A couple years ago I was invited to participate in the seed round of a new Run of River (ROR) power generation company that was being formed to acquire concessions in Nepal. Yep, I know, Nepal? Turns out the geography lends itself perfectly to this type of renewable, clean and green energy generation scheme.
Not to sound like a broken record, but I was attracted to the opportunity solely because of the management. New readers will soon realize that this is THE single overriding theme on our blog, capitalistexploits.com. Whereas real estate is location, location and location, investing is always management, management and management – at least that’s how we see it.
I had a long chat with Global Renewable Infrastructure Development’s (GRID for short – clever huh?) CEO, Mr. Nenad Kostic recently. Nenad is a solid fellow, and he gave us a fantastic overview of Run of River hydro power and Nepal!
MW – GRID is a power generation company focused on run-of-river (ROR) hydro power. Most people are familiar with the large hydro power installations like Hoover Dam, Three Gorges, etc. ROR is different, much different. Can you give us a layman’s definition for ROR? And, talk a bit about what makes it better (e.g. environmental concerns) than a reservoir setup.
NK - In conventional reservoir storage hydro projects there is a very large dam constructed, which creates a lake behind it. The advantage is that once the lake is built up, this water is stored so that the plant can run at full load for weeks or even months at a time, even while it’s not raining. Of course, the negative (and according to our corporate policy, this is a BIG negative), is the huge environmental impact of immersing hundreds or thousands of acres under water, permanently. In ROR projects, there is not a large dam – only a diverting weir across the river, perhaps 3 or 4 meters high, which creates negligible ponding behind it. Since there is no storage, we make maximum power when it rains, and we make less power when it doesn’t. A portion of the water is diverted from the river, sent through the turbines, and returned to the river; by design, the remainder is always returned downstream to sustain the river’s ecosystem. The result is a facility that very much blends with the local environment. ROR facilities often blend so well with the landscape that they’re difficult to notice.
MW – Many of our readers are likely familiar with how mining and resource development work. Does planning a ROR hydro power project share any similarities? Drilling, feasibility studies, resource calculation, etc.?
NK - Yes, there are some similarities, but a ROR hydropower project can be assessed for its viability much more inexpensively than a mining project. With the aid of 1:50,000 and 1:10,000 topographical maps of the project location and catchment area (the number of hectares in which rainfall and/or snow melt runs downhill into the project’s river), a detailed analysis of 25 to 40 years of rainfall and stream flow data (which, surprisingly, is nearly always available from any government’s environmental authority), and a 2-3 week site civil survey, a pre-feasibility report can be generated which provides an optimal capacity for the project in megawatts, the anticipated yearly generation in an average rainfall year (broken down into month by month figures), and a budgetary cost for all the civil and mechanical components of the project.
The next critical component is the power purchase agreement (NYSEARCA:PPA). The PPA tariff (the amount the utility is willing to pay for each megawatt-hour of energy produced), terms, and contract duration are based on either standardized rates published by the utility or the country’s electricity regulator, or on terms which were recently agreed upon by the utility with another independent power producer (IPP). This information is added to a financial model which determines if the NAV & IRR are acceptable.
Once the pre-feasibility study is complete, geotechnical drilling is conducted in key areas around the project, such as the weir, tunnel or canal trace, forebay, penstock and powerhouse locations. Unlike the drilling for resource development, however, the purpose of this drilling is simply to determine the strength of the underlying rock, so that the detailed civil design can be finalized. So before the drilling ever occurs, all the project parameters are well-known.
NK – A valuation based on installed MW capacity is misleading, because the cost of construction and the PPA tariff structure are unique to each project. In addition, the hydrology will determine the plant factor, which is the yearly generation as a percentage of its installed capacity. Recall that ROR projects generate only when it rains, so while a 100MW project may be constructed, it may only generate as much energy in one year as a 35 – 75MW reservoir project would generate, since reservoir projects can run at full capacity 100% of the time. In other words, ROR projects have a “Plant Factor”, which typically varies from 35% to 75%. Again, this is based on the hydrology, and it is the actual average year’s generation as a percentage of the plant’s generation if it were to run at 100% capacity all year.
So there are a variety of factors that contribute to a ROR project’s valuation; it ultimately boils down the standard metric of a multiple of the project’s EBITDA.
MW - GRID is focusing on hydro power generation in Nepal. It’s a jurisdiction that most people probably know absolutely nothing about. That’s not necessarily a bad thing. Why did you choose Nepal?
NK – There are two components which combined together to form the “perfect storm” for us. First, the hydrology in Nepal is very attractive in that river water is derived not only from rainfall, but also from snow melt in the Himalayas. Each day the sun shines on the mountain snow and melts it, and each night, it snows again onto the same mountain faces to replentish the snow. The circular process begins again with the next morning’s sunshine. This snow melt, combined with the rain which occurs in the lower elevations, results in an excellent plant factor, in the range of 65-80%, as compared to projects relying on rainfall only, which are in the range of 30-50%.
