As one of the most well-managed private companies, the Chinese government has delegated us the task to build what would probably become the world’s largest hydro project – the Three Gorges Dam. This won’t be just a simple project, as a lot of uncertainties and good/bad factors pertaining to its profitability are involved. We would need to carefully examine all the financial aspects affecting our company to be able to decide if this project is generally worth undertaking.
The Three Gorges Dam project will be built along the banks of the Yangtze River. This won’t be the tallest nor the widest dam in the world but it’d be the largest hydroelectric project yet. Currently, China is generating 70% of their total electric supply from coal, making them one of the biggest contributor to air pollution and the greenhouse effect. With the construction of this Three Gorges Dam, the Chinese would be able to greatly minimize this serious environmental problem while also addressing their current power shortages. Another major advantage for constructing this dam is for flood control. The region by the Yangtze River is known for its frequent and severe floods killing thousands of people and destroying millions worth of agricultural produce and other properties. The project is also expected to bring about improvements in navigation and water commerce which would eventually lead to a decrease in shipping costs by as much as 35%.
However, with the above advantages given, there are also several inevitable major tradeoffs that should be considered. Obviously, the construction cost is one. The Three Gorges Dam would be using the latest technology and best materials to be able to meet expected results. This would surely cost us much. Another major consideration would be the resettlement of millions of people. The dam will create a large water reservoir which is estimated to totally submerge about 13 major cities, 140 towns and 326 peasant villages. The construction of the dam also means losses in arable land and rich fisheries by the river. Also, a lot of historical and archaeological places would have to be destroyed, generating additional government losses on tourism. These sites are considered to be the cradles of Chinese civilization and are important in understanding Chinese history. The dam would take years to construct and therefore, operation and maintenance cost, which is definitely costly, is another huge consideration. Other costs associated with the ongoing construction of the dam such as accident costs and the downstream effect or the cost associated with the downstream pollution must also be considered.
Being a private institution, we’re not greatly concerned with the broad public benefits as much as the profits this Three Gorges Dam would bring us. Also, we would have to give careful considerations to the associated expenses. Unlike the government, we have very limited available funds. For us, a project is viable only if it’d be able to give us a positive net present value. We must understand that every aspect of the dam construction should be translated to monetary terms to make it easier for us to analyze the project. We would have to look closely at all factors affecting the project’s net present value.
As mentioned above, our main goal in undertaking the project is the profit brought about by large power generation. The flood control benefits and clean power provisions are not our primary concerns, and thus, we won’t be associating much value with them. The construction of the dam is also expected to boost economic growth. Although our company would in a way benefit from this economic growth, the benefits wouldn’t be as large as what Marimoto and Hope had estimated in their research. Since we’re a private company, we could say that great benefits for our company due to the country’s economic growth is largely uncertain. Improvements in the navigation and water commerce won’t also be bringing us so much benefits. Though our company would be able to take advantage of low shipping costs and create added business with ship lockings, that won’t give us as much profits based on Marimoto and Hope’s estimates since it’d still be the government who would largely control navigation. Therefore, analyzing this project in our point of view as a for-profit private entity, the net present value we’ll get would definitely be lower compared if this would be analyzed in the government’s view.
Next, we’ll also have to carefully examine those factors that would contribute to a negative net present value. Costs associated with archeological losses, tourism losses, economic losses due to the submersion of rich fisheries and arable land are also the least of our concerns. We won’t be allocating much costs with these losses either. They’re more of a governmental concern and are out of our scope and interests as a private entity. However, as part of our social responsibilities, we would have to take part in the resettlement costs. The government has given an estimate of about 1.3 million people who needs to be relocated. Just to keep within the safe grounds, we might have to add a buffer of 5% to the total estimated resettlement costs. Social issues during the resettlement process definitely would arise which adds to our bill.
