The Melamchi Water Supply Project

The Melamchi Water Supply ProjectAn effort to quench the ever growing thirst of the Kathmandu ValleyFinance 663 International Finance, Spring 1 2014Team Pancha: Chris Freeman, Nabin Khanal, Waqas Satti, Abhinav Upreti, Grace Webster

1OutlineNepalMelamchi Water Supply Project (MWSP)StakeholdersFinancingRisksThe Dilemma

Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, Webster2Nepal3

28M+ people comprising more than 100 ethnic groupsPercent of Nepals workforce employed in agriculture:75%

End of a decade long civil war in 2005Transition from a Constitutional Monarchy to a Democratic Republic in 2008Percent of Nepals population living below the poverty line:25%Hydropower potential:42,000 MW (10th largest)

Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterNepal is a landlocked country between China to the north and India to the east, west and south.

A monarchy throughout most of its history, Nepal was ruled by the Shah dynasty, until 2008; a decade-long Civil War involving the Communist Party of Nepal (Maoist) ended in 2005. In 2008, a constituent assembly voted overwhelmingly favored the abolition of the monarchy and the establishment of a multiparty democratic republic.

3Nepal2007/20082013/2014Government StructureConstitutional MonarchyDemocratic RepublicGDP$12.5 billion$18.7 billionFDI Total Amount$15 million$290 millionInflation12.6% (208th worldwide)8.3% (187th worldwide)Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, Webster4GDP:FDI: Since the end of Nepals civil war and the transition to a Republic, the country has benefited greatly from an influx of FDI, improving from $15M in 2007/2008 to $290M in 2013/2014, with a substantial amount of this coming from China (more than 60%).INFLATION: With the transition to a more stable government, the inflation rate in Nepal has plummeted over the past 5 years

4Melamchi Water Supply Project (MWSP)

Kathmandu ValleySupply water to Capital City w/ 2.5 MM populationImprove existing treatment and distribution system

Melamchi ValleyMelamchi River as source170 MLD (45 MGD)Social and Environmental Support

Tunnel27.5 km (17 miles)5Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, Webster170 MLD slightly smaller than average water demand in the City of Raleigh in 2009 was 48 MGDThe Valleys pipe-water system development dates back to 1895 A.D.Government initiated the project in 1998 to ease chronic water supply shortage Semi Autonomous project is also intended to improve the institutional framework overseeing water supply in the region The core essence of the project is to transfer 170 MLD of fresh water from the adjoining to Melamchi river to Kathmandu valley in Phase IBy providing clean water to the residents of the valley, government hoped to promote health and well being of the residents which were estimated at 2.5 million (ADB)27.5 km (17 miles) tunnel

Exponential rise in population and burgeoning settlements soon exhausted the water sources in the Valley. Rampant urbanization also led to pollution of rivers beyond recovery.

5MWSP Project Timeline6Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterFirst milestone achieved when a consortium of multilateral agencies and bilateral agencies led by World Bank agreed to fund the project in 2000The funding became effective on 28th November 2001. It was estimated that the project would cost US$ 464 millionIn 2004 World Bank decided to cancel its funding for the project as their funding was conditional on Govt of Nepal finding a private sector partner to manage the projectIn June 2005, there were allegations of corruption in the procurement process. Although, allegations were not proved, it did lead to further delays in the projectIn 2008, ADB approved major restructuring of the project which would allow the project to move forwardThere were also changes in the funding consortium. The modified consortium was again led by ADB (US$ 91.72 million), Government of Nepal (US$ 53 million), JICA (US$ 46.28 million), (US$ 13.7 million)

6MWSPProject structure and goalsSub Project 1: Melamchi River DiversionMelamchi Water Supply Development Board (MWSDB) as project management agency

$235.32 MM

Construct Melamchi tunnel (27.5 km) to supply 170 MLD (45 MGD) water

Improve Social and Environmental conditions construction of health care center, schools, forest nursery

Sub Project 2: Kathmandu Valley Water Supply and SanitationKathmandu Upatyaka Khanepani Limited (KUKL) implementation agency

Leased assets and operating license from Kathmandu Valley Water Supply Management Board (KVWSMB) the asset owner

$64.08 MM

Improve distribution and treatment system network in Kathmandu Valley

Adjust existing water tariff structure

7Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, Webster$17mm for project management and other overhead.7StakeholdersStakeholdersCurrent funding and rolesGovernment of Nepal$90.6 MMMinistry of Urban Development chairs MWSDBEnsures counter party fundingAsian Development Bank$137.0 MM @ 1-1.5% p.a. for 32 yrsMonitors loan covenantsSupervises the overall project implementationJapan Bank for International Cooperation$47.5 MM @ 1% p.a. for 30 yrsSupport for water treatment plant upgradesJapan International Cooperation Agency$18.0 MM @ 1% p.a. for 30 yrsSupport for shallow groundwater wellfield near KTMNordic Development Fund$10.5 MM @ 1-1.5% p.a. for 32 yrsSupport for diversion tunnel constructionOPEC Fund for International Development$13.7 MM @ 1% p.a. for 20 yrsSupport for access road construction in Melamchi Valley

8Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterThere were also changes in the funding consortium in 2008. The modified consortium was again led by ADB (US$ 91.72 million), Government of Nepal (US$ 53 million), JICA JBIC, NDF, and OPEC Fund

8StakeholdersAsian Development BankThe Asian Development Bank aims for an Asia and Pacific free from poverty. Approximately 1.7 billion people in the region are poor and unable to access essential goods, services, assets and opportunities to which every human is entitled.

