Cost Burden: Impact of high capex requirement on HEP tariffs

Impact of high capex requirement on HEP tariffs

The development of hydroelectric projects (HEPs) is more complex and time consuming than that of fossil fuel-based and renewable energy projects. Small HEPs typically take at least 30 months for completion, whereas the large ones can take up to 10 years. This can be attributed to delays in project execution due to challenges related to land acquisition, environmental and forest approvals, and resettlement and rehabilitation of locals, which also result in time and cost overruns.

Factors impacting costs

HEPs face significant challenges due to the non-availability of infrastructure, various components of construction cost (steel, cements, aluminium and labour), and design elements such as length of the tunnel. Also, owing to their long gestation period, HEPs are highly sensitive to financing costs since an increase in the interest rate during construction could be as high as 50 per cent of the total project cost. Other issues pertain to project terrain. Many sites are difficult to access and thus, significant investments are required to build infrastructure in these remote locations. These expenses have to be incurred by the developer itself.

In addition, the cost of inputs used in HEPs is highly volatile with  a long-term upward bias. So it can be reasonably assumed while constructing projects on a long-term basis that there would be an upward bias in input cost and a fair amount of volatility, particularly in inputs like aluminium and steel.

Another important factor impacting cost is interest rates. During the past five years, the interest rate has been on the lower side. However, many hydro projects that have become non-performing assets now or under construction achieved financial closure in the late 2000s. Hence, these were adversely impacted by the interest rate movement that happened during 2008-15, before the interest rate cycle started reversing.

Trends in capital costs

While thermal and renewable projects already have certain cost benchmarks, it is difficult for hydro projects to have such benchmarks since the cost per MW depends on various factors such as geological surprises, project size, infrastructure availability at site and location. Thus, the capital costs of similar hydro projects may vary. According to ICRA Limited, before the year 2000, the average capital cost of hydro projects was around Rs 40 million per MW, which increased to Rs 1 billion per MW in 2016. This is because the ease to access and develop hydro projects has reduced significantly. As a result, large projects are being set up in remote locations with high complexities.

Tariff determination for hydro power

Unlike the thermal power segment where competitive bidding guidelines have been introduced, the hydro sector has retained the cost plus mechanism due to the complexity of projects.

In December 2018, the Central Electricity Regulatory Commission (CERC) notified the draft regulations for the next control period, that is, April 2019 to March 2024. Under the CERC tariff norms for the period 2020-24, the annual hydropower tariff  consists of annual fixed charges for recovery of regulated return, interest on term loan, depreciation, interest on working capital and operations and maintenance (O&M) expenses. The fixed charges are to be computed on an annual basis and recovered on a monthly basis as capacity charges (including incentive) and energy charges. Further, the energy charges payable on a monthly basis will be calculated on the basis of the energy scheduled for supply.

The CERC has retained capacity and energy charges for hydropower projects in the tariff norms for 2020-24. The norms for return on equity (RoE) are in line with the norms approved for 2015-19, with a 15.5 per cent increase in RoE from the actual tax rate. However, the incentive of 0.5 per cent RoE for the timely completion of projects has been withdrawn for 2020-24.

The norms related to fixed charges such as RoE, interest on loan capital and depreciation remain similar to the norms approved for 2015-19. The normative operating parameters for hydropower projects for the 2020-24 control period are also similar to the norms approved for the 2015-19 period. However, the annual escalation rate for O&M expenses has been reduced to 4.7 per cent for 2020-24 from 6.64 per cent approved for 2015-19. Also, the receivable days for the computation of interest on working capital is proposed to be reduced to 45 days from 60 days earlier.


Going forward, in a cost-plus tariff regime, any increase in capital cost impacts the overall tariff. According to ICRA Limited, an additional capital cost of Rs 10 million per MW will result in over 40 paise increase in tariff. Similarly, a 0.5 per cent increase in interest rate increases the tariff by 25-30 paise, and every 5 per cent change in capacity utilisation factor impacts the tariff by 20-25 paise. In view of this, developers need to work out ways to ensure that hydropower tariffs remain viable and attractive for buyers.