India: A Special Supplement

India: A Special Supplement

India came to the forefront of the international community as one of the most promising and most needy markets in 1991 when the government opened its doors to the global industry. The Indian power market promises to exceed (US)$150 billion in the coming decade. Experts predict that this region will need anywhere from 100,000 to 142,000 MW in the next 10 years. India currently accounts for 2.7 percent of the total global installed capacity and has increased its capacity 50-fold in the post-independent era. In this special section, Power Engineering International takes a closer, more in-depth look at this fascinating section of the global market.

It`s a slow process, but India is opening up its electric power industry to foreign investors and developers.

Foreign companies face many challenges in developing Indian power projects

By Vishvjeet Kanwarpal

Asia Consulting Group

The Indian liberalization process initiated in the early 1990s has awakened the sleeping giant. Private-sector participation; public-sector disinvestment; deregulation; lowering of trade barriers; and a radical overhaul of industrial, financial and tax policies has unleashed the Indian economic and market potential in an unprecedented manner. Decades of central planning, government controls, subsidies and a public sector notorious for its low productivity all collectively served to exhaust the government`s financial ability to meet the needs of the nation. Left with little choice, in 1991 India opened its doors, invited foreign capital and looked to participate in the global market.

The Indian power market promises to be more than (US)$150 billion in the next 10 years. Success in the Indian market is a function of long-term, strategic commitments to develop the market; a flexibility to adapt to dynamically evolving market conditions; and the will and resources to sustain trials. These attributes are best exhibited by veterans like Enron. The Dabhol project was confronted by a continuum of challenges and disasters that could easily have sealed the fate of the project.

Political risk

As no political party received a clear mandate to form the government in the recent national elections, there is caution about the nature of the coalition forming the new government and its foreign investment policy. Irrespective of the coalition that comes to power, or its stability, it is important to note that almost all party manifestoes highlighted the need for infrastructure development with the assistance of foreign investment. Even the Left Front has declared recently that they will not reverse the economic reforms initiated by the Congress government.

The top business chambers have reflected the irreversibility of economic reforms in the country through their national agendas for the new government. Shekhar Dutta, Confederation of Indian Industry (CII) president, feels that top priority should go to infrastructure and Public Sector Unit (PSU) reforms. The Federation of Indian Chambers of Commerce and Industry (FICCI) holds poor infrastructure responsible for the high costs faced by the industry. FICCI`s view on Foreign Direct Investment (FDI) is that the consumer sector should be opened up progressively by “retooling the tariffs indexed against the reduction of infrastructure costs and the cost of borrowing.” On fiscal reforms, both CII and FICCI have reiterated demands to widen tax base, reduce corporate tax and rationalize indirect taxes.

CII`s national agenda–1996-1997:

– Give high priority to infrastructure and PSU reforms.

– Reduce size of central cabinet.

– Set up anti-trust mechanism to promote fair competition.

– Reduce government stake in PSUs to below 50 percent.

– Reduce corporate tax rate to 35 percent.

– Introduce Freedom of Information Act.

– Provide more transparency in policy and procedures.

FICCI`s minimum economic program:

– Reduce fiscal deficit to 3.5 percent of gross domestic product in two years.

– Continue trade liberalization.

– Reduce government role in infrastructure.

– Corporatize and privatize the public sector.

– Wind up terminally ill PSUs.

– Free interest rates.

– Give a human face to economic reforms.

Mr. R. H. Patil, India`s National Stock Exchange managing director, feels that India should not be protectionistic in regard to foreign capital. He stated, “One of the most important reasons why we need to welcome foreign capital is that our savings levels are too low to sustain high levels of growth.”

Mr. Nimesh Kampani, Association of Merchant Bankers of India chairman, stated, “Any party that comes to power will not be able to reverse the program initiated by the previous government. India needs foreign capital as well as technology in the power, telecommunications and transportation sectors. The government must take care to remove all hurdles between the inflow of investment in this area.”

Indian political, industrial and financial systems have accepted the ground realities of foreign investment in infrastructure and the need to end India`s protectionistic regime.

