Indian Power Sector - Is it ready for open access?

Posted on February 21, 2006
Posted By: Sidhartha Das
 
Many improvements have been made in the Indian power sector in the past few years. There has been improved performance at various levels of transmission and distribution, particularly in the distribution sector with the AT&C (Aggregate Technical & Commercial) losses all over the country being curbed to a large extent, thus increasing the dependability of the power distribution sector. Tremendous improvements on the technology front in these distribution sectors across India have ensured better delivery of power to the consumers.

But, everything said and done, are the distribution sectors ready for the open access is a question that needs to be asked and answered at the foremost. With our revered MP (Member of Parliament) Mr. Ajay Maken, advocating for open access in the year ahead – 2007, can we think we can handle retailing in a sector which is cumbersome and when there stands shortage of power as the demand exceeds the supply almost all throughout the year. Considering for once, open access comes into existence, where from these distribution sectors raise money for their new installations or for that reason for their R&M (Repair & Maintenance)? Does the energy policy as has been laid down by the Government of India (GOI) enough to battle the oncoming competition & challenge? Most private distribution companies have a fixed return on equity based on the AT&C loss level in their area. Will that return on equity suffice? How many market players can GOI handle with the regulatory asset (of Regulatory Commissions) increasing? What happens at the end is that the consumer has to pay. The GOI predicts an 8 to 8.5% growing economy at whose cost? Is it not time that the finance by these private power distribution companies and the state electricity boards be re-visited? Is it not time that the energy policies be re-visited? All that happens is a fire – fighting approach as of now and probably in times to come, hence it is high time that the finance & policies are re-visited again.

Talking about energy policy in a developing country like India, two major instruments for efficient actualization of the energy policy would be:

a) Energy Planning and
Development of a set of policy instruments for effectively implementing the plan.

b) The basic lag in any kind of energy planning in India is that the ethical considerations are being ignored or being bypassed thus making the base of the energy planning unstable and hence problems do arise in its implementation. The ethical consideration and beliefs should form the basic composition of the energy planning since India is wedded to the market economy as its guiding principle. For example, GOI now considers for power trading, the reason behind it being there is an influx of FDI in that reason overlooking the ethical considerations embedded into it.

Again, the emerging new renewable and non – conventional energy sources is an increasingly important component of energy scenario in the world and in India is being impeded by too much emphasis on the market mechanism. It is pertinent to mention here that the market economy in power distribution sector is centered on relative cost, a cost which is entered into the book of accounts of the supplier and the buyer thus rendering the renewable/non-conventional energy resources stand at a distinctive disadvantage compared to conventional energy resources which rules the roost at this point of time in any developing country for that reason.

Energy planning, like all other kinds of planning involve usually some or other models having various assumptions and the efficacy of the models depend upon its underlying assumptions and their implications. These models which are available commercially can be used by the power distribution companies for forecasting the energy needs.

Energy planning, as reiterated earlier, needs an ethical consideration as has been advocated by Mr. Bani P Banerjee because energy planning in any developing country for that reason is aimed towards modulating the growth of energy acquisitions and usage along desirable directions. The private power distribution players governed by the regulatory commissions (owned by state) or for that reason, any state utility should be governed by the law of distribution justice and that several criteria have been laid down for the same which include:

a) That “Energy” needs to be distributed absolutely equally

b) That “Energy” should be distributed according to need (Depends on how accurate the forecasting is and how negligible is the gap between demand & supply)

c) That “Energy” be distributed in proportion to merit or due return.

As stated in the Economist, a comment made by the Nobel Laureate Mr. Amartya Sen, “Indian Government & Political Parties, all are elitist in nature”, the basic reason behind such a statement is because the existing energy policy in India overrides certain essential boundary considerations as has been advocated by Mr. Bani P Banerjee:

a) Energy Policy should be sustainable both in respect of intergenerational resource availability, as also the environment

b) Energy Policy should ensure energy security

c) Energy Policy should ensure political security

d) Energy Policy should ensure foreign exchange policy (A must since open access would require more players in the market)

As of now, The GOI’s (Government of India) energy policy seems to be concerned with making of energy resources which is depleting at a faster rate than forecasted, both in terms of electricity & fossil fuels and which is available to the affluent urban population. Again, the GOI is wedded to the market economy. More than a third of the Indian population subsist below the poverty line and are unable to use the commercial energy resources made available by the government. As has been indicated in my earlier papers, a meager 2A of connection to the slum dwellers for their basic needs like cooling, heating & cooking is a serious violation of the ethical considerations being taken into account during “Energy Planning”. No systematic attempt has been made for developing cleaner, indigenously available fuel for the rural poor so far and we talk of open access.

