for a major infrastructure project in a low income country tend to be highly complex, involving a number of commercial banks, a couple of ECAs and one of the IFIs.

4.3 Key Issues Related to Limited Recourse Financing

Issues that have surrounded limited recourse financing of infrastructure projects, and especially power generation projects, include:50

• An over-reliance on foreign borrowings is making additional claims on a country�s foreign exchange earnings and jeopardises its creditworthiness. This is in no way inherent in the project finance approach but rather a result of the host country�s underdeveloped credit market or the private sector being crowded-out by excessive government borrowings. Indeed, most project sponsors and the foreign lenders would like to see as much as possible of the financing provided by domestic banks and equity investors. Malaysia is one of the countries with the largest amount of money invested in private infrastructure projects and local banks have provided much of the financing.

• Governments have assumed too great contingent liabilities through the guarantees provided in the implementation or concession agreements. However, if government agencies had undertaken the same investments, the government�s direct and indirect liabilities certainly would have been even higher. It should also be noted that in normal limited recourse transactions, the host governments do not guarantee the returns to investors or repayment of the loans. The real issue is the failure of governments to properly account for the contingent liabilities in their own foreign exchange management strategy.

• The cost of the power (or other output produced by the project) is too high due to the high cost of financing. Implicit in this argument is typically the assumption that concessional financing would have been available. Given the policies of the donor community described above, it is not at all certain that concessional financing would be available for power generation projects.51 Furthermore, the soft terms are intended to benefit the borrowing country. Most donors would argue that such funds should be on lent to the utilities on commercial terms (with the treasury

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 40

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

using the �spread� to help finance urgently needed social programs). If the utility itself sought commercial financing, in most cases the terms would be no better and possibly worse than those obtained by properly structured BOO/BOT projects (see Box 4.2).

Box 4.2: Is Private Power More Costly?

A frequent comment in the discussion of private power generation is that it is too expensive and that the existing state-owned utility can generate power more cheaply. This argument deserves careful scrutiny since it is commonly the result of faulty assumptions and incomplete (or biased) analysis. The first key assumption is that the plant will be built for the estimated cost and completed as planned. However, as Bacon et al (1996) demonstrated, most power plants experience both delays and cost over-runs. Their review of 135 generation projects indicated that the average project experienced a cost over-run of 21% and the completion date slipped by 36%. Taking into account the interest during construction, the combined effects of the slippages, these two factors increased the capital cost of the projects by one-third. The second key assumption is that the plant will be operated according to best practices. However, as noted by the World Bank, poor maintenance means that the typical public sector generating plant in developing countries is available for operation only about 60% of the time as opposed to more than 80% of the time under best practices. Thus, cost over-runs, completion delays and operating problems often results in capital costs (per kWh of energy produced) that are 50-100% higher than estimated at the sanctioning stage. IPPs are typically built with fixed-price, date-certain construction contracts, which means that the tariff will not be adjusted if there are construction delays and/or cost over-runs. Similarly, a failure to meet the plant availability targets typically results in penalties to be paid to the power purchaser who, thus, doesn�t have to absorb the cost of poor operation and maintenance. The comparison of private and public sector power generation is often biased through implicit subsidies in the financing of state-owned facilities. Frequently public sector entities are provided credit on very favorable terms either from the government or from commercial banks due to treasury guarantees or lending directives. Any lending terms (in terms of interest rates and maturities) that are better than those that can be obtained by private sector entities (with similar creditworthiness) represent subsidies to the utility and should be removed before any cost comparisons. Basically, government owned utilities and well-structured IPPs should be able to access commercial debt on similar terms. Many governments also provide equity to state-owned entities on which they earn little or no return. Again, this represents a subsidy that tends to obscure the real cost of power development. Theoretically, the target return on governments� equity investments should reflect the opportunity cost of government revenues, which would tend to vary from country to country. On the whole, however, it would tend to be higher in developing than in industrialized countries. A reasonable order of magnitude for the return on equity would be 10-15%. For example, Vattenfall AB, the big Swedish state-owned power company, earned a 12% return on equity during the second half of the 1990s. IPP investors, however, typically require higher returns on their equity. In general the returns are 16-20%. For IPPs with a debt-equity ratio of 3:1, the higher target return increases the annual capital cost by around one-sixth. In short, any comparison of the cost of power generated by public and private plants must be done carefully and take into account the actual operating performance.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 41

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

5 Issues and Emerging Practices in the Financing of Dams

5.1 Hydropower Dams

5.1.1 Overview Role in Global Generation Hydropower currently accounts for approximately twenty percent of the world's electricity production, with about 650,000 MW installed and approximately 135,000 MW under construction or in the final planning stages. Notwithstanding this, there are large untapped resources on all continents, particularly in the areas of the world which are likely to experience the greatest growth in power demand over the next century. It is estimated that only about a quarter of the economically exploitable resource has been developed to date, leaving the potential for hydro to continue to play a large role in sustaining renewable global electricity production in the future. However a number of factors are currently combining to prevent this potential being realised. In particular, the worldwide trend towards deregulation of the power industry is seriously impacting on the perceived "attractiveness" of hydro and this is being exacerbated by increasing sensitivity, and in some cases open opposition, on environmental grounds. As a result there has been a marked downturn in the numbers of new hydro projects being started, with the consequence that under present trends hydro is heading towards playing a smaller role in global generation in the future. Current Situation Deregulation of the power sector is invariably accompanied by privatisation of the generating function. As noted in Section 2.2.1, this has led to the emergence of the Independent Power Producers (IPPs) which are private companies specifically created to finance, develop, own and operate power stations. IPPs vary greatly in character and size, but they all have the common objective of commercial viability, which tends to be measured in terms of their ability to raise funding, and generate profits in the medium-term. Unfortunately hydro tends to be a long-term, capital-intensive investment, which does not sit easily with these objectives, and for this reason only less than one-twentieth (by capacity) of new IPP projects are hydro. The great majority of the remainder is fossil fuel burning thermal generating plant (gas, oil, and coal). In recent years a number of countries with large hydro resources have actively pushed forward programs to encourage private investment in the hydro sector. Although this has been successful as far as the sale of existing assets is concerned, the experience in terms of encouraging the private funding of new hydro projects has been disappointing. The record to date shows a high failure rate, with projects often taking several years to bring to financial closure and incurring excessively high up-front costs. Notwithstanding this, a number of private hydro projects have been completed and governments continue to adjust their policy to try to overcome the obstacles. The international agencies are also closely involved, and the World Bank has recently commissioned a study into the modalities of private hydro financing with the objective of determining what other steps can be taken to facilitate the process (see Head 1999). As can be seen from Figure 5.1, the Projectware database indicates that projects with a total planned capacity of slightly over 4,000 MW reached financial closure from the beginning of 1994 and the first quarter of 2000 (Rojas and Aylward, 2000). This capacity was about evenly split between, Latin America, Eastern Europe & Central Asia and South & East Asia. The database did not record any private hydropower schemes reaching closure in the Middle East or in Africa.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 42

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 5.1. Private Hydropower Plants Reaching Financial Closure, 1994-2000

0 200 400 600 800 1,000 1,200 1,400 1,600 MW of Installed Capacity

Latin America

Asia

E Europe & C Asia

M East & N Africa

Sub-Saharan Africa

Source: Projectware database (Rojas and Aylward, 2000)

In parallel with these private sector initiatives, there remain many hydro projects being built by publicly owned utilities in countries like China, India and Iran. At present these represent by far the larger proportion of hydro projects under construction, but the trend is towards public funding becoming scarcer and it is likely that when the present tranche of projects is completed, it will not be replaced at the same level as before. Irrespective of whether projects are being developed in the public or private sector, the environmental issues are looming larger and taking a more central role than in the past. Whereas twenty years ago the Environmental Assessment (EA) for a prospective hydro project would occupy perhaps one chapter in the Feasibility Report, it is now invariably a separate report, often with detailed supporting annexes and usually undertaken by an independent party. Many, but not all, countries would require the studies to be undertaken to World Bank or similar guidelines, and most international consultants in the sector would expect to work to these standards. This does not avoid contentious issues, but it ensures that they are identified and thoroughly investigated in advance of any final commitment to the project. As a result the more recent projects have generally been subjected to a much more thorough environmental screening process than previously. The trends discussed in the previous chapters and the increasing environmental concerns give rise to a number of interrelated issues that are explored in this section of the report. Character of Hydropower Plants A central feature of the issues to be explored here is the uniqueness of each hydropower site, and the importance of developing that site for the optimal national benefit (i.e. for utility purposes) consistent with acceptability amongst local stakeholder groups. These objectives are encapsulated in the emerging criteria for hydropower projects in a number of countries, which require that they should be:

• Economically viable

• Environmentally sustainable

• Acceptable to the local community.52

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 43

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

To appreciate the first point it is necessary to understand the differences between basic types of hydro project, and the quality of electricity that they can produce. They are: Run-of-river projects have no reservoir and generate only on the natural, unregulated river flow. These projects have relatively minor environmental impact, other than the depletion of river flows between the intake and powerhouse on tunnel schemes. However due to the lack of storage they produce relatively low value base load energy, and offer few of the ancillary benefits inherent in a storage project (e.g. load following, spinning reserve, energy standby). Storage projects have the flexibility to adjust output to meet system requirements. They are used to store energy and service the high-value peak of the load curve. Most importantly they are more responsive in terms of load following frequency control and emergency standby than any other form of generation. In summary storage projects produce higher quality electricity, but at the cost of generally raising more environmental concerns over such issues as loss of land, population displacement and changed flow patterns. The distinction between these two types of scheme is not absolute. Some run-of-river schemes can have very limited storage (e.g. hourly) and reservoirs for storage schemes can provide everything from daily to seasonal regulation. For example in Southern Africa it is not unusual to find reservoirs which can hold three times the mean annual flow (MAF) whereas in South-East Asia, with its more regular rainfall pattern, typical storages might be the equivalent of three to six months' MAF. 5.1.2 Trends in the Regulatory Environment Traditionally hydropower projects have been developed by public sector utilities, and the question of regulation has not arisen. However, with the move towards private ownership of power projects, the regulatory environment becomes very important. This is particularly true in the context of hydro where each project involves the "once-only" exploitation of a unique national asset (the site) with the associated land and water rights. Experience has shown that hydro requires a different regulatory environment from thermal power because the issues are more complex, they affect more stakeholders and a greater level of public support is needed to make projects viable in the private sector. The special regulatory problems posed by hydro include:

• Ownership of the site, water rights and the regulation of natural flows.

• The allocation of risk between the public and private partners.

• Responsibility for feasibility studies and project definition.

• Responsibility for the EIA and any environmental mitigation measures and resettlement.

• The level of public support needed to achieve bankability under a private sector scenario.

• The method of awarding the concession. Early attempts by some governments to attract private investment to the hydro sector on the basis of an ill-formulated regulatory framework and unclear risk allocation proved a failure. The private sector response to such overtures was poor because of concerns over:

• Perceived high commercial risks, particularly in terms of uncertain energy production and high exposure to completion risk due to the nature of the works.

• Delays and heavy costs involved in feasibility studies and obtaining the necessary permits.

• Possible late interference and unforeseen costs or delays arising from environmental and resettlement issues, and problems with land and water rights.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 44

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

• Difficulty in financing projects with a large local civil works content and long payback periods. It became evident that if private investors are to be attracted to fund hydro projects, the public sector has to be prepared to assume some of the risks, and to play a much larger role in the project than for thermal IPPs. Furthermore, there are key issues to be resolved regarding the interface between the public and private partners if the project is to be developed and operated in a way that realizes the full potential of the site. In general, private hydro schemes are on a BOT basis (build, operate, transfer) with the scheme eventually reverting to the state-owned utility at the end of the concession period. Under such arrangements, it is natural that the private concessionaire will take a shorter-term, narrower perspective that may be in conflict with the broader interests of the host government and the utility. For example, most private hydro projects are being promoted as run-of-river schemes because financiers and guarantee agencies are reluctant to become involved with storage projects due to concerns over environmental problems and negative publicity. In consequence there is a tendency to develop run-of-river schemes irrespective of whether the site might be better developed as storage project yielding higher quality electricity and possible multipurpose benefits. Other problems can arise when it comes to the operation of existing storage schemes, where a private operator will naturally try to adopt a reservoir release policy to maximise the returns from the sale of electricity. Under a power pool system there will be a tendency for all hydro schemes with storage to bid into the peak of the load curve where the higher price is obtained, but this can result in an unacceptable pattern of river flows downstream and may be in conflict with other requirements. The regulatory framework therefore has to address, on the one hand, the need to induce the private sector to participate in an area in which it is not particularly comfortable, and on the other hand provide the necessary checks and balances to ensure that the wider and longer-term national and local interest is being preserved. A key issue with which many governments are struggling is the method of awarding hydro concessions in a manner that meets certain basic obligations, namely that:

• The site is developed in an optimal manner, not only for the power system but also for multi-purpose use where appropriate;

• The selection of the concessionaire, and the setting of tariff levels, meet adequate standards of public accountability;

• A sensible balance is achieved between the benefits that the state receives and the support that it provides.

• The project meets adequate environmental criteria, and is acceptable to the local population.

• The engineering, operation and maintenance of the project are consistent with public safety requirements and maximising the project life.

The World Bank study already mentioned, examined trends in the regulatory environment for in about seven countries at various stages of development. All have been trying to promote privately financed hydro with varying degrees of success, and tuning their regulatory approach accordingly. The current position can be briefly summarised as follows: Lao PDR. Legislative reform has been focussed on encouraging foreign investment for the development of export projects as Lao's hydro resources are far in excess of its domestic demand. Two projects have reached the construction stage and a third (Nam Theun II) is still under planning following a delay of several years while the environmental impact was reviewed.53 There is no BOT legislation as such. Each project has been directly negotiated on a tripartite basis between the developer, the government and EGAT, the Thai utility. The government is expected to benefit as a

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 45

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

shareholder using concessionary ADB lending to purchase its shares and from royalty payments and tax revenues. Potential export revenues will form a significant part of GNP. Nepal. Nepal also has hydropower resources far in excess of its domestic requirements. Like Lao it has been traditionally dependent on concessional financing, but the New Industrial Policy of 1992 opened the door to private financing. To date there have been two privately funded hydro projects (36 MW and 60 MW) aimed at the domestic market. Both have been directly negotiated and depend heavily on support from international lending agencies (ILAs). The trend is now towards encouraging competitive bidding for the next generation of domestic projects, and reviewing the way forward on larger export projects. Philippines. The government and the utility (NPC) have modified the regulatory framework considerably following a poor response by the private sector to earlier rounds of BOT hydro bidding. Despite many attempts and a large number of projects being offered to the private sector, there are only three BOT hydro projects actually under construction. Negotiations on a number of others are being blighted by the reluctance of the utility to enter into further power purchase agreements pending full privatisation of NPC. There have been no public sector hydro projects for many years. Turkey. The position is similar to the Philippines in that there much effort has resulted in very little action on the ground. Despite favourable risk sharing arrangements from the viewpoint of the private developer, and the "award" of about 80 BOT hydro concessions, only a handful of projects are under construction. One of these is the 600 MW Birecik project that is reported to have taken eight years to negotiate. There is growing recognition that the private hydro program in Turkey is stalling due to bureaucracy and financing problems. India and Pakistan. Both countries have tried, largely unsuccessfully, to attract private finance to the hydropower sector, and both have recently issued new policy guidelines which lay more emphasis on state participation in private projects, particularly in terms of project preparation, environmental permitting and support with financing. Much emphasis is being placed on the sharing of commercial risks and the provision of sovereign guarantees for the underwriting of power off-take agreements. Brazil. Currently undergoing deregulation of the power sector, with accompanying legislation to encourage private generators. The regulatory framework is based upon a competitive bidding process that varies according to the size of project. To date most of the activity has focused on the sale of existing assets, but there are a small number of new quasi-private hydro schemes in progress, many involving the local utility company in partnership with private industries. As will be seen from the above, the picture is unclear and changing. No standard regulatory model has emerged for hydro projects, but in general terms the trend is in the following directions:

• In most cases utilities are assuming production risk (i.e. payments are not dependent on river flows) and sharing some of the construction risks.

• The public sector is increasingly recognising that the feasibility study and project definition are public responsibilities, and that it is anyway advantageous to retain them in the public sector.

• Similarly EA studies and the resulting mitigation/resettlement plans have to be carried out by the public sector before the private sector becomes involved.

• The host government has to be prepared to back the utility's payment obligations with sovereign guarantees.

