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Power market or myth?

Vishvjeet Kanwarpal
Managing Director
Asia Consulting Group Pvt. Ltd.

With problems at Dabhol and key investors exiting the market, India’s power sector has been receiving bad press. But some key issues are being forgotten, and opportunities for the right type of project still exist.

Government forecasts suggest that India needs 10 000 MW of new capacity per year
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With a series of high profile international players exiting the Indian market, investor confidence has ebbed. There is a clear and unsubstantiated possibility of “throwing India out with Enron”. Far away board rooms observe only that high flyers such as Enron and Mirant have faced substantial problems’ in India and decided to quit. However, there are several issues that rarely receive center-stage.

India is the unquestionably the largest power market in Asia for greenfield generation opportunities for international developers. Only China’s greenfield generation requirement is larger than India’s. However, due to China’s substantial indigenous capability in power, most of it is not open to overseas developers, equipment suppliers, EPC contractors or project finance players.

There is no doubt that India represents considerable risks and is a tedious market to develop, but at the same time, the IPP experience across most Asian countries has hardly been a ‘safe or quick bet’. India does represent considerable Despatch Risk & Payment Risk, particularly for larger power projects. An analysis of these risks signals that a rethink and refocus is clearly required at several policy levels à‚— national, state and SEB as well as at an investor strategic level.

Contractual commitments

Exaggerated demand forecasts have indirectly resulted in considerable damage to investor plans, efforts and confidence in India. Government forecasts suggest that India needs 10 000 MW per year. Asia Consulting Group’s assessment is that the number is closer to 5500-6000 MW per year. India’s IPP and utility capacity addition has averaged only 3500 MW on an annual basis in the past few years. Captive power has added another 1000 to 1500 MW. Yet the peak and energy shortages in the country have not shot through the roof. On the contrary they have been stable and have even come down in several states. This in itself demonstrates that India should only target about 6000 MW per year. To the cursory observer this issue may be an academic one. A closer state level analysis reveals the enormous fallout of this “semantic and academic” issue.

While Maharashtra was unable to absorb Dabhol Phase I (740 MW), the officials continued to insist that Maharashtra needed 1300 MW capacity addition on an annual basis. While Enron is at fault for not having conducted its own detailed power demand forecast prior to making plans to invest $3 billion, the official forecasts clearly sent a signal to Enron that an integrated project of 2144 MW could be absorbed within a year as a baseload plant.

India has neglected adequate investment in transmission
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The reality is that Maharashtra state can probably absorb closer to only 600 MW of competitive power on an annual basis. Therefore, if the Dabhol project were a competitive one, it would take four years to absorb this capacity into the Maharashtra power system. These four fateful years are clearly the “risk years” and as Maharashtra can neither absorb nor pay for this power, we witness the ensuing endless battles over contractual commitments made which were not market sustainable.

Neglected sector

India has traditionally invested in generation and distribution but neglected adequate investment in transmission. The concept of a National Grid is a relatively recent one and states have traditionally planned for their own power needs. The lack of an effective National Grid does not permit large inter-state power transfers. Projects, particularly mega-projects that hinge on substantial inter-state power sales, face considerable risk based on this “academic” oversight.

Everyone loves a big project. This includes the developers, equipment suppliers, the EPC contractors, project lenders, the governments, and so on. The argument they put forward is often that the “effort” required to develop a 1000 MW or larger project is only marginally greater than that required in developing a smaller project. However, this obsessive focus on ‘marginal efficiency’ has led to a repeated fatal flaw in plans by the large international power project developers in India.

Size matters

Importantly, most of the high profile international power players that have exited India were developing projects that were typically 1000 MW or larger. Among the ones prominently splashed in the press and industry are Cogentrix (1000 MW), Electricité de France (Bhadrawati 1000 MW), Daewoo (Korba 1070 MW), Enron (Dabhol 2144 MW), and Mirant (Hirma 3960 MW).

In Asia Consulting Group’s perspective the failure of these projects to effectively mitigate risk was inevitable and the ultimate decision to exit these projects should hardly come as a surprise. Importantly, these project failures are not indicators of India’s unattractiveness as a power market, but a complete disregard for market fundamentals by all parties concerned.

In Asia Consulting Group’s view, India needs to implement “load-centric”, distributed generation and a refocus on ‘right sized projects’. This size is in the range of 500 MW or below at the state level for the larger states of India. It can be demonstrated that the risk period for 1000 MW or larger projects in India is in the range of four to six years. This is an Indian power system reality. It is not possible to mitigate risk on these projects via contracts. A review of the 27 IPP and private sector projects (4740 MW) that have been commissioned to date in India reveals a range from a few MW to the 740 MW Phase I Dabhol. 14 of these IPPs are over 100 MW and account for 4400 MW or an average of 314 MW.

