INTERNATIONAL BUSINESS PROGRAMS

Master Program in International Finance and Economics (MiFE)

SEMINAR PAPERS IN INTERNATIONAL FINANCE AND ECONOMICS

Center for Applied International Finance and Development (CAIFD)

Renewable Energy Development

Hydropower in Norway

Authors: Gonzalez, David; Kilinc, Aygn; Weidmann, Nicole

SeminarPaper1/2011
ISSN21914850
I Renewable Energy Development Hydropower in Norway

Table of Contents

List of Figures ............................................................................................................. II

List of Abbreviations .................................................................................................. III
1. Introduction .......................................................................................................... 1
2. Renewable energy ................................................................................................ 2
2.1 Situation and outlook ..................................................................................... 3
2.2 The role of hydropower ................................................................................. 5
2.3 Definition of hydropower .............................................................................. 8
2.4 Technical aspects of hydropower ................................................................ 10
2.5 Advantages and disadvantages of hydroelectric power ............................... 10
3. Hydropower in Norway ...................................................................................... 12
3.1 Norwegian water resources and hydropower .............................................. 13
3.2 Norwegian hydropower potential ................................................................ 14
3.3 Norwegian expertise in the hydropower sector ........................................... 15
4. Economic Framework ........................................................................................ 16
4.1 Current hydropower market in Norway....................................................... 16
4.1.1 Supply and demand in the Norwegian Electric Industry...................... 17
4.1.1.1 Wholesalers ................................................................................... 18
4.1.1.2 End-users ....................................................................................... 18
4.1.2 Price determination .............................................................................. 19
4.2 Norways power exports .............................................................................. 21
4.3 The Nordic Power Exchange Nord Pool Spot ............................................. 24
4.3.1 The physical market ............................................................................. 25
4.3.2 The financial market............................................................................. 27
4.4 Investing for the future ................................................................................ 27
4.5 Barriers to newcomers in the Norwegian hydropower market .................... 29
5. Legal Framework ............................................................................................... 31
5.1 The Ministry of Petroleum and Energy ....................................................... 31
5.2 The Norwegian Water Resources and Energy Directorate .......................... 31
5.3 Legislative and political framework ............................................................ 33
5.3.1 The licensing process ........................................................................... 33
5.3.2 Protection plans and the Master Plan of Water Resources ................... 35
5.3.3 The Industrial Licensing Act ................................................................ 36
5.3.4 The Watercourse Regulation Act ......................................................... 37
5.3.5 The Water Resources Act ..................................................................... 38
5.3.6 The Energy Act .................................................................................... 38
5.3.7 Further Legislation ............................................................................... 40
6. Financial Framework .......................................................................................... 42
6.1 Small vs. Large Hydropower plants ............................................................ 42
6.2 Key players .................................................................................................. 44
6.3 Small hydropower project costs .................................................................. 45
6.4 Profitability analysis of a small hydropower station ................................... 48
6.5 Subsidies and Tradable Green Certificates .................................................. 54
6.6 Risks involved in Hydropower Investments ................................................ 56
7. Conclusion .......................................................................................................... 58
7.1 Summary of main points.............................................................................. 58
7.2 Recommendations ....................................................................................... 59
References .................................................................................................................. 61
II Renewable Energy Development Hydropower in Norway

List of Figures

Figure 2-1: 2008 shares of world Total Primary Energy Supply ................................ 3
Figure 2-2: Annual growth of renewables from 1971 to 2004 relative to TPES ........ 4
Figure 2-3: 2008 renewables in electricity generation ................................................ 6
Figure 2-4: Worldwide hydropower development and capacity ................................. 7
Figure 2-5: Percentage of current electricity generated by hydropower ..................... 7
Figure 2-6: Electricity demand per capita ................................................................... 8
Figure 3-1: Leading hydropower producing countries in 2007 ................................. 12
Figure 3-2: The largest hydropower stations in Norway in 2008 .............................. 13
Figure 3-3: Norways hydropower potential as of January 2008, TWh/year. ........... 15
Figure 4-1: Electricity spot price in 2008 and 2009, weekly average. NOK/MWh. . 20
Figure 4-2: Electricity spot prices and forward prices in the financial market ......... 21
Figure 4-3: Norways Power Imports and Exports, 1970 - 2007 .............................. 22
Figure 4-4: Production split in Nordic countries in 2008 .......................................... 25
Figure 4-5: Elspot system and area prices as of 13.11.10 ......................................... 26
Figure 4-6: Power exchange in the Nordic region in 2008, GWh ............................. 27
Figure 4-7: Industry-related objectives, Energi21, sub-group hydropower .............. 28
Figure 5-1: Organizational Chart NVE ..................................................................... 32
Figure 5-2: Legislation governing licensing in the hydropower sector ..................... 33
Figure 5-3: Licensing process (more than 40 GWh / year) ....................................... 35
Figure 6-1: NVE definitions of small hydro plant in kW.......................................... 42
Figure 6-2: Investment costs of small hydropower plants in selected European
countries ..................................................................................................................... 49
Figure 6-3: Project Cash flows, in NOK ................................................................... 52
Figure 6-4: Effect of discount rate and lifetime on the NPV .................................... 53
Figure 6-5: Effect of leverage on the IRR ................................................................. 53
Figure 6-6: NOK/EUR exchange rate development since 2005 ............................... 56
III Renewable Energy Development Hydropower in Norway

List of Abbreviations

CfD: Contract for difference

CHA: Canadian Hydropower Association
CO2: Carbon dioxide
CRW: Combustible renewables and waste
EEA: European Economic Area
EIA: Environmental Impact Assessment
EUR: Euro
GWh: Gigawatt hour
ICOLD: International Commission on Large Dams
IEA: International Energy Agency
IHA: International Hydropower Association
IRR: Internal Rate of Return
kWh: Kilowatt hour
MFA: Ministry of Foreign Affairs
MGCA: Main grid commercial agreement
MW: Megawatt
NOK: Norwegian kroner
Norad: Norwegian Agency for Development Cooperation
NPV: Net Present Value
NVE: Norwegian Water Resources and Energy Directorate
PPA: Purchase Power Agreement
R&D: Research and Development
SHERPA: Small Hydropower Energy Efficiency Campaign Action
TPES: Total Primary Energy Supply
TWh: Terawatt hour
TSO: Transmission System Operator
VAT: Value added tax
1 Renewable Energy Development Hydropower in Norway

1. Introduction

Water has always been a vital resource for mankind. In the course of human history,
it has not only been used as a source of life, but also as a source of energy.
Hydropower, the energy that comes from the natural flow of water, is a renewable,
reliable, and most importantly, nonpolluting source of energy.

Supplying almost one-fifth of the worlds electricity, hydropower exceeds by far the
contributions made by other renewable sources, making it especially valuable in
reducing energy-related carbon emissions. Thus, hydropower plays and will play an
important role in todays paramount endeavor to reduce greenhouse emissions
worldwide.

The present study aims at providing a thorough insight into the benefits of investing
in hydropower. For this purpose, Norway presents itself as an attractive location for
such an investment. In Norway, hydropower represents approximately 99% of the
total electricity produced, and there is still room for further development. Norwegian
expertise in hydropower construction and management of water resources stands out
globally, offering an exceptional fundament for a sound investment.

Private investment in the hydropower sector can take place either through the
upgrading and rehabilitation of existing schemes, or through the construction of new
projects. While the first category is clearly important, it nevertheless has no
significant impact on emission reduction. This report therefore focuses on attracting
private investment to new projects. Large-scale hydropower projects were at peak
during Norwegian industrialization. Nowadays, Norway targets the development of
small hydropower. Hence, a small hydropower scheme will be the base for analysis.

The reader will be introduced to the investment environment and relevant data will
be provided which are meant to allow for informed decision-making. The first
section of the present report exhibits the current situation of hydropower in the
world, and the position of Norway in this field. Subsequently, the economic
background as well as the institutional and legal framework in Norway will be
examined in detail. The last section considers the financial aspects of the project and
is intended to evaluate the profitability of a small hydropower station.
2 Renewable Energy Development Hydropower in Norway

2. Renewable energy

Renewable energy sources, among which the most popular are solar, wind, hydro,
and biomass, have recently become the heart of sustainable development. Though not
new, sustainable development now occupies a primary position in the worlds public
agendas as a critical concern. Yet, the term is in fact understood by only few, and
thus, a clear definition of sustainable development is central to the understanding of
the aim of the present paper given the focus on renewable energies. Therefore, an
extensive description put forward by the European Commission will serve as the
starting point of reference to the reader:

Sustainable Development stands for meeting the needs of present

generations without jeopardizing the ability of futures generations
to meet their own needs in other words, a better quality of life for
everyone, now and for generations to come. It offers a vision of
progress that integrates immediate and longer-term objectives,
local and global action, and regards social, economic and
environmental issues as inseparable and interdependent
components of human progress.1

In this respect, renewable energy could contribute to the attainment of sustainable

development in the following aspects:

Renewable energy promises greater security of energy supply by utilizing

abundant, diverse, and domestic (non-imported) sources. This eliminates the
resource exhaustion constraint.
When substituting fossil fuels with renewable energy, global and local
greenhouse gas emissions will be substantially reduced.
Innovation and technology development in this field enable enhanced
opportunities for implementation, particularly in rural areas and in emerging
countries.
The exploitation of renewable energy promotes local and regional employment in
the energy manufacturing sector, installation and maintenance.

1
European Commission. (2010). Environment. (Internet).
3 Renewable Energy Development Hydropower in Norway

Despite this evident potential, renewable energy is being barely exploited in

commercial markets. Reasons for this can be attributed to high set-up costs as well as
technical and institutional limitations. In the best locations, renewable energy is
competitive with ordinary energy sources; however, in most of the cases, it is still at
an early stage of development and technically immature. Hence, supportive measures
are required to foster the further expansion of renewables in energy markets.

2.1 Situation and outlook

With the purpose to understand and illustrate the main features of the current
renewable energy situation, this section will provide an overall evaluation of the
position of all renewable energy types.

When referring to world energy, the standard of measurement is Total Primary

Energy Supply (TPES), which represents all energy consumed by end users, except
for electricity but comprising the energy needed to produce electricity. To put
renewable energy in the context of world energy, Figure 2-1 shows the various
shares of energy in 2008.

Figure 2-1: 2008 shares of world Total Primary Energy Supply

Source: International Energy Agency. (2010). 2010 Key World Energy Statistics. (Internet)

In 2008, renewable energy corresponded to 12.9% of TPES. Within this category,

combustible renewables and waste represented the largest portion (77.5%), followed
by hydropower (17%). Contributions made by solar, wind, and other renewable
sources were minimal. Put in other words, Figure 2-1 reveals that renewable energy
4 Renewable Energy Development Hydropower in Norway

accounts for a relatively small fraction of TPES, and thus, it has ample room to
expand further.

Figure 2-2: Annual growth of renewables from 1971 to 2004 relative to TPES

Source: International Energy Agency. (2007). Renewables in Global Energy Supply - An IEA Fact
Sheet. Retrieved from International Energy Agency Publications and Papers database.

With an annual growth rate of 2.3% over three decades, total renewables supply rose
only slightly faster than TPES. Nevertheless, certain types of renewable energy
experienced an impressive growth rate during the same period of time, most
prominently wind (48.1%) and solar (28.1%) energy. This extraordinary growth can
be partly explained by the very small base in 1971.

At present, markets and political concerns point to a more important future role of
renewable energy in the worlds total energy supply. Due to increased environmental
awareness combined with technological improvement and growing demand in
industrialized countries, the use of renewable energy is expected to rise over the next
years.2

The exploitation of renewable energy sources is strongly connected to a countrys

resource endowment. However, it is also often determined by technology
development, policy framework, and private sector investment, to the extent that
even countries with limited availability of renewable resources have achieved rapid

2
International Energy Agency. (2002). Renewable Energy. p. 3. Retrieved from International Energy
Agency Publications and Papers database.
5 Renewable Energy Development Hydropower in Norway

growth through the implementation of measures that encourage the development of

renewable energy technologies.

Thus, the principal constraint in the progress towards the utilization of renewable
energy is its cost-effectiveness. Renewable energy has been, with the exception of
large hydropower, combustible biomass, and larger geothermal projects, an
expensive source of energy compared with fossil fuels.3 Hence, substantial
technology enhancement to attain cost competitiveness is number one priority.

The ongoing implementation of stricter environmental regulations and protocols for

greenhouse gas emissions is already a driving force for policy initiatives in many
countries that address the cost-effectiveness constraint. Such initiatives concentrate
on research and development investments as well as financial incentives.

To sum up, markets for renewable energy are growing and look ahead at a promising
future. Strategic policy programs are contributing towards making renewable energy
exploitation more affordable; i.e. reducing technology costs for users through
subsidies and research and development schemes. This not only benefits the users of
one country, but also those in other countries, reinforcing overall cost reductions and
performance advancement.