• Political risk cover and funding support mechanisms are needed from the ILAs whose role is central to the success of most privately financed hydro projects.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 46

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

In conclusion the public sector in the form of the host government, the utility and the ILAs will continue to have a strong influence on any new hydro projects irrespective of whether they are developed in the private or the public sector. 5.1.3 Trends in Project Financing The cost breakdown of a typical hydro project (as a percentage of the total cost) is as follows: Civil Works 60 - 70% Equipment 25 - 35% Engineering 5 - 10% As the civil works are largely local costs, a significant proportion of the total project funding could be sourced in local currency if it was available, and would return immediate benefits to the local economy. In contrast most thermal power stations have a very high percentage of equipment, which is usually imported, and the foreign exchange component can reach over 80%. In the past it has been difficult to exploit this advantage in the developing world, because of limitations on local capital resources and the fact that the scale of the works is usually beyond the capability of local firms. In practice hydro projects, especially in low-income countries, have therefore also had a large foreign exchange component, generally by the multilateral development banks or bilateral donors. Twenty years ago, a major portion of public sector hydro project in the developing world was financed by donor agencies, but in more recent years there has been a tendency for this type of financing to be restricted to the civil works leaving the remainder to be funded through export credits.54 In addition to providing finance, most export credit agencies (like the USEXIM, ECGD, Hermes and Coface) offer insurance cover for certain types of risk in support of their own exporters. ECA funding is more readily available than straight commercial lending and at somewhat easier terms that sit partway between commercial credits and loans provided by the international development banks like IBRD and ADB. Hydropower projects have long gestation periods and economic lives and are capital intensive. Whereas the cost of energy from thermal stations has a major fuel component that is common to both public and private sector projects, the cost of energy from a hydro plant is totally dominated by the overall cost of the works including finance. Thus, the declining availability of government funding and long-term loans or grants from the donor community has a significant impact on the development of hydropower projects and alternative means for meeting the growing energy demand in developing countries. The ways in which a hydropower project can be financed depends on its size and whether it rests in the public or private sector. Broadly speaking the options are as follows: Public Sector Public sector projects are typically financed from either central government funds or by the utility on the strength of its balance sheet, which normally implies corporate borrowing. Depending on the country concerned it might still be possible to mobilize debt from one or other of the ILAs, although this is a diminishing source of funds (see Chapter 3). More creditworthy borrowers in the developed world will often raise money on the bond markets. Public sector financing will undoubtedly remain an option in a number of countries where the power utility still is state-owned, and in those areas of the world where the necessary legislative framework is not in place. However it has to be recognised that the global trend in the financing of infrastructure projects, including power, is inexorably towards increasing dependence on private investment.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 47

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Although a project may initially be publicly funded, it is possible to introduce private finance at a later stage by selling or leasing a completed project. In general an existing hydro asset is an attractive investment provided the power off-take position could be secured. In countries like China, the public sector is either borrowing on the strength of existing hydro assets or selling equity in them. However this approach is clearly only viable if there is sufficient public sector funding available in the first place to implement the project. Private Sector Financing for Large Projects Private sector projects are generally financed as stand-alone IPPs created specifically for the purpose of developing, owning and operating the project. Whereas thermal power projects are generally of the BOO type, most hydropower schemes are eventually transferred back to the state or the utility, and the concession is therefore granted on a BOT basis. Hydropower projects are riskier than thermal power projects and, thus, debt/equity ratios for hydro projects are typically in the region 70%/30%. For thermal power projects with their high equipment content, the traditional source of debt has been the export credit agencies. However for the typical hydro project ECA credits are unlikely to account for more than 30% of total project cost. With equity accounting for perhaps another 30%, this leaves 40% of the overall project cost including financing to be sourced from elsewhere as follows: Sponsor's equity 30 % ECA credits 30 % Commercial loans or ILAs 40 % Total 100 % Unless the host country has a well developed financial market and/or an investment grade credit rating, this gap is usually too large to be filled by commercial loans and experience has shown that for the larger projects ILA support is usually needed. Amongst the projects examined in the recent World Bank study (Head, 1999) the ILAs were seen to have acted in a number of roles, including:

• surrogate lenders (i.e. through the host government)

• direct lenders

• equity holders

• providers of technical assistance

• guarantors. In general, private financing is only sustainable with support from the host government and within a security package that often requires sovereign guarantees (see Chapter 4) Some of the international power developers are assembling portfolios of projects located in a single country. So far, these holdings generally have not been consolidated into a single corporate entity. However, as privatisation of existing generating plants is progressing and more green-field projects are being built, such consolidation is likely to occur. This offers some hope that the project finance approach will gradually be replaced by a corporate finance approach, which would facilitate the mobilisation of long-term debt. An intermediate approach has been adopted by a few developers who have pooled the debt of several projects and issued bonds with the revenue stream from the pooled projects as security. Private Sector Financing for Smaller Projects One of the difficulties with the financing of large-scale hydro projects is that in most developing countries, local capital markets are too under-developed to finance a major share of the civil works

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 48

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

component. This, of course, has led to developers seeking international financing and, thus, putting additional strain on the balance-of-payments of the host country. Consequently, it is encouraging to find that local entrepreneurs in some developing countries have shown an interest in the development of small hydro projects. Such projects can range from a couple of hundred kW to perhaps 10 or 20 MW. (The upper limit largely depends on the ability of local banks to provide long-term financing). Armenia, for example, has established an independent regulatory authority and restructured the power sector. The units of the formerly state-owned monopoly have not yet been divested. However, private entrepreneurs have invested in 13 small hydropower plants that now produce about one percent of the country�s electricity. Similarly, with the help of an IDA credit, Sri Lanka has encouraged private investments in small hydro plants (with capacities ranging between a couple of hundred kW to a couple of MW). Over the last three years 13 projects have been built with an aggregate capacity of 12 MW. Local banks are presently considering loan applications for projects with a total capacity of 16. (The IDA funds are channelled through local banks at commercial interest rates�although at somewhat longer maturities than would normally be available.) India also seems to be on the verge of rapid development of small hydropower plants (although the size range is higher than in Sri Lanka and Armenia). Besides reducing the balance of payment impact of hydropower development, these small-scale projects tend to be fairly inexpensive (in Sri Lanka the cost ranges from $800 to $1,300 per kW) and have short gestation period. Furthermore, the social and environmental impacts tend to be limited. Politically, these small-scale projects with local owners are often more acceptable than large projects with foreign owners. One pre-requisite for this type of small-scale development is that the government has an efficient approval process and use simple, standardised power purchase contracts with an uncomplicated and transparent tariff formula. Public-Private Partnerships Many types of hydro project are proving to be difficult to finance entirely in the private sector, and yet traditional sources of public funding are no longer available. The solution to this problem may well be a combination of public and private funding, with the public sector providing in effect the minimum needed to bring the private financiers to the table. This can be achieved in a number of ways: Hybrid Projects where the project is effectively divided into separately financed public and private elements. For example, the public sector can finance the dam structure and the private developers can be responsible for the powerhouse. This approach is most common in multi-purpose projects, such as the San Roque project in the Philippines. Another variation on the same approach is when a private developer retrofits the powerhouse associated with an existing publicly owned dam. Lease-Purchase Arrangements under which public money in injected into the project in the form of lease-purchase payments during the construction phase to reduce the amount of private funding required. This has the effect of reducing the amount of private finance needed (and overall cost of the project) making it more affordable and bankable. Under both of these arrangements ownership and effective control of the project remain in the hands of the (public sector) utility. To date there is little actual experience of implementing projects under these arrangements (although similar approaches have been used extensively for other types of infrastructure).

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 49

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

5.1.4 Future Roles for the Public Sector in Hydropower development Irrespective of the actual source or arrangements for financing, it is evident that in the future the public sector must continue to play an important role in the development of all but the smallest hydropower projects. Although the arrangements will vary from country to country, and from project to project, it can be anticipated that the support of the host government and its utility will continue to have a strong influence on most future hydro projects, notwithstanding the trend to increased private sector participation. In summary:

• The host government will establish the necessary legal and regulatory framework, and overview the terms under which any private concessions are awarded. It will levy any taxes and other charges (e.g. water), and in most cases will be required to guarantee the obligation of the utility, particularly in respect of payment.

• The utility should prepare the projects in sufficient detail and assume responsibility for environmental permitting and any mitigation measures. It will generally conduct the solicitation process and be the contracting party in any power off-take agreement.

• Although traditionally off-take agreements have been long-term, for concession periods of 20 years or more, in totally deregulated markets this may not be tenable and IPP owners will then have to find their own buyers or sell on a short-term "spot" market as merchant plant. Although one or two small private hydro plants are being developed as merchant plant, it is doubtful whether medium to large schemes can be financed on this basis�except in countries with well developed regulatory regimes and with investment grade credit ratings.

• The ILAs will continue to play a central role in the provision of finance which can either be on quasi-commercial terms direct to the IPP company, or, where appropriate, to the host government which can then on-lend to the IPP company at commercial terms or use the loan to purchase equity in the project. .

• An increasingly important role of the ILAs is to facilitate the flow of foreign investment by the provision of political risk guarantees through organizations like MIGA and the provision of credit enhancement mechanisms such as the World Bank partial risk guarantees55 that can be used to extend the maturity of debt financing.

5.1.5 Influence of Financing on Project Selection It has already been noted that the current trend towards the private financing of power projects has resulted in a marked downturn in start of hydropower projects, with a commensurate increase in new thermal stations. However, it is also influencing the type of hydro schemes being developed, in the following ways:

• There is a swing away from storage schemes to run-of-river projects, because private developers and financiers are reluctant to expose themselves to the risk of delays, cost increases and cancellations arising from opposition to reservoir projects. The fact that most hydropower purchase agreements fail to place a value on peaking energy or the ancillary benefits associated with storage further reinforces this trend.

• Limitation on funding and the time it takes to construct large projects has tended to restrict the size of privately financed hydro schemes to under 300 MW. Although larger schemes are in contemplation, the evidence to date suggests that it will be very difficult to privately finance the larger hydro projects that could make a significant contribution to regional energy balances in South America, Africa and parts of Asia.

• The configuration of all hydro projects is unique to the site, but for privately financed hydro it tends to be driven by the need to eliminate risk, reduce construction time and achieve adequate returns over the medium-term. Such considerations may or may not conflict with the longer-term

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 50

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

and wider interests of the state in achieving the optimum development of the site, but such conflicts can exist.

• There is a tendency on the part of private developers to avoid multi-purpose projects because of: the perceived complications of dealing with a number of government departments representing the different water-user interests; the low�or non-existent�revenues from purposes other than power generation, and the fact that most multi-purpose projects involve storage.

• Projects on international rivers are relatively rare because of the reluctance of international organisations like the World Bank to become involved unless there are water-sharing agreements endorsed by the affected riparian states.

In terms of environmental impact assessments, and the subsequent mitigation measures, the outcome is not significantly influenced by the approach to project financing, because the international banking community, ECAs and the major commercial lenders are all moving towards adopting a consistent approach which is to require studies to internationally acceptable guidelines before they will even consider a project for financing. 5.1.6 Constraints and Opportunities For about one hundred years hydropower has been used as a renewable energy resource. It is, indeed, the only renewable resource that is available in a sufficiently concentrated form to be commercially exploitable on a large scale in a way that can impact on world energy balances. Hydro also has great longevity. Many of the projects that were developed in the early part of the twentieth century are still operating perfectly satisfactorily today. On a well-designed plant the civil works should last indefinitely, and the electro-mechanical equipment may well last for 40 years or longer. Traditionally, hydropower has been used in certain societies as a catalyst for local and national development. This extends from the small mini-hydro schemes serving isolated communities in many parts of the world, to the mega-projects that have been used for developing large regions through the provision of employment, improved infrastructure and a cheap energy. In the days of the former Soviet Union certain of the Central Asian republics, like Kyrgyzstan, were developed largely on the basis of their ability to supply the rest of the Soviet Union with abundant and cheap hydro energy. The creation of the Tennessee Valley Authority and the, initially, massive federal subsidies were aimed at developing this lagging region in the USA. In future a number of low-income countries with abundant hydro resources and little other export potential (like Lao PDR and Nepal) have the prospect of significantly adding to their GNP through the export of hydro energy to neighbouring states. For example the controversial Nam Theun II project56 in Laos would generate revenues of more than $250 million/year through the sale of energy to EGAT in Thailand, and the government's share over the concession period would amount to about 50% derived from a 25% equity holding in the project company, royalties and other levies. The country offers few other opportunities for creating export revenues of this magnitude. It is notable that the importance of hydro to local and national economies invariably overrides transient political differences where projects hare a common boundary. For example the Kariba project on the Zambezi continued to operate and supply power to both Zambia and Zimbabwe right through the Rhodesian war of independence when the two countries were effectively in conflict. There are similar examples elsewhere in the world. Given the obvious benefits it may well be asked why hydro appears to be falling out of fashion. As already noted there are a number of constraints that together are continuing to stifle new hydro development. They are:

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 51

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

• The withdrawal of public sector funding from infrastructure projects in general, and power in particular because it is perceived to be commercially viable in its own right.

• The reluctance of private investors to engage in projects that have long lead times, heavy front-end expenditure, a high risk profile and long payback periods.

• The problems of financing projects with a relatively low import content and a high proportion of local civil works costs, often in countries with a low credit rating and immature capital markets.

• The financing problem is exacerbated by the reluctance of many ILAs and commercial bankers to become involved with projects that they think might become controversial.

• Developers themselves are naturally tending to opt for the easiest projects, which do not necessarily reflect the optimal development of the site or the project that the system most requires.

• The lack of a clear regulatory framework and a mature, proven model for the private financing of hydropower projects is also inhibiting progress.

• The price of projects is being increased by the risk sharing mechanisms and contract arrangements imposed by bankers, and by the cost of raising private finance. When combined with the relatively short payback period this often results in unacceptably high tariffs�especially in the early years--which cannot compete with the thermal alternative.

• The comparison with thermal plant is further distorted by the fact that hydro is increasingly required to internalise its environmental mitigation and social costs (e.g. resettlement) whereas in most countries there is no carbon tax or similar charge levied for the environmental impact of fossil-fuel generation.

5.1.7 Key Issues Arising from New Approaches to Project Financing Several of the most controversial hydropower projects in recent years have been pursued by private developers: Bakun in Malaysia, Maheshwar in India, Ilisu in Turkey, Nam Theun II in Laos. It must be noted, however, that all four projects were originally planned as government sponsored schemes and that, due to a shortage of public financing, the concerned governments in essence invited the private sector to construct the schemes. It is also noteworthy that none of the schemes, after several years of negotiations and resource mobilisation, have reached financial closure.57 Still, this leads to a fundamental question: �Will private developers and their financiers accept and conform with the guidelines that are likely to be proposed by the WCD?� An answer to this question can be derived from the experience from the private infrastructure projects that have been built over the last decade and from the risk minimisation process inherent in limited recourse financing. Hydropower facilities (and other dam projects) have greater up-front costs than alternative projects serving the same purpose.. Adopting WCD�s recommendations on an appropriate environmental and social framework for the construction of dams will likely add to these up-front costs. However, compliance with WCD recommendations will indicate that a dam project has a wider social and environmental acceptance and, thus, completion and other risks would be significantly lower than for non-compliant projects. Consequently, most lenders (who are highly risk averse) are likely to insist that the projects they finance conform to international best practices, i.e. to WCD guidelines. For the sponsors, adherence to the guidelines would be a key factor to maximise the probability that the project would be financed. There is also a possibility that the risk minimisation could lead to lower up-front financing costs (e.g. through lower interest rates, better bond rating, lower insurance costs, etc). In general, however, the main benefit of conforming to the guidelines would be to ensure financing for the project.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 52

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Box 5.1: Murphy's Law and the Mandate of the WCD

Murphy�s Law (�anything that can go wrong, will go wrong�) is the basic premise on which project finance is based. The Eurotunnel, the largest project financing in recent times, resulted in losses amounting to many billions of dollars for both equity investors and lenders. In simple terms, the problems were delays, cost overruns and overoptimistic revenue projections. The lessons learnt from this experience are now reflected in the security package for infrastructure projects in developing countries. Fixed-price, date-certain turnkey construction contracts are aimed at limiting the construction risk for the financiers. Similarly, the off-take agreements (for example, power purchase agreements) seek to ensure that the state-owned utility will buy a reasonable amount of the output and pay a fair price. Besides the obvious technical/engineering risks (geology and hydrology) that large dam projects pose, the environmental and social issues related to the construction of dams increase the risk to lenders and equity investors. Basically, project financiers see these as political �completion risks� that can delay and increase the cost of the project and ultimately make it into a failure. The starting point in any due diligence process carried out by commercial lenders is the question: �Does this project meet all legal and regulatory requirements?� This leads to a number of more specific questions:

• �Does the sponsor have legal title and unencumbered access to the land?� • �Does the project meet all environmental requirements of the government?� • �Does the project meet all safety requirements?� • �Has the project received all required clearances and licenses?�

A negative answer to any of these or similar questions means that the project will not be financed. Difficulties arise when the answer is ambiguous. This is rarely the case in energy and water resource projects such as thermal power plants that do not involve the construction of dams. In the case of dam projects, however, the social and environmental impacts are much wider and few developing countries have norms and procedures that are unambiguous and acceptable to the affected people. This, of course, is why dam projects tend to be highly controversial. Under these circumstances, commercial lenders are unlikely to take the completion risks. Broad acceptance of a clear set of the criteria and guidelines � such as those that are expected to emerge from the Commission - and the incorporation of these in national resettlement and environmental policies will reduce the ambiguity and, thus, the perceived risks to investors and lenders. While the adoption of such criteria and guidelines might increase the cost of individual projects (and reduce the investors� return), this will be outweighed by the risk mitigation impact of the guidelines. Consequently, the forthcoming WCD guidelines are likely to be an attractive alternative to �business as usual� for reputable developers and lenders. A related issue is raised by the distinction between financial and economic analyses of profitability (see Thematic Review III.1 on Financial, Economic and Distributional Analysis). Economic analysis may be used to identify the most attractive option from the standpoint of the national economy (including its social and environmental effects) but there is no guarantee that the top project will be the most financially attractive project, or that it will be financially viable.58 This is a result of two factors: (1) the difference between the financial and economic benefits of water and energy services and (2) the difference between the social/environmental impact of the project as viewed through either the economic valuation of these impacts or the financial costs/benefits of internalising these through available mitigation and financial mechanisms. As part of the process, then, there is a need for a partnership between private developers and the government to ensure a �financeable� allocation of costs and risks. Otherwise, projects that meet society�s objectives � whether they are dam or non-dam alternatives � may go un-funded in favour of projects that meet the narrower criteria of financial

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 53

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

viability. Since the divergence between economic and financial results will vary from project to project, there is a need for governments to be flexible in their support and adjust it based on the individual situation. As far as the "big dams" debate is concerned, the other issues arising from the new approaches to project financing can be summarised as follows:

• There is a need for clarity in the consultation and environmental permitting processes, which should be undertaken by the host government (or its utility) before the involvement of the private sector. These are issues better handled at government level and well in advance of any moves to project implementation.

