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Response to Investor's Concerns in Indian Power Sector, Shri R V Shahi, Former Secretary, Ministry of Power

Last week, CLSA organised an International Conference on 2nd to 4th November, 2009 at Gurgaon. This was one of their regular Annual Events and the invitation to me was to be a Keynote Speaker at the 12th CLSA India Forum. CLSA India is a large institutional equity broker and is a part of the Credit Agricole Group, France. Headquartered at Hongkong, it operates in fifteen countries globally with direct access to sixty five global equity markets. In India it has been functioning for the last ten years. The event of this year was attended by over 200 delegates from various countries consisting of Financers, Merchant Bankers, Developers and Legal Firms.

While, I did take this opportunity to give an overview of the Indian power sector, with emphasis on prospects and perspectives based on the interests that this sector has generated in last few years, particularly after the new Electricity Act 2003 and other statutory policies have been put in place, in this paper, I would like to focus only on following six issues that I tried to cover in detail. These issues are generally raised in different Conferences, discussions with investors, with Research Analysts, and lenders etc.

1.

Key Hurdles in creating new power generation capacity in India. What can be done to address these?

This issue needs to be dealt with under two heads - (a) General problems for all new projects, whether meant for Eleventh Five Year Plan or for future Five Year Plans, and (b) Main hurdles specific to projects meant for commissioning in the Eleventh Five Year Plan (2007-12).

So far as problems in general for the new power projects are concerned, they relate to availability of fuel, regulatory clearances in respect of environment and forest, expanding the manufacturing capability within the country matched with the expansions of the power industry, creating commensurate construction and commissioning capabilities and providing required finances for projects. Some of these issues are also relevant to the projects already in implementation. Where the intensity of these key hurdles differs is in terms of the urgency of the need to tackle these challenges. Actions for long term solutions which would provide better levels of comforts for smooth execution of the future projects in Twelfth and subsequent Five Year Plans would somewhat differ from the actions that are immediately needed to ensure completion of the projects which are already off the ground and are expected to be commissioned by 2012.

For the Eleventh Plan, about 18,000 MW capacity has already been done. Including these, about 80,000 MW spread over a large number of projects are under construction, or are already commissioned as mentioned. A recent review indicates that there is a high degree of probability that the overall capacity addition in this Plan will be of the order of 62,000 MW and balance about 16,000 MW may shift to the first and second years of the Twelfth Plan. The most important hurdle in execution of these projects is the timely manufacturing and supply of equipment (Main Plants as well as Balance of Plants). Steps are being taken to see that projects with high degree of probability are accorded highest priority, so that they do not slip. In these cases similar approach will be followed also for channelizing the available resources of experienced construction and commissioning agencies and of skilled manpower, so that any diffusion of these resources over larger number of projects is avoided and such a focused attention leads to ensuring that projects which have better certainty do get commissioned during the Plan period. In the last few years, because of substantial pressure from the Government as well as developers, the manufacturing companies have expanded and are in the process of further expansions. Medium and long term outlook in this regard is very positive because of emergence of four to five new groups getting into manufacturing of boilers, turbines and generators. Similarly, the manufacturers of Balance of Plants are expanding their capacities, and also a number of new initiatives are being launched to start such factories. These factories would obviously take care of the expansions in the pipeline and also for the future.

2.

Likely capacity addition in the 11th and 12th Plan versus Government targets. Enabling factors and challenges?

Only about a month back, we had the first meeting of the Advisory Group on Power which is chaired by the Union Power Minister and carried out a detailed review of the power projects which are under construction and are targeted for commissioning during the Eleventh Plan. The review was mainly based on the assessment by the Central Electricity Authority. After commissioning over 18,000 MW so far, the projects with greater degree of certainty might add up, as mentioned earlier, to an aggregate capacity of about 62,000 MW in all as compared to the target of 78,000 MW. What needs to be appreciated is that this would be a great achievement if we compare with the capacities added in previous Five Year Plans (in the range of 22,000 MW to 25,000 MW). In any case, projects which are not completed during this Plan period, may get completed in the next Plan during the first or the second year. They are all progressing well. But, experiences show that towards the end of the Plan period always there are a bunch of projects which need to be attended to in terms of supplies of equipment and commissioning. With limited resources, therefore, normally quite a few of them get shifted to the next Plan period. During the Twelfth Plan (2012-17), the targeted capacity addition is likely to be of the order of 100,000 MW. This would include a number of projects which are now targeted for Eleventh Plan, but might shift to the next Plan as mentioned above. Critical comments and pressures on equipment suppliers, both the existing and those which are setting up their factories, have led to better preparations on their side. We can definitely expect that during the Twelfth Plan these issues of delayed supplies and inadequate construction and commissioning capabilities would have been addressed appropriately. Therefore, the Twelfth Plan targets could be expected to be achieved more smoothly and to a better level of realisation vis-?-vis the targets.