2.2 The role of hydropower

Hydropower is one of the most mature technologies in the realm of renewable energy
supply. For this reason, it is also one of the most competitive renewable energy
sources. Due to its technological, economic, and environmental benefits, hydropower
is considered to be a significant contributor to the future worlds energy supply.

According to Figure 2-1, hydropower accounted for 2.2% of TPES in 2008 which is,
in fact, a relatively modest share. However, the electricity generation market exhibits
a very different pattern.

As can be seen from Figure 2-3, hydropower was by far the largest electricity
supplier from renewable sources in 2008, representing nearly one-fifth of the worlds
electricity production. Third in importance after coal and gas, hydropower has been

3
International Energy Agency. (2007). Renewables in Global Energy Supply - An IEA Fact Sheet. p.6.
Retrieved from International Energy Agency Publications and Papers database.
6 Renewable Energy Development Hydropower in Norway

propelled to an efficient electricity supply technology which, in contrast to most

other renewable sources of electricity, has the capacity to satisfy a considerable
portion of the worlds electricity needs.

Figure 2-3: 2008 renewables in electricity generation

Source: International Energy Agency. (2010). 2010 Key World Energy Statistics. (Internet)

Hydroelectric power has nevertheless immense remaining potential. In a joint study

carried out in 2000 by the IEA Implementing Agreement on Hydropower
Technologies and Programmes, the International Hydropower Association (IHA), the
International Commission on Large Dams (ICOLD), and the Canadian Hydropower
Association (CHA), the worlds total technically realizable hydropower potential was
estimated at 14,370 Terawatt hours (TWh) per year. About 8,082 TWh/year thereof
were considered economically feasible for development, 2,600 TWh/year were
already in operation, and around 400 TWh/year were under construction.

At the time of publication of the study, reports indicated that hydropower represented
more than 50% of national electricity supply in about 65 countries, more than 80% in
32 countries, and almost all of the electricity in 13 countries.4

In the midst of accelerating economic growth in Europe and North America during
the twentieth century, hydropower potential in these regions was extensively
developed and progress has continued until today. There, potential has been already
utilized by more than 60%. On the contrary, Asia, South America, and Africa still

4
IEA Implementing Agreement on Hydropower Technologies and Programmes, the International
Hydropower Association, the International Commission on Large Dams, and the Canadian
Hydropower Association. (2000). Hydropower and the worlds energy future. p. 4. (Internet).
7 Renewable Energy Development Hydropower in Norway

have enormous untouched reserves of hydropower potential. As can be seen from

Figure 2-4, for instance, Africa utilizes only 7% of its hydropower capacity.

Figure 2-4: Worldwide hydropower development and capacity

Source: IEA Implementing Agreement on Hydropower Technologies and Programmes, and the
United States Bureau of Reclamation. (1999). Hydropower A Key to Prosperity in the Growing
World. (Internet)

In contrast, when considering Figure 2-5: Percentage of current electricity

electricity generated through generated by hydropower
hydroelectric power, it be-
comes evident that Asias
generation capacity exceeds to
a high degree that of Europe
and North America, despite
the fact that potential there has
Source: IEA Implementing Agreement. (1999).
been much less exploited. Hydropower A Key to Prosperity in the Growing World.
(Internet)
This can be attributed to large-scale hydropower development programs that have
hRussave been
been undertaken particularly in China and Russia, and thus, total installed capacity is
substantially larger.

The ever-intensifying need for power as world population increases, emerging

economies advance, and developed nations remain on their course for growth allows
an early prognosis of augmented demand for electricity in the years to come. Figure
2-6 describes the expected increase in electricity demand per capita from 1990 to
2020. Growth rates in electricity demand are presumed to be highest in South and
Central America, and Europe.
8 Renewable Energy Development Hydropower in Norway

Figure 2-6: Electricity

demand per capita In view of the risk of increased combustion of
fossil fuels and its major impact on the
environment and climate change, there is a strong
focus on renewable energy as an alternative to
meet rising electricity demand. In this respect,
hydropower, which already makes up a significant
share of the total amount of electricity generated,
becomes an exceptionally convenient recourse due
to not only its large remaining potential but also its
remarkable advantages with respect to costs and
technology over other sources of renewable
energy.

The next section will stress the benefits of

Source: IEA Implementing
Agreement. (1999). Hydropower hydropower as a reliable, clean source of
A Key to Prosperity in the
electricity.
Growing World. (Internet)

2.3 Definition of hydropower

Hydropower is an energy that comes from the force of moving water. The water
cycle is part of the continuous natural cycle that fall and movement of water.

Energy from the sun evaporates water in the earths oceans and
rivers and draws it upward as water vapor. When the water vapor
reaches the cooler air in the atmosphere, it condenses and forms
clouds. The moisture eventually falls to the earth as rain or snow,
replenishing the water in the oceans and rivers. Gravity drives the
water, moving it from high ground to low ground. The force of
moving water can be extremely powerful.5

Water on the earth is continuously replenished by precipitation. Hydropower is

called a renewable energy source as long as the water cycle continues.

5
The National Energy Education Development Project. (2010). Hydropower. (Internet).
9 Renewable Energy Development Hydropower in Norway

Hydropower can be used to generate electric power. Also it can be used to create
mechanical motion that runs machines for a variety of needs. 6 Unlike many other
sources of energy, water cannot be depleted such as fossil fuels.

There are different types of naturally occurring kinds of water that can be used for
hydropower. The main occurrence is water that flows along a river, or down
waterfalls, which is used for generating power as the force comes from the water
flowing from a higher place to a lower place.7

Dams are mainly used to produce electricity. They are often built alongside other
types of power plants. They can be used to regulate the amount of water that flows
through them to produce different amounts of power. It is not too much necessary to
build a dam for every hydropower plant.

Brief History of Hydropower

For decades hydropower has been used in the world, Greeks used water wheels to
grind wheat into flour. In the early 1800s, American and European factories used the
water wheel to power machines.8

The water wheel is a simple machine which is located below a source of flowing
water. It captures the water in buckets attached to the wheel and the weight of the
water causes the wheel to turn. Water wheels convert the potential energy of the
water into motion. That energy can then be used to grind grain, drive sawmill or
pump water.

In the late 19th century, the force of falling water was used to generate electricity.
The first hydroelectric power plant was built at Niagara Falls in 1879. In the
following decades, many more hydroelectric plants were built.9

Plants were burning coal and oil for many years. It made electricity more cheaply
than hydropower plants.10 After the oil shocks in the 1970s, people showed a
renewed interest in hydropower.

6
Ibid
7
Ibid
8
Ibid
9
Ibid
10
Ibid
10 Renewable Energy Development Hydropower in Norway

2.4 Technical aspects of hydropower

Damming rivers to store water in reservoirs is the most common method of

generating hydroelectric power. The flow turns turbines, which can generate
electricity.

Water is collected and stored into the dams above the power station for using when it
is required. Some dams create a big lake behind the dam wall. Other dams simply
block the river and divert the water through pipelines down to the power station.
Flowing water gives up some of its energy to run the turbine, which is then
discharged through drainage pipes or channels and it is called the tailrace.

Small hydropower often simply uses canals or streams to produce enough electricity,
for example lighting and running the appliances of individual households.

2.5 Advantages and disadvantages of hydroelectric power

Hydropower electricity generation offers several advantages compared with the other
energy sources that are renewable. The use of water to generate electricity is
considered a renewable energy source and hydropower energy will be available as
long as there is water flow.11 Therefore, hydropower energy generation is not
dependent upon the price of uranium, oil, or other types of fuel. This makes
electricity costs lower and more stable. This is one of the most significant advantages
of hydropower plants. Moreover, working with many employees is not required for
hydroelectric stations. This is one of the other advantages which help keep the cost of
hydroelectricity low.

When in use, electricity produced by dam systems does not produce greenhouse
gases. They do not pollute the atmosphere like power plants that burn fossil fuels
such as coal, oil or natural gas.

Hydropower is a domestic source of energy, produced locally near where it is

needed. Furthermore, hydroelectric power stations can be set up in almost any size,
depending upon the river or stream used to operate them and these stations can
operate for many years after they are built.

11
Vermont Energy Partnership. (2007). A Resource Guide to In-State Hydropower Production.
(Internet).
11 Renewable Energy Development Hydropower in Norway

Hydropower is also a flexible source of energy. The sluice gates can be shut,
stopping electricity generation if electricity is not needed. The water can be saved for
being used at another point in time when electricity demand is high. That means that
energy can be stored until it is needed.12 This way, hydropower is generally available
as needed and engineers can control the flow of water through the turbines to
produce electricity on demand.

Nevertheless, it also carries some disadvantages that have to be taken into account
when building a new hydropower station. Dams must be built at high standards;
therefore building a new dam could be greatly expensive. Therefore, they must be
operated for many years to become profitable because of the high cost of
construction.13

Sometimes hydropower stations can cause serious problems between neighboring

countries or localities. Dams built blocking the progress of a river in one country
usually means that the water supply from the same river in the following country is
out of their control.14 Additionally, in the case of flood, people who live in the
villages and towns near the plants must move out. This means that they lose their
farms and businesses.15

As stated before, hydropower is an energy that makes it possible to produce

electricity without using fossil fuels. Thus, it does not produce emissions such as
those caused by electricity production in coal, oil, or gas fired power plants.
However, generating hydropower energy causes some environmental consequences
in some cases. Damming areas with rich biodiversity of flora also risks a negative
effect on the climate because of large amounts of carbon, thereby leading to a high
concentration of methane.16

Hydropower often entails changes to the natural variations in the water in a

watercourse. For instance, dams may cause changes to the level and flow of water,
affecting fish population. This means that hydropower has also an effect on
biodiversity.
12
Ibid
13
Wordpress. (2008, November 17). Nuclear Energy based power plants Discussions on future
dependability for production of cleaner power. (Internet).
14
Ibid
15
Ibid
16
RenewableEnergy.no. (n.d.) Environmental Impact of hydropower. (Internet).
12 Renewable Energy Development Hydropower in Norway

3. Hydropower in Norway

As it has been exposed earlier in this paper, electricity generation from hydropower
makes a significant contribution to meeting the worlds growing demand for
electricity. Countries all over the world make use of hydropower, yet capacity and
utilization vary considerably among different countries. While some nations
demonstrate a share of hydropower equivalent to 99% of total electricity generation,
others have no hydroelectric power production at all or it represents only a negligible
share. These variations in countries reflect not only geographic and climatic
constraints but also policies in operation and, surely, money.

Figure 3-1: Leading hydropower producing countries in 2007

Source: Norwegian Water Resources and Energy Directorate. (2009). Energy in Norway. (Internet)

Figure 3-1 shows the worlds largest hydropower generating countries. In the last
decade, China has developed its hydroelectric facilities massively, becoming the
leader in hydroelectricity generation with 485 TWh in 2007. Brazil and Canada
follow the ranking with 374 TWh and 369 TWh, respectively.

It is worth pointing out the position of Norway as the sixth largest hydroelectric
power producer. Recalling from section 2.2, Europes hydropower potential has been
already exploited to more than 60%. Nevertheless, hydroelectric power generation by
European countries appears to be inferior when compared to other countries where
potential has been developed to a lesser extent. This can be indeed attributed to the
specific regions water resources and capacity, and thus, the importance of Norways
hydropower strength within Europe becomes evident.
13 Renewable Energy Development Hydropower in Norway

3.1 Norwegian water resources and hydropower

Norwegian watercourses have exceptional commercial importance for electricity

generation. Norway has been a major producer of hydroelectric power for more than
a century. The country possesses natural resources and a geography that enables to
build environment-friendly hydroelectric stations. In fact, close to 50% of the
European reservoir capacity is located in Norway. 17

Norway counts about 4,000 river systems, each of which comprises a river and all its
streams, lakes, snowfields and glaciers. A typical hydropower station in Norway is
characterized by a reservoir located in an elevated mountain area which, in turn,
benefits from a glacier as second level storage resource. Figure 3-2 exhibits the
largest hydropower stations in Norway in 2008; Kvilldal, Sima and Tonstad being
the most important ones with an average annual production of 3,517 Gigawatt hours
(GWh), 3,441 GWh, and 4,196 GWh, respectively.

Figure 3-2: The largest hydropower stations in Norway in 2008

Source: Norwegian Water Resources and Energy Directorate. (2009). Energy in Norway. (Internet)

Today, Norways installed hydropower capacity amounts to 30,000 Megawatt (MW)

and annual hydropower production averages 125 TWh. Hydropower currently
represents some 96% of the Norwegian electricity production, compared to 11% in
the European Union. In this regard, a share of 60% in Norways total energy

17
Statkraft. (2009). Hydropower in brief. (Internet).
14 Renewable Energy Development Hydropower in Norway

consumption stems from renewable energy, which is by far larger than the European
Unions target of 20% by 2020.18

3.2 Norwegian hydropower potential

Primary energy demand is expected to increase in the following years, not only in
developing countries but also in industrialized nations. This increase in energy
demand poses a challenge for modern society in view of climate change and global
warming. New renewable power is therefore important to reduce the worlds
greenhouse gas emissions.

