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Overcoming constraints in developing merchant power plants, Shri R V Shahi, Former Secretary, Ministry of Power

I have written a separate piece on the rationale of and need for development of Merchant Power generation capacities for developing electricity market. This concept has, over last couple of years, gained acceptance. A number of power project developers have also come forward, decided to take risk and set up power plants, not necessarily based on long term contracts for sale of power. There are, however, a number of constraints and issues which do inhibit the commencement and smooth execution of these projects. Before we highlight and analyse these constraints and also try to suggest remedies and actions, it may be important to address the doubts concerning the very concept of merchant plant.

In India power generation capacities have been developed, over the years, to meet the needs of the States by State Electricity Boards and their own generating companies. Therefore, right up to the end of seventies, power generating plants were developed to meet the captive needs of the State Electricity Boards which also had the responsibility of distributing power. Starting from the eighties, with the emergence of central generating companies like NTPC, NHPC etc., the need for contractual arrangement for purchase and sale of power between the Electricity Boards and these generating companies arose. The past practice, together with this type of approach, led to a totally protected and steel jacketed framework of commercial transactions on generation and sale of electricity. This was an antithesis of an electricity market structure.

Normally, in a market one has to have a number of suppliers of goods and services and customers have a choice to select. The mutual understanding of the two types of stakeholders and culture of competition regulates the dynamics of market behaviour. In such arrangements the scope for making investment purely on the basis of long term contract for procurement of goods and services, leaving very little for market to absorb, is rather limited. Many sectors in India had similar approaches in the past. Even if we take the example of the steel industry and its structure in the past, though investments in steel plants were not based on the long term contracts between likely buyers of steel and the steel manufacturers, the pricing structure was regulated. For the last many years now the steel industry operates without such external regulation and sails through the fluctuating domestic and global market conditions of demands, supplies and prices. Similar could be the examples in many other sectors. Power industry, however, remained far away from the features of a matured electricity market. As a matter of fact, it has not even started in a significant way towards developing a matured electricity market.

I have held the view that so long as any energy segment (power, coal, oil, gas etc.) remains under extreme shortage situation, regulation will be essential and things cannot be left totally to the market forces in such a transition period. However efforts have to be made toward creating such a market. Electricity Act 2003 aims at developing electricity market. There are a number of provisions and features in the Electricity Act and in the subsequently formulated statutory rules and policies such as National Electricity Policy, Tariff Policy that provide enormous opportunities to create ultimately a good electricity market which should have various features of competition, provide not only an opportunity to invest but a great scope to derive the benefit of competition for consumers. It is my considered opinion that obsession of different players in the electricity sector to confine to long term contract on purchase and sale through Power Purchase Agreement, covering a period of 25 years or so for the entire capacity, has been the greatest hurdle in evolution of electricity market.

Though the Act provides for Power Trading to be a distinct licensed activity and there are a number of agencies which have been given trading licenses, this instrument has hardly made any visible impact towards creating a competitive electricity market. In fact, the volume of transactions is so small (less than 3%) as compared to the total power supply in the system that to expect any reasonable contribution in evolving electricity market through trading would be unreasonable. One of the major causes of such small volume has been the insufficient amount of electricity, beyond long term contracted arrangements, to be used to develop market. Though National Electricity Policy provides for 15% of capacity for developing such a market, it is felt that even this amount may not be sufficient. In any case, even to reach the 15% level in the next 4 to 5 years when the total installed capacity would be of the order of over 200,000 MW, at least over 30,000 MW of capacity should be outside the long term contract arrangement.

Merchant plant has not been defined as such in any document. What is commonly understood is that if a project developer undertakes to set up a power plant which will be fully or partly outside the preview of long term contract on sale and purchase of electricity, it takes risk to develop such a plant, gets the financial closure done, such a plant or capacity could be considered in the merchant category. No matter, subsequently if the developer is able to tie up certain amount of the capacity of the plant under a medium or long term contract, still such a plant could be considered as a merchant plant. In the Competitive Bidding Guidelines for development of power project, as stipulated under the Electricity Act, the Ministry of Power has envisaged development of power generation capacities under two types of dispensations - (i) Case I Bidding would aim at inviting project developers to develop their own sites, identify the fuel and take necessary steps, including the initial steps, to set up project and offer bid for competitive price of power. This competition would aim at selecting a power project developer who quotes for the best price of power to the State Distribution Utilities or Private Distribution Utilities., (ii) In Case II Bidding, the distribution companies will be expected to identify specific project, location, fuel etc. and carry out the initial preparatory project management activities, and bidders would be expected to quote the best possible price of power from such a specified project. Ultra Mega Project initiated at the Government of India level and similar projects initiated in a number of States are the examples of option (ii). A number of tenders have also come for project developers to respond with reference to option (i). It is this option which will lead to development of merchant plants and developers, after tying up various initial inputs, would be in a position to put up their offers for sale of power to the distribution utilities and based on the competitive strength of their offers they may enter into short, medium and long term power purchase arrangements. A number of State Governments, particularly those States in which there are coal mines and also those which have hydro electric potentials, have been encouraging power project developers for setting up such power plants.

