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Indian Power Sector: Investment Opportunities (Part-II), Shri R V Shahi, Former Secretary, Ministry of Power

Current Concerns of Investors

Last week, I covered the "Presentation on Indian Power Sector : Investment Opportunities", that I made in the "Asia-Pacific Power, Energy & Coal Conference 2010" organized by Macquarie at Hongkong on June 28, 2010. I had not covered in that Article the various concerns which were raised by the investors during several one-o-one meetings I had with them. In this paper, I wish to cover these concerns and the response that I gave:


Most of the Investors and Research Analysts expressed concern about the mismatch of fuels for the massive capacity additions that are happening and are in the pipeline.

It is true that even at the existing level of power generation, availability of coal has emerged as a critical issue. It is reported that more than 15 power stations are running at highly critical stock levels of less than seven days. However, the following initiatives and actions, would, it is felt mitigate these concerns.


The power utilities are now fully conscious that part of their coal requirements have to be met through imported coal. In fact, blending of Indian coal with about 20 to 25% of imported coal is a reality.


With all the problems and inadequacies of domestic coal production, we must also remember that the coal based thermal power plants in India have been regularly improving their Plant Load Factor. More than three dozen power stations in India are performing at Plant Load Factor of about 90%. The average PLF itself is about 80% which is quite impressive.


It is true that unlike power sector, reform in coal sector has been lagging far behind. The sector needs to be opened up. But, we need to recognize that the second best course of action has been taken by way of substantial streamlining and liberalization of Captive Coal Block Policy. Several power project developers, both in public and private sectors, have been given coal blocks. Once, production starts in these coal mines, significant addition to coal supply could be expected beyond what public sector coal companies would produce and supply.


Coal India itself is likely to undergo transformation and they could be expected to provide a much higher growth rate in coal production than they have been able to deliver so far.


The recent announcement by the Ministry of Environment and Forest, declaring 48% of coal mines having forests, as "No-Go-Area" can jeopardize the ambitious power sector expansion programmes, which are mainly based on coal based thermal power projects.


Indeed coal will continue to be the most dominant fuel for Indian power sector. In spite of priorities given to hydro, nuclear, gas and renewables, if we look at the scenario, 20 year down the line, when India should be having the installed capacity of the order of about 800 GW, in 2032, coal based generation would still be almost 50%.


Therefore, the announcement of the Ministry of Environment and Forest is bound to be questioned. If India has to attain a double digit growth, which the Indian Prime Minister has been aiming at, power sector must move at 8 to 9% annual growth rate. If 48% of coal mines are banned for being developed, the economic growth rate target would be impossible to achieve. Ministry of Coal and Ministry of Power both have raised serious objections to the announcement made by the Ministry of Environment and Forest. Since the logic does not support them, it is unlikely that 48% of coal mines could be taken out of the development process. In view of resistance from different quarters, it would be reasonable to expect that Ministry of Environment and Forest may be asked to re-examine their stand.


Naxal Movements are getting aggressive. Their presence and actions are mostly in coal belt areas. Obviously, these movements may hamper not only the coal mines development activities, but also construction of power projects.


At present, after commissioning of about 22,000 MW of power project capacities in this Plan, spread over different parts of the country, additional more than 115,000 MW of projects are under construction. So far, Naxal Movements have not affected progress in these projects.


As a matter of fact, development activities including coal mining and power projects could be a good answer to the problem of Naxal Movement. Once huge economic activities are undertaken in these areas, and these generate employment opportunities, the mindset of people may change. Already there is a realization among the policy makers that while Naxal Movements have to be handled as a law and order problem, but simultaneously the grievances of these people, mainly arising out of economic deprivation, also need to be addressed. Such a realization is likely to lead to satisfactory outcome in medium to long term. Economic activities like mining and power projects, and associated numerous economic activities, would help mitigate these problems to a great extent.


At the same time, the importance and likely impact of these movements have to be taken seriously. Policy makers as well as project developers have also to reorient their thinking to ensure that local population must see direct and indirect benefits coming out of project developments. The approach towards rehabilitation, resettlement and involvement of people in project development has to be restructured in a manner that people start identifying with these projects more positively.


Large number of project developers are setting up merchant power plants. They are projecting revenue and profit on the basis of ambitious price ranges. Sustainability of such prices is doubtful.


The whole idea of merchant power plant, which was announced by Ministry of Power in 2006, was to facilitate electricity market development. It was recognized that long term PPA's do not allow appropriate price discovery nor do they provide a good framework for market development. Merchant power plant capacities, away from PPA's, would increase the proportion of Power Trading through Trading Agencies, Power Exchanges and Bilateral Arrangements.


