Financial advice

Over the last 15 years, large dams have been no strangers to controversy, due mainly to a range of environmental and social factors. And it is the dam projects funded by multilateral development banks, such as the Asian Development Bank (ADB) and World Bank (WB), that have tended to draw the lion’s share of flack, due to their stated environmental and social safeguard policies, institutional public disclosure requirements, and the close scrutiny of nongovernmental organizations (NGOs).

There is no denying that any project that permanently alters river flow will have physical impacts, and depending on the location may have significant long-term environmental and social impacts. Large storage dams are problematic due to radical changes in erosion patterns and sediment flux, obstruction of fish migration pathways, irreversible negative impacts on fisheries and agriculture, negative impacts on drinking water aquifers, and - in many but not all cases - large-scale involuntary resettlement.

As described in a report prepared by the World Commission on Dams (WCD¹), such environmental and social concerns must be addressed to ensure project success, although the WCD findings are quite contentious in some countries. Advertisements by WWF suggest there is no such thing as a ‘good’ dam, but as noted in the WCD report, project success depends to a large extent on local ‘ownership’, i.e., the degree of participation in project development and execution by directly affected people.

From the early 1990s, ADB’s primary mission has evolved to emphasize poverty reduction through economic growth. This primary mission combined with current energy policy and environmental and social safeguards sets the framework for its current hydro power project portfolio. Hydro represents only a few percent of the current lending portfolio,² but may increase during the next three years as some client countries expand the share of hydro power relative to thermal power.

Early ADB dam projects

A quick review of a few hydro projects funded in the 1980s and 1990s illustrates some of the problems encountered in the days when hydro power development was viewed mainly through the lens of engineering and construction. Four projects reviewed by ADB’s Operations Evaluation Department (OED) in 1999 are highlighted for discussion,³ with emphasis on environmental and social problems encountered (Table 1).

The Batang Ai hydro power project in Malaysia was approved in 1981 before ADB had adequate expertise on environment and social concerns. The Singkarak (Power XX) project in Indonesia was approved in 1990 prior to the required circulation of the summary environmental impact assessment (SEIA) to ADB’s Board of Directors. Both the Hunan Lingjintan project in the People’s Republic of China and the Theun-Hinboun project in the Lao People’s Democratic Republic (Lao PDR) (owned by a joint venture company) were approved in 1994, with SEIAs for each and a resettlement plan for the Lingjintan project, but these projects relied extensively on the capabilities of local authorities to adapt and continue the mitigation measures after the power plants were in operation.

The consultation process was not very effective in most of the study projects. Weak consultation resulted in improper identification of impacts, a build-up of unrealistic expectations among the affected persons, and inadequate mitigation measures. In some cases it was not the lack of knowledge that weakened consultation but the lack of traditional or formal institutional arrangements for carrying out consultation.

Although the four projects reviewed had significant environmental and social impacts, they are not considered to be disastrous. In retrospect, many of the problems could have been avoided or compensated for with more diligence on the parts of the project proponents, borrowing country agencies, and ADB. Identification and mitigation of project impacts improved over time, with better upfront analysis on the projects approved in the later 1990s. Measures that were conspicuously needed (i.e., housing) were planned during project design and implemented. Other measures that necessitated coordination among local agencies, effective participation from affected persons, and substantial funding from the DMCs were not always carried out in an efficient and timely manner.

The 1999 OED study revealed significant weaknesses in predicting and managing environmental and social impacts on hydro power projects, especially in countries with limited institutional capacity to mitigate those impacts. Several recommendations resulted from the OED study, including:

• Pre-construction analysis of impacts needs to be improved, so that a holistic impact assessment is made, from which a comprehensive mitigation program can be defined.

• Itemised funding allocations should be made for environmental and social impact mitigation.

• Construction contractor responsibility and obligations should be strengthened.

• ‘Internal’ monitoring by project owners, and ‘external’ monitoring by third parties and ADB should be improved during construction and initial operations.

• Public consultation should be improved.

To a large extent, these recommendations were adopted with the approval of ADB’s Environment Policy in 2002, and the related operational procedures for environmental and social safeguards (resettlement and indigenous peoples) that became effective in 2003. In retrospect, these four early projects were treated more as engineering projects rather than economic and social development projects.

Evolution of ADB’s framework for hydro development

ADB now has a system of checks and balances in project selection and preparation that are designed to weed out problematic investments. This system has evolved rapidly since the late 1990s, and today’s approach is much more holistic in principle than that of the pre-1990s. Today, any project funded by ADB has to clear higher standards of policy, technical, financial, economic, social, and environmental analyses before approval.⁴ All of these aspects must be reviewed early in the project cycle, and failure to clear any single hurdle will disqualify a project for ADB funding.

