Peru’s economy has been growing at a rapid pace over the last decade and is now investment grade. Energy demand has grown at a comparable pace, particularly in natural gas because of new discoveries and a gas pipeline. However, the pipeline has reached capacity and the author argues that mini hydro projects are well positioned to take up the pace. The Peruvian government has provided a fast track solution for projects below 20 megawatts, and the country’s Andean landscape allows for significant locations and development opportunities.
Invited Contributor: John Harman authored this piece exclusively for The Review. He is chairman of Central Hidroeléctrica Langui S.A., with more than 20 years experience in the small hydroelectric market in Peru.
Peru is a comparatively small developing economy, but during the past ten years it has been growing at a good rate and is investment grade (currently BBB by Standards & Poor’s). During 2000-09 its GNP grew at an average rate of 5.3% per annum, giving it an accumulated growth of 59.7% — and since 2009 it has kept growing at an even faster pace.
GNP Growth in Peru
Source: Central Reserve Bank Peru (BCRP)
This growth has been due to a happy combination of higher commodity prices, conservative government policy, support to private investment, economic stability and improved market growth. Of course the GNP growth has created a similar effect for the local power industry, the demand for electricity has being growing at more than 5% per year; the maximum demand for 2012 was registered in December at 5,291 MW, an increase of 6.6% more than the previous year.
The Ministry of Energy & Mining (MINEM) reported for 2012, a total production of 3,582 GW-h, an increase of 6% compared to the previous year. Power generation in Peru has grown these past years very rapidly in response to the growing demand — mainly due to the development of natural gas found in the Amazon basin, which is being transported across the Andes by a gas pipe to the coast where most of the demand is concentrated. This has allowed a fast response to the new power demand, with the building of gas turbine power plants, but it also means a decrease of participation of renewable energies in the market, which from an average of 75% during the end of the past century, has lost market share down to an average of 55% for the past three years. But the growth of gas generated power has momentarily stopped because the gas pipe across the Andes has reached its maximum transportation capacity, but will be expanded in another three years, the time a new gas line is developed and built.
Market share by Type of Energy (December 2012)
Hydrology in Peru
In Peru, the Andes define the flow of water: west to the Amazon basin, where the market is low density and the power lines few and far between; east to the Pacific Ocean, after flowing down short and fast rivers, where water flow is very dependent on the rain season. But here the market is dense and power lines more accessible. These facts have to be taken into account when evaluating a small hydroelectric project in Peru.
The ruggedness and altitude of the Andes, coupled with the heavy rains that fall on them, creates many water storage glaciers and high altitude lakes, which improves the persistence of rivers flowing down the mountain slopes. Most of the water falls on the western slope of the Andes, while the eastern slopes receive much less water: some of the rivers to the Pacific basin only flow for six to eight months during the year, during the rainy season, and shortly after it.
The size and great number of water basins in the Andes has created a great number of potential locations for small hydroelectric facilities, of which only a few number have been built, but therefore there is a great number of opportunities to develop new projects, but as usual although the engineering conditions can be found, the economics have to be adequate to pay back for the project.
Benefits in Peru for Small Hydro Projects
Peru is a signatory to the Kyoto Protocol. Therefore, hydroelectric projects are eligible for carbon credits through the United Nations MDL program, and this also applies for small projects.
The development and construction of a hydroelectric project of over 20 MW will usually take three to four years; in the case of Peru, this can extend for another year due to new legislation in place that requires that stakeholders in the project area approve the project and allow for land purchase at the site, a process that can be long and complicated. The response of the government and private investors has been to allow smaller hydroelectric projects a fast track process and simpler way to generate power.
The Ministry of Energy & Mines (MINEM) also has additional benefits for the small hydropower projects under 10 MW installed capacity, which are defined as small projects:
- All the permitting process is carried out at the regional level with local authorities, where the project is located
- No Environmental Impact Study (EIA) is required; it is enough to file a non-environmental impact commitment document.
- The power market in Peru also has additional benefits for the small hydroelectric projects, due to their small size.
- The power generated can be sold directly to a power distributor or to a single customer, which can purchase all the offtake, therefore avoiding having to participate as a member of the Committee of Economic Management of the Power System (COES) — and therefore avoiding having to pay for membership in COES, which can run up to 1% of revenue.