A number of power project developers felt that the prices at which they could sell power in situations of extreme shortages could be assumed to be sustainable levels. I have been maintaining that the price range for merchant power will be significantly higher than the price range for power transacted through long term PPA. But, any assumption of excessive price would be unreasonable. It is true that under merchant power dispensation, the price has been in the range of Rs. 6 to Rs. 7 per Kwhr, but as the proportion of merchant power increases, the price will go down. We may assume the difference, at the most, in the range of 30 to 50%. Thus, if the normal price is about Rs. 3, the merchant price could be Rs. 4 to 4.50 per Kwhr on a sustainable basis.


This itself is a reasonable upside on the profit margin. There could, however be, occasions that in shortage seasons of extreme summer and winter, the price range could be significantly higher, thus, adding further, to the profit margins.


The pressure from the power sector, in the last few years, on power plant manufacturers has led to expansion of manufacturing capacity in BHEL as well as setting up of new equipment manufacturing facilities. But, inadequacies on construction and erection infrastructure continues to be critical.


Three years back, the manufacturing capacity of BHEL was just 5,000 MW per year. The spate of orders and the interest of private sector became so massive that not only BHEL undertook the expansion of their factories, but four new agencies have come. At present the manufacturing capacity has crossed 10,000 MW and in next three years it might cross 25,000 MW per year.


Expansion of not only power but, in fact, of the entire infrastructure sector has led to serious inadequacies among the construction and erection agencies. Power sector, including the manufacturing group, is responding to this challenge by (a) setting up of new training centers, (b) encouraging new construction and erection agencies to come up, (c) expansion of existing construction/erection companies and, (d) main manufacturers are expanding their commissioning teams in a big way.


The Central Electricity Regulatory Commission is contemplating Price Capping on Power Trading through Trading Agencies and through Power Exchanges. This might go counter to the efforts on market development.

No doubt, the CERC has issued a discussion document. But, there are a number of reasons why it should not be done. These are outlined below:


It has been seen that in FY 2009-10, as compared to the previous year, average prices have come down for bilateral trade from Rs. 7.31/kWh to Rs. 5.26/kWh and for power exchange from Rs. 7.49 /kWh to Rs. 4.99/kWh.


Since prices are showing downward trend, the question arises whether it should be really a matter of great concern, and whether it is the right time to look for such a market intervention. My view is that we should not get over alarmed.


It is heartening to note that prices have come down in both the platforms, bilateral and OTC. It is also observed that for procuring 5% of the total in the short term electricity, utilities had to incur a cost of 6.83% of the total which again shows that there is nothing alarming, realizing that short term power option is used by utilities sparingly under distress situation.


It is also important to note that cost of procurement by utilities, which was 8% during 2008-09 has come down to 6.83% during 2009-10. In view of this, I do not think that these figures support intervention being contemplated.


Power sector reform almost hit a dead end in 2000-01. We do need to be conscious of the fact that we have reached this stage of development with almost a decade of trials and tribulations. Power market has generated enthusiasm which is reflected in the investment coming forward in the power sector through private developers as well as by resource rich States.


Predictability of regulation is a sine-qua-non for continued and renewed investment interests. The proposed intervention in the market may achieve pretty little but may give a wrong signal to the investors. Therefore, this intervention is avoidable.


One would like to cite the example of telecoms, where mobile call charges were excessively high in the beginning, but with large investments and rising competition, call rates have come down drastically and consumers have finally benefited. We need to create congenial and facilitative framework to allow similar situation in the power sector. As the volume of power in short term market increases, prices would stablise.


One worried last year when prices in power exchange touched Rs. 17/kWh. In such an alarming situation, the Commission may consider some sort of circuit breaker arrangement. Immediate intervention in such situation for a few days will lead to a balancing effect.


In sum, it needs to be emphasized that this intervention is avoidable. Situation has improved and is well under control. CERC may keep the option for "Circuit Breaker" approach, to control volatility, for short durations, in case needed.


Distribution sector reform, which received a lot of attention during the Tenth Plan, seems to have gone into background. As a result financial losses of State distribution companies, as a whole are mounting. Sustainability of large scale investments in power generation and transmission may be doubtful unless distribution reforms are seriously implemented.


By the year 2001-02, State Electricity Boards were not able to pay to the generation and transmission companies more than 75% of their bills. This led to a situation of even companies like NTPC not being able to generate internal resource to take up their expansion programmes.


Serious and definite reform initiatives were launched and implemented by the Power Ministry across the country. Within couple of years, the payments by State Distribution Utilities to generators and transmission companies rose to almost 100% of the bills. This has continued for last seven years. There is no example of any default. That is precisely the reason that the Ultra Mega Project initiative, which required investment of the order of $ 4 billion in each project, got responded by developers without any Government guarantee as payment security mechanism.


Of late, financial losses of State Distribution Utilities have started rising and it is indeed a cause of concern. But the good news is that distribution reform is receiving renewed attention in the Ministry of Power. Shortly we should be seeing actions which will bring back distribution reform agenda as a central theme of power sector reform.