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Financing Issues in Power Sector: Investor's Concerns and Response, Shri R V Shahi, Former Secretary, Ministry of Power

In the recent months, when the effects of global slowdown are being experienced in all the sectors of economy, concerns have also emerged about financing of power projects. As a matter of fact, power sector was identified as one of the most difficult sectors with large amount of risks to invest ever since the opening up of Indian economy in early 90's. It is only in the last five years or so, when a new structure of power industry has been created on the basis of complete overhaul of the legislative framework and various policy instruments, that the investments in the sector started coming in a significant manner. Until Ultra Mega Project Schemes became a reality in 2006, nobody believed that this Scheme, requiring as large investments as Rs. 16,000 to Rs. 18,000 Crores ($ 3 to 4 billion) in each project would be responded by developers so overwhelmingly. But, now in the present context, when funding is becoming critical for all the sectors, its effect, it is but natural that, will have to be felt by power sector project developers.

Last week, as per a predetermined schedule, a group of investors had tele-conference discussions with me, during which several important issues were raised and I attempted to answer them. Since, this set of questions concern many others - developers, lenders, equity investors - I thought I should present, in this weekly article, a gist of my answers, which reflect that in spite of various issues and challenges, power sector is worth investing and lending.

i.

If India's GDP grows by 7 - 8%, what will be your sense of the growth in power demand?

This issue has been adequately addressed in the Integrated Energy Policy document which was finally presented in August 2006. For this document, from the Ministry of Power we had prepared projections of power demand and consequently requirement of installed capacity for two scenarios - 8% growth and 9% growth. If we assume that electricity consumption over a period of time would be done in a responsible manner with various energy efficiency measures (efficient technologies and efficient practices), we may assume a degree of correlation between GDP growth rate and electricity growth rate which may be less than 1:1. It could be as low as 1:0.7. Our experience, however, shows that it may not be entirely correct to assume that all sectors of consumption would, even in a period of five to ten years, reach a situation of perfection or near perfection in this regard. Also considering the fact that the present baseline data starts with a shortage (energy shortage about 10%, peaking shortage about 14%), it would be desirable that in the beginning we assume a 1:1 correlation and subsequently reduce it depending on the outcomes of energy efficient technologies and consumption habits. It is these principles which led to project an installed capacity of the order of 800,000 MW during 25 year period of 2007-32. There is no question of power sector demand pattern looking back. We must also recognise that the level of development, which our economy has reached so far, requires the principle to be followed that in respect of power it is availability which creates demand.

ii.

In the current situation the peak shortage is of the order of 14%. How is the unrestricted peak demand calculated ? Also, what is the assumption on pricing ? Is it assumed that the free power in the agricultural sector would continue?

It is true that the estimation of Average Energy Shortage as well as Peak Shortage are done on the basis of suppressed demands. There are connected loads in the system. To the extent these loads are not adequately supplied the estimation of shortage captures such situations. However, if 50% of rural India does not have even electricity connectivity, and if they had, the demand would have mounted. Such demands and, therefore, mismatches between demands and supplies are not captured in the estimation of shortages. It is a very important point that power sector developers, investors and lenders should need to take note of that the projected shortage is understatement because these shortages are grossly under estimated. We need to imagine that when urban infrastructure is sought to be created in rural India, when new townships are developed in places where nothing exists the demands could mount.

As regards relationship between price and demand, it cannot be stated that demand for electricity is inelastic with reference to price. However, there are ranges of demands which may not follow an elastic pattern with reference to price. Right now, during current summer months, there are occasions during peak hours, not on one day but on several days, not during one month but covering several months, the electricity generators have been selling power through Power Exchanges or through Trading Agencies at rates which have varied between Rs. 10 to Rs. 15 per kwhr. Price will, no doubt, have an effect on demand. But, we must also give due recognition and respect to the principle, though upto a limit, that no power is costlier than no power. A visit to rural India will more than adequately identify with this principle. I have personally seen that even not so well-to-do people pay for diesel based electricity at rates which are well beyond Rs. 10 per kwhr.