Hydro power projects must be consistent with ADB energy policy, be part of a least-cost generation plan, and be evaluated in the context of integrated river basin management. ADB safeguard policies specifically address local participation in project development and require that adequate compensation be made for any land acquisition and resettlement, both temporary and permanent. Projects must be financial and economically viable.⁵ With respect to policy and safeguard considerations, hydro power projects are evaluated essentially in the same manner as other large infrastructure projects (e.g., expressways, railways).

Large dams⁶ with storage reservoirs and/or inter-basin transfers can be considered, but resettlement and impacts on downstream water users typically will require more extensive upfront analysis and mitigation planning than simpler run-of-river projects.⁷ Project selection and design should be based on host country energy development strategy and a rigorous analysis of alternatives, considering economic, financial, environmental, and social aspects as noted above. ADB has no technology preferences, as design is site-specific, but international best practices are expected to be incorporated into project design in order to reduce project risk. Operational design must include minimum environmental flow and sediment sluicing.

Hydro in the 21st century

As a development agency that funds power projects, ADB is not pro- or anti-hydro. Hydro power projects are evaluated in the context of ADB’s overarching mission of poverty reduction and economic development and are a subset of infrastructure and power projects. They are therefore considered in the context of economic and social benefits, and must be consistent with ADB energy and safeguard policies.

Hydro projects should be developed by client countries as part of a rational water and energy resource development strategy, and should be designed with best practices of integrated river basin management. Social impacts, especially those related to involuntary resettlement, should be minimised to the maximum extent possible, with emphasis given to local consultation and allocation of adequate funding for mitigation measures. Environmental considerations weigh heavily, with requirements for environmental impact assessment, and management and mitigation plans.

Further evaluations of early hydro projects⁸ concluded that the extent of some impacts is visible only after the power plant begins operation and ADB funding for the project is fully utilised. Therefore sufficient funding should be secured to sustain mitigation measures during operations. One option for such funding is to divert a small portion of the power generation revenues for development and sustainability of the socio-physical environment of the hydro power plant. Clean Development Mechanism (CDM) potential normally will be developed in parallel with other project analyses.⁹

Given ADB’s limited role as a project financier, it is important to examine the national hydro power development strategies of borrowing countries to get a clear picture of emerging trends. For example, Bhutan, Lao PDR, and Nepal continue to pursue electricity export strategies, while India and the PRC are attempting to increase hydro-to-thermal mix from the current 25:75 to around 40:60. While there is no ‘typical’ hydro power project today, there are a few examples that represent the spectrum of projects currently funded or under consideration by ADB.

One of the first projects approved under the current policy and safeguards framework is the Xiaogushan hydro power plant (98MW, run-of-river), funded by the Gansu Clean Energy Project in the People’s Republic of China (see Table 1). ADB’s technical assistance for project preparation resulted in two key design changes: the proposed 3x30MW configuration was changed to 2x40MW plus 1x18MW to optimise annual power output, and the power house was altered to underground design to reduce geotechnical risk.

The diversion weir is a ‘large dam’ as defined by the International Commission on Large Dams (icold) based on height, but does not meet the large dam definition based on reservoir volume. The reservoir footprint is less than 10ha, and only 3km long. Only two families were affected directly and no resettlement was required.¹⁰

Downstream there are six dams that fully obstruct the river flow. The river originates in the mountains at the north edge of the Qinghai plateau and terminates in Inner Mongolia with no connection to the ocean. There are no commercial or indigenous fisheries in the project area. No new induced or secondary development is expected in the area around the project site. The project was classified as Environment Category A, and a full EIA was prepared by the borrower. A summary EIA (SEIA) was made publicly available for 120 days prior to ADB Board consideration.¹¹ The project displaces coal-fired generating capacity: after commissioning, an obsolete 80MW coal-fired power plant in nearby Zhangye City will be decommissioned. The project has been proposed for CDM carbon trading, and the Prototype Carbon Fund has negotiated a transaction to buy all of the carbon credits generated by the project.

The Wangan Aji I project is a 125kW micro-hydro project in Central Java, Indonesia, on the irrigation canal in the district of Wonosobo. It is 75% grant financed from ADB’s Poverty and Environment Program (cofinanced by ADB, Norway, and Sweden), It is a decentralised community-based micro-hydro project that will provide electricity to the community of Wangan Aji and generate income from sale of surplus electricity.

