Adapting Wisely: Financing Nepal’s Energy Infrastructure in Dynamic Regional Markets

Historically, Nepal’s energy sector financing has predominantly focused on small to medium-sized projects, which have played a crucial role in laying the foundation of the country’s energy infrastructure and supplying essential electricity to households and industries. Apart from the promoter’s equity, a significant portion of this investment, approximately USD 4 billion, has originated from local banks and financial institutions, highlighting the nation’s robust domestic investment capacity and dedication to developing its energy resources. Local banks, financial institutions, and government- associated funds have been instrumental in supporting these projects. To ensure a steady stream of funds into the energy sector, Nepal Rastra Bank, the central bank of Nepal has implemented directive lending provisions, mandating that banks allocate a certain percentage of their lending portfolios to energy projects, thereby ensuring continuous financial backing for the sector.

Looking forward, there’s a noticeable trend towards financing medium to large-scale projects in Nepal, which reflects the country’s ambition to undertake more substantial and impactful energy initiatives. These are crucial for meeting the nation’s growing demand for energy, integrating with regional energy markets, and fostering sustainable economic development. Future energy projects must address broader local and regional market dynamics, environmental concerns, and social issues. Adopting a holistic approach to project assessment and funding will ensure that energy developments are sustainable and beneficial to the wider community. In the past, the market explored innovative funding mechanisms such as crowdfunding, project-specific bonds, and private equity. These leverage public participation and investment to potentially unlock new capital sources for energy projects. Crowdfunding democratizes investment opportunities, allowing citizens to directly contribute to the country’s energy future and enabling a local community benefit-sharing approach.

To attain its ambitious energy production targets and facilitate exports to the regional market, Nepal must tap into varieties of funding sources. Traditional banks and financial institutions (BFIs) will retain their pivotal role, furnishing the backbone of financing for big projects owing to their established financial infrastructure and adeptness in managing substantial funds, rendering them dependable partners in energy development. Contractual saving entities such as the Employee Provident Fund (EPF), Citizens Investment Trust (CIT), Rastriya Beema Sanstha (RBS), and insurance companies boastsubstantial financial reserves, and they are being contemplated as significant funding sources, notwithstanding the inherent risks, particularly for contractual saving institutions where funds are earmarked for future security. In addition to traditional and government-associated financing, Nepal will explore diverse funding avenues, encompassing international investors, development banks, and private sector investments. To facilitate this, Nepal should prepare for regional integration, where international financial institutions and investors are more amenable to assuming regional market-related risks, thereby enhancing market competitiveness. Acting wisely in this regard along with fostering competitive production practices, will be imperative. This diversified approach will serve to mitigate risks and ensure a consistent capital inflow for energy infrastructure financing.

Government Strategy: The 12-Year Plan

The Government of Nepal (GoN) is preparing a comprehensive 12-year plan, which aims at significantly boosting energy production and market expansion. The plan sets a target of producing over 28,500 MW of electricity by 2035. Achieving this target would mark a substantial increase from current levels, positioning Nepal as a major player in the regional energy market. To meet these ambitious targets, the plan requires over USD 46 billion in funding. This substantial financial requirement underscores the need for robust and diversified financing strategies. The 12-year plan will likely include detailed roadmaps for project implementation, financing models, and policy frameworks. This structured approach will help attract both domestic and international investors by providing clear guidelines and reducing uncertainties.

Nepal’s energy sector stands on the brink of transformative growth. By shifting focus to larger projects, addressing broader market and environmental issues, and leveraging innovative funding mechanisms like crowdfunding, Nepal is setting a bold path forward. The government’s comprehensive plan, targeting over 28,500 MW of electricity production by 2035, exemplifies this ambition. Meeting these targets will require a concerted effort from all stakeholders, including financial institutions, government bodies, private investors, and the general public. With a strategic approach to financing and a commitment to sustainable development, Nepal is poised to significantly enhance its energy production capabilities, driving economic growth and improving the quality of life for its citizens.

Nepal is at the cusp of an energy revolution, with ambitious plans to dramatically increase its electricity generation capacity and expand its market reach by 2035. This vision, however, comes with substantial financial requirements and a significant funding gap that must be addressed to ensure the success of these plans. This article examines the investment needs, potential funding sources, and strategies to bridge the funding gap in Nepal’s energy sector.

