Monday, November 23, 2015

An agenda for distribution sector reforms

I blogged earlier on my skepticism with power sector reforms. My concerns arise from deep-rooted fundamental problems that afflict the sector and not the details of the financial restructuring plan. 

On the face of it, the distribution side of power ought to be technically the simplest to manage. Power flows without any transactional engagement by the discom. The purely operational transactions done by the discom are secondary and just three - repair and restore supply when interrupted, replace non-working meters, and do periodic operation and maintenance (O&M). And then there are the management issues of releasing new services, spot-billing, and theft detection and disconnection. The discoms do none of these to any reasonable degree of satisfaction. State capability and political economy constraints bind big-time. And even if we get this right, we run into the twin challenges of free farm power and low tariffs. 

The limited technology adoption, archaic processes, low level of professional competence among field-level engineers (a reflection of our workforce employability crisis), limited large and credible enough local service providers (spot-billing, transformer and other equipment servicing, O&M contracting of services etc), unionization, corruption etc are first order problems. They are amplified many times over by weak state capability, sensitive electoral politics, and inherently complex nature of the problem, all of which make technology adoption, howsoever beneficial, a very difficult challenge.

I have blogged earlier here, here, and here on this and am being deliberately provocative in arguing that technology solutions like GIS, SCADA (maybe DA, but surely not SC), DTR (transformer) metering etc are not going to happen in even our best discoms (power point presentations in conferences and seminars apart!) anytime for the foreseeable future. In a difficult and constraining environment, a strategy that focuses on these first-best solutions is certain to crowd-out the effective implementation of even feasible second-best solutions. It would detract from the effectiveness of supervision and make the best the enemy of the good!

So what is the way out? Understand the problem, acknowledge it, and then start work on it. As a first-order and non-negotiable requirement, discoms need to measure and audit its energy distribution and bill and collect from services, the equivalent of plain good governance in the distribution side. But this requires real-time metering of feeders, consumer mapping under each feeder (and keeping track of the dynamic downstream LV network), and then rigorous monitoring and enforcement. And the same with billing services, replacing non-working meters, and collecting dues. Simple as it appears, given the environment, this is a super-difficult challenge and unlikely to happen in quick time. Without arguing for a sequential approach to reform, this is an essential pre-requisite for any other reform. 

Technology can be useful here, but not as top-down GIS/SCADA/AMR solutions, as is currently being advocated. The best strategy is to make available the full spectrum of technology and re-engineering options available in the market and let discoms adopt what they can sustain and suit them best. Different categories of technology interventions in energy audits should be implemented across and within discoms and technology solutions should be allowed iterate and evolve. Given the size of the country, the three orders of the interventions (multiple discoms, multiple areas within a discom, and different technologies) should, if done in a focused manner, over a period of time, throw up technologies that emerge as successes and can diffuse into scale.

Sunday, November 22, 2015

Weekend Reading Links

1. David Evans in the World Bank blog has an awesome compilation of the papers presented at the Northeastern Universities Development Consortium Conference.

2. FT has a nice article which explores the valuation problem in mature start-ups arising from a new category of private shares with guaranteed returns. The insurance against downside distorts the valuation since the investors are now less concerned about the valuation and only interested in the pre-determined guaranteed returns,
Many of the investments in the more mature start-ups are structured: in effect giving investors guaranteed returns and a degree of protection against any losses.Financial experts refer to these headline valuations as “marketing numbers”, highlighting that they are a function of image as much as anything else: the greater the degree of guaranteed return a company is prepared to give, the higher the hypothetical value that investors place on the company... Even some of the best-regarded tech companies have used these methods. At Uber, a major investor received a guaranteed 25 per cent return during an early investment round. Investors also received significant protections during Airbnb’s $10bn round last year.
Square, the most prominent of the current generation of start-ups to have so far opted for a public listing, is typical of this trend. In its most recent private fundraising investors paid $15.46 per share, generating headlines about a $6bn valuation. Those who bought in were guaranteed a 20 per cent share price bump in an IPO. Their compensation, if Square fails to hit this: extra shares to make up the difference, potentially diluting the value for earlier investors and many employees.These new investors may have paid a higher price for their shares, giving them less upside if the company does well. But they also have a degree of insurance unavailable to other investors if the company falls short of expectations.
These multi-share class structures, along with the lack of a liquid market for private shares, have made it almost impossible to calculate an accurate valuation for many start-ups. Even investment professionals whose job it is to assess the value of private shares in their portfolios admit that they cannot do this with 100 per cent certainty. In a private company, unlike in public markets, each class of share commands a different price because of the protections that come with it. In Square’s case, the headline valuation figure of $6bn assumes wrongly that all shares could command the highest share price.
This trend to guarantee returns has been driven by founders desire to join the unicorn club, which enables them to raise more cash, recruit employees and raise their profile.

