Infrastructural Develoment

                   POWER

To attain the targeted GDP growth of 6-7 per cent per annum, India needs approximately 60,000 MW of additional capacity by 2002. The Government expects private producers to contribute half of this capacity. However, this is unlikely to happen without a major change in policies with regard to this sector.

Post 1991, power sector reforms have focused on attracting investment in generation through Independent Power Producers (IPPs) who would sell power to monopoly distribution entities, the State Electricity Boards (SEBs). However this process has failed to yield the desired results because of the extreme financial weakness of the SEBs.

SEBs are financially weak for three main reasons: (1) Average tariffs are well below costs due to subsidies to agricultural and domestic users. (2) Collection is poor, leading to an average receivables position of 30 per cent of revenues. (3) Transmission and distribution (T&D) losses are extremely high - as much as 21 per cent, mainly due to theft.

Attempts to encourage investment in generation will not succeed unless SEBs are made financially viable. The focus of reforms must therefore shift from generation to distribution. Accordingly, the Group recommends that States restructure the power sector on the following lines.

(a) Set up State Electricity Regulatory Commissions (SERCs)

States should establish an independent regulatory authority, the SERC, to regulate the power sector.

The SERC would set tariffs for various categories of customers and define efficiency norms. SERCs should move towards a cost-based average tariff. This would include rebalancing tariffs to ensure a rational level of cross-subsidy. Costs used for this purpose would be based on achievement of the defined efficiency levels.

To maintain viability, any subsidies required should be provided as clear budgetary transfers from the State Governments. In other words, State Governments should provide explicit budgetary support for additional subsidies beyond those proposed by the SERC. For example, if the SERC proposes an agricultural tariff of Re. 1/unit and a State wishes to supply power to farmers at 50 paise/unit, the State Government should pay a subsidy of 50 paise/unit to the distribution company or SEB.

Establishing SERCs would help reduce the impact of politically driven tariff setting and improve the realisations of the SEBs. This step of the restructuring process has been proposed in the 1998 Power Reforms Act, and should be implemented by all States.

(b) Restructure the SEBs

States should restructure the SEBs in two phases:

Phase I: Corporatise the SEBs and separate generation from transmission and distribution

States should separate the SEBs into independent operating companies for generation, transmission and distribution.

The operating companies should be professionally managed, without political appointees at senior levels. The management team should be held accountable for the performance of the corporatised entities.

The generation companies and IPPs should sign Power Purchasing Agreements (PPAs) with the transmission and distribution companies for off-take of their power. Transmission would be a unified, regulated monopoly; distribution could comprise regional monopolies in different parts of the State. The area of operation of the distribution companies should be defined to include a suitable mix of industrial and rural loads. Power dispatch should also be unified based on the marginal cost of delivered power.

This step of the restructuring process has already been implemented in Orissa. Annexure 3.1 describes Orissa's successful restructuring of SEBs.

Phase II : Privatise the unbundled companies

To ensure operational independence and improve efficiency, the State Governments should divest at least 51 per cent of their stake in the corporatised generation and distribution companies to private investors through a transparent bidding process. The SERC would mandate efficiency improvements, such as reduction in T&D losses, that the distribution entities must achieve and set tariffs based on the achievement of these efficiencies.

The profitability of the privatised distribution entities would depend on the actual efficiency improvements they achieve. This would create a strong incentive for efficient management, and help eliminate the problem of theft that plagues SEBs. Orissa plans to implement this step by the end of 1998.

(c) Introduce competition by allowing large users to buy directly from generating companies

The final stage of restructuring would be the introduction of competition to deliver lower prices and better service to customers. This would be initiated by allowing large users (above 1 MW) to negotiate direct contracts with generating companies instead of purchasing power from the distribution monopoly. The distribution companies will continue to serve small users.

The SERC would continue to set tariffs for small users. It would also decide the wheeling charges payable to the transmission and distribution companies for transmitting power from generators to end-users. The distribution companies would have to provide access to their networks for wheeling power to these large users.

This system can be introduced only after sufficient generating capacity to meet demand has been set up. So far, no State in India has considered this step. Similar reforms have, however, been implemented in the UK, USA and Argentina and have delivered substantial benefits in terms of lower costs to customers. For example in Argentina, the average price of electricity has decreased by as much as 30 per cent due to the implementation of this step. Annexure 3.2 provides a detailed account of Argentina's power sector reforms.

(d) Set up a Power Trading Corporation in each State

A Power Trading Corporation should be set up in each State to act as a market maker in a competitive spot market for power. Generating companies would sell surplus power to this corporation, which, in turn, would sell it to end-users and distribution companies.

The changes in the power sector that will take place due to this restructuring are summarised in Annexure 3.3

(e) Reduce T&D losses and theft to save Rs. 8,000 crore per annum

SEB Reforms should aim to reduce theft and losses and improve realisations from sale of power. Existing T&D losses average about 21 per cent across the country, compared to less than 10 per cent internationally. A substantial part of these losses are due to theft. Moreover, the World Bank estimates that 50 per cent of the total agricultural load in the country is diverted to other uses.

