Power sector reforms

Energy security will be the fundamental determinant of both our economic growth and national security in the days ahead. The Planning Commission estimates that power shortage is fast becoming the single most important infrastructure bottleneck facing India. Acute power shortages and peak-time load reliefs in many states poses a serious threat to achieving the double digit growth rates we aspire to. Securing access to assured oil and gas, and thermal and nuclear fuel supplies would be a primary goal of our foreign policy.

The Power Ministry has set a target of "power for all" by 2012, achieving which would entail enhancing power generation from 144 GW to atleast 250 GW. Of the present capacity of 144 GW, 92 GW comes from thermal plants, 36 GW from hydel, 12 GW from renewable and 3.8 GW from nuclear fuels. The Eleventh Plan power generation target is 78.5 GW.

The first generation of power sector reforms involved un-bundling of the integrated State Electricity Boards (SEBs) and their corporatization, the setting up of Regulatory Commissions, and setting the policy framework for private participation. Now the time has come for the second generation of reforms, which should put in place an enabling policy framework to usher in private investments in power generation. On the downstream side, it is imperative that a competitive environment be created that facilitates power trading and open access which expands consumer choice.

It is hoped that implementing the next generation of reforms in electricity sector will usher in a revolution in the sector similar to that experienced by the telecom sector in the aftermath of its deregulation. It is hoped that prices, especially for bulk industrial consumers, would fall and the quality of supply will improve dramatically, and scarce power resources will be allocated more efficiently. Crucial to this happening would be the implementation of open access in transmission in its full spirit and a gradual and phased movement in the direction of full implementation of the same in distribution.

Meeting the rapidly growing demand requires the establishment up of large numbers of power generation plants. Absence of clarity in policies and their implementation, bureaucratic delays, problems in securing assured fuel supplies, and difficulty in acquiring land and settling encumberances have come in the way of many projects achieving financial closure.

These issues need to be addressed at the earliest if we are to come anywhere near achieving our targets. Awarding of projects should be expedited by standardizing bid process management, especially in the EPC mode, using model bid and contract documents and principles, and concession agreements. Similarly, the process of getting commitments and clearances from transmission and distribution companies on PPAs, should be fast tracked. Ideally, all the clearances should be tied up before the bidding process gets initiated. All this would go a long way towards bringing in transparency to the process and generate a competitive environment in the sector.

Environmental and other mandatory clearances can be expedited through single window clearance mechanisms to fast track these projects. Land acquisition procedures will have to be revised along the lines of that being followed by the National Highways Authority of India for road projects. Project displacement concerns can be mitigated effectively if the rehabilitation and re-settlement (R&R) of the project affected are done quickly in a fair and transparent manner, minimizing the pain associated with dislocation.

The massive demand has exposed the problems in sourcing plant equipment and tying up its supply chain. Standardization of boiler, turbine, and other equipment designs and specifications would enable suppliers to swiftly execute bulk purchase orders and expedite their delivery. The opportunity presented by the massive requirements should be utilized to demand that foreign firms transfer technology and set up domestic production facilities, thereby expanding the depth and breadth of the domestic market.

The acute scarcity in coal being faced by power utilities, especially the smaller generators, and the inability of state agencies to import adequate quantities of coal carries a strong forewarning. Coal powered plants form 53% of our generation capacity and will continue to remain the mainstay of our power generation program for the foreseeable future. The situation is even worse in the supply of natural gas, with only 50% of the demand being met and valuable capacity lying idle.

The State producer Coal India Limited (CIL), which supplies coal to most thermal power plants in the country, will have to not only substantially ramp up domestic production, but also aggressively acquire mines overseas. Taking a cue from the success of the oil and gas exploration policy, the Government of India (GoI) will need to expedite identification and handing over of coal blocks to private companies for captive use. These blocks should be allocated in a transparent manner, following a tariff-based international competitive bidding, instead of the regular screening committee route. In order to incentivize immediate development and prevent hoarding of land, there should be sunset provisions to revert back the mines in the event of non-development. Given the inevitability of large coal imports, we will need to make substantial investments in additional port, rail and handling infrastructure.

With the peak hour deficits likely to continue for the foreseeable future, merchant power plants become a commercially attractive proposition. The emergence of an active power trading market and enabling open access framework, can go a long way towards helping generation projects achieve financial closure quickly. Power purchase commitments from distribution utilities will help the promoters access debt at cheaper rates.

Except for the limited success by a few generation companies in accessing the debt market, transmission and distribution utilities have not managed to raise debt successfully from the open market. The availability of easily accessible debt from government backed financial institutions like the Power Finance Corporation (PFC) and the Rural Electrification Corporation (REC) has had the effect of "crowding out" the development of a private debt market. It is therefore important that these instiitutions scale down their activity, and confine themselves to the smaller and weaker utilities.

The state utilities are too cash strapped for internal resources to be of any significance. Given the excellent commercial potential of merchant power plants, the equity market is a good source of raising funds. In any case, the Indian equity and especially debt market is too narrow and does not have the required depth and breadth to finance these huge requirements. It is therefore inevitable that Foreign Direct Investment (FDI) be incentivized, so as to meet the huge investment requirements.

India has an estimated hydel power generation capacity of 150 GW, especially from the Himalayan fringes, of which only 35 GW has been realized and another 15 GW are under various stages of development. Atleast another 100 GW can be generated by tapping water resources in neighboring countries like Nepal and Bhutan. This hydel power should contribute the major share of the peaking load requirements for the future.

Massive investments are required in upgrading and expanding the transmission network to evacuate electricity from the upcoming plants and from surplus to deficit regions. A modern and seamlessly integrated National Grid, is critical to the functioning of robust power trading exchanges that can ensure optimal utilization of scarce resources. Given the relative difficulty of managing private ownership of transmission networks, the Government entities will have to make the bulk of investments, atleast for the foreseeable future.

