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

Financing Issues in Power Sector: Investor's Concerns and Response
[R V Shahi's Weekly Column for Infraline, May 11, 2009]

Part-II

In my last Weekly Article, I had covered seven questions posed by a group of investors and had attempted answering these issues. There were altogether fourteen questions. In this part, I would attempt to answer the remaining seven questions.

viii.

A large number of private players who have been allotted coal blocks, have plans to sell power on merchant basis and thus capture huge profits. Do you think that the Government could go ahead and try to cap the selling price of power from these projects?

Those of you, who have been covering power sector, would recall that when the Ministry of Power introduced, towards the end of 2006, the concept of merchant plants, we had organised a large Conference with the likely developers with a view to fine tuning the approach on this subject. One of the concerns that they had was in relation to fuel linkage and coal block allotment. Accordingly, while evolving the approach of the Coal Ministry on coal linkage as also coal block allotment, these concerns were kept in view. Another area was in relation to evacuation of power and, therefore, Open Access on the transmission system. Normally, for the generation capacities which are developed on the basis of long term Power Purchase Agreements, the transmission systems are also tied up and planning and development of such systems is relatively easier. In the case of merchant capacity, since the likely destination of power is not known, planning for transmission is indeed a challenge. In the Working Group on Power for the Eleventh Plan, we made a clear and specific recommendation that we should plan for transmission of such power and, therefore, sufficient amount of cushion should be provided in the Transmission Schemes. The objective was that atleast 15%, if not more, of the total power supply should be aimed at, in a period of next five years, to be away from long term Power Purchase Agreements and should be traded on merchant basis. This would facilitate development of a healthy electricity market. Central Electricity Authority and Power Grid (CTU) are already working with a provision of 30% additional transmission capacity to take care of both maintenance requirements as well as movement of power from merchant plants. At present the types of price signals that we are receiving from a very limited quantity of power which is being traded are, in fact, false signals. With less than 3% of power transacted outside the PPA arrangement and in view of shortage, the prices are on excessively higher side. The problem has been further compounded by the fact that charges for Unscheduled Interchange (UI) are also in the range of Rs. 8 to Rs. 10 per Kwhr, which has been primarily introduced to bring discipline in the matter of drawal of power to safeguard the Grid from collapsing. Once we have larger number of merchant plants with much larger proportion of power sold through arrangements otherwise than through long term PPA's, a greater degree of smoothening of prices will be achieved. No doubt, price of such power will be significantly higher than from plants which are on long term PPA's, but variations would be considerably different. I do not think it would be desirable for the Government to fix any ceiling on prices of such power. Better availability will automatically regulate the price, just as it has happened in the case of telecommunication sector.

(ix)

A large number of private players have been planning capacity on imported coal. Do you think that the continued power shortage will lead to a situation where merchant power prices will be determined by the price of imported coal based power?

Firstly, it may not be correct to assume that a large number of plants are proposed to be developed on merchant mode based on imported coal. It may be noted that the Ultra Mega Projects with capacities of 4,000 MW each, being developed on coastal locations, such as Mundra and Krishnapatnam, are on the basis of Competitive Bidding and they are linked with long term PPA's. Most of the coal based power projects being developed on merchant route are being set up based on domestic coal (through coal linkage or through allotted coal blocks). Some of them, particularly the smaller ones, are on the merchant basis, but most of them are planning only part of their capacities on merchant basis. It is also relevant to mention here that most of the lenders have not been very enthusiastic about total capacities of large power plants to be fully on merchant basis. They do insist that a substantial part of the capacities should be tied up through long term PPA's. When power market develops to a satisfactory level, when the level of confidence of lenders increases with reference to the risks in relation to payment for power generated, which get totally eliminated, lenders may find it more acceptable to fund even large projects away from long term PPA's. During the transition period, it appears, it will have to be an acceptable blend of PPA linked capacity and merchant capacity in the same plant. At this stage, it appears to me that if, at a particular project level, about 60% of the capacity is attempted through PPA, leaving the balance 40% for merchant trading, it would perhaps create a win-win situation both for equity investors and lenders. Under the circumstances, when larger coal based capacities would be from plants based on domestic coal than on imported coal, it is unlikely that the price would be driven by imported coal based power plants. Price will always be influenced, in so far as merchant plants are concerned, by demand supply consideration rather than by the nature or source of fuel.

(x)

In 2008, although traded power was only 3% of the overall power sales in the country, States like Maharashtra was buying - 7% of their power (by volume) and 18% of their power (by value) in the merchant market. Do you think the State distribution companies can continue to purchase such high power - i.e. Does the buyer of merchant power have the paying capacity?