• The host government (or its utility) has to retain control over the definition of the project to ensure it returns maximum economic benefits to the country consistent with acceptability at the local level. Again this is not principally an issue for the private sector.

• A balanced approach is needed in evaluating the benefits and costs of specific hydro projects, bearing in mind that the alternative will almost certainly be to build another power station elsewhere.

• The costs of feasibility studies, resettlement, if carried out by the concerned government, should generally be paid for or be reimbursed by the concessionaire.

In summary hydro is too valuable a potential source of generation to ignore, but care has to be taken to ensure that it is sensitively developed with more consultation and care than has often been the case in the past. Host governments need to understand that private money will follow the most favourable projects, and that if hydro is to fall into this category much has to be done to build confidence in the process by which schemes are processed, permitted, financed and constructed.

5.2 Water Supply Dams

As noted in Section 2.3, most private participation in the urban water supply and sanitation sector has taken the form of concessions where the private operator takes over operation and maintenance of an existing system and assumes responsibility for future investments for network expansion and service quality improvements. Discrete major facilities like water and sewerage treatment plants and water conveyance schemes have also been developed in accordance with the BOO/BOT approach. In this case, the project company sells its product/service to the municipal utility under a long-term contract. In either case, the financing follows the limited recourse model described in Chapter 4. The issues are virtually identical to those described above for hydropower dams. Given the poor financial performance of virtually all water utilities, various forms of sovereign guarantees are usually imperative.

5.3 Irrigation and Flood Control Dams

In most countries irrigation water is seldom priced at its full supply cost, and although there are many commercially viable private irrigation schemes around the world, there are equally many publicly owned irrigation projects which do not bear their direct cost in financial terms but are nevertheless economically justified. Public sector canal schemes typically serve hundreds, if not thousands, of smallholders, often growing relatively low-value crops. The implementation of a successful irrigation scheme for smallholders hinges around many more factors than just the completion of the works. For these reasons the public and private sectors tend to be quite separate and there is not the same

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 54

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

fundamental shift to financing occurring in the irrigation sector as in the power industry, at least at the present time. Large-scale private irrigation projects supplied from dams tend to be centrally managed estates growing high value cash crops. A good example is Agro Guayabito A.S. that grows tomatoes and asparagus for export in the desert north of Lima, Peru. The estate is supplied with irrigation water from a dam built and owned by the company. Besides $8 million from IFC, domestic investors and banks raised $28 million in financing for the project. Experience has shown that flood control is usually difficult to justify as the sole reason for building a large dam, and typically it tends to be treated as an (often un-quantified) additional economic benefit to be added to the overall benefits of a dam whose primary function is power generation or irrigation. In the operation of such a dam there is often a trade-off to be achieved between the interests of flood attenuation which requires the reservoir level to be held down at certain times of the year so that buffer storage is available, and the irrigation/hydropower interest which will generally be seeking to maintain a full reservoir for security of supply. It is not unusual to find that the provision of flood attenuation storage in the reservoir can only be achieved by sacrificing some of the hydropower benefits, which may well represent a larger overall economic loss but a socially justified position.

5.4 Multipurpose Dams

5.4.1 Overview Roughly one-third of large dams (using the ICOLD definition) are for multipurpose use. The different functions are listed below: • Irrigation 48% • Electricity generation 36% • Water supply 36% • Flood control 39% • Recreation 24% • Inland navigation 5% • Fish breeding 5% With the exception of electricity generation and (sometimes) water supply, the above functions tend to fall within the "non-commercial" category as far as the provision of storage is concerned. That is to say that it is relatively unusual for a dam to be promoted primarily for flood control, recreation or fish breeding, although these may be useful spin-offs. In summary therefore the financing of multipurpose dams tends to hinge around the primary functions of hydropower, irrigation and water supply. 5.4.2 Main Considerations In terms of financing, most multipurpose dams still lie firmly in the public sector. They typically are funded by the ILAs on a long-term concessional basis. Although such schemes will not be immune from the wider pressures towards privatisation of infrastructure development, multipurpose projects are difficult to fund privately because they share many of the problems of hydropower and, in addition, have the following factors to take into account:

• Potential water management conflicts.

• They are usually reservoir projects.

• Multiple beneficiaries result in a complicated and potentially vulnerable contract structure.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 55

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

• Lack of financial viability. From the government's viewpoint, the regulatory issues are more severe than for hydro alone, because a multipurpose project can exercise control over a large area of the river basin in terms of determining downstream flow patterns and water availability. The situation is complicated because of the necessity to protect not only the position of existing projects but also the rights of future projects yet to be developed. In these circumstances water rights issues, always sensitive at the best of times, loom particularly large because no government can afford to commit itself for a long period to methods of reservoir operation that it may subsequently wish to change. Yet to the private owner the limits within which he is free to operate the reservoir and use water will be crucial to the income of the project and the profitability of his investment. Against this background it is not surprising that there have been very few privately financed multipurpose schemes. One of the few exceptions is the Casecnan Transfer Project in the Philippines. In this case, a private company is building a 26 km long tunnel that will carry water to irrigate 50,000 ha on the Luzon Island (as well as produce 400 GWh per year of hydropower). The National Irrigation Authority of the Philippines will buy both the bulk water supplies and the power under long-term contracts. Besides the potential efficiency gains, the real attraction of such a scheme, from the government�s point of view, is budgetary. If the public agency faces a budget constraint that limits its ability to invest, it can replace an up-front expenditure with a long-term contract where it in essence pays for the construction with what is akin to a lease payment. Another example, also from the Philippines, is the San Roque Hydroelectric Project, with a planned capacity of 345 MW. The project will also provide irrigation water for 87,000 ha and some flood control benefits. It is estimated that 49% of the benefits will be derived from power generation, 40% from irrigation and the balance from water quality improvements and flood control. The National Power Corporation (NPC) will buy the power. NPC has obtained a $400 M loan from JEXIM that will be passed on to the sponsors (in essence to cover the cost of the dam attributed to the non-power benefits). The sponsors have obtained equity and commercial debt to cover the balance of the $1,100 M construction cost. The San Roque Power Corporation will be paid for the non-power benefits of the dam through the power tariff.59 5.4.3 Trends in the Development of Multipurpose Schemes In the past most multipurpose projects were implemented by the public power utility or, to a lesser extent, the water utility or the public agency responsible for irrigation development. In many cases the power benefits effectively underwrote the financial viability of the project, while the multipurpose benefits allowed access to more concessional financing than might have been available for a power-only project. A further factor was that in many countries the power utility had more experience and capability in implementing large capital works projects. However this approach of a single-purpose agency, like the power utility, developing a multipurpose project gives rise to problems. There are inevitable rivalries and conflicts of interest between the different water users, and projects were often plagued by the lack of a cohesive approach. There is a growing recognition that planning considerations extend far beyond the interests of a single project, and needed to be viewed at the river basin or even the national level. It is now widely accepted that the river basin is the natural planning unit for water resources developments. In consequence many river basin development authorities have been established over the last two decades, particularly in the parts of the world where the development process is still relatively immature and has far to run. The Tana and Athi Rivers Development Authority (TARDA) in Kenya is an example: founded in the mid-1970s it has responsibility for planning and co-ordinating

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 56

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

all water-related developments in a catchment that provides most of the country's power and irrigation potential, and the water supply to the capital Nairobi. However TARDA only implements multipurpose projects, leaving single purpose projects to the government agencies concerned. This pattern is being repeated elsewhere for the large multipurpose projects, although in practice there is, as for hydro, a significant downturn in new starts, due to:

• The withdrawal of traditional sources of public sector funding, particularly for large dam projects.

• The complexity of launching multipurpose projects in the private sector (regulatory issues).

• The relative unattractiveness of most multipurpose projects to private investors because they often depend upon accruing "benefits" from a number of water-users, most of whom will not be creditworthy.

• The fact that following privatisation, the power and water utilities are no longer able or interested in promoting projects that are not immediately beneficial to their core activities.

• Most significant multipurpose projects involve large storage reservoirs that are facing increasing opposition on environmental grounds.

5.4.4 Key Issues Arising The key issues arising from the trends in multipurpose project financing are:

• The willingness (or otherwise) of host governments to allow private control over any strategically important water project that can influence all other downstream projects in the river basin.

• The reluctance of the private sector to get involved with projects that it views as being complicated and circumscribed with potential bureaucratic hurdles because of the involvement of many parties.

• The regulatory controls that would be needed to achieve a sensible balance between the interests of the private investor, the consumers and the host government are complicated and not easily replicable from project to project.

• The public sector has an even larger role to play than for private hydro in terms of providing funding for projects that are economically viable but may not be financially viable in their entirety, but for which discrete elements may well be viable.

• Most multipurpose projects require dams, and a balanced approach is needed to firstly weigh the benefits and costs, and then to streamline the consultation and permitting process. Without such clearance already in place, the private investor will not be attracted.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 57

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

6 Issues and Emerging Practices in the Financing of Non-Dam Options

6.1 Large Scale Energy Projects (Grid Connected)

Two key implications of power sector reforms are that most decisions regarding choice of technology will be taken by independent (private) companies and these companies will base their decisions on fairly strict financial criteria. Given the undeveloped capital markets in developing countries, the ability of the operators to mobilise long-term financing will strongly influence the choice of technology and investment alternatives. Thermal power generation has undergone a dramatic technological development during the last decade, which has significantly changed the relative importance of hydropower development. As described in the WCD Thematic Review Paper on Electricity Supply and Demand Side Management Options (IV.1), the cost of especially combined cycle gas turbine (CCGT) plants have fallen by more than 50% since 1990 while their fuel efficiency has improved enormously to over 60%. The cost of the latest CCGT technology is now in the range of $375 to $450 per kW, or about a quarter of the cost of large hydropower plants. The up-front development costs are small and the construction period can often be as short as two years. Compared to other thermal technologies (and hydro), CCGT plants have few environmental issues. Thus, CCGT have emerged as the preferred generation technology when gas is available. The plants are also often easy to modify to accept liquid fuels. From an economic point of view, the main drawback is that these plants are most economical when operated as base load plants. Thus, if the government isn�t careful in its system planning and solicitation of IPP generating plants, it might create an unbalanced generating system that can meet demand only at high costs. The spread of CCGT technology has been aided by an increased emphasis on natural gas in hydrocarbon exploration. Similarly, regional gas transmission grids are being built or planned in many parts of the world. This significantly increases the number of countries where CCGTs represents the least cost generating option. Other thermal technologies have also become cheaper albeit to a lesser extent than CCGTs. As noted in the Thematic Review Paper IV.1, they are expected to continue to lose market share to CCGTs. Whichever thermal technology is selected, most generating plants in the future will be financed on a limited recourse basis (see Chapter 4). The equipment component of thermal plants is often as high as 80%, which makes mobilising export credits or export guarantees fairly easy. This is the primary reason why thermal plants have accounted for more than 90% of all generating capacity created by the private sector during the 1990s. This inherent bias against hydropower in limited recourse project financing is discussed in Chapter 5. Depending on local conditions, wind and geothermal projects are also suitable for grid connection. Geothermal technology has reached a commercial state and commercial lenders are willing to provide financing. According to the Projectware database, large scale renewable energy projects with an aggregate capacity of about 2,600 MW reached financial closure between 1994 and the first quarter of 2000 (Rojas and Aylward, 2000). Virtually all of this capacity was provided by geothermal projects in the Philippines and Indonesia. Wind power, however, appears not to have reached the commercial stage as yet and�in the near term--large scale applications in developing countries will require off-take agreements that involve a substantial subsidy.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 58

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Figure 6.1. Large Scale Renewable Energy Projects Built by the Private Sector, 1994-2000,MWs

0

500

1,000

1,500

2,000

2,500

Latin America Asia E Europe & C Asia M East & N Africa Sub-Saharan Africa

Source: Projectware Database (Rojas and Aylward, 2000)

Nuclear power plants in developing countries have so far been built only by government owned entities (with quasi-commercial export financing). Given the construction risks and the environmental issues involve, it is highly unlikely that commercial lenders will contemplate financing such projects.

6.2 Non-Grid Connected Energy Options

Three factors are frequently seen as the main constraints to wider adoption of small-scale (often renewable) energy sources in areas that cannot be served in a cost-effective manner from the power grid: (i) the absence of suitable delivery mechanisms for appropriate technological solutions; (ii) high up-front costs and a lack of long-term financing; and (iii) inadequate local capabilities for operation and maintenance. In part based on the work carried out by NGOs�and recently supported by governments and bilateral and multilateral donor agencies�effective programs are being introduced in many developing countries. The modalities vary significantly from one case to another depending on the type of development activity being undertaken, the strength of government and civic institutions, culture and local traditions. The perceived mismatch between the costs of alternative technologies and consumers� ability to pay has been tackled through a variety of financing and subsidy schemes. Such schemes, when justified, need to be carefully designed in order to be sustainable. Subsidies should be assessed in terms of their efficacy,60 sector efficiency61 and cost-effectiveness.62 In general, the greatest impact of subsidies is achieved if the public sector supports the early stages in the product cycle, i.e. research and development (Kammen, 1999). Similarly, the public sector often has a role to play in the commercialisation of environmentally attractive technologies (Duke and Kammen, 1999). Financing schemes need to be tailored in such a manner that they represent a logical evolution of the financial system in the country and that it encourages the mobilisation of resources. The literature on rural development contains many examples of successful micro-credit schemes. Over the last couple of years, however, there has been a growing interest by commercial lenders in supporting energy efficiency and renewable energy schemes. In Kenya, for example, more rural

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 59

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

households have solar PV systems than are connected to the power grid. NGOs started the program in the 1980s but it became commercial in the 1990s, with about 20,000 units sold per year. An estimated 15% of the units are sold through hire-purchase arrangements and commercial banks and rural savings and credit co-operatives are showing interest in financing solar PV systems. At a different level, IFC and the international investment community are showing interest in renewable energy. IFC is participating in two global investment vehicles supporting investments in developing countries:

• The Solar Development Corporation supports solar PV system technology for non-grid applications. The corporation can provide debt, equity and quasi-equity to a broad range of actors, such as local assemblers/system integrators, distributors, retailers, energy service companies, financial intermediaries and NGOs.

• The Renewable Energy and Energy Efficiency Fund provides equity and debt to enterprises investing in grid connected and non-grid connected schemes requiring funding of between $1 million and $50 million.

Thus, gradually, a support system is evolving that covers small- and large-scale renewable energy technologies, mobilising resources from households, community groups, NGOs, governments, local entrepreneurs as well as international energy companies and investors. This is likely to lead to an acceleration of the adoption of sustainable energy projects.

6.3 Demand Side Management Options

Power sector reform in developing countries has two different types of impacts on energy efficiency programs: first, in most countries, reforms will in the short-to-medium term will lead to higher consumer tariffs and, thus, increased incentives for more efficient use of energy; second, the privatised generating, transmission and distribution companies will have little incentive to invest in demand side management (DSM). (On the other hand, they have strong incentives to minimise their own losses and increase their own operational efficiency.) The basic difficulty associated with DSM programs in low and middle-income countries is the scarcity of capital. Households typically display the �one-cigarette-syndrome�63 and are reluctant to use their scarce savings to buy more energy efficient appliances if this involves a significant additional up-front cost. Similarly, enterprises are generally unwilling to borrow and invest in more efficient technologies unless the returns are both fairly certain and quite high.64 This means that there is a definite role for governments in the design and implementation of DSM programs. The basic approaches that need consideration are well described in Thematic Review IV.1. The bilateral and multilateral development agencies have a significant role to play in providing technical assistance and in reducing the risks (and costs) for local financial institutions that are supporting various DSM programs.

6.4 Small Scale Water Supply and Irrigation Options

A broad range of traditional financing alternatives exist for small wells and pump sets that are used for water supply and/or irrigation: family members, village money lenders, credit co-operatives, savings clubs, commercial banks, etc. Most of these have well known limitations and drawbacks. There are, however, a number of examples of financing schemes that have proven to be extremely successful. As the key factors behind the successes are analysed, disseminated and incorporated in other schemes, there are prospects for an increase in the financing for small-scale water projects.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 60

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

The greater challenge occurs when the schemes serves a group of families, for example a village or a squatter settlement in a city. Participation by beneficiaries and grass roots institutions is critical for the long-term success of most schemes of this type. Thus, increasingly governments and donors are adopting approaches that build on grassroots initiatives. In the IDA sponsored Community Water and Sanitation Project in Sri Lanka, for example, local NGOs help develop schemes in collaboration with community groups that contribute part of the funding and assume the responsibility for operation and maintenance. The schemes are subsequently presented to a committee with both government and NGO representatives, which approves funding for the schemes based on their merit. A number of similar programs exist in Latin America, Africa and Asia. They are commonly called �social funds� or �rural infrastructure funds.� When properly designed and tested on a pilot scale prior to full implementation, they can be effective vehicles for meeting basic infrastructure needs in rural areas and in low-income urban neighbourhoods.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 61

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

7 Synthesis: Implications of Financing Trends for the Debate on Dams

7.1 The Changing Pattern of Dam Financing

7.1.1 Multilateral Development Banks (MDBs) • The MDBs are increasingly focusing their lending on poverty alleviation, social and

environmental projects with declining amounts (in real terms) devoted to infrastructure.

