Incentives entice investors into Indias power market

Incentives entice investors into India`s power market

To meet the modern electricity demands of its 900-million-plus inhabitants, India turned to foreign investors to shoulder part of the load

By Dr. Anupam Sanyal

International Environmental & Energy Consultants

India, with 900 million people and growing, is the most populous country after China. The country is also undergoing unprecedented industrial growth and development. The growth rate has increased from 2 to 2.5 percent in 1991 to 5 to 6 percent in 1995 and continues to rise. As growth increases, the demand for power also increases. To meet this demand, in one of the largest projects offered anywhere in the world, India has opened its power sector to foreign investment with attractive incentives.

Power generation growth and its future

Since independence in 1947, India has multiplied its electricity generation capacity nearly 60 times from a meager 1,362 MW to 81,164 MW as of March 1995 (Figure 1). Generation leaped from 4 to 351 billion units during this period. Although per capita power consumption is still a mere 310 kWh (compared to 12,170 for the US), India faces an acute energy shortage with a supply and demand gap of 8.5 percent, peaking at 19 percent.

Thermal plants account for 74 percent of the installed capacity, with hydroelectric supplying 24 percent and nuclear supplying the 2 percent balance. At 351 billion units in 1994 to 1995, power generation recorded a near-targeted growth of 8.5 percent over the previous year. The government has estimated that in order to keep up with the projected growth, an additional 142,000 MW will be required by 2007. Based on an installed capacity of 69,352 MW in 1992, this addition corresponds to a threefold increase in capacity with an average addition of 9,500 MW per year.

At a modest installation cost of (US)$1,000/kW, this scale of expansion needs (US)$142 billion in capital over 15 years, or (US)$9.5 billion every year. This is a monumental task for any country, but especially so in India, where power generation has mostly been the responsibility of the central and state governments. Approximately 5 percent of India`s generation comes from private sources. The government is responsible for the transmission and distribution, including that for the private sector power supply.

The power sector of the state governments is the responsibility of the State Electricity Boards (SEB) who generate and distribute power, set tariffs and collect revenues. The SEBs have faced a plethora of problems over the years. Different tariff rates (Table 1) are charged to the different consumer sectors ranging from 0.7 cents/kWh to 7.6 cents/kWh. Agriculture and industry are the two most important consumer categories for their relative shares. SEB charges are set far below unit cost for the agricultural sector and above unit cost for the industrial sector. As a result, the revenue from the agricultural sector has been extremely poor, leading to heavy financial losses. In addition, the transmission and distribution losses are high due to sparsely distributed load over a large rural area, where the SEBs must sell a substantial amount of electricity at low-voltage levels. Other causes include underinvesting in the transmission systems, inadequate billing recovery and other unrecoverable losses. The overall problem is exacerbated by the low-capacity utilization of the thermal power plants. This situation is largely due to deficiencies in operation and maintenance (O&M), poor coal quality and generating equipment. These lead to enormous SEB losses, which were more than (US)$2.25 billion in 1995 to 1996.

The central and state governments have recognized this gloomy scenario as a formidable challenge to the nation and radically reformed the entire electricity framework to address this.

The pre-amendment framework

Under the 1910 Indian Electricity Act and the 1948 Electricity Supply Act, the legal framework provided for three utility types–SEBs, licensees and fully government- owned generating companies. The SEBs were responsible for generation, supply and distribution within the state. Licensees supplied electricity generated from their own stations to specified areas within a state. The generating companies, promoted and owned by the central or state governments, supplied power to the grid without specific responsibility for retail distribution. Fifty-seven distribution licensees and five private utilities comprised a generation capacity slightly less than 3,000 MW or 5 percent of national capacity.

Post-amendment framework

The governments recognized the additional capacity requirement would require a colossal investment well outside their capabilities. They amended the two electricity acts in October 1991 to attract domestic and foreign investment in electricity generation, supply and distribution. They also modified the financial, administrative and legal environments to attract private enterprise to invest in the power sector.

Incentives under the new policy

Below is a summary of the incentive package for both domestic and foreign investors:

– All companies will be allowed a debt-equity ratio of 4-to-1.

– The companies will be allowed to raise a 20 percent minimum of the outlay through public issues.

– The promoter`s contribution should be at least 11 percent of the total outlay, with a ceiling of 40 percent from Indian public financial institutions. To ensure that the private entrepreneurs bring in additional sector resources, they must obtain 60 percent of their contribution from sources other than public financial institutions.

– For both licensee and generating companies, up to 100 percent foreign equity participation will be permitted for projects set up by foreign private investors.

– The import of equipment for power projects by foreign investors will be permitted in cases where foreign suppliers extend concessional credit.

– To safeguard return on investment against a possible power demand shortage, private generating companies will be allowed to sell power under a two-part tariff structure. This will be based on operational norms and optimal plant load factor (PLF)–an important indicator of the plants` operational efficiency. The PLF will be prescribed by the Central Electricity Authority (CEA), the central government`s advisor to the Department of Power on technical and economic matters.

– The rate of depreciation will be periodically announced by the central government.

The specific incentives for the licensees are:

– a license duration of 30 years in the first instance and subsequent renewal for 20 years, instead of 20 and 10 years, respectively, prior to the amendment;

– a 5 percent return rate in place of the previous 2 percent above the RBI (Reserve Bank of India) rate;

– capitalization of interest at actual cost during construction instead of the previous 1 percent above RBI rate; and

– special grants to meet debt redemption obligations.