3.

Outlook for returns from Ultra Mega and Mega Power Projects, given the history of aggressive Bidding by participants?

The whole idea of the Ultra Mega Project (UMP) Scheme was that the process of competition should bring down the cost of power in the larger interest of consumers. The corner-stone of this objective was the extra ordinary inputs from the Government that most of the pre-construction risk factors would be mitigated through co-ordination with various Central and State Government agencies, power purchasing distribution utilities and their bankers. It is precisely this approach which not only fetched overwhelming response, but also led to highly competitive, infact aggressive, price of power at which the Bidders promised to deliver power. I personally verified, subsequently, the spread sheets of the winning developers and was convinced that they have not indulged in any adventurism but the mechanics of tariff computation over a 25 year period, the expected cost of construction of project, the margin they would be able to generate in the development of mines, and financial engineering, would all lead to reasonably attractive returns on their investments. Therefore, the investors must feel at ease and comfortable that Ultra Mega Projects are sound investments worth investing in and lending.

4.

Performance track record of Chinese equipment in India - is this an issue of significance for developers using this equipment and for India's capacity expansion plans?

The issue of the quality of Chinese equipment has been raised time and again. In this context, let us examine a few facts. Chinese industry in general has demonstrated its capability. Today, China has the largest capacity base on manufacturing of steel, of the order of 450 million tonnes of annual capacity. Their production of steel in 2008-09 was of the order of 421 million tonnes. India produced 40 million tonnes. China's capacity is more than four times of the second largest producer in the world. During the last 60 year period, China has expanded its power capacity base from 2,000 MW to over 700,000 MW, most of it through coal based power generation plants. Therefore, any doubt on quality per se definitely appears to be misplaced. However, what I have been advising the various developers is that they must tie-up proper arrangements for future spare parts requirement, so that maintenance problems are properly handled. Secondly, it would be a prudent practice on the part of these developers that they put in place proper inspection mechanism which should ensure adherence to quality checks at various critical stages of manufacturing of important equipment. This practice is followed by Indian developers even for supplies from BHEL and other major manufacturers. Developers are, as a part of contract with Chinese suppliers, providing inspection hold points in manufacturing. Thirdly, some of the plants which have been commissioned in India by the Chinese main plant manufacturers are performing reasonably well. A 330 MW unit recently commissioned at Mundra by Adani Power, in the first phase of their 4,600 MW power project, which consists of 4X330 MW, the experience is that this unit, within a few months of commissioning, is performing at almost 100% Plant Load Factor. Fourthly, in India at present almost 21,000 MW of capacity is being developed based on supplies of boiler, turbine and generator by Chinese manufacturers. Very soon, we will have the advantage of assessing their performance. I have no doubt that these plants will perform equally well provided that the developers have taken due care of (a) stage-wise inspection during manufacturing, (b) proper preparations for spare parts management, and (c) comprehensive understanding of operation of these units in other plants in China and elsewhere. Lastly, if Chinese equipment is 15-20% cheaper than others we need a proper cost benefit analysis to arrive at the right conclusions.

5.

High merchant tariffs in India - causes and solutions. Was it a good idea to open the market to competition while there is huge base load capacity shortage? What is the long term outlook of merchant power tariffs?