• Within the infrastructure field, policy advice and lending support power sector restructuring, privatisation of power and water utilities and new investments by private enterprises.

• The MDBs are placing a growing emphasis on energy efficiency, renewable energy and participation of beneficiaries in the design, implementation and operation of smaller scale infrastructure facilities in rural as well as low-income urban areas.

• The MDBs have significantly tightened their social, resettlement and environmental safeguard policies and operational review procedures related to dams and other infrastructure projects.

• Prior to 1990, the MDBs were major sources of financing for multi-purpose, hydropower, irrigation and water supply dams.

• During the 1990s, the MDBs have significantly curtailed their lending for dams, which presently is a fraction of the peak level around 1980.

7.1.2 Bilateral Donor Agencies • In real terms, official development assistance from the industrialised countries has declined

significantly over the last decade.

• Most bilateral agencies have shifted their lending from infrastructure to poverty alleviation, social and environmental projects.

• Several of the donors have provided significant technical assistance to support power and water sector restructuring and privatisation.

• Generally, these agencies have adopted social and environmental safeguard policies similar to those of the multilaterals but monitoring and enforcement are uneven.

7.1.3 Export Credit Agencies (ECAs) • Overall levels of funding as well as the amounts devoted to infrastructure have gone up

significantly during the 1990s.

• Loans and guarantees have been provided to both public and private sector dams.

• The ECAs� social and environmental safeguard policies are varied and the application of the policies is highly uneven. However, OECD�s �Working Party on Export Credits and Credit Guarantees� has been given the mandate to exchange environmental information and develop common approaches to handling environmental and resettlement issues.

7.1.4 Developing Country Governments • Budget constraints and poor financial performance of state-owned utilities have curtailed public

investments in infrastructure.

• Most developing countries have weak social and environmental safeguard policies and the enforcement, when it comes to construction of public sector dams, appear to be even weaker.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 62

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

• The �dam lobby� remains strong in many developing countries, but it is facing a growing domestic resistance to the construction of new dams and, especially, the resulting resettlement of large numbers of people.

• The construction of publicly financed dams appears to be on a downward trend, mostly due to the difficulties of mobilising the required resources.

7.1.5 The Private Sector • Private developers and commercial lenders have responded strongly to the new opportunities in

the infrastructure field. Investments increased eightfold between 1970 and 1977 and, for the decade as a whole, private infrastructure investments in developing countries amounted to almost $600 billion.

• There was a marked decline in private infrastructure investments following the Asian crisis in 1997. However, as economic growth accelerates in Asia and reforms are pursued in more developing countries, the private infrastructure investments are likely to resume their upward trend.

• Of the areas relevant to the WCD�s mandate, the power sector attracted by far the largest amounts of private investments (around $130 billion over the 1990s) followed by the urban water and sanitation sector (around $30 billion). Foreign private investments in irrigation and flood control, however, were negligible.

• Since hydropower projects have long gestation periods, are highly susceptible to cost overruns and completion delays, private investors have a strong preference for thermal projects. Thus, only about 5% of the generating capacity being built by private developers is in hydropower plants.

• Developers and lenders shy away from projects that involve resettlement and contentious environmental issues. Consequently, most private sector hydro projects are 40-400 MW run-of-river schemes with little or no storage.

• International �best practices� for environmental impact assessments and mitigation measures exist for thermal generation projects, and most developers are following these practices. Many are also implementing social and economic development programs in the areas surrounding their plants. However, they rarely are in a position to deal with resettlement issues and often believe that their obligations stop at paying fair compensation (i.e. well above market value) for the land acquired.

• Private capital flows for infrastructure are highly skewed:

o Asia and Latin America have received more than 90% of all private infrastructure investments.

o Sector reforms started later in Eastern Europe and the former Soviet Union, but are now accelerating. Private investments are following suit.

o So far, Africa and the Middle East are the areas that have failed to attract significant amounts of private infrastructure investments.

• The greatest financing difficulties occur in low-income countries with below investment grade credit ratings:

o About four-fifths of all private investments have been directed to middle income countries.

o China has received roughly two-thirds of the flows directed to low-income countries, with India accounting for approximately one-third of the remainder.

o Thus, all other low-income countries have in aggregate received only about 5% of the private capital flows to developing countries.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 63

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

• However, projects in some of the poorest and least creditworthy countries (Laos, Nepal, Bangladesh) demonstrate that financing can be mobilised if:

o The policy framework is appropriate with reasonable tariffs,

o The security package (i.e. the contractual allocation of risks and rewards) is properly structured, and

o Multilateral development banks and ECAs provide either loans or guarantees limiting the lenders risks associated with foreign currency availability and convertibility.

• A promising development is the emerging interest by local entrepreneurs and commercial banks in investing in small scale (100,000 kW to 10 MW) hydropower projects�provided the contractual framework is simple and the tariff formula provides reasonable returns commensurate with the risks.

7.2 Implications of Present Trends

7.2.1 Impact on Consumers • In the short term, reforms of the power and water sectors imply removing or reducing subsidies,

which means higher tariffs for most consumers. However:

o Subsidies in most countries have been poorly targeted, mostly benefiting upper and middle-income consumers.

• In the medium and long-term, low-income households (that presently have to make alternative and more costly arrangements for meeting their water and energy needs) are likely to benefit from private investments in system expansion.

• Similarly, in the medium term, all consumers are likely to benefit from improved quality of service. (There is overwhelming evidence that when reforms have been undertaken in a proper manner service quality has improved rapidly.)

7.2.2 Macro-Economic Impact • The impact of privatisation of water and power utilities depends in part on how the proceeds are

used:

o If they are used for paying off commercial loans owed by the public sector, the impact on the balance of payment is likely to be neutral.

o The reduced need for subsidies and/or transfers from the treasury to the utility to meet its investment requirements should reduce the public sector deficit and, thus, inflationary pressures and �crowding-out� of private enterprises from local debt markets.

o Alternatively, the budgetary savings can be used for essential social sector expenditures benefiting the poorer sections of society.

• The macro-economic impact of new financing techniques for greenfield power investments

depends on how the �without private investments� scenario is defined:

o Power shortages are costly.65 If the host country has been experiencing severe shortages, private investments in power generation can have significant multiplier effects, both through relieving constraints on industrial growth and encouraging new investments in other sectors.66

o If private power investments have been required to keep pace with rapid growth in demand, the macro-economic impact has most likely been beneficial.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 64

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

o In the aftermath of the Asian crisis, it appears that a couple of countries might have invested too heavily in power generation creating a surplus capacity. However, this is primarily due the unanticipated decline in demand rather than over-expansion compared to reasonable growth projects when the projects were initiated.67

o If the cost paid for power is artificially inflated and new greenfield construction exceeds any reasonable projections, private generating investments can definitely contribute to macro-economic problems. It has been argued that this was the case in Indonesia.

7.2.3 Impact on State-Owned Utilities • Where no restructuring of the power sector has taken place and the state-owned utilities are the

buyers of power produced by IPPs, the utility has often been squeezed between (politically motivated) low consumer tariffs and perceived high prices68 paid to private generators. In some cases, this has resulted in default on the utilities payment obligations to the IPPs or in increased subsidies from the government. Frequently, however, this situation has created a pressure on the state-owned utility to reduce losses and improve collection performance.69

7.2.4 Impact on the Use of Indigenous Energy Resources • In practice there is little difference between the financial calculations of a private power developer

and the least cost analyses that state-owned utilities generally undertake. The developers and lenders unfailingly prefer a clean and cheap indigenous fuel�as long as it can be reliably supplied. Thus, the preferred choice of private generating companies is indigenous natural gas. If, however, there are perceived difficulties with the reliability of supply of domestic fuels (as in the case of coal in India), the developers would seek to import the most economical fuel. Consequently, the increased private investments in power generation has made very little difference to the choice of fuel�with the exception of the bias against hydropower development described above.

7.2.5 Impact on the Use of Renewable Energy Resources • Besides the obvious criteria of commercial viability, private developers and, especially, lenders

require that the plant should be based on proven technology. This is especially important in developing countries where supply of spare parts tend to be problematic. Thus, besides hydropower, the only large-scale application that private developers would consider is geothermal plants. With special incentives, wind and solar-thermal would probably also be considered. (Of course, state-owned utilities would also require special incentives/subsidies to undertake such projects given their lack of commercial viability at present.)

• The new financing approaches for large greenfield projects that have emerged during the last decade have little impact on incentives for the development of smaller energy projects using renewable sources.

• Sector restructuring and privatisation of distribution and transmission facilities definitely provide strong incentives to the operators to reduce system losses but the impact on the development of smaller renewable energy resources depend primarily on the regulatory regime and can not easily be generalised.

• The opening up of the generation sector to new entrants has in some countries sparked a major interest by local entrepreneurs in co-generation and small hydropower schemes.

• The international development agencies are increasingly shifting their focus away from large generation projects and are increasing their lending for energy efficiency and renewable energy

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 65

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

projects. They and the host country governments have developed ways of working with NGOs and community groups in developing small-scale energy and water supply projects.

• International investors are also finding renewable energy projects attractive as indicated by two recent initiatives:

o The Solar Development Corporation that supports solar PV system technology for non-grid applications in developing countries.

o The Renewable Energy and Energy Efficiency Fund that provides equity and debt to enterprises investing in grid connected and non-grid connected schemes requiring funding of between $1 million and $50 million.

7.3 The Outlook for the Financing of Dams and their Options

7.3.1 Official Development Assistance • Development assistance has been on a gradual decline throughout the 1990s and there are no

signs that this decline is going to be reversed. There is a similar decline in the share that is being devoted to infrastructure.

• The paradigm shift described in this report does not only affect the developing countries but also the industrialised nations. Thus, the donor community is likely to continue to support (through policy advice, lending and loan conditionality) an expanding role for the private sector in the provision of infrastructure facilities.

• The donor community is likely to continue to emphasise environmentally sustainable development focusing on delivering basic economic and, especially, social (i.e. health and education) services to the poorest segments of the population.

• Given these basic trends and assuming there is a broad consensus on international norms for the handling of resettlement and environmental issues, the outlook for development assistance for dams and alternatives to dams can be summarised as follows:

o Private sector hydropower dams will be supported through the various instruments that the development agencies have to their disposal. The amount of support from multilateral and bilateral agencies is likely to increase�although not dramatically.

o Most development agencies are likely to stay away from single purpose hydropower schemes built by state-owned utilities.

o The disillusionment with large-scale irrigation projects goes beyond the issues related to dam construction70 and, thus, no major reversal in the downward trend for donor financing of big canal schemes is likely.

o Dams for water supply will continue to be supported on a modest scale.

o It is less clear how the donor community will respond to requests for support of large multi-purpose dams. There is clearly role to play for both governments and official development agencies in such projects. Ceteris paribus, if international �best practices� are applied to the planning and implementation of multi-purpose projects, the donors should be more willing to provide financing than they are today. However, this might be offset by the reluctance to support large-scale canal irrigation schemes.

o Donor support for energy efficiency and renewable energy projects is likely to continue to increase, although it is likely to account for no more than a couple of percent of the total volume of development assistance.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 66

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

7.3.2 Private Investments in Dams and Options to Dams • Dams built for smallholder canal irrigation or flood control and multi-purpose dams will remain

in the public sector. Private investors and lenders are likely to participate only on an exceptional basis. In general, such investments will occur only if special BOT type structures are put in place, as was the case in the Casecnan project in the Philippines.

• In cities where a private concession has been granted for water supply, dams and related headwork structures will increasingly be built by the concessionaire. However, in some of the private water concessions (like in Manila), a government agency is responsible for bulk water supply and the concessionaire only for water distribution. In a few cases private developers can be expected to build small dams to supply water to a municipal utility on a BOT basis. (Given the relatively low rate with which the private sector has been taking over urban water supply systems, the public sector will account for the predominant share of investments in urban water supply and sanitation in the foreseeable future.)

• Private power investments declined significantly in 1998 and 1999. Commercial bank lending and direct private investments in developing countries tend to go through cycles. Usually, a default in a major borrowing country leads to curtailment of lending also in other regions. Thus, it is not clear if the recent downturn is temporary or the start of a period of more cautious lending. However, it appears likely that the two main target regions for private power investments will see some continued slowdown in new commitments. In Latin America there might well be some consolidation after the wave of privatisations in the 1990s. In East Asia, the economic downturn has depressed electricity demand and created a temporary surplus. In both regions, private power investments are likely to pick-up in a couple of years provided economic growth remains on track. In other regions, the trends towards increasing private power investments are likely to continue. Over the medium to long-term, private investments in power should continue to grow, as demand growth continues and the private sector accounts for an increasing share of the global power market.

Box 7.1: What is the Future for Private Capital Flows?

During the 1990s, developing countries experienced a major surge in private capital flows that helped sustain the boom in private infrastructure investments. Seen in a historical perspective, this surge was not unique. Since the middle of the 18th century, there have been at least three other periods when private capital flows to emerging markets expanded rapidly. The first major surge took place from around 1870 to the outbreak of World War I, with much of the capital taking the form of bond financing for railroads and other infrastructure facilities. The second was the post-World War I boom that lasted until the Great Depression. The third followed the 1973 oil price shock and lasted until the 1982 Mexican crisis. The boom of the 1990s was similar to the earlier expansion periods in terms of its size (relative to the economies of the borrowing countries) and its close relationship with rapid growth and technological progress. A striking difference, however, is the much greater importance of equity flows during the 1990s. The three previous episodes were punctuated by currency and financial instability in the capital receiving countries, and eventually ended in global political or financial crisis. The rapid expansion in private sector lending to developing countries during the 1990s came to an abrupt halt following the financial crises in East Asia and Russia. In net terms (i.e. disbursements less principal repayments) private long-term debt flows fell to $47 billion in 1999, less than one-third of the level in 1996. Foreign direct investments, however, have continued to grow and reached an unprecedented $192 billion 1999. Private infrastructure projects in developing countries tend to be highly leveraged and, thus, mostly dependent on debt financing. The World Bank (2000b) projects a gradual recovery in long-term private sector lending between

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 67

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

2000 and 2002. Foreign direct investments are expected to grow at a more modest pace than in the past decade. In terms of the longer-term outlook, the World Bank concludes: �The next decade may well se another capital boom to emerging markets, accompanied again by high volatility of capital flows.�

• Within this overall trend of growing private power investments, there will be a move away from IPPs with long-term power purchase agreements towards merchant plants that sell on a wholesale market. This is going to lead to premium prices being paid for power produced during peak demand periods. This, in turn, will make hydropower projects with storage more attractive to private investors.

• The potential switch towards reservoir projects will depend on the regulatory regime that is put in place (related not only to tariffs but also to the environmental clearance process and to the approach taken for dealing with land acquisition and resettlement).

7.4 Summary Recommendations

Detailed recommendations on the governance structure required for socially and environmentally sustainable development have been presented in most of the thematic review papers. Thus, this section presents only those recommendations that arise from the specific issues related to private ownership and financing of large-scale energy and water resource projects.

• The fundamental principle should be that the same governance structure applies to both public and private sector projects. This means, for example, that a dam built by the irrigation department should be subject to the same criteria and scrutiny as a dam for a private sector hydropower project.

• Environmental and social/resettlement issues need to be explicitly�and transparently�incorporated in the process that grants concessions to both private and public operators.

• Options assessments should be the responsibility of the government. Issues like hydro versus thermal generation or demand side management versus new generation are fundamental policy issues and should not be dealt with in the context of an individual project.

• Basin planning and broad definition of projects should be the responsibility of the government. Water is a valuable resource to the nation and only the government can decide on the optimal use of this resource.

• Assessments of alternatives should be the responsibility of the entity proposing a given project. In the context of a dam project, this might involve analyses of alternative dam locations, configuration of the generating plant, etc.

• The greatest benefits of private participation in infrastructure are generally derived from competition. Bidding/competition is also the best way of minimizing the potential for corruption. The competition in the case of power generation can take two different forms: If the country still is in the early stages of reforming the power sector, IPP sponsors can be selected based on the lowest tariff that would be part of a long-term power purchase agreement (for thermal generating projects this is an increasingly common�and generally successful�practice). If, however, the host country has introduced a competitive power market, the project sponsors would be �free� to build their plants �at any cost� but would have to compete with other plants once in operation. In the context of hydropower projects, this process would be modified somewhat in order to ensure that the consumers and/or government gets the maximum benefits of the competition71:

o Case 1�IPPs with long-term power purchase agreements: Potential developers would submit bids on the lowest (average or �levelised�) tariff they would require.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 68

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

o Case 2�Competitive power market: The potential developers would bid for the right to develop the site. This could take the form of a royalty or an agreed profit sharing formula.

