The Indian power sector - today and tomorrow

Author: | Published: 12 Jul 2001
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The evolution of the sector and the applicable laws

The present state of the Indian power sector could well be characterized as that of a melting pot. But then, as Lord Tennyson, said: "The old order changeth yielding way to the new".

The history and evolution of the power sector in India dates back to the 1880s, when a small power generating station with local distribution was established in the hills of Darjeeling in the eastern part of India. Since then there has been a chequered evolution of the sector, a fact that is also true of the governing legal and regulatory framework for private utilities owning and operating the system.

This article seeks to identify and highlight the key initiatives and reforms undertaken in the electricity sector in India, and some issues that are being grappled with in the effort to make the sector efficient and attractive for private participation and investments. There is no doubt that these reform initiatives will eventually lead to increased private participation in the power generation, transmission and distribution of electricity and possibly other areas, which will become available to a private investor after the reforms.

The legislation of 1887 and 1903 that provided for private power and minimal regulation, evolved into a more comprehensive Indian Electricity Act 1910, (IE Act) an amended version of which still governs the sector. Post-independence came the Electricity (Supply) Act 1948, (ES Act) which provided for the establishment of semi-autonomous vertically integrated utilities, ie State Electricity Boards (SEBs) owned by the state to undertake the generation, transmission and supply of power. The Industrial Policy Resolution 1956 clearly put the generation and distribution of power under state ownership. The context of this was infrastructure bottlenecks, resource constraints, the constitutional commitment to social justice, and 'electricity' being a concurrent subject, both Central and State Government are competent to enact laws on the subject. The evolution of the SEBs into vertically integrated monoliths driven more by employment generation and other social objectives (such as cheap power to the agricultural and domestic sector) rather than commercial viability form the backdrop of the legislative and policy initiatives in India since 1991. The skewed and unreal tariff structure, where nearly 40% of the generated power is lost due to technical and commercial inefficiencies, and the balance of nearly 60% is provided on subsidised rates, has led most SEBs towards bankruptcy.

The need for private capital and enterprise (1991)

Recognizing the inability of the state and SEBs to bridge the demand-supply gap, the India government has undertaken a number of initiatives to invite private participation in the sector. The process started with the passing of Resolution No 237 of the Ministry of Power, which declared policy initiatives for promoting greater private participation in power generation, supply and distribution. As regards legislation, the Electricity Laws (Amendment) Act 1991 came into force providing for the following:

  • the formation, expansion and functioning of private sector generating companies;
  • provisions for determining for the tariff for the sale of electricity. Provisions were laid down that such tariffs will be based on normative parameters regarding operations and plant load factor (PLF), as detailed in notifications issued under section 43-A of the Electricity (Supply) Act 1948 for depreciation and reasonable rate of return;
  • a fast-track clearance mechanism of private investment proposals;
  • increasing the licence term from 20 years to 30 years, and extending the term from 10 years to 20 years;
  • the establishment and functioning of private sector licensees, including recognizing in the Sixth Schedule the elements of debt redemption, depreciation and interest liabilities;
  • initiatives to promote captive and co-generation power plants; and
  • enhancing the threshold limit for electricity schemes requiring CEA approval from Rs5 crores to Rs25 crores, which has since been enhanced to Rs400 crores.

The Ministry of Power also introduced a policy for private participation that laid down a range of incentives for private players, including, among other things:

  • a 16% return on equity at a 68.49% PLF, under a two-part tariff system;
  • a debt-equity ratio up to 4:1 was permitted with up to 100% FDI;
  • the threshold for CEA clearance was raised from Rs5 crores to 25 crore; and
  • the importation of equipment was permitted subject to government approval.

The private power policy laid down attractive norms for private participation. Foreign investors have been popular with the Indian government and Press Note No 2 of 1998 is proof of this fact. This note enhanced the limit of automatic approval for FDI for electricity generation, transmission and distribution projects from 74% to 100%, subject to the limit of Rs1500 crores (a ceiling that has since been removed).

Despite the law and policy for private participation being in place, the achievements in terms of adding improved generation capacities have not been substantial. The financial health of the SEBs has been an impediment to new private players. Most of the projects being promoted by private parties were not able to achieve "financial closure" due to the non-availability of reliable and assured revenue stream from SEBs, including appropriate alternative security mechanisms. The private power developers debacle over the availability of escrow accounts in the State of Madhya Pradesh cost private developers a couple of years in litigation both at the High Court at Madhya Pradesh and the Supreme Court of India, in the process revealing the financial handicaps of the SEBs.

Reform initiatives – 1996 onwards

The entry of private developers shifted the focus of reforms to the financial health of the SEBs who, under the framework then if force, were the sole buyers in every state. Keeping in mind the objective of bringing efficiency and accountability to each part of the sector, in 1996 the government determined and declared the Common Minimum National Action Plan (CMNAP) for power, whereby for the first time the realities of the sector were highlighted.

