In my series on Gross Fixed Capital Formation (GFCF) in the infrastructure sector, I wish to complete the trilogy with Energy (mainly Power) sector which witnesses an investment of almost USD 65-75 bn every year in India. Along with railways and roads, power is one of the top three sectors (within the broader infrastructure space) and hence a critical sector to reflect upon. However, a little background and history is important to identify and assess the medium-term (3-5 years) investment and growth drivers.
I conducted a small survey to find out what is the general view on the power situation in India. The answer should not surprise many. Two most obvious answers were (a) policy paralysis of last few years has been constraining new capacity additions and (b) India is a power deficit country.
Policy Paralysis – Above perception is in spite of the fact that in last 18-20 months, India has witnessed series of initiatives by this new government to revive the power sector – be it (a) coal blocks (auctioning and rationalization) (b) gas subsidy support (for stranded gas based power plants) (c) re-introduction of depreciation benefit (for wind power) (d) UDAY scheme (for loss making DISCOMs) (e) revised power tariff policy (f) green corridor (for transmitting renewable energy) or (g) national smart grid mission – to name some of them. One therefore is ought to believe that the bottlenecks are removed, foundation is laid and stage is set for next phase of capital investments.
Power Deficit (or surplus) – Interestingly, the situation is so different. In December 2015, India for the first time in it’s history, became a power surplus country. In last 7 years (FY09-FY16), India has added more than 110 GW of capacity (~15 GW p.a.) taking the total capacity to close to 300 GW. This is even more creditable when one were to look at this growth from either Global (immediately after Global Financial Crisis) or Domestic (political instability) environment.
It is important to understand what drove this 110 GW capacity addition.
De-licensing of power generation led to significant capacity expansion – In 2003, the new Electricity Act replaced Electricity Act of 1910. One of the most transformational development was ‘delicensing’ of power generation. From timing perspective, this new Act incidentally happen to precede an impressive 8.5% average annual GDP growth between FY04 and FY08. Cheap liquidity was an add-on. Considering that all three viz., Regulations, Opportunity, Capital (R-O-C-) were favourable, one started witnessing aggressive participation by private sector in power generation (largely thermal). FY09 to FY14 witnessed capacity additions which was almost two-third of the total capacity that got created in the previous 62 years of post-independence.
But the power shortages continue – Isn’t it a paradox? Unfortunately, significant parts of India continue to experience load shedding, 15,000+ villages still don’t have access to power. In a way it means that capacities are created, but are not being utilized. In technical parlance, power plants are operating at very low Plant Load Factor (PLF). So why is that so? What went wrong during the first 10 years (2005 – 2015) of power generation environment?
- Is it ‘over- supply’?
- Are there operating constraints? Or
- Is there an intent issue?
Over-Supply: Indeed over supply is an issue. In FY16, against a capacity of 289 GW, generation was only 135 GW equivalent units – capacity utilization of only 47%. A little muted GDP growth is obviously one of the reasons. But still this is very low. And if this is the case, why is India having an ambitious plan of adding another 250+ GW of power over the next 6 years (FY17-22). Bigger question therefore is why not first sweat the existing assets (more on this later)?
- Slow coal production, coupled with huge coal price hikes – Between FY09 and FY15, almost 100 GW of thermal capacity got added. Considering that every 20 GW of capacity needs ~100 million tons (MT) of coal, it meant additional requirement of ~500 MT. Even at 75% PLF, incremental coal demand was to be 350-375 MT. However, Coal India Limited (CIL) is unable to increase it’s production by not more than 5% annually (between 2009 and 2015, CIL’s production increased by only 90 MT, from 403 MT to 494 MT). So against incremental demand of 350 MT, incremental production of 90 MT left a gap of almost 250 MT. Power generating companies were being compelled to import coal. Incidentally, global coal prices kept moving northwards, peaking in 2011 (USD c. 130 / ton) as against only USD c.57 when these companies started executing Power Purchase Agreements (PPAs) in 2004-05. Many projects thus started becoming unviable.
