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Indian Power Sector –

Emerging Challenges to Growth


With a critical mass of progress in regulatory reforms and soaring economic growth, the Indian power sector is now primed for take
off. Over the next ten years, the sector will need US$200 bn in new investments. How India deals with the remaining challenges of the
restructuring process and emerging fuel shortages will dictate what happens in the years to come.
By SANDEEP KUMAR, ANURAG KHETAN & BISHAL THAPA .

I
ndia received the perfect Valentine’s Day investment need of 9,000 bn Indian Rupees (INR), (1) How India overcomes the remaining elements
present this year. The Sensex, India’s key stock or US$ 200 billion to make it possible 1. The of restructuring that seek to sever the last few
market index, which had been on a bull run investment plan aims to expand the power vestiges of political influence.
since November last year, finally peaked at 6,700, infrastructure base for economic growth while (2) How India deals with the emerging challenges
up almost 50% from the low of May last year. If making electricity accessible to all. Nobody is of fuel shortages that threaten to derail power
the news was received with subdued euphoria, it quite betting on its success just yet but it is clear capacity expansion plans.
was only because announcements about growth that Government and policymakers are taking the The remainder of this article discusses the two
have become just too commonplace. Of the 650 problems of the sector seriously. identified challenges to growth in the Indian
companies that had announced quarterly profits Transforming the state-led bureaucratic Indian power sector.
by December, over 150 had posted profit growth of power sector into a competitive market attractive
over 200%. Fuelled by foreign inflows and to private investors was never going to be easy. REFORM CHALLENGES
expectations of yet another miracle budget, the But economic liberalisation of the nineties along The Indian power sector, long considered a
run up to the Valentine’s Day Sensex was with the pressures from the country’s economic symbol of the nation’s state led economic
indication that the love affair between foreign development, has been plagued by bureaucratic
investors and India Inc. may be over the first date
jitters. But the courtship isn’t quite ready to turn
India has set itself an inefficiency and political interference for
decades. Vertically integrated state utilities
into a full fledged wedding proposal yet. ambitious target of more (State Electricity Boards (SEB)) are practically
The key worry for investors is whether India can insolvent with commercial losses estimated at
sustain the 6-7% economic growth rate. An ailing than doubling per-capita INR 225 bn (US$ 5 bn) for FY 2004 alone 2. The
infrastructure network that needs massive electricity consumption tariff structure is differentiated by consumer
reinforcement and expansion remains one of the category with a cross subsidy charge that
largest obstacles to such growth. Progress in the by 2011 penalises commercial and industrial users at the
Indian power sector, with current electricity expense of the more politically influential
shortages of over 11% of peak and 7% of energy, growth has forced open the sector. Previous agricultural sector. Transmission and distribution
will be one of the key determinants to future reform efforts etched slowly into industry’s losses remain high – almost 40% – and power
growth. All this is not breaking news; the Indian regulatory structure, ownership, investment, and theft is endemic and tolerated.
government has long been aware of the need to management practices. Political will has gradually The Electricity Act 2003 struck at the core of
transform the power sector. Throughout the coalesced through the reform process of the these issues. Replacing the disparate reforms of
nineties it worked steadily to liberalise the sector nineties and the Electricity Act 2003 is now the 1990s, the Electricity Act 2003 brought
and initiated reforms that culminated in the galvanising change. With the implementation of together structural and regulatory reforms
Electricity Act 2003. And thus far, the momentum the Electricity Act, progress on structural and designed to foster competitive markets,
on power sector reforms has survived regulatory reforms has achieved enough critical encourage private participation and transform the
Governments of both left and right. mass to become irreversible. The change has state’s role from service provider to regulator. The
India has set itself an ambitious target of more sparked renewed interest in private investment Act directs the unbundling of vertically integrated
than doubling per-capita electricity consumption opportunities. What happens next in the sector utilities and creates autonomous state electricity
by FY 2011 and the Ministry of Power projects an will now depend critically on two things: regulatory commissions. Electricity trading has
been recognised as a separate line of business and
TABLE 1. INDIA’S POWER SECTOR PLANS – THE US$ 200 BILLION PACKAGE
regulatory commissions have been directed to
Planned Enhancements Estimated Cost FY 04 - FY 11 (bn)
develop rules on open access, rationalise tariffs to
FY 2004 FY 2011 INR USD
progressively reflect cost of supply, reduce cross
Generation Capacity (thousand MW) 115 207 5,532 123 subsidies, institute strong anti-theft provisions
Transmission 1,265 28 and protect consumer interest.
Interstate Transmission Capacity (MW) 9,000 30,000 In India’s constitution, electricity is a shared
Transmission (‘000 ctk Kms) 326 386
responsibility between the centre and states.
Distribution & Rural Electrification 1,949 43
Households with access (%) 60% 100% Though overall progress at the state level is
Peak Deficit (%) 11% 0% mixed, almost all the states have initiated some
Energy Deficit (%) 7% 0% structural and regulatory reforms. About 22 of the
Renovation & Modernisation 250 6 29 states have established electricity regulatory
Electricity consumption per capita (kwh) 326 819 commissions empowered to regulate tariffs and
Source: Planning Commission (Xth Plan) and Ministry of Power
establish performance codes. About half the

