IPPs must reassess Indian business development strategies

IPPs must reassess Indian business development strategies

A key to surviving India`s IPP development process is learning how to work with politicians and bureaucrats at all levels

By Shashank S. Nadgauda

Renova Engineering

When India`s economic policies were liberalized in the early 1990s, the country`s politicians, bureaucrats and industrialists chanted a mantra that was worthy of the world`s largest democracy. The prospects of acute power shortages were well proclaimed, as were the country`s need for more than 50,000 MW of capacity. With a growing middle class population of more than 200 million, the New India was deemed ready for private power.

Indeed, at the time, it appeared India, second only to China in market size, would be the new growth frontier for U.S. independent power producers (IPP). However, after five years duration, only about 60 MW of private power promoted by a US IPP has come on line–hardly a success story given the fact the aforementioned capacity reflects the first phase of a 240 MW Project in which the developer (CMS Energy) holds only a minority interest. IPPs already active in India and those planning market entry still need to reassess their business development strategies to ensure success.

Fast-track flashback

By 1993, IPPs from all over the world were full of pro-India enthusiasm. They submitted proposals for 100 projects, amounting to a total capacity of more than 35,000 MW and an investment of $40 billion. A year later, the Government of India (GOI) identified eight projects with a total capacity of 5,700 MW for fast-track approval; of these projects, six greenfield plants totaling almost 4,000 MW aggregate capacity were pursued by US IPPs.

The well documented Dabhol project led the way, with more than 2,000 MW of capacity at an investment of $3 billion. The Enron project was touted as the first major showcase of India`s liberalized policies; the company would have earned about 25 percent after tax return on its equity in India. The Maharashtra State Electricity Board (MSEB) would have received a long-term supply of electricity at an initial price of about Rs. 2.40/kWh starting in 1998 (or 7.5 cents/kWh at the 1994 exchange rate of Rs. 32=$1.0).

By 1995, this initial pro-India sentiment began to unravel when the Dabhol project was scrapped by the newly elected state government in Maharashtra. When the State realized the magnitude of potential damages which could result from arbitration, it decided to renegotiate the power purchase agreement (PPA) with Enron. It took more than a year before the state government and Enron could reach a new agreement. The revised agreement was finally approved by GOI last May. However, the project continued to languish as a result of several court cases.

In December, Enron finally won the last lawsuit in the state`s high court; the company may now be able to bring the initial 845 MW on line in 2000, two years behind schedule. And recently, the project`s status remains uncertain, especially if MSEB cannot purchase its contractual equity stake, and doubts within the public domain continue to persist regarding the actual Enron tariff. For example, when the State renegotiated the PPA last year, it boasted the tariff had been reduced to Rs.1.86/kWh at Rs. 32 equal to $1.0, an exchange rate which was no longer valid. As a result, it admitted recently that the starting year tariff could be anywhere between Rs. 2.86 to Rs. 3.75 per kWh, depending upon actual inflation levels and dollar/rupee exchange rate.

Other fast-track projects sponsored by US IPPs have also faltered. For example, Cogentrix`s 1,000 MW Mangalore project, while approved by GOI last summer, is facing major court cases brought on by local fishermen in Karnataka and environmental groups. AES`s 400 MW Ib Valley project had remained entangled in local state politics in Orissa; the government has now approved the project and sent it to the central government for final approval. Again, this project`s fate is uncertain, since the state government approved the project with caveats on estimated investment and production costs.

In the interim, power shortages in India have worsened, and the situation is not likely to improve in the foreseeable future. Industrial and urban consumers, long used to planned load shedding a certain number of days per week now face frequent and prolonged blackouts. As a result, urban consumers have resorted to violence against local offices of government, in particular, the state electricity boards (SEB). For example, farmers, who represent the largest load on most of the SEBs, have demonstrated for more reliable power, while insisting on their rights for free or highly subsidized electricity. Meanwhile, politicians remain reluctant to address the issue of subsidized power to farmers, who also represent the largest voting block.

Diversification developments

The SEBs are burdened with inefficient plants, excessive manpower, rampant corruption and high transmission and distribution losses. They sell electricity under outdated tariff policies which rely upon subsidies from state governments. The policy does not distinguish between the expensive peak and cheaper baseload power. A recent estimate indicates that of the 82,000 MW of installed capacity, only about 30,000 MW is effectively available for generating potential revenues for SEBs. As a result, many of the states and their SEBs would be considered as being bankrupt by lending institutions in India and those abroad.

IPPs with an interest in large, 250 MW plus grid-connected projects may be best served by focusing their appetites on a menu that includes developing projects in credit-worthy states. Alternatively, the best course may be devoting resources to development of several medium-sized projects, since many Indian states now allow wheeling and banking under a loose definition of captive generation. It is possible to develop 100 MW or smaller projects under “all-private deals” involving credit-worthy industrial hosts.

It is always advisable to work with a credible Indian partner for each project. The partner should make a meaningful equity contribution, since a token offering by an SEB or an industrial host is at best of only limited value and at worst, a hurdle in the development process. Furthermore, by working with a credible Indian partner, an IPP is able to spread development risks as well as benefit from a partner`s experience coping with any entrenched bureaucracy. Remember, ruling politicians depend on officers of the Indian Administrative System for advice and policy implementation at all governmental levels; a change of ruling party invariably leads to an officer and policy reshuffle.