At present, Norwegian power generation produces virtually no carbon dioxide (CO2)

emissions, and thus, it can contribute to the reduction of greenhouse gases and create
added value for Norway. Still, an active approach is required or otherwise, growing
domestic demand will lead to an increase in CO2 emissions. Within this context, the
need for increased water-storage capacity in Norway is now more imperative than
ever. In a speech held by State Secretary Sigrid Hjrnegrd at the 6th International
Conference on Hydropower in February 2010, he declared:

Some think that developing hydropower here in Norway, is history.

That is wrong! We will both develop new median size projects and
upgrade existing plants to secure more renewable and clean
electricity supply. There is also a huge interest in developing small
hydro projects below 10 MW.

Estimations by Norwegian authorities indicate that the available potential in the

country is about 205 TWh, out of which around 45.5 TWh are located in protected
areas. 121.8 TWh have already been developed, leading to a remaining potential for
development of 37.7 TWh.19 As can be seen from Figure 3-3, new projects with a
capacity of 1.3 TWh are currently under construction. In the same manner, licenses
were granted for construction as well as refurbishment and upgrade projects which
correspond to increased generating capacity of about 1.8 TWh.

18
Hjrnegrd, Sigrid. (2010, February). Norwegian Policy on Renewable Energy. Opening address at
the 6th International Conference on Hydropower. (Internet).
19
Ministry of Petroleum and Energy, (2008). Fact 2008 Energy and Water Resources in Norway.
p.24. (Internet).
15 Renewable Energy Development Hydropower in Norway

Figure 3-3: Norways hydropower potential as of January 2008, TWh/year.

Source: Ministry of Petroleum and Energy. (2008). Fact 2008 Energy and Water Resources in
Norway. (Internet)

3.3 Norwegian expertise in the hydropower sector

As a result of Norways long hydropower history, the country has gained expertise
covering all stages of hydropower development, from planning and design to the
delivery and installation of technical equipment. More importantly, there has always
been a strong focus on achieving efficient, environment-friendly practices.
Norwegian authorities and power companies have developed expertise in monitoring
and managing hydropower resources, leading the national power market to become
an exemplary embodiment of operating efficiency.20

Demand for Norwegian expertise in hydropower operation and market development

is augmenting. Hydropower will play a crucial role in the output of energy in the
future, in which climate issues will require a substantially cleaner power production
and in which Norway will interact with the European power market ever more.
Norways hydropower expertise will be of great value internationally to educational
and research institutions, consultants, suppliers, and energy companies. Knowledge
transfer will most probably take place in fields such as operational and
environmental regulation of power generation, market-related and technical
coordination of production as well as the optimal usage of water resources to
enhance operational efficiency.

20
Ibid., p. 29.
16 Renewable Energy Development Hydropower in Norway

4. Economic Framework
4.1 Current hydropower market in Norway

Norway has the world's largest per capita hydropower production, and is the sixth
largest hydropower producer in the world and the largest hydropower producer in
Europe.21

In 2009, hydropower generation in Norway amounted to around 132.8 TWh and

electricity production declined about 6.9% compared to the previous year.
Norwegian electricity generation varies with the inflow conditions. Dry weather
conditions in 1996 and 2002 resulted in low production, and wet conditions in 2000
and 2005 resulted in high production. Low snow volumes in winter 2006 and the dry
summer in the same year caused low generation. A lot of rain and high inflow in
2008 led to high production. The hydropower generation was down again during the
first half of 2009 in Norway.22

Norwegian electricity consumption amounted to 123.8 TWh in 2009. This was a

reduction of 3.9% on the previous year. The reduction in the year 2009 was primarily
due to lower consumption in the power intensive industries in the same year. 23 From
April 2006, consumption was reduced for 12 months. From May 2007, consumption
rose until summer 2008. Since then, consumption has trended downwards. The main
reason for this is the financial crisis and the slowdown of the economic growth.

Around 50% of Norways electricity generation capacity is owned by local

authorities and county councils. Central government owns about 30%, and private
companies roughly 13%. Norways 10 largest generating companies have nearly
70% of the countrys total mean production, and about the same proportion of
installed capacity. 24

Statkraft, Statnett, Hafslund, BKK, Lyse, Agder, Skagerak, Eidsiva, and

Trnderenergi are the major players on the market. There are also a number of
smaller companies geographically spread around the country. Whereas large
companies naturally represent a major share of the market, the smaller parties tend to

21
Ministry of Petroleum and Energy. (2007, March 23). Norways Energy Profile. (Internet).
22
The Norwegian Energy Regulator. (2009). Annual Report 2009. (Internet).
23
Ibid, p.37
24
Ministry of Petroleum and Energy. (2007). Owners and organization in the power sector. (Internet).
17 Renewable Energy Development Hydropower in Norway

group into regional cooperation units in order to derive synergies in smaller

procurement projects.25 These companies are Kjpekraft Vest in Western Norway,
Trnderkraft, Buskerud, and Elinor in the north.

Similarly, there are a lot of grid companies in Norway. A grid company may own a
local, regional or central grid. 178 companies are engaged in grid management and
operations. Of these, 42 are solely grid operators and 136 companies are vertically
integrated in the sense that they are engaged in production and/or trading.
Municipalities and counties own most of the regional and distribution grids in
Norway. The authority to make decisions pursuant to the Energy Act has largely
been delegated to the Norwegian Water Resources and Energy Directorate (NVE),
which is subordinate to the Ministry of Petroleum and Energy. Because the grid is a
natural monopoly, consumers are obliged to buy grid services from the owner of the
local grid.26 The NVE is responsible for monitoring and regulating grid
management and operations.

4.1.1 Supply and demand in the Norwegian Electric Industry

There are a lot of players and consumers that actively participate in the Norwegian
electricity market. Therefore electricity supply is a highly competitive business in
Norway.

The prevalence of expensive deliveries makes the industry be preoccupied by general

reliability, quality, compatibility and complementarily of the sought solutions. A
wrong choice of either supplier or product can result in a range of problems, such as
reduced lifespan or a sudden electricity black-out in a given geographical area. As
such, the consequential cost can be much higher than initial investment costs.

Under the administrative regulation in the supply sector, pursuance of laws about
public procurement was introduced in 1994 and was then was revised in 2010. In the
same manner, the power supply is subject to governmental legislation, which
includes licensing, supervision, control and other regulations.

25
Dalane, Natalia. (2010). Supplier Cartels in the Norwegian electric utility business, How Buyers
Behavior Affects Competition. Norges Handelshyskole, Bergen.
26
IPA Energy Consulting. (2006). Review of EU Electricity Markets. (Internet).
18 Renewable Energy Development Hydropower in Norway

High shifting costs related to existing solutions, unavailability of substitutes in the

market, the importance of system reliability for the customer combined with well
established selling networks with sometimes exclusive access to sub-suppliers, all
this creates an imbalance in favor of the supplier. Moreover, should they try to
cooperate on pricing this would have a negative impact on the utilities industry and
lead to increased costs for the end consumers. In order to counterbalance this
imbalance, the government regulates the settings in which competition takes place.
On the one hand, suppliers are regulated through the Competition Law supervised by
the Norwegian competition authorities. On the other hand, buyers have to follow
clearly defined tendering procedures established under EU-regulations on public
procurement. Both sets of laws are relatively new and came into force within the last
two decades. The Competition Law was established in 1993 with last revisions in
2009.

The power market is often divided into two parts, the first one being wholesale
market and the second one being end-user market.

4.1.1.1 Wholesalers

The wholesale market consists of generators, suppliers, big industrial enterprises and
other large undertakings. Electricity is traded bilaterally between different market
players and in the markets organized by the Nordic power exchange, Nord Pool. 27
Currently, a number of company trade standard bilateral contracts, but growing
proportions of contracts are traded in Nord Pools markets.

For a power producer, the amount of electricity sold directly to clients at any time
need not correspond to the amount generated. Generators dispose the water in the
reservoirs on the basis of the spot price at any given time and future price
expectations to maximize the income. To ensure that output corresponds to sales
commitments, generators can buy and sell power in the market.28

4.1.1.2 End-users

The end user market is characterized by a division between its participants, namely
the suppliers, distributors and end-users. Anyone who buys electricity for his or her

27
Ministry of Petroleum and Energy. (2007). The power market. (Internet).
28
Ibid
19 Renewable Energy Development Hydropower in Norway

own consumption is an end-user. Normally, small end-users buy electricity from an

electricity supply company. In contrast, larger end-users often buy from the
wholesale market directly.29

The distribution companies operating as natural monopolies are subject to regulation.

On the other hand, supplier companies operate as the generators under free
competitive conditions. Therefore, the distribution companies have important
responsibilities.30

The total electricity invoice has several components such as electricity price,
transmission tariff, consumption tax, and value added tax (VAT). All end-users must
pay a transmission tariff to the connected local grid company and the consumption
tax is imposed on electricity that is consumed in Norway.31

4.1.2 Price determination

All generating companies supply electricity to the transmission or distribution

network. Supply and demand in the Nordic power market determines the electricity
price.

The Nordic countries power systems are connected, and the countries systems are
mutually dependant. The power price is determined based on generation,
transmission and consumption conditions in the Nordic electricity market. And the
price will vary over time. The power price also reflects possible congestions in
transmission capacity between the areas. But if there are no such congestions, the
price is equal in all areas of the Nordic region. Inflow to hydropower plants is of
great importance for the determination of the power price, since hydropower
represents such a large share of the Nordic power supply.

In Norway, consumption is slightly higher than the power production in years with
normal precipitation and temperature conditions. In years with low inflow, the need
for power imports is even higher. 32 Also temperature and weather conditions
influence demand in the Nordic region on short term, which also affects the power
prices. Especially periods with cold temperatures and high demand can result in

29
Ministry of Petroleum and Energy. (2007). The power market. (Internet).
30
The Norwegian Energy Regulator. (2009). Annual report 2009. (Internet).
31
Ministry of Petroleum and Energy. (2007). The power market. (Internet).
32
The Norwegian Energy Regulator. (2009). Annual report 2009. (Internet).
20 Renewable Energy Development Hydropower in Norway

higher power prices. All end-users are free to choose electricity supplier and contract
type. The most common contracts for households have prices that vary according to
market conditions.33

Figure 4-1: Electricity spot price in 2008 and 2009, weekly average. NOK/MWh.

Source: Nord Pool Spot. (2010). Nord Pool Spot. (Internet)

Between the start of 2009 and the end of September, the spot price decreased from
400 NOK/MWh to 200 NOK/MWh. Figure 4-1 shows variations in the spot price for
the years between 2008 and 2009.

Nord Pool's financial derivatives market covers the market for futures, forward and
option contracts. Futures and forward markets are financial markets for price hedging
and risk management. The system price in the spot market is the reference price for
future and forward contracts traded on the Nordic power exchange. Power
derivatives enable to hedge purchases and sales of power with a time horizon of
several years to market participants. Such products can be traded on the Nordic
power exchange.34

33
Ministry of Petroleum and Energy. (2007). The power market. (Internet).
34
The Norwegian Energy Regulator. (2009). Annual report 2009. (Internet).
21 Renewable Energy Development Hydropower in Norway

Figure 4-2: Electricity spot prices and forward prices in the financial market

Source: Nord Pool Spot. (2010). Nord Pool Spot. (Internet)

Nord Pool forward contract prices increased during the fourth quarter of 2009 and
also in the first and second quarter of 2010. At the beginning of the quarter, the
contract for the first quarter 2010 could be traded at 283 NOK/MWh , while the
contract for the second quarter was traded at 257 NOK/MWh. 35

4.2 Norways power exports

In 2008, Norways electricity exports were estimated to 17.29 billion kilowatt hour
(kWh).36 Historically, Norway has been a net exporter of power. However, this has
changed since the late 1990s as power consumption in Norway increased faster than
the production of hydroelectric power. As it was already described above,
precipitation influences the electricity output generated by hydropower.
Consequently a higher precipitation and a higher inflow to reservoirs lead to a net
export position of Norway, while imports exceed exports in dry years. Figure 4-3
shows the high fluctuations in Norways import and export position. Therefore, it is
important for Norway to reduce its dependency on precipitation and inflow as well as
the reserve capacity as insurance in dry years for its power generation. A stable

35
Ibid
36
Central Intelligence Agency. (n.d.). The World Factbook. (Internet).
22 Renewable Energy Development Hydropower in Norway

energy supply is guaranteed for Norway by trading as most of the countries trading
electricity with Norway base their power production on thermal energy sources such
as coal, oil, gas and nuclear energy. At the same time, the high price fluctuations in
the Norwegian energy supply system are softened by trade.