1  Reprinted from WorldPPower 2005


India

FIGURE 1. INDIA’S POWER SYSTEM AT A GLANCE – INSTALLED CAPACITY (115,476 MW)


INSTALLED CAPACITY, JANUARY 2005 (MW)

2% 3%
10%
Coal 59%
Hydro 26%
59% Gas 10%
Nuclear 2%
26% Others 3%

INSTALLED CAPACITY BY OWNERSHIP


11%
33%

56%

Central 33% State 56% Private 11%

Source: Ministry of Power & ICF Consulting Research

states have unbundled the vertically integrated PAYMENT RISK liabilities and re-establish the financial credibility of
state electricity boards. Some form of unbundling One of the biggest worries for private generators electricity purchasing entities.
across all the states is expected by the target is that they may never get paid for the electricity
date of June 2005. Despite the variation on they produce. Most distribution companies are still TARIFF RATIONALISATION
progress, it is clear that the basic thrust of the under state control, either directly through the SEB Subsidies to agricultural and household
Electricity Act has percolated down to the states. or their unbundled successors, and are financially consumers coupled with very high levels of T&D
A critical mass of reform initiatives has developed distressed. Commercial losses at SEB in 2004-05 losses have long kept tariffs out of sync with costs.
and implementation hurdles now relate mainly to alone are estimated to be INR 225 bn (US$ 5 bn)5. Seeking to bring revenues in line with the cost of
difficulties of the restructuring process. Average sales revenue to cost ratio remains well supply, the Electricity Act required the
While the centre-led Electricity Act laid out the under 70%. Much of these losses result from the independent regulatory commissions to rationalise
vision for a deregulated power sector, states have underlying tariff structure and low revenue tariffs. Most states have followed the guideline
the charge of implementing the restructuring collection rates. The tariff structure is defined by with vigour. Through the tariff orders, a number of
process. There is as yet no clear road map for the consumer class and a cross subsidy structure is
restructuring process and the Electricity Act used to subsidise domestic and agricultural users. Most distribution
leaves it to the states to decide. Delhi and Orissa, The higher rates paid by industrial consumers are
the states at the most advanced stages of insufficient to cover the subsidies provided. In companies are still under
restructuring, pursued two different models and addition, revenue arrears, or collection state control ... and are
provide the only real life experiences. inefficiencies, on average are about 25 – 30%. In
The road to competitive power markets in India, some states like Bihar and Jammu and Kashmir, financially distressed
particularly one with active private participation, revenue arrears are astoundingly high – as much as
will depend on how the restructuring process 155% and 227% respectively. In a recent rating of commissions have instituted measures to allocate
deals with three key issues: SEBs conducted by the Ministry of Power, the revenue requirement in an economically efficient
1) Payment risk from sale of electricity median score for financing risk was well short of 10 manner by reducing the extent of cross subsidies.
2) Tariff rationalisation against a maximum of 23. Only ten states achieved Though these new tariff orders are steps in the
3) Open access a score greater than 10. While investors may be right direction, bringing them in line with supply
lured into power costs will ultimately involve raising prices for the
Key Features of the Electricity Act projects with promises vast majority of consumers, particularly in the
* Unbundled vertically integrated state utilities of long-term agricultural sector, that have been used to decades
* Established independent electricity regulatory commission
agreements, the ability of subsidised power. The planning commission
Generation No license required for establishing of SEBs to pay for the estimated that for SEBs to post a rate of return of
non-hydel plants purchase of electricity 3% in FY 2001, average tariffs would have to be
Distributed generation and generation from renewables encouraged
still remains increased by approximately 50% (or INR 1.17
Transmission Non-discriminatory open access to transmission system questionable. Simple /kWh)6 that year. Such increases challenge the
Introduction of power trading as a separate line of business unbundling followed by fundamental nexus between politicians and
Independent power transmission companies allowed privatisation or consumers. Tariff rationalisation will be more than
Unbundling of transmission and trading
corporatisation may not an exercise in bringing revenues at par with cost
Distribution Right to choose supplier be sufficient. The and will require significant political capital to be
Rationalisation of tariff restructuring process spent in convincing agricultural users to accept
Progressive reduction of cross subsidies must determine who higher prices. Thus far, the politicians have yet to
Metered supply of electricity and strong anti-theft provisions
absorbs the existing wager their bets.