It has become evident from any measure that the energy policy of GOI, to-date has fallen dismally short of the demands and that any desirable energy plan for the future would have to see a decrease in the gaps between the projected performance and the boundary conditions and that the ethical requirements of the consumers are substantially reduced if not eliminated altogether.

Developing countries like India face three major problems:

a) Ecological Destruction increasing at an alarming rate

b) Economic developments at its low since just only influx of FIIs or FDIs or for that reason the SENSEX touching a miraculous 10000 mark doesn’t mean that there is an economic rise in the utility sector when the electricity sector’s contribution is just only 2% in the rise of the SENSEX. Psychologically the economy is booming but its effect is not being felt in the electricity distribution sector.

c) Last but not the least, the problem of maintaining the political pluralism.

With the SENSEX registering a whooping 10,000 points and with a large amount of cash flow from foreign investors, developing countries have a right to exploit the economic opportunities and we need more investments to enhance efficiency with a minimal environmental destruction and a neutral budgetary allocation for the rural and the urban poor. As stated in my earlier paper, there is a huge migration from rural areas to urban cities for various reasons like better work place, better life, even better amenities but with loads of power shortage and low investments, all these people have can be considered to be very much paltry in comparison to their urban counterparts.

A sustainable development is perhaps more critical for a developing country than a developed one. Many things like population explosion, ecological destruction, and natural resource exhaustion only appear as problems after a long delay. If such kinds of problems are not accentuated upon immediately, it might lead to conditions which would be beyond repair.

Energy is a necessary requirement in all sectors of any given society. While formulating an energy policy, it is important to distinguish between different levels of energy issues. The energy issues can again be desegregated further thus making the analysis much simpler to understand and follow. It is well agreed upon that AT&C loss is a major component in determining the energy efficiency but if we take “Delhi” for instance, the AT&C loss levels in the northern part of the city is 30% (which is low compared to 56% when privatization occurred), but then again with so much of reduction of AT&C loss level, there are frequent power cuts. Ask them the reason and they say, the peak demand is more and that it goes on increasing every second. So, what are the energy policies doing? GOI says, we are adding another 25,000 MW generation but seeing the stats of the Generation & Transmission companies, they are at a huge loss which has been incurred over the years and the losses are so huge that it is difficult to write it off as a bad debt. GOI goes on adding generation of power but again meets with a deficit at the end of the day. Why? It’s because of the faulty energy policy that they have adopted, since these policies are based on some facts but the consideration of ethical issues have not been taken into effect when the policies were being determined.

SUGGESTIONS (ENERGY POLICY)

Some considerations that should be taken while formulating the energy policies are being listed below:

a) India benchmarks world-class energy companies for its amelioration which is a basic lag since the environment in a developed country is much different from that of a developing country like India. Hence, benchmarks should be taken on the characteristics of developing countries like China, Indonesia & Malaysia to name a few.

b) In India, there is a large disparity between income and consumption patterns. Stratification of the society cannot be ignored at any cost and hence the pricing should be also strata pricing instead of postage pricing. Sub – specification of consumers on SIP, LIP, Commercial, Domestic and Agriculture is not sufficient. A more detailed specification is also required. The reason behind such specification is that there have been a rising number of cases in various courts in India although tremendous improvements have been made. Most of the cases being analyzed lead to billing issues. This is due to that there has been an increase of 11.5% in the tariff within a period of 5 years which consumers are unwilling to pay thus enhancing the “Low Level Equilibrium Trap” and reducing the WTP (Willingness to Pay) factor.

c) GOI does not consider that 75% of the human population in India (a developing country) only amounts to 25% of global energy use or consumption. With such a low consumption, the regulatory asset of the regulatory commissions are bound to rise and the energy requirements of different sectors – Industrial, Agricultural, Commercial, Domestic have to be given enough consideration basing it on social, environmental factors like transfer of knowledge & technology from developed to developing countries, employment, status quo of individuals and last but not the least the political evolution.

Copying from Klienpeter (1995), GOI should take into consideration the consumption sector as is enacted below:

d) Ask GOI about power shut downs, they say its power shortage because of the increased peak demand. Then ask what are they doing with the extra addition of power and then they say, it’s difficult to electrify each and every colony and that electrification is expensive. No doubt, electrification is expensive but such electrification also serves to influence the establishment of settlements in developing countries. GOI should think on terms of providing electricity supply to smaller/rural settlements thus increasing local employment and hence can restrain the influx of population into urban areas.

e) GOI should consider alternate source of supply of electricity like renewable sources. India ranks 5th in generation of wind power but it is trying to benchmark the success route of developed economies and not giving enough consideration to the geographical structure of India. To harness the wind power in India requires deep research on lines of ecological & environmental outlay. GOI should again consider using of biomass with so much of abundant cattle. Biomass contribution can lead to cost reduction in near future of electricity.

