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View the document 1. BASIC APPROACH a) Cost-Benefit-Approach for Socio-Economic Selection

1. BASIC APPROACH a) Cost-Benefit-Approach for Socio-Economic Selection

a) Cost-Benefit-Approach for Socio-Economic Selection

b) Constraints on the Selection of Energy-Sources

c) Concluding Remarks on Decision-Criteria


When the World Bank says that future energy demand should be met at the least cost the question arises what cost are to be considered. Likewise one has to decide what kinds of benefits should be taken into the calculation. It is appropriate to say that energetic infrastructures - as all infrastructures have expecially many external economies and diseconomies. One way to get hold of most of the important effects, internal and external, could be the following system.

External cost and benefit are defined as the influence which an economic project's creation and performance exercises unvoluntarily on the "situation" (mostly profitability) of other units. Thus the operation of a micro-hydro plant could exercise stimulating effects-via backward linkages -on local workshops for the construction of generating equipment, or on civil engineers etc. (external economies), but would perhaps foster some new sociological stratification if one grainmill-owner or one sawmill-owner uses most of the produced electrical or mechanical energy to the detriment of others (external diseconomies).

It is for operational reasons advisable to differentiate among various levels of the cost-benefit-analysis. Here, three levels are suggested:





· tangible internal cost:

-Civil works (dam, canal, powerhouse etc.)

-Generating equipment (turbine, governor, generator etc.)


-Operation and maintenance (also fuel cost if non-renewable energy-source, or labour-cost for collecting dung for biogas-purposes)

-Local distribution network (L.T.)

-Other (R+D, project-design, land acquisition etc.)

· tangible internal benefit:

-Mechanical and/or electrical energy-supply

for consumption (domestic) uses

for productive (entrepreneurial) uses

-as "price per kWh" (as measure of comparison to other energy-options)

-Surplus revenues within local community

-Producers IER (internal economic rate of return)


· Internal cost means cost of producing unit plus some local public investment in local grid.

. Internal benefit means benefit to all individuals, households and economic units (incl. the hydropower-producing unit). which are integrated into the new energy-system

· The price per kWh is to be calculated over the life of the project

· The surplus-revenues of customers (be it economic units or individuals) are obtained because of more economic activity as such and/or because of productivity-effects providing more foodstuffs per acre, more textiles per day, more cement per hour etc.

· The calculation of the IER needs a forecast of costs and revenues (those of the hydropower-producing unit) which requires a concept about selling prices and tariffs. The estimated future costs and revenues (e.g. the net balance) must be discounted as will be shown later on. Here comes in a difficult adjustment problem: the shadow-prices, i.e. distorted prices, be it too high or too low prices for cost-components of the hydropower-plant, or of alternative energies (e.g. subsidies for kerosene).

It remains to be said that the two-fold aspect of the tangible internal benefit (consumption-aspect and producers-revenue-aspect) coincide when a household or an economic unit is supplier and sole consumer at the same time (e.g. a family-biogas-plant).

So the first cost-benefit-level, by aggregating all cost over the life-period of the installation, determines a selling price of energy (which provides at least a cost-covering IER); the selling price must be related to given purchasing power (incl. the energy-induced increases of it) as well as to the selling prices of alternative energies and their revenue-increasing potential.


· tangible external cost:

-Interlocal (regional, national) distribution-grids (H.T.)

-Step-up and -down transformation

-Distribution-losses of energy


-Need of foreign currency

· tangible external benefit:

-Increased tax revenues

-More diversified and possibly cheaper (for economies of scale arise when energy-input increases production per hour) product-supply to the local and regional community

-Less subsidies for alternative energy-sources

-Lowering of import-bill (e.g. oil) and increasing of import-substitution


Though this level is still "tangible" the quantifying problem becomes more difficult. At least rough indications should be possible. The result of this level cannot stand for itself; it has to be superimposed on the result of the first level. To elucidate this: it would make sense to accept a negative IER and subsidise the hydropower plant with a fraction of the increased tax revenues generated by more economic activities. There would still remain a net benefit to the community.

THIRD COST-BENEFIT-LEVEL intangible cost (examples):

-new need arises to regulate the use of rivers by law and enforce its adherence

-Price-increases for consumer goods in case of monopolistic markets

-Privileges of electrified households, workshops, farms etc. in contrast to others

-Increase of local capital-interest and credit-shortage as a consequence of concentrated capital-allocation on a hydroplant

-Short-term displacement of human energy/work in economic production by mechanical and/or electrical power

-etc. intangible benefit (examples):

-more comfort

-educational effects (lighting), health effects (heating)

-environmental protection, flood control

-recreation (in case of dam ' end lake)

-degree of "self-reliance", local production

-slowing down of urbanization because rural quality of life increases

-learning process

-"fall-out" and "trickle-down effect" of more productive methods as a consequence of hydropower and the demonstration-effects

-Prevention of deforestation



The larger the powerplant the more difficult it usually becomes to seize and to assess all intangible effects, internal and external.

Again, considerations of this cost-benefit-level should be at least added if not integrated into the net-effects of the first and second level.

Summarising one may say: there is an actual problem of quantifying the inputs into the cost-benefit-analysis. Many factors -above all on the third level can only be assessed in a qualitative way; and even this is arbitrary. The first-level-result may be a negative IER, e.g. perhaps because of wrong input-prices (expensive turbine, possibly because of a highly overvalued rate of exchange, expensive cement), because of wrong selling-prices per kWh, or wrongly structured tariffs, because of a low use of a high-cost project (load-factor problem), etc. But these influential factors are quantifiable; more difficulties arise when one has to justify a bad IER with intangible benefits like the longrange value of "rural development" or "local self-reliance". Fortunately this problem will not arise too often since empirical evidence shows that large, centralised hydropower-plants have difficulties to compete successfully with smaller plants where loads are small and scattered, when calculated on the basis of tangible (internal and external) costs and benefits. Thus, the intangible benefits are rather an additional than a compensating incentive.