• There is a need for public-private partnerships in the development of dams in order to mitigate the unique risks and ensure that the externalities associated with such projects are adequately accounted for. Each dam project is unique and, thus, the sharing of risks, costs and benefits needs to be tailored to the specific nature of each project.

• The host government should assume the responsibility for feasibility studies and preliminary designs. Thermal power plants are increasingly becoming standardised and the cost varies little from site to site. Each hydropower project, however, is unique and tailored to the specific site. The cost depends primarily on the site�s hydrology, topology and geology and can easily vary by a factor of 2 or 3 from one site to the next. Thus, without detailed soil, geological and hydrological investigations, no developer can estimate the cost with any reasonable degree of accuracy. The uncertainty will be reflected in the very high bids. Since the investigations are costly and time consuming, it doesn�t make sense to have each potential bidder carry out all the surveys and prepare a feasibility study. Rather, this should be the responsibility of the relevant government agency. The feasibility study should be carried out by a reputable international consulting firm�ideally with guidance from an advisory panel, possibly comprising the short listed bidders.

• The host government should carry out the environmental assessment and prepare the mitigation and resettlement plans prior to inviting the private sector. These activities require extensive studies and public participation. The risk to the developers is minimized if the whole approval process has been completed before bids are requested.

• Governments need to retain responsibility for land acquisition and resettlement�unless it is on a minor scale. Lenders will probably insist on the land being handed over to the project company, free of encumbrances, prior to the first draw-down on the loans.

• The dealings between the host government and the private developer(s) have to be transparent. The development of dam projects involves politically sensitive social and environmental issues and requires a closer co-operation between private sponsors and government agencies than other infrastructure projects. To ensure the long-term sustainability of the contractual (project) structure, the selection of the private developer has to be competitive and transparent. The same need for transparency applies to subsequent negotiations of contract conditions related to risk and cost sharing.

• It is essential to establish an appropriate tariff regime for hydropower projects. The basic purpose of (and economic justification for) dam projects is to change the availability of water/power over the time. Tariffs based purely on energy output fail to properly compensate hydropower projects for their ability to meet daily, weekly and annual peak demands. Such tariffs tend to create a bias in favour of thermal and run-of-the-river schemes. As a minimum, the tariff structure should include both a capacity and an energy component. Ideally, the tariff should be differentiated to allow for peak pricing and reflect the value of the ancillary benefits that hydropower can provide for system management.

• The international development agencies and ECAs should review their lending policies related to dams and adopt the recommendations of the Commission. A consistent handling of environmental and social issues related to dams is imperative. Project developers (in �collusion� with the host government) should not be able to �shop for the least restrictive lending conditions.� However, the policy changes should go one step beyond adopting policies that are consistent with the expected recommendations by the Commission. The private sector�s bias against hydropower and other water resource projects means that there is potentially a greater role for multilateral and bilateral donors in making up for financial shortfalls. Participation by the multilateral

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 69

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

development banks can also provide additional safeguards in ensuring proper handling of social and environmental issues.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 70

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

References AfDB (African Development Bank). 1998. Review of the Bank's Experience in the Financing of Dam Projects, African Development Bank, Operations Evaluation Department. Albouy, Yves and Reda Bousba. 1998. �The Impact of IPPs in Developing Countries�Out of the Crisis and into the Future.� Viewpoint 162. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Bacon, Robert. 1999. �A Scorecard for Energy Reform in Developing Countries.� Viewpoint 175. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Bacon, Robert W., John E. Besant-Jones and Jamshid Heidarian. 1996. Estimating Construction Costs and Schedules: Experience with Power Generation Projects in Developing Countries. World Bank Technical Paper 325, Energy Series. Washington, D.C. Dhawan, B. D. 1998. �India�s Irrigation Sector: Myths and Realities.� Indian Journal of Agricultural Economics. Vol. 53 (1) Jan-March Briscoe, John. 1998. The Financing of Hydropower, Irrigation and Water Supply Infrastructure in Developing Countries. Mimeo. World Bank, Washington, D.C. Crousillat, Enrique. 1998. �Developing International Power Markets in East Asia.� Viewpoint 143. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. EBRD (European Bank for Reconstruction and Development), 1996, Latvian Hydropower Plants Receive EBRD Financing, press release, 29 April, London, European Bank for Reconstruction and Development, http://www.ebrd.com/english/opera/PRESSREL/PR1996/30APR29.HTM. EBRD, 1999, EBRD Signed and Approved Projects in Slovenia: as at 31 December 1999, London, European Bank for Reconstruction and Development, http://www.ebrd.com/english/opera/COUNTRY/Slovproj.htm. EBRD, 2000a, EBRD Activities in Azerbaijan: EBRD Signed Projects in Azerbaijan, London, European Bank for Reconstruction and Development, http://www.ebrd.com/english/opera/COUNTRY/AZERACHT.HTM. EBRD, 2000b, EBRD Signed Projects in Georgia: as at 30 June 2000, London, European Bank for Reconstruction and Development, http://www.ebrd.com/english/opera/COUNTRY/Georproj.htm. Estache, Antonio and Martin Rodriguez-Pardina. 1997. �The Real Possibility of Competitive Generation Markets in Hydro Systems�The Case of Brazil.� Viewpoint 106. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Gray, R. David and John Schuster. 1998. �The East Asian Financial Crisis�Fallout for Private Power Projects.� Viewpoint 146. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Head, Chris. 1999. Financing of Private Hydropower Projects. Final Draft Report. Mimeo. The World Bank, Washington, D.C.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 71

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

IDB (Inter-American Development Bank). 1999. IDB's Dam-Related Projects (1960-1999), unpublished, Inter-American Development Bank, Washington DC. Izaguirre, Ada Karina. 1998. �Private Participation in the Electricity Sector�Recent Trends.� Viewpoint 154. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Izaguirre, Ada Karina. 2000. �Private Participation in Energy.� Viewpoint 208. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Jones, William I. 1995. The World Bank and Irrigation. A World Bank Operations Evaluation Study. Washington, D.C. Lagman, Anneli. 2000. Database of ADB Large Dams, unpublished, Asian Development Bank, Manila. Lovei, Laszlo and Alastair McKechnie. 2000. �The Costs of Corruption for the Poor�The Energy Sector.� Viewpoint 207. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. OECD (Organisation for Economic Co-operation and Development), 2000. Development Assistance Committee International Development Statistics: Online Databases, Paris, Development Assistance Committee, Organisation for Economic Co-operation and Development, http://www.oecd.org/dac/htm/online.htm O'Leary, Donal T., Jean-Pierre Charpentier, and Diane Minogue. 1998. �Promoting Regional Power Trade�The Southern African Power Pool.� Viewpoint 145. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Postel, Sandra. 1999. Pillars of Sand: Can the Miracle Last? WW Norton. Washington, DC. Roger, Neil. 1999. �Recent Trends in Private Participation in Infrastructure.� Viewpoint 196. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Rojas, Manrique & Bruce Aylward. 2000. Summary of Preliminary Analysis of Private Sector Financing for Current and Pipeline Power Projects. Contributing paper to the World Commission on Dams Thematic Review III.2, WCD: Cape Town. Silliman, J. and Roberto Lenton. 1985. Irrigation and the Land Poor, Paper for the International Conference on Food and Water, Texas A and M University, College Station, TX. Silva, Gisele, Nicola Tynan, and Yesim Yilmaz. 1998. �Private Participation in the Water and Sewerage Sector�Recent Trends.� Viewpoint 106. World Bank, Finance, Private Sector and Infrastructure Network, Washington, D.C. Sklar, L., McCUlly, P. 1994. Damming the Rivers: The World Bank's Lending for Large Dams, Working Paper 5, Berkeley, International Rivers Network, WCD Submission eco029. Sunman. 2000. �Financing Statistics, Trends and Policies of International Financial Institutions.� Contributing Paper to the World Commission on Dams Thematic Review III.2, WCD: Cape Town. Ulfsby, Øyvind. 1997. Project Financing of Hydropower Projects in Developing Countries. Paper presented at the World Bank �Energy Week.� Mimeo. World Bank, Washington, D.C. White, Wayne. 2000. A Review of the Power Purchase Agreement between the Republic of the Philippines National Power Corporation and a consortium constituting the San Roque Power

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 72

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Corporation Concerning the Construction and Operation of the San Roque Multipurpose Project, Foresight Associates, Acton, Massachusetts, WCD Submission eco019. World Bank. 1992. Effective implementation: Key to development impact. Report of the Portfolio Management Task Force, Washington, DC. World Bank. 1994. World Development Report 1994: Infrastructure for Development. New York: Oxford University Press. World Bank. 2000a. Database on Active Dam Projects: Unpublished Database. The World Bank, Washington, D.C. World Bank. 2000b. Global Development Finance 2000. The World Bank, Washington, D.C.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 73

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Appendix I: List of Contributing Papers to the Thematic Review III.2 Trends in the Financing of Water and Energy Resource Projects Note: Materials from these contributing papers were incorporated directly into the text or annexes or provided necessary background information for the author(s) of the thematic. Chris Head Hydropower Dams Chris Head Multipurpose Dams Hilary Sunman Financing Statistics, Trends and Policies of

International Financial Institutions

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 74

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Appendix II: Submissions for Thematic Review III.2 The WCD is committed to an open and consultative process. To broaden the scope for participation and input from all interested groups and stakeholders the Commission invites submissions on all aspects related to its work programme. As they are received, submissions are classified according to the area(s) of the work programme to which they are relevant. Therefore the submissions used here are those that have been identified as applicable to the Thematic Review (III.2) on Trends in the Financing of Water and Energy Resources Projects. Submissions arrive in parallel to the drafting process of the WCD�s reports. Those listed here are the submissions specifically for TR 111.2 which were received by the end of July, 2000. Also note that submissions are not necessarily numbered sequentially. Every submission has been read carefully. Some are informed individual perspectives on which the WCD cannot mediate. For example, there are some submissions that seek the endorsement of the WCD, however the WCD�s mandate is neither to adjudicate nor to mediate on specific dams or disputes. Therefore, the submissions received for Thematic Review III.2 have been used as background information for the paper. All submissions have informed the WCD as to the different positions on the dams debate. A few submissions only included an abstract or an outline for a presentation at one of the consultations with insufficient detail to be included. Those with a serial number in grey are submissions for which there is an electronic copy, which may be available at the WCD website (www.dams.org). Author Serial # Title White , Wayne C. ECO019 A Review of the Power Purchase Agreement for the San

Roque Multipurpose Project Ryder, Grainne ECO023 Theun-Hinboun Public-Private Partnership: A critique of

the ADB's Model Hydropower Venture Bosshard, Peter ECO024 The Political Economy of Large Dams User, Ann Danaiya (submitted by Goran Ek)

ECO026 Dams as Aid: A Political Anatomy of Nordic Development Thinking (The summary is available in electronic form.)

Bosshard, Peter ECO027 Export Credit Agencies and Large Dams Sklar, Leonard and McCully, Patrick

ECO029 Damming the Rivers: The World Bank's Lending for Large Dams

Matsumoto, Satoru ECO031 Developing Dams in Lower Mekong River Countries and Japan

White, Wayne ECO032 Structuring Finance for Dam Project Sustainability Bond, Patrick ECO033 Paying for Southern African Dams: Socio-economic

Environmental Financing Gaps Ulfsby, Oyvind ECO035 Project Financing of Hydropower Projects in Developing

Countries Kochendorfer-Lucius, Gudrun Dr

ECO037 International Investement Policies: Which Strategies for Developing Countries?

Colajacomo, Jaroslava ECO039 World Bank Financing for Large Dams Bosshard, Peter ECO040 An NGO Look at Large Dams

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 75

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Millan, Jaime ECO043 The Future of Large Dams in Latin America and the Caribbean: IDB's Energy Strategy for the Region

Moore, Deborah ECO044 Dams and Export Finance Agencies: Need for Evaluation within the WCD Work Programme

Moore, Deborah ECO045 Many World Bank Projects Haunted by Grand Delusions Rich, Bruce ECO046 Smile on a Child's Face: From the Culture of Loan

Approval to the Culture of Development Effectiveness Rich, Bruce ECO047 Established Common Elements of International Good

Practice For Environmental Assessment - Background Memorandum

Moore, Deborah and Sklar, Leonard

ECO048 Reforming the World Bank's Lending for Water: the Process and Outcome of Developing a Water Recource Management Policy

Whitten, Patience ECO049 What Does Financial Engineering Have to Do with Environmental Protection

Boscolo, Marco ECO050 Chapter 13 Emerging Carbon Market and the Role of Central America

Bristol, Michael OPT115 Developing Power Sector in the GMS Region (Date: 2000)

Rich, Bruce ECO064 Race to the Bottom Eggen, Oyvind ECO068 Private Benefit, Public Risk: Theun-Hinboun Power

Project as an Example

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 76

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Appendix III: Comments Received for Thematic Review III.2 The WCD is committed to an open and consultative process. To broaden the scope for participation and input from interested groups and stakeholders, the Commission invited specialists, centers of excellence and WCD Forum members to prepare comments on the thematic drafts. Comments were received throughout the progression of the thematic review. The comments were incorporated to the extent possible into subsequent drafts of the thematic. However, to provide readers with a complete record all comments received are included in an annex to the report. Every comment has been read carefully. Some are informed individual perspectives on which the WCD can not mediate. For example, there are some comments that seek the endorsement of the WCD, and the WCD�s mandate is neither to adjudicate nor to mediate on specific dams or disputes. Others may go beyond the scope of the individual thematic review. The comments are separated into Appendix sections relating to the specific draft that they refer to. Section numbers referred to in individual commentaries will have changed in the final version of the report. I: Comments on Draft of 24 May 2000 a) John Besant-Jones World Bank b) Peter Bosshard Berne Declaration, Switzerland c) Bob Crick EGCD, UK d) Shripad Dharmadhikary Narmada Bachao Andolan, India e) Janak Karmacharya Nepal Electricity Authority, Nepal f) PC Mathur Ministry of Water Resources, India g) Ruth Meinzen-Dick International Food Policy Research Institute,USA h) Steve Rothert International Rivers Network * Refers to the comments that were received after the June 26, 2000 deadline. a) Comments by John Besant-Jones (received 18 June 2000) The revised draft of 24 May 2000 that you sent out on June 12 is retitled �Trends in the Financing of Water and Energy Resources Projects�, and basically this draft deals well with this topic. But it only deals with about 70 percent of the TOR contained in the Scoping Paper on �International Trends in Project Financing� that you sent out on June 15. I presume that this change was properly authorised.

I have only two comments on the 24 May 2000 draft of Trends in the Financing of Water and Energy Resources Projects�, putting aside my observation above.

1. The paper mentions greater flexibility in structuring of hydropower transactions in the Executive Summary, but I could not find any treatment of this subject in Chapter 5. It would be useful to examine some of the risk-sharing options available. For example, cost overruns caused by unexpected geological conditions could be split in agreed proportions between client and sponsor. Also, the structuring of off-take pricing to allow for hydrological uncertainty is interesting, whereby this risk could be placed on the off-taker by structuring nearly all the payment as a capacity payment, or in the case of a project with substantial capacity to regulate river flow the owner could accept the incentive to regulate stored water efficiently by accepting a substantial energy charge.

2. A minor point is the incorrect attribution in endnotes 23 and 36 to the World Bank�s Operations

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 77

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Evaluation Department of the World Bank�s review of cost and schedule performance of power generation projects. OED had no input to this exercise, which was done by three staff members in other departments as a personal interest and published under the title �Estimating Construction Costs and Schedules: Experience with Power Generation Projects in Developing Countries� as Word Bank Technical Paper No. 325. I�d be grateful if you would ensure that this attribution is corrected.