Reprinted from WorldPPower 2005  2


India

Competing Models for Restructuring

The Orissa Model The Delhi Model


Orissa was the first state to embark on the reform The Delhi Electricity Reform Act comes into force in March
programme after the state Electricity Reform Act became 2001.
effective in April 1996.

Almost immediately, the Orissa State Electricity Board is Two months later, Delhi Vidyut Board (DVB, the state’s
partially unbundled into three separate entities: Orissa electricity board) establishes six shell companies (holding THE RACE FOR FUELS
Hydro Power Corporation (OHPC – for hydro generation), company, generating company, transmission company, While India’s reforms have attained enough
Orissa Power Generation Corporation (OPGC – for thermal three distribution companies) to be operationalised on critical mass and are slowly winding their way
generation) and Grid Corporation of Orissa (GRIDCO – for transfer. through the states, a more immediate concern
transmission and distribution). on fuel shortages threatens to derail short-term
growth prospects in the power sector. At the
Generation is first privatised. In June 1998, AES purchases Distribution is first privatised. 51% of the equity in three end of February, 24 plants (23,000 MW, 35% of
49% stake in OPGC. In the second phase, the distribution distribution companies are sold to two privately owned
total coal capacity) had coal stock of less than
assets, properties and personnel of GRIDCO is broken into Indian power companies, BSES and Tata Power. DVB ceases
7 days out of which about 8,000 MW had stock
four distribution companies. BSES purchases three of them to exist and is replaced by the holding company, the
of less than 4 days8. The failure to activate fuel
(NESCO, WESCO and SOUTHCO) in April 1999 and one (CESCO) generation company and transmission company. Delhi
supplies has threatened the operation of some
is transferred to AES Transpower (joint venture of AES and government retains ownership of the holding, generation
Jyothi Structures Ltd) in September 1999. and transmission company. plants and postponed the building of several
others. In January, NTPC had to begin seeking
GRIDCO retains most of the past liabilities of distribution Holding company retains all unserviceable liabilities. Asset alternate fuel supply options because the mines
companies in order to conclude sale. Its cash deficit soars values of successor companies are pegged to serviceable supporting its new pit head plants (Talcher –II
almost 40% between 1998-1999 and 1999-20003, and the liabilities. Existing serviceable DVB liabilities will be paid by and Rihand-II, total 2,000 MW) had yet to
company has difficulty covering operating expenses. successor agency after a four year grace period. receive clearance9. Of the 4,300 MW planned
capacity additions off-track in the Xth Plan,
Private investors bid for distribution companies based on Introduced concept of aggregate technical and commercial almost 65% had slipped for fuel supply
assumptions contained in the information memorandum. (AT&C) losses, rather than transmission and distribution reasons10. The 100,000 MW of capacity additions
Assets of distribution companies may have been over-valued (T&D) losses. Private investors bid for distribution needed through FY 2011 is unlikely to
because of underestimated losses (estimated at 35%, companies on the basis of a five year AT&C targets, materialise unless India can find the fuel supply
actually more than 50%; the 100% collection efficiency indicative multi-year tariff profile and projected
sources and distribution networks to support
estimated is actually 83%) 4. Bidders assumed that future Government assistance. A five year transitional period with
the projected growth.
tariff adjustments would balance any initial over-valuation. some Government support over the period.
No transitional support to private distribution companies
COAL MARKETS
planned and turn-around expected in 2/3 years.
India’s coal demand is expected to grow 7%
OPEN ACCESS subsidy. Though the Electricity Act may have annually over the next decade11. Much of this
The Electricity Act recognised open access as given SERCs the authority to levy a surcharge to increased demand will come from power
one of the most important instruments for support subsidy financing, its implementation generation, which currently accounts for about
transforming the power sector. The Act afforded has merely helped protect incumbency rights 80% of total coal consumption. For a country
consumers the ability to directly source their and reduce the pace of restructuring. The vision that has relied heavily on domestic coal, the
electricity from suppliers using existing of competitive markets with open access is stresses of such a demand growth are already
networks and recognised trading as a separate apparent. Over the last decade, coal imports have
line of business. A number of central and state India’s coal demand steadily risen at an annual rate of 12%12. Coal
level regulatory initiatives have sought to consumers, both in the power and industrial
develop and strengthen open access rules7.
is expected to grow sectors, have increasingly begun to look for
These rules could well be the panacea for much 7% annually over the sourcing options from abroad. Jindal Stainless
of India’s electricity woes. By challenging the and Tata Steel were reported to be looking to
sole-purchasing power of the state electricity next decade acquire coal mines in Indonesia, Australia and
board (or their successors), generators have an New Zealand to support the expansion of their
opportunity to reduce the payment risk, avoid unlikely to be fully realised without further power and steel ventures in India 13.
the hazards of commercial losses from theft and clarity on ‘surcharge’. Proven coal reserves in India are estimated to
provide industrial users the incentive to seek Though India’s power sector reforms are not yet be 94 billion tonnes and at current production
out more cost-efficient supply sources. Despite free of difficulty, the ongoing restructuring efforts levels, enough for the next 230 years. But current
the obvious progress on open access rules, the illustrates that a critical mass of reforms have production levels are simply not enough to meet
benefits of it are yet to be realised. The been achieved. The process now appears the growing demand. Imported coal, though an
effectiveness of open access has been stymied irreversible. The pace and eventual outcome of option, does not provide the same cost benefits of
by provision of a ‘surcharge’ that is currently reforms, however, will be dictated by the domestic coal (especially for pit-head plants
levied on open-access customers belonging to willingness of politicians and policymakers to where most new coal plants are likely to be
any category contributing towards the cross sever the remaining political ties with the sector. located) but could fundamentally alter the