Typically the 1000 MW or larger projects lack detailed commercial due-diligence and rely heavily on contractual and financial instrument based risk mitigation à‚— counter-guarantees (state or central), escrow cover or letters of support. It’s one thing to successfully finance a project, it’s quite another matter to develop a project that delivers competitive power to the people and returns to the investors.

Another highly negative fallout of exaggerated demand projections was the heavy focus on mega-projects. Hirma has again come to limelight with Mirant’s departure from India. The project concept is fundamentally strong. Cloned units based on domestic coal with a competitive power generation tariff. However, in an attempt to offset years of capacity that was ‘not added’ the size of the project betrays a phenomenal disregard for what is ‘practical’. Were the project staggered in 600 MW segments over several years it could have been the right answer for India. India could have witnessed a spectacular positive domino effect, wherein the obvious success of the first 600 MW would support successive investments and obviate the need for defunct concepts of central guarantees. Instead we are staring at yet another ‘failed’ project and a ‘disillusioned’ investor.

Creative accounting

It is no new news that the Indian State Electricity Board financials are in very poor health and constitute a primary payment risk to power projects in India. However, many myths abound regarding the fundamental causes of this situation and the potential cure. The main myths are that the agriculture sector is such a massive liability that there is no possibility of revenue collection matching the cost of power procurement.

A lesser known fact about the Indian power sector is that almost all the historical data regarding consumption and revenue realization by category of consumer and T&D loss figures have been doctored by the SEBs since the early 1980s. This creative accounting practice coincided with the heavy induction of agriculture pumpsets. Consumption by industry has been systematically recorded and reported under the agriculture segment and historical T&D losses of 18 per cent have been arrived at by accounting jugglery.

The true transmission and distribution losses are in the range of 40-60 per cent. But in an extremely ironic manner this is good news. A quick calculation assuming 100 000 MW installed base, average 65 per cent PLF, 50 per cent T&D loss and average tariff of Rs2.50 suggests that the Indian power system losses amount to over $10 billion annually. Were India to end theft of power, India could self-finance all its future generation and investment requirements in ‘cash’.

India is moving towards regulatory reform, which will fetch dividends
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The truth is that the primary problem in Indian power is theft of electricity by non-agriculture customers who can pay. This theft is at many levels à‚— metering, billing and collection. The culprits often escape prosecution and even when the prosecution is successful the ultimate amount payable is far below the theft.

Lack of political will is often blamed for the travails of the sector. The truth is that it is Indian industry and not just the agriculture sector, which has enjoyed subsidized power for a long time. By way of general proof one offers the fact that many Indian industries have the potential of almost 25-40 per cent energy efficiency gains. Additionally, industrial users will admit that they only pay about 60-70 per cent of their electricity bills.

In a similar vein, farmers do not get enough power for irrigation to justify the official consumption figures in the agriculture sector. Farmers get five to eight hours of power per day in most states and a majority are willing to pay for power if it is provided reliably. Calculations of consumption per pumpset based on official figures produce unbelievable results. One concludes that were farmers actually consuming the levels of electricity that the SEBs insist they do, growth rates in agriculture production should be sky-rocketing instead of the staid three per cent rates that are witnessed.

While much of the above analysis is damning, it offers a massive upside potential to the Indian power sector. The primary problem is theft of power. Once this is addressed via distribution privatization then the payment risk factors automatically will be reduced leading to renewed interest in capacity addition. There is no doubt that distribution privatization will ultimately deliver the results. The key question is how soon?

One of the sector’s main problems is theft by non-agricultural customers who can pay
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The Indian consumer’s capacity to pay for power including the agriculture sector is considerable. India boasts about 20 000 MW of captive power capacity. In a country where the customer base can self-finance $20 billion worth of investment in power, it is impossible to believe that the ultimate debate is about cents per kW/h.

Hope or hype?

No doubt, in recent years, India’s image has taken a severe drubbing where investor interest is concerned. But in the long run its perhaps better that India’s investment image takes a hit rather than its sovereign rating wherein India refuses to honor its sovereign (and unsustainable) payment guarantees.

India is moving towards distribution privatization and regulatory reform, which will fetch the dividends. The Indian power market is real and significant on a global scale. Investor’s are likely to return in substantial strength if India can demonstrate its commitment to power sector reform and tangible achievements. The return will not however be to the grand projects but the ‘right sized’ projects that India needs and can pay for.