The electric power sector

The electric power sector, including generation and transmission and distribution (T&D), has been the domain of the public sector since the Industrial Policy of 1956. Currently private power accounts for a meager 4 percent of generation. The Indian Energy Supply Act of 1948 established the state electricity boards (SEB) to develop the power sector at the state level and the Central Electricity Authority (CEA) at the center to develop and coordinate national power policy.

Until the late-1970s, India was a power-surplus country. Today, the country is experiencing acute shortage of electricity, with an average shortfall of 10 percent and peak shortfall of 20 percent. Regional shortfall is estimated at 27 percent in the eastern region, 22 percent in the northern region, 18 percent in the western region, 17 percent in the southern region and 12 percent in the northeastern region. Commenting on the shortages and the impact early this year, Mr. P. Abraham, power secretary, admits that “the outlook is very bleak.”

Government investment in the electric power sector has been inadequate. Additionally, there has been a slowdown based on scarcity of funds and the expectation that independent power producers (IPP) will add the required capacity. In the VIIIth five-year plan (1992-1997), the government had originally planned to add 45 GW. However, successive revisions reduced it to a target of 30 GW. Currently, government capacity addition is expected to be 19 GW, or 42 percent, of the original target for the VIIIth five-year plan. With IPPs–including fast-track projects–facing slow development, the crisis is deepening further. Figure 1 shows the evolution of private power in India from 1990-1996.

The VIIIth five-year plan of the government (1992-1997) planned a total allocation of (US)$23 billion for the five years. An average annual amount of (US)$4.6 billion. This amount is for the entire power sector and not just for capacity addition.

Conflicting forecasts

Asia Consulting Group`s national power model demand forecast suggests that the oft-quoted 142,000-MW additional capacity will be required (including peak demand) in the next 10 years, but only under certain conditions. One such set of conditions are:

– New projects are operated at 75-percent plant load factor (PLF).

– T&D losses continue at 22 percent.

– No further captive or cogeneration capacity is added, and no installed base plants are repowered.

However, all of these are untenable as most power purchasing agreements (PPA) are signed for 85 to 90 percent off-take and T&D losses are likely to decrease with privatization. Captive and cogeneration capacity is also expected to increase rapidly in the near future. In addition, there are extensive plans for repowering of base-loaded power plants.

Under these conditions, the demand for additional capacity in the next 10 years could fall well below 100,000 MW. This figure may be further reduced with wheeling of power from surplus areas to deficit areas and in the long run through demand-side management. These aspects can have an enormous impact on capacity planning and particularly PPAs that will be signed in the next five years. To date, Asia Consulting Group has recorded approximately 250,000 MW of new capacity additions at all stages of project development (Figures 2 and 3).

Private and public power projects in development

Since mid-1994, the call for private participation in the power sector by the government has been overwhelming. In December 1995 the Ministry of Power recorded more than 225 proposals for 100,000 MW of power generation capacity by developers.

Although the crisis in the power sector is getting worse, electric power projects have been slow in developing. However, the government has responded by initiating several measures to accelerate project development, weed out less serious projects and streamline the project-clearance process.

One of the most significant initiatives has been to eliminate the mandated clearance required from the CEA for projects costing under Rs. 400 Crore [(US)$ 115 million], thus giving a boost to medium and small power project development.

The clearance issued by the CEA is a “Techno-Economic” clearance that examines key parameters of a project. However, many in the industry have felt that the CEA clearance, which is applied for after detailed feasibility studies, and the securing of a PPA and fuel supply agreement (FSA), is too general in nature, adds little value and unnecessarily delays projects. According to some former senior power-sector officials and industry captains, CEA does not possess the resources to assess the large number of private power projects of increasing structural, technical and financial complexity. The CEA clearance was initially not required for projects under Rs. 25 Crore. This limit has been progressively increased to Rs. 100 Crore, then Rs. 200 Crore and, finally, Rs. 400 Crore.

State governments have taken advantage of the above changes and taken independent initiatives to woo private power developers. Asia Consulting Group`s “National Project Track” is currently tracking almost 1,300 projects under development in the country. These projects include IPPs, captive projects, new government projects, as well as small projects. Collectively these account for a staggering 250,000 MW of capacity under development, with IPPs accounting for almost 189,000 MW (Figures 4 and 5).