In the architecture of the Indian power industry, we had envisioned, in the Electricity Act, a significant role of power trading in developing electricity market. I genuinely believe that all transactions of purchase and sale of electricity through long term Power Purchase Agreement is, infact, the anti-climax a sound of electricity market. Unless a significant proportion of power is transacted outside the purview of long term Contracts, it is hard to believe that electricity market will develop. Trading as a distinct licensed activity, sale and purchase of power through online systems in Power Exchanges are some of the important features of this architecture which would facilitate development of competitive electricity market structure. At present less than 3% of power is traded either through trading licensees or through Power Exchanges. This is the reason that the price of power through such arrangements, in the face of occasional and seasonal shortages, is excessively high. The objective of facilitating development of merchant plants, a Scheme which was articulated by us in the Ministry of Power in 2006, was to enhance substantially the proportion of power purchase and sale outside PPA. Infact, I suggested even to NTPC to develop merchant plants/capacities, which they responded and, they are in the process of doing so. In the Working Group on Power for the Eleventh Plan, which I presided, we provided that sufficient amount of cushion, by way of redundancies, of the order of 30%, should be planned in the transmission capacity to allow transmission of power from merchant plants to undetermined destinations. A question is often raised, whether the price of power in the range of Rs. 8 to Rs. 10 per Kwhr, which are the prevailing rates for merchant power, would be the going rates on a sustainable basis. My answer has always been "NO". The whole idea of facilitating merchant plants has been to expand the base of such plants - large numbers and large capacities - so that such short term trading leads to lessening of the prices. However, I must also say that the tariff of merchant plants would always be significantly higher than those from PPA based power plants and capacities. If the PPA based prices vary between Rs. 2 to Rs. 3 per unit, we could expect the price of merchant plants in the range of Rs. 4 to Rs. 5 on a long term and sustainable basis. But, this range of prices would be reached when we succeed in getting to almost 15% of total capacity as merchant capacity. Till then prices would reduce only progressively. Therefore, the future of merchant plants, in my opinion is bright. But to assume that on a long term basis the price would be on the range of Rs. 7 to Rs. 10 per unit would be wrong.

6.

Climate change concerns. How will India deal with pressure from developed world to control emissions and its growth needs? Likelihood of carbon taxes being imposed in India in next five years. Implications for power sector?

It is true that India's power sector profile is heavily weighted in favour of fossil fuel based power generation, viz. coal and gas constituting almost about 65% of the total capacity. But, the track record of power development strategy through renewable sources has also been excellent. We must note that power from hydroelectric projects is renewable. India has been able to harness more than 20% of its hydroelectric potentials, which is better than the world average of about 18%. Inclusive of non-conventional and hydro projects, the renewable proportion is more than 35% of the total. India has committed to develop all its hydroelectric potentials of the order of 1,50,000 MW. We are the fifth largest in the world in respect of wind based power generation with more than 10,000 MW capacity. The development strategy includes building power projects through wind, bio-mass and solar. Almost entire wind potential of 45,000 MW is planned to be harnessed. The National Action Plan on Climate Change is the most comprehensive approach and Plan of Actions to mitigate concerns relating to CO2 emissions. The Action Plan includes development of 20,000 MW of solar power generation in next ten to fifteen years. National Electricity Policy lays special emphasis on developing nuclear power plants. Integrated Energy Policy has projected that by the year 2032 the proportion of nuclear power capacity would rise from less than 3% to about 7% i.e. from 4,000 MW to almost 60,000 MW. These are substantial and significant initiatives towards addressing climate change concerns. As it is, India has one of the lowest per capita emission of CO2 at about 1 tonne, as compared to about 20 tonnes of U.S.A., 10 tonnes of Europe, and 4 tonnes of world average.

I do not see the possibility of carbon tax as such in next five years. But, I do see that instruments like Renewable Energy Certificates and Energy Efficiency Certificates would become realities and they would be traded. These instruments, when traded would obviously place burdens on those who deploy technologies which cause CO2 emissions and reward those who deploy technologies which may be costly, but do not entail generation of green house gases. These initiatives would ultimately prepare Indian power industry better to take care of climate change concerns.

There could be many issues which bother the minds of many investors. Their concerns need to be appreciated because they take risks by investing in Indian power industry. These few concerns obviously are upper most in their minds. I tried to cover these issues in my address in the Conference mentioned above.