3. Much the same is happening in India, with late stage VCs putting in tough riders to guarantee their investments and startups accommodating those demands in order to attract the capital required to both sustain operations as well as expand their market shares. Such conditions, commonly described as 'liquidation preference' (LP), ensure that the investor takes back "its entire capital or the amount due to it in proportion of its shareholding in the firm, whichever is higher". As valuations froth, the LP multiples demanded has been rising. The immediate losers from such deals are the start-up founders, whose shares come only after the late and early stage investors recover their investments. 

4. John Reed, the former Chairman of Citigroup, comes out in favor of restoring Glass-Steagall and dispensing with the universal banking model. Apart from the questionable claims on financial benefits from a single entity, he also points to the unstable cultural balancing in bringing all activities under one roof,
As is now clear, traditional banking attracts one kind of talent, which is entirely different from the kinds drawn towards investment banking and trading. Traditional bankers tend to be extroverts, sociable people who are focused on longer term relationships. They are, in many important respects, risk averse. Investment bankers and their traders are more short termist. They are comfortable with, and many even seek out, risk and are more focused on immediate reward. In addition, investment banking organisations tend to organise and focus on products rather than customers. This creates fundamental differences in values.
In South Korea virtually all of your wants and needs can be met by Samsung, the most dominant conglomerate. You can be born in the renowned Samsung Medical Center, attend a prestigious Samsung-owned university, live in Samsung housing complexes — even buy life insurance from a Samsung subsidiary and go for vacation to the Samsung-owned Everland amusement park. It is possible to use virtually only Samsung electronic devices in daily life. And, if you ace the widely taken GSAT — Global Samsung Aptitude Test — you can land a prized job at one of its subsidiaries. No wonder that Samsung is so large that it is responsible for a fifth of South Korea’s exports and about 17 percent of the annual gross domestic product.
6. FT has this dismal assessment of the impact of QE exit on emerging markets,
By some estimates, $7tn of QE dollars have flowed into emerging markets since the Fed began buying bonds in 2008. Now, a year after the Fed brought QE to an end, companies in emerging markets from Brazil to China are finding it increasingly hard to repay their debts. The excess capacity these companies created became apparent just as China’s slowing economy triggered a collapse in global commodity prices, hurting companies across the emerging world and sending Brazil’s economy into deep recession. Some experts say QE policies by the Fed and other central banks have left a legacy of oversupply from which it will take years to recover.
The article also describes how the search for yields resulted in leveraged 'carry trade' from developed to EM economies. The BIS estimates an amount of $9 trillion flowed into the EM economies as bank loans and bonds in the 2009-14 period. As I have blogged earlier, it also found evidence of cash-rich EM firms using this route to speculate with 'carry trade' rather than for investment purposes.  
This has had the effect of driving up EM private sector debt, raising concerns about its repayment once the interest rates in developed economies start to rise.
The disturbing thing about this debt build-up is that it comes at a time when the EM economies are themselves slowing down sharply and consumer demand has been tanking. Apart from declining asset prices, the massive over-capacity in many of these economies mean that the ability of local borrowers to repay their debts once the capital flows tide reverses, as it can in very quick time, is seriously suspect. 

7. The FT has a graphic of the 10 most polluted cities in the world, with India contributing 6 and Pakistan 3.
In fact, the latest Global Burden of Disease report estimates that ambient air pollution was responsible for 586,788 premature deaths in India in 2013, up from 365,592 in 1990.

