Butterfly Valve Chamber in the Mangdechu project that controls water flow. Photo Courtesy: Mangdechu project

Ongoing Mangdechu project tariff negotiations vital for Bhutan’s upcoming projects and economy

If there is one negotiation to keep an eye on, then it is the ongoing electricity tariff rate negotiations for the 720 MW Mangdechu project scheduled to be commissioned by November 2018.

This is because in the ongoing negotiation between Bhutanese and Indian officials the method of setting the tariff rate and the tariff rate itself will become a precedent for the bigger 1200 MW Punatsangchu I and 1020 MW Punatsangchu II projects.

A fair tariff rate for Mangdechu would also translate into significant internal revenue for Bhutan and may portend the same from the P I and II projects in the future, which would strengthen Bhutan’s internal domestic revenue, and in doing so, its economy.

The negotiation team from Bhutan consists of the the Secretary of Ministry of Economic Affairs Dasho Yeshi Wangdi, Director General of Department of Hydropower Sonam P. Wangdi, DGPC MD Dasho Chhewang Rinzin, Royal Privy Council member and former BPC MD Dasho Bharat Tamang and a representative from the Ministry of Finance.

The Indian side is represented chiefly by Joint Secretary North, Sudhakar Dalela of the Ministry of External Affairs and Joint Secretary Hydro Archana Agrawal from the Ministry of Power with representation from India’s Central Electricity Authority (CEA).

There have been three rounds of tariff meeting held so far with the last held on 9th May.

The Cost plus model and tough negotiations

The in principle and long standing agreement between Bhutan and India in deciding tariffs has been the ‘cost plus model’ where the cost of the project including the cost of financing is calculated along with a return on equity or the project. It is also written into the Mangdechu project agreement.

Given that the Nu 47 bn Mangdechu project is 70 percent loan and 30 percent grant compared to 40 percent loan and 60 percent grant for Tala, the cost of financing is significantly higher for Mangdechu.

In short India may have saved itself grant money in financing Mangdechu project, but the bigger loan component pushes up cost of financing and hence the tariff rate.

As a result, the cost of financing is becoming the main factor in pushing up the tariff rate.

For Bhutan the higher loan component means a chunk of the revenue has to be paid for loan servicing and so there is automatic logic for higher tariff under the cost plus model.

In-fact, in 2009 itself, the then Indian power secretary H.S Brahma in an interview with an Indian media outlet had forecasted that tariff rates from Bhutan would be higher as the loan component had been increased to 70 percent for P II, Mangdechu and other projects compared to 60 percent for P I and 40 percent loan for Tala and Chukha.

With the cost of finance being an advantage for Bhutan at least in the tariff negotiations, the Indian side’s initial stratagem to try and bring down tariff rates is in raising questions on Royalty energy and return on equity which are part of Bhutanese law and policies and also the long standing Tala model of deciding tariff rates.

This is also something that has never been questioned before.

The Bhutanese side on its end is essentially pushing the Tala model of coming up with the tariff rate citing the last precedent and understanding between the two countries.

The model and principles to be selected to decide the tariff rate are important as they finally decide the tariff rate.

It has been learnt that the Bhutanese side, like in Tala, is asking for a 15 percent Royalty or free energy to be computed in the tariff negotiation.

Bhutan’s Electricity Act and its Hydro policy mandate a 15 percent royalty or free energy to be given to the Bhutanese government out of any project.

The addition of the 15% Royalty energy slightly pushes up tariff rates as tariff would apply on the 85 percent remaining power. The government currently uses royalty energy from its existing projects to subsidize the electricity bills of Bhutanese citizens.

Here, the Indian side is objecting to the royalty energy by interpreting it as a kind of a levy or fee in the export of power which goes against the Mangdechu agreement between the two countries which says that there will be no levy on export of power.

Bhutan on its end does not agree with this stand.

The other component that Bhutan is pushing for is the return on equity on the 30 percent grant given by India with Bhutan treating that 30 percent as its equity on the project.

Currently Indian government norms give up to 16.5 percent return on equity.

The Tala project tariff negotiations saw a return on equity being given.

It has been learnt that the India side in the early rounds wants to limit the return on equity provision to keep the tariff rates lower.

The Bhutanese side has floated some options to the Indian side to push down the cost of financing. One is two reduce the loan interest rate to be paid by Bhutan, another is to extend the interest payment period beyond the current 15 years and another is to do away with the interest during construction. One more option is to calculate all the money given in the beginning of the project as the 30 percent grant so that the loan interest rate kicks in only later.

