Profitability concerns in 114 MW Dagachu project after escalating costs

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Both DGPC and NPPF stand to get reduced dividends if the project cannot negotiate a higher tariff with Tata power

Bhutan’s first medium sized hydro project with a foreign private company partner is facing the possibility of reduced profitability due to a sharp increase in its construction costs. The reduced profits would also affect the profit margin of the National Pension and Provident Fund (NPPF) which is a major investor in the project.

The project cost which was estimated to cost Nu 8.160bn has now shot up Nu12.266bn due to poor geological conditions which were not foreseen in the Detailed Project Report. The project was also delayed by a year with it expected to be complete only in 2014 April instead of 2013.

Earlier the Dagachu Hydro Power Corporation (DHPC) based on the original construction cost of Nu 8.16bn had agreed to a tariff power export rate of Nu 2.40 per unit to be bought by Tata power which is also a partner in the project.

At this rate the shareholders of DHPC would get a return of equity of dividend of at 10% per year. However, with the increased constructions costs the return on equity would be only around 8% according to DHPC CEO, Thinley Dorji.

“The power tariff will have to be revised to at least Nu 3 per unit for the shareholders to get a 10% return on their equity,” said CEO Thinley Dorji.

So far a meeting with the Tata power in October 2012 for an increase in the tariff has not produced any positive results.

“Tata power has instead offered to share the profits if they can sell the power at a rate above Nu 2.40,” said the CEO.

He also said that if DHC does not get Nu 3 per unit the return on equity would be lower for the project.

He said more meetings will have to be held in the future to discuss the issue. The agreement between DHPC and Tata power has a provision to increase the tariff if projects costs increase but it is not automatic and has to be negotiated by both sides.

One concern is that if DHPC’s tariff price becomes too high to find buyers in the Indian market. Currently peak hour morning powers are sold for as high as Nu 5 to Nu 6 per unit but in non peak hours the rate falls as low as Nu 1.50 per unit.

The shareholding patterns of DHPC are 59% held by Druk Green Power Corporation, 15% held by National Pension and Provident Fund (NPPF) and 26% held by Tata Power.

If DHPC is unable to get higher dividends all equity or shareholders would get less than expected dividends.

While this will affect all shareholders NPPF could get particularly hit as it is NPPF’s largest ever equity holding in any project. The NPPF invested Nu 480 mn as part of its equity and due to the cost escalation will be putting an additional Nu 150 mn bringing it to a total investment of Nu 630 mn.

Lower returns of eight percent for NPPF will not mean a loss but it will hamper their efforts to increase the life of the pension plan.

“We expected a return of 10% but even if we get anything above seven percent we are sustainable,” said the NPPF MD, Dubthob Wangchug.

However, a finance official from NPPF admitted that higher returns on investment would increase the life period of the pension plan.

As of now the pension system on an interest rate of seven percent return is viable only to 2042 after which it will no longer be sustainable. Returns higher than seven percent would increase the pension plans life by a few more years and make it more viable. The total size of the NNPF is currently around Nu 13 bn.

Dagachu project is expected to generate between a high of 500 million units a year to a low of 360 million units a year. At a rate of Nu 2.40 per unit this would mean revenue of around Nu 1.200 bn to Nu 864 mn.

One of the reasons that the cost of tariff for Dagachu project is higher is because unlike the bilateral or joint venture projects the cost of financing is higher and the equity is not given as grant.

When the project cost was Nu 8.16 bn the loan component of 60% came as 41 mn Euros from the Austrian government, USD 51 mn from the Asian Development Bank and Nu 600 mn from the NPPF.

The 40% equity came as Nu 1.925 bn from DGPC, Nu 848 mn from Tata power and Nu 480 mn from NPPF.

With the increased costs DHPC shareholders have to pump in additional equity of Nu 892 mn. A total of Nu 2.4 bn will be required for the additional costs of construction.

Another major headache that would reduce the profits for Dagachu is the depressed global carbon trade prices.

This was because DHC was the first major hydro project in Bhutan to be registered under the Clean Development Mechanism which would allow it to earn carbon credits and take part in the global carbon trade.

Earlier the carbon credit was worth 3 to 4 chetrum per unit which has dropped to 1.5 Chetrum today due to the global financial crisis.

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