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Power Project Development: Need for a different approach for financing, Shri R V Shahi, Former Secretary, Ministry of Power

We are aware that to meet the targeted economic growth rate, commensurate development of infrastructure and, more particularly, of power is essential. Capacity additions of more than 70,000 MW in the current Five Year Plan and more than 90,000 MW in the Twelfth Five Year Plan would be necessary. Thus, for a sustained economic growth rate of approximately 9%, over a long period of time, which is what is necessary, and which is what has been targeted, commensurate power supply will be a prerequisite. Experiences have shown that in the past our overall economic growth rate suffered because electricity growth rate hovered around 4 to 5%. Experience has also shown that when the economy got an electricity generation growth of 7.3% in the year 2006-07, we had the highest economic growth rate of more than 9.6%.

It is, therefore, essential that all possible steps are taken to see that projects, which are in the pipeline and projects which can be brought on track, are provided necessary supports. There are a number of issues which come in the way of project development. These include acquisition of land, environment and forest clearance, linkage for water supply, fuel linkage, fuel transportation, transmission systems for power evacuation. These are indeed important ingredients of power project management and obviously the project developers have to ensure that necessary tie-ups are established, so that the project cycle moves forward. No doubt, even in these cases the project developers would need and should get supports from the concerned Government agencies. With certain degree of follow-up, and depending upon the seriousness of efforts by project developers, it has been seen that in most cases these are arranged.

Financial closure, through which the total financing arrangement in respect of loans is made, is essential to proceed with the project. Unless this is done, the contracts for supply of equipment and construction cannot be accomplished. In the cases of public sector power projects, this has been comparatively easier because the tariff determination by the concerned Regulatory Commissions (CERC for Central Sector Projects and also Multi State Projects, and State Regulators in case of State specific projects) is possible under the present Policies. The Lenders, therefore, have no difficulty in appraising these projects and entering into Loan Agreements and subsequently even making disbursements of loan, even though tariff has not been fixed, because they know that as and when the project get completed, these companies will get their tariff decided which will be acceptable to the buyers of power viz., the State or private sector distribution utilities. In all such cases, public sector generating companies enter into Power Purchase Agreements which only specify the extent of power that various distribution companies will off-take, modalities of payments etc., and the most important element of the PPA viz. the tariff is left to be determined by Regulators in due course. This arrangement is fully acceptable both to the generating company sellers and the distribution company buyers.

For private sector project developers, it has become an issue and a task that they have complete Power Purchase Agreements which also specify the tariffs. In case of power projects, which are developed under the Competitive Bidding dispensation under Section 63 of the Electricity Act, the tariff is spelt out and the Law provides that such a tariff which emerges out of Competitive Bidding process shall be acceptable to the concerned Regulators. The Act also provides that under Section 63, the Central Government will notify Guidelines in accordance with which such competitive tariff will emerge. Implementation of this provision by the Central Government has led to two types of Bidding Process, which are now commonly known as Case-I Bidding and Case-II Bidding. Under Case-I Bidding, the distribution utilities are expected to float enquiries for project developers to Bid for power supply at a tariff and the criterion for selection, in such cases, is the minimum tariff offered by the Bidder. In this category of Bidding, it is the Bidder who has to choose the location of the project, the type of the project, the fuel etc. What the distribution company is interested in is the price at which the Bidder promises to supply power. Under Case-II Bidding, it is the distribution company/group of companies which identify a project, with all the basic ingredients of the project put in place, and the Bidders are expected to quote the tariff at which they will develop that `specific project'. The famous Ultra Mega Projects initiated by the Ministry of Power in 2006, and a number of similar specific projects initiated by State Governments, are the examples of Case-II Bidding. In these projects, if the Government agencies have been proactively mitigating the pre-construction risk factors, in the manner as provided in the Guideline, and have rendered necessary hand holding, experience has shown that the developers have quoted very aggressive and competitive tariff. Examples of Case-I Bidding, however, have not been many, and the few that came up, have been facing different types of difficulties. This is because a number of issues which should have been taken into account by the State agencies to address the practical problems of the Bidders surfaced later. It is only a few weeks back that a more comprehensive Guideline on Case-I Bidding has been notified by the Ministry of Power and it may be expected that there would be more examples of Case-I Bidding now which would be floated.

How does a project developer respond, in a meaningful way, to a Tender floated by a distribution company to procure power under Case-I Bidding? It is here where the entire mechanics needs to be understood by the financial sector lenders. In order that the developer makes a realistic quotation on the price of power, he should have already done a number of things, which would include that he knows the project, the cost of land, the cost of equipment, the cost of financing and every other thing which has a bearing on the cost of generation of power. If we expect that the project developer will make a realistic Bid, win the Bid, enter into PPA and, therefore, presents all these to the lenders even during the initial process of loan discussions, we are not only being unrealistic, we are only reflecting that we are not aware that how a power project gets developed. It is this gap which is creating avoidable hurdles in the process of loan discussions and finalization. We need to recognise that a lot of expenditure would have to be incurred, and a minimum period of 12 to 18 months would be needed to complete various elements of initial project development activities, such as land acquisition, engineering, tendering, environmental clearance etc. to be able to prepare a tender to respond to Case-I Bidding. This preparation would also involve cost of funding and, therefore, lenders need to appreciate that they should come in this process quite early in the project cycle, enable the developers, atleast to a tentative Loan Agreement good enough for them to know in a conclusive way the cost of funding. What is, therefore, necessary is to create two lists of factors and conditions which (a) would be necessary for loan discussion and agreement and (b) for loan disbursement. We also need to appreciate that participation in tendering is not necessarily winning the Bid. A developer may participate in a number of tenders and his success rate would depend on the probability factor which would also depend on the number of players in the field, besides the most important element which is the price he quotes. Again, winning the Bid does not mean that the Power Purchase Agreement would be available the next day. It is a process and it takes time. Anxiety of lenders may be genuine but equally important is the need for our appreciation of the mechanics of Bidding, the sequence of events in the entire process and the lead time that each event might require. I am aware of a number of projects which are facing difficulties in financial closure on account of lack of appreciation of these issues.