- Coal mine cancellation – UPA government had anticipated CIL’s inability to meet such high coal requirement and hence wanted private sector to play a larger role in coal mining in India. Aggressive allocation of mines to private sector took place between FY04-FY09. However, the process was questionable. As a result Supreme Court (SC) cancelled 204 coal mines. On the international front, countries like Indonesia changed laws restricting sale of coal below a certain base price. Hence, even companies that acquired mines overseas were constrained to acquire feedstock at prices which would keep power generation viable.
- Gas unavailability – India has ~25 GW of gas based power plants (10% of total capacity), which largely was relying on Reliance’s KG reserves. Reliance started producing gas in FY09. However since their rate was USD 2.34 / mbtu while global rates were hovering in double digits (even touched USD 13 / mbtu), they wanted the gas price to be revised substantially. Since it didn’t happen, Reliance curtailed the production significantly (it is only 15% of what it produced in FY10). With increasing demand from City Gas Distribution (CGD) for transportation (CNG) as well as residential purpose (PNG), domestic gas production is finding it difficult even to meet the demand of fertilizer industry. Imported gas costs almost double than domestic gas and hence makes gas based power plants very unviable if they were to operate on imported LNG. Hence, the entire capacity is either non-functional or operating at less than 20% PLF.
Viability and Intent:
- Aggressive bidding – In 2005, Ministry of Power introduced Competitive Bidding Guidelines (CBG) for supplying power under PPA to licensed distributors (replacing the traditional cost plus model). Private companies were keen to ensure that they have assured power off-take agreements as it helped in expediting financial closures as well as finalizing Fuel Supply Agreements (FSA) with CIL. Increased competition tilted the scales slightly in favour of electricity buyers which resulted in very aggressive bidding by these power companies. Tariffs started getting very competitive.
- Failed attempts to re-negotiate PPAs (intent of power generating companies) – Because of aggressive bidding, private power companies ended up agreeing for very competitive rates under PPA (and that too for 25-years). However, surge in coal prices made those PPAs unviable. Companies therefore had no choice but to renegotiate PPAs. However, since electricity falls under the concurrent list of Indian constitution, any renegotiation of PPAs meant involvement of not only power generating companies but also of CERC, SERC, DISCOMs. In case of disputes even Appellate Tribunal for Electricity (APTEL) steps in (besides state governments always trying to influence the decision). The bigger question to be asked is would these power generating companies also renegotiated if fuel prices would have gone down in their favour. Basically business calls have gone wrong and attempt is to renege and if not renege atleast give every attempt to renegotiate (legally or otherwise).
- Continuing deterioration in financial health of DISCOMs (intent of distribution companies) – It is said that the value chain is as weak as its weakest link. In India where states own almost the entire distribution infrastructure, making available cheap / free power appears to be the vote bank for every state government. Close to 90% of the power generated by the power producers are sold to DISCOMs (state owned distribution companies). Unfortunately these DISCOMs are one of the most inefficiently managed institutions. They are unable to control power theft (these losses run north of 25%) and 20+% power is sold at subsidized rate. Increasing tariff (at final consumer end) is a big challenge. DISCOMs argue that in the past 10 years, cost of power has increased 300%, mainly because of higher coal prices and a rise in the financing charges due to higher interest rates, while the rate at which it is sold to retail consumers has increased by only 70% during the period. In the process, they have accumulated a total debt of Rs 4.3 lakh crores (FY15) as against Rs 2.4 lakh crores in FY12 – and continuing to incur annual losses of Rs 65,000 crores. All this means they would rather prefer to have shutdowns and power cuts than trying to get into long term obligations which they can’t fulfill. So new PPAs are far and few and power sector is directionless.