Follow-on Comments by John Besant-Jones (received 21 June 2000) Let me preface my response about 70% fulfillment of the TOR with the qualifier that I was not inferring that this indicated a shortfall in the paper's coverage. This is because the authors of the paper refer to other thematic papers that cover some parts of the original Scope of Work for this paper, and hence they avoid duplication (see opening para. to Section 7.4 Summary Recommendations, and second para. of Section 6.1 Large Scale Energy Projects (Grid Connected)), My comment referred to the fourth, seventh and ninth elements of the Scope of Work. I hesitate to make the following general comment about the latest draft, but since I have another opportunity to comment, I'd like to offer it as an interpretation of what I read into the paper. Basically, the paper paints a gloomy prospect for financing medium to large hydropower and multi-purpose hydro projects due to the trend towards project financing. This message comes through in various guises in many parts of Sections 5, 6 and 7 (see text on pages 45, 46, 47, 51, 54 and 55) covering the iniquities of project financing, the built-in advantages of gas-fired plant, the withdrawal of MLAs from large hydro projects - which is unlikely to be substantially reversed soon, etc.. Assuming that there will not be a wholesale return to public financing of hydropower projects, the best prospects for private financing of hydropower projects according to the paper, will occur if/when investors finance them off corporate balance sheets (Section 5.1.3, page 39, fifth para) and sell their outputs as merchant plants rather than under long-term PPAs (Section 7.3.2, fourth bullet). But given the undeveloped state of local capital markets in developing countries, as well as the considerable forex and regulatory risks for investors in these countries, this prospect must be distant. If my interpretation is correct, all the discussion throughout the Thematic Papers about how to do hydro projects would be of academic interest if no way can be found to finance them! Is this a fundamental issue? By the way, there is one typo that should not be allowed to stand, which is on page 39, fifth para, second line where a stray full stop interrupts the flow of the text "So far, these holdings have not been consolidated into a single corporate entity." b) Comments by Peter Bosshard (received 7 June 2000) Since time must be very short now, the following comments are based on a limited reading of the Executive Summary (ES) and the Summary Recommendations (SR). They cover a small number of specific issues, and focus on the central theme of the role of the state in financing dams. Specifics: On the level of specifics, some recommendations of the RD - e.g. that a regulatory regime must be established prior to any privatisation (ES), or that development agencies and ECAs should develop a consistent approach to environmental and social issues (SR) - can certainly be supported. Others must at least be qualified. While the state might indeed assume the responsibility for feasibility studies and resettlement plans (as suggested in the SR), the costs for these tasks should clearly be borne by the sponsors in the case of private projects. The role of the state in financing dams:

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 78

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

The central question of this Thematic Review is the role of the state in financing dams. In a very general statement (in the ES), the RD remarks that there is a "need for public-private partnerships in the development of dams in order to mitigate the unique risks and ensure that the externalities associated with such projects are adequately accounted for". Like many other NGO observers, I believe that the involvement of the state is a necessary (even if obviously not sufficient) condition for the avoidance, minimization or mitigation of social and environmental costs in infrastructure projects. So I would certainly agree with the government side of the above equation. Towards the end of the ES and the SR, the author reveals his own interpretation of state involvement in dam projects. In the ES, he states: "Once criteria and guidelines for economically, socially and environmentally acceptable development of dams have emerged from the WCD process, these should be adopted by the international development agencies for both lending and guarantee operations. The existence of such guidelines should allow the international donor community to expand lending for sound dam projects where a participation of the public sector is justified." And the SR maintain: "The declining ability of governments to finance infrastructure projects and the private sector bias against hydropower and other water resource projects have meant that an increasing number of socially beneficial, environmentally benign and economically attractive dam projects remain undeveloped. Multilateral and bilateral donors can play an important role in making up for the financial shortfalls as well as encouraging proper handling of social and environmental issues." Obviously, both of these statements are totally unbased and unacceptable. In order to assess them, it is necessary to touch on the question of development effectiveness (a question which the WCD, inspite of its mandate, has so far consistently shied away from): * I believe that social and environmental impacts should be avoided, minimized or mitigated in any and all infrastructure projects. Doing so can make such projects socially and environmentally acceptable - which is different from being socially beneficial or environmentally benign. * Infrastructure projects which meet the minimum criteria of social and environmental acceptability should make economic sense, and should not be subsidized by the (host or donor) state. * The (host or donor) state should only subsidize projects which, beyond simply being acceptable, have a positive development value for poor social groups or regions - e.g. for rural electrification schemes which are identified through a democratic option assessment process. The statements and recommendations of the RD contradict this perspective of dams and development effectiveness: * In the ES, the author states that "the donor community has found ways of working with NGOs and designing projects that fully involve the local community and project beneficiaries". While this statement might be true for some sectors, it is certainly not true for dam building. The impression arises that it is simply being made in order to prepare the ground for the concluding call for state subsidies for dams. * In the following paragraph, the ES claims that "a number of successful examples [of projects fully involving the local community and project beneficiaries] and recommendations are provided in the various options papers prepared for the Commission". Even without having read all the options papers, I very much doubt that this statement is correct. Again this comes across as the wishful thinking which is needed for the concluding call for state subsidies. * As quoted above, the SR then conclude: "The declining ability of governments to finance infrastructure projects and the private sector bias against hydropower and other water resource projects have meant that an increasing number of socially beneficial, environmentally benign and

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 79

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

economically attractive dam projects remain undeveloped. Multilateral and bilateral donors can play an important role in making up for the financial shortfalls as well as encouraging proper handling of social and environmental issues." With the twisting of evidence which NGOs have well documented, some WCD case studies might claim that certain dam projects have been socially and environmentally acceptable. I would strongly question however whether the global review - or the author of the DR - can identify one single large dam which is "socially beneficial, environmentally benign and economically attractive". * Again as quoted above, the ES concludes: "Once criteria and guidelines for economically, socially and environmentally acceptable development of dams have emerged from the WCD process, these should be adopted by the international development agencies for both lending and guarantee operations. The existence of such guidelines should allow the international donor community to expand lending for sound dam projects where a participation of the public sector is justified." The term "sound" presumably means economically attractive and socially and environmentally acceptable. Acceptability is a minimum requirement for any project to go ahead, but is not a sufficient requirement for (host or donor) state subsidies. Otherwise, since only acceptable projects should go ahead, the state would need to subsidize all infrastructure projects. As long as the knowledge base cannot identify any dams which are "socially beneficial, environmentally benign and economically attractive", the call for expanding state subsidies is therefore totally unwarranted. Conclusion: My impression is that even in the era when social and environmental costs could simply be externalized to the affected communities and the environment, most large dams did not make economic sense. If in the future, all external costs are indeed to be internalized, the economic and financial viability is even more out of reach. So purely private funding for large dams will not materialize. And except for the theoretical case where disadvantaged affected communities opted for a large dam as a socially beneficial development project, state subsidies are not justified. So this Thematic Review should simply state that private finance for large dams will not materialize, and should refrain from proposing recommendations which are based on wishful thinking from a dam builder's perspective. c) Comments by Bob Crick In relation to para 7.1.3, the OECD Working Party on Export Credits and Credit Guarantees [its full title] is a body of long standing, and has already been mandated by Ministers to undertake work on export credits and the environment. The OECD had just published on its web site the comprehensive Work Plan which had been agreed. OECD Ministers had just noted in their Communique from the 2000 OECD Ministerial meeting that good progress had been made in this area and that they urged completion of the work in 2001 as envisaged in the Work Plan. d) Comments by Shripad Dharmadhikary (received 25 June 2000) OVERALL COMMENTS The �Purpose� of the TR has been described in the Executive Summary (ES) as: • Describe recent international trends in financing for water and energy resources projects, focusing

on dams and the associated non-dam options. • Highlight the main features of the project financing approaches and models that are emerging in

different regions and settings. • Review the key implications relevant to the WCD mandate.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 80

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

First Objective: Trends in Financing The first of these has been done adequately. Of course, there are some gaps in information where it has been made clear that these will be filled in later, but it is not likely that the new information will change the substantial conclusions of the financing trends. Second Objective: Features of the Project Financing and Various Models The second objective, namely to highlight the main features of the financing approaches, and the models that are emerging is covered only partly. In terms of the features, the fact that large dam projects are a �high risk� propositions and that the financial returns accrue on longer term has been brought out clearly (and repeatedly). This is a very important feature of the financing of large dams. While the risks are analysed � and indeed most of the recommendations in �Conclusion� recommend essentially that these should be taken up by the Government � the paper fails to note that this is what is already being done. At least the experience in India is that the agreements are being so structured that virtually all the risks � financial, political, force majuare, hydrological etc � are taken up by the state (or ECAs of other countries). In spite of this, the participation of the private sector is limited and they are looking for even more concessions. The features of irrigation project have been covered well and as has been pointed out, it is unlikely that the mode of ownership and financing will change as far as irrigation projects are concerned. Third Objective: Implications of Present Trends In terms of the third objective, however, the paper has failed to analyse what the implications are vis-à-vis the issues covered in the Mandate of the WCD. In fact, the Paper has turned out to be a paper on �how to ensure that private funding is made available for large dams�. This is clear from the Conclusions as stated in the ES, which are nothing but a series of recommendations related to making it easier for private sector financing of dams. (barring a couple of recommendations which say that social and environmental issues need to be incorporated in the process that grants concessions, and that Governments need to undertake initiatives to encourage development of alternatives to dams on a sustainable basis.) The Summary Recommendations also show the same approach. This aim of the Paper is re-confirmed from the statement (Page 57 of Report, Summary Recommendations):

�The declining ability of governments to finance infrastructure projects and the private sector bias against hydropower and other water resource projects have meant that an increasing number of socially beneficial, environmentally benign and economically attractive dam projects remain undeveloped.�

This is an astounding statement. There is no basis shown for such a statement. It would be useful if the authors could mention a few large dams that are �socially beneficial, environmentally benign and economically attractive�. The key features and implications of the financing trends that remain unexplored or explored inadequately include (even though these issues have been identified and set out in sections 1.2): Implications of current trends in financing for ensuring proper EIA, SIA and proper implementation of the social and environment safeguard measures and the resettlement and rehabilitation.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 81

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

The implication of the financing trends for the development of the alternatives � whether the privatisation will encourage or discourage development and implementation of non-dam alternatives for water and energy. It is repeatedly stated that several measures will be required to make the financing of large dams attractive to private sponsors. However, the implications of these measures � like counter guaranteees, escrow coverage, elimination of cross subsidies, high cost of power etc. is not discussed at all. These are intrinsically related to the �development effectiveness of large dams� � the central mandate of WCD. To give an example, it has been shown, based on official figures and studies, that the Maheshwar Hydel Power Project (400 MW, on river Narmada, India, fully private sector, project promoters � S. Kumars of India, equity holder include Ogden Energy, USA, Siemens, ABB, and seeking support of Hermes Export Credit guarantees) will result in power that is so costly that the current billings of the state utility (Madhya Pradesh Electricity Board) will barely be enough to cover the purchase of power and hence even the payment of salaries of staff would suffer. The project (with a few other IPPs) has the potential to make the utility go bankrupt. The project has recently been given escrow cover. Another implication is that the utility will have to abandon the �single point� connection scheme which today provides domestic lighting to the poorest and most backward of the people in the state. In general the issue of what will happen to supply of power to poor people and consumers with low paying ability has not been addressed. It is brought out very effectively in the paper that the hydro projects are high-risk projects. However, from this, the paper directly jumps to how there is a need for sharing of these risks and how the same may be shared by the Government and how the projects may be made more attractive to the private developers. However, this is not a correct approach. If the projects are high risk, then it does not automatically follow that assumption of the risks by the Governments will be the best option. There was a need to examine, critically, whether it would be better for the Government to assume these risks and make feasible these hydro projects, or would it be better for the Government to develop, encourage and implement non-dam options? Will the private sector be more responsible, responsive and accountable to the local people, and for ensuring social and environmental sustainability? This is a very crucial issue as in case after case, it has been found that the private sector is far less responsible and accountable compared to the public sector (whose own record is certainly not glorious). The paper discusses the risks for the private developers and how to minimise these; it also talks about the how the Government should share most of these risks; however, there is no discussion whatsoever of the risks to the affected people and who will share these.

COMMENTS ON SPECIFIC STATEMENTS

A. Page V, ES : �Most private investors in power schemes in the developing world have been responsible in meeting internationally acceptable standards for environmental mitigation.�

It is statement that is completely contrary to the international experience. No support is put forth for this statement in the whole report, no examples cited, and existing examples ignored. Indeed, some of the most controversial dam projects in recent years have been those which have been privately funded. These include the Maheshwar Project in India, the Bakun in Malaysia and Nam Theun II in Laos. In all these projects, the handling of the very serous social and environmental issues is terrible,

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 82

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

and the role of the private sector sponsors is nowhere even near �meeting internationally acceptable standards�. The example of Nam Theun II given by the authors of the papers also shows a lack of appreciation of the environmental issues. It is stated in endnote 48:

�Nam Theun II has been a controversial project on environmental grounds, but it is worth noting that a portion of the project revenues will be directed specifically for the protection of the Nakai Plateau where the scheme is located. It is argued that without such measures the existing environment would be substantially destroyed within a relatively short period of time, and that although the project submerges 450 km2 (about 40%) of the plateau most importantly provides the means for protecting the upstream catchment area which comprises some 3,500 km2 of primary forest. The developer will contribute $1 million/year over 30 years towards the management of this forest which is of outstanding international significance in terms of its bio-diversity, in addition to meeting the direct environmental mitigation costs arising from the project.�

If this is what the authors of the paper mean by private developers meeting international standards, then one can offer no comments. It is somewhat equivalent to saying that the Amazon forest would be depleted and degraded in any case, so let us allow a company to log away 40% of it and this will help pay for protecting the remaining 60%. This approach confuses the cause and effect (if the existing environment is under threat of destruction, then what needs to be done is to identify the reasons for the same and address those, not allow 40 % to be submerged by a dam which then will presumably pay partly for protection of the remaining one.). B. Page viii- ix of ES:

� Consequently, most successfully financed hydropower projects are of the run-of-river type with limited social and environmental impacts.�

It is not clear whether the terms �run-of-river� and �limited social and environmental impacts� are used interchangeably. There is no guarantee that run-of-river schemes will have limited impact. Some of the most controversial projects, and those with massive social and environmental impact have been the run-of-river schemes. For example, the Pak Mun dam in Thailand, and the Maheshwar Hydel Project in India. Indeed, while there is some correlation between the size and the impact of the project, this is by no means a fixed equation. Private developers will be attracted towards projects with lesser financial risks � which is their main concern, and not to schemes with lesser social and environmental impacts. This is all the more so because the way financing is being structured (and this is also the recommendation of the paper) is that the Government, the public sector, the utilities are taking up all the (financial) risks. Regarding the social and environmental impacts, in most cases the liability of these remains undefined, or vaguely defined. C. Page x of ES:

�In most cases, commercial lenders go through a comprehensive due diligence process that covers not only the financial aspects of a project but also all its technical, economic and environmental aspects. They are also ready to support programs aimed at promoting economic and social development in the area around the project. Thus, it is likely that they will voluntarily support improved criteria and guidelines for project development.�

Again, it is not clear as to what has been the basis to draw this conclusion. Experience has shown that the commercial lenders are concerned only about their (recovering) their lending, and since this is in most cases covered by some sort of guaranteees, there is virtually no risk to them, and they are hardly bothered about the other aspects of the project. To give again the example of Maheshwar Hydel Power Project, the equipment supply to the project is to come from Siemens of Germany, and was to be financed by (then) BayrischeVeriense Bank, now the Hypoverience Bank. (Spelling subject to

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 83

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

correction). This was to be covered with an EC guarantee from Hermes (ECA for Germany), which had already extended a �in principle� guarantee to the project. It was only when the affected people got organised under the Narmada Bachao Andolan and started raising various issues that this situation changed. After a campaign on the Hermes guarantee, Hermes realised that they had not looked at many of the issues, many of the ground realities had been wrongly reported to them, and so it suspended the Guarantees about 2 years ago which have till date not been re-instated. It may be mentioned that this is a very rare occurrence and normally �in principle� guarantee is virtually a final guarantee. Further, the commercial lender, Bayerischeverience Bank even refused to answer the letters written by the affected people�s organizations, namely NBA, and when ultimately contacted and forced to discuss (on the phone) took a stand that they were not concerned about the social and environmental impact since their lending was fully covered by the Hermes guarantee. (this was at the time when the �in principle� guarantee was still in place). This is the general approach demonstrated by the commercial lenders, and certainly consistent with their general interests. It is thus highly unlikely that they will voluntarily support any new (and hopefully stronger) guidelines laid down by the WCD, especially since their commercial risks are normally fully covered. It may be pointed out that today, even the ECAs do not have uniform guidelines and NGOs and people�s movements have to make a herculean effort to get them to introduce even the minimum and common standards. (US ECA is one rare exception). The point about commercial lenders, or even project sponsors being �ready to support programs aimed at promoting economic and social development in the area around the project� also needs to be looked into in more carefully. Normally, such efforts are nothing but superficial measures, opening a school here, or a temple there, or at best a hospital, done more to white-wash their role in destroying the livelihoods, environment and culture of the area. D. Page ii, ES:

�Strapped for financial resources and realizing that infrastructure bottlenecks hampered economic growth, governments started to change their roles from that of a provider of services to being a regulator and a facilitator of private investments.�

If the paper is discussing the reasons for the change in financing of infrastructure projects and the trend towards privatisation, one important reason is the pressure form international financial institutions like the WB and IMF. This pressure, at the behest of the private capital interests globally have played an important role in the changing trends, and it is important to recognise this. This is essential since there is a lot of opposition to the role being accorded to the private sector and it is by no means likely that this trend will not see a reversal, or at least strong and continuing opposition. E: Page iii, ES

�Since the 1970s, the financial performance of many power utilities has declined and their ability to finance investments utilising their own resources has correspondingly declined. Although this trend is being reversed, self-financing is still difficult and, for the reasons given above, governments are no longer able to provide as large contributions to investments�

A very important criticism of the policies for privatisation (at least in India) has been that the inability of the public institutions to finance projects using their own resources has been largely due to the restrictions imposed on them by the political leadership � for example provision of electricity to agricultural consumers at rates far below generation cost. If the public sector is given the same terms as the private (PPAs signed with an assured rate of return on equity, assured purchase of power at previously decided rates which are fixed for the duration of the operation of the project, assumption of the risks by the Government rather than the project, counter guarantees and escrow facilities,

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 84

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

preferred supplier status � i.e. their plant will be the last to be backed down, deemed generation facility � i.e. if the power can�t be purchased due to surplus in the grid, even then the project would be paid for the power ) � if all these are provided to the public companies, there is not reason why they too will not be able to run the plants at a profit and finance their own expansion. Critiques of this kind are growing in India and could have an impact on the financing and the kind of facilities being provided to the private sector. F. Page ix, ES

�The cost of the power (or other output produced by the project) is too high due to the high cost of commercial financing. Implicit in this argument is typically the assumption that concessional financing would have been available. Given the policies of the donor community described above, it is not at all certain that concessional financing would be available for power generation projects�.