A further problem connected with cost-benefit is the question of discounting in order to calculate the IER. As mentioned earlier, the IER needs a forecast of costs and revenues which then are related to each other and should produce some positive return on total initial investment over the life-period of the project. At least the running cost, including capital-interest cost, should be reimbursed. The problem of depreciation is treated later (refer to end of section 2 lit. a). The question is how one can compare costs or revenues of today with those of thirty years ahead? Obviously it can only be done if all future costs and revenues are discounted to the present value of costs and revenues. The concept underlying this is simple: money -be it cost (C) or revenue (R) - of a future date (tn) is worth less than the synonym amount today (to) since this money -if accessible today -would be invested at a given interest-rate (i). Up to tn. the initial amount would have increased according to the formula Ctn = Cto (1 + i)n. This elucidates that much of the IER depends on the interest-rate chosen, since in hydropower plants, all costs occur today whereas the revenues are distributed over thirty to fifty or even more years. This simplifies the discounting calculation since only the future revenues which one anticipates, have to be discounted to their present value. A high interest-rate lowers the today-worth of future revenues, a low interest-rate makes future revenues appear high at to.

Fig. 72 exemplifies the discounting method; it is assumed that all future revenues occur together at tn.

Fig. 72: Discounting Alternatives


Case I shows that in view of the present value of the future revenue, the today's capital investment is comparably low, since more capital than Cto would have to be put into alternative investments today (loans, bank-account etc.) to reach the future revenue Rtn.

The following example (refer to fig. 73), will further illustrate the problem. A hydropower plant of 50 kW installed capacity at a cost of $ 1'500/kW ($ 75'000.--total investment) is planned for a life-period of 10 years. The prevailing interest rate of the country -also to be used for discounting -is 14 % p.a., for investments through a bank or other financial institutions. Applying the formula mentioned earlier the capital at t10, including compound interest, will amount to $ 278'025.--. If the investor's estimated revenue of the investment into the hydropower plant is higher than $ 278'025.--(estimation I) he will quickly embark on this energy-investment. Should the estimated future revenue be lower than $ 278'025.--(estimation II), then the investor will prefer to entrust his capital to a bank or another institution granting the return of 14 %.

Fig. 73: Investment Decisions

The term "investor" needs a further explanation. The discounting procedure is relevant in two cases:

· the private investor choosing among alternative investment-opportunities

· the public investor having an utility-obligation, thus choosing among investment-alternatives within the energy-supply possibilities.

A certain complication of the discounting-method stems from the fact that the future revenue will rather be a yearly return than an aggregated sum at the end of the plant's lifespan. Mathematically it means that each year's revenue must be discounted separately or, should costs also arise yearly, the net balance between yearly cost and revenue.

In other words: the higher the discount-rate must be chosen (again: meaning that at this interest rate one could invest today's money) the less advantageous are capital-intensive installations (unless staggering kWh-prices are applied); a high discount-rate favours labour-intensive installations because it keeps down capital-investment at to. The low initial capital-investment respectively the low capital (interest) cost, will thus allow for more labour-intensive plant operation.

In practice, analysts have tended to underestimate seriously the level of discount rates prevailing in poor areas. One result has been to focus attention exclusively on relatively capital-intensive and complex energy systems (see: French: Renewable Energy Systems, p 41; for example of calculation see NRECA, Small Hydroelectric Powerplants, p 104 f).

In summary it is necessary to:

· Determine all pertinent factors to be included into the three cost-benefit-levels

· quantify and qualify these factors . discount the tangible costs and revenues.

The results may then be used to:

· compare hydropower plants of different types and sizes

· compare hydropower plants with alternative energies.

As to the latter point however, one will first have to consider the "second law efficiency" of thermodynamics before embarking on economic analysis since there is a distinct interrelationship between task, energy-source and energy-device, which - when one end-use (task) is considered -eliminates many energy-alternatives at the outset for thermodynamic reasons rather than for economic reasons.

b) Constraints on the Selection of Energy-Sources

End-uses like lighting, cooking, heating or grainmilling, sugar-processing, brick-making, water-pumping, dyeing, cooling etc. may require very different energy-sources, ranging from wood, liquefied biomass, grid electricity, mechanical hydropower, biogas, kerosene etc. To begin with, a selection will consider thermodynamic constraints by tabulating the tasks into temperature-grades, lighting, stationary and mobile power. In an outstanding analysis of a village's energy needs, Reddy shows this as reproduced in fig. 74. Thus the economic cost-benefit-analyses will have to concentrate on the alternative options left over after this energetical pre-selection.

Fig. 74: Selection of Sources and Devices for Pura

Source: Reddy c) Concluding Remarks on Decision-Criteria


The energetical selection (lit. b) and the economic cost-benefit-approach (lit. a) will both limit the energy-options to a few; to narrow further down the remaining alternatives, some more general criteria might be helpful. These are:

· the matching of the time-dependence of the energy-utilising task with the time-variation -if any -of the supply of energy from the chosen source. If matching is bad, energy-storage becomes necessary which implies new cost. The problem may arise with the variable discharge of rivers, the time of sunshine, variable wind-velocities etc.

· the primacy of basic needs

· the local self-reliance and system-independence providing social participation and control

· the environmental soundness; the primacy of renewable energy-sources and the minimising of negative ecological impacts

These additional criteria may be a useful guidance when a non-decisive result among alternatives arises.

The following sections will illustrate some of the criteria of lit a), b) and c), by way of examples of hydropower plants and alternative energy-sources. A full three-level cost-benefit analysis of each and every option is impossible at this place, however.