I have the following suggestions to make Case-I Bidding happen and succeed. They are outlined below:

  1. There is a need to discuss with the project developers on the Guidelines for Case-I Bidding. A little bit of amendments here and there might make the process workable and smooth. It is good that in the whole country more than fifty companies are in the process of developing power projects from the private sector group. Most of them are thinking in terms of developing part of their capacities as merchant and balance to respond to Case-I Bidding by various States.

  2. Ministry of Power may prevail upon and co-ordinate with the State Energy Departments that the State Distribution Utilities or an agency on their behalf should float enquiries at the earliest under the Case-I Bidding Guideline, just as they need to also offer projects under Case-II Bidding route.

  3. Central Electricity Authority and Power Grid may facilitate consideration and decision on requests for Open Access on transmission systems. Here, a more pragmatic approach would be needed. Unless the developer finally knows which distribution company, under Case-I Bidding, is going to purchase the power from his project, he may not be able to exactly specify the destination. In the last few months a positive development has already happened inasmuchas the developers are now expected to specify the Region of power supply rather than the State of power supply. As the development process goes along, flexibility to change the destinations so long as it does not lead to idling of transmissions systems could also be provided.

  4. The most important role would be that of the lenders. They should consider entering into discussions for Loan Agreement, let the developer know the cost of funding so as to firm up his approach on pricing the Bids, sign the Loan Agreement and in select cases even make initial disbursement, if the lenders are convinced that the cost of power is within such a range that its sale may not be an issue. This needs considerable shift in the present approach of lenders. I strongly recommend such a shift because electricity market will have much larger demands and if the cost of power is within certain limits, there shall be no difficulty for marketing such power.

  5. Obviously developers cannot expect the roles of Ministry of Power, CEA, Power Grid and Lenders to be played by them in the manner suggested above, unless they also play their own constructive and positive role. All the above agencies should get convinced about the seriousness, commitment and capability of the developer. With certain degree of flexibility and proactive approach, developers should be able to tie-up the entire equity requirement. It is worth mentioning that expectation of lenders that a developer should be able to organize entire equity requirement from his own resources may not be reasonable, because it doesn't happen in any sector.

  6. Another important issue which requires appreciation by lenders is the need for electricity market development. Unless we allow a certain proportion of the capacity of the plant being developed now as merchant capacity, not blocked with long term PPA, and allow their transmission to different destinations under the Open Access dispensation, electricity market will not develop. A good beginning has been made by allowing the developers, under the Hydro Power Policy, to keep 40% of their capacity outside the long term PPA. Similar consideration should also be allowed by the lenders while finalizing the Loan Agreements with developers.

Another important issue which has emerged is about the legality of procurement of power by distribution utilities only through Competitive Bidding process as prescribed in the Electricity Tariff Policy. There are two schools of thought. According to one, Tariff Policy is a statutory document as prescribed under the Electricity Act. It enjoins upon the distribution companies to purchase power on the basis of Competitive Bidding and the only exemption which has been made is for Government companies, and that too upto January, 2011, after which PPA's even with Government generating companies will have to be on the basis of Competitive Bidding. This opinion is based on Section 63 of the Electricity Act and the connecting provision of the Tariff Policy (Para 5.1). Section 63 of the Act prescribes that if the tariff has been determined through transparent process of Bidding, in accordance with the Guidelines issued by the Central Government, the same shall be adopted by the Appropriate Regulatory Commission. It is under this provision of the Act that the Central Government has issued Guidelines for Case-I Bidding and Case-II Bidding.

The second school of thought does not contradict the modality of tariff and finalization of PPA on the basis of tariff determined through Competitive Bidding. But, it opines that Section 63 does not take away the provisions of Section 62, under which the Regulatory Commissions have been empowered to determine the tariff in accordance with provisions of Electricity Act for supply of electricity by a generating company to a distribution licensee. Obviously there is considerable strength in this argument. We need to test legally the provisions of Para 5.1 of the Tariff Policy. It appears that both Sections 61 and 62 co-exist in a harmonious manner. The only difficulty that will arise would be the manner in which the Commission will fix tariff and the most important issue would be the determination of the capital cost. In this regard, it appears relevant to mention another very important and powerful provision of the Act in Section 62, which says that appropriate Commission may, in case of shortage of supply of electricity, fix the minimum and maximum ceiling of tariff for sale or purchase of electricity in pursuance of an Agreement, entered into between a generating company and a licensee or between licensees, for a period not exceeding one year. Obviously determination of tariff, as it is being done at present for the Central sector and State sector generating companies, may not be very easy for the private sector companies. But, based on these benchmarks for different types of power projects, the tariffs could be specified by the appropriate Commissions, within which the distribution companies may be permitted to finalise PPA's with developers. This is just an outline of a framework. Its complete structure will need to be fine tuned. Ministry of Power and Forum of Regulators could deliberate on this for an appropriate line of action. In case required, even a clarification on the Tariff Policy could be issued after necessary approval by the Cabinet.