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Issues in Financing of Private Power Projects, Shri R V Shahi, Former Secretary, Ministry of Power

It has now been established beyond doubt that the type of expansions of power generation capacity, and associated transmission capacity, that the country is targeting to achieve, would require not only public sector organisations to fund and execute them, but also private sector involvement will have to be increased substantially. Without this, only public sector resources would be unable to meet these targets. Post 1991, when the liberalised economic policies were put in place and also the Private Power Policy was announced, we lost almost one decade when these Policies were being tested through trials and errors. For the power sector the decade of 90's can easily be called as the decade of lost opportunities. We may also treat this period, in a more positive way, as the period of learning curve, though somewhat longer. During this period, the meager outcomes of less than enthusiastic response in a concrete and effective way led to a very useful learning and that was that unless the sector was radically reformed and restructured, it was not amenable to any meaningful private sector investment. Fortunately, the first decade of the 21st Century saw emergence of series of legislative and policy initiatives starting from Electricity Act 2003. As predicted, effective private sector response has come back. In the whole decade of 90's, we could hardly get additional private sector investment for not more than 7,000 MW. Today as predicted, in addition to almost 23,000 MW private sector capacity, which has risen to 16% of the total capacity, new projects under execution by private sector would contribute as much as about 22,000 MW, 27% of the total projects under implementation aggregating to about 81,000 MW. When implemented in next two to three years, we will have more than 40,000 MW capacity under private sector. These factual details are necessary to be indicated to highlight how private sector response has changed from almost nil in 2001 to almost every private business group aspiring to become a large player in the power sector. We have to cultivate this emerging thrust and interest.

Apart from a number of other issues, such as land, water, transmission system, environmental clearance, fuel etc. which also become constraints in varying degrees in different projects, one of the other important constraints relates to financing of private sector projects. Other issues have been discussed, and would be discussed in other papers. In this paper, I propose to cover the issues concerning financing of private power projects. Infraline Energy organised a Round Table on 4th August, 2009 and I had the opportunity to co-ordinate the discussions. We had three important Presentations - one from a major private player viz. Lanco represented by its Director (Finance) and two from the financial institutions viz. Power Finance Corporation represented by Executive Director and IDFC represented by Vice-President.

Let us look at the perspectives of the private developers first. These are outlined below:

  • There are serious lending mismatches. Lender's expectations from project developers have considerable disconnects from the ground realities. While on the one hand we are talking of market development, creating capacities on merchant plant basis, lenders expect, as in the past, Power Purchase Agreement for entire capacity.

  • Arrangement for Open Access on the Central Transmission or State Transmission System is another challenging task. In case of public sector generating companies, off-take of power and Power Purchase Agreement is a routine affair because of certain set pattern of allocation of capacity and finalisation of PPA. Such an approach is not, and perhaps cannot be, available for private sector projects. Therefore, any expectation on the part of lenders on these lines can only make financial closure exercise not only lengthy but also tedious and complex and perhaps even unworkable.

  • States, particularly the coal bearing States, have started expecting and demanding unreasonable concessions and benefits such as free power, power only on payment of fuel cost, premium in terms of cash for the State Government, development of a number of infrastructures with huge costs etc. These are making the project viability more difficult and, therefore, financial closure a more challenging task.

  • At the stage the project is posed to lenders, the cost estimates are based on studies and investigations. They do undergo changes on account of variations between assumed parameters in the project reports and ground realities during execution. Cost of land may go up, cost of rehabilitation and resettlement may increase, cost of construction materials invariably go up, based on nature of competitive tendering even cost of equipment may vary from the estimates. Quite often lenders become insensitive to such inevitable differences between the cost estimates and the actual costs and suggest that variation should be fully borne by developers.

  • Another reason for escalation in the capital cost of the project would be the rising interest rates, with inevitable increase in the interest during construction. Therefore, it is necessary that lenders should appreciate the reasons of increase in estimates of project cost beyond the control of project developers, which may also include unpredictable geological surprises in cases of hydroelectric projects.

  • After several years of indifference, a number of private business groups, which have many other business interests, have decided to get into power sector in a big way. This has been a very positive development. But, if constraints like exposure limits on the concept of group capping are enforced, it would be difficult to execute a number of projects. What is needed is to tap profitably the interests of private sector, which have got created, to maximise capacity additions, and for doing so the lending exposure limits for various business groups need to be reviewed.

  • Similarly, sectoral capping, which determines the limits on lending to power sector, which any financial institution and bank has to comply with, has emerged as one of the major financing constraints. No doubt, this limit was marginally enhanced sometime back, even the revised limit is totally inadequate if projects under execution have to be completed. We need to recognise that power sector, within the infrastructure group, constitutes almost 50% of the capital expenditure estimates. Therefore, sectoral capping should generally correspond to this proportion and should be atleast 50% of total funding by banks and institutions to all the infrastructure groups including power.

  • Tenure of loans is another important issue. Particularly for hydroelectric projects, gestation is long and capital cost is comparatively larger. Even in thermal power projects, the depreciation allowed by the Regulatory Commission requires a longer tenure of loan to meet the debt service obligation. Indeed, in the last few years, there have been some improvements in the loan repayment period, but there is a need that the uniqueness of this sector is recognised and the tenure is increased to 20-25 years.