As regards free power in the agricultural sector, it is an aberration from the established practices. National Electricity Policy and Tariff Policy discourages this practice. In the year 2002 the Ministry of Power had succeeded in eliminating, from the power map of India, the practice of free power, which then existed in the States of Madhya Pradesh, Punjab and Tamil Nadu. Unfortunately this got reintroduced in 2004 starting from Andhra Pradesh and again it was followed by Tamil Nadu and Punjab. All other States do not have this practice. Even in the States where such a practice exists, I see a clear possibility of supply being metered, so that the equivalent amount as per prescribed tariff is paid by the State Government to the utilities. In any case, we must take note of the fact that Electricity Act provides for a legal obligation on the part of the State Government to pay for any subsidised tariff, directly to the distribution utilities, so that their finances are not adversely affected. As regards demand projections to take care of power supply in agriculture, normative assumptions are made to make the estimations.

iii.

Do you think States would be able to significantly improve the transmission and distribution losses in next few years ? Would this have a large impact on the shortage situation?

During the Tenth Plan Period Ministry of Power introduced a very powerful Scheme APDRP which aimed at not only augmenting and modernising the distribution systems in towns, cities and industrial estates, but also at incentivising the technical and commercial loss reductions. Whichever States implemented this Scheme to atleast 75 to 80% of the estimated capital expenditure the results have been rewarding. Examples are in Andhra Pradesh, Gujarat, Karnataka, West Bengal etc. APDRP has been further improved, based on recommendation of a Committee which had been set up earlier, for implementation during the Eleventh Plan. The initiative of Franchisee Scheme, next best option to privatisation of distribution, introduced in Bhiwandi in Maharashtra and few other towns in Maharashtra, and recently in Kanpur and Agra in Uttar Pradesh, holds tremendous potentials for effecting significant reductions in technical and commercial losses in distribution. As regards impact of reduction in losses on demands for power, it would be right to say that it will have some effect. But, it would be wrong to assume that it would drastically reduce the demand. These losses, atleast the major part of these losses, have been on account of theft of electricity and therefore consumption was taking place anyway. If the thrust of this question is to search an answer to conclude that with reduced technical and commercial losses demand will substantially go down, my answer is in the negative. Delhi is an example. At the beginning of the privatisation exercise in Delhi, the losses in the three distribution companies in Delhi were in the range of 45 to 60%. These have reduced now to 22 to 30%. Yet, as we all know, demands have been growing and consequently the shortages.

iv.

If there is a big shortage of power. Why are the State distribution companies not coming out with more Case-I Bids and tying up long term power instead of being exposed to high merchant prices in future ? Do they believe that increase in demand would be lower?

The reasons for a number of States not coming out with Case-I Bids are different. It is not because of their belief that the demands would be lower. In fact, they all fear the consequences of widening of gaps in demand and supply. Case-II Bidding exercise was initiated by the Ministry of Power with identified location, fuel, transmission arrangement, land, PPA and Escrow Agreements. The objective was to minimise the preconstruction risk factors which should lead to most competitive rate for power to be supplied by the generators. The objective was, as predicted, fully met. But, it needs to be recognised that this exercise needed a comprehensively structured approach as much as a well orchestrated coordination mechanism with all the stakeholders. Case-I Bidding has to deal with more uncertain factors and issues. Location, fuel and all other pre-construction arrangement have to be in the jurisdiction of the developer. Accordingly, the Bid papers have to comprehensively capture different situations and possibilities and yet formulate an acceptable an objective method and manner of evaluation of totally different types of offers. Some States have able to do it, many States are still struggling. The States which have come out with Bids have also been facing rough weather at different stages of progress on this front. Ministry of Power has notified a Guideline for the Case-I Bidding, and it may be expected that a good part of the problems faced by States could be addressed on the basis of this document. However, I do believe that some amount of hand holding by Government agencies will still be required to facilitate this mode of power project development without which developers may find it very difficult to progress smoothly.

v.