Figure 4-3: Norways Power Imports and Exports, 1970 - 2007

Source: Norwegian Ministry of Petroleum and Energy. (2008). The electricity market. (Internet)

The power exchange between countries is determined by the following factors:

Ways of generation and consumption patterns

Maximum capacity of interconnectors
Conditions of accessing and using power from interconnectors
Benefits from differences in national generating systems for all countries
involved

Norway is trading electricity with the following countries: Russia, the Netherlands,
Sweden, Denmark and Finland. The trading connection to Russia is limited to
electricity imports to Norway and is currently very small. To increase electricity
trade between Norway and the Netherlands, Statnett in Norway and the Dutch
transmission system operator (TSO) TenneT invested in a subsea cable with a
capacity of 700 MW. Sweden, Denmark, Finland and Norway are forming together
the Nordic Power Pool which will be explained in detail in chapter 4.3. The
transmission capacity between Norway and Finland is again regarded as relatively
small. The highest trading capacity of Norway is towards Sweden, where Norway is
exporting approximately 3,450 MW while the imports from Sweden to Norway are
smaller. The transmission between Norway and Denmark amounts to 1,000 MW.
23 Renewable Energy Development Hydropower in Norway

The difference in the transmission capacities into and out of the country lies within
different forms of generation and demanded amount for consumption.37

The total Nordic region has interconnectors for trade with Germany, Estonia, Russia
and Poland. The way Norway profits from trading through stable prices and stable
supply, so do its trading partners from Norway in the same aspects. As it is not easy
to adjust the production in thermal power to the current demand and an enlargement
of existing power plants is very expensive, Norwegian power supply can overwhelm
these short cuts.38

By participating in international agreements such as the European Economic Area

Agreement, EEA, for a common energy policy as well as the development of the
energy market and renewable energies, Norway prepares the way for further trading
and integration on an international basis.39

Companies licensed to export power

Currently, two Norwegian companies hold a license which allows them to trade
power with other countries. These two companies are Statnett SF and Nord Pool Spot
AS.40

The TSOs of the Nordic region, which are Statnett SF in Norway, Affrsverket
Svenska Kraftnt in Sweden and Fingrid in Finland, own the Nord Pool Spot AS.
The Norwegian and Swedish companies own 30% each, while Finland and the
Danish company Energinet.dk possess 20% of Nord Pool Spot AS each.41 This
company is the marketplace for physical power contracts in the Nordic Pool Group
which will be explained in detail in chapter 4.3. In the year 2007, approximately 70%
of the total electricity consumption in the Nordic countries was traded through Nord
Pool Spot AS, which is in fact a monopoly company. This monopoly arises as the
delivery of power is limited to the ability and capacity of transmission of the cables
and grids.42 The company was established in 2002 with the aim to create a market
place for spot trade in electrical energy as well as offering services with regard to this

37
Norwegian Ministry of Petroleum and Energy. (2008). Appendix. Facts 2008: Energy and Water
Resources in Norway. p. 12. (Internet).
38
Norwegian Ministry of Petroleum and Energy. (2008). The electricity market. (Internet).
39
Norwegian Ministry of Petroleum and Energy. (2008). International Cooperation. (Internet).
40
Norwegian Ministry of Petroleum and Energy. (2008). The Legal Framework. p. 10. (Internet).
41
Nord Pool Spot AS. (Internet).
42
Norwegian Ministry of Petroleum and Energy. (2008). The electricity market. (Internet).
24 Renewable Energy Development Hydropower in Norway

topic. The goal is to create a transparent market with an optimized use of grid
capacities, reduced price differences and a product mix for customers. Nord Pool
Spot ASs vision is to become the leading physical energy exchange in Europe. 43

Statnett SF became an independent state owned company in 1992 when the

administration company Statkraftverkene was split into Statnett SF, responsible for
the grids, and Statkraft SF, responsible for the power plants. 44 Statnett SF has three
main functions: it is the main grid owner, the main grid operator and the main grid
regulator in Norway. As the main grid owner, Statnett is not generating electricity
itself but is responsible for the high voltage electricity transmission and distribution
in Norway. By leasing transmission facilities to the main grid commercial agreement,
MGCA, most of the revenues are earned. It is Statnetts task as Norways TSO to
ensure the balance between supply and demand, the electric power exchange with
other nations and the operation of Norways electric power system.45

Three levels of electricity grids can be distinguished: the main grid, the regional grid
and the distribution grid. Statnett owns and manages the main grid and is as main
grid operator responsible for the development of the infrastructure. Therefore it
developed an annually updated grid development plan with a 10-year time
perspective. Within this plan, the grids are adapted according to the demand based on
an analysis of the changing environment, for example industrial developments or the
building of new international cable connections.46

Finally, Statnetts task as main grid regulator is to guarantee a constant balance

between supply and demand in real time. It ensures an optimal use of the grid with a
reliable supply as well as routine disconnections for maintenance purpose and
temporary restrictions.47

4.3 The Nordic Power Exchange Nord Pool Spot

As a result of power market deregulation, a common Nordic market for electrical

energy has emerged. Norway, through its Energy Act of 1990, was the first Nordic
country to liberalize its power market. Sweden, Finland and Denmark eventually

43
Nord Pool Spot AS. (Internet).
44
Statnett SF. (Internet).
45
Ibid
46
Ibid
47
Ibid
25 Renewable Energy Development Hydropower in Norway

followed suit, laying the groundwork for an integrated market for electricity trading.
Nowadays, Nord Pool Spot represents the largest market for electricity worldwide:
317 companies from 20 countries trade on the exchange.

In 2008, electricity production in the Nordic countries amounted to 397.5 TWh.

Power production differs considerably among countries. Figure 4-4 displays the
various energy sources in the Nordic region in 2008. While Sweden and Finland use
a combination of different sources, it is clear that Norway relies heavily on
hydropower and Denmark mainly utilizes conventional thermal power.

Figure 4-4: Production split in Nordic countries in 2008

Source: Own creation based on Nordel annual statistics 2008.

Nord Pool Spot serves as a marketplace to producers, energy companies, and large
consumers, on which electricity can be bought or sold. This marketplace
accomplishes the key function of balancing supply and demand, which is particularly
critical in the power market due to the inability to store electricity and the high costs
associated with any supply failure.48 On Nord Pool Spot, the electricity spot price is
set hourly. The spot price provides a reference price for the Nordic bilateral
wholesale markets as well as end consumer prices.

4.3.1 The physical market

Physical power contracts are traded at Elspot for physical delivery the next day. As
in every other market, the price is determined by establishing the equilibrium
between bids and offers made by market participants. The spot market price provides

48
Hjalmarson, Lennart. (n.d.). Price Formation at Nord Pool Spot. (Internet).
26 Renewable Energy Development Hydropower in Norway

the basis for the TSOs, which are responsible for both the security of supply and the
high-voltage grid.

Elspot differentiates between system and area prices (see Figure 4-5). The system
price reflects sales and purchases in the entire region without taking into account
transmission capacity between geographical areas. On the other hand, area prices
may arise because of possible bottlenecks in the transmission network, meaning that
areas with a deficit of power have a higher price than the system price. In the absence
of bottlenecks, area prices equal the system price. The difference between area and
system prices is called the capacity fee. This fee represents an income for the TSOs,
namely the congestion income, and thus, it contributes to tariff-reduction for network
users.

Figure 4-5: Elspot system and area prices as of 13.11.10

Source: Nord Pool Spot. (2010). Nord Pool Spot. (Internet)

Once the day-ahead market (Elspot) is closed, trading can take place up to one hour
prior to delivery on Elbas, the intra-day market. In addition to the Nordic countries,
Elbas covers Germany and Estonia. Elbas offers the possibility to adjust imbalances
that an energy company may face after Elspot trading has finished.
27 Renewable Energy Development Hydropower in Norway

Figure 4-6: Power exchange in the Nordic

region in 2008, GWh.
Power exchange between countries
depends on local production and
consumption patterns, in addition to
the interconnectors capacity and the
conditions for their use. Through
power trading, countries can obtain
reciprocal benefit from variations in
national generating systems. Figure
4-6 illustrates the flow of power
between Nordic countries in 2008.
Norways power exchanges were
primarily with Sweden.
Source: Nordel annual statistics 2008.

4.3.2 The financial market

Trading in derivative contracts is also possible at Nord Pool Spot. The financial
market uses various financial instruments that are intended for risk management and
price hedging; a physical delivery of power does not take place. The most common
instruments include futures contracts, forward contracts, options contracts, and
contracts for differences (CfDs).

4.4 Investing for the future

According to the Energy Information Administration, Norway had resources of oil

on January 1, 2009 of 6.68 billion barrels and 81.68 trillion cubic feet of natural
gas.49 Even though Norway has the greatest reserves within Europe, these resources
are limited while energy consumption is growing steadily. Therefore, effort has to be
put in further development and investment of renewable unlimited energies such as
hydropower.

To ensure a steady and innovative development of future energy generation and

consumption, Norway developed a plan called Energi21. This strategy aims at

49
Energy Information Administration. (2009). (Internet).
28 Renewable Energy Development Hydropower in Norway

increasing value creation by investing in research and development (R&D) and new
technology50. The stationary production of energy as well as its distribution and use
is covered within this strategy. Additionally to a focus on basic and applied R&D,
training of specialists and development and demonstration of new technologies, the
following priority areas have been determined:

Development of good framework conditions for research and innovation in

the field of energy and business as well as industry policy.
Creation of a flexible energy system including the infrastructure and
transmission grids.
Encouraging CO2-neutral heating from bioresources and heat pumps.
Further development of climate-friendly power from wind, water and the sun.
Promoting efficient energy use in buildings, households and the industry. 51

The ministry of Petroleum and Energy demanded a review of the original strategy to
form a more concrete target. This revised version is expected to be published in
2011, leading to the vision Norway: Europes leading energy and environment-
conscious nation from a national energy balance to green energy exports52. Within
this review of the original strategy, the hydropower industry has developed four
industry-related objectives as follows:

Figure 4-7: Industry-related objectives, Energi21, sub-group hydropower

Industry-related objective 1: Industry-related objective 2: Industry-related objective 3:
Develop short and long-term Construct new hydropower Maintenance, conversion,
balance power production for capacity to boost energy modernisation and expansion
Europe and a competitive production in Norway and of existing hydropower
industry to serve this market. internationally. systems.
Industry-related objective 4:
Develop and further refine expertise within all areas of the hydropower segment.

Source: Energi21. (2010). (Internet)

The target of the EU countries and Norway is to increase the production of

renewable energy by 2020. One objective to reach this goal was stated by the

50
Norwegian Ministry of Petroleum and Energy. (2008). Appendix. Facts 2008: Energy and Water
Resources in Norway. p. 4. (Internet).
51
Ibid.
52
Energi21. (2010). (Internet).
29 Renewable Energy Development Hydropower in Norway

hydropower industry in Norway by demanding an enlargement of hydropower

capacity.

4.5 Barriers to newcomers in the Norwegian hydropower market

Markets with many players usually have low barriers for entry. As soon as the
existing companies set prices to a certain level via coordinated price setting
practices,53 newcomers are attracted. Therefore the existence of barriers to entry is
an important condition for the investors.

Entry into power production is severely restricted in Norway. New generation

facilities signify large investments that require high prices to be profitable. Such
investments are strictly regulated through concession laws. Therefore, current
Norwegian hydropower projects are generally small and some of them disputed. But
only actors with already established power plants can expand these plants.54 The
incentives for established actors to invest in new production capacity will be reduced
if they possess market power.

The current concession law discourages to entry into hydro generation through
acquisition of existing capacity. The provisions oblige private undertakings to
return acquired waterfalls to the State after a period of 60 years. These provisions do
not apply to state or municipal companies.55

Limited amount of producers accounts for the high level of concentration in the
selling industry. The production is characterized by high fixed costs which translate
into high barriers to entry.

The industry-specific products have no substitutes for buyers. Coupled with the fact
that all existing solutions have been delivered by the same suppliers, it makes the
demand both predictable and very inelastic, despite of either positive or negative
decisions regarding investments into new procurement projects, service, maintenance
and replacement on the existing plants have to be carried out no matter what.56

53
Danish Competition and Consumer Authority. (2003). The Nordic Electricity Sector. (Internet).
54
Ibid
55
Ibid
56
IEA ETSAP Technology Brief. (2010, May). Hydropower. (Internet).
30 Renewable Energy Development Hydropower in Norway

Presence of large customers who might tolerate higher input prices in the industry is
at place. That means that buyers themselves strengthen entry barriers by creating
market limitations. In other words, it could be difficult for new players to come in
and provide more competition. This way, the current suppliers would be given an
opportunity to have a technology-based artificial monopoly on their products with
related services, a monopoly that differs from the conditions in which the buyers
themselves as a legal monopoly have to operate.57 The main distinction of
monopolies in private markets is not regulated by the government. And that means
competitors can demand whatever prices they want.

