Development Banks Step Up Lending for Hydropower, Sustainability Remains Focus

Andrea Vittorio, Bloomberg BNA
Wednesday, July 3, 2013

Leading multilateral development banks have recently stepped up financing of large hydropower projects after a decade-long slowdown due to environmental and social concerns, according to an analysis of bank data by BNA.

Lending by three major banks--the World Bank, the Asian Development Bank, and the European Bank for Reconstruction and Development--increased fivefold from 2003 to 2012, as hydropower has become a popular source of renewable energy to satisfy growing demand for electricity in the developing world.

With the growth in hydropower financing, the banks have recognized the need to be sensitive to the impact large-scale projects have on the environment and the lives of people living in areas surrounding the dams. Over the past decade, the banks have either updated their own social and environmental guidelines or adopted guidelines developed by others, at least partly in response to questions raised over the costs of large hydro projects.

Financial support for large water infrastructure has traditionally come from the public sector, including state-owned utilities and national governments, where advocacy groups say accountability for environmental and social impacts may not be as strong, especially in developing countries.

Multilateral banks represent only a piece of the hydro financing puzzle--about 8 percent globally, according to one estimate--but they are still an important component, analysts say.

Multilateral banks remain “very influential,” especially in the developing world, when it comes to mitigating risks that would normally deter private sector participation, such as legal frameworks, political regimes, or market reliability, Richard Taylor, executive director of the International Hydropower Association, told BNA.

Dams 'Synonymous' With Development, Progress

Dam building peaked in the 1970s, when on average two or three large dams were commissioned per day, according to a 2000 report by the World Commission on Dams (WCD).

During their heyday, dams were often considered “synonymous with development and economic progress,” the report said.

Dams have made significant contributions to energy and water needs in many countries through power generation, irrigation, domestic and industrial water supplies, and flood protection. They can also provide indirect benefits through local employment and the expansion of infrastructure, such as roads and schools, the WCD said.

For climate change mitigation and adaptation, hydropower has been touted as an energy option with relatively low greenhouse gas emissions and no fuel required.

But as more dams were built, the WCD said their costs became apparent. When the flow of a river is altered for a dam, it can cause losses in biodiversity and prevent sediment from being transported to coastal areas, which in turn increases coastal erosion and blocks nutrient delivery to agricultural regions.

Dams also have effects on local populations due to resettlement and loss of livelihood, particularly among fishing communities. At the time of the WCD report, dams had displaced 40 million to 80 million people globally.

Public concern over these social and environmental impacts helped cut construction rates for dams in half during the 1990s.

Dam Building Trend Reverses

In a reversal of that trend, dam construction has accelerated since around 2005, particularly in developing countries where the demand for water and electricity is climbing rapidly.

The most dramatic scaling up of hydropower lending over the last decade has occurred at the World Bank, which typically accounts for about 2 percent to 5 percent of the world's hydropower financing. The bank spent almost $1.8 billion on hydropower projects in fiscal year 2011 and an additional $955 million in 2012, which is five times as much as it spent in 2003.

Other development banks have seen a more modest resurgence in hydropower financing.

The Inter-American Development Bank's support for hydropower started to “stage a comeback” between 2000 and 2005, according to a bank summary of its water resources support. In 2005, the most recent year for which figures are available, IDB funding for hydropower totaled $950 million--its highest level since 1993.

Although up-to-date aggregate figures are not available, the African Development Bank has also put money toward a handful of large hydropower projects lately, including more than $20 million for the planning stage of the 4,800-megawatt Inga 3 dam on the Congo River in the Democratic Republic of Congo.

South Africa will be the principal purchaser of the power generated at Inga 3, with the remainder of the energy going to mining companies. As a result, critics say the dam fails to benefit the poor in the DRC, which has one of the lowest rates of electrification in Africa, according to estimates from the World Bank Group's Lighting Africa program.

AfDB has defended the project, saying it is expected to promote “regional integration” and “green growth” by improving the business climate and economic productivity of beneficiary countries.

High Risk, High Reward

For projects that may not directly help the poor, the World Bank says it has made an effort to better distribute benefits.

“That's one of the big lessons of the past 20 years,” Julia Bucknall, manager for the World Bank's water practice, told BNA. “We've found ways of making that happen.”

