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Current Investors concerns about Power Sector, Shri R V Shahi, Former Secretary, Ministry of Power

Last Friday, JSW had organised a two day Conference on Steel and Power issues at their magnificent steel complex at Vijayanagar in Karnataka. Apart from the professionals of the two industries, a large number of investor's representatives were present. I had the privilege of addressing the Conference in the first Session alongwith Shri O.P. Bhatt, Chairman of the State Bank of India and Shri Sajjan Jindal, the Managing Director of JSW. I was expected to cover the power scenario in the country.

Since the participants consisted of, as mentioned above, the technical and other professionals from steel sector as well as power sector besides the investors, I briefly outlined the important aspects of the sector including demand - supply mismatch, initiatives to create additional generation capacities, legislative and policy reforms during the current decade, major constraints being faced in expansion of generation and transmission capacities, long term perspectives covering the 25 year period upto the year 2032 as brought out in the Integrated Energy Policy (2006), financial health of the electricity sector etc. I don't propose to elaborate these points, which were explained to the participants, in this article. What I propose doing in this paper is to discuss the important concerns of investors, which I dealt at length in my address. For doing so, I had done a quick exercise with a few friends while travelling to Vijayanagar in the aircraft. Through this brief brain storming, we identified a few current concerns of investors in power sector. And, it is these concerns which formed the basis of my articulation in major portion of my address.

  1. In the wake of so many power projects coming up, would there be excess of power supply? Would it then not affect profitability of project developers?

Indian power sector has got used, over last several decades, to capacity additions in the range of 20-25,000 MW in a Plan period of five years. Therefore, when with massive preparations undertaken during the Tenth Five Year Plan for Eleventh Plan, it was projected that a capacity addition of more than 70,000 MW could be undertaken and implemented, during Eleventh Plan, it was a surprise to all concerned. Now, when this has started happening, there are many who believe that we would have excess power and, therefore, it might affect the industry in the manner it affects other industries when there is surplus of steel, cement etc. My answers to such concerns are as follows:

  1. Power is not a commodity where supply follows demand; in fact, availability of power creates demand. If Indian economy has to grow at the rate of 9 to 10%, over next few decades, which is what is being planned, then availability of power has to grow at a rate of atleast 8 to 9%. In the Integrated Energy Policy, therefore, it was targeted that the capacity of about 130 GW as in March, 2007 should increase to over 800 GW by March 2032.

  2. China has been able to expand its power generation capacity, mainly in last 30 years, to more than 800 GW. Even then during this winter, in the situation of heavy snowfalls in several parts of China, the demand peaked so high that they had to do rationing of electricity. Even now China continues to add capacity, though it may not be at the same peak rate of 100,000 MW a year. Therefore, any apprehension that India would be faced with surplus power situation and that too in the near future would be based on a highly ill-founded and misplaced assumption.

  3. In the wake of global recession, whose impact was experienced even in Indian economy, though in a substantially diluted and marginal manner, our industries such as steel, cement, construction etc. did face the situation of excess supply which affected product prices and also profitability. Even in such a situation we had severe shortages of power supply in most parts of the country during most of the seasons. It would, therefore, take several decades when we can even think that we will have a power surplus situation and that power generating companies would have to be confronted with a situation of lack of demand.

  4. More than 50% of rural India, even now, does not have access to electricity, and those villages which have electricity connectivity, in many parts of the country, face load sheddings not in terms of hours but in terms of days and weeks. Rural economy cannot grow unless electricity connectivity is extended to all the places and electricity supply is made reliable.

Therefore, power project developers, equity investors and lenders should all feel fully convinced that in the electricity sector, the situation of supply outstripping demand is unlikely, atleast in next couple of decades. Occasional surplus during certain hours may be a different issue, but on overall basis the generating sector in this industry will need to produce at high capacity utilisation factor irrespective of the large capacity additions that are happening and are being targeted.

  1. Reforms in the power sector have indeed led to enthusiastic response from developers. Fuel supply, particularly domestic coal, has emerged has emerged a critical factor. Would the shortage of fuel not affect plant performance?

It is true that policy movements in the coal sector have not at all kept pace with the several legislative and policy initiatives which took place during current decade, in the power sector. It is also known that power sector is greatly dependant upon domestic coal industry. Therefore, lack of policy reforms in the coal sector definitely generates concerns and rightly so. However, the following facts need to be kept in mind while critically evaluating these concerns:

  1. Even though coal industry could not logically conclude the exercise on Amendment to the Act, which could have provided a more flexible approach and participation of private sector in the coal industry, Captive Coal block Policy was liberalised in a significant way, so that a State owned public sector power generating companies and private sector companies could be allotted coal blocks to meet the requirement of their power plants. This change in the Policy has resulted in allotment of coal blocks with aggregate reserve capacity of the order of 20 billion tonnes, equivalent to more than 80,000 MW of power generating capacity. During the initial years, there are teething problems faced by power project developers in development of these mines. Coming years will definitely witness significant in flow of coal produced in these mines

  2. Coal India subsidiaries are also organising to step up their expansion and production programmes, which could lead to a coal supply growth rate of the order of 6 to 7%. While definitely there is scope for improving further the working and efficiency of these coal companies, availability of fund for their expansion is not an issue. They have been assuring that they should be able to meet the requirement to the extent of atleast 70% of the power sector need.