- Significant fall in merchant power tariffs (intent of state governments) – Success of any industry hinges on free markets and free pricing. The Electricity Act of 2003 did recognize power trading as a distinct activity (and since then ~45 trading licensees have been issued) but the momentum has started picking up only in last few years (for above reasons). It is gradually evolving the way equity capital markets evolved in late 90s and decade following that. In 2008 the first power exchange was set up. Absence of new PPAs provided power generating companies (both IPPs as well as captives) a new platform to sell their power. Volume of electricity transacted through power exchanges has gone up by more than 12 times from 2.77 billion units in FY09 to 34+ billion units in FY16. However, inspite of such sharp increase in volumes, Market Clearing Price (MCP) on IEX has gone down from Rs 7.49 / kwh in FY09 to Rs 2.73 / unit in FY16. Considering that the PPAs were being signed at around Rs 2.50 / kwh in FY09, merchant power appeared as a great alternative. While few players adopted this as a conscious strategy, others who couldn’t execute PPAs used this as an alternative platform. As a result, supply outstripped demand (and continues to do so). Operational problems like availability of transmission infrastructure continues to be a big issue because state governments don’t want subsidizing power to move away from controlled environment to free market.
Few measures taken in the recent past:
- Focusing on increasing coal production – The government moved very swiftly to auction the cancelled coal mines. However unlike in the past when the objective of many private players was to just get access to resources (coal prices were also peaking), this time the government is serious of monitoring actual coal production from these mines. Further coal prices have also been coming down consistently (current coal price at about USD 55 / ton is even lower than 2004 levels). This means that viability is back and it makes little sense to own mining assets and that too by aggressive bidding when better quality coal is available at cheaper rates. Hence the interest came down significantly. Government has managed to auction only 32 of the 204 cancelled mines. Increasing coal imports also reflect the above. Imports have risen by almost 250% from c.59 mil tons in FY09 to c.210 mil tons in FY15.
While government is targeting 1 billion tons of coal production by 2020, it seems quite aspirational as neither CIL can do something dramatic (quality, technology, connectivity, evacuation continues to be an issue) nor private companies are going to bid aggressively. Hence, more noise than any meaningful change, as of now.
- Operationalizing stranded gas based power plants – Of the 24 GW gas based capacity, ~14 GW has no gas availability (and the balance is operating at extremely low PLF). In an attempt to resolve this, in March 2015, the Ministry of Power set up a Power System Development Fund (PSDF) and earmarked Rs 7,000 crores (to be spent over FY16 and FY17) for providing subsidized gas to stranded gas based power plants. The government is importing gas and making it available to stranded power plants through reverse auctions. Three rounds of e-auctions have already been completed (May 2015, Sept 2016 and Mar 2016). Infact, in March’16 bidding, no power plant sought any subsidy thereby indicating that sheer availability of gas was more important to these plants than any subsidy from government. About 8,500 mw of gas-based power capacity is thus made operational and are operating at about 35-40% PLF. This ensures that the infrastructure is utilized, fixed costs are partially recovered and stress on banking sector is hopefully minimized.
However current gas prices are almost at its lowest and government could afford to earmark some funds. But government will find it difficult to increase gas availability either for higher PLF’s or if gas prices increases (fiscal challenge). And in an environment where more domestic gas is being diverted to CGD, increasing domestic supply is fundamental – and one sees no major progress on that front (Ecosystem is held hostage for a ransom by those who can produce gas).
- Turning around the financial health of DISCOMs – In November 2015, the Ministry of Power launched a scheme called Ujwal DISCOM Assurance Yojna (UDAY) with a view to improving the financial health of DISCOMs. Under this scheme, states are required to take over 75% of the outstanding debt by March 31, 2017 (also future losses, to the extent of 50% to be borne by states). In FY16, 8 states took over these loans and already issued bonds worth Rs 99,000 crores (USD 15 bn). Rajasthan was the highest issuer with Rs 37,000 crores bonds, followed by UP (Rs 24,000 crores), Haryana (Rs 17,000 crores), Punjab (Rs 9,000 crores) Jharkhand (Rs 6,000 crores), J&K / Bihar (Rs 2,000 crores each) and Chattisgarh (Rs 1,000 crores). EPFO and LIC subscribed to more than 15% of these bonds.