Investment Requirement: A Herculean Target

Nepal’s energy sector development plan is structured with detailed annual targets for both generating capacity and fulfilling the associated funding needs. The goal is to increase generation capacity from 3,000 MW in 2024 to 28,500 MW by 2035. This expansion requires substantial investments each year. For instance, the additional fund requirement for generation alone starts at USD 1.53 billion in 2024 and escalates to a cumulative USD 40.46 billion by 2035. Transmission investments, equally critical, begin at USD 0.38 billion in 2024 and total USD 6.31 billion by 2035. Combining these, the total annual investment starts at USD 1.91 billion in 2024 and summing up to USD 46.77 billion by 2035. These figures highlight the scale of financial commitment needed to achieve the projected growth in Nepal’s energy sector. Given Nepal’s GDP could reach around USD 113 billion, assuming a 10% nominal annual growth, achieving the investment target of USD 46.77 billion, which comprises a significant percentage of the GDP, represents a Herculean challenge.

Funding Sources: Falling Short of Targets

In a bid to bridge the substantial financial gap, Nepal aims to leverage a variety of funding sources, encompassing traditional BFI credits, directive lending, increased BFI investments, contractual savings, and innovative avenues like crowdfunding. However, despite the anticipated growth in directive lending from USD 3.84 billion in 2024 to USD 10.94 billion by 2035, alongside an expected rise in overall credit from USD 38.36 billion to USD 109.45 billion during the same period, these endeavors fall short of the required funding.

It is anticipated that contractual savings and equity/crowdfunding will also make significant contributions, adding USD 4.09 billion and USD 8.18 billion respectively by 2035. Nevertheless, even with this diverse approach to funding, it’s evident that these sources alone are insufficient to address the extensive financial requirements of the sector. This presents a substantial challenge to Nepal’s aspirations for growth in the energy sector, emphasizing the urgent need for alternative strategies or additional avenues of funding.

The Alarming Bell

The GoN has ambitious plans to export power to regional markets, particularly India and Bangladesh. However, rapid changes in the energy dynamics in India, particularly more focus on renewable energy and storage, pose significant challenges. On the other hand, Nepal has made little effort to makeits energy prices competitive. While discussing energy pricing, the focus often remains on current prices, ignoring long-term power market trends, evolving technologies, and alternative mechanisms. Nepal’s hydro-nationalism, rising costs, slow adaptation, and cost behaviors could result in a scenario where India might not be willing to purchase electricity from Nepal, leaving the water resources of the Himalayan country underutilized.

India’s massive investment in storage capacity, including an announcement of an estimated addition of 140-200 GW of battery storage capacity by 2040, the largest for any country, further complicates the situation (Source: IEEFA Report). Additionally, India plans to add 18 gigawatts of pumped hydrostorage by 2032.

Given India’s expanded renewable energy goals and its considerable geopolitical dominance in the area, there’s an anticipation of it exporting renewable energy to Bangladesh as well. This dynamic shift underscores the urgent need for Nepal to review its strategies and enhance its energy sector’s competitiveness, rationality, and speed of delivery to stay pertinent in the regional market.

Adapting Wisely: before it becomes a mere dream

There’s no dispute about Nepal’s abundant river resources for generating power, but until its benefits are realized, it remains just a dream. Given the changing dynamics in the regional market, including massive investments in alternative storage mechanisms and the significant financial resources required for Nepal’s energy sector development, a cautious approach is essential due to the increased dependency on the regional market to raise large amounts of capital. Government and stakeholder actions should focus on necessary interventions and reforms to address the financing gap and promote sustainable energy development. Keysteps include emphasizing projectspecific benefits sharing modalities, issuing green bonds, developing the debt market, exploring alternative financing mechanisms, encouraging private sector participation in transmission and trade, and fostering a conducive investment environment. “ADAPTING WISELY” should be the primary agenda for financing Nepal’s energy infrastructure in these evolving regional markets.

