One of the greatest ironies of this century is the announcement by Nepal Electricity Authority (NEA) that it would stop signing Power Purchasing Agreements (PPA) after 2017-2018. NEA claims that it has already locked in over 2,000 MW for domestic supply, starting 2017. That supply, it believes, will be more than enough to meet domestic demand,at least for the wet season.
The irony in this situation is simply about timing. Most of Nepal will be puzzled to hear that NEA has stopped signing PPAs even as the country reels under as much as 16 hours of daily load-shedding. The fact that NEA intends to stop signing PPAs only after 2017 will be lost on the Nepali public for whom this era of darkness, at least for now, seems infinite.
Many stakeholders, including me, disagree with NEA’s assessment that it has adequate future supply to meet future demand. But many, including me, challenge only the basis of the estimates upon which NEA concluded that it had enough future supply to meet future demand—we don’t challenge the right of NEA to make such a decision, once it has concluded its demand and supply estimates.
Clearly, if NEA determines that it has enough future supply, then it must stop signing PPAs. More agreements in that case would simply mean opening itself up to certain bankruptcy. There would be no way to recover payments for the surplus energy it would be forced to purchase. Refusing to sign further PPAs is the least NEA can do to protect against a certain financial destruction.
The question is what happens if NEA demand estimates are wrong. What happens if in 2018 or beyond, there is still a mismatch between demand and supply and load-shedding persists? What then? How should NEA be held accountable?
Here is my simple proposal: NEA should pay a penalty for every unit of unmet electricity demand.
NEA should pick a date, say 2018, 2019 or whatever it is comfortable with and commit to a level of demand it can meet. But there should be a penalty clause in case it fails to meet that demand. For every unit of electricity demand that it is not able to meet, it must pay a penalty to the end-users affected by load-shedding. The penalty must be equivalent cost of a displaced diesel generator.
Such penalty clauses are not a novelty. They are being increasingly forced on state-owned companies to ensure better quality of service.
One of the best examples is Coal India Limited (CIL), India’s state owned near-monopoly producer and marketer of coal. After years of persistent coal shortages, CIL has now signed up to a penalty clause for failure to meet contracted demand. The penalty clause is graduated: in the initial years CIL is committed to meeting penalty that comes to 65 percent of the contracted demand; in later years it is committed to meeting with penalty all of the contracted demand. Initially, independent directors of CIL’s board declined to agree to such a penalty fearing the potential future liability. But a Presidential Directive forced the company to adopt the structure.
NEA could mirror that penalty clause in the PPAs it signs. It is already doing that to an extent by diluting the “take or pay” provision in its current PPAs. Nevertheless, it will probably be practically impossible to impose such a penalty on NEA. The provision could straddle NEA with a large fiscal liability because it lacks the ability to manage such risks.
The spirit of the penalty clause is not that it could be financially destructive for NEA. To the contrary, if done right, it could be the basis for sustained power sector reforms in Nepal.
One way NEA could manage the financial liability of penalty-based obligation is for it to pick a modest demand it would be willing to commit to meeting at all times. NEA’s current demand projections are basically just that–a very modest outlook based on what it can deliver.
With the penalty system, once NEA decides the level of demand it is willing to meet, the government must then open the market to private parties. Companies that believe there is a higher demand than what NEA has projected could bring that demand to market.
Such a structure could help create a uniquely Nepali power pool in which NEA has the right to first serve up its contracted demand. The remainder could then be served by private companies by contracting directly with the end-user.
Rather than being disruptive to NEA, this approach could be a gateway to meaningful reforms in the power sector. It would preserve NEA as the dominant player in the sector. At the same time it would slowly build a critical mass of private companies willing to participate in the entire electricity supply chain, from generation to distribution.
Most importantly, such a structure would help connect those that want electricity (demand) with those that are willing to supply it (supply). That could be the genesis of the Nepali power market.
One of the key questions concerns mechanisms that would be required to put such a market structure into operation. What kind of rules and institutions will be required?
The most important will be independent demand creation. There has to be a mechanism to identify demand beyond what NEA has contracted and is obligated to serve. In effect, there must an independent pool operation with the ability to add new transmission and distribution lines.
These mechanisms could kick-start the development of a whole set of reforms that may not entirely unbundle NEA but could instead add a layer of transparency and competition. It could, for instance, lead naturally to the creation of an independent system operator that manages demand creation, beyond NEA, to come into the system.
Many recent efforts to reform the power sector elsewhere begins with the standard model of markets—unbundled and with private participation. Nepal is also enamoured with the idea of power trading. But year after year, reform efforts continue to fail; power trading may be more a mirage than a panacea.
There is no question that Nepali power sector must be reformed and trading allowed. But rather than merely adopting glamorous international mechanisms, Nepal must recognize its limitations: the importance of NEA to the sector; the weakness of private sector, including of the financial community; and the country’s singular reliance on hydro.
Reforms are not always about discarding what’s broken. They are also about smarter partnerships that can repair the damage.