57
Ibid
31 Renewable Energy Development Hydropower in Norway

5. Legal Framework

5.1 The Ministry of Petroleum and Energy

The principal responsibility of the Ministry of Petroleum and Energy is to achieve a

coordinated and integrated energy policy.58

The Ministry of Petroleum and Energy is responsible for the energy policy and
legislation in Norway, supported by its associated organizations Enova SF, the
Norwegian Petroleum Directorate and the Norwegian Water Resources and Energy
Directorate. While the Norwegian Petroleum Directorate and the Norwegian Water
Resources and Energy Directorate are departments of the Ministry, Enova SF is a
public enterprise owned by the Ministry. Its contribution to the Ministrys tasks is to
stimulate market actors and mechanisms to achieve national energy policy goals 59
by financial instruments and incentives.

The Norwegian Petroleum Directorate aims at a responsible management of the

resources oil and gas and creating with that the greatest value for the society. As our
focus lies on hydropower, the Norwegian Water Resources and Energy Directorate is
the responsible department. Therefore its aims and tasks will be explained separately
in the next chapter.

To sum up, the topics the Ministry of Petroleum and Energy is covering are carbon
capture and storage, power and consumers, energy and petroleum research, state
participation in the petroleum sector, energy in Norway, oil and gas as well as water
resources.60

5.2 The Norwegian Water Resources and Energy Directorate

The Norwegian Water Resources and Energy Directorate was founded in 1921 as a
department of the Ministry of Petroleum and Energy. The NVE aims at ensuring an
integrated and environmentally sound management of the countrys water
resources61. This includes not only the national flood contingency planning and the
maintenance of national power supplies, but also the promotion of efficient energy

58
Norwegian Ministry of Petroleum and Energy. (n.d.). (Internet).
59
Norwegian Ministry of Petroleum and Energy. (n.d.). Enova SF. (Internet).
60
Norwegian Ministry of Petroleum and Energy. (n.d.). Subjects. (Internet).
61
Norwegian Water Resources and Energy Directorate. (n.d.). (Internet).
32 Renewable Energy Development Hydropower in Norway

markets, cost-effective energy systems and efficient energy use. As national center
62
of expertise for hydrology in Norway , the NVE is also doing research on the
respective topics.

The head office of the NVE is located in Oslo with departments in five regions to
cover the West, the East, the North, the South and the central regions of Norway.

Figure 5-1: Organizational Chart NVE

Source: Norwegian Water Resources and Energy Directorate. (2010). NVE Organisation. (Internet)

Additional to its tasks in its home country, the NVE transfers its knowledge and
expertise to support other countries. This refers mainly to developing countries as
water and energy are seen as fundamental factors in the struggle to combat poverty,
improve health conditions, and increase prosperity 63.

This international engagement is no single work but a cooperation of the Norwegian

Agency for Development Cooperation (Norad), the Ministry of Foreign Affairs
(MFA) and the NVE64. While the other two involved parties determine the country of
engagement and suggest possible projects to the NVE, the tasks of the NVE vary

62
Ibid.
63
Ibid.
64
Norwegian Water Resources and Energy Directorate. (2009). Annual Report 2009. (Internet).
33 Renewable Energy Development Hydropower in Norway

from identifying specific water and energy projects, analyzing and evaluating reports
as well as managing and monitoring new projects.

Anyone who wants to undertake a project related to the energy sector needs to apply
for a license at the NVE. The NVE weighs up the impacts on the environment and
surrounding society against the use and necessity of the construction. The detailed
process will be described in the next chapter. All in all, the NVE possesses the
65
legislative power to issue regulations and to grant licenses following these
regulations.

5.3 Legislative and political framework

As the aim of the NVE and the Ministry of Petroleum and Energy is to ensure an
efficient and adequate use of Norways water resources, they created a legal
framework. The following figure gives an overview of the respective acts and
regulations which are applied when exploiting water as an energy source.

Figure 5-2: Legislation governing licensing in the hydropower sector

Source: Norwegian Ministry of Petroleum and Energy. (2008). The Legal Framework. (Internet)

5.3.1 The licensing process

Before someone is allowed to build a new power plant, he or she has to apply for a
licence at the licensing authorities. These licensing authorities are the NVE, the
Ministry of Petroleum and Energy, the Government and the Storting, the Norwegian
Parliament. It is their task to examine possible conflicts between the environment and
65
Norwegian Ministry of Petroleum and Energy. (2007). Rules. (Internet).
34 Renewable Energy Development Hydropower in Norway

the different interests groups involved. Underlying this examination process is a

framework of laws and regulations, containing the protection plans for water
resources, the Master Plan for Water Resources, the Industrial Licensing Act, the
Watercourse Regulation Act and the Water Resources Act 66.

After the applicant has gotten an approval according to the Master Plan for Water
Resources, this notification is sent to the NVE to open the public examination of the
application. Within this public examination, the authorities involved decide together
with the NVE, if an environmental impact assessment (EIA) is demanded. The
Regulations on Environmental Impact Assessment determine that an EIA is needed
67
for all power stations larger than 40 GWh . In case the authorities are highly
concerned about the impacts on the environment, the nature and local community,
the EIA can also be required from 30 GWh on. Independently from the GWh, the
applicant has to describe in detail the consequences of the project following the
Planning and Building Act.

In the next step, the project is discussed by government authorities, landowners and
other organisations affected. Basis for the discussion is the EIA together with the
licence application. At the end of this discussion, the NVE sends an overall
evaluation to the Ministry of Petroleum and Energy. Based on all available
information about the project, the Ministry gives a separate recommendation which
then goes to the Government for preparing the final decision in form of a royal
decree. In case of a major or controversial project, the Storting is involved in the
process, too, so that it has an opportunity to debate the matter before a licence is
68
formally granted by the King in Council . The following figure provides an
overview of the whole licensing process.

66
Norwegian Ministry of Petroleum and Energy. (2008). The Legal Framework. p. 3. (Internet).
67
Ibid., p. 3
68
Ibid., p. 4
35 Renewable Energy Development Hydropower in Norway

Figure 5-3: Licensing process (more than 40 GWh / year)

Source: Norwegian Ministry of Petroleum and Energy. (2008). The Legal Framework. (Internet)

The process for smaller plants with a yearly capacity of less than 10 MW is simpler.
Additionally, the NVE having the authority of licensing according to the Water
Resource Act has fastened the process, too.

5.3.2 Protection plans and the Master Plan of Water Resources

The Protection Plan for Watercourses protects many watercourses legally against an
extensive exploitation. These plans prevent authorities from licensing regulation or
development of certain watercourses for the purpose of hydropower generation 69.
All in all, a potential of 45.5 TWh per year of hydropower have been protected.

As the Protection Plans are binding for all mentioned watercourses without
exceptions, the Government developed the Master Plan of Water Resources. It is a
bunch of recommendations to the Storting to evaluate certain projects individually.
Therefore, the projects are split into two categories, the one determining the project
70
as it can be considered for licensing immediately and the other for possible
licensing in the future. All projects of the second category as well as projects not
included in the Master Plan will not be licensed at the moment.

69
Ibid., p. 5
70
Ibid., p. 5
36 Renewable Energy Development Hydropower in Norway

While the protection plans base on for example preserving river systems or possible
outdoor recreation areas, the Master Plan is founded on economic aspects as well as
the degree of conflict with other interests. Generally, the recommendation is to
implement projects with the lowest impacts and the cheapest power gain first. The
notification of the Master Plan is only the first step to take for the final license.

Today, the Master Plan faces two major problems. First of all, all projects with a
capacity of less than 10 MW per year are excluded from the Master Plan and
therefore are not proven. As most of the major developments have already been
carried out71 future projects might easily avoid a categorization by the Master Plan.
The second problem is that there have been several changes and developments in
technology which affects the impact on the environment as well as financial aspects.
Judging these projects according to the Master Plan established in 1993 does not
seem appropriate. Consequently, an adjustment by the Government is already in
progress.

5.3.3 The Industrial Licensing Act

In case the applicant wants the ownership of a waterfall to implement a hydropower

plant there, he will be licensed according to the Industrial Licensing Act. Exceptions
are the State as well as small waterfalls with less than 2,944 kW.

The major regulations of the Industrial Licensing Act are the pre-emption rights, the
right of reversion to the State and the licences of limited duration. The pre-emption
right says that the State is allowed to take over an agreement instead of a purchaser
without changes in the rights and obligations. With the right of reversion, the State
can get possession of a waterfall and any hydropower installation free of charge
when a licence expires72.

The Industrial Licensing Act has been adjusted to avoid a further violation of the
EEA Agreement. The EEA Agreement makes sure, that hydropower resources
belong to the general public and therefore need to be managed in the publics
interest. Consequently, the ownership structure must be based on that of public
ownership on the central, county and municipal level.

71
Ibid., p. 5
72
Ibid., p. 6
37 Renewable Energy Development Hydropower in Norway

The changes undertaken to fit the EEA Agreement were the following:

New licences for the ownership of waterfalls are only granted to public-sector
owner.
The right of reversion is only possible for public-sector operators.
Private entities have no right to renew their licences in a sale-back or lease
after the reversion right has been exercised.
Private entities cannot buy more than one-third of publicly owned waterfalls
or power plants.

Untouched by the changes, private owners are still allowed to own up to one-third of
public-sector companies. When current licences expire, they are still reverted to the
state. Private owners may then sell their power plants to a public-sector owner or
merge with it. In case of a merger, the private stake may not exceed one-third. All the
changes entered into force on September 25, 2008.

Obligatory according to the Industrial Licensing Act is the payment of a licence fee
as well as a sale of 10% of the power generated to the municipalities within the area
of the waterfall. Further conditions may be considered depending on the impact on
the environment and the local communities.

5.3.4 The Watercourse Regulation Act

It is economically necessary to be able to regulate the output of a power plant

according to the current need. Therefore, it should be possible to store the water in a
regulation reservoir. The authority to use water from a regulation reservoir is not
included in the ownership of a waterfall but is determined separately by the
Watercourse Regulation Act.

The measures of the Watercourse Regulation Act are meant to balance fluctuations in
the water flow during the year. For that, it works with similar conditions as the
Industrial Licensing Act. Additionally, the act allows the authorities to demand a
compensation for a damage caused by the regulation, for example a fish fund for
damages in the fish stocks.
38 Renewable Energy Development Hydropower in Norway

The rules fix not only the highest and lowest water levels in the reservoir, but also
the minimum rate of flow of the watercourse as well as the permitted volume that
may be released in the different times over the year.

The NVE decides whether the regulations for the specific plant are revised after 30
or 50 years to adjust to changes or unforeseen damages in the environment.

Included in the Watercourse Regulation Act is again an obligatory sale of the

generated power as well as an annual licence fee to the central government and the
municipal authorities. Basis for the calculation is the additional electricity won by the
regulation. Furthermore, the plant contributes to a business development fund. The
aim of this fund is that the municipality profits of the economic benefits of the
hydropower station and has the means to reduce damages and other adverse effects.

5.3.5 The Water Resources Act

The Water Resources Act gives regulations to compensate for and mitigate the
adverse impacts of developments in river systems 73. Even though it is considered
better to have a licence following the Water Resources Act, small power stations are
not obliged to undertake the process.

The Water Resources Act is valid for any kind of works in a watercourse and all
measures that are needed to exploit the hydropower potential.

Again the aim of the act is to make sure that the benefits gained through the plant
outweigh the caused damage or inconvenience to the surrounding. The river systems
as well as the groundwater shall be used and managed in the interests of the whole
society.

5.3.6 The Energy Act

Norway was the first country to allow its customers to choose their power supplier
freely. This was able through the Energy Act, the organizational framework of
Norways power supply system. The Energy Act includes regulations of:

Construction and operation of electrical installations

District heating systems

73
Ibid., p. 7
39 Renewable Energy Development Hydropower in Norway

Electricity trading
Control of monopoly operations
Foreign trade in power
Metering
Settlements and invoicing
Physical market for trade in power
System coordination
Rationing
Electricity supply quality
Energy planning and contingency planning for power supplies

It lies within the authority of the Ministry of Petroleum and Energy to issue
electricity export and import permits. All other licences are granted by the NVE
directly, in contrast to the licensing process according to the Water Resource act, for
example.

Within the local area licence, distribution companies are obliged to supply electricity
to the communities in the area covered by the licence. The licence is demanded for
the construction of installations of electricity distribution and lines carrying less or
equal 22 kV.

All installations, lines and plants with a higher voltage are licensed following the
construction and operating licence. This licence guarantees standards in the
construction and operation of electrical installations. Due to a higher impact on the
environment and the landscape of high-tension transmission lines and transformers, a
contribution to rational energy supplies, regulations to avoid or limit damage to the
environment and utilisation of capacity at each plant is determined, for example. To
ensure that most of the possible impacts are known in advance, the applicants have to
present long-term plans of their projects to the responsible authorities.

All companies except from the State need a trading licence when they are trading
electricity. This is obligatory for pure trading companies as well as companies
transmitting power through their own grids to end-users and companies with
distribution or transmission grids. With the regulation of prices for electricity
transmission which may not exceed what is required over time to cover grid
40 Renewable Energy Development Hydropower in Norway

investment and operating costs plus a reasonable return on investment 74, fair prices
in the customers interests are ensured.