T&D losses should be reduced from 21 per cent to 15 per cent, saving about 22 billion units of electricity worth Rs. 4,100 crore per annum nationally. Diversion of agricultural load should be reduced to a maximum of 25 per cent of total agricultural load leading to savings of Rs. 3,800 crore per annum. Overall, these measures would lead to a total saving of Rs. 8,000 crore per annum.

(f) Promote restructuring of SEBs in every State

Since power is on the concurrent list, it is imperative that measures are taken to ensure that all State Governments commence the recommended restructuring process. So far, Orissa has implemented the first step of the suggested reforms as part of a World Bank aided project. Andhra Pradesh, Haryana and Rajasthan are considering such reforms.

To drive the process of reform from the pioneer States to the rest of the country, the Central Government should:

Provide matching funds to States that receive World Bank/ADB assistance for SEB reforms.

The centre should provide matching Rupee funds to States that receive World Bank/ADB assistance for distribution reforms. This could be done by increasing the allocation to the power sector by about Rs. 1000 crore.

These funds would be utilised for writing off existing bad debts, executing Voluntary Retirement Schemes (VRS), and investing in metering and upgrading the transmission and distribution (T&D) system.

The objective should be to kick-start restructuring in 3-4 States each year. Additional debt funding could be raised through the Power Finance Corporation and the capital market. Savings from the reduction of T&D losses and theft would help pay back restructuring loans and make the reform process viable.

Develop model legislation for States to corporatise and privatise SEBs.

The 1998 Power Reform Bill provides States with model legislation for implementing the first step of this process. The Central Government needs to draft model legislation for implementation of the other two steps: privatisation and introduction of competition. The legislation should be drafted after examining the nature of reforms carried out in other parts of the world such as Argentina. It should suggest the optimal process and time frame for these reforms.

2. Take Measures to Attract Investment and Improve Asset Utilisation

The comprehensive reforms outlined above would cure the major ailment of the power sector: the weak financial position of the SEBs. However, to ensure the optimal development of this sector, the following measures must also be undertaken simultaneously:

(a) Reduce fuel supply risk for IPPs

IPPs face significant fuel supply risk due to the unwillingness of Coal India and the Indian Railways to offer performance guarantees to power producers. This risk can be reduced by drafting model agreements including quality and delivery guarantees for:

• Coal supply by Coal India Ltd.

• Transport of fuel to the power plant by the Railways.

(b) Simplify the project clearance process

Many power projects are held up due to the reopening of signed PPAs, lack of environmental clearance and judicial review of clearances already granted. To overcome these hurdles, the Government should:

• Set-up Special Purpose Vehicles (SPVs) which would obtain all clearances before projects are opened to bidding by the private sector.

• Clearly specify environmental clearance criteria allowing automatic approval of projects at State level.

• Set up special courts to deal with public interest litigation on infrastructure projects.

• Prohibit reopening of signed PPAs unless malafide behaviour is clearly established.

(c) Develop a national transmission network through the Powergrid Corporation

There are currently very limited facilities for transmitting power from one region of the country to another. This prevents the transfer of surplus power from one region to another. It also makes it impossible to develop large multi-state generation projects.

The Central Government, through the Powergrid Corporation (PGC), should develop a National Grid that would allow improved capacity utilisation and the development of large multi-state generation projects. The National Power Trading Corporation should be activated to ensure optimal utilisation of this grid.

(d) Increase availability of generating stations to release 4500 MW of capacity

The average Plant Load Factor (PLF) of thermal power plants in the country is just 64.4 per cent compared to over 80 per cent internationally. This is mainly due to the poor availability of plants. Poor availability, in turn, is primarily due to the poor condition of equipment. Therefore, the Power Finance Corporation should fund the renovation and modernisation of generating stations on a priority basis to make available about 4500 MW of generation capacity. This would lead to a rise in PLF to about 70 per cent. Creating this capacity would cost about Rs. 1 crore/MW.

(e) Reduce receivables of SEBs to 15 per cent of revenues

Most SEBs face a high receivables position and bad-debt losses. The average receivables position of SEBs is 30 per cent of revenues. Improving collection effectiveness and bringing down the receivables level through measures such as prepaid meters would help raise funds for investment in system upgradation. States should also ensure that distribution utilities are permitted to act against Government owned bodies that default on payments. The objective should be to bring receivables down to a maximum of 15 per cent of revenues, This will lead to a gain of Rs. 2,750 crore.

3. Restructure the Delhi Vidyut Board (DVB) as a "Showcase Project"

The DVB is currently one of the poorest performing SEBs. Delhi faces a peak power shortage of 7 per cent. Its losses in 1997-98 were Rs. 839 crore, providing a return on capital of - 45.1 per cent. T&D losses were 43 per cent in 1997-98 compared to about 12 per cent for BSES in Mumbai. The DVB also has outstandings of over Rs. 1500 crore with central utilities such as NTPC and PGC. Given the poor financial condition of the DVB, it is highly unlikely that Delhi will attract private investment without drastic restructuring.