8. FT reports that peer-to-peer (P2P) lending platforms like Lending Club, Funding Circle, and Prosper have the potential to disrupt the banking sector in a Uber-style revolution. They offer higher yields to lenders, and faster, cheaper, and more convenient loans to borrowers of different categories - consumers, students, small businesses etc. Investors globally have raised more than $80 bn over the past two years for direct lending funds. Though, P2P lenders make up just 1.1% of all unsecured consumer loans in the US, PwC expects annual P2P lending in the country to soar from $5.5 bn in 2014 to $150 bn in 2025. As the article writes, their business model,
P2P lenders say their algorithmic credit scoring technology is as good as the banks. But because they do not need to hold regulatory capital or liquid assets, operate expensive physical branches or deal with costly legacy IT systems, they are more efficient than banks... the “frictional cost” for their companies in making a loan is equal to about 2 per cent, against about 5—7 per cent for a typical bank... As a result, P2P lenders can offer investors a higher yield than banks do to depositors. 
The P2P market has attracted insurers and asset managers who have launched direct lending arms, lending especially to small and mid-sized companies.

Four observations on this trend. One, as banking sector regulations tighten, such platforms could crowd-in the riskier categories of borrowers. Two, the very nature of such lending makes it difficult for the emergence of large lenders. Given that the major source of P2P financing are high-net worth individuals and also given the limits to how much you can lend through impersonal and algorithmic due-diligence, there may be an inherent self-limiting factor to the sizes of such enterprises. Three, this may be a welcome trend shift in the global banking sector in so far as it promotes greater systemic risk diversification. Four, however, the entry of financial institutions like insurers and asset managers makes greater regulation, atleast of their P2P lending arms, essential. Or this could end up being yet another of the "dark corners" of financial markets. 

9. This FT graphic is a very good illustration of the state of the Chinese economy. All the leading indicators of economic growth are falling.
10. In the recently concluded local government elections in Kerala, a corporate social responsibility initiative group won the Panchayat elections in Kizhakkambalam of Ernakulam district in Kerala state. Candidates of Twenty20 Kizhakkambalam, a CSR initiative of the local Anna-Kitex group, a Rs 15 bn garment and aluminium company, won 17 of the 19 wards and 2 out of 3 block panchayat seats. The village, with an area of 32 sq km, 8000 households and population of 23000 is predominantly agricultural and has a literacy rate of 94.74%. The 'party' campaigned on a platform of "improving facilities for drinking water, housing, food, toilet, electricity, healthcare, education and employment besides reviving agriculture in the village".

11. Finally, a reminder of the global downturn comes from this,
The price of iron ore in Qingdao, the widely accepted benchmark for Chinese metal consumption, is down 76 per cent from its 2011 peak... The Baltic Dry index, a measure of the cost of shipping commodities around the world, subsided this week to its lowest ever. It has now dropped 95.5 per cent from its peak set in 2008, shortly before the financial crisis.

Saturday, November 21, 2015

The digital platform opportunity

This report advocates digital platforms in fostering innovations. The example of Aadhaar is the most obvious and successful. It talks about other similar platforms. I think this is one idea that has great potential, far beyond what is outlined in the report.

Consider two examples - healthcare and schooling. In health care, the value chain of activities range from informational (where are the nearest hospital or diagnostic facility or specialist and their respective quality) to medical (outpatient consultations or immunization or treatment follow-up or disease surveillance) to logistical (ambulance or drugs supply chain management or fake drugs testing) services. Similarly, in school education, the activities include informational (nearest school and quality or student's report card), pedagogical (learning content and teaching support materials), and administrative (management of student records or on-line access to school transfer and conduct certificates, mark-sheets, degrees etc) services. 

In each of the specific interventions, while there are enormous opportunities, there are also critical regulatory and other challenges. While on the one hand hospitals, public and private, would find great value in having access to electronic health records, there are issues of data protection and portability. In all these cases, if data ownership and privacy concerns are satisfactorily addressed, then the possibilities from mobile and other software applications (apps) are enormous. Only governments, through enabling policy frameworks and proactive market opening interventions, can be impartial administrators in these areas. 

