Power oversupply: The genesis and the way out

Published: May 19, 2018 3:00 AM

It will be a loss for the economy if new power plants remain underutilised for long. We need an enabling environment for discovery of sizeable latent power demand, which, in turn, can boost productivity.

power grid, power sector, economyDiscoms should be nudged to float PPAs to replace their ad hoc power purchases. The nudge can be in the shape of tax breaks or the creation of an environment where power price discovery is improved in the PPA market.

 

The Reserve Bank of India (RBI) has recently recommended stricter norms for non-performing assets (NPAs) recognition by banks. This has stoked fears that operational power plants totalling more than 40GW (Gigawatt) capacity and owing more than Rs 1.5 lakh crore to financial institutions can slip into the NPA bucket. More worryingly, these plants, coupled with the 50GW power capacity in the pipeline, are pointing at 45% excess capacity in India’s coal-based power industry. This, and the government’s ambitious renewable energy push, may accelerate some of these plants’ slump towards structural unviability unless fundamental and holistic reforms are initiated urgently.

Problems for the power sector had started 7-8 years ago, largely as a coal availability issue, but these have, over the last 4-5 years, turned into more of a demand-supply situation. PLF (or plant load factor, effectively the capacity utilisation of a power plant) has drifted below 60%—from the healthier 75% levels that existed in FY2010. This can be ascribed largely to the widening gap between demand and capacity.

On the supply side, a fundamental flaw crept into the system starting 8-10 years ago. Power business models got disfigured as project risks started ballooning, rendering the hitherto industry standard of RoE (return on equity) of 14-16% vulnerable. The revenue visibility of new power projects started receding with an increasing proportion of projects coming up without (or, with partial) PPA (power purchase agreements). Many bidding-based projects were having fixed power selling prices at surprisingly low levels after the auctions.

Then, the prospects of stability in availability and costs of fuel worsened drastically. The deterioration in land acquisition and environmental issues added further to project risks. Strangely, the project funding structure did not budge from the standard 70:30 model. A generous dose of debt from banks continued to provide 70% of the required capital, with equity providing the balance 30%. This underestimation of risks and open taps on debt funding by lending agencies emboldened the promoters to proceed aggressively, causing a whopping 11% CAGR (compound annual growth rate) in India’s coal-based power capacity during FY2008-FY2018.

The demand-side of the equation has two dimensions. Firstly, the end-consumer demand has been, and continues to be, disappointingly sluggish. In fact, versus industry expectations of a CAGR of 7-8%, India’s power demand has grown at 6% in the last 10 years. Now, for a country where even state capitals face frequent power outages, where industrial units often work sub-optimally due to power shortages, and where large rural areas have limited access to power, it is nothing short of an enigma that power demand growth remains less than the GDP growth.

History suggests that, as annual per-capita income reaches around $1,500 and/or per-capita power consumption approaches about 1,000kWh (kilowatt hour) in a country, the per-capita power consumption sets off on a multi-year leap. A quick look at data for a diverse sample set of France, Japan, Iran, Brazil and Mexico confirms this hypothesis.

Starting around similar levels of per-capita income and power consumption—obviously at different points in time—these countries witnessed 10-15 years of blistering growth in power consumption. India, with its per-capita GDP of about $1,800 and per-capita power consumption of 1,100kWh, may be at the cusp of a similar phase now. However, regulatory and policy environment must be supportive, or else these demand growth expectations will continue to be belied.

Unaffordability, to some extent due to cross-subsidisation that residential, commercial and industrial segments have to bear for agricultural users, is definitely a factor that is holding back power demand growth. In addition, there is a forced subsidy for power theft, for which again the genuine power users have to take the burden. Quick progress is required here to make power more affordable by rationalisation of prices, and by curbing inefficiencies. In addition, the under-served segments need to be connected to the grid. For example, satisfying rural demand can easily add a percentage point to total power demand annually over 3-4 years.

The second dimension of India’s power demand shortage is a persistent lack of incremental demand by power distribution companies (or discoms). In the last five years, very few PPAs have been floated by discoms. Essentially, despite enough latent demand and sufficient supply of power, the poor condition of intermediaries, i.e. discoms, is hurting the sector’s prospects.

Discoms have accumulated huge losses over the years, and are often running short on working capital. For most discoms, losses still continue even though scales have reduced in last two years. With such precarious financial condition, they prefer load shedding—or, occasionally, ad hoc buying on power exchange—rather than committing to fresh PPAs.

The government ought to estimate effective subsidy to the end-users and compensate discoms annually. Or better still, subsidies should be provided as a direct transfer to the targeted population. Expediting UDAY (Ujwal Discom Assurance Yojana), to rationalise distribution costs and to curb aggregate transmission and commercial losses, too is needed to mitigate discoms’ woes.

In addition, discoms should be nudged to float PPAs to replace their ad hoc power purchases. The nudge can be in the shape of tax breaks or the creation of an environment where power price discovery is improved in the PPA market. Further, penalties should be imposed on discoms for load shedding.

It will be a deep loss for the Indian economy if these new power plants remain underutilised for long. What is needed here is an enabling environment for the discovery of the sizeable latent power demand, which, in turn, can boost productivity in the broader economy.

By Vipul Prasad

Founder & CEO, Magadh Capital

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