During its break from large hydropower, the World Bank focused on “a few flagship projects” to learn how to better handle resettlement issues and environmental aspects, Bucknall said.

“This is not your grandfather's hydropower,” she said.

The World Bank signaled its return to large dam lending in 2003 when it updated its water resources sector strategy to re-engage in what it called a “high risk-high reward” approach to water infrastructure projects, especially dams.

The bank has said the surge in large dam lending will help meet its central poverty agenda while tackling water challenges associated with climate change.

“The water challenge that our clients face is getting increasingly complex and increasingly important,” Bucknall said. “What we need to do is intensify our response so that we have more impact.”

Water supply and sanitation projects have consistently received the most water sector lending from the World Bank, at an annual average of about $3 billion since fiscal year 2003. But hydropower has recently become the fastest growing component of the bank's water lending portfolio. From fiscal year 2009 to 2011 alone, financing for hydropower more than doubled to reach $1.74 billion, before falling back in 2012.

The bank has said its newest hydropower projects are larger and more complex than ever, part of a more recent trend toward “transformational” projects, which was outlined in its infrastructure strategy for 2012-2015. The bank's transformational projects, such as regional power grid connections and large-scale renewable energy, are intended to address systemic development challenges.

One transformational project funded by the World Bank is the $1.3 billion Nam Theun 2 hydropower project in Laos, which is often regarded as the first symbol of development banks' return to large hydropower. While about 75 megawatts will be reserved for domestic use, the project is expected to generate 1,000 MW of energy for export and $2 billion in revenue through power sales that the country will use for economic development and poverty reduction.

EBRD Focuses on Small Hydro

The European Bank for Reconstruction and Development has likewise focused its attention on hydropower in the last few years, but primarily for small-scale projects. The bank has also funded hydropower projects that are considered large in its regional context but are more likely to be categorized as medium-sized hydropower by global standards.

In the bank's early years after its establishment in 1991, EBRD funded mostly rehabilitation of existing hydropower facilities because hydropower capacity was “maxed out” in many countries of focus, Nandita Parshad, director of power and energy utilities at EBRD, told BNA. “Building new hydros has been a relatively recent phenomenon,” Parshad said.

Since 1993, the bank has directly invested in nearly 40 projects for new hydropower or rehabilitation, totaling more than €1 billion, according to figures provided by EBRD. In 2011 alone, the bank signed deals for more than 10 hydropower projects, including a €200 million ($279 million in 2011 dollars) loan to Ukrhydroenergo, Ukraine's largest hydropower company, to rehabilitate seven of its hydro plants. The project is part of a larger rehabilitation program for all 4,600 MW of the company's generation capacity.

Parshad said the surge in hydropower is due in part to a growing number of government policies supporting renewable energy that have made small hydropower a more attractive investment. Technological advances in small hydropower have also helped reduce costs.

Still, small-scale hydropower can be very capital intensive, with a long payback period, she said.

“There's a misconception that small hydros are cheap and cheerful,” Parshad said. “They can be more expensive than large hydros.”

The cumulative damage caused by small hydropower dams can also be more significant than large dams for certain environmental impacts, according to a five-year study by scientists from Oregon State University (2013 WLPM, 6/19/13).

The bank frequently enters partnerships with private sector banks, industries, and businesses to finance projects, but the trend is even more pronounced for small hydropower. “Almost all” of EBRD's small hydropower projects have been developed alongside the private sector, Parshad said.

To construct the 87-MW Paravani hydropower plant in the Republic of Georgia, the bank shared project costs with commercial banks and the International Finance Corporation (IFC), the private sector lending arm of the World Bank Group. EBRD took an additional $5 million equity stake in Georgian-Urban Energy, which is managing the plant's construction.

The bank has also developed a mechanism for providing indirect financing for hydropower. Through its Sustainable Energy Financing Facilities, EBRD extends credit lines to local financial institutions that pass the funds along to small and medium-sized businesses, corporate clients, and retail clients.

Regional Cooperation 'Ongoing Challenge.'

The Asian Development Bank has also been a major player in hydropower financing.