The high cost of power in such projects is not only due to the higher cost of financing, but also due to loaded PPAs which guarantee excessive rates of returns, cost padding (since the normal way of calculating cost of power is a cost plus approach), such skewed terms accorded to the private concerns presumably for a �consideration�. Lack of transparency has not helped the matters. G. Page 29, �Emergence of New Financing Instruments��

�In either case, the project needs to be carefully structured to ensure lenders that it is economically, technically, environmentally feasible and that it is capable of servicing the debt under most reasonable scenarios.�

This kind of concern about risks of lenders, promoters etc. find place in the report at several places, but the need to structure (or choose a dam / non-dam alternative) so as to assure affected people and the environment does not find the same importance. H. Page 34 chap. 5, Current situation

�Despite this the international lenders and guarantee agencies have come under a lot of pressure from groups who appear to be lobbying against hydropower in general, sometimes without regard to the specific characteristics of individual projects or the environmental cost of alternatives.�

What is the basis of this statement? The critiques of the affected people and NGOs are among the most studied and it is not only unfair but ridiculous to make such statements which try and demean the opposition to large dams. I. Page 34, Character of Hydropower Plants

�Run-of-river projects have no reservoir and generate only on the natural, unregulated river flow. These projects have relatively minor environmental impact, other than the depletion of river flows between the intake and powerhouse on tunnel schemes�.

This assumption that R-o-R plants are low impact is not correct and has already been pointed out above. J. Page 36, Trends in Regulatory Environment �Under a power pool system there will be a tendency for all hydro schemes with storage to bid into the peak of the load curve where the higher price is obtained, but this can result in an unacceptable pattern of river flows downstream and may be in conflict with other requirements� This is a very important point and particularly relevant from the point of view of the Criteria and Guidelines that WCD will develop.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 85

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

K. Page 39

�In general private financing is only sustainable with support from the host government and within a security package that often requires sovereign guarantees (see Chapter 4)�

This is a very important conclusion, and one of the most important significant facts about private sector financing of large hydro. What remains to be analyzed in the paper however, is whether it is worth it for the host Government to provide such a security package (which involves great costs � financial, social, environmental ) or it would be better to go for alternatives. e) Comments by Janak Karmacharya (received 27 June 2000) 1. The report is quite comprehensive and informative, although it is more extensive in dealing with

the financing of hydropower projects rather than financing of water and energy resources projects. Navigational aspect of the water resources use does not find any place in the report. For the completeness of the report, the use of rivers for navigation and financing opportunity for such projects may need to be addressed.

2. The report rightly points out �in future a number of low-income countries with abundant hydro resources and little other export potential (like Lao PDR and Nepal), have the prospect of significantly adding to their GNP through the export of hydro energy to neighboring status�. In order to realize this dream of low-income group countries, experts should help develop appropriate mode of financing. The World Bank is assisting to establish a Power Development Fund (PDF), in Nepal to encourage private sector participation in hydropower development. This fund could be extended to include other bilateral or multilateral donors. The PDF will not only provide various guarantees but also contribute up to 25% of capital investment in a particular projects. The fund is envisaged to work as a resolving fund with the provision of continuous replenishment. The report could suggestion other innovative ways to ensure financing for hydropower/water resources projects.

3. There has been recognition of the feet that involvement of multilateral donors in water resources projects, especially hydropower projects, should continue as:

i. South Asia�s development is contingent on a balanced, cost efficient and sustainable energy supply system, which can be achieved only through developing huge volume of untapped hydropower resources:

ii. Participation of multilateral donors in hydropower projects can serve as a catalyst of best practices in project implementation state-of-the art in environmental protection and social compensation works.

iii. The much needed power sector reforms in low-income countries could be ensured by such participation.

iv. Involvement of multilateral donors will make hydropower projects fairly robust in weathering adverse political and implementation conditions.

4. Although it is correct to observe that private investors, in general, are reluctant to engage in hydropower projects because of the long payback periods, investors from petroleum producing countries, sometime seem not to be particularly concerned with payback period, but quality of project which could guarantee a steady flow of resource over long period of time with negligible operation and maintenance requirements. Some research for such investment possibilities should be made.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 86

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

5. The concept of �avoided cost� has been widely accepted in calculation of the benefit of a power station. The economic analysis of hydropower project should be done in the basis of �full life time � of a project, which automatically takes into consideration the operation and maintenance requirements, adopting the principal of �avoided cost�

6. While there are legitimate environmental and social concerns created by development of water

resources project, which need to be addressed properly and adequately, there are cases when these concerns are overblown out of proportion and cross all the boundaries of reality. Yet, because of effective networking of such campaign, the �innocent� project becomes a victim. Hence, if WCD guidelines are complied with by developers of hydropower projects, there must be the obligation for such �concerned groups� to stop opposing just for opposition. The WCD guideline should create two-way contract. This will encourage the private investors to participate in the hydropower development.

f) Comments by P.C. Mathur (received 3 August 2000) The paper has been examined and we believe that the paper needs revision to reflect the following. "Investment in water resources projects is not to be seen from the angle of financial returns alone. The impact of water resources projects on overall prosperity of the area benefited, poverty alleviation, employment generation, utilisation of renewable resources, nil fuel cost unlike thermal, environment up gradation by extra green cover & plantations, checking desertification, drought proofing, micro climatic change, lake environment, fisheries, birds, water plant for fauna, recharging of ground water, facilitation for conjunctive use, etc. all lead to social and economic transformation and well being of the people. It is the prime responsibility of a welfare state to invest in harnessing of its water resources potential and its needs to be given top priority." g) Comments by Ruth Meinzen-Dick (received 22 June 2000) The terms of reference and the review rightly stress the shift from public funding and aid to private sources of funding for dams. However, the assumption seems to be that this will mean multi-national corporations. It seems to overlook the potential (and implications) of domestic private sector investment. Although in countries like Laos this may not be a significant source of funds, it has become a major source in India, and potentially in numerous other countries. Both the bond market and other channels for raising funds are possible. The implications in terms of adequate returns for investors and a clear regulatory capacity would be the same for domestic or international private sector investment, but domestic investment would not generate quite as much distrust and emotional objection from consumers as the specter of MNCs profiting from the �sale� of water. This distrust is not really addressed in the paper, but it remains a significant issue in responses to private financing of dams in quite a few countries (as evidenced by the protests at the World Water Forum, but also in quite a few protests in countries from India to Bolivia. Part of the distrust originates in attitudes toward foreign companies profit-taking, but much also derives from a deep distrust of the regulatory capacity of the state. The paper identifies the need for transparency and public participation in the setting of prices and regulating the projects at several points, but this really needs to be emphasized as an essential condition. Not only must there be an effective and transparent regulatory body, but there must be public confidence in such a regulatory body�not a trivial issue, or one that can be assumed into existence in most developing countries. The acceptability of private financing hinges upon this.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 87

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Section 2.4 on irrigation is quite strongly negative with very little supporting evidence. Statements like �It is well documented that few of these schemes provide the quality of water supply � that is needed for growing high value cash crops or achieving high yields from traditional food and fodder crops.� are too strong, and require citations for support. A thorough review of World Bank funded irrigation projects by Jones (1995) gives a rather different picture: weighted by size, 84% of irrigation projects had satisfactory ratings, which was higher than for the agricultural sector as a whole. Furthermore, larger projects were significantly more likely to have satisfactory ratings, which is different from the implications of this section. Groundwater may have more private investment by individual farmers, but this has also been heavily subsidized, especially through cheap energy policies. The final paragraph of section 2.4 is not quite accurate. Water rights are important for any type of use. Power generation may technically be a �non-consumptive� use, but if water is released for power generation at times when it is not needed for downstream water uses, then it effectively consumes the water. Irrigation, on the other hand, may �consume� a large portion of the water, but if it is during the rainy season when the water would otherwise run to the sea, it is less of a loss to the system. The paper makes a very important point that electricity charges should have peak and off-peak rates: so also water use should be treated differently for peak and off-peak periods. Municipal and industrial uses, which require reliable water supplies year-round have much higher storage requirements (and therefore incur higher costs and water losses) than wet-season irrigation. Although it was not in the terms of reference, it would have been good if the paper had also dealt with the implications of different types of financing for the management and incentives for management of systems. Small and Carruthers make a very persuasive case for financially autonomous irrigation agencies (as opposed to traditional government agencies) because, they argue, the need to collect revenue from the farmers will introduce incentives for a client service orientation among agency staff. Although this does not appear to happen in every case, different forms of financing create different accountability. Projects financed by the government, MNCs, or local contributions will differ in who they are accountable to, how they are accountable, and how that is translated into incentives for staff. There is an assumption that private financing will create efficiency, but perhaps would only create incentives to serve those who can afford it. Greater attention to these issues would be valuable. Finally, both the TOR and the paper assume that thermal power plants will be more desirable than hydropower in many cases. However, hydro not only has the advantages of being able to adjust to peak loads, but it also does not emit carbon. If attention to global climate change becomes serious in the next few decades (which is quite likely), then hydropower generation could once again become more attractive. The paper makes a real contribution to the discussion of the future of dams, and I look forward to the final version. References: Jones, William I. 1995. The World Bank and Irrigation. Operations Evaluations Study. Washington

DC: World Bank. Small, L.E. and I. Carruthers. 1991. Farmer-Financed Irrigation: The Economics of Reform.

Cambridge, MA: Cambridge University Press in association with the International Irrigation Management Institute.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 88

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

i) Comments by Steve Rothert (received 22 June 2000) The Executive Summary (p. v) statement �Environmental and social/resettlement issues need to be explicitlyand transparentlyincorporated into the process that grants concessions to private operators�, can be supported. The Executive Summary (p. v) states �private companies are likely to find it difficult, if not impossible, to acquire large tracts of land and resettle hundreds or thousands of families. They (and their financiers) are likely to insist that the government provide the land with no encumbrancesprior to start of construction.� Similar statements were made by industry representatives at the WCD meeting in Cape Town in April, highlighting the important issue of whether responsibility for and financing of resettlement/social costs should be separated from other project costs. While the argument that governments have a greater responsibility to address such issues than dam developers seems logical, the paper should remind readers that the cost of providing unencumbered land (and other resettlement costs) can not be divorced from other project costs in the economic analysis of power and water supply options. Global experience in the dam building sector does not support the Executive Summary (p. vi) statement that governments and the donor community have �found ways of working with NGOs and designing projects that fully involve the local community and project beneficiaries.� The document states in the next paragraph ��a number of successful examples and recommendations are provided in the various options papers prepared for the Commission.� Based on my reading of the WCD papers, this statement also cannot be supported. The Summary Recommendations (p. 57) state �the declining ability of governments to finance infrastructure projects and the private sector bias against hydropower and other water resource projects have meant that an increasing number of socially beneficial, environmentally benign and economically attractive dam projects remain undeveloped.� This statement is unsupportable and flies in the face of the record the WCD has built on the development effectiveness of dams worldwide. I would challenge the author to identify one dam that is socially beneficial, environmentally benign and economically attractive. If such dams had been or would be proposed, one would expect that there would be no need for multilateral and bilateral donors to �play an important role in making up for the financial shortfalls as well as encouraging proper handling of social and environmental issues�, as the author calls for. II: Comments on Draft of Executive Summary of April 2000 a) John Besant-Jones World Bank a) Comments by John Besant-Jones (received 4 April 2000) (i) Nature and Implications of Infrastructure Reforms, power sector, page v, second bullet: two points are being made here which should be distinguished. Firstly, peak load pricing applies to retail power tariffs, and secondly payment for ancillary services is an issue for wholesale prices that are not specifically reflected in retail tariffs. (ii) Nature and Implications of Infrastructure Reforms, power sector, page v, last bullet: the issue for IPPs is the structure of the power sales arrangements. The typical Asian IPP has placed the full market risk on the off-taker (usually the national power utilitiy) which has became unsustainable under heavy devaluations and a slow-down in growth of power demand. The alternative structure is to place the market risk on the IPP by having it sell its output under a merchant arrangement in a

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 89

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

competitive wholesale power market, but this type of deal would be unfinanceable in developing countries until both the capital and power markets were properly developed. (iii) page vi, second bullet: try "heterogenous" for "multi-dimensional"? (iv) Flood control - page vi: the UK example cited here is similar to tolling arrangments that have been used for the first IPPs in highly risky countries for foreign investments in infrastructure, such as in Philippines in the early 1990s and recently in Cote d'Ivoire. Tolling involves the investor constructing and operating the plant, and passing electricity produced in its plant to order from fuel supplied on the account of the off-taker. (v) Implications of Project Finance (Non- or Limited Recourse) Model - page viii, second para.: it's worth adding that these observations apply because typical project-financed deals in developing countries are undertaken with a high degree of gearing - say 70% loans/30% equity, and the lenders have no potential to increase their earnings in the way that equity holders do, whereas both face a potential loss of earnings. (vi) Same as point v, fourth para. Note that IFC and its counterparts also take equity stakes. (vii) Same as point v, last para. The issue here is that the absence of credible anti-monopoly regulation of the wholesale power market is compensated by regulation through the legal system by means of the project contracts, which is unwieldy and inflexible but much better than nothing. (vii) page ix, first para.: the suggestion that lenders will shy away from hydropower needs to be more clearly qualified than here because IFC and its counterparts have lent for hydropower. (viii) page ix, third bullet point: the interest rate spread between donor lending terms and on-lending terms is needed as payment for the loan repayment guarantee that the state treasury usually provides. (ix) Generally, the paper does not address some of the innovative ways to share construction risks for privately-financed dams that have been adopted by clients and sponsors, which are worth mentioning. (x) Likewise, the issue of relative contributions to debt servicing from muti-users of dam services needs to be highlighted, in view of the low levels of cost recovery from irrigation and water supply users and zero cost recovery from flood control beneficiaries. In practice, therefore, hydropower has usually the been the main source of cost recovery, but this is no longer possible generally in competitive wholesale power markets. This situation may explain the increased difficulty in financing multi-purpose dam projects. III: Comments on Indicative Table of Contents a) James Mahoney Ex-Im Bank, Engineering and Environment Division, USA a) Comments by James Mahoney The comments provided below, which reflect an approach to addressing issues and trends from the perspective of an export credit agency, are broad in nature and therefore are presented in a form that is not targeted to specific sections of the proposed TOC. While I believe that the contents of the proposed TOC are relevant and comprehensive, I feel that certain subsections would need to be altered or reorganized somewhat to accommodate the comments and suggestions provided below. My initial attempt to provide specific comments on individual sections led to redundancy and did not

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 90

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

appear as useful and constructive as the approach provided below, which leaves to the author of the TOC the option of how best to integrate into the TOC any of the following comments or suggestions. 1) As an overall comment, lending institutions usually refer to the term �Project Finance� to mean

�Limited Recourse Financing� or that specific type of financial support formulated to respond to the requirements of projects having private ownership (such as independent power producers - �IPPs�) and structured as a Build-Own Transfer (BOT) or Build Own-Operate Transfer� (BOOT) undertaking. I believe that the TOC of the paper should address this point by providing separate sections that describe and explain the specific finance issues and trends that are attributable to the different types of project ownership structures and their respective financial risks.

2) First, the overall financing issues and trends associated with hydro and water resource projects

should be addressed in a broad context. Many of the major elements that impact decisions by international lending institutions to support water and hydroelectric projects transcend the differences associated with the various financial programs offered to provide support for specific ownership schemes. For example, some lending institutions require environmental and social impact evaluations for all hydro or water resource projects, irrespective of how the project is structured. To what degree is the repayment term of lending institutions a function of amount of financing provided for the project? Do certain financial institutions offer financing �incentives� (as does Ex-Im Bank, for example) for hydroelectric projects in recognition of their status as a renewable energy source?

3) Second, financing issues and trends attributable to straightforward sovereign risk hydro and water

resource projects should be addressed separately. Can one expect a net increase or a decline in the demand for financing of new publicly owned hydro and water projects? (One may expect that due to the very large investments associated with large dam projects, such as the mammoth Three Gorges project, such projects would remain in the public or sovereign-risk domain.) What are the responses and trends of lending institutions to projects having conventional public ownership? Are elements of financial support, such as the length of repayment terms, readily adjustable to the needs of projects in this category? Is �mixed credit� or concessionary support for such projects declining, with financial support expected to come from Export Credit agencies or multilateral lending institutions?

4) Third, the specific issues and trends associated with hydro and water resource projects requiring

actual �project finance� (or limited recourse financing) should be addressed. These cover the category of privately owned projects that include the IPPs with BOT/BOOT ownership schemes. What are the mechanisms or trends that could encourage financial institutions to assume the unique risks associated with supporting privately owned hydro and water resource projects?. How are export credit agencies (ECAs) and IFIs responding? What are they identifying as the risks, and are these consistent with the general perception of the owner�s risks? What is a generally accepted debt-to-equity ratio for a hydro project, and is it similar to the ratios of projects in other sectors? How do lending institutions address the currency transfer risks inherent in hydro projects?

5) Forth, the specific issues and trends associated with lending institutions� risk assessments of

hydroelectric projects, as opposed to conventional thermal power projects, should be addressed. For example, are the advantages (if identified) of hydroelectric projects, in contrast to thermal power projects requiring fuel supply agreements (and the associated risks related to such agreements), taken into account by lending institutions? Are risk advantages acknowledged for independent power producers that exploit hydroelectric potential with no fuel supply risk? Do lending institutions recognize this apparent advantage? What is the bond market for hydro projects and are there any trends for accessing this source of capital? Is the predictability of revenue (a function of hydrology) the real issue or risk facing lending institutions, as opposed to

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 91

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

the perceived issue of length of construction? If so, what are the mechanisms being devised by project sponsors, public utilities and lenders to mitigate this risk?