Preliminary bottom-up analysis at the project level suggests a maximum addition of around 95 GW within the next 10 years. IPPs are expected to account for almost 60 percent of the total addition. Analysis by the group suggests that power projects currently under development will undergo an attrition of almost 60 percent in the coming years based on demand-based analysis alone (Table 1).

Continuous revisions of PPAs have pushed project cost and tariff cost down toward internationally acceptable standards. However, project risks in India continue to be high. Additionally, in the aftermath of the Enron experience, there has been a substantial increase in the risk premium for India. With higher project and country risks built into the lending rates and with higher risk insurance premiums, the PPAs may well return to haunt some developers. Securing financing itself is a substantial challenge. This will apply more acutely to project developers who have no prior or core competence in the power sector.

Genesis of the power crisis

The genesis of the crisis in the Indian power sector lies in India`s policies and objectives of rural electrification, subsidized electricity to the agricultural and domestic sectors, and utilization of the power sector as an employment scheme. These policies received their most aggressive boost in the early 1980s. Almost 75 percent of India`s population is still rural, and the government has electrified nearly 85 percent of India`s 580,000 villages. Today, agriculture consumes 30 percent of power generated in the country, while only paying (US)$0.6 cents per kWh on average. In recent years, the agricultural sector consumption has been growing at more than 12 percent annually. The Indian power sector employs more than 1.7 million personnel, which computes to approximately 21 personnel per MW. No surprise that the accumulated losses of the public power sector stand at (US)$6.4 billion.

The SEBs are probably the most unfortunate scapegoats in the power crisis in India. They have been forced to serve as instruments of national and state policy for decades and cannot be held solely responsible for the current state of affairs. The demands made on the SEBs have been gigantic with inadequate budgetary support from the government. Today, they are effectively being abandoned by the government and expected to deliver performance like private corporations. Central agencies–such as National Thermal Power Corp. (NTPC), which focus on only power generation and its sale to SEBs–have a clear advantage.

The power sector has posted some impressive efficiency gains in the past 10 years. The national average PLF for thermal plants has increased from 44.3 percent in 1979 to 61 percent in 1993, with the central sector recording a PLF of nearly 70 percent in 1993.

However, India`s national public power sector PLF (including all technologies) is under 50 percent. The eastern and northeastern regions record PLFs as low as 38 percent and 29 percent, respectively. The most ailing units are those below 140 MW in size, which have run for more than 100,000 hours. Around 250 such units exist in India, and every 10-percent rise in PLF of these units can roughly increase the generation by 3 percent, which is equivalent to adding 2.2 GW at one-fourth the cost. Cost of life extension by 15 years is 20 to 30 percent, of the cost of a greenfield project and the implementation period is half that of a greenfield project. This has been an important area of focus for the government, which has identified more than 160 old plants for renovation and modernization. To date, 22 stations with 55 units have been renovated, and an average of 18-percent PLF increase per unit has been achieved.

SEB restructuring

Restructuring is most talked of in electricity boards that are characterized by T&D losses, highly subsidized agricultural tariffs and excessive number of employees. Table 2 indicates five SEB restructuring scenarios. T&D losses are more than 20 percent in most states. A majority of the consumers are from the privileged agricultural sector, who are charged less than half the cost of generation. Electricity theft is not easy to stamp out. The perpetrators are usually a “vote bank” and enjoy tacit political protection.

According to N.K.P Salve, the former union power minister, “inefficiency of SEBs” is the biggest problem, and he has urged the states to change their attitudes toward entry of private companies. The central government has suggested five models of restructuring programs to facilitate reformation of SEBs into commercially viable outfits, regularization and rationalization of tariff, and improving T&D network.

Orissa, the first state to opt for restructuring, passed an electricity reform bill in November 1995. Subsequently, the SEB was broken up into three separate entities: generation, transmission and distribution. At the same time, an independent regulatory body was also set up with a mandate to set operating norms and fix tariff structures. This process was funded by the World Bank. The World Bank has also expressed interest in funding of reform projects in many other states, provided they set up independent regulatory authorities similar to Orissa.

Key stages in the development of India`s T&D system is shown in Table 3.