Large hydropower projects accounted for about 14 percent of the bank's water sector lending between 1992 and 2009, totaling $2.3 billion, according to ADB data. After a dip in funding in the early 2000s, lending over the past few years has generally returned to 1990 levels, Anthony Jude, senior adviser and practice leader for energy at ADB, told BNA.

In 2005, the Asian Development Bank joined forces with the World Bank for the Nam Theun 2 hydropower project on a tributary of the Mekong River. It is one of about a dozen dams being built or considered within the Mekong basin, where water resources are shared among four Southeast Asian countries.

Many of the Mekong dams are being funded by the private sector or national governments, making coordination a challenge, Jude said.

“We need cooperation between different hydropower operators” to facilitate basin-wide planning that takes the entire network of projects into account, he said. But coordinated planning is an ongoing challenge “that cannot be resolved today or tomorrow,” he added.

The ADB acknowledged that challenge in a 2010 evaluation of its water policy.

“Regional cooperation in water resource management has been a difficult area for ADB and other multilateral development banks due largely to the political sensitivity involved in crossborder water sharing within and outside national borders,” the evaluation said.

Dam building in the Mekong has been criticized as a failure in coordinated planning.

In 2012, Laos went ahead with construction of the 1,285-MW Xayaburi dam on the main stem of the river, despite opposition from its neighbors that the configuration would be too harmful to downstream ecosystems and economic activities. The dam is being funded by Thai commercial banks.

“The lower Mekong hosts the most productive inland fisheries in the world and millions of people depend on its rivers and lakes,” according to the WWF, also known as the World Wildlife Fund.

The Xayaburi dam is expected to block fish migration routes, which WWF said would have a negative impact on other species, subsistence fishermen, and regional food security.

Jude made it clear that the Asian Development Bank has not funded any dams on the Mekong's main stem but only on its tributaries. In addition to the dam on Nam Theun River, the bank has provided $115 million in loans to the Lao government for the 440-MW Nam Ngum 3 hydropower project on the Nam Ngum River.

Dam Built 'On the Wrong River.'

Constructing the Xayaburi dam on the main stem of the Mekong River is “contrary” to the dam building principles, WWF has suggested, Jian-hua Meng, water security specialist at the organization, told BNA.

The dam is being built “on the wrong river,” in an area that should be off-limits for hydropower development because of its high conservation value, WWF said in a 2013 evaluation of nine dams. River location was one of seven “sins” that WWF outlined in its evaluation, such as neglecting effects on downstream river flows and failing to acquire a “social license” to operate.

Dam siting is becoming a “crucial” question as hydropower investment shifts to the developing world, Meng said.

“These are the places that are still pristine in terms of environmental aspects,” Meng said. “The little free-flowing rivers left on the planet should remain free and not be dammed as well.”

Most of the world's existing large dams are in Asia, followed by North America and Central America, according to a 2011 survey by the International Commission on Large Dams. The construction of new dams, however, has been concentrated in developing countries and remote locations, particularly in Africa, Asia, and South America, which together account for at least 75 percent of the world's unexploited hydropower potential, according to the World Bank.

“Over the history of dam building, the most favorable spots, the easy locations, they're taken,” Meng said. “Every new development automatically will go to those places that were hard to reach, not accessible, remote, maybe also politically risky.”

'One Extreme to the Other.'

Private sector participation in hydropower has also been on the rise, climbing from $2.7 billion globally in 2005 to $5 billion in 2010, according to data compiled by the World Bank.

“The private sector used to do nothing but the smallest of schemes,” said Taylor, the executive director of the International Hydropower Association. “Now larger and larger projects are coming through in a private model.”

But “the transition is going from one extreme to the other at the moment,” Taylor said. As the private sector takes over the engineering and construction of hydropower, the public sector still needs to stay involved to strengthen associated infrastructure, he said.

Taylor said he expects to see an “evolution of private and public involvement” in the future, but defining boundaries between the two sectors for responsibilities within “bigger strategic picture of development” will be key.

“There are a lot of projects that combine public and private components,” potentially with different parts of the infrastructure being constructed under public and private direction, he said.

“But you have to recognize that the private sector does its business for a return,” he said. “At what point do you say it's the project developer's responsibility to build schools and health clinics and public amenities when you're actually effectively building a power plant?”

