Upside for mini-hydro with expected revival in economic activities

• Demand for power to grow by 5-6% over next 2 years
• Avoided cost tariff likely to increase due to volatility in oil prices
• Authorities have finalised a new tariff structure based on fixed tariff with an escalation on an annual basis
• New tariff plan to be applicable retrospectively from January 1, 2019

Despite the heightened headwinds from the extreme climatic conditions, Sri Lanka’s mini-hydro producers are poised to reap higher margins and profits and would further receive an additional tailwind from the rising demand for electricity. 

“The power sector is a critical sector in the economy and it is worth over Rs.291 billion (2018). About one-third of the electricity generation is generally consumed by the industrial sector. 
Going forward, with the revival of economic activities, we expect the demand for power to grow by 5-6 percent over the next two years, thereby aiding the private power producers to benefit from the surging demand,” ICRA Lanka said in a research note, yesterday. 

Sri Lanka’s power sector is mired in a web of issues from red tape, corruption, inefficiency, political interference and powerful trade unions, which have held the management and government hostage. 

The Ceylon Electricity Board (CEB), the near-state monopoly for power generation, has been locking horns with the energy sector regulator, the Public Utilities Commission of Sri Lanka (PUCSL), for years over the Long-Term Generation Plan (LTGP). 

Lack of foresight from the policymakers and bureaucrats and little co-ordination between the CEB and PUCSL have resulted in the LTPG getting delayed for nearly five years and the country is facing the risk of blackouts.

According to ICRA Lanka, the hydropower segment contributed 43 percent of the total installed power generation capacity, becoming the second largest contributor in 2018. 

Out of that, 6 to 8 percent or 366 megawatt was generated and plugged to the national grid by the private sector power producers, who run mini-hydro plants, which are generally less than 10 megawatt capacity each. As Sri Lanka experienced incessant rains during the second half of last year, the hydropower generation was at a high level.

“This is credit positive for the mini-hydro producers as they would benefit from the increased power generations (in the absence of the deemed hydrology clauses in their PPAs with the CEB),” the rating agency stated. 

Another three factors why ICRA Lanka pins hopes on the sector are: availability of sufficient water flows (run off river flow) due to favourable weather last year, the CEB’s decision to renew the expired power purchase agreements (PPAs) and the likely increase in the avoided cost tariff due to the volatility in oil prices. 

Currently, the CEB pays the private power producers based on the avoided cost principle—a mechanism where the PPAs are paid the equivalent unit generation cost that the CEB reported. While this pricing methodology is phasing out, ICRA Lanka expects the remaining PPAs to benefit from the avoided cost pricing as the increasing oil prices could lead to a higher generation cost for the CEB—the cost which is used as the price paid to the PPAs. 

However, the positive news is the authorities have finalised a new tariff structure based on the fixed tariff with an escalation on an annual basis. 

This is favourable for the private producers due to the higher tariffs, compared to the tariffs under the avoided cost tariffs.  “In addition, the new tariff plan will be applicable retrospectively from January 1, 2019, allowing the power producers to recover some profits. Therefore, the CEB’s decision to renew the expired PPAs is a credit positive for mini-hydro power producers, whose PPAs had expired in the recent past,” the rating agency added. 

However, ICRA Lanka, a Moody’s group company, cautioned of the ability of these mini-hydro plants to operate at optimum level for a longer period due to increased climatic risks, policy uncertainty on new mini-hydro plants and long delays to receive the payments from the CEB.

These factors have pushed the producers to diversify their operations in recent times, ICRA added.