- Use of the power grid power lines free of charge, since usually they are owned by the customer. Otherwise a toll cost for this item is discounted.
- Given the short development time, small projects can be developed and built in two years.
In general a small hydroelectric project, due to the small output, can be sure to sell all their production. This mitigates revenue risk; but on the downside will have to accept the average market price for their production.
Renewable Energy Resources Program
The Peruvian government is paying attention to the worldwide need for cleaner energy and has developed a Renewable Energy Resources (RER) program. The RER, developed by the MINEM, is aimed at helping projects that will use solar, wind, or water power to generate electricity. It assigns installed capacity quotas that they auction, to these three different technologies, by providing a long term Power Purchase Agreement (PPA) contract with the Ministry at the energy price auctioned by each project, beginning from the lowest price to the higher ones, until the auctioned power quota is completed.
For the case of hydroelectric projects, a limit of 20 MW installed total capacity per project has been set as the limit to participate in the RER program. The PPA awarded by the MINEM for 20 years allows for long term revenue, which in turn gives the small projects a bankable cash flow to finance the project (as per Decreto Supremo Nº 012-2011-EM, published in El Peruano Official Gazette on 23/03/2011).
Recommendations from the MINEM
These small hydroelectric projects have the following recommendations for their design and construction to obtain all the benefits of their size and to avoid the pitfalls due to their inherent weakness as small projects, because of their limited revenue and small financial structure. For example:
- Run of the river design, to minimize environmental impact, to avoid higher construction costs and to be eligible for carbon credits;
- Manage the permitting and legal issues in-house with the minimum outside legal fees;
- Careful assessment of the projects hydrology at the scoping study level;
- Location near an existing power line, usually a distance of more than 10 kms. for an interconnection line, will be too costly for a small project;
- Use a small engineering firm, with the adequate experience in hydroelectric projects, and retain them all the way through to detailed engineering and construction supervision;
- Location of the project, near to power lines;
- Nearby road access to lower construction cost;
- Good hydrology, water flow aiming at an average persistence of 75% or better as an annual average;
- Head, between 200 to 400 meters to maximize the benefit of gravity, but avoiding the cost and technical issues of a penstock with higher head;
- Water transport with canal only, a tunnel can be a deal breaker;
- Overhead is the enemy of small projects, so aim at developing and operating several small projects, better still on the same basin;
- For construction do not use an Engineering & Procurement Contractor (EPC), due to its inherent high overhead; it is not justified by the lower risks of a small project;
- Use different and specialized construction companies for each stage of the civil works, generation equipment and power line. Use an owner’s engineer to coordinate the construction stages;
- Suppliers of main equipment will include some detailed engineering design.
The benefits of small hydroelectric projects in development and construction are such that even some of the bigger power generation companies are investing in them in Peru, in some cases buying them as greenfield projects at the permitting stage or by acquiring hydroelectric power plants in production, and investing additional funds for improvements. In some cases water storage facilities are added to the projects to enhance production, without altering water use permits and seeking support from the local stakeholders that have already seen firsthand the benefits of having a local power plant operating, and knowing that they can also benefit from the water regulation facility.
In this case bigger companies reap all the benefits of small projects, since the overhead will only be incremental, and a lot of the engineering and legal work can be done in-house. In this case the initial development, engineering, construction for the small project can be done with their own financial resources, and only use bank financing after the facility is built, again obtaining more benefits in low interest rates due to low risk for the bank, and using the project financing for leverage and tax shield.
About the Author:
John Harman is Chairman of Central Hidroeléctrica Langui S.A., with more than 20 years experience in the small hydroelectric market in Peru. He is an economist graduated in Peru with an MBA from the University of Leuven in Belgium.
He started in the power business with G.C.Z. Ingenieros supplying hydroelectric generation sets to small power plants operated by mines in Peru, and since become a consultant to the power industry in developing small hydroelectric projects. He has participated in the development of Las Pizarras (18 Mw) for Rio Doble SAC/ALUZ C&O; Central Hidroelectrica de Langui SA (3.2 Mw), also for ALUZ C&O; Roncador (4 Mw) For Maja Energia SAC; and Santa Rita (240 Mw) as hydroelectric project advisor.