6) Finally, as a general observation, Ex-Im Bank does not view the tenor or term of ECA loans as

representing a particular obstacle to the financing of hydroelectric projects. For limited recourse financing projects, a more likely obstacle would be reflected in the ability to quantify risks that are a function of natural phenomena, such as rainfall and hydrology. Also, hydro and water resource projects have a higher percentage of host country or local costs to foreign exchange costs (for imported equipment and services) than is the case for IPP thermal power plants. This may impact the �appetite� of international lending institutions (especially ECAs) to provide adequate support of such projects.

7) It is important that the role or mission of the various types of lending institutions be explained in

this paper, together with the trends associated with their support for hydro and water resource projects. Also, is the OECD (or even the WTO) expected to impact the way that ECAs and other lending institutions address the environmental and social impact of hydro and water resource projects? Are private lending institutions, especially those that have signed onto the UNEP Environmental Framework Agreement, expected to show greater sensitivity to the environmental issues associated with hydro and water resource projects? To what degree is the review or evaluation of the environmental and social impacts of large dams, hydro and water resource projects evolving to encompass issues that were not deemed particularly relevant or important in the past? What is the impact that NGO intervention has on the decision-making policies of lending institutions? To what degree are lending institutions acknowledging the importance of recognizing all of the �stakeholders� associated with water and hydro projects and following through to solicit input from these identified stakeholders?

8) How �transparent� are the policies of lending institutions with respect to the broad spectrum of

both financial and environmental/social issues that are generally acknowledged to be attributable to hydro and water resource projects? Does the transparency of a lending institution�s policies in this arena impact its ability or willingness to support controversial large dams or water resource projects?

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 92

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Annex 1: Asian Development Bank Financing Trends

ADB Financing: All Large Dams

-

200

400

600

800

1,000

1,200

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

US$

M, 1

998

pric

es

ADB Financing: Hydro Dams

-

200

400

600

800

1,000

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

US$

M, 1

998

pric

es

ADB Financing: Irrigation Dams

-

50

100

150

200

250

300

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

US$

M 1

998

pric

es

ADB Financing: Water Supply Dams

-

50

100

150

200

250

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

US$

M, 1

998

pric

es

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 93

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

ADB Financing: Hydro vs. Electric Power

-

1,000

2,000

3,000

4,000

5,000

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

US$

M, 1

998

pric

es Hydro Dams

Electric Power

ADB Financing: Irrigation Dams vs. Non-Reservoir Irrigation Projects

-

500

1,000

1,500

2,000

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

US$

M,1

998

pric

es Irrigation DamsIrrigation

ADB Financing: Water Supply Dams vs. Non-Reservoir Water Supply Projects

-

400

800

1,200

1,600

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

US$

M, 1

998

pric

es Water Supply DamsWater Supply

ADB Financing: All Dams by Type

-

200

400

600

800

1,000

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

US$

M, 1

998

pric

es Hydro DamsIrrigation DamsWater Supply Dams

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 94

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Share of Large Dams to Total ADB Loan Approval

0%

2%

4%

6%

8%

10%

12%

14%

1968-74 1975-79 1980-84 1985-89 1990-94 1995-99

ADB Financing Structure of Large Dams

0%

20%

40%

60%

80%

100%

1970-74 1975-79 1980-84 1985-89 1990-94 1995-99

Shar

e to

tota

l pro

ject

cos

t

ADB Bilateral MultilateralCommercial Export Credit Borrower-financed

Note: This chart shows the levels of co-financing in dams to which ADB has committed funds.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 95

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

Endnotes 1 This thematic review paper focuses on developing countries for several reasons: (i) most dam projects to be built in the future are likely to be located in developing countries; (ii) the changes in financing practices have had and are likely to have the most dramatic impact in developing countries; and (iii) industrialised countries typically have a stronger tradition of regulating dam projects than developing countries. 2 There are no overall statistics on financial flows for dams and, consequently, a picture must be developed by pulling together a range of information from various sources that may or may not be consistent. 3 The countries in Asia and Latin America with the largest hydropower systems have a well-developed domestic manufacturing capacity for most types of turbines, generators, and transformers, etc. Thus, the import content in their hydropower schemes is fairly low. 4 When problems have arisen, it has usually been cases where the government was the formal owner but �squatters� lived on or derived their living from the land. While proper resettlement and reasonable compensation to ensure that the affected people at least can maintain their living standards is the international norm, some governments and private companies have found it difficult to handle some cases. 5 The recent decision by the World Bank to also offer guarantees for projects in the poorest and least developed countries makes this instrument much more important as a facilitating instrument for private infrastructure investments. (Previously guarantees could only be offered for projects in middle income countries and a couple of the more creditworthy low-income countries.) It deserves to be noted that partial risk guarantees provided by the World Bank and the regional development banks are covered by the same guidelines social and environmental guidelines as loans. 6 B-loans are syndicated loans for which IFC is the lender on record. A-loans are direct loans from IFC. 7 Often the arguments for or against limited recourse finance actually concern private ownership of infrastructure facilities and the process of sector reform and privatisation. This set of issues is dealt with in the previous sections of this summary. 8 The World Bank, for example, is presently holding back any lending to the Power Development Board in Bangladesh while it is ready to support two private power plants through loans and/or partial risk guarantees. 9 In the case of lending on quasi-commercial terms (for example IBRD loans), the spread is often justified by the repayment guarantee that the state treasury provides to the lending agency. 10 While most commercial lenders set the interest rate and repayment period for a project based on its risk profile, the variations are relatively minor. The assessment of risks primarily influences the lenders� decision regarding whether to support the project or not. Sponsors and equity investors are, however, likely to adjust their target return on equity based on the perceived level of risks. 11 Note that the use of Multi-Criteria Analysis in place of the standard Cost-Benefit Analysis does not change this situation: the project preferred by society in either case may not be financially viable per se for the reasons mentioned in the text. 12 The concept of bidding for the right to develop hydropower projects is controversial. Some experienced developers argue that not even competitive bidding for the selection of the EPC/turnkey contractor is appropriate (Ulfsby, 1997) 13 However, telecommunications was the sector where liberalization occurred first and it is the sector that has attracted the largest amount of private investments to developing countries. This process was � and still is � driven by exceptionally rapid technological innovation, falling costs and the virtual disappearance of economic barriers to entry. 14 The success of the rural electricity co-operatives in Bangladesh, for example, shows that even very small distribution entities can be managed extremely well. Improved methods for dispatch also makes it quite feasible to operate a system with a number of small, independent generators.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 96

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

15 However, it took almost a decade before all legal and political issues were resolved and the Turkish BOT program moved ahead. 16 A number of variations of the BOT/BOO model have been used, for example, �repair-operate-transfer� (ROT) where a private party finances the repair of a facility, operates it for a number of years to recover the cost and subsequently hands it back to the utility. Other variations include �build-lease-transfer� (BLT) where a private party finances and builds a facility, leases it to the utility and subsequently transfers ownership. 17 In the case of the 1,200 MW Hub power project, the process took more than five years before construction started in late 1993. 18 The most publicised case is the Dahbol generation project in India. A number of private power projects in Pakistan have recently been forced to re-negotiate for the same reason. 19 A striking example of this was the great divide at the World Water Forum, held in the Hague in March 2000, between NGOs and trade unions on one side and the representatives from governments, international organisations and corporations on the other. 20 A review by Jones (1995) of 110 World Bank financed gravity irrigation projects showed that these schemes had, on average, an estimated economic rate of return of 14% at the time of loan closing (i.e. when the World Bank stopped its disbursements but typically prior to full completion of the works). However, for a more limited sample of projects for which an assessment was made after the schemes had been in operation a few years, the economic rate of return was in the order of 9% - that is below the 10% typically considered as the minimum criteria for economic viability. 21 Farmers at the head-reaches tend to get a good water supply while those near the edges tend to get only a sporadic supply. The �tail-enders� usually suffer more from the negative externalities (water logging and salinity) due to over-irrigation in the higher lying head-reaches. Thus, some tail-enders might actually see declining incomes after a canal scheme has been built. 22 Low water charges are often justified by references to important secondary benefits from irrigation, and as the US example clearly demonstrates (see the WCD Grand Coulee Case Study), heavy subsidies for canal water are not limited to developing countries. 23 See section 3.3.3 for further details. 24 In part this is because the ultimate beneficiaries of hydropower tend to be the electricity consumers while in the case of irrigation water for a large private estate, the main beneficiary is the owner of the estate. 25 See section 5.4.2 for further details. 26 See WCD Thematic Review IV.2 on �Assessment of Irrigation Options.� 27 The URL for the site is: http://www.ids.ac.uk/ids/particip/ 28 The data is from ICOLD�s 1998 register of large dams. Assuming a two-year lag in data reporting, the data for the 1990s would represent about 60% of the completions during the decade. This would imply a completion rate in the developing world of about around 200 dams per year. Extrapolating to the end of the decade, this would give a total for the 1990s of around 2,000 dams�or about 70% of the level during the 1980s. The same calculation for industrialized countries would give a total of about 1,400 for the decade. 29 Analysis of IDB database in Sunman (2000). 30 The actual overrun of the large dams in the IDB project list was 45%, roughly equal to the overall overrun for a sample of 250 large dams of 54% found in the WCD Thematic Review III.1 �Financial, Economic and Distributional Analysis.� 31 From World Atlas, 1998. 32 This declining trend is also borne out by the financing flows from the multilateral development institutions. IDB�s support for dam construction peaked around 1982. Between 1973 and 1985, the IDB was investing in over 20 hydropower dams at any one time. By the late 1990s this had fallen to less than 5. 33 A check on the magnitude of investments in canal irrigation can be provided by the following calculation: Globally, about 36% of the irrigated area is supplied from dams (estimate provided by the WCD Secretariat). According to the analysis by Jones (1995) surface irrigation is approximately

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 97

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

twice as high as the cost for pump irrigation. This would imply that canal irrigation (relying on dams) would account for 53% of the aggregate investment cost for irrigation. 34 The other loans were for: repair of the generating facilities at Selingue in Mali (FY96); construction of the run-of-river Ghazi-Barotha in Pakistan (FY96) which relies on regulated releases from Tarbela; installation of generating facilities at the existing dam at Manantali to serve Mali, Mauritania and Senegal (FY97); installation of pumped storage facilities at Tongbai in China (FY00). 35 See http://www.worldbank.org/html/extdr/pb/dams/factsheet.htm for further details. 36 Although it is reported that 2 irrigation dams are in the ADB pipeline. 37 The World Bank (Izaguirre, 2000) estimates that private investments in power and natural gas transmission facilities in developing countries fell from a peak of $46 billion in 1997 to $25 billion in 1998 and only $15 billion in 1999. 38 The Projectware database is created and managed by Capital DATA, a joint venture company between Euromoney Publications Plc and Computasoft Ltd. The Projectware database is updated quarterly. 39 The countries in Asia and Latin America with the largest hydropower systems have a well-developed domestic manufacturing capacity for most types of turbines, generators, and transformers, etc. Thus, the import content in their hydropower schemes is fairly low. 40 Countries like Brazil, China and India with major hydropower programs have well developed equipment manufacturing capabilities. 41 The regional development banks have generally moved in parallel with the World Bank and their policies are in most respects the same. 42 The full text of the relevant World Bank policies are available on the Bank�s web-site: www.worldbank.org 43 In February 2000, the World Bank had no loans for state-owned power plants in its lending pipeline. However, it had under active consideration four partial risk guarantees to support private power plants. 44 A review of World Bank projects by Bacon et al. (1996) of 71 hydropower projects and 64 thermal power projects approved between 1965 and 1986 showed an average cost overrun of 30% for the former versus 11% for the latter. See the WCD Thematic III.1 for a larger database on cost overruns. 45 This experience which is contrary to �common wisdom� is probably due to the fact that dam projects typically approved later in the project cycle. (Most agencies usually approve dam projects first when the contracting has been completed.) 46 For example, the Yacyreta project in Argentina-Paraguay whose first loan was approved by IDB in 1979 is still unfinished. 47 In the case of power generation projects, the typical set of political risks that the lenders are protected against are: (i) breach of contract by government entities; (ii) availability and convertibility of foreign exchange; (iii) changes in law (including tax law); (iv) political force majeure events. Normal construction, operating and natural force majeure risks are not covered but have to be born by the project sponsor. 48 The European Bank for Reconstruction and Development (EBRD) is somewhat different than its older �cousins.� It has, inter alia, a mandate to allocate at least 50% of its lending to private enterprises. 49 �BBB-� by Standard & Poor�s or equivalent by any of the other rating agencies. 50 Often the arguments for or against limited recourse finance actually concern private ownership of infrastructure facilities and the process of sector reform and privatisation. This set of issues is dealt with in the previous sections of this summary. 51 The World Bank, for example, is presently holding back any lending to the Power Development Board in Bangladesh while it is ready to support two private power plants through loans and/or partial risk guarantees. 52 At a minimum, this would require that the local population would have a voice in the process and that the standard of living of the affected community would be at least as high after construction of the project through appropriate compensation and rehabilitation measures.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 98

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

53 The timing of the project remains uncertain due to the slump in power demand in Thailand following the Asian crisis. 54 However, under the umbrella of the OECD, the bilateral donors have severely reduced their use of �mixed credits� (i.e. when development aid is combined with ECA financing) for commercially viable projects. The reason is that it was viewed as giving an unfair advantage to those suppliers that could easily persuade �their� aid agencies to co-finance projects. Single purpose hydropower projects are generally be regarded as �commercially viable.� Thus, ECAs generally co-finance projects with the multilateral institutions rather than with the aid agency from the same country. 55 The World Bank is presently processing its first partial risk guarantee for a private hydropower project, the 200 MW Bujagali Hydropower Project on the Nile River in Uganda. The project, which follows the BOT model, is sponsored by AES Corporation of the US. 56 Nam Theun II has been a controversial project on environmental grounds, but it is worth noting that a portion of the project revenues will be directed specifically for the protection of the Nakai Plateau where the scheme is located. It is argued that without such measures the existing environment would be substantially destroyed within a relatively short period of time, and that although the project submerges 450 km2 (about 40%) of the plateau most importantly provides the means for protecting the upstream catchment area which comprises some 3,500 km2 of primary forest. The developer will contribute $1 million/year over 30 years towards the management of this forest which is of outstanding international significance in terms of its biodiversity, in addition to meeting the direct environmental mitigation costs arising from the project. 57 According to press reports, the Malaysian government has taken over responsibility for the Bakun project and is studying options for its implementation. Preliminary site work appears to be underway. 58 Note that the use of Multi-Criteria Analysis in place of the standard Cost-Benefit Analysis does not change this situation: the project preferred by society in either case may not be financially viable per se for the reasons mentioned in the text. 59 For a critique of the PPA for this project see White (2000 eco019). 60 Efficacy means that the subsidy reaches those for whom it is intended (i.e. minimizing errors or inclusion and exclusion). 61 Sector efficiency means that the subsidy is structured in such a way that it encourages provision of services at least cost (taking into account externalities). 62 Cost-effectiveness means that the subsidy achieves its social goals at the lowest program cost while providing incentives to businesses to serve the target groups. 63 Most consumers in developing countries tend to buy cigarettes one-by-one although they would save buy buying a full package of cigarettes. The same way of adapting to budget constraints is displayed in most of their buying habits. This means, inter alia, that most households are willing to pay a higher monthly cost for electricity (or water) if they can avoid an up-front connection fee. 64 Frequently, small and medium sized businesses would be looking for payback periods of 24 months or less when investing in new equipment. 65 For example, the power shortages (reflected in load-shedding, blackouts and burn-outs) in Pakistan around 1995 were estimated to cost the economy around $900 million a year. A recent World Bank sponsored study revealed that energy shortages in Bangladesh in the late 1990s cost about $1,000 million and reduce GDP growth by about half a percentage point (Lovei & McKechnie, 2000). 66 There is little doubt, for example, that the successful BOT program in the Philippines played a significant role in restoring growth in the mid-1990s. 67 It should be noted that power shortages are much costlier to the economy than a similarly sized surplus. Thus, it makes economic sense to err on the high side than on the low side when planning for generation system expansion. 68 If the subsidized capital costs, implementation delays and the low operational efficiencies in most state-owned generating facilities are taken into account, the tariffs paid to IPPs are in most cases lower than the real cost of the utility�s own cost of generation. 69 WAPDA in Pakistan is a good example of how these pressures led the utility to improve its operational performance.

Thematic III.2 Trends in the Financing of Water and Energy Resource Projects, 99

This is a working paper prepared for the World Commission on Dams as part of its information gathering activities. The views, conclusions, and recommendations contained in the working paper are not to be taken to represent the views of the Commission

70 The concerns of the donors include: (i) the inequitable growth that occurs due to the high expenditures benefiting relatively few people; (ii) the relatively low economic returns due to inefficient water use in the absence of functioning water users organizations; (iii) negative environmental impacts from waterlogging and salinity (and to some extent the use of agro-chemicals). 71 The concept of bidding for the right to develop hydropower projects is controversial. Some experienced developers argue that not even competitive bidding for the selection of the EPC/turnkey contractor is appropriate (Ulfsby, 1997)