With the market place licence, authorities gain the possibility to fix certain
conditions and factors such as price-setting, transparency, neutral behaviour and non-
discrimination. This licence is required for the organisation and operation of
marketplaces for physical trading in electrical energy 75.

As the authority of electricity export and import permits is with the Ministry of
Petroleum and Energy, a licence has to be demanded there when trading power with
foreign countries. Within this licence a most secure and efficient power exchange
shall be guaranteed. Today, Statnett SF and Nord Pool Spot AS have this licence in
Norway.

The municipal authority is allowed to require plants in their area to connect to the
district heating system. Furthermore, all district heating plants with a higher output
than 10 MW have to be licensed.

All companies in the energy sector have the responsibility to ensure the sufficient
and high quality supply of electricity. Consequently, they have to make sure that the
generation and the consumption are in balance. The Energy Act demands an energy
report of all distribution companies which describes for example the current system,
the energy mix and the expected future demand. This yearly energy report shall
contribute to an efficient energy planning and therefore to the development of a
rational energy supply system.

To ensure a sufficient power supply in case of a state of emergency or in the event of

war, contingency measures are implemented by the authorities.

5.3.7 Further Legislation

The environmental assessment EIA, described in the licensing process, is part of the
Planning and Building Act and obligatory for projects in the energy and water sector.

As an extension to the Energy Act, the new Competition Act of 2004 also regulates
competition in the power market. Dominant market positions often appear in the

74
Ibid., p. 8
75
Ibid., p. 9
41 Renewable Energy Development Hydropower in Norway

energy sector due to natural monopolies. A misuse of this is punished under the act.
Furthermore, an examination of mergers and acquisitions is compulsory.

The rights of the consumers are protected in the Consumer Purchase Act, which is
also valid for the energy sector. For example it is the right of the customer to demand
a price reduction or compensation in case the supplier does not deliver the good as
promised.

According to the Pollution Control Act, no one is allowed to pollute the environment
without a licence from the pollution control authorities. Hydropower stations have to
apply for a licence at the Ministry of Environment, too.
42 Renewable Energy Development Hydropower in Norway

6. Financial Framework
6.1 Small vs. Large Hydropower plants

Hydropower plants can be categorized into small and large schemes. Large
hydropower schemes capacity is over 10,000 kW and small hydropower schemes is
up to 10,000 kW according to EU definition. The definition of small hydropower
schemes also covers micro schemes with installed capacity of up to 100 kW. Figure
6-1 shows NVE definitions of small and large hydro plants in kW.

Figure 6-1: NVE definitions of small hydro plant in kW

Source: Energy policies of IEA Countries Norway (2005). International Energy Agency.

Norwegian energy production focused on large hydro plants after World War II. And
most of micro, mini and small hydropower plants closed down in these years.
Operating costs and inflexible electricity production from small plants were the main
reasons for this development.76 However, during the last decade there has been an
increased interest in hydropower projects with capacity less than 10,000 kW. Norway
is positive about developing small hydropower plants because they usually have a
smaller environmental impact and are used as a local energy resource. In the recent
years, the development of small scale hydropower production portfolios has proven
popular with the major domestic power producers in Norway. 77

Small hydropower generation plants have two to five years gestation period.
Conversely, large hydropower plants usually have a longer gestation period (about
seven years) than small hydropower plants. Additionally, small hydropower plants
give a higher return on investment due to the low capital investment and operational
costs.

76
International Energy Agency. (2005). Energy policies of IEA Countries Norway. (Internet).
77
Sandwick, Jarle Erick and Jon Rabben. (2009). New Opportunities in the Norwegian Renewable
Sector. Wikborg Rein, p.3. (Internet).
43 Renewable Energy Development Hydropower in Norway

Construction and commission due to simpler designs of small hydropower plants are
easier than those of large schemes. This helps to keep costs down. Small hydro
facilitates community participation and capitalizes on local skills for plant
construction. Small hydropower plants do not require things that are necessary for
constructing a large hydro plant such as rigorous surveys, investigations and designs.
In addition to the above, construction of small hydropower plants are more
environmentally friendly than larger plants as they do not disturb the local habitat.
Small hydropower installation does not involve the building of large dams and
reservoirs. Therefore deforestation, submergence and rehabilitation problems do not
occur.78 Furthermore, it does not require a large land area. Small hydro plants can be
constructed in areas with small streams of water and small to medium rivers.

Educating developers is an important aspect of the effort to improve small hydro

development in Norway. 79 The land and rivers ideal for small hydro development
usually are owned by small farmers. Also, larger energy firms have found small
hydro interesting for investment, and they are growing in number.

Development Capacity

Although the hydropower potential in Norway is large and the focus on renewable
energy is growing, only modest activities are expected. This will change as a result
of higher prices for renewable energy in the electricity market. 80

Norway is giving special attention to small hydro and focuses on this technology
through research and development and also by giving priority to the licensing
procedure.

The political parties continue to favor small hydropower development. The

government has decided that each county can develop its own master plan for small
hydro development.81 This plan will include identifying areas for the development
outside protected rivers and mapping out areas where conflict may exist with regard

78
AltEnergy eMagazine. (2010). Global Small Hydropower Market Analysis to 2020 Installed
Capacity, Generation, Investment Trends. (Internet).
79
Ray, Russell and Andrew Lee. (2010). A World of Opportunity. (Internet).
80
Norwegian Water Resources and Energy Directorate (NVE) and Ministry of Petroleum and Energy.
(2003). Norway Report. (Internet).
81
Ibid
44 Renewable Energy Development Hydropower in Norway

to development of small hydropower plants such as landscape, natural environment,

cultural monuments and outdoor life. This work began in 2007.

Small hydropower has a huge, as yet untapped potential, which could allow it to
make a significant contribution to future energy needs. There is a considerable scope
for improvement and optimization. Maintenance and refurbishment of existing plants
could contribute to the development of small hydro. 82

6.2 Key players

Several parties are involved in building up a new hydropower plant. Among the key
players are the developer of the project, the contractor, the sponsor, the lenders and
the investors.

The developer is one of the most important participants in the development of a

hydropower project. He ensures that all necessary permissions are acquired, that the
contracts with consultants, equipment suppliers and contractors are signed as well as
that all financial resources necessary for the project are available.

In such a project, there are many separate contracts to be signed for different
elements. To avoid losing the overview of the contracts and resulting obligations, a
turnkey contract is signed with a contractor who takes over the responsibility for all
contracts and their fulfilment.

The role of the sponsor is more important for large hydropower projects and loses its
importance for small hydropower projects. The sponsor is a government agency or
utility that is promoting the project.

The majority of the financial resources needed to install such a project are provided
by lenders such as banks or other investment institutions. Their contribution amounts
to 60 to 80% of the money needed.

The missing financial resources of 20 to 30% is provided as equity capital by

investors who get in return for the higher risk of providing equity capital an
anticipation on the profits, a strong influence on the project or other special benefits.

82
Ibid
45 Renewable Energy Development Hydropower in Norway

Investors are mainly:

Local industry or local government agencies that want to promote

electrification in their area.
Power utilities that long to influence or control the electricity supply in their
area.
Industrial companies that seek for access to power production utilities.
Financial institutions that look for a long-term investment.83

Investors play a key role in the realisation process of a hydropower project.

6.3 Small hydropower project costs

The first step in the economic valuation of a small hydropower project is to estimate
its costs. When assessing an investment in hydropower plants, two major
characteristics must be taken into consideration:

(a) Large costs of technical infrastructure, and

(b) Long lifetimes of hydropower projects.

It is difficult to determine a general cost level for investments in small hydropower

schemes given that projects are neither uniform nor comparable, and depend on
several aspects that include (1) the type of hydropower system (run of river,
reservoir); (2) installed power and number of hydro-generators; (3) useable head; (4)
capacity of water reservoir; (5) financing sources; and (4) local environmental
circumstances such as terrain configuration, hydrological conditions, costs of land
use, etc.84

Generally, small hydropower plants have high initial costs but relatively low annual
costs compared with conventional fossil production. In fact, maintenance costs are
the lowest of all energy-producing technologies. Given that each hydro site is unique,
about 75% of the development cost will be determined by the location and site

83
Jenssen, Lars, Tor Gjermundsen and Grner Trondheim AS. (2000). Financing of Small-Scale
Hydropower Projects. IEA Technical Report, Trondheim.
84
Bobrowicz, Wladyslaw. (2006). Small Hydro Power Investor Guide. p. 35. Koncern Energetyczny
SA. (Internet).
46 Renewable Energy Development Hydropower in Norway

conditions. Only about 25% of the cost can be categorized as fixed, i.e. the cost of
the electro-mechanical equipment.85

Cost estimates incorporate construction costs, development costs, and the different
operating expenses that would be expected in the process of power generation.
Construction costs comprise those for the major equipment components,
supplementary mechanical and electrical gear, and the civil works. Total costs of
development, in turn, encompass construction costs together with costs incurred for
licensing, feasibility studies, and project design. Operation and maintenance
expenses include salaries, insurance and taxes in addition to cash outlays in major
component replacement or repair.86

a. Construction costs

A more detailed breakdown of the construction costs includes the costs for civil
works, turbines, generators, transformers and transmission lines as well as other
required mechanical and electrical equipment. Likewise, engineering and
construction management make part of the total construction costs. As mentioned
before, these costs are determined by various aspects such as the plant capacity,
turbine type, the design head, transmission line length and voltage, etc.

b. Total development costs

Total development costs consist of the construction cost in addition to a variety of

costs that are applicable to the development of a small hydropower plant. These
entail costs of feasibility studies, licensing costs, and transmission right costs,
amongst others. Furthermore, site-specific costs which include fish passage
requirements, water quality monitoring, and mitigation for wildlife and recreation
may apply. Mitigation costs arise when the project development is expected to
impact upon the environment, and thus, planning permissions are required.

85
Natural Resources Canada. (2010). Micro-Hydropower System: A Buyers Guide. (Internet).
86
U.S. Department of the Interior. (2010). Draft Hydropower Resource Assessment at Existing
Reclamation Facilities. (Internet).
47 Renewable Energy Development Hydropower in Norway

c. Operation and maintenance costs

Although minimal for a hydropower system, the most important annual costs are for
operation and maintenance. These costs reflect an array of expenses that are incurred
for electricity generation and the proper functioning of the plant. Typically, they
include labour and materials for clearing the intake, equipment servicing, spare parts,
and general maintenance. Others costs may comprise land leases, insurance, property
taxes, water rental and general administration. The estimates for these expenses are
usually based on either the installed capacity or the total construction cost, and are
generally indicated as a fixed lump sum.

The projects prospects are examined carefully in the feasibility study, i.e. the
hydrological and environmental situation is assessed, the preliminary design is
created, and permit applications for water, land use and construction are filed. In the
same manner, interconnection studies need to be carried out in order to determine
whether the electricity generated can be transmitted to the central power grid.
Another fundamental factor is the drafting and negotiation of power purchase
agreements (PPA), which by definition are legal contracts between an independent
power generator and a power purchaser.

It is important to point out that generation costs per MWh will be determined by the
annual electricity output. In other words, the more electricity is produced the lower
the generation costs per MWh. Furthermore, many hydropower stations are
principally operated for peak load demands during cold seasons and as back-up for
frequency fluctuations, which raises the marginal costs, and ultimately the value of
the electricity generated. Since generation costs are almost entirely linked to the
depreciation of fixed assets, the generation cost will decrease if the projects lifetime
is extended. Many hydropower plants built 50 to 100 years ago are fully amortized
and still operate efficiently today. 87

The most recent data available report total electricity generation costs from small
hydropower in Norway that fall into a range between 120 - 450 NOK/MWh (15.43 -
57.86 EUR/MWh).88

87
International Energy Agency. (2010). Renewable Energy Essentials: Hydropower. (Internet).
88
Juliussen, Erik. (2007). Small hydro Possibilities and experiences for remote communities. p.7.
Norwegian Water Resources and Energy Directorate. (Internet).
48 Renewable Energy Development Hydropower in Norway

6.4 Profitability analysis of a small hydropower station

The profitability analysis is an evaluation of costs and benefits that will enable the
investor to make an informed choice whether to proceed with the project or abandon
it. In the present report, the method that will be applied for the assessment of the
profitability of a prospective small hydropower project is the net present value
method (NPV). This approach integrates two important variables that must be
considered in any economic analysis, namely money and time. According to the
concept of time value of money, a certain amount of money paid or received at a
sooner point in time is more valuable than if it is paid or received at a later point in
time. This follows from the theory of opportunity cost of capital.

In general, the value of a project can be described as the value of its output less
production costs, and this is also true for small hydropower plants. Hence, the value
of the plant will equal the expected cash flows from the sale of electricity during the
lifetime of the plant minus the cost of generation, discounted over the lifetime by the
appropriate discount rate. The concept of present value allows the evaluation of how
much the annual sales revenue is worth to the investor today.