What do you think would be the achievement in terms of generation target of 78 GW in the Eleventh Plan, historically we have not achieved more than 50-55%?

As we know, power projects have long gestations, mostly 4 to 5 years, in cases of hydro projects even more, to complete and commission them. Normally, what we prepare and start in one Plan period we get them on to the grid in the next Plan. When we began the Tenth Plan in April, 2002, we had, based on preparations in the Ninth Plan, less than 20,000 MW under construction. A little more than this, we could get on line in the Tenth Plan. These included those projects on which starts could be made in the first year of the Tenth Plan. During the entire period of Tenth Plan, therefore, we made exhaustive preparations for getting better outcomes in the Eleventh Plan. These preparations included investigations, project reports, tendering and placing Contract Awards to ensure that construction begins. We had the predicted advantage of beginning the Eleventh Plan with almost 49,000 MW under construction. This included about 10,000 MW of those projects which should have been commissioned in the last year of Tenth Plan (2006-07), but slipped to next year. 78 GW of target, therefore, includes the projects which slipped from Tenth Plan into the Eleventh Plan. The problems of manufacturing sector, though reduced, continue. Similarly, inadequacies on the part of the construction and commissioning agencies make it almost impossible to cope with 15,000 MW plus of annual capacity addition. My own assessment is that we should definitely get those projects (about 50,000 MW) on which work had already started when we began the Eleventh Plan. Some of the short gestation projects which were started in the early months of the Eleventh Plan could also be expected. Thus, about 55,000 MW appears to be a realistic expectation. Other projects may slip to the early years of Twelfth Plan viz. 2012 and 2013. Extensive preparations of Tenth Plan leading to 55,000 MW in Eleventh Plan, though less than targets, would be a great achievement.

vi.

Two out of the four Ultra Mega Projects rely on imported coal but have been bid out without any fuel pass through. Do you think there is a possibility of re-negotiation if the international coal prices again cross through the roof?

It is wrong to assume that in cases of Coastal Ultra Mega Projects, for which imported coal has to be used, the Bidding process did not provide for pass through of price increases in the international coal market. As a matter of fact, there is a mechanism according to which the fuel price is linked to international indices which reflect the movements in coal prices. The Central Electricity Regulatory Commission would be, based on these movements in the indices of coal prices, would notify the extent of pass through in the fuel price in so far as these Ultra Mega Projects are concerned. Obviously, these changes would be linked to the component of fuel price as provided in the Bid papers of the concerned developers.

vii.

The progress of work on these Ultra Mega Projects has also been very slow (work started in only one). Do you think Ultra Mega Projects could be an important factor in the next 6 to 7 years?

We should recognise that these are very large projects, each one requires capital costs of the order of Rs. 16,000 to Rs. 18,000 Crores. Normally, they would have ended up with comparatively much higher tariff in view of such large investments and risks. What really made the difference was the mitigation of all the risks associated with pre-construction parameters and activities. The Ministry of Power had also committed continued hand holding till be issues connected with clearances and various input linkages were resolved. Obviously, for the first couple of projects there would be delays of the type which are associated with learning curves in all such exercises. The fundamentals of this Scheme are so strong that they are bound to succeed. I am more than convinced that meticulous implementations by the Shell Companies should be able to achieve 6 to 8 such projects, if not more. The Ministry had initiated the process with various State Governments that they should also facilitate development of relatively smaller projects (1,500 MW - 2,000 MW each) by providing similar assistance and support. Some of the States have taken up these exercises, more would follow. Thus, we may expect that under this category of projects, (both Central and State level) almost 35,000 to 40,000 MW could definitely be developed in next 6 to 8 years.

There are seven more questions which are important and were responded. We will cover them in the next Weekly Article.