Need for 'Common Definition of Impacts.'

Over the last decade, there have been several international efforts to set shared sustainability standards for dam building.

“One of things that has plagued these debates is that we don't have a common definition of impacts,” the World Bank's Bucknall said.

The World Commission on Dams proposed in 2000 a set of guidelines for decisionmaking that emphasized the need to protect dam-affected populations and the environment while ensuring that the economic benefits of dams are more evenly distributed. The guidelines received a mixed reaction from hydropower developers. Many multilateral banks endorsed the recommendations while some national governments and parts of industry rejected them.

For commercial banks, the Equator Principles were established in 2003 to provide investment guidance for weighing environmental and social risks, though they did not focus specifically on hydropower.

Most multilateral development banks follow environmental and social safeguard policies, which advocacy groups say have generally become more stringent than standards among commercial banks or other financiers.

Safeguard policies, which cover all bank work, not just dams, generally promote sustainable development that protects biodiversity, natural and cultural resources, and public health and safety. Some banks, including EBRD, have expanded the scope of their policies over time to include more social issues, such as working conditions, gender equality, and involuntary resettlement.

'Existential Moment' for World Bank

Aligning sustainability standards among financing partners is a growing challenge, Zachary Hurwitz, policy program coordinator at International Rivers, told BNA. International Rivers is an environmental and human rights nonprofit that has criticized many large dam projects for ignoring social and environmental impacts in their cost-benefit analyses.

The World Bank, for example, “can't have standards that are too strong because they don't want to lose finance partners,” Hurwitz said.

“The World Bank right now is at a very existential moment, finding itself locked out of a lot of potential funding activities” because it is implementing standards with higher costs, Hurwitz said.

He said one way the World Bank has approached the topic is by forming public-private partnerships in which it provides technical assistance loans to help borrowers achieve better social and environmental standards.

Through the Eastern Africa Power Pool, for example, World Bank experts have offered training, sharing of software, and technical support to help borrower governments better track hydrology, weather patterns, and other factors that might affect the reliability of hydropower, Hurwitz said. The bank's technical assistance loans have also gone toward cumulative impact assessments so that hydropower developers can plan at the basin level rather than project by project, he added.

The World Bank is piloting with one of its hydropower projects the use of a new auditing tool that measures performance against best practices for sustainability.

The Hydropower Sustainability Assessment Protocol, which rates projects across 20 environmental, social, technical, and financial categories, was developed by the International Hydropower Association, commercial and development banks, governments, and civil society.

IHA's Taylor said “some of the world's biggest environmental champions are supportive of the protocol,” including WWF.

While the protocol is targeted toward industry self-assessments, it has also emerged as a potential screening tool for development banks to weigh investment risks. The protocol is not a standard, though, so it should not replace banks' sustainability safeguards, Hurwitz cautioned.

'Jury Still Out' on Implementation

Despite a lack of consensus in the past on the definition of sustainability, representatives from industry, governments, and nongovernmental organizations at the International Hydropower Association's 2013 World Congress said the debate over sustainability standards has shifted instead toward implementation (2013 WLPM, 6/5/13).

“I think we are getting to a stage where we know what it takes to make a sustainable hydropower project,” Cameron Ironside, program director for sustainability at IHA, previously told BNA. “But it's a case of actually driving it forward and implementing it.”

The first official assessments using the Hydropower Sustainability Assessment Protocol showed that hydropower projects worldwide generally performed well across a range of sustainability measures but often failed to meet proven best practices for certain environmental and social issues, including biodiversity and resettlement of dam-affected populations (2013 WLPM, 5/22/13).

“Taking guidelines and implementing them, that's not an easy thing,” WWF's Meng said. “You have to have a sustainability-enabling culture in your organization and this is what many commercial banks don't have.”

Ensuring that sustainability standards are followed will require capacity building so that lenders can better anticipate impacts “further down the road” and be more “aware” of the risks they are taking, he said.

Still, “some of the problems related to dam building, especially social impacts, indigenous peoples, and endangered species, those aren't going to go away,” Hurwitz said. “The jury is still out in terms of whether large dams will ever be a good investment.”