At the heart of the NPV method is the discount rate, i.e. the rate at which the future
cash flow stream will be converted into todays monetary terms. With regard to a
small hydropower plant, there are some possible risk factors that may influence the
discount rate. These comprise technical and political risk. The technical risk is
associated to a probable malfunction and the necessity of replacement of
components, but also the danger that the plant is not built properly. Similarly, there is
a bankruptcy risk that arises when precipitation is unusually low during several
consecutive years. The political risk entails the risk that the taxes for small
hydropower plants are modified or that the government starts providing subsidies to
this type of electricity generation.

Based on this reasoning, a risk premium should be incorporated into the profitability
analysis of the small hydropower plant through the discount rate. In other words, to
allow for the riskiness of future cash flows, a risk premium rate needs to be added to
the risk-free rate. Such a composite discount rate is intended to reflect the investors
attitude towards risk. The long-term interest rate for 10-year Norwegian government
49 Renewable Energy Development Hydropower in Norway

bonds (risk-free rate) equals 3.30% as of November 19, 2010. 89 Considering the high
level of technology and expertise in the Norwegian hydropower sector and the
current stable legal framework, technical and political risks are believed to be
relatively low. The current market risk premium of 4.70% for Norway90 will
therefore be used as the risk premium. From this, the discount factor for the NPV
calculations will be 8.00%.

The effective life of a small hydropower station can vary from project to project,
with some larger plants reporting effective lives of more than 50 years. Normally, a
lifetime of at least 25 years is assumed.91 An effective lifetime of 35 years will be
taken into consideration for the calculations in this report.

With regard to the investment costs, estimates for Norway were extracted from a
study that was carried out by the Small Hydropower Energy Efficiency Campaign
Action (SHERPA). As can be seen from Figure 6-2, Switzerland and Germany report the
highest investment costs which fall into a range of 4,000-10,000 and 4,000-6,000 EUR
per installed kW, respectively. Scandinavian countries, more specifically Sweden and
Norway, exhibit relatively low investment costs with an average of 1,500-2,500 and
1,000-1,500 EUR/kW, respectively.

Figure 6-2: Investment costs of small hydropower plants in selected European

countries

Investment costs
Country
Euro/kW
Switzerland 4,000 - 10,000
Germany 4,000 - 6,000
Austria 2,900 - 4,300
UK 2,000 - 4,800
Norway 1,000 - 1,500
Sweden 1,500 - 2,500
Source: Small Hydropower Energy Efficiency Campaign Action. (2008). Strategic study for the
development of small hydropower in the European Union.

For the purpose of valuating a small hydropower project in Norway, a hydropower

scheme with installed capacity of 4.5 MW will serve as the basis for calculations . Based

89
Financial Times. (2010, 19 November ). Bonds & Rates Overview. (Internet).
90
Damodaran, Aswath. (2010). Country Default Spreads and Risk Premiums. (Internet).
91
Bckman, Thor et al. (2006). Investment Timing and Optimal Capacity Choice for Small
Hydropower Project., p. 10. Norwegian University of Science and Technology, Trondheim.
50 Renewable Energy Development Hydropower in Norway

on the study previously mentioned, investment costs will amount to 1,500 EUR/kW
which corresponds to around 12,028 NOK/kW. This leads to total investment costs
of 54,126,500 NOK (6,750,000 EUR).

One portion of the investment costs will be externally financed. Therefore, a bank
loan amounting to 35,944,000 NOK (4,480,000 EUR) will be made. This equals to
66% of total investment costs. A finance period of 12 years with 2 years grace period
will be assumed for calculations. The bank interest rate on loans in Norway currently
amounts to about 5%. The leverage ratio is an important aspect of the profitability
analysis as it exerts a strong impact on the investors return. This will be explained in
more detail later in this chapter.

The input data that have been exhibited so far can be summarized as follows:

a. Total investment costs 54,126,500 NOK 6,750,000 EUR

b. Bank loan 35,944,000 NOK 4,480,000 EUR
c. Interest rate on loan 5%
d. Discount rate 8%
e. Effective life of the plant 35 years

As a general rule, a small hydropower plant is a price-taker. Once the generation

capacity has been fixed, optimal production is always at full capacity provided that
the price exceeds production cost.92 The average production per year depends to a
large extent on capacity choice, but also on the water inflow to the plant. For this
reason, electricity generation may vary from year to year. This contingency together
with electricity distribution losses during power transmission may well influence
actual output. For the sake of simplicity, a constant annual output of 15,800 MWh
has been assumed in the present study.

Revenues from hydropower plants come from the sale of electricity, which is
normally done through a power company that participates in the Nordic power
exchange, Nord Pool. Consequently, revenues are strongly dependent on price
developments in the Nordic market. After a fall in electricity consumption in the
Nordic region due to the decline in industrial consumption during the recent financial
crisis, Nordic power demand is expected to recover in 2010 with a lasting upward
92
Ibid, p. 7.
51 Renewable Energy Development Hydropower in Norway

trend.93 Moreover, integration with the continental European market is advancing,

where production costs are higher because of the dominance of thermal power plants.
These two aspects are likely to exert an upward pressure on future electricity prices.

Next to the generation costs, the costs for grid use have to be included. In Norway,
transmission tariffs are set by Statnett, a state-owned company responsible for the
national power grid. The tariff is composed of a variable component (also called
energy component) and a fixed component. When electricity is transmitted, heat is
generated in cables and transformers, leading to a loss of energy. The energy
component is intended to reflect the electricity loss for every MWh that is
transmitted to the grid (marginal loss), and thus, it depends on the current input of
energy and is determined for each input point. The fixed component shall cover the
remaining costs that cannot be directly attributed to the individual producer. Finally,
the cost for selling the electricity to an electricity company has to be considered. This
cost depends on what the company offers and therefore varies from company to
company.

From the above, supplementary information needed for the NPV calculation has been
collected:

f. Current electricity spot price 405 NOK/MWh 50.51 EUR/MWh

g. Fixed tariff component 8 NOK/MWh 0.99 EUR/MWh
h. Energy component 2.5 NOK/MWh 0.31 EUR/MWh
i. Cost for selling electricity 3.5 NOK/MWh 0.44 EUR/MWh
j. Contribution margin 391 NOK/MWh 48.76 EUR/MWh
k. Annual growth rate of
electricty prices 1%

It is assumed that the project will be developed in four years. The feasibility study,
project design, and licensing process will be done in the first year. This will result in
nearly one-sixth of the investment costs being spent by the end of the first year.
Similarly, costs incurred in the second year will amount to a further one-sixth of total
costs. In the third year, about one-third of total costs are assumed to be due. At the
end of the fourth year the whole development is finished and paid. In the first two

93
Fortum, Keilaniemi. (2009). Annual report 2009. (Internet).
52 Renewable Energy Development Hydropower in Norway

years, only interest payments are made to the bank; principal repayments on the bank
loan start in year three.

As reported by already existing plants, operation and maintenance costs per year are
estimated at 3% of the total investment. This amounts to 1,623,795 NOK (202,490
EUR). These costs will grow annually at the current inflation rate of 1.9%.

The annual cash flows of the investment are shown in Figure 6-3:

Figure 6-3: Project Cash flows, in NOK

Investment Contribution Interest on Energy price

Bank loan O&M Annual output Inflation Discount rate
cost margin loan annual growth
54,126,500 NOK 35,944,000 NOK 1,623,795 NOK 15,800 kWh 391 NOK 5.00% 1.90% 8.00% 1%

Principal Principal Interest on Operation and Cumulated cash

Year Investment Bank loan Revenues Cash flow PV of cash flow
repayment residual loan maintenance flow
-4 -8,947,500.00 -8,947,500.00 -8,947,500.00 -8,947,500.00
-3 -9,235,000.00 -9,235,000.00 -18,182,500.00 -9,235,000.00
-2 -16,727,500.00 16,727,500.00 0.00 -16,727,500.00 0.00 -18,182,500.00 0.00
-1 -19,216,500.00 19,216,500.00 0.00 -35,944,000.00 -836,375.00 -836,375.00 -19,018,875.00 -836,375.00
0 0.00 -35,944,000.00 -1,797,200.00 6,177,800.00 -1,623,795.00 2,756,805.00 -16,262,070.00 2,756,805.00
1 -2,995,333.00 -32,948,667.00 -1,797,200.00 6,239,578.00 -1,654,647.11 -207,602.11 -16,469,672.11 -192,224.17
2 -2,995,333.00 -29,953,334.00 -1,647,433.35 6,301,973.78 -1,686,085.40 -26,877.97 -16,496,550.07 -23,043.53
3 -2,995,333.00 -26,958,001.00 -1,497,666.70 6,364,993.52 -1,718,121.02 153,872.80 -16,342,677.28 122,149.19
4 -2,995,333.00 -23,962,668.00 -1,347,900.05 6,428,643.45 -1,750,765.32 334,645.08 -16,008,032.20 245,974.12
5 -2,995,333.00 -20,967,335.00 -1,198,133.40 6,492,929.89 -1,784,029.86 515,433.62 -15,492,598.57 350,795.46
6 -2,995,333.00 -17,972,002.00 -1,048,366.75 6,557,859.19 -1,817,926.43 696,233.01 -14,796,365.57 438,744.89
7 -2,995,333.00 -14,976,669.00 -898,600.10 6,623,437.78 -1,852,467.03 877,037.65 -13,919,327.92 511,743.04
8 -2,995,333.00 -11,981,336.00 -748,833.45 6,689,672.16 -1,887,663.91 1,057,841.80 -12,861,486.12 571,519.01
9 -2,995,333.00 -8,986,003.00 -599,066.80 6,756,568.88 -1,923,529.52 1,238,639.56 -11,622,846.57 619,628.16
10 -2,995,333.00 -5,990,670.00 -449,300.15 6,824,134.57 -1,960,076.58 1,419,424.83 -10,203,421.73 657,468.34
11 -2,995,333.00 -2,995,337.00 -299,533.50 6,892,375.91 -1,997,318.04 1,600,191.38 -8,603,230.36 686,294.65
12 -2,995,333.00 0.00 -149,766.85 6,961,299.67 -2,035,267.08 1,780,932.74 -6,822,297.61 707,232.90
13 7,030,912.67 -2,073,937.15 4,956,975.51 -1,865,322.10 1,822,669.61
14 7,101,221.79 -2,113,341.96 4,987,879.83 3,122,557.74 1,698,178.76
15 7,172,234.01 -2,153,495.46 5,018,738.56 8,141,296.29 1,582,115.70
16 7,243,956.35 -2,194,411.87 5,049,544.48 13,190,840.77 1,473,913.90
17 7,316,395.92 -2,236,105.70 5,080,290.22 18,271,130.99 1,373,044.71
18 7,389,559.88 -2,278,591.70 5,110,968.17 23,382,099.16 1,279,014.82
19 7,463,455.47 -2,321,884.95 5,141,570.53 28,523,669.69 1,191,363.92
20 7,538,090.03 -2,366,000.76 5,172,089.27 33,695,758.96 1,109,662.48
21 7,613,470.93 -2,410,954.78 5,202,516.15 38,898,275.11 1,033,509.74
22 7,689,605.64 -2,456,762.92 5,232,842.72 44,131,117.84 962,531.74
23 7,766,501.69 -2,503,441.41 5,263,060.28 49,394,178.12 896,379.61
24 7,844,166.71 -2,551,006.80 5,293,159.91 54,687,338.03 834,727.81
25 7,922,608.38 -2,599,475.93 5,323,132.45 60,010,470.48 777,272.65
26 8,001,834.46 -2,648,865.97 5,352,968.49 65,363,438.98 723,730.78
27 8,081,852.81 -2,699,194.42 5,382,658.38 70,746,097.36 673,837.88
28 8,162,671.34 -2,750,479.12 5,412,192.22 76,158,289.58 627,347.34
29 8,244,298.05 -2,802,738.22 5,441,559.83 81,599,849.41 584,029.12
30 8,326,741.03 -2,855,990.25 5,470,750.78 87,070,600.19 543,668.62
31 8,410,008.44 -2,910,254.06 5,499,754.38 92,570,354.57 506,065.67
32 8,494,108.52 -2,965,548.89 5,528,559.64 98,098,914.20 471,033.53
33 8,579,049.61 -3,021,894.32 5,557,155.29 103,656,069.49 438,398.04
34 8,664,840.11 -3,079,310.31 5,585,529.80 109,241,599.29 407,996.73
35 8,751,488.51 -3,137,817.21 5,613,671.30 114,855,270.59 379,678.09

NPV 9,824,383.31
53 Renewable Energy Development Hydropower in Norway

The NPV of the project is positive and amounts to 9,824,383 NOK (1,225,138 EUR)
at a discount rate of 8.00%. This is a signal to the investor that the project is indeed
profitable. The NPV method is usually employed when comparing different projects,
among which those with the greatest NPV value will be chosen.