The win-win here for Bhutan and India is that for Bhutan  high loan repayments would eat into revenue generated by the project and so loan burden reduction would mean more revenue. While for the Indian side the lowering of financing cost could mean a lower tariff rate than what Bhutan is demanding.

The first three rounds of meeting between the two sides has seen discussions mainly around the principals or methods to be used for the tariff negotiation.

Given that Mangdechu is a bilateral government to government project like Tala, the expectation from Bhutan would be that this model is followed to ensure stability and continuity.

Prevailing market conditions

Another important principal in deciding tariff rates apart from cost of project and financing and return on equity is the prevailing market conditions at the time.

The Bhutanese paper found that though India declared itself power surplus in 2017 and power prices dipped in India from 2015-17, that trend has changed for a while and power prices are now on a continuous rise.

This is expected to further pick up as the Indian economy comes out of a slump with even the latest GDP data from India showing much higher growth rates at 7.7 percent in the first three months of the March quarter.

The Indian Energy Exchange (IEX) which is India’s premier power buying and selling platform as of 1st June 2018 recorded the average price of power at Nu 5.94 per unit. The energy exchange on 1st June shows a clear shortage in supply with 280,457 million units in demand but only 218,175 million units available on the exchange.

The spot rate of power or rate at a peak time recently touched Nu 11.51 per unit in the power exchange market in India.

The average sport tariff in the IEX in May was Nu 4.7 per unit and as indicated it is expected to rise even higher in June.

In India there is clearly increasing demand for power and the supply side is unable to keep up, resulting in increasing prices.

On the hydropower front the new hydro projects in India are charging up to Nu 6 per unit and even the more competitive hydro projects in India still charge way above any existing, or for that matter, upcoming project in Bhutan.

Bhutan, in that sense, even without negotiation from the Indian side to bring down tariff for Mangdechu, would already have the most competitive rate in South Asia.

80.5 percent of Indian power is generated from Thermal sources like coal (76.5%) and gas (4.0%).

This is unsustainable in the long run given that thermal power is a major contributor to air pollution in Indian cities and towns which already have among the worst air pollution indices in the world.

Apart from that thermal power rates are also expected to increase from 2018 as announced by the Indian Power Minister R.K Singh in January 2018 as Thermal power plants will pass on the costs of installing expensive emission cutting equipment.

With India making a big push for renewable 175 Giga Watt (GW) of renewable energy by 2022 from the current 62.8 GW hydro will playing an increasingly important role in being a part of this energy mix.

Currently the overall tariff rate in India is around Nu 5 per unit and so it would be reasonable to expect that the tariff rate for Mangdechu hovers close to this mark though both sides are yet to release their tariff expectations.

How India has benefitted from Bhutanese projects too

While the prevailing narrative so far has been of Bhutan benefitting with revenue and India benefitting with power from the mega projects there is another to consider for India.

The projects apart from the above are also a sound economic investment for India with good returns.

Even in the case of the first mega project the 336 MW Chukha project where India provided the most favorable financial terms of 60% grant or free money India made its recovery of the investment in a short time.

A detailed study on the issue was conducted in 2008 by the Center for International Development, Duke University, U.S.A, and the Department of Economics, Queen University, Canada.

The research in a detailed paper concluded that India completed the recovery of the investment cost with its economic opportunity cost by 1997 which is just nine years after the project started in 1988.

The value of net economic gains as of 2008 evaluated in 2008 prices has been 2. 286 bn USD for Bhutan and 2.521 bn USD for India. Taken as a ratio this means that as of 2008 the gain has been 48:52 slightly favoring India.

Final decision on Tariff likely to be a political one

It is hoped that both sides can negotiate a mutual tariff rate based on the cost plus model and also the Tala model. However, going by the Tala experience while officials from both sides draw up their reasons and logic for their tariff figure, the final decision is expected to be left to the political leadership of both Bhutan and India.

The negotiation between the officials of the two sides however will provide an important basis for a political decision.

In the Tala project commissioned in 2006 officials from two sides negotiated for two years from 2004-2006 on the tariff rate. In the end the political leadership from both countries agreed to a rate above what the Indian officials were offering and below what Bhutan had wanted.

However, the big difference in Mangdechu project is that with its 70 percent loan component unlike Tala’s 40 percent loan the cost of financing is much higher in Mangdechu, and it is the cost of financing which is the largest component in fixing the tariff rate.

A tariff rate below Bhutan’s well calculated expectations based on agreement, laws, past precedence and prevailing market conditions may lead to Bhutan leaving the table feeling like it has been shortchanged.

A fair tariff rate on the other hand would further strengthen relations between the two countries and provide a positive precedent for the future.

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