3  Reprinted from WorldPPower 2005


India

FIGURE 3. COSTS OF SUPPLIES & TARIFFS


400

300

Paise (kwh)
200

imported coal-gas choice dynamics for new plants.


Against this backdrop, some reforms have been 100
initiated in the coal industry but hardly with the
Average Cost of supplies Average Tariff
zeal of a sector so urgently in need of change.
Between 1996 and 2000, after several decades 0
FY 96 FY 97 FY 98 FY 99 FY 00 FY 01
of control, coal prices were deregulated along
Source: Annual report on the working of State Electricity Boards & Electricity Departments, Planning Commission 2002
with the distribution to industries other than
power and steel. Captive mining by private sector
engaged in iron and steel and power generation FIGURE 4. COAL DEMAND & SUPPLY
800
have also been allowed. Although FDI limits for
captive mining for power plants have been Projection
removed and those for iron and steel have been Coal Demand
600
Millions of Tonnes

increased to 74%, private companies are still Domestic Production

restricted only to captive coal mining. It is unlikely


that the state-owned coal companies that have 400
long held a monopoly over coal markets in India
can alone bring the investment and efficiency
improvements in the sector14. Without some major 200
reforms or restructuring that unlocks the
constraints in coal supply, India’s vast potential
for growth in coal capacity additions may remain 0
FY 92