Also, we would have the responsibility to take care of the downstream effect and allocate funds to clean the pollution caused by the dam construction in the downstream part of the river. Of course, operating and maintenance costs and construction costs are directly associated with the project, thus we would have take these into full consideration. We’ll also be responsible for added costs which might be brought about by accidents during the construction. The dam is large enough project giving it a lot of room for project failures.
Another important consideration is the cash flows associated with the project. We have to keep in mind that we are a private company. In the early life of the construction of the dam, it wouldn’t be able to generate power yet. All it might be good for would be for flood control, which we’re not really interested in since this won’t be bringing us monetary benefits. Therefore, before this dam would be fully functional to generate power for profit, all we have are cash outflows.
Referring to Marimoto and Hope’s cost breakdown on their study about the Three Gorges Dam, and doing the necessary adjustments on the above categories that we’re not mainly concerned about, the project is less likely to give us a positive net present value. Power generation and navigation benefits are not enough to even compensate for the direct construction costs and resettlement costs. In Marimoto and Hope’s study, the bulk of the benefits are carried by the increased in the economic growth of the country as a whole. China would largely benefit from the reduction in economic damage brought by frequent and severe floods. China’s economy would also experience steady growth by the improvement in navigation. However, we’re particularly concern with the growth of our own company. If our company would benefit from the decrease in shipping costs, it wouldn’t account for much. Also, being a for-profit company, we don’t actually care if the Chinese government would be able to deliver clean power to its people. Definitely, by having this project handled by a private organization instead of by the government, calculations of benefits and net present values would adversely be affected. Other reduction in costs such as tourism, fishery, archeological losses in the calculations won’t be enough to compensate for the reduction of the benefits.
In addition, there is a big possibility that the dam won’t be able to provide the expected power resource due to the huge issue of sedimentation. Other constructed dams have lost up to 50% of their power because of this. If this happens, we would have to decrease our estimated net present value calculations for power generation, which decreases our estimated net present value even more. This sedimentation process is caused by natural factors which may be out of our control, thus losses due to this could largely be uncertain. To give a conservative estimate on the power that could be lost over the life of the dam, we might have to be a bit pessimistic. The effects of sedimentation could be assumed to exponentially increase with time as the dam wears off.
Our net present value would also be affected by the total life of the dam. The materials and technology used in the construction would shed us some light in giving a realistic estimate of the useful life of the dam. Also, environmental factors are to be considered. The dam would be constructed as such that the great floods would only use up to 30% of the strength or capacity of the materials used. This would give the dam a long useful life, however, when we take into account unexpected circumstances such as wars or fierce earthquakes, an estimate of its useful life would drastically drop.
If we’d like to be conservative in our estimates and give the dam about 35 years to be operational, we would have to also consider the net present value of power. Although China is a growing economy and is currently having a few power shortages, power costs in the future might eventually go down. With the fast rate the technology is developing, even if we’d be using the latest technology in building the dam, it is not an assurance that hydroelectricity would still look very attractive to consumers or even to China a few decades from now. It is very much possible that China would turn into much cheaper alternatives for power like nuclear power. If this happens, we might not be able to recover our investments. Net present value of the project would exponentially decrease.
In Marimoto and Hope’s research, they used a 5% discount factor. Since we are a private and for-profit company, we would have to use a much higher discount factor. The several uncertainties involved in the dam’s construction and generation of profit would lead us to use about a 10% discount factor. Examples of these uncertainties are the success constructing and operating what would be the world’s largest hydro project. The dam would use technologies not have been tested before. Assigning a relatively high discount factor should give us a safer estimate.
The construction of the Three Gorges Dam does have major advantages, however, these are more of bringing nationwide benefits. These do not directly benefit us as a private entity. Calculating from our stand as a private company, the net present value of the total costs outweigh the net present value of the total benefits, giving us a negative net present value. The analysis of the paper might be based on loose estimates and huge uncertainties, however, working on our statistics, we’d be able to figure out that chances of getting a positive net present value for this private project are slim. Though it is an honor to be offered such a big project, we would have to decide not to proceed with this for the sole reason that we are a private entity whose priorities and interests largely differ from that of a government.