However, this is nothing but a bailout of DISCOMs. Its simply converting the contingent liability of states into an on-balance sheet item. The hope is that states will try to bring in more efficiency in DISCOMs and be more pro-active in increasing power tariffs. However, this is the 3rd bailout of DISCOMs in last 14 years and nothing seems to be changing. It appears to be more of a debt swap than a genuine re-structuring and the states’ fiscal deficit will start getting impacted after two years.
This time too, it appears to be nothing more than a short-term steroid. Hence, I am not too excited with this UDAY scheme. It may have averted the impending NPA crisis but to assume that it will change the landscape of power sector in a big way (on the assumption that these DISCOMs will transform and implement measures for extensive metering, reducing power theft, controlling distribution losses and rationalizing power tariffs) is a little too much of an optimism.
- Revised Power Tariff Policy – In January 2016, the government approved the new power tariff policy focusing on following 4 areas:
- Reducing disputes – Most of the litigations were for renegotiating PPAs due to either increasing fuel cost or increase in government levies. The new policy has permitted pass-through for such cost increases (likely to reduce disputes and litigation).
- Increasing PLF – Power plants are allowed to sell their excess capacities (which DISCOMs had promised to purchase under PPA but are not purchasing) in open market, through power exchanges. This should increase PLF.
- Adding capacity – Existing power plants (with regulated tariffs) are allowed to double the generating capacity at the same location, thereby removing a plethora of hurdles typical of a green-field plant.
- Flexibility in tariff revisions – SERCs have been provided flexibility to revise tariffs more frequently (monthly / quarterly) as against annual revisions.
It is a bit premature to comment on this, but these indeed look a little more practical and a lot more confidence booster than many other announcements.
- Alternate fuels – Availability of fuel (at right price) has been one of the important constraints in running at optimum PLFs. Needless to say that Indian government wants to diversify the sources and hedge the risks. An ambitious target of setting up 175 GW of renewable energy over next 6 years (FY17-22) seems to be a plausible solution.
However, compare this with the fact that India added only 7 GW in FY16 and has a plan to add about 16 GW in FY17. So we are talking of adding 35 GW ‘every’ year (Global capacity addition in FY15 of renewable energy was about 120 GW, almost equally split between solar and wind). So, with these numbers, India will be a 30% contributor. Little aspirational but definitely not unachievable. If government can ensure availability of land, execution of these projects is much faster and easier.
However, biggest concern is whether enough is happening to transport this electricity. It’s like setting up a manufacturing capacity with no roads to transport those goods. The concern stems from the fact that while a 10 GW solar plant can be set up in 90-120 days (post all clearances), the average time taken to build transmission systems could be 3-4 years (yes years, not months or days). Thus the mismatch between Time to Market (TTM) for solar vis-à-vis corresponding TTM for evacuation is one of the biggest risk for this program.
Thus, while there is an element of certain positivity around the power sector, it is still questionable if the above measures are adequate to re-start capital investments in the power sector and whether these would help in increasing the PLF of existing power plants?
What will drive change? Can the answer be ‘disintermediation’ of electricity?
It is quite evident that while there are many proactive steps being taken, these measures seem to be more damage limiting rather than investment driving. Unless and until the fabric of this sector is changed, cycles will often keep repeating. The key to transformation is disintermediation of electricity. Even today 91% of the power is sold through loss making, inefficient, de-motivated DISCOMs. They make losses because of theft of power or free power. To compensate this loss, DISCOMs either can get a subsidy from the state government or they are required to charge higher tariffs from HT users (residential & commercial entities). However, cross-subsidization is reaching unsustainable levels, state governments’ fiscal health is vulnerable and bank borrowings are reaching unmanageable levels. So while bailouts are short-term solutions, eventually if the political will is weak, dependency on state governments need to be reduced by creating alternate channels of selling power.