The Presentations on behalf of the financial institutions, by the representatives of IDFC and Power Finance Corporation, highlighted the concerns of lenders in the context of weaknesses in the power sector. The important points made by them are outlined below:

  • We all need to recognise and appreciate that financiers are not expected to be risk takers as developers are. Lender's returns on their fund are known and are within limits. Developer's returns could be much more and, therefore, their risks also are expected to be more.

  • Financiers mobilise fund at a cost and, therefore, their capability to fund projects get determined largely by the terms and conditions and constraints within which they themselves mobilise resources.

  • In the case of power sector, while the promoters expect much higher returns than the lenders, the fact of the matter is that the funding exposure, by lenders, in a power project is as high as 70%, and in some cases even upto 80%, of the project cost. Therefore, the care and caution which the lenders try to exercise have to be viewed under the above background.

  • While in the cases of other sectors, there is flexibility in respect of offtakers, in the case of power sector such a flexibility is rather limited. This single factor changes the character and dimension of risk altogether.

  • Many of the concerns about the successful implementation of projects are similar to what is being experienced by developers. These include problems relating to land acquisition, inadequacies in the transmission systems, uncertainties and delays in decisions about grant of Open Access, interventions by a number of State Governments demanding allocation of power, or free power or power just at variable cost. Many a time these factors lead to delays in completion of financial closures.

These Presentations, highlighting concerns of developers on the one hand and perspectives of the lenders on the other, were followed by detailed discussions, questions and answers. These also revealed that financing of power project is not only constrained on account of the debt portion of funding, but in many cases even equity funding will need to be organised. Expectation of lenders in the past that promoters should be able to organise the entire amount of equity may need to be revisited. It is not very usual, in any other sector, that promoters mobilise the entire equity. Funding exercise from the financial sector, therefore, needs to focus and provide assistance, both for lending as well as for equity to some extent.

Conclusions of this Round Table could be summarised as below:

  1. There should be a clear list of conditionalities which should be expected as conditions precedent to loan finalisation and agreement, as distinct from conditionalities which should be precedent to disbursement of loan.

  2. At the stage the promoter approaches the lenders with the DPR, there would be a large number of issues which would have been initiated and would have made only some progress. These would include identification of site, some initial work on land acquisition, finalisation of Terms of Reference (TOR) for environment studies, application for fuel linkage and some progress thereon, application for grant of Open Access and some progress thereon etc. These should be generally sufficient for initiating discussions on financial closure. Expectations for completion of any of these milestones at that stage would be impractical.

  3. As the financing discussions proceed, there would be progress on each of the above aspects of project development. By the time financial closure has to happen, sufficient amount of land would have been acquired, environmental clearance would have been obtained (or very close to getting it), clarity on grant of Open Access (or very close to getting the decision) on the same would be available.

  4. In the Case-I Bidding, Power Purchase Agreement can be made only after the developer is in a position to know the cost of funding and thus is able to Bid a reasonable tariff. Therefore, PPA cannot be a condition precedent to financial closure. In fact, it can facilitate PPA. At the most, PPA could be a condition precedent to disbursement.

  5. The way electricity market is now being proposed to be developed, lenders need to appreciate that a good portion of the new capacity has to remain outside the preview of long term PPA. Unless this happens, market development will not be possible. Around 60% of capacity on PPA and 40% on merchant basis could be a good guide for financial closure. In cases of smaller projects (less than 1,000 MW) even larger proportion on merchant basis could be considered.

  6. The recent notification by the Central Electricity Regulatory Commission is a step in the right direction and addresses greatly the concerns of both developers and lenders in the matter of grant of Open Access. The facility of transmission of power to a Region, rather than to a specific State, which was required earlier to be indicated by the developer, would provide a lot of relief to the project companies. Similarly, the procedure for grant of Open Access has also been streamlined.

  7. Keeping in view the likely mismatch between schedule of commissioning of power project and of the coal block, the approach of the Coal Ministry to provide tapering coal linkage to specific projects on merit, should be adequate to address the concern.

  8. Interconnection of transmission line upto pooling point of the National Grid, as decided by the Regulatory Commission, addresses greatly the uncertainty about evacuation of power.

  9. Cost increase on account of reasons beyond the control of the developers would be a reality and should be positively viewed positively for funding rather than this becoming a very lengthy exercise.

  10. The issues which will need to be considered and decided include - (a) extending the tenure of loan, (b) enhancing the exposure limits for power sector, (c) increasing the exposure limits for business groups, (d) accessing long term funding through insurance companies and provident fund trusts and organisations. These are valid issues and Ministry of Power may need to pursue, so that satisfactory resolutions of these lead to relief to a large number of projects.

  11. A number of project developers will need equity support. Organisations like Power Finance Corporation, Rural Electrification Corporation, IDFC, IIFCI, PTC etc. should consider providing equity support to good projects. These organisations may also think of creating platforms for raising funds for equity investment. Many of them have already started doing this.

Power sector continues to be a good growth story. Given the financial support on the lines suggested in this paper, all the projects which are already off the ground and those which are in the pipeline could be expected to proceed smoothly. These dispensations would also go a long way to further inspire and enthuse other project developers. Growth in power sector, which has gained good momentum, is a continuing phenomenon. It would be important to dynamically keep reviewing the concerns and obstacles so as to provide remedial measures for successful development of various projects.