Obviously, value wise the cost of power procured by State distribution companies through trading would be significantly higher in terms of proportion as compared to the percentage in terms of volume because normally traded power is being purchased in the range of Rs. 6 to Rs. 10 per Kwhr, as compared to the power through PPA which costs in the range of Rs. 1.5 to Rs. 3 per Kwhr. So long as the overall trading volume is an insignificant proportion, like 3% as at present, the price is excessive, as soon as the trading volume increases in next 3 to 4 years we can expect these to go down to the range of Rs. 5 to Rs. 6 per Kwhr and subsequently even lower. Regulatory Commissions have started recognising such procurements and therefore they do factor in the financial burdens caused on account of such purchases while determining the tariff for distribution companies. In a way, these developments are bringing about better awareness about the commercial working of distribution business and what is even more important is that this awareness is percolating from the top down to the working level functionaries, a development which is important for reform of the sector.

(xi)

Do you see CERC trying to regulate the merchant power prices by either (i) introducing a cap on a per unit basis (ii) Allowing central utilities to sell power on merchant basis?

Let me answer the second part of the question first. If central utilities wish to set up merchant plant or undertake expansion of an existing plant on merchant basis, they do not need any permission from the Regulatory Commission. As a matter of fact, NTPC has already started doing so. The issue is not whether central utilities set up merchant capacity or the private sector does so, what is important is that the power sector needs atleast 15 to 20% of the generation to be outside the purview of long term PPA, so that good electricity market develops. I do not consider the desirability or even the practicability of introducing a price cap for traded power. We have examples in other sectors in which demand supply gaps have led to high price, which, in turn, has led to investments thereby making available larger amounts of goods and services, ultimately leading to moderation of prices. As it is, a large proportion of power generation in the power sector is and would remain to be regulated. Deregulation of about 15 to 20%, which may have a magical effect to promote electricity market, will be a desirable approach. It will bring investments and once the present volume of 3% gradually moves towards 15 to 20%, the market itself will regulate the price behaviour.

(xii)

A large number of projects are coming up in the eastern belt. Do you see power evacuation risk in these projects?

The Ministry of Power, Central Electricity Authority and Power Grid are all aware that we have huge potentials of hydroelectric projects in the North-Eastern region. Similarly, Eastern Region has considerable amount of coal reserves, though there are coal reserves in West as well as some reserves in the South. So far as evacuation of power from Eastern region States is concerned, the problem is comparatively simpler. North-Eastern region, mainly Arunachal Pradesh and Sikkim, have almost 50,000 MW of hydro potential. Evacuating power from these areas is indeed a challenge because of very narrow right off way available near Siliguri in West Bengal. However, Central Electricity Authority and Power Grid have been working out and choosing the technologies of transmission which should be able to address this problem adequately. What is important, however, is that the project developers need to create better degree of certainty about the schedules of their projects, so that they are able to tie-up appropriate commercial arrangements with the transmission utilities to avoid any mismatch between commissioning of generation projects and readiness of the transmission systems.

(xiii)

These players are planning to sell directly to individual industrial customers through Open Access. What do you think would be Government's policy in this regard?

Open Access on transmission systems to supply power to distribution utilities is already a reality, because it was implemented right from the beginning of Electricity Act in 2003. Open Access on transmission as well as on distribution systems to supply power to consumers, as provided in the Act, had been compulsorily mandated to be implemented latest by January, 2009 by Regulatory Commissions. There have been mixed outcomes on this front. A number of suggestions have been made in the recent months. CERC as well as Forum of Regulators have been considering this issue now more seriously than in the past. Based on these developments, I do think that in about a year's time Open Access to large consumers should become a comparatively smoother affair. Cross subsidy surcharge has remained to be one of the major factors inhibiting better progress on this front. Electricity Tariff Policy 2006 has provided that latest by January 2011, the Regulatory Commissions should ensure that the band-width of tariff should be within + 20% of average tariff. This has started happening in many States and we can expect that by January 2011 a number of States, if not all of them, could have brought the maximum and minimum tariff within this range. Once this happens, the Open Access on distribution would get further encouragement.

(xiv)

Do you see nuclear power becoming a game changer in the next 5-6 years?

In the Electricity Policy (2005) and subsequently in the Integrated Energy Policy (2006), it has been clearly projected that nuclear power should be encouraged and its share in the total capacity should increase. At present it is less than 3%. By the year 2032, its proportion is projected to increase to over 7%. In the near term of 5 to 6 years, I do not think that it will constitute a significant proportion. More or less it would remain at around 3 to 4%. In terms of absolute capacity, it is about 4100 MW now, by the year 2020, it is targeted to rise to 20,000 MW, and by the year 2032 to about 60,000 MW, by when the total capacity is targeted to rise to over 800,000 MW.

These fourteen questions have covered a wide range of issues and concerns which investors have often been critically evaluating. On similar lines lenders also evaluate these concerns. In power sector 70%, in some cases even 80%, of the total capital cost is debt funded. These concerns, are therefore, valid from both investors and lenders perspectives. I have attempted to address these issues in the overall framework of policies and, wherever required, tried to project the future developments. I do think that this sector provides an unparalleled opportunity both for investors and lenders.

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