Distribution captures the last mile in the electricity value-chain, and its efficiency is critical to ensuring cost recovery and profitability of the entire sector. Unfortunately, it remains the achilles heel of power sector, with nation-wide Aggregate Technical and Commercial (AT&C) losses at an unacceptably high 34%. Rampant power thefts, inadequate metering, run-down networks and poor management, accumulating dues, lack of prudent financial management, and government subsidies all contribute to these high losses.

Lowering AT&C losses would be critical to making the power sector commercially viable. The Accelerated Power Development and Reform Programme (APDRP), with policies incentivizing loss reduction, has brought to focus the need to reduce AT&C losses to 15% by 2012. Technology interventions like GIS, SCADA, and IAMR can go a long way in bringing down these losses.

Distribution offers the full spectrum of opportunities for private participation, from selective distribution franchising to outright privatization. Given the large legacy systems and political opposition to privatization, the most prudent way to involve private partners in distribution is the franchisee model. Under this, the state utility transfers the rights to operate and maintain network, supply power, and bill and collect tariffs in certain circles to private players. This arrangement should be initiated in urban circles initially, since their consumption is high and the benefits of improvement much larger.

The Electricity Act of 2003 took the radical step of providing "open access" to distribution and transmission networks and recognizing power trading. Open access can be implemented in its full spirit in a phased manner, starting with transmission. This will require removing transmission capacity constraints and lowering transmission surcharges, besides the emergence of active power trading exchanges. A robust trading regime will require adequate depth in the market - both in terms of numbers of sellers and buyers and quantity traded.

The market can be deepened by trading a part of the central pool reserves thorugh the exchanges, encouraging more distribution and generation companies to participate, and by incentivizing setting up of merchant power plants. Floating availability based tarrifs will help in more efficient allocation of the scarce power available, especially during peak times. Open access can then be extended to facilitate the entry of private distribution companies that can purchase power and then sell it to atleast bulk consumers.

The present tariff arrangement, which does not differentiate between peak and off-peak uses, distorts the incentives for efficient utilization of power. Given the average national peak load deficit of 16%, distribution utilities are forced to purchase power at exorbitantly high rates of Rs 7 to Rs 9, thereby placing unsustainable burdens on their already weak finances.

Further, the present arrangement distorts the incentives for IPPs who hope to cash in on the high peak-time demand, and make handsome profits at the expense of the state utilities and consumers. In this scenario, IPPs can enter into PPAs with utilities at relatively cheaper rates, and still make handsome returns from their peak time sales.

A floating availability-based tariff regime and a merit order based load despatch system will go a long way in efficiently allocating power consumption across different categories of consumers. It will help lower tariffs, especially for bulk consumers and reduce peak power consumption. An active power trading platform, supported by a robust transmission grid and deployment of real-time consumption monitoring technologies like IAMR and SCADA will help facilitate implementation of this regime.

Addressing this peak load deficit is a huge challenge, and has to be overcome by adopting an appropriate mix of base-load and peaking load plants. With the overwhelming majority of new generation capacity coming in base-load plants, it may be economically efficient to make small investments to convert the existing hydel power plants to peaking load plants. Given the need to meet the large peak deficit, the role of natural gas driven peaking load plants become even more important.

Nuclear power forms just over 2% of our total power generation and the proposals on the pipeline are expected to add a meager 3 GW. The Indo-US nuclear deal and the subsequent removal of restrictions on trade in civilian nuclear components by the Nuclear Suppliers' Group (NSG), has come as a shot in the arm for nuclear power generation. In the face of high commodity prices and environmental concerns, nuclear power plants, with its low opearting costs, becomes an attractive proposition, despite high construction costs.

The huge business opportunity in nuclear capacity addition, estimated at over $40 bn, should be enough to attract global majors like GE, Areva, Hitachi and Westinghouse. Collaborating with these majors will enable technology transfer and facilitate the development of domestic expertise in the private sector, which would be critical to sustaining the program. Similar to what China has done in every sector, we should leverage this opportunity and the economies of scale to our advantage and lower costs.

The biggest challenge facing the development of our nuclear power generation program is that of sourcing uranium fuel. With scarce domestic sources and being denied access by major producers like Australia, even the existing nuclear power plants are running at barely half their meager capacity. All equipment supplies should be tied to assured supply of fuel for the entire plant life or access to captive uranium mines across the globe. The commercial clout of these large companies would facilitate the tie-up of critical uranium supplies. Given the plentiful domestic thorium reserves, efforts should be strengthened to expedite the development of the thorium-based fuel cycle.

A strong regulatory regime, with specific focus on safety and nuclear waste disposal, will have to be put in place to reassure the significant public safety concerns on nuclear power generation.

Renewable energy sources like wind, biomass, and solar have enormous potential in India and will become attractive propositions in the coming years as the cost of production declines and if oil stays expensive. The government will need to encourage its development with appropriate output-based fiscal incentives. With most of the solar and wind power potential areas being located away from load centers, there will have to be substantial investments in transmission capacity to evacuate the power generated.

All the aforementioned reforms have the potential to unleash competitive forces in the electricity market, similar to that in the telecoms market in the aftermath of deregulation. This will in turn incentivize setting up of merchant and captive power plants, expand consumer choice, improve the quality of supply, and finally lower tariffs.

Finally, all these reforms will become unsustainable and come to naught without political commitment. The wave of free-power induced competitive populism sweeping through many states is the most pernicious manifestation of this danger. States will need to eschew such bad policies and the GoI will need to incentivize the states to follow suit by tailoring their policies accordingly.