Scope for participation

Private participation is welcome for projects based on coal, gas, hydro, solar and wind energy. A private investor has two options: It can either operate as a generating company or as a licensee. As a generating company, the investor would sell to the grid without responsibility of distribution. As a licensee, it would generate its own power and/or buy power from the SEBs and other generating companies, selling to the consumers through the supply and distribution lines.

Project clearance procedures

The new policy has simplified the clearance procedure and provided a single reference facility with the creation of the Investment Promotion Cell. Companies must now clear a power project in terms of 17 major parameters with 13 statutory and four nonstatutory categories (Table 2). A new board will monitor the clearance of the projects under the chairmanship of the cabinet secretary, the central government`s most senior employee reporting directly to the prime minister. This ensures that the statutory clearances are obtained and any outstanding issues are resolved within a specific time frame.

Two-part tariff and investment return

In order to ensure the security of the investor`s cash flow and maintenance of liquidity, the new policy introduces a two-part tariff system. The system provides for the signing of a contractual agreement, which lays down rates (for a specified period) for the sale of bulk power by the generating companies to an SEB. The first part of the rate ensures fixed cost recovery, including returns based on performance at normative parameters described earlier.

The second part ensures meeting variable expenses, based on electricity units actually supplied. This part also provides incentives for achieving efficiency levels higher than the normative parameter. The sale rate is calculated based on the operational and load factor norms, as well as depreciation rates periodically announced by the central government. Once the investor and government agree on the sale rate, no limit is imposed on actual profits earned by a generating company. Under the two-part tariff structure, the fixed costs cover interests on loan capital, depreciation, O&M expenses, taxes on income, return on equity, interest on working capital and variable costs comprising primary and secondary fuel costs.

The two-part tariff provides benefits to the investor with regard to both fixed and variable charges. The fixed charge covers sunken costs and does not vary with levels of generation, whereas variable charges vary directly with achieved generation levels. For a licensee, the new policy brings a guaranteed return of 16 percent on investment, 5 percent above the RBI rate. Since tax is treated as an expenditure while fixing the tariff for a licensee, the return is actually higher, being in effect, a post-tax.

The response to the new policy has been overwhelming. Through November 1995, the government received 245 expressions of interest to set up power projects with a capacity of 93,661 MW. This corresponds to an investment of more than (US)$102 billion. Of these proposals, 52 are from foreign investors and joint ventures. The government has already cleared 16 proposals with regard to foreign investment considerations.

Investment opportunity in existing plants

The low-capacity utilization of the thermal power plants has been of major concern to the state and central governments for various reasons discussed earlier. Better utilization of the existing capacity can greatly mitigate the present gap in demand and supply position. It is estimated that a 1 percent improvement in the power load factor by the SEBs would make available an additional 390 MW. The trend in the thermal PLF is shown in Table 3.

If the SEBs were able to increase the PLF levels from their current 55 percent to the 69 percent level achieved by the central generating segment, an additional 5,400 MW of power would be available. The central government has formulated an action plan to improve the performance of the power sector on short-, medium- and long-term basis, covering both physical and financial aspects of generation, transmission and distribution. The short-term measures include improvement of boiler O&M, optimal regional grid operation, improvement of station availability and an increase in the PLFs. The power sector can achieve a significant improvement in the PLF through medium-term measures like proper maintenance planning. In the long term, it can improve the availability of older thermal power plants by appropriate renovation and modernization (R&M) programs. The Confederation of Indian Industries formed a committee to examine the R&M potential of the existing power plants in three age categories–less than 15 years, 15 to 25 years and more than 25 years.

Current status

To make the private participation more attractive, the government has twice amended the tariff notification, offering an additional assortment of incentives to investors, including investment in hydroelectric projects. It has issued the policy and guidelines to attract private investment in the R&M and upgrading of old power plants and offered incentives to industries to encourage captive/cogeneration plants. In view of the short completion periods for these plants, the government has decided to allow power projects based on naphtha, heavy petroleum stock, low sulfur heavy stock, heavy oil, furnace oil and natural gas as primary fuels. To facilitate construction of large thermal plants, the government has suggested identifying projects of 1,000 MW or more which supply power to more than one state as megaprojects. The CEA will identify sites for these projects. The feasibility reports will be prepared by National Thermal Power Corp. (the largest utility owned by the central government) and Power Grid (the central government-owned transmission agency). This will facilitate measures for selecting promoters and finalizing power purchase agreements between the promoters and the SEBs. Beginning March 31, 1996, the state governments have been advised to introduce a competitive bidding element in the process of awarding projects.

Indian power generation resources

There are adequate energy resources available in India to provide the fuel required for increased generation. India, the third largest coal-producing country in the world after the US and China, raised more than 274 million tons in 1974 and has abundant reserves to meet the country`s demand for several hundred years. The primary resources are summarized in Table 4. Sweeping reforms have thus countered earlier perceptions and apprehensions of domestic and foreign investors who saw a high risk posed by structural inefficiencies and a sapping regulatory structure. With strong incentives now available for both domestic and foreign investors, several major projects are already under way. Investment in the Indian power industry looks very attractive, indeed.

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EUR Ing. Dr. Anupam Sanyal, International Environmental & Energy Consultants president, specializes in conventional fuel-fired power generation performance enhancement and emission control. He has a bachelor`s degree in chemistry and a master`s in applied chemistry from Calcutta University and received a doctorate in fuel technology from Sheffield University, England. Sanyal is an energy environmental consultant to the World Bank and Sargent & Lundy, Chicago, USA, and is a member of the American Society of Mechanical Engineers, a fellow of the Institute of Energy, UK, and a chartered engineer.

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