  3. Power industry has been fully aware of the likely gap between the requirement of coal and the supply from domestic sources including from Coal India companies and from captive coal blocks. Therefore, import of coal has been duly recognised as a source of supply to supplement the domestic coal inputs. Over the years, preparations have included for handling coal imports development and augmentation of ports and further evacuation arrangements beyond ports. These issues have been fully captured and are being concurrently addressed. It is not to say that everything is fine and perfect. What is being suggested is that all efforts are being mounted to address the issue arising out of shortages of coal supply. On balance, we should feel that situation would be under control.

  4. As early as in 2004, in the Energy Coordination Committee (ECC), presided by the Prime Minister, it was decided that both public and private sector companies should be encouraged to acquire coal mines abroad. This process has already started yielding results - though modest now, may become significant in coming years.

  5. When the Ultra Mega Power Project Scheme was being conceived, consciously it was decided that a chain of coastal power stations, based mainly on imported coal should also be developed so that dependence of Indian power industry on domestic coal is partly reduced, and the problems arising out of mismatches between requirement of coal and supply from domestic sources are appropriately mitigated.

Thus, there is multiple strategy which has been put in place, and is being further strengthened, to address the issue of coal demand - supply mismatch.

  1. Large scale import of coal may lead to escalation of prices. Would it not impact the financials of the power generating companies?

The concern is genuine. But the following facts need to be kept in mind while evaluating these concerns:

  1. In the year 2011-12, if the capacities that are being projected get commissioned, the shortfall in coal supply is expected to be of the order of 75 million tonnes. However, since there could be slippages in the commissioning of certain power projects, this gap in the coal supply might be somewhat less. By that time, if the captive coal developers gear up and expedite production of coal, the gap could further reduce. In spite of all these, we may expect an impact on coal price for the simple reason that the quantity of coal being imported would be significantly higher than in the past. All such power projects which have long term Power Purchase Agreements do have the provisions for pass-through of additional cost of coal. Therefore, they need not fear any financial burden on them on this score. No doubt, there would be a marginal increase in the price of power, though it would be much less on the weighted average basis.

  2. For project developers on merchant plant basis these fluctuations obviously would be determined on market dynamics. It needs to be noted that merchant capacities have themselves been beneficiaries of market prices of power in times of shortages. While in certain situations they may have to absorb the higher cost of coal, in certain other situations such additional burdens would be more than offset by additional revenue on sale of power.

  3. In case of Ultra Mega Projects the price variation in coal has been duly taken into account in terms of the Power Purchase Agreement and the project developers do get compensated through an indexation mechanism which has been provided in the Agreement.

On balance, it is a conscious strategy that a part of the coal supply requirement should be met through imports. Even though India has huge coal reserves, the strategy suggests that it should be used in a manner that it lasts for generations. Inevitable implication of such an approach, in terms of price of coal from outside, has to be duly factored in. Indian power sector and Indian consumers have started recognising this reality.

  1. Transmission systems, in many cases have proved to be bottlenecks even in the past. With large scale expansion in generating capacity, would this problem not accentuate even further?

Commensurate development of transmission systems is a must not only for evacuation of power from generation sources but also for smooth supply through sub-transmission and distribution infrastructure. The concern is genuine. However, the following developments, which have taken place and those which are in the pipeline, should adequately address these problems:

  1. In the Working Group on Power for Eleventh Plan, it was recommended that the transmission system should have a cushion of 30%, so that besides meeting the requirements of generating projects, in which cases the customers are predetermined and accordingly destinations for power supply are also known, for such projects which are being developed outside long term PPA, the transmission should be able to cope with the requirements. This has been accepted as an approach in transmission systems planning and both Central Electricity Authority and Central Transmission Utility, viz. Power Grid have already started working on this.

  2. Unlike in the past, the State Electricity Boards and State Transmission Utilities, in fact, the entire power sector, have now recognised the needs for rapid augmentation of transmission systems - National Grid, Regional Grid and State level transmission and sub-transmission networks. They have seen and experienced the impact of inadequate transmission capacity resulting in non-transmission of power, in many cases, even though power was available. This change in the mindset has facilitated quicker conclusion and finalisation of transmission system planning by CEA and Power Grid.

  3. Power Grid has been performing excellently and has come out with new approaches such as pooled transmission hubs in select pockets where power generated at various locations could be pooled together and transmitted through National grid across various States. In the recent months, Power Grid has also declared that from projects beyond specified capacity they would also be able to connect the transmission system right upto the power station.

  4. In the last few years of Power Trading and Power Exchange operations, it has been seen that by and large Open Access in transmission system, except for a few cases here and there, is being handled effectively. Transmission constraints, though experienced, have been reducing, and will reduce further when the transmission systems in the pipeline get completed.