Nevertheless, it needs to be mentioned that NPV results are extremely sensitive to

the discount rate and the lifetime of the project. In other words, the higher the
discount rate and the shorter the lifetime, the lower the NPV value will be (see
Figure 6-4).

Figure 6-4: Effect of discount rate and lifetime on the NPV

8.00% 10.00% 12.00%
25 years 4,468,597.52 -725,506.67 -4,457,552.04
30 years 7,621,211.25 1,166,066.35 -3,311,367.53
35 years 9,824,383.31 2,372,104.66 -2,643,530.17
Source: Own calculation

A further consideration which is of great importance to the investor is the internal

rate of return (IRR). The IRR is the discount rate which reduces the NPV of the
project to zero. Generally speaking, the higher the IRR the more attractive is the
project. The IRR can be thus expressed as the return that investors will receive on
their equity. The small hydropower plant being analyzed yields an IRR of 10.85%.
The IRR can be improved by increasing the leverage ratio, i.e. by reducing the equity
portion. As Figure 6-5 shows, as the leverage ratio increases, the IRR becomes
higher. This is due to the advantage of substituting equity capital by debt as the latter
is less expensive.

Figure 6-5: Effect of leverage on the IRR

Leverage ratio 0% 66.00% 75.00% 80.00%
IRR 9.39% 10.85% 11.04% 11.16%
Source: Own calculation

Based on the effect of leverage on the IRR, investors will strive for a high leverage
ratio in order to get the highest possible return. However, the leverage ratio is limited
since lenders will always demand a minimum portion of equity so as to assure that
risk is borne by all involved parties. Debt financing has a significant effect on the
return to the investor, yet the extent to which the project can be financed by debt will
depend on the financial prospects of the project as assessed by the lender.
54 Renewable Energy Development Hydropower in Norway

In conclusion, the small hydropower plant exhibited here is believed to be an

attractive investment. Notwithstanding, the investor has to take into account the
exceptionally long investment horizon and the large initial investment costs that are
associated with such an investment. For this reason, small hydropower plants are
believed to be of interest to a selected investor segment, namely owners of water
resources as well as electricity companies that want to hedge against supply
shortages.

6.5 Subsidies and Tradable Green Certificates

The development of new projects of renewable energy in Norway is relatively low,

as the market especially the hydro electric industry is already very well established
and supports from the state are low. As Norway is participating in the EU targets to
increase the share of renewable energy, it aims at increasing the number of new
projects. For that reason, a common market for electricity certificates with Sweden
has been established, although throughout Europe feed-in tariff systems are more
practiced94

In 2006, the first attempt of a common certificate market was stopped by Norway
with the reasoning of high costs. Norway wanted to promote renewable energy
projects through the state energy fund.95 In Sweden, however, the electricity
certificate system was introduced successfully in 2003. This system aims at the
development of renewable electricity production and is created technology neutral,
which means it does not differentiate between wind power, hydropower, biofuel etc.
At the beginning, targets are defined by how much the electricity produced by
renewable energies has to rise till a certain date. As the production in Sweden
increased by more than 6.5 TWh/year since 2002, the aims for the future
development have been adjusted to a higher level.

Through the trading of electricity certificates, the government supports on a market-

based system the construction and development of renewable energy projects. The
State awards for every unit of renewable electricity generated one certificate, which
corresponds to 1 MWh of electricity, to the electricity producer. To create a demand

94
Economic Instruments Tradable Permits. (2008). Green Electricity Certificates (Sweden).
(Internet).
95
EurActiv. (2009). Nordic green power certificate becomes reality. (Internet).
55 Renewable Energy Development Hydropower in Norway

for these certificates, a quota obligation is introduced. This is an obligation for

electricity suppliers and certain electricity users such as electricity intensive
companies to purchase and hold a certain quota of certificates related to their
delivery and consumption of electricity. The supply of certificates on the certificate
market is provided by the producers of renewable electricity. Through the selling of
certificates, they gain additional money to the selling of electricity. As electricity
gets more expensive for the suppliers, there will be a small increase in market prices
for the end users.96

The introduction of green certificates has three major effects:

The production costs for electric energy will decline.

Unless the supply of traditional energy is completely price inelastic, its
production will decline.
The production of renewable energy will increase.97

By introducing the green certificate market, Norway aims at increasing its share of
renewable energy from todays 60% to 70 74% which means a plus of 25
TWh/year between 2002 and 2020. As Norway is regarded to small for a national
solution, an agreement has been signed between Sweden and Norway for a common
market. As it is the case in Sweden, the certificates will be technology neutral.

If plants want to participate in the system, they need to refund any previously
received subsidies. All plants constructed after September 7, 2009 or plants
constructed after January 1, 2004 with 1 MW or less may participate. Till the
establishment planned on January 1, 2012, the final targets of the participating
countries, the duration of the certificates and the eligible production still have to be
determined.98 To ensure new projects till the date of establishment, Enova will
provide investment support.99 Enovas task is, among others, the administration of
the Norwegian Energy fund. This renewable energy fund amounted to 2.5 billion
EUR in the year 2006, which corresponded to 20 billion NOK, and was based on a

96
Wikborg Rein. (2009). A common Swedish-Norwegian Market for Electricity Certificates. p.12-13.
(Internet).
97
Bye, Torstein and Hoel, Michael. (2009, December 7). Green certificates and the effect on the
climate. (Internet).
98
Wikborg Rein. (2009). A common Swedish-Norwegian Market for Electricity Certificates. p.12-13.
(Internet).
99
AMT. (n.d.). A market for electricity certificates. (Internet).
56 Renewable Energy Development Hydropower in Norway

tax on transmission tariffs.100 In 2010, the EFTA Surveillance Authority agreed to an

increase of the budget of 365 million NOK.101

6.6 Risks involved in Hydropower Investments

Financing a hydropower project is very heavily dependent on the prudent

management of various types of risks. This involves identification of various risks
associated with a project and assessment thereof. However, the most important step
lies in arranging measures to mitigate such risks including an effective insurance
program.

For a foreign investor, the first risk that becomes apparent is exchange rate risk.
Because revenues are denominated in foreign currency, fluctuations in the foreign
exchange market may alter, either in a positive or negative manner, the relative
performance of the project when results are translated into the investors own
currency. Assuming that mainly European investors seeking to secure local energy
supply will be interested in Norwegian hydro, the exchange rate risk is reasonably
low since large fluctuations against the Euro have been rather unusual. Figure 6-6
shows the development of the exchange rate over the last five years. It can be seen
that only in the aftermaths of the recent financial crisis a significant depreciation of
the NOK took place. On average, however, a fairly stable performance around 8.00
NOK per EUR can be observed.

Figure 6-6: NOK/EUR exchange rate development since 2005

Source: Reuters. (2010). Currencies. (Internet)

100
Finfacts Ireland. (2006). Norway launches 2.5 billion renewable energy and energy efficiency
fund. (Internet).
101
EFTA Surveillance Authority. (2010). PR (10)09: The EFTA Surveillance Authority approves
NOK 365 million budget increase of the Norwegian Energy Fund. (Internet).
57 Renewable Energy Development Hydropower in Norway

A foreign investor is also exposed to risk such as those associated with the
governments credit worthiness, the possibility of confiscation, expropriation and
nationalization changes in the local political environment and enforceability of
contracts.102 These types of risks are called sovereign and country risk.

Usually lenders offer two kinds of interest rates to the borrowers. These are floating
rate and fixed rate. During the term of the loan, the floating rate requires to be
changed according to the changes of the interest rate. Generally, banks prefer
floating rate as they need to be able to adapt to changes in financial market as well as
cover their own exposure to the changing interest rates that includes bank rates.
Fixed rate is the best way to mitigate this risk for the developer.

Inflation risk is also a big risk factor for investors. The real value of a unit of
nominal currency tends to depreciate over time with inflation. Even hard currency is
subject to this risk.103

Changes in the countrys laws are another risk such as increasing rates and taxes or
other expenses and liabilities which reduce project revenues and the value of the
assets. Such changes impact the viability of a project.

Payment risk exists when there is a lack of creditworthiness on the part of the utility,
the buyer of the energy. Developers are known to ask the government to issue a
counter guarantee to cover the payment risk. This basically entails a government
standing surety to the fact that the utility pays its dues to the developer in
time.104And in the case of a utilitys failure to meet its obligations the government
is required to make the payment to mitigate the delinquency of the utility.

Time and cost overrun risks are one group of construction risks. Time overrun risk
results in a loss of revenue due to inflation and an increase in the total amount of
interest during construction on the debt financing.

If there is no water to generate energy due to the change in the level of precipitation,
climatic reason or changes in the hydrology of the catchments area create an
hydrological risk as well.

102
Shrestha, Ratna Sansar. (2007). Investment in Hydropower Sector: Opportunities and Risks.
(Internet).
103
Ibid
104
Ibid
58 Renewable Energy Development Hydropower in Norway

7. Conclusion

7.1 Summary of main points

This paper has shown that sustainable development is a core issue in todays world to
reduce greenhouse effects and CO2 emissions. The development of renewable
energies is part of such sustainable development. Renewable energies guarantee a
stable energy supply compared to fossil fuels, as they are available without limits.
Furthermore, countries use their own available sources and offer a high potential of
development.

Hydropower provides one of the most mature technologies among renewable

energies and therefore, it is highly competitive within this group. The potential to
exploit hydropower worldwide is estimated to be 14,370 TWh/year.

Norway has a huge expertise in the field of hydropower due to its long history in this
sector. Norway participates in the European Economic Areas goals of increasing the
portion of renewable energy on the long-term and it offers a great potential for
hydropower investments. Furthermore, investments in Norwegian hydropower
projects support the Energi21 strategy of Norway which aims at an increase of
hydropower capacities for a higher supply in Norway and Europe.

Hydropower offers some advantages compared to other energy sources. It is not only
free of greenhouse gases in the production but is also available locally and
continuously, which keeps electricity prices rather stable. The supply can easily be
adapted to the demand by shutting down the dams. However, the building of the
plant can affect the environment and surrounding area. To ensure that the
hydropower project is really implemented in an environmentally friendly manner, the
licensing process proves the fulfilment of the respective legal regulations. The
responsible authority is the Norwegian Water Resources and Energy directorate
which examines, together with all parties involved in a public examination, the
impacts of the project on the environment and the society and outweighs these
factors against the benefits of the hydropower plant. Among a list of other laws, the
Protection Plan for Watercourses which treats environmental aspects and the Master
Plan of Water Resources, treating economic aspects, are proven for fulfilment.
59 Renewable Energy Development Hydropower in Norway

Due to less environmental impacts and the focus on guaranteeing regional supply,
there is a high interest to install small hydropower plants in Norway. One positive
aspect of small hydropower lies in that operational and maintenance costs are lower
than for other renewable sources of energy. The financial attractiveness of small
hydropower projects has been shown in the profitability analysis resulting in a
positive NPV of 9,824,383 NOK and an IRR of 10.85% by using a leverage ratio of
66%. Long effective lives of hydropower plants enable a full amortization and still
efficient operation.

The Norwegian government is starting to support the generation of electricity from

new projects in renewable energy by establishing a green certificate market.
Although new hydropower plants are very attractive investments, investors have to
be aware that these investments are long-term and require high initial costs.

7.2 Recommendations
Finally, there are some recommendations to make for the investment in a
hydropower project in Norway about the profitability of projects and the risks
involved.

In the profitability analysis it is shown that a higher leverage ratio leads to a higher
internal rate of return. Therefore, investors should consider the leverage ratio while
they are comparing their possible small hydro investments. If they seek for a higher
rate of return for their investment, they should decide for the project with the highest
leverage ratio. However, investors have to be aware that this will be more risky
because the project will have to pay back a higher amount of debt. This may lead to
bankruptcy in the long-run in the case of instable incomes. The profitability analysis
shows as well that the life time of the project affects its NPV, meaning that a higher
investment horizon will lead to a higher NPV. When choosing a longer lifetime,
investors should consider the increased risks associated with the longer time period
of their investment.

Further, investing in the Norwegian electricity market contains other risks such as
exchange rate risks, interest rate risks and foreign market risks. The investor who
runs up into these risks should be able to manage them. If an investor is able to do so,
60 Renewable Energy Development Hydropower in Norway

the opportunity to invest in the hydropower sector in Norway is highly

recommendable.

Reducing foreign exchange risks can be possible through hedging in the long-term
horizon, but in some cases this can be expensive for investors. The best way to
manage interest rate risks is to negotiate fixed interest rates with lenders. However,
banks will probably add a margin to this fixed rate to reduce their own risks. A
simple way to mitigate the market risk is to acquire a long-term PPA with the local
utility. PPAs are long-term agreements to buy power from an electricity producer and
serves as an alternative to secure revenues.
61 Renewable Energy Development Hydropower in Norway

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Contact

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