In developing countries like India, with the GDP reaching to new heights, there stands out market distortions and skilled human resources since the attitude of the senior management is irksome (Remember the attitude – What can a young lad who joined yesterday would know of the electricity sector) thus pushing him to shift jobs and a recession of the skilled human resources happens in the utilities sector. With attrition rate being high in these utilities, much is being spent in training of new talent thus enhancing the cost factor. These two factors add to the already complicated problems like increased tariff, costing of projects and others faced by energy researchers and analysts in India & other developing countries.

I had even advocated in one of my earlier papers that there should be a tie – up with the local meteorological department so as to gauge the peak demand during a particular season to reduce the gap between the demand and supply. I had even advocated that a more proactive approach should be given consideration in tackling any disaster & crises instead of the existing reactive ones. Ask them what they have done towards this and they say, we are a developing country and it will take time to implement all these things which just an excuse that is costing the GOI a lot and in turn consumers have to pay more to avail the basic amenities.

GOI should also give enough consideration and emphasize on ensuring economic efficiency in supply and use all forms of energy including a mix of commercial & renewable sources of energy for proper energy growth. Electricity Distribution Companies should consider various ways to raise sufficient revenue from sale of energy to finance their own sector development so that the money which is pulled in from the regulatory asset can be used for other infrastructure development. Again, GOI should meet the basic energy requirements of the poor without advocating that electricity will be free thus helping it to contribute to the GDP. GOI should ensure price stability and should roll off subsidies so as to attain uniformity. An 11.5% increase in tariff is too high for cash – stripped economy like India.

SUGGESTIONS (Raising Finance)

State owned utilities and for that reason private owned utility in which the Government has a stake raise CAPEX through return on equity (PBT – Profit before Tax) and the deficit for R&M expenses, new projects are financed through Regulatory Asset of State Regulatory Commissions monitored by Central Regulatory Commission. For example, in Delhi, “North Delhi Power Limited” and BSES, both being private owned utilities (with Government having a particular stake in both the organizations) earn the CAPEX through ROE (Return on Equity) so provided in the provisions during the acquisition and through sale of Electricity to the consumers but still then there stands a huge deficit which is fulfilled by the regulatory assets. The GOI should allow these private owned utilities and thus the state owned ones also to raise finance for R&M and new projects through project finance.

An important source of finance at the national, state and city level is project finance. Project Finance for non – recourse lending is defined by ING bank as “The development or exploitation of a right, a bond.” GOI should allow the state owned as well as the private owned utilities the chance to raise adequate finance for sector development instead of harping more on the regulatory asset of the regulatory commissions.

Mehta (1996) summarizes all the advantages of ‘debt for utilities’ in developing countries like India. A list of credit enhancing measures include

a) Debt service reserve fund

b) Over collateralization of cash flow

c) Flow of funds structure

d) Additional bond tests

e) Double barreled bonds

f) Bond insurance or financial guarantees from private insurance companies

g) Letters of credit from banks or other arrangements supported by their respective state governments.

Apart from the above, private capital can be tapped from international capital markets. The five major instruments are (Van Dijk, 1998):

a) Direct Foreign Investments (DFIs have a long term perspective while other categories can be easily withdrawn and are more of short – term in nature)

b) Loans from international financial institutions. With the high amount of influx of FDIs & FIIs, this would not be a problem and GOI should allow private owned and state owned utilities to be able to take the loan for sector development (GOI has already allowed FDI in power trading looking at the open access regime which is to begin in 2007).

c) Non – Bank Credit

d) Portfolio Investment (An issue that should be given a yes by GOI – reason with SENSEX rising, it would be a boon in disguise)

Foreign and local investors both can be approached for raising funds although they are not necessary alternatives to each other, but are often complementary and can work together. Again, non – conventional forms of finance can also be used to finance electricity projects. They can range from Rotating Credit and Savings Association (ROSCAs) to linking traditional forms of saving (chit funds) with modern forms of credit (Kropp, et al., 1989). The basic criterion to get this kind of financing possible is to be transparent as possible for all the parties so involved. Again, this would ensure deletion of low level trap in toto.

The basic reason behind the raising of finance is to curb down the steep hike in Tariff every year causing a lot of inconvenience to the consumers because with all the expenses growing at a geometric rate, the income stands to grow in an arithmetic progression.

Since, the new projects like electrification and R&M schedules cost a fortune; the cost is being diverted in form of hiked tariff to the consumers. So, these utilities planning any new infrastructure projects or any such process in execution should go for Marginal Costing. This would ensure proper costing of the project. If the NPV of the project over a period of time is positive, it is better to go for it rather than expecting that with the improvement in the life style of the consumers and a boom in the economy would ensure positive inflows in the future.