Haryana, Bihar, Uttar Pradesh, Rajasthan, Andhra Pradesh, Pubjab and other states have all initiated restructuring studies with substantial external assistance or using internal resources. However, the challenges that all states will face involve hard measures in tariff rationalization, employee retrenchment and overall efficiency improvement. Cosmetic restructuring may do little to change the systematic problems the SEBs face.

Installed capacity

India currently accounts for 2.7 percent of the total global installed capacity and has increased its capacity 50-fold in the post-independence era. This growth is heavily front-loaded, largely owing to the multipurpose, mega hydro projects. Although the demand for electricity has grown steadily since the late-1980s, capacity additions have failed to keep pace. Public utilities own 96 percent of the installed base-load capacity (central sector–27 percent and state sector–69 percent) (Figure 6).

In 1970, thermal capacity accounted for 54 percent and hydro for 43 percent. Today, 66.5 percent of India`s installed capacity is coal-fired, and 27 percent is hydro. This reflects India`s increasing dependence on coal-based power plants in spite of a hydro potential of approximately 130 GW. Hydro project development challenges include: funding shortfalls, environmental and land-acquisition problems, water-sharing disputes among states, issues of population relocation, and rising maintenance and management costs. However, assuming a 60-percent PLF, there is a 11-percent demand shortfall in coal supplies for the country`s existing coal-fired power plants. Currently, 10 to 20 million tons of coal is imported.

The major natural gas-producing states of Maharashtra, Gujarat and Assam account for 68 percent of the total gas-based power. The availability of natural gas in domestic and international markets and the relative costs will determine whether the optimistic addition of gas-based power (6.8 GW in VIIIth five-year plan) is achievable. India has 1.8 GW of installed diesel and wind-based plants and 2 GW of nuclear-based plants. However, issues of nuclear-waste disposal, funding constraints and political sensitivity have been a deterrent to further nuclear power development.

IPP project development in India–Gujarat Torrent: Paguthan

After accounting for the Dabhol factor, and the confusion among IPP developers and their partners, Gujarat Torrent Energy Corp.`s (GTEC) 655-MW dual-fuel, combined-cycle (natural gas-based) power project near Baruch in Gujarat can be portrayed as a show case of sensible business development.

While all the other fast-track projects signed their memorandums of understanding (MoU) before July 1993, GTEC began its act as late as May 12, 1994; but within two years had overtaken most of the other projects.

Unfortunately, by the end of 1994 the Enron debacle had started affecting all foreign investors and their efforts in India in varying proportions. After Dabhol Power Co.`s PPA with Maharashtra SEB was put to review by the new state government in May of 1995, that culminated with the project being scrapped on 3 Aug. 3, 1995. GTEC came through unscathed even after review of its PPA and allegation of kickbacks in a writ petition. However, as a precautionary measure GTEC sought legal counsel from Mr. Nani Palkhiwala, a leading constitutional expert, in August 1995.

By November, when Enron seemed to come back on track, GTEC has already received the state`s guarantee. Over the next months, the fuel supply and transport agreement, the PPA and most of the other agreements were finalized. Foreign and domestic debt components have been worked out, and formal work should start soon. The schedule calls for the project to be completed in 22 months from financial closure.

There are important reasons for this success. In June 1995, Siemens agreed to absorb Rs. 500 Crores of cost hike owing to appreciation of deutsche mark against the rupee. This was a preventive action taken when the Dabhol case was being reviewed. Neither did they venture into a 2,000-MW project, nor did they try complex fuel arrangements. The partner mix in equity and debt reflects sound strategy. In April 1996, BHEL became part of the group and will supply some of the equipment. The state government-owned Gujarat Power Corporation Ltd. (GPCL) has a 10-percent stake, which enforces the agreements between the developers and the state-owned organizations.

GTEC did have its share of luck in clearing the political hurdle, as the final nod had been given by the new BJP government, even though the previous Congress government had done most of the review.