Recently, in last couple of weeks, I had the occasion to be associated with two important interactions on the subject of Issues and Constraints in developing merchant power plants - one at Raipur hosted by the Energy Department of the Government of Chhattisgarh on 23rd July, 2008 and another, the Monthly Round Table organised by Infraline Energy and IDFC on 6th August, 2008. In Chhattisgarh alone as many as 50 private project developers have shown interest and are working on developing power projects based on domestic coal, near coal mines, with an aggregate capacity of about 42,000 MW. This is in addition to the projects which are being developed directly by the Central and State Government agencies. Quite a number of people perceive that such a huge interest for such a large capacity is hard to believe that it would materialize into creation of additional generation power plants. Obviously this perception is based on the bitter experiences of 90's when a large number of project developers showed very strong interests to develop almost 50,000 MW of capacity but the enthusiasm faded and the country could not get more than 6,000 MW out of all such initial responses. Better examples of last 3 to 4 years, post the new Act and new Policies, have now demonstrated that the enthusiasm and interests are not only much stronger but, in fact, they are fructifying into concrete actions and a large number of projects are indeed coming up. The day long deliberations at Raipur with 50 and odd independent power project developers, mainly aiming at setting up major portions of their capacities on merchant basis, brought out a few relevant concerns and constraints, which if rectified would go a long way in quicker execution of these projects.

  • The most important of all the issues which these developers face relate to evacuation and transmission of power to the desired destinations which, to start with, are not known. Part of the capacities which will be contracted on a medium and long term basis with various State and private sector utilities on the basis of competitive bidding under Case I option, will be known only after sometime when these developers are in a position to evolve and compute a reasonable competitive offer. Before they do so, a number of things would have to be gone through such as freezing the location, source and methodology of drawl of water, arrangement for fuel and cost implication thereof, a reasonable estimate of cost of setting of the plant on the basis of competitive EPC or package contract offers, and above all cost of financing of a project. Unless these determinants are known, no reasonable assumption about the price of power can be made by the project developer to respond to Case I Bidding. It will be only a portion of the total capacity of the plant may be in the range of 40% or so that can be left for short and medium term transactions through trading particularly for large capacity power projects. Such projects may find it very difficult to have a financial closure done if they wished to keep the entire capacity under short term trading and no Power Purchase Agreement even under the Case I Bidding option. Smaller plants may do so for entire capacity on short/medium term.

  • Given the above situation, no doubt, it is a major problem for project developers to specify where the power has to be transmitted. Equally problematic it is for the Central Transmission Utility (CTU) and the Central Electricity Authority to plan the transmission system. Both have real problems. Yet, the issue has to be addressed and resolved. Reasonable assumptions to be made both by the power project developers and by the CTU/CEA will definitely lead to a workable solution.

  • In the Raipur meeting this issue was discussed threadbare. We had the advantage of the presence of Chairman, Central Electricity Authority,

  • Member (Power Systems), CEA, and Executive Director of Power Grid. Some of the conclusions which emerged go a long way to address the problems mentions above:

  1. For the 42,000 MW capacity which are to be developed in different parts of the State it would be necessary to set up Pooling Points at four or five locations which will be able to handle 6,000 to 10,000 MW capacity each.

  2. The power project developers may be expected to have dedicated transmission lines from their power stations to the Pooling Points. This can be done directly from the power station to the Pooling Point or through an appropriate network for group of power projects connected to the Pooling Point.

  3. For the dedicated network as mentioned in (ii) above, IDFC has offered that they could set up a Special Purpose Vehicle (SPV) in which, as an option, the concerned IPP could also take nominal equity stakes. IDFC would be prepared to take the initial risk to create the first tier of transmission infrastructure upto the Pooling Point.

  4. The second tier of the transmission system would emanate from these Pooling Points and connect upto to the regional grids.