The Plan specifically admitted the following problems :

  • a demand-supply gap in power;
  • the need to bring in viability in the functioning of the SEBs, and improve their operational performance was felt to be crucial for sustaining the sector; and
  • the need for encouraging private sector participation in generation, transmission and distribution was felt.

The Plan envisaged: establishing a Central Electricity Regulatory Commission and State Electricity Regulatory Commissions in the various states; the rationalization of retail tariffs to secure a minimum return for each utility; imposing the burden of deviations/subsidies on the state government; the inclusion of a fuel adjustment charge in the tariff; greater autonomy to SEBs; and improvements in the performance parameters of SEBs.

In 1998, parliament enacted the Electricity Regulatory Commissions (ERC) Act 1998 to provide for the establishment of a Central Electricity Regulatory Commission and State Electricity Regulatory Commissions, rationalization of electricity tariffs, transparent policies for subsidies, and to promote efficient and environmentally benign policies. The Electricity Regulatory Commissions Act (ERC Act) 1998 was enacted with the following key objectives:

  1. improving the financial health of the SEBs through rationalizing the tariffs, establishing retail tariffs and correcting the high level of cross-subsidies;
  2. securing efficient planning and operation;
  3. addressing the bottleneck of inadequate capacity to meet the demand;
  4. enhancing the quality and quantity of supply and service standards;
  5. attracting the involvement of private sector skills and resources; and
  6. appointing independent regulatory authority/ies.

The good news is that the Central Electricity Regulatory Commission (CERC) is in place and its pro-active approach has kick-started growth in the power sector. It has already passed specific orders rationalizing tariffs, formulating clear policies on subsidies, technical operations and grid codes, and is promoting environmentally benign policies.

Many states have started to set up State Electricity Regulatory Commissions (SERCs), corporatizing and unbundling SEBs. To top it all, they are creating a conducive climate for assured returns for private investors at the same time as clearing massive debts to the central power companies.

The power to create a Central and State Transmission Utility was granted under the Electricity Laws (Amendment) Act 1998. This enactment amended the Indian Electricity Act 1910 and the Electricity (Supply) Act 1948, and provided for a legal and regulatory framework for the development of the power sector, including private investment. It gave the central government the powers to specify by notification any government company as the Central Transmission Utility and State Transmission Utility.

Reform experiences of the states: unbundling and restructuring

Based on their experiences in countries where reforms have been introduced, reformers are of the view that vertically integrated, state-owned power utilities are incapable of functioning along commercial lines, and unless they are unbundled and competition is introduced, a market for private investment cannot be created. After much debate and discussion, the restructuring and reforms of the SEBs has been started in some states. It is expected that after restructuring, imbalances and inefficiencies will be identified and localized, and the financial health of the SEBs should improve. Furthermore, some power utilities have started the process of unbundling the vertically integrated monopolies, and have started separating generation from transmission and distribution.

Restructuring of the electricity industry

Level I: Separation of Powers

 

Level II: Unbundling of SEB's
Level III: Commercialisation & Private Participation
  • Financial Model - Re-Valuation Of Assets.
  • Dis-Aggregation and Rationalisation Of Tariffs.
  • Inter-Se Utility Commercial Arrangements - PPA, BSAs, etc..
  • Metering, Meter-Reading, Billing, Recoveries And Disconnections.
  • Functioning As Profit Centres


Most states have put forward State Reform Acts to facilitate the process of reforms – they are wide, both in their scope and coverage. The Acts, in addition to creating an autonomous SERC, vest overall regulation of the power sector (covering licensing; tariff revisions; investment and disposal of assets; operational, planning and security standards including grid code, distribution code, consumer interest safeguarding regulations, etc) in the SERCs, and also establish the legal and regulatory framework for restructuring/unbundling of the SEBs into corporatized successor entities, licensing and exemptions, commercialization and private participation, and give supremacy to the Reform Acts over the provisions of IE Act and ES Act (the State Electricity Reform Acts set out the applicability and modification of provisions of the IE Act and ES Act that have been modified).

The reforms undertaken in the states are expected to have a positive impact on the health of the SEBs, as the changed legal and regulatory framework enables each of the unbundled entities to function independently, and in an autonomous and professional manner without interference. The state government's role has been confined to issuing policy directions and it is not entitled to interfere in tariff issues. Further in the case of a subsidy being granted to any class of consumers, a duty is cast on the government concerned to compensate the utility/licensee for that amount. Tariff setting has become a public hearing process achieved through a quasi-judicial procedure. Thus, apart from bringing efficiency and transparency to the functioning of SEBs, the reform initiatives have laid down a good precedent for maintaining a healthy balance between utilities and consumers.

In states where there has been no unbundling of SEBs, the SEBs are taking steps to file their annual revenue requirements and are seeking tariff revisions from the Regulatory Commissions. To a large extent, the government has played a key role in expediting the reform process as it has promised support to states that are undergoing reforms and filing for tariff before the Regulatory Commission under the Accelerated Power Development Programme (APDP).

