Reforming the Power Sector: A Long Road Ahead
At a summit on the 18th January 2012 with the heads of private-sector power
companies, the Prime Minister made many people happy with assurances of a
'practical, pragmatic and viable' solution to the myriad issues they face. Given
how critical the power sector is for India's long-term growth, Dr Singh rightly
pointed out that fixing it is a national challenge, rather than merely a sectoral issue. The pink papers cheered the setting up of an
'A-Team' that will,
in the next 90 days, lay out a clear roadmap for reform, and there is, once
again, hope of meaningful change in the air. Yet, even as it would be too
cynical to entirely write it off, there is something disingenuous about
promising a mere 'roadmap' for a sector, whose problems are blindingly obvious
and yet, no Indian government of the last two decades has taken serious steps
towards a lasting solution - devilishly hard as they may be to implement.
Truth be told, the government already has a framework in place for righting
the numerous wrongs of this troubled industry. It may not be laid out in a
single document, but, at the higher levels of government, just about everyone
knows what needs to be done. Just a month ago, it released yet another of many
insightful studies that have suggested a sensible way forward. (This one,
spearheaded by former CAG VK Shunglu, reviews the functioning of State
Electricity Boards (SEBs) and distribution companies, or 'discoms'.) Nor is
there any dearth of global case studies that can help fill in the gaps, in terms
of what 'works' and what does not. As with much else in India, however, what is
critically missing is political will - for the changes that must occur go far
beyond merely finding ways to 'up' the supply of coal to power producers, or
other stop-gap solutions. What is needed is a complete overhaul of how the
sector works, and equally, how other, related industries, especially coal,
function. Unless this happens, it is no exaggeration to say, India faces one of
the most serious road-blocks to maintaining 9% or even 7% GDP growth a year.
A SURFEIT OF WOES
Power distribution: What's the use of privatisation?
Power distribution is the most visibly 'broken' part of the system, but also
the place where the first reforms were implemented. Since the passage of the
Electricity Act in 2003, almost all of India's state electricity systems have
been 'unbundled' into three separate components - generation, transmission and
distribution. Power generation has been opened up, though not entirely
successfully, to the private sector, and a number of discoms have been
restructured as public-private partnerships, and in some cases, as franchises.
On the other hand, transmission has remained in state hands, and - because it is
a natural monopoly - will remain so. However, even the unbundling of utilities,
as the Shunglu Committee report confirms, is more in name than in substance. In
reality, most states continue to own, manage, and financially control all three
divisions and many continue to run them as government departments, rather than
as autonomous companies. The net result is that the discoms (mostly state-owned,
but some PPPs) are forced to purchase power generated and transmitted by largely
inefficient, state-owned enterprises on a cost-plus basis.
Whilst one-end - purchase - has a direct pass through of the escalating costs
of coal and other input to them, they are constrained at the other end, usually
by populist governments, from raising tariffs often enough, or to the extent
required to cover their costs. Needless to say, they are unable to charge
anything from the vast majority of agricultural users, and they often serve huge
areas, spanning the urban, rural and semi-urban. This makes it expensive to
provide the service (having to lay and maintain cables and metres for a large
number of widely-spread users), relatively low-yielding (many users will consume
few units of electricity), and difficult to collect payments. Monitoring becomes
difficult, and power theft and defaults are common. Expectedly, their aggregate
technical and commercial (AT&C) losses - a euphemism for 'theft and
inefficiency' - are massive. According to the Shunglu report, the actual AT&C
losses are considerably higher than the 30% figure that is usually bandied
about, but by how much is anyone's guess.
Some examples of efficiency exist...
Squeezed from both ends, most discoms - left to their own devices - would be
financially unviable. The exceptions are a handful of PPP-based firms that run
power distribution in the bigger metros, notably Delhi and Mumbai. However, they
too, faced years of heavy losses, and stiff public opposition to their
bill-collection 'enforcement' efforts, before the turnaround finally came.
Further - and unlike with most PSU discoms - they were able to make significant
new investments in systems and hardware. On the other hand, they have also had
the advantage, which many discoms will not - unless broken up into smaller parts
- of serving relatively compact areas, which makes for greater efficiency and
fewer defaults.