Second, our local partner in Nepal is extremely valuable. Our team has found time and time again that our success in penetrating new markets depends to a great extent on the reputation, community management skills and political strength of our local partner. In this case, they are proving to be very valuable and well-connected partners indeed. One was the former Managing Director of the government-owned electric utility; and the other is a long-standing and prominent member of all Nepal hydroelectric and renewable energy associations, and is able to open doors in all the necessary ministry departments. In addition, she is in constant communication with many hydropower project license holders / promoters in Nepal, and initial inquiries by her have shown that an investment of a few million can easily bring in an excess of 500MW to GRID’s portfolio, and perhaps more than 1,000MW, by way of acquisition of these licenses.
The Nepalese are extremely resistive to acquisition of projects by Chinese and Indian investors, who have attempted to penetrate the market for years. Where these other foreign investors have failed, we are succeeding, because of our affiliation with our nationally-recognized local partner.
Thirdly, there is a serious deficiency in the country’s installed capacity, especially in the winter months – on the order of hundreds of megawatts. Customers through the nation are accustomed to daily rolling outages of up to 12 hours duration. The Government has now implemented measures to attract foreign investment, such as more favorable PPA tariffs, tax holidays, duty-free import of machinery and, arguably most importantly, the ability for foreign investors to repatriate profits out of Nepal. These new measures make the financial analysis of projects very attractive.
Lastly, the Government of Nepal is developing an intricate and robust transmission network throughout the country, but particularly in an East-West corridor along Nepal’s Southern border with India. We have all heard of India’s exponentially-growing demand for electrical energy, and GRID is poised to avail ourselves of this opportunity. With each project, we will retain the option to sign a PPA to deliver the energy either directly to the Nepal Electricity Authority (NYSE:NEA), or to sell directly to the Indian power trading representative, using the NEA’s transmission lines and paying nominal wheeling charges.
MW - The potential for hydro power development in Nepal is clearly massive. Give us an idea how large the opportunity is for a small company like GRID.
NK – We are in final negotiations with a large Chinese power corporation to partner at the project level for our first three projects, 85MW Chameliya-Chettighad, 32MW Chettighad, and 16MW Makari Ghad. They will provide all the required equity (approximately $70MM) and arrange the debt financing (approximately $280MM) with China Development Bank to retain 51% interest in the project, while GRID retains 49%. These three projects are all on the same river, within a few kilometers of each other in Darchula Province in Western Nepal. China Development Bank has indicated that they will leverage the projects to 80% at 4.0% to 5.0% interest. Please note that since this partnership occurs at the project level, GRID’s corporate shareholding is not diluted.
Once this deal is inked, it will provide a template for all future deals at an accelerated pace; as our local partner identifies potential sits to acquire, our team will assess its viability, and if it’s accretive, we will negotiate for the acquisition, establish a new Nepalese project company, and enter into another 51/49% agreement with our Chinese partner.
So you can see that with very little corporate capital, GRID is poised to become one of the largest IPP’s in Asia. It’s really exciting stuff.
MW – What about Nepalese politics? Is it considered a stable situation? How about it’s relationship with China and India, two markets that will likely be end users of some of Nepal’s power generation capacity..?
NK – One thing that all incumbent Nepalese politicians agree – because of the national outcry – is the need to attract foreign investment to solve the electricity deficiency issue. While much less power will be exported to China (due to the geographical challenges), as I mentioned before, there is excellent progress being made to integrate the NEA grid with the Indian system. Several lines are already under construction, with scheduled completion prior to the completion of our projects. Our political due diligence measures included obtaining the investment opinions of several high-ranked World Bank representatives; their response was very favorable, citing the fact that World Bank was funding several of the transmission projects as well as others in the country.
Each project’s PPA will be backstopped by an “implementation agreement” (IA) with the Government of Nepal which provides security on the existing tax and other project concessions, and protection against political expropriation. These IA’s will remain in force regardless of the political party in power.
Lastly, our local partners’ reputations carry weight with both the representatives in power and the opposition, so as, for example, the Ministry of Energy position shifts from one individual to another, our partner simply establishes the rapport with that new individual.
MW - How much of the power generated from GRID’s projects will be consumed domestically versus internationally?
NK – It completely depends on the deals we strike with the NEA versus the Indian power trading representative; we envision that the first three projects, totaling 133MW, will likely supply the NEA. We also have two smaller projects, 8.5MW Naughad and 3.75MW Hadikhola, which are shovel-ready, and the PPA’s for those two projects are already fully negotiated with NEA.
MW - What is the average lifespan of a ROR project? Is it a matter of simply replacing equipment as the project ages, or do they eventually have to be mothballed?
NK – Regular maintenance is important. In our financial models we account for this with and “overhaul sinking fund” which provides the cash from operating revenues to inspect and maintain the equipment. It’s also crucial to choose our operations staff very carefully and to implement written operation procedures which the staff can follow. With these measures in place, it is very feasible to expect a ROR hydropower plant to continue operations for fifty years.
The Nepal projects are Build, Own, Operate and Turn Over (NASDAQ:BOOT), which means that after 35 years of operation GRID is obligated to sell the project to the Government of Nepal for a pre-determined terminal value.
MW – What is the company’s exit strategy for early investors?
NK – GRID will be conducting an IPO within the next 12-24 months, most likely on the Toronto Stock Exchange, which is an optimal exchange for renewables investments.
Nepal is oft-overlooked, but it may just be one of the best kept secrets out there. If you have specific questions, just drop us a note.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: GRID is a private company in which I have a direct investment, acquired in a seed round several years ago.