The Government should, therefore, embark on radical reform of the DVB through the following process. Generation should be unbundled from transmission and distribution. Distribution should be privatised into one or more utilities. An SERC should be set up in Delhi to regulate the operations of these utilities. The SERC should set targets for reducing T&D losses and improving collections. The State Government should provide legal support to these privatised utilities to curb theft of power. The Centre should contribute towards the investment required to reduce T&D losses and improve collections.

T&D losses in Delhi should be brought down to Mumbai levels of about 12 per cent leading to savings of Rs. 1,000 crore per annum at the current tariff level of Rs. 2.4 per unit. This would turn power distribution in Delhi into a profitable business. Successful restructuring of the power industry in the national capital would clearly demonstrate the benefits of reform, and spur restructuring in other States.

Summary

The three main recommendations in the Power Sector are summarised below:

This would require the following initiatives:

• Set up State Electricity Regulatory Commissions (SERCs).

• Restructure the SEBs.

- Phase I: Corporatise the SEBs and separate generation from transmission and distribution.

- Phase II: Privatise the unbundled companies.

• Introduce competition by allowing large users to buy directly from generating companies.

• Set up a Power Trading Corporation in each State.

• Reduce T&D losses and theft to save Rs. 8,000 crore per annum.

• Promote restructuring of SEBs in every State by

- Providing matching funds to States that receive World Bank/ADB assistance for SEB reforms.

- Developing model legislation for States to corporatise and privatise SEBs.

• Take measures to attract investment and improve asset utilisation.

This will call for the following actions:

• Reduce fuel supply risk for IPPs.

• Simplify the project clearance process by setting up SPVs, which will obtain all clearances before projects are opened to bidding.

• Develop a national transmission network through the Powergrid Corporation.

• Increase availability of generating stations to release 4500 MW of capacity.

• Reduce receivables of SEBs to 15 per cent of revenues, to release Rs. 2,750 crore .

Restructure the Delhi Vidyut Board (DVB) as a showcase project.

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As part of its World Bank-supported power sector reforms, Orissa has designed an unbundled organisation and passed State-level legislation to support the restructuring of its SEB. The major steps in this restructuring are depicted in the next page.

The main features of the legislation enabling restructuring and privatisation are:

• Setting up a State-level electricity regulatory commission.

• Corporatising the SEB, while retaining transmission with State-owned corporation.

• Introducing provisions to facilitate the transfer of State/SEB assets to new licensees and privatised entities.

As part of this reform, the SEB has been divided into three entities: (1) Orissa Power Generation Corporation (OPGC), which controls the thermal units in the State; (2) Orissa Hydel Power Corporation (OHPC), which controls hydel generation; and (3) Grid Corporation of Orissa (GRIDCO), which controls transmission and distribution.

OPGC has been privatised through the sale of a 49 per cent stake to AES of the USA through a competitive bidding process. A further 25 per cent stake would be divested at a later stage.

The distribution function under GRIDCO has been divided into four zones operated by subsidiary companies of GRIDCO. One of these zones was handed over to a private utility, BSES, for operation through a management contract. However, BSES pulled out of this contract following disputes with the regulator. The four distribution subsidiaries are being privatised through a bidding process.

Orissa has thus implemented the first step of the recommended restructuring process, and is currently implementing the second step.

Orissa Power Reform

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Argentina has successfully transformed a highly inefficient power sector into a model one.

Before restructuring commenced in 1992, the Argentine power industry was bedevilled by many of the problems that afflict the Indian power industry. Most utilities were vertically integrated and owned by the Government. Tariffs were politically set and not based on real costs. Shortages were on the increase and investment in the sector had almost stopped.

Efficiency was extremely poor; thermal plant availability was just 45 per cent and T&D losses were about 30 per cent. This led to high prices (between 6 and 12 US cents per unit), despite heavy subsidies. The largest distributor was losing as much as US $ 2 million per day.

To remedy this situation, Argentina followed a power sector reform process similar to that recommended in this document. The sector was unbundled into separate entities for generation, transmission and distribution. These entities were then privatised. Prices were set based on marginal generation costs. Competition was then introduced, starting with very large users (above 5 MW), and gradually moving to encompass all users above 0.1 MW. All players were guaranteed equal access to the transmission and distribution grid. Transmission and distribution functioned as regulated monopolies subject to a price cap mechanism.

This restructuring has dramatically transformed the situation in Argentina. The key benefits of this program are shown below. Prices of electricity have decreased by about 30 per cent. Theft has been curbed, and T&D losses have been reduced to 15 per cent in three years. Reliability of service has improved. Despite the drop in prices, the profitability of major players in the industry has increased. Consequently, investment in generation, as well as in the T&D network, has increased.

Key Benefits of Restructuring

Key facets of this restructuring process are as shown in the next page.

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