...but overall losses are staggering, with other knock-on effects
In the 2005-10 period alone - the most recent period for which reliable data
is available - discoms racked up losses of Rs 1.79 trillion, which is more
than the central government spent on all subsidies (including oil, fertilisers and
food) last fiscal. While the states and the Centre cover roughly a quarter of
this shortfall, most of it is covered by loans from the financial system - and
the knock-on effect is starting to become apparent. Even as NPAs related to the
power sector are still at negligible levels, many analysts expect them to rise
sharply in the next 2-3 years. Discussions with players in the power sector
reveal an expectation that things will get much worse in 2012; most banks, even
with approved credit lines, are no longer disbursing funds to the sector.
The supply of coal is the ultimate spoiler...
At the other end of the supply chain, India hopes to add 78 gigawatts (GW) of
power-generating capacity over the next five years (2012-17); up from the 65-odd
GW it has managed to create in the past five. The reality, though, is that in
the last few Plan Periods - as also, from all indications, in the current one -
it has achieved less than two-thirds of its target levels. Even giving it the
benefit of doubt, it is one thing for the government to set such ambitious goals
for itself, but something else to expect others to make good in its stead. Yet,
it is counting on the private sector to create the bulk (55%) of the new
capacity it aims for between now and 2015. This looks highly optimistic.
Investor interest in the power sector has soured, not just owing to the prospect
of having to sell to bankrupt clients (i.e., the discoms), but also by uncertain
and costly fuel supplies. A severe shortage of coal has, in fact, become the
biggest challenge to running the thermal power-plants that produce 65% of
India's electricity - and few expect a marked improvement in the medium term.
...and a government monopoly doesn't help
In recent months, Coal India, a government monopoly that accounts for 80% of
India's coal production, has fallen far behind target, mostly owing to the
flooding of its major mines during the monsoon. It may yet meet its output goals
for fiscal 2011-12, but so far, it has been providing power companies with just
about half of the amount of coal agreed upon in its annual contracted quantity (ATQ)
agreements - which it shortly hopes to 'raise' to 70%. It has not signed any new
supply agreements since 2009.
While Coal India should be able resolve its immediate problems, there are
bigger worries about the long term. Even with the world's fifth-biggest
reserves, India's coal output has only inched up in recent decades, a sharp
contrast to China's exponential growth over the same period. Nor, without doing
two things - making land acquisition easier and more transparent; and allowing
the private sector to participate more meaningfully in coal mining - can it hope
to break out of this stupor. (There have been issues, too, with the
generally-low quality of Indian coal - and equally, its pricing. Until now,
generating companies have been forced to pay for coal on the basis of a
vaguely-defined 'band' of its estimated heat value - which means that they have
been spending more than they should be per usable unit of coal. However, a
recent - and long recommended - move to start pricing it on its calorific value
should help address this problem.)
In any event, over the next five years, India will have little choice but to
buy a lot more coal abroad. Industry estimates suggest, in fact, that the
demand-supply gap will grow five-fold, forcing India to import more than a
quarter of its coal requirements - equal to Australia's entire output today - by
2017. Anticipating this, private-sector power producers have been acquiring
large mining assets abroad, and the more recently built, large private power
plants are all within easy distance of the coast. As a more logical, but
tougher-to-implement alternate, power plants could come up in and around coal
mines (lower cost and therefore more competitive pricing of power is natural).
States such as Orissa and Jharkhand would then be automatic beneficiaries, if
they could sight this opportunity and enhance investor attractiveness. If that
is not challenge enough, transmission systems themselves will then need to be
beefed up to carry power outwards to end recipients
The transmission network is underinvested in
There are, however, major challenges to overcome in terms of the transmission
network. Even if it manages to produces much more electricity, and to put its
discoms in order, India still needs to be able to efficiently move large amounts
of power from one end of the country to the other. Globally, most countries
spend as much on their transmission and distribution (T&D) networks as they do
on power generation, but India has historically spent just half as much on T&D.
Tellingly, compared to a global average of 50-60%, its transmission lines are
now loaded to 90% of their capacity. This leads to burnouts and inefficiency
losses, and in the longer term, will make it difficult to 'evacuate' enough
power from surplus to deficit regions.
THE LONG ROAD AHEAD...