Project-Specific Benefits-Sharing Mechanism

The current uniform approach to benefit-sharing, particularly regarding free energy, requires re-evaluation due to the significant differences among hydroelectric projects in terms of hydrology, geology, transmission, accessibility, and social and environmental impacts. A one-size-fits-all strategy is inadequate. The recent MOU with the larger Indian PSU, which applies the same 21.90% free energy mechanism to develop projects, including storage, could undermine development due to financial viability issues. This concern is substantiated by their recent letter to the government expressing reservations about the project delivery after investing a substantial amount of time. This situation not only affects project viability but also triggers social outcry and media scrutiny. Therefore, it is recommended to develop project-specific benefits-sharing modalities. This approach involves comprehensively assessing the costs and benefits of each energyproject to ensure economic, social, and environmental impacts are evaluated transparently. Tailoring the benefits sharing to each project’s unique characteristics will help optimize resource allocation, enhance stakeholder engagement, and promote sustainable development. Specifically, adjusting the current provision of 21.90% free energy to the government based on the project’s specifics is crucial for the viability and long-term success of future storage projects.

Green Bonds and Financing

Green bonds are pivotal in financing environmentally sustainable projects, including renewable energy initiatives. By initiating green bond issuances, governments, and financial institutions can attract investments for green infrastructure projects while aligning with climate change mitigation goals. It is essential to remove barriers to green bond issuance and offer competitive interest rates to incentivize investor participation in sustainable energy financing. This will not only provide the necessary capital for green projects but also demonstrate a commitment to sustainable development practices.

Development of the Debt Market

The development of a robust debt market is vital for mobilizing capital for energy projects from both the government and private sectors. Issuing project-specific bonds can fund energy infrastructure developments, leveraging the vast resources of the global debt market. Promoting debt market development will diversify financing sources, reduce dependency on traditional funding avenues, and unlock capital for energy sector expansion. A well-developed debt market can provide the necessary financial support to meet the ambitious energy targets set by Nepal.

Alternative Financing Mechanisms

In addition to traditional financing methods, it is crucial to promote alternative mechanisms, such as Funds, PPPs, Hybrid Annuity models, and green financing. Encouraging innovation in financing structures and instruments will catalyze investment in sustainable energy solutions, drive technological advancements, and accelerate the transition towards a low-carbon economy. By exploring these alternative financing avenues, the government can enhance the availability of capital for energy projects and foster a more dynamic investment environment.

Private Sector Participation in Energy Transmission and Trade

Encouraging private sector participation in energy transmission and trade is essential for enhancing efficiency, promoting competition, and expanding the energy market. Introducing investment modalities like Hybrid Annuity models and Minimum Revenue Guarantees (MRGs) on wheeling charges can attract private investments in energy infrastructure projects. By fostering a conducive regulatory environment and offering incentives for private sector engagement, the government can stimulate growth in the energy sector. Private sector involvement will bring in expertise, efficiency, and additional financial resources necessary for the sector’s development.

Conclusion

Given the intricate energy dynamics in the region, particularly India’s strong focus on renewable energy and storage, alongside Nepal’s ambition to export power to neighboring markets, it’s crucial to approach energy financing with prudence and innovation. The significant investment required to meet Nepal’s energy generation targets by 2035, coupled with evolving market trends and concerns about future demand, underscores the urgency of the situation. Nepal must address its competitive energy pricing, adapt to changing technologies, and overcome hydronationalism to remain relevant in the face of India’s growing energy capacity. Additionally, India’s plans for massive storage capacity further complicate Nepal’s energy landscape. In light of these challenges, Nepal must adapt wisely. This entails strategic government interventions, policy reforms, and collaborative efforts with stakeholders to bridge the funding gap and promote sustainable energy development. Initiatives such as project-specific benefits sharing, green bond issuance, debt market development, and private sector involvement in transmission and trade are key steps in this direction. “ADAPTING WISELY” serves as a guiding principle for financing Nepal’s energy infrastructure in these evolving regional markets, ensuring prudent decision-making and long-term sustainability.

(The writer of this article is the former Chief Executive Officer of Nepal Infrastructure Bank Limited. This article is taken from the 6th issue of Urja Khabar, a bi-annual magazine. Which was Published on 15 June, 2024)