  5. Just like Competitive Bidding for power generation projects to select developers, the exercise has already started in the area of transmission. Private companies have responded well to these tenders. Coming years will see transmission lines constructed by private developers in addition to those by Power Grid and State transmission companies. Another development in the last three years in this field is also relevant to be mentioned. Some of the developers such as Jindal Power and Adani Power have started developing large transmission systems linked to their power plants and extending upto National Grid and to the transmission systems of their customers.

Thus, there are a number of initiatives which have already been launched and are being implemented both in private and public sectors to substantially augment and expand the transmission network. These, it is felt, should be able to take care of the additionalities in generation capacities which have been planned.

  1. Price of power from merchant plant has been showing a declining trend. Will it not adversely affect the profitability of merchant power plant developers?

In the year 2006, Ministry of Power organised a Conference of developers with the objective of brain storming the prospects and possibilities of developing capacities on merchant basis. It was suggested that power market cannot develop unless a substantial amount of power is sold and purchased through dispensation beyond long term contracts. To address the concern arising out of declining prices of merchant power the following facts need to be analysed:

  1. Power Trading has remained confined to less than 3% of the total power supplied in the system. Obviously, the prices at which the Trading is done, either through Trading Licensees or through Power Exchanges, cannot be termed as price discovery. With such a low volume of power transacted, the rates are obviously outcomes of a distress situation. When the trading volume increases prices are bound to come down.

  2. The objective is that gradually around 15% of power in the system should be outside the long term PPA. When slowly the market reaches that situation the prices determined can be a termed as valid price discovery.

  3. In the past we have seen power being sold during certain seasons and during peak hours at rates varying between Rs. 8 to Rs. 10 per Kwhr. These are not price signals of any reliability for a long term investment decision.

Merchant power price will always be significantly higher than the price through long term contract. The difference, however, will not be of the types which we have seen sometimes in the past. In my view, if the PPA price is in the range of Rs. 2.5 to Rs. 3.0 per Kwhr, as at present, the merchant price might stabilise between Rs. 4 and Rs. 5 on an average. Any major deviation from this may be unlikely. Even with this, development of merchant plants, with risks which are obviously higher than those for PPA projects, is attractive enough and should be pursued.

  1. A number of project developers in the country are sourcing plant and equipment from China. There is a general apprehension about quality. How far these apprehensions are valid?

The following points are relevant to be mentioned:

  1. China has an installed a capacity of more than 800 GW, mainly based on the domestic plant and equipment.

  2. There could be manufacturers of Balance of Plants in China who could be producing high quality products and there could be others whose products may not be of that quality. In respect of Balance of Plant, therefore, one needs to identify the manufacturers of better quality and rating.

  3. In respect of boiler, turbine and generator, the major manufacturers have licensed technologies. In my considered view, there is no quality problem as such. Recently in a matter of three to four months, one of the Units commissioned by Adani Power, has been able to consistently perform at 95-98% Plant Load Factor.

  4. A word of caution, however, is necessary for long term contractual arrangement for maintenance and spares. Large project developers could perhaps insist on Chinese suppliers to set up repair facilities and also to stock critical spares, so that in times of needs urgent action could be taken.

If the price differential is favourable, there could not be any in principle reservation on Chinese equipment on the ground of quality as such. Appropriate arrangement for spares and local repair facilities could be a step in the right direction.

  1. If India wants to develop at the rate of 100,000 MW or more each Five Year Plan, would the domestic manufacturing capacity be adequate to meet this challenge?

Domestic manufacturing has indeed been a right concern. Many of the projects got delayed and continue to get delayed on account of serious delays in deliveries of plant and machinery. Till the end of Tenth Plan (2007), in spite of persuasions and pressures, the manufacturing capacity of BHEL remained at around 5,000 MW per year. The good point is that several positive developments on this front have happened. Following facts are relevant:

  1. Now the capacity of BHEL is more than 8,000 MW. In the next three years, we could expect more than 10,000 MW, in the next five years to more than 15,000 MW and subsequently to around 20,000 MW per year.

  2. Besides BHEL, three more large manufacturers are coming up. In the next five years each one of them should have a capacity between 3,000 to 5,000 MW.

  3. Therefore, after about five years, we may definitely expect an annual domestic capacity of about 25,000 MW. Similar expansions are also happening in respect of Balance of Plants.

These positive developments on the domestic manufacturing front supplemented by also import of power plant equipment should be able to adequately address the issue concerning supply of plant and machinery to take care of the massive expansion programmes of Indian power sector in coming years.

There were a few other concerns also expressed such as possibility of environmental regulation affecting the profitability of project developers, and possibility of a Carbon Tax. It was clarified that in the power sector where the need for investment will continue and it would be important to attract investors, it is unlikely that any policy decisions would be taken which will be adverse to the interest of investors. It is better to assume that Government will continue to provide policy initiatives which will attract investors rather than taking decisions which will be restrictive in nature and would discourage investments.