Correcting this sorry state of affairs will require too many changes to list
here. There will be a place for alternative sources of energy - including solar
and nuclear power (which is, though, today under a cloud of fear emanating from
Fukushima) - but for the foreseeable future, coal will continue, quite
literally, to power India. This makes it imperative that the mostly-thermal
energy sector works as well as it possibly can, and that it attracts large
investments. In turn, this requires a laundry list of reforms, everywhere from
the distribution stage upwards. However, the details of such reforms are less
important than the broader principles they are based on. In many ways, they will
mean simply taking forward the agenda that was laid out nearly a decade ago in
the Electricity Act, and augmenting it with more recent studies and best
practices. Most of all, though, it will mean truly embracing certain core ideas,
and then ensuring that, at all levels, there is a sufficient 'buy-in' for the
reform agenda.
Within the developing world, several Latin American countries stand out on
this front, and there are important lessons to be gained from the experience of
Argentina, Chile and Peru, among others. In the 1990s, these countries
successfully privatised large sections of their power sectors. They managed to
raise efficiency and worker-productivity levels dramatically, cut their AT&C
losses (in some places, by more than half), and eventually, to markedly reduce
the wholesale rates for power. Each country followed its own path - though one
loosely modelled around Argentina's - but what was common to all of them was a
commitment to a much stronger governance/regulatory framework - which is
entirely missing in the Indian scenario, CERC notwithstanding. From a financial
perspective, they required that the revenues from electricity sales, together
with any subsidies - which themselves must be both transparent and efficiently
delivered - fully cover the costs of supply and distribution, and thereby
generate a reasonable return on capital. They also cut the large cross-subsidies
that existed across different types of consumers, and perhaps most critically,
ensured that an autonomous regulator set tariffs. For their part, consumers
received reliable power supplies, which made them less resistant to tariff hikes
- a lesson that, populist temptations notwithstanding, applies across sectors
and countries.
From a legislative angle, it proved vital to have clear provisions in the law
defining the supply of electricity as a commercial service that will be made
available only to those who pay for it - and equally, guaranteeing utilities the
right to deny service to those that refuse to pay. The laws also provided for
effective payment-recovery systems, and made the theft of electricity a criminal
offense, with a separate set-up to ensure a quick prosecution. At the
corporate-governance level, a key requirement, many reforming countries have
found, is to ensure that utilities and their managers are able to fully assert
their property rights, and equally, to have full control over their employees -
regardless of how strong the unions are, or how rigid the public-sector
employment rules may be. Nearly everywhere, politicians and bureaucrats tend -
whenever they can - to use utilities as a source of patronage. Cutting them out
of the loop is both tricky and essential.
There are many other learnings - some specific, others general - to be had
from the experience of other countries, but the long and short of it is fairly
simple: 'Make consumers pay for what they consume, at rates that are set
rationally and independently, and require (and allow) the utilities - preferably
privately-run - to earn what they spend. Make property rights non-negotiable,
and make any violations strictly punishable. Keep the politicians out.' If India
were to follow these principles to the T (the last one gives you a sense of how utopic this expectation might be), it would go a long way to towards resolving a
problem that today is both seemingly intractable and potentially ruinous.
Unfortunately, it is probably too much to hope for the kind of statesmanship
that would create truly independent, powerful regulators who can set
market-determined prices in a timely and transparent way, enable the rapid
prosecution of power thieves, and generally bring order to what is today a zone
of anarchy. In a country where half the population (read: vote bank) still
depends on a low-yielding agricultural sector, politicians not only get away
with, but depend for their survival on promises of free power on their election
manifestos. Driven towards competitive populism, their compulsions may be
understandable, but they lead to disastrous results. Moreover, the manufacturing
sector - which, in many other countries, has been an important reform lobby -
remains relatively small, and not determined enough to drive through the changes
that are needed.
A crisis is clearly looming although that in itself may have a silver lining
- state government and SEBs may soon be left with no choice but to encourage
private investment in generation more aggressively, and to look at transmission
bottlenecks far more urgently. For lasting change, however, one can only hope
that the roadmap for reforms that Dr Singh and his colleagues will present to
India in the coming months disprove our doubts - instead of offering mere window
dressing and temporary fixes - but the odds of that happening are not high. In
the balance hangs a sector whose growth is desperately needed, if we are to
continue to power (pun intended) ahead and in the absence of which, all the
plans of mice and men for India could be brought to nought.