The project will demonstrate the technical viability of utilising the irrigation channel in Wonosobo for electricity generation and prove that such an approach is economically feasible under the government instrument of ‘PSK Tersebar’, a facility that promotes the development of distributed small power generation utilising renewable energy sources. The project will increase livelihood generation options and better health, education and communication facilities of the community, thereby alleviating poverty levels of the community and preserving the natural environment. Environmental benefits will be realized by replacing or offsetting higher-cost diesel based generation, with a net reduction of carbon dioxide emissions. The state electricity utility (PT PLN), has confirmed its interest in purchasing electricity from the project. Provincial officials support the project and indicated that it will serve as a model demonstrating the technical and economic feasibility of downstream micro hydro sites on the same irrigation canal and other similar micro-hydro power plants in the region. Some 75% of the revenue from this project will flow into a revolving fund, which would be used to provide seed money to other micro-hydro projects.

At the other extreme from Wonosobo, after 2.5 years of analysis, ADB recently approved financial support for the 1070MW Nam Theun 2 hydroelectric project (NT2) in the Lao PDR with several development partners including the World Bank. NT2 has been at the center of the global debate on hydro power development. The government’s development strategy includes export of hydro to bring economic and financial benefits to the country, yet the scale of the NT2 project’s environmental and social risks are significant and must be addressed properly. The NT2 project demonstrates how a US$1.5B project could be successfully put together in a small economy like the Lao PDR's, using a private-public-partnership to reduce dependence on official development assistance by mobilizing commercial financing. NT2 utilised innovative and effective local consultation process founded on three key principles: ‘transparency, balance, and meaningfulness’. The exhaustive due diligence process for NT2 would not be readily replicated, but the project provides a good reference point – albeit contentious – for future large hydro power development.

Uttaranchal State in India provides a counterpoint to economic and engineering bias toward large storage projects. The domestically-financed Tehri project, originally conceived in 1978, comprises a 1000MW storage dam (260m high), a second 400MW storage dam downstream, and a 1000MW pumped storage facility. The 1000MW storage dam has been topped out and initial operations are expected by mid-2006.¹² Although this project was conceived as a low unit-cost power project, the opportunity costs associated with the long development time are now considered to be unaffordable. As one government officer noted in June 2005, ‘we could have built 10 times as much generating capacity 10 times faster, with the same amount of money’. Another officer noted that ‘one Tehri is enough’. Today, Uttaranchal plans to develop an additional 10,000MW of new power from about 80 plants, ranging from 3MW to 600MW, with 55 plants rated at < 100MW. A variety of designs are being employed, with trench weirs quite common for small plants (< 25MW). Aside from the Tehri project, only seven storage dams are proposed, and one of these, originally conceived as a 1000MW storage dam, has been re-designed as three run-of-river plants totaling 940MW, partly due to environmental considerations. Uttaranchal is also embarking on a major programme for renovation, modernisation, and upgrade (RMU) of about 1100MW of existing capacity at 12 plants.

Afghanistan offers a similar counterpoint as Uttaranchal. The Ministry of Electricity and Water has requested donor agency support for development of more than 20,000MW of potential capacity from large hydro power projects on the upper Amu Darya and Panj rivers, mainly as a means of creating jobs. Needless to say, these Soviet-inspired schemes are highly problematic with respect to total cost, lack of transmission connectivity, transboundary water issues, and security. ADB is supporting development of more modest, and realistic, projects up to 50MW per site. Other donors are funding RMU of existing hydro power plants.

Finance requirements

Over the next three years, ADB is considering a broad spectrum of projects and designs, with a general preference for run-of-river projects less than 100MW, and one or two large storage dams. There is some regional variation, with a large storage project proposed in Viet Nam, small and medium scale (20–50MW) hydro power and multi-purpose projects in Afghanistan, and small (< 25MW) run-of-river projects in India and Pakistan. Grant funding is being provided for some mini and micro-hydro power (< 1MW) projects in India and Indonesia.

As noted above there is no typical hydro power project in the ADB portfolio, but there are a few key ideas to keep in mind.

• ADB funds economic and social development projects, not hydro power projects, which contribute to meeting the Millennium Development Goals. Hydro power has to be integral to national energy development strategies, clear all policy and safeguard tests, and include a robust – and adequately funded - mitigation programme before financing will be approved.

• Size does matter… and so does time. Large storage projects can be considered, but excessive development time and transaction costs are inconsistent with ADB efforts to improve its internal operational efficiency and overall development effectiveness. Alternatively, small run-of-river plants normally pose few development challenges and may bring extra dividends from CDM or other carbon asset transactions.

• There is no ‘business as usual’ scenario. ADB policies evolve over time, as do those of its member countries. Alternative approaches for financing and ownership are encouraged in order to maximise benefits to directly affected stakeholders.

The authors are Dan Millison, Senior Energy Specialist, South Asia Department and Mala Hettige. Contributors are WooChong Um and Sujata Gupta.