Marginal cost methods have been used for sector analysis of utility infrastructure for long-term optimization of system expansion. Although its use for long-term capacity expansion has been less prominent, marginal cost can be handy yardstick to resolve planning problems at the margin of least cost program.

Three methods of estimating marginal cost have generally been advocated for any project costing. Such methods would reduce the cost of implementation of these projects thus diluting the transfer of the cost onto the consumers in the long run.

This kind of costing gives insight into various aspects including the operation and maintenance costs to be incurred on a long term basis without diverting the cost so incurred to t he consumers.

Utilities have to take care that over utilization of grant funds and under utilization of loan funds is a big problem that can lead to reallocation in the project budget. Completion of projects on time reduces the unnecessary cost escalation and expenditure. But armed with ethical considerations in the energy policy and given ways to raise finance would generate enough revenue and aid in cost recovery without diverting the said cost onto the consumers and thus help these utilities be prepared for the open access from both the financial & policy point of view and can think to encounter competition.

 
 
Authored By:
Currently employed by North Delhi Power Limited (TATA POWER) in the capacity of Officer (Project Finance), I am looking after preparation of the fixed asset module, forecasting of the CAPEX limit so as to help build the ARR & other developmental issues of the organization and had been handling “Consumer Grievance Redressal Forum” which gives me an insight to problems faced by consumers of the power industry. Strategically inclined that
 

Other Posts by: Sidhartha Das

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Comments

February, 21 2006

Ferdinand E. Banks says

In the elementary energy economics textbook that I am in the process of completing now, I make only a few comments on the subject of open access, but before drawing too many conclusions about this topic let me suggest that the author of this paper should consult the work of Professor David Teece of the University of California (at Berkeley). In his opinion, open access appears to be one of the worst acts in the electric deregulation circus.

February, 21 2006

Sidharth Das says

Dear Ferdinand,

I agree I should have consulted more books and I do agree that open access has failed in a few areas but India is just the blind follower of USA. They see what has failed in USA and try to implement that praying that it would work. I don't have much access to David Teece work and since the exchange rate is very high of Indian rupees and us dollars I can't order a copy also.

The organization that I am working in has benchmarked Baltimore Electric & Gas and has implemented AMR which has also got drawbacks, many infact and the Indian Government talks only of US and is unwilling to benchmark developing countries which are more of less of the same geographical area as India but no. Hence, for that reason I have written this paper. Why do you think I had advocated for a change in policy and raising of finance Ferd?

I will try to lay my hands on the work of Prof. David Teece and also request you to please give me a summary of your energy economics textbook which you are about to complete. And thanks for the comment. I will try to follow the work as advocated by you.

February, 28 2006

Durga Prasad Kar says

Please browse the website www.adire.org about poverty and development through appropriate energy. Let me know what you think about it. I have already gone through that the complicated and incomrehensible process of developing big government and private energy projects of India in last decades. I will be the last person to go back to that grid power model again without a convincing argument or a working model not to be seen anywhere in the developing world delaing with the poor people.

February, 28 2006

Sidharth Das says

Sir, I appreciate your comments and the crisis that you must have gone through in handling the projects. What I had advocated in my first paper is the same as suggested in the website. When there is ample opportunity for the same in India, it is not taken into consideration by GOI. Secondly, in this paper, it has been advocated for taking into consideration the ethical issues like poverty etc before arising at any final conclusion. Not necessarily that, the policies so framed are benefitting the rich so where will the poor go? Privatized sectors in India are drawing a 16% ROE (which shud be on PBT but they are drawing it on PAT and the depriciation factor which shud lie with the privatized companies lies in the hands of the government)

I had also advocated in my earlier papers about utilizing wind energy India being the 5th largest producer of wind power and moreover, a research paper by Nuclear Informatics Centre, India (Bangalore) had also detailed out the use of wind power. You can very well see that India is in talks with US to use Nuclear Energy, The Government thinks that production of more power wud reduce the demand supply gap which is not so since with the rising population, the demand would grow always and the rural people as well as the urban poor wud suffer the max.

The policy decisions by the GOI is whimsical (since they say that we hold meetings with common people like RWAs etc) but hardly any of the suggestions are being followed. I never said that you shud model the grid power stations, my paper just only speaks of some ethical considerations that should be kept in mind while taking any decisions on energy and the second part speaks of riaisng finance instead of harping on the regulatory assets of the regulatory commissions thus allowing competitive pricing and preparedness for open access. The more these privatized companies harp on the regulatory assets, the more the price will increase per unit of supply and as a result, the transmission & generation sector would be at a loss since the price at which the power so purchased is just miniscule if compared to the rate at which it is sold.

Thank you once again for forwarding me the site address.

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