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Reforming the power sector: A Long Road Ahead
13 Feb 2012

Reforming the Power Sector: A Long Road Ahead

IDEA IN BRIEF:

  • India's power sector is in crisis. An incomplete privatisation process and extreme operating inefficiencies in most State Electricity Boards has resulted in a total power deficit of over 10% a year. While huge chunks of the country are not yet even electrified, Aggregate Technical & Commercial losses (AT&C - read theft and inefficiency) are in excess of 30%.
  • Closely linked to this challenge is the state of coal mining in India and the near-monopoly of Coal India. Coal still powers 65% of India's energy requirements, but in the current fiscal year, Coal India does not even expect to meet 70% of the power sector's fuel requirements.
  • Power generating companies enjoy a direct pass-through of the escalating costs of coal, whether local or imported, and neither they, nor the power transmission companies are driven to be more efficient.
  • At the other end, distribution companies continue to deal with the intense challenge of theft and the inability again, to price power rationally. Those privatised have now seen success and have ramped up investments, but the horribly hard way. There are, regrettably, too few to make a tangible difference to the overall power distribution scenario in the country. The total losses of discoms came to a whopping Rs 1.79 trillion in 2005-10 - the most recent period for which data is available.
  • The sensitive middle of these two ends of the chain - transmission - is seriously compromised with inadequate investment. Alarmingly, India's transmission lines are now loaded to 90% of their capacity, compared to 50-60% elsewhere in the world.
  • What is needed to reform this sector is well known. Any of those steps however will need one thing - political will - to create an independent and powerful regulator and the active encouragement of private sector participation with its resultant efficiencies - and political will that recognises the eventual fallibility of fiscal handouts. The merry-go-round will stop one day, with potentially disastrous consequences.

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.

This article is tagged under the following categories:
Subject: @Economy   |  Category: Infrastructure and industry   |  Subcategory: Infrastructure
Subject: @Economy   |  Category: Infrastructure and industry   |  Subcategory: Energy
Subject: @Politics and Geo-Politics   |  Category: Domestic politics   |  Subcategory: Domestic policymaking
Subject: @Society and Environment   |  Category: Public services
 

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