The Jegurupada combined-cycle power project

GVK Industries` combined-cycle power plant at Jegurupadu will be one of the first IPP projects to come on line when the first 53-MW unit becomes operational in July 1996. The project consists of three gas turbines and a steam turbine. The first unit, which was scheduled to be commissioned in March, was delayed by two months as the Ministry of Finance delayed the clearance of the counter guarantee. As a result, funds from International Finance Corp. (IFC) were delayed. The respective SEB, on behalf of the central government grants` “counter guarantee,” is expected to clear the Operation Finance Action Plan (OFAP) and earn a minimum 3-percent rate of return. The SEB revenue earning is not up to the mark, and the state government will have to pay subsidies to Andhra Pradesh SEB for it to clear its OFAP.

In Andhra Pradesh, 43 percent of the power is consumed by the highly subsidized agricultural sector, which is already affecting the financial position of the SEB. The restricted counter guarantee which was subsequently cleared by the ministry, covers only the debt obligations and not the energy payment dues from the Andhra Pradesh SEB.

GVK Industries also faced problems with fuel supply. The bankers insisted on a fool-proof contract from the Gas Authority of India, which the authority did not agree. Because of this, GVK Industries has taken the fuel risk on its own. Owing to the shortage in gas, gas linkages are available for only two units, and at least one unit of the project will be forced to operate on naphtha. Considering the fact that naphtha is twice as costly as gas, the Ministry of Finance has objected to deemed generation benefits to the naphtha-based unit.

Even with some setbacks, the Jegurupadu project is one of the first IPPs nearing completion. Power will be sold at a levelized tariff of Rs 2.06 per unit, based on the assumption that the gas-based power station will run for 15 years before the first major overhaul becomes due. As per the government guidelines, the insurance premiums are kept at a cap of 1 percent of the capital cost and operations and maintenance (O&M) expenses to 2 percent of the capital cost.

The three gas turbines will be installed in June, August and December 1996; and the steam turbine will be installed in May 1997. The total project cost is Rs. 827 Crores–of which the equity portion is Rs. 252 Crores, and the debt portion is Rs. 575 Crores. The project has several debt and equity participants, both foreign and Indian. This complex structure of ownership may well become typical for future power projects.

AES Corp.`s Ib Valley project

AES Corp.`s Ib Valley power project, one of the initial fast-track projects, faced rough weather as the Congress government ordered a review of the project as soon as it came on line last year. The project was initiated in the regime of the earlier Janata Dal government. Review was ordered on the basis of allegations of lack of transparency, excessively high project costs and high tariff rates.

The comptroller and auditor general also criticized the Orissa SEB for not following the route of global tendering and also signing a PPA, which it termed as financially disadvantageous.

Orissa SEB insisted on a tariff of Rs. 1.55 to Rs. 1.60 per unit, pointing out that the first-two units of Ib Valley operated by the Orissa Power Generation Co. were already supplying power at a rate of Rs. 1.55 per unit to Orissa SEB. Subsequently, AES reduced tariff rates, in stages, from Rs. 2.39 per unit to Rs. 2.04 and then down to Rs. 1.90 per unit. Project costs were reduced from Rs. 4.76 Crores per MW to Rs. 4.15 Crores. Site of the project was changed from Ib Valley units 3 and 4 of 210 MW each, to Ib Valley units 5 and 6 each of 250 MW. Project for units 3 and 4 will be undertaken by Orissa Power Generation Corp.

Ib Valley was the only fast-track project, apart from Dabhol, to have received a counter guarantee from the central and state governments. But renegotiation and subsequent changes will require AES to put in fresh proposal for a counter guarantee and draft a new PPA. Considering the present situation of acute shortage of power prevailing in the country, the Ministry of Power and the Ministry of Finance is likely to give quick clearances to the project.

Two units of 250 MW each are likely to be commissioned in 1999. General Electric will be supplying the steam turbines and generators for both of the units. The company is seeking linkages of 2 million tons of coal from the near Ib Valley coalfields of Mahanadi Coalfield Ltd., a subsidiary of Coal India Ltd.

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EDITOR`S NOTE:

The author wishes to give special thanks to Asia Consulting Group analysts: Shouvik Ray, Ejaz Mohammed and Iqbal Javeed.

Asia Consulting Group is an infrastructure strategy consulting firm with a focus in the power sector. Asia Consulting Group develops client strategy by leveraging its advanced project modeling capability in conjuction with its proprietary power market models and industry tracking databases.

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