Another worthwhile strategy is diversifying the fuel base of a project portfolio. Fuel linkage is one of the most critical issues which IPP developers will face in India, given that production, delivery and pricing are all controlled by the government. A developer`s portfolio should include projects based on a variety of fuels ranging from coal, naphtha and natural gas to renewables. Fuel risk can be further reduced by focusing on fuel-intensive, captive opportunities where a host partner would have the know-how for handling the fuel linkage under the quota system prevalent in India.

Privatization of existing or partially built SEB plants is an area which has been largely untapped by US IPPs. Faced with global competition under the General Agreement on Tariffs and Trades, many energy-intensive industries in the private sector would like to sell their existing captive plants. This could enable them to generate cash, which they need for improving core production facilities. Hence, it is wise to consider investment in existing plants to compliment a greenfield project portfolio.

Cost conundrum

Existing power plants were built by the Indian government with low-cost financing from World Bank and other donor nations. The bureaucracy has little or no familiarity with high expenses incurred by IPPs in developing projects up to financial closure. And in today`s era of transparency championed by politicians and media, bribery rumors have become a bigger issue regardless of the facts or parties involved in financial transactions.

Every increase in the price of electricity has created in-country controversy, since power shortages continue to become worse. In its drive to encourage IPPs, GOI identified eight projects for fast-track approval on a negotiated basis. It did not use a well-defined, uniform competitive bidding and evaluation process. Because of the resulting political fallout, none of the so-called fast-track projects has attained financial closure in a timely manner.

Currently, a relatively well-managed SEB earns about Rs. 2.0 /kWh on average from its customer base (or 5.6 cents/kWh at the current rate of Rs. 36=$1.0). It appears most of the SEBs have set a ceiling of Rs. 2.25/kWh on the starting tariff, regardless of the year in which a project would come on line. They do not wish to recognize IPPs would substantially incur higher generation costs. For example, the accompanying figure illustrates the starting tariff for a typical 250 MW coal-fired plant as a function of capital investment (see figure). It shows that the starting tariff in 2001 will be closer to Rs. 2.80/kWh; assuming an investment of Rs. 40 million/MW, a rule of thumb investment estimate frequently used by politicians and bureaucrats in India.

Production costs for captive plants widely vary, because of non-uniform accounting methods which mask true production costs. Industrial hosts with existing captive plants do not fully appreciate the concept of avoided costs which they need to pay an IPP when it takes over captive site generation. Hosts which do not have captive plants currently pay about Rs. 3.50/kWh to SEBs for their high-tension (HT) power supply. They recognize that the HT tariff will continue to escalate even faster, and at the same time, the grid reliability will deteriorate more, thus compounding production losses. On the other hand, the same hosts will insist that a developer`s production costs should be substantially lower than SEB`s HT tariff.

Hence, developers will face a Herculean task of convincing potential customers that their generation costs are reasonable, regardless of whether they sign PPAs with SEBs or industrial hosts. You would help yourself if you keep the development costs to a minimum. If you are involved in a sole-source negotiated deal, obtain competitive engineering, procurement and construction bids to build up trust with your host partner. If you are involved in projects which are bid competitively, make sure that the specifications are clear about bid evaluation procedures.

Always start the PPA dialogue using an indicative tariff and build the final PPA contract using an incremental approach. Provide adequate “escape hatches” in your PPA negotiations so that, if necessary, you can walk away from the deal without jeopardizing the successful conclusion of other projects in your portfolio.

Party politics

Central government no longer dominates Indian politics. As long as the Congress party ruled both at the central and state government levels, policies adopted by the central government were routinely carried out by the states. Party leaders were able to pacify various internal factions within Congress. When Congress liberalized the economic policies, squabbling within the party increased and opposition parties got a new “political” issue.

Several key states are now controlled by regional parties or by other opposition which have varying degrees of national following. Recently, the politics have become even more complicated since the central government passed on project approval responsibility to state government agencies, many of which do not have the necessary expertise in soliciting and evaluating IPP offers on a rational basis.

Electricity tariff and foreign investment are highly political issues in India. The entrenched bureaucracy of SEBs has vested interests. For developers, a captive project could also threaten existing staff employed by a host partner. A majority of projects will be in rural areas where they can have a large impact on the livelihood of farmers, the largest voting block in India.

A key to survival during the project development process is learning how to work with politicians and bureaucrats at all levels. It is best to adopt and adhere to the mantra of environmental improvement rather than stress repeated willingness to comply with existing environmental laws. IPPs must always keep in mind that in order to be successful, the number of nay-sayers must be minimized in conjunction with obtaining all government approvals.

GDP implications

It is estimated that because of power shortages, India currently loses industrial production amounting to about 1.5 percent of its gross domestic product. Politicians and bureaucrats have begun to realize that with worsening power shortages, these losses will increase substantially. They are also worried that worsening power shortages could possibly lead to riots in the nation.

In order to continue to attract much needed investment from foreign IPPs, India needs to adopt a market-based tariff policy for consumers and a policy which does not depend upon cross-sector subsidies to make SEBs financially viable. There is some hope IPPs can play a major role in India over the long term. In the meantime, developers must diversify their portfolios, minimize costs and learn to handle Indian politics under a prudent, persistent and patient power market strategy.

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Author bio

Shashank S. Nad-gauda is president of Renova Engineering in Staten Island, N.Y., US (Phone: 1/718/981-3582). He has more than 25 years experience in the regulated and non-regulated electric utility industry. For the last five years, he has been advising several US IPPs in developing projects in India. He holds a doctorate`s degree in engineering from the Cooper Union.

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