So how is disintermediation possible?
One has to create mechanism to allow producers of electricity to reach the consumers directly. Now to reach the consumers, one needs two broad enables (a) a platform to agree on the commercials and (b) infrastructure to deliver price.
- Strengthening the platform for trading power through exchanges – In the past, in absence of any organized and credible platform, PTC acted as the only intermediary for trading in electricity. PTC was instrumental in acting as an arranger of electricity for DISCOMs and was also the canalizing agency for procuring electricity from neighboring countries like Bhutan and Nepal. But the real transformation commenced in 2003, when the new Electricity Act recognised ‘Trading’ as a distinct licensed activity. Objective was to provide alternative choice to consumers. Since 2004, CERC has issued about 40 inter-state trading licenses. However, PTC continues to be the largest energy trader with ~35% market share. While it’s share has come down from ~70% in 2006, none of the private player’s market share individually accounts for more than 10% share (Tata Power Trading Company, JSW Power Trading, GMR Energy, Adani Enterprise, NTPC Vidyut are a few of them). Nature of trading started changing from 2008 onwards with the establishment of Power Exchanges. Today of the 100 bn units being traded in the short term power market, power exchanges’ share is 33%. Almost 3,500 customers trade on IEX. Clients include central and utilities, IPPs, captive power plants and industrial consumers.
While both (a) increase trading by private players as well as (b) increasing share of power exchanges are welcome, I see intention of state governments as a major road block going forward, at least for few more years. Let me explain. Today, state governments are able to provide subsidized or free power by cross subsidizing High-Tension, large industrial and commercial users (by charging them higher tariffs). Now these are the ones who are gradually moving to platforms like power exchanges. Power Exchanges are thus becoming a serious potential threat to states. So SERC impose Cross Subsidy Surcharge (CSS) on consumers who purchase power through open access i.e. not through licensed distribution companies (largely DISCOMs) but through trading companies or on exchanges. Further, SERCs further imposes wheeling charges, etc. It’s akin to something that happened in the past with railways where they allowed private players to operate wagons but didn’t gave them free railway tracks on schedule. Regulation needs another round of serious look.
- Transmission infrastructure – While trading in electricity has been increasing, transmission infrastructure has been significantly lacking. To give an example, in FY16, ~3.5 billion units on power exchanges could not be traded due to transmission congestion. This is approximately 10% of the total traded volumes of 33 billion units on power exchanges. For 175 GW of renewables and another 75-80 GW of thermal capacity planned over next 5 years, one needs to add incremental 2,50,000 c.kms of transmission lines, effectively translating into a capex of USD 100 bn. Some serious focus is visible with orders worth USD 15 bn in the process of getting awarded. However, PGCIL is operating at its peak with close to USD 4 bn execution every year. This means that private sector has to play a far meaningful role. Sterlite Grid and Adani Transmission are amongst the more active private players (besides Tatas, Essels and L&T). Under the Tariff Based Competitive Bidding (TBCB), these companies have created a transmission infrastructure of about 15,000 c.kms.
However, private companies’ share is less than 5%. So with PGCIL operating at optimal capacity and private participation restricted to a couple of players, ability of transmission to match speed of renewables capacity addition appears to be a major bottleneck.
To conclude, a lot has happened, a lot is happening but a lot needs to be done in the Power sector. It will continue to witness stable investment flow. However, what fuel did to thermal, transmission should not do to renewables. Open Access and Transmission should energise energy.
Disclaimer: This is a personal blog. The opinions expressed here represent my own and not those of my employer or of any organization that I am associated with. This blog provides a view at the time of writing this post and as such any thoughts and opinions expressed within out-of-date posts may not be the same. All data and information provided on this site is for informational and awareness purposes only. I make no representations as to accuracy, completeness, correctness, suitability, or validity of any information on this blog and will not be liable for any errors, omissions, or delays in this information or any losses, injuries, or damages arising from its display or use. All information is provided on an as-is basis and should not be construed as advice.