The situation in 2001

Despite the various reform initiatives, the sector is yet to achieve its targets. As per the projections of India's Central Electricity Authority, India requires the creation of 100,000 to 120,000 megawatts of additional generation capacity over the next 10 to 12 years. Taking into account the approximate investment norm of Rs4.5 crore per megawatt and Rs4 to 6 crore per megawatt for additional evacuation and distribution capacity, India has an investment requirement of Rs400, 000 to Rs500, 000 crores just for the creation of additional generation capacity at current costs over the next 10 to 12 years, ie an annual requirement of around Rs40, 000 crores and will require an additional 40,000 - 60,000 crores annually for evacuation and distribution.

In the ninth plan, a target of 4,2000 megawatts was set, but only 22,000 megawatts were achieved. The demand-supply gap can only be bridged by the optimum use of all available sources of electricity, and by seeking active private participation in all areas, ie generation, transmission and distribution. The electricity sector in India is in the process of transition, and in this process many fresh avenues for private participation are being created and will be created in future.

Electricity Bill 2000

The central government has finalized a new Electricity Bill 2000, intended to be a comprehensive, which will repeal the existing electricity laws, ie the Indian Electricity Act 1910, the Electricity (Supply) Act 1948, and the Electricity Regulatory Commission Act 1998. The Bill is likely to be tabled in the forthcoming monsoon season.

The draft of the Electricity Bill has been prepared by the National Council for Applied Economic Research (NCAER) after a range of consultations with state governments, state electricity boards, financial institutions, consumer forums, investors, experts and other stakeholders. Some of the key features of the Bill are as follows:

  1. functional disaggregation of generation, transmission and distribution with a view to create independent profit centres and accountability;
  2. reorganization and restructuring of the SEBs in accordance with the model, phasing and sequencing to be determined by the respective state governments (states would have the freedom to retain their boards until they decide to restructure their electricity industry);
  3. states to determine the extent, nature and pace of privatization. (public sector entities may continue if the states find them sustainable);
  4. competition, economy and efficiency are to be promoted in the best interests of the consumers and the national economy;
  5. transmission is to be separated as an independent function for the creation of transmission highways that would enable viable public and private investments in the electricity industry;
  6. amendments made in 1998 to the Indian Electricity Act 1910 and the Electricity (Supply) Act 1948 for facilitating private investment in transmission are to be broadly retained;
  7. the present entitlements of states to cheaper power from existing generating stations to remain undisturbed;
  8. compulsory metering for enhancing accountability and viability;
  9. Central and State Electricity Regulatory Commissions to continue broadly along the lines of the Electricity Regulatory Commissions Act 1998;
  10. special provisions for promoting access to electricity in rural areas and for economically weaker persons;
  11. stringent provisions to minimize theft and misuse;
  12. provisions for the transition from a state-owned monopoly to a liberalized and competitive industry; and
  13. recognition of trading as an activity and the creation of a bulk electricity spot market.

Private participation – concerns and opportunities

Despite the sincere efforts of policy makers, private investment has not really received any great boost because, among other things, the sanctity of contracts has turned out to be a major issue. The experience of the developers of the Dabhol Project in Maharashtra speaks for itself. It is important that contracts are honoured both in spirit and content. The reform process, apart from introducing efficiency and accountability in the sector, is also going to attract private participation. The areas and avenues for private participation in the legal framework (in the post-reform era) would include the following:

  • Distribution – private participation in the unbundled distribution companies is being sought by some states. There are ample opportunities for private players with experience to take a leap into the business of electricity distribution. The market potential of the distribution market, especially in India's metropolitan cities, is good and there are several cities where the process is yet to start. The presence of a regulator in the state only goes to increase the comfort level for a private investor;
  • Energy Efficiency mechanisms – the government is also taking serious initiatives to promulgate a law on energy efficiency mechanisms which would open avenues for those with energy conservation experience to implement programmes such as demand side management (DSM), and other energy efficiency and conservation programmes in India;
  • Trading – the imbalances in the availability of power in different regions of India makes the power sector attractive for 'trading' electricity. There is specific mention of both trading and setting up a bulk electricity spot market in the Electricity Bill 2001, a Bill proposed to be placed before parliament in the forthcoming monsoon session .
  • Alternative fuel – some states have shifted their focus towards alternative forms of energy such as solar and wind power. Some states have also encouraged setting up power plants using solid municipal waste as fuel; and
  • Captive/co-generation/small hydel plant – a number of states are encouraging schemes for setting up captive plants, co-generation plants and small hydel plants. The advantages of investing in smaller plants is that the exposure to risk for the lender are reduced.

Conclusions

The reforms are at the nascent stage and their positive impact will only be seen with time. As far as business avenues for private investors are concerned, the sector does offer opportunities. There is no doubt that with the implementation of reforms in the SEBs, the sector will benefit and prosper, but this depends on active private participation. To achieve this, sensitivity would be required to the issues of concern raised by the private investor, whether pertaining to sanctity of contracts, removal of monopolies at any level, or bringing in competition in any area or sector.


Power Sector

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