FY 00
FY 90

FY 94

FY 96

FY 98

FY 04

FY 10
FY 06

FY 08
FY 02
just that – a great potential.
Source: International Energy Association, 2002 and Planning Commission (Xth Plan)
GAS MARKETS
Gas has emerged as the new frontier for energy and the National Commodity and Derivatives are already evident. Imports of natural gas started
supply in India and as a new industry relatively Exchange Limited. A petroleum and natural gas in 2004 after the commissioning of Petronet’s
free of bureaucratic red tape, holds the hopes for regulatory board has been proposed along with a Dahej LNG terminal. At least 2 more LNG terminals
supporting the expansion in the power sector. Gas draft pipeline policy seeking to unbundle gas are expected to come online by 2009 and the
demand in India is expected to increase sharply at transportation from supply and establish ‘contract Dabhol LNG terminal is also gearing up for
an annual average growth rate of about 8.5% carrier’ norms for access. operations. Proposed plans for LNG terminals could
through FY 2011. Increased demand comes not Expanding gas supply sources and distribution add over 80 million standard cubic metres per day
only from the power sector, which currently infrastructure is now the key to further evolution (MMSCMD) of gas capacity. Gas-import pipelines
accounts for about 40% of gas consumption, but of gas markets in India, and visible signs of from Iran and Myanmar are also under serious
also from the industrial and fertiliser sectors. progress in tackling the infrastructure bottlenecks consideration. Domestic gas exploration has
Current supply options, however, are extremely
limited. Baseline projections, including LNG FIGURE 5. GAS SUPPLY & DEMAND
imports and Reliance Gas from the KG basin, 100
indicate a supply shortage of about 15-20 billion Projection
cubic metres (bcm) annually by FY 2011. Reliance Gas
80
Gas markets in India have matured considerably
Supply Demand
since the sector was first opened in the mid
60
nineties. The New Exploration and Licensing Policy
BCM

(NELP) was launched to attract private capital in


exploration activity and has been successful in 40
drawing both domestic and international
participants. Several key discoveries have been 20
made under the NELP, though much of the LNG Imports Begin
sedimentary basins of the country remains 0
FY 92

FY 00
FY 90

FY 94

FY 96

FY 98

FY 04

FY 06

FY 08

FY 10
FY 02

untested. Downstream gas marketing has also


been liberalised. An online spot trading facility for
gas contracts is jointly being developed by Gail Ltd Source: Prime Minister’s Office (Hydrocarbon Vision, 2025) and Planning Commission (Xth Plan)

Reprinted from WorldPPower 2005  4


India

and expanding capacity at its plant in the state;


Reliance Energy announced plans for additions of
3,000 MW of gas-fired capacity in UP. The US$ 200
billion investment bill may not be the primary
constraint in transforming the Indian power
sector. Instead the emerging challenges to growth
relate to the remaining issues of regulatory
reform and fuel supplies. While progress on
reforms now appear irreversible, political will on
resolving the remaining regulatory issues still
remain unclear. Furthermore, fuel shortage
resulting from limited supply options and
transportation infrastructure threaten to derail
power capacity expansion plans. How India tackles
these obstacles remains to be seen. But if the
aggressive vision of Indian planners is to be
believed, it may not be long before the courtship
TABLE 2. LNG TERMINALS
of foreign investors and India Inc. does indeed
Capacity Supply Partners blossom into a full fledged wedding proposal 
LNG Terminals MMSCMD Source Indian Foreign
Footnotes
Dahej * 20 Ras Gas (Qatar) GAIL, ONGC 1. Planning Commission (Xth Plan) and Ministry of Power.
IOC, BPCL GDF, ADB 2. Indian Budget 2005-06.
Hazira ** 10 Various Royal Dutch Shell,Total 3. “Orissa Power Sector Reform: A Brief Overview of the Process,”
Kochi 10 Ras Gas (Qatar) GAIL, ONGC Infrastructure Development Finance Company Ltd. (IDFC Ltd.),
February 2000.
IOC, BPCL GDF, ADB
4. Ibid, IDFC Ltd.
Dabhol *** 20 Oman MSEB GE, Bechel 5. Indian Budget 2005-06.
Enmore 10 Qatar Grasim Unocal, CMS Energy, 6. “Annual Report on the Workings of State Electricity Boards and
Woodside Energy, Electricity Departments,” Planning Commission, May 2002.
Siemens Project Ventures 7. Open access regulations rules relating to transmission customer
class definition and pricing, were approved by CERC in January
Kakinada (Krishnapatnam) 10 Various IOC, Coconada Port BP, Petronas, ISP 2004 and amended in September 2004 and January 2005. CERC
Gopalpur 20 Australia Orissa State, VOGL AMIG, Australia LNG also approved trading related regulations in January 2004.
Several states, including Rajasthan, Maharastra, Tamil Nadu, Andra
Pipavav LNG 10 Yemen BG Pradesh