  5. The third tier would form part of the National grid system and can take the power to the desired destinations.

  6. Another important conclusion was that keeping in view the relative positions of power shortages, the power project developers could, to start with, indicate the likely region (and not necessarily the specific State) to which power will flow with approximate quantum of such flow. It relevant to mention that so far Power Grid has been asking, as a part of the application for Open Access, a specific State to which the required quantity of power has to be transmitted. This alteration in the approach, asking for the region to which power will flow than the State to which it has to be carried, will lead to considerable relief to the intending project developers.

  7. Power Grid has also agreed that during the initial period of 6 to 8 months the project developer could fine tune the estimated quantity of power flow as also the region of flow.

  8. It was also agreed that in an area where a large number of projects are coming up, like in the State of Chhattisgarh, Power Grid could expect a concessional rate of fee from each of the project developers for initial study on the transmission system.

  • The above dispensations on the most vexious issue of transmission of power in a totally uncertain situation will provide the greatest relief and will take away the hurdles in proceeding forward on project development.

  • The next issue which is somewhat similar, but not as difficult, relates to water supply systems for different power projects. Here again, there is a good possibility of creating, on a common basis for a group of projects, the water drawal systems when the source of water supply is common. Perhaps all the project developers could integrate their resources and attempt such an approach. IDFC or any such other organizations could also step in.

  • A number of power project developers have been allotted coal blocks - some of them individual coal blocks while many others joint coal blocks for group of projects. A coordinated approach among the developers of power projects could lead to a more optimal solution. Such an approach could be implemented through a joint venture on their own or IDFC could consider rendering necessary assistance through a separate instrument (SPV).

  • Coal transportation from these coal mines to the power plants provides another important opportunity where a pooled arrangement could be a much better and economical solution than each developer trying to develop its own railway transportation system. In many cases Indian railways could also be approached to create railway corridors to meet the needs of different project developers.

  • It was also suggested to the State Government Energy Department that though it is expected of the project developers to mobilize their resources and effect land acquisition so as to make targeted progress from their projects, facilitation by the State Revenue Department and the local State Administration will be a great help and such an assistance can really make a difference in expeditious acquisition and possession of land. This may be true both for power plant as well as for coal mines.

  • Another important issue which could not be deliberated at length in the Raipur meeting but was discussed in the Round Table on 6th August at Delhi, relates to grant of benefits and concessions to merchant plants at par with Mega Project Scheme. As we know, thermal projects of capacities of 1,000 MW and higher and hydro capacities of 500 MW and higher, get the benefit of exemptions from Custom Duty, Excise Duty etc. under this Scheme, provided power is supplied to more than one State, the equipment procurement is done through an international competitive Bidding and further provided that the States concerned where electricity is to be supplied have agreed to privatize distribution of electricity in cities of population of 1 million and more. Subject to these, Power Ministry has been authorized to give certificate for grant of Mega Project benefits. It is also understood that the Mega Project Scheme, at various stages has been under discussion for a review to cover more projects and to relax some of these conditions. The point that needs to be appreciated that even if the Mega Project Scheme is not amended - the amendment needs approval of the Cabinet - even within the framework of existing Scheme the benefit could be extended to merchant plants of 1,000 MW and above (thermal) and 500 MW and more (hydro). The matter concerns a realistic interpretation and not formulation of a new rule. As regards privatization of distribution in large cities, this issue has already been settled in the Power Purchase Agreements of NTPC and even of Ultra Mega Projects. Invariably merchant plants will supply power to more than one State which will be clear from the applications for Open Access that they file with the Central Transmission Utility. The third point relating to international competitive bidding will be an undertaking given by the project developers and in any case that will constitute a condition of the certificate that the Ministry of Power would issue. Therefore grant of Mega Project benefit is more a matter of procedure, of a practical interpretation, rather than of formulating a new policy.

  • Unless the financial sector takes the emergence of merchant plant as a necessity for creation of electricity market and looks at this development in a more positive way, the initiative will not take off. For Case I Bidding these developers need to know the cost of financing, without which no reasonable bid can be offered. Therefore based on the initial inputs, even though finality has not been arrived at, the lenders should consider loan negotiations and finalization. No doubt, disbursements of loan could be predicated to a number of specific certainties to realistically mitigate the risks. Trying to find specific answers to all possible questions right in the beginning and making these answers as preconditions even to loan finalization may render these whole exercise unworkable. If a realistic and practical approach is followed, there is no doubt, merchant plant initiative could make its meaningful contribution, in next 3 to 5 years, in developing a good electricity market.