67 member countries$165 billion capital baseBorrowing on the world marketMember country contributionsTiered financing structure

9Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterThe ADB seeks to eradicate poverty by financing projects in five core areas of operations: infrastructure; the environment, including climate change; regional cooperation and integration; finance sector development; and education. The ADB provides various forms of financial assistance to its developing member countries, including loans, technical assistance, grants, guarantees, and equity investments.

67 member countries: 48 from within Asia-Pacific and 19 from outside. The largest shareholders are the United States and Japan at 12.78% each. Additional shareholders include China with 5.45% and India with 5.36%.

Capital base tripled from 2009-2011 in response to global financial crisis

In 2012, ADBs operations totaled $21.57 billion, of which $13.30 billion was financed by ADB (Ordinary Capital Resources (OCR) and Special Funds) and $8.27 billion by co-financing partners

9StakeholdersAsian Development FundRepresents 25% of Asian Development Banks financingVery low interest rate loans and grants for ADB's poorest member countriesPerformance-based allocation policy guides the allocation of resources:Macroeconomic and structural policiesGovernance and public sector managementPolicies and institutions promoting equity and inclusionPerformance of its portfolio of ongoing projects and programEncourage private sector reform and participation in member countries10Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterIn 2009-2012 alone, over 220 loan and grant projects totaling $11.8 billion were made to developing member countries of ADB.

Eligibility is based on gross national income per capita (using the World Banks criteria) and country creditworthiness

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11Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterStakeholders ADB country ratingsStakeholders ADB Loan Features

12Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterFinancingSourcesOriginal cost: $464mmRestructured cost: $355mm13Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterFinancingUsesUseAmountAdditional Financing NeedsTotalInfrastructure development213.119.8232.9Social and environmental support7.2-7.2Project implementation support53.58.962.4Taxes & duties20.42.923.3Contingencies17.65.923.5Financing charges during implementation5.50.66.1Total317.338.1355.4Figures in US$ millions14Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterFinancingCost of capitalADB assigned 7.95% as the project cost of capitalADB granted loan at 1% to 1.5%Assumed 10% as the nominal cost of capital according to Nepal savings rate bondsAdjusted for 1.9% inflation

True project cost of capitalADB used NPR denominated bonds as proxy for sovereign riskFX exposure not accounted forProject specific risk not accounted for15Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterFinancingValuationMarket RateSubsidized RateCost of Equity20.35%20.35%Cost of Debt19.73%1.38%Weighted Average Cost of Capital19.91%6.91%Jan 2014 Project NPV$84,725$589,819PV of Subsidies$505,094Project IRR12.5%16Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterFigures in US$ millionsAs a class should we invest in this project or not?Real optionsPrivate sectorProject pipeline for another 170MLDPower projectReputationIndia/China interestPollev??16Project risks17Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterThe DilemmaShould the MWSDB approach ADB for additional $25mm funding? Additional funding needed to cover the cost overrun in tunnel constructionGON already committed $13.1mm in additional equity fundingWhat about getting private investors involved?Equity investment?Would they be willing to bear the risks?18Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterPrivate investor perspectiveRisks, Cost of CapitalProject valuationWhat % of the project would private investor require for $25mm investmentWhat are the pros and cons of bringing in additional equity investors to the project at this stage:Government of Nepals perspectiveADB and debt lendersPrivate investors

18The DilemmaGetting private investors involvedProsFrees up government and ADB dollars for other critical areas of economyTransfers risk away from public partner to private entityProvides diversification to investorsGreater accountability and long-term efficiencies Opens the door for future private investorsConsLimited number of investors willing to fund long-term projects due to illiquidityPrivate investors seek high returns for bearing risks, which may not always come to fruitionApproval process at this stage may be lengthy19Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterThe DilemmaKnocking on ADBs dooragainProsConcessionary financingStrong existing relationshipStrategic geopolitical locationPrevious lack of domestic supportConsUnderlying problems still existFunds could go to other development projectsNeed to stimulate private sector investment20Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterUnderlying problems still exist: Kicking the can down the road. Project management is still inefficient. ADB/GON wants private investors involved in these kinds of projects eventually..

20The DilemmaWhat happenedMWSDB approached ADB for additional $25 MM funding in Jan 2014ADB approved the loan in Feb 12, 2014 to complete the tunnelCompletion date stays 2016

21Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterPvt investors still spooked. Not willing to invest.Refer to real sequencing option for later project if we have time.21A long wait ahead?

22Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, WebsterAppendix23Melamchi tunnel

24Intl. Finance. Team Pancha: Freeman, Khanal, Satti, Upreti, Webster