The most important enabling policy framework would be one on data protection protocols that would allow app developers to offer services - medical history tracking, drugs verification, antenatal and immunization interventions etc. Many of these services can be offered through a fee-for-service model, with data remaining protected and with the patient and the respective hospital, or leverage alternative revenue streams. The other critical enabler would be standardization of protocols. This would facilitate dual inter-operability - use of the same app by different service providers and different apps delivering the same service by the same client (hospital/school and patient/student/teacher). Market opening services would include some large government hospital taking the lead in commissioning an electronic health records management system for its patients and then letting the network expand to include the other public and private hospitals in its vicinity. 

A doctor in a private clinic treating a patient covered under a state government health insurance program, say Aarogyasri, could through a software application access the patient's primary care records from the PHC database, and see diagnostic reports retrieved from the diagnostic center's database. Instead of visiting the far-away hospital, the patient can then follow-up on whether the patient is adhering to the treatment protocol. Another app would help the patient find the nearest medical store where the drug is available and check whether the drugs purchased are fake or not by scanning the QR code. 

The state medical and health department could put out standardized maternal and child health treatment protocols for developers to create apps. PHCs could download and subscribe to such apps on a fee-for-use model, on a range of differentially priced services. While the basic services may be available for a very negligible fee, the more value-added ones could be priced higher and would be subscribed by PHCs and other clients only if they find significant value proposition in them. This would also foster competition among PHCs and different other health units. Much the same dynamics would be generated with education, where schools could choose from the menu of services that are catalyzed and those which they find valuable.  

In both these cases, the hospital records and school records can be the respective platforms to catalyze entrepreneurship and create an eco-system of services which significantly impact health and education sectors.

Thursday, November 19, 2015

Nudging with Amazon Prime

From Times on how Amazon uses its Amazon Prime ($99-a-year free two-day shipping and a host of free music, video, TV shows, and books) subscription service, which is estimated to grow by 10 m to 40 m by end of this year, to nudge shoppers,
Growth in Prime subscriptions matters because Prime alters the psychology of shopping. Once you’ve prepaid for shipping, you tend to start more of your shopping excursions at Amazon. According to some estimates, people spend three or four times as much with Amazon after they sign up to Prime...
But this “Prime effect” is key to Amazon’s long-term profitability. Analysts at Morgan Stanley reported recently that “retail gross profit dollars per customer” — a fancy way of measuring how much Amazon makes from each shopper — has accelerated in each of the last four quarters, in part because of Prime. Amazon keeps winning “a larger share of customers’ wallets,” the firm said, eventually “leading to a period of sustained, rising profitability.
The article lays out how Amazon has slowly built up a massive retail logistics infrastructure, apparently insurmountable for competitors, that appears to be now paying off and which positions the company comfortably to dominate the market for many years. It has built more than 100 (and growing) warehouses to store, package, and ship goods, which lowers logistics costs and allows the company to pass on benefits to customers by way of lower prices. And, Jeff Bezos has been patient,
What has been key to this rise, and missing from many of his competitors’ efforts, is patience. In a very old-fashioned manner, one that is far out of step with a corporate world in which milestones are measured every three months, Amazon has been willing to build its empire methodically and at great cost over almost two decades, despite skepticism from many sectors of the business world.
And Bezos has the deep pockets of its rollicking cloud computing service arm, Amazon Web Services (AWS), which has similarly built out massive computer storage infrastructure and rents out server space, to expand the Amazon's e-commerce business even more.

What could be a disruption? Amazon relies on stocking and selling its own products. But in many countries, including China and India, the e-commerce sites mainly connect buyers and sellers, taking a cut on each transaction. This model has proved successful because it enables the large numbers of legacy small retailers (and even small manufacturers) to directly sell to the end-users, thereby eliminating their transaction costs. But Amazon could as well do the same in these markets, as is happening, and use its other offerings to create a better shopping experience and induce a stickiness among them.

Wednesday, November 18, 2015

The search for the optimal PSC

In a departure from existing investment recovery model of production sharing contracts (PSCs) in oil and gas blocks allotted for exploration, India's Ministry of Petroleum and Natural Gas now proposes to adopt the revenue sharing model in all their future PSCs. The “bidders will bid the percentage of revenue that they will share with the government against two revenue scenarios—when revenue is less than or equal to lower revenue point or when revenue is more than or equal to the higher revenue point”. It also proposes to permit them to price and market gas as well as bid for areas/blocks of their choice (open acreage licensing).

In the former, the explorer recovers the entire capital investment before revenues or profits are shared, whereas in the latter, the revenue/profit sharing starts as soon as the production begins. Accordingly, while the investments risks are mitigated in the back-loaded sharing model, the latter transfers all the risks to the explorer and leaves the government as a rent seeker. The former runs into problems of valuation of investments made, with explorers incentivized to gold-plate their investments, while the latter is far simpler to monitor and suits a risk-averse bureaucracy.

I have blogged earlier on India's most famous gas pricing controversy, challenges of PSCs, and the dilemma for governments between maximizing auction revenues and allowing commercial viability. While the decision for the most appropriate type of PSCs is a difficult one to make, I have written in favor of a more nuanced approach, with a slight preference for a hybrid capital investment recovery model. The preference was also motivated by the fact that India does not have large oil reserves and is almost completely dependent on oil and gas imports, thereby making any new production a bonus.

My concern with the revenue sharing model is more fundamental. Given the risks involved with deepwater oil exploration, especially in an area not known for rich deposits, India needs to attract the major international oil exploration firms with the expertise and technology required to prospect efficiently. But a PSC where all the risks vests with explorers and the government is a passive rent-seeker may discourage the major firms, especially at a time of low international oil prices with not-so-promising medium term prospects. 

The major exploration firms will find the proposed structure attractive only if the technical and political risks are low enough and commercial attractions large enough. The PSC structure may be one militating factor too many.  

Tuesday, November 17, 2015

Power sector reforms - is this time different?

The markets have been largely appreciative of the latest round of power distribution companies debt restructuring. In this context, I am tempted to repost what I had written in the context of the 2012 debt restructuring. In particular, this graphic of the cumulative discom losses as a share of nominal GDP is very instructive - we are today at the same stage in terms of cumulative losses as in 2002.
So is this time any different? On the positive side, as this and this suggests, some of the originally anticipated biggest concerns in terms of the impact of the dilution of FRBM on the economy's credit ratings and perceptions may have been over-blown. The most realistic assessment would be that this is a necessary first-order macro-level intervention required to discipline the discoms. But in the absence of other more important field level initiatives like feeder mapping and rigorous energy audits followed by strict enforcement, we may well end up back to square one come the next electoral cycle. 

Saturday, November 14, 2015

Weekend reading links

1. Conventional wisdom would have it that the troubles of commodity producers are due to the slowdown in China. Merryn Webb in FT feels that there is another dynamic at play, the massive capital investment cycle since the turn of the millennium which has left commodity markets flush with excess capacity and supply,
When China started to go nuts for urbanisation and infrastructure, commodity prices rose alongside this frenzy and so did the profits of the big mining companies. Then the spending started: annual mine production rose by 20 per cent a year from 2000 to 2011. Banks doubled and then tripled the size of their commodity teams. New players poured in (small- and medium-sized miners were raising $30bn a year on the equity market by 2011). Mining capital expenditure rose from $30bn a year to $160bn. By 2014, a cumulative $1tn had been invested. Supplies soared — global iron production rose 125 per cent in a decade. And then commodity prices and mining share prices duly collapsed.
The natural end-game for such commodity boom and busts are mine closures, mothballing, and reduced CapEx. Over time, the excess capacity will shrink and prices will rise. The Minsky cycle repeats. 

2. Ashok Gulati draws attention to the very high levels of agriculture subsidies across countries in the form of high output prices, low input prices, direct income support, or crop insurance. Most countries have very high producer support estimates (PSE) which capture the levels of support to farmers as a share of gross farm revenues. He makes the case for sharp increase in agriculture support, mainly as direct income transfers to Indian farmers,
One of the reasons behind China’s spectacular achievement on the agri-front is the level of support given to farmers. China’s PSE level increased from 2 per cent in 1995-97 to 19 per cent in 2012-14. For Indonesia, the PSE has gone up from 4 per cent to 21 per cent over the same period. There are no PSEs available for India, but subsidies on major inputs like fertilisers, power, irrigation, and agri-credit — the main policy instruments through which the government supports farmers — hover between 6-8 per cent of the value of agri-output (2012-14)... The Chinese government has realised the limitations of using pricing policy to provide inputs at cheaper rates. It has begun making direct payments for input subsidies to farmers at a flat rate per unit of land. Overtime, aggregate amount of transfer has increased from 12 billion yuan in 2006 to 107.1 billion yuan in 2014 (about $17bn). The government has also increased the coverage under crop insurance to 73 million yuan per hectare (45 per cent of total planted area in 2013) by providing premium subsidy of 80 per cent.
I am not sure what should be the strategy on this. Unless there are wrinkles within the numbers, it does appear to contradict the arguments of those demanding pruning down of agriculture subsidies in India. Instead, we may need to increase, and sharply at that, the level of subsidies. But the types of subsidies may need to be revisited. Price support, farm power, fertilizer subsidies etc may not be the most efficient means to support farmers. Investment in irrigation infrastructure, massive expansion of extension services including leveraging technology, the creation of linkage infrastructure (godowns and cold storages), and direct income support may be a more effective strategy. 

3. L&T have announced the sale of Kattupalli Port near Chennai to Adani Port and Special Economic Zone Ltd (APSEZ). The deep-water, all-weather port, which started operations in January 2013, has the capacity to handle 1.2 million TEU of container traffic and dry-bulk and break-bulk cargo. This follows, the L&T's sale of Dhamra port in Odisha to APSEZ in May 2014. It appears to signal a trend of segmentation in the ports sector, with construction contractors like L&T building the port and then exiting by selling to port operators like APSEZ, which have greater expertise in attracting cargo and developing an eco-system for a port. Also, as I have blogged earlier, the creeping nature of such acquisitions by one developer raises concerns about monopoly and competition.

4. Vox has a map of countries scaled to the amount of aid received from the US, which underlines the importance of politics in aid financing.
5. Also in Vox a color-coded mapping of Africa's ethnic diversity. Uganda and Liberia are the most ethnically diverse. An interactive version of the map is here
6. China continues its investment-driven growth strategy. Despite a professed commitment to renewable energy sources and declining capacity utilization of thermal power plants, the country has been building coal powered plants unabated. The Times writes about
... a glut of coal-fired power plants — an astounding 155 planned projects received a permit this year alone, with total capacity equal to nearly 40 percent of operational coal power plants in the United States... In the first nine months of this year, state-owned companies received preliminary or full approval to build the 155 coal power plants that have a total capacity of 123 gigawatts, the report said. That capacity is equal to 15 percent of China’s coal-fired power capacity at the end of 2014. .. Greenpeace estimated that if the 155 plants operated at typical levels for new projects, they would emit 560 million metric tons of carbon dioxide annually, equal to Brazil’s total energy emissions.
This raises questions about the country's renewables commitment and the commercial viability of renewable energy sources,
The construction boom — with capital costs estimated by Greenpeace at $74 billion — is a clear sign that China remains entrenched in investment-driven growth, despite promises by leaders to transform the economic model to one based on consumer spending. It also raises questions about whether China is weaning itself from coal as quickly as it can and whether officials are sufficiently supporting nonfossil fuel sources over coal, which is championed by some state-owned enterprises... Renewable-energy interests — wind, solar and hydropower — are pushing back against coal-fired power plants, which have 40-year life spans. They say the rising number of coal plants prevents other energy sources from selling electricity on the grid and attracting more investment. They want the government to move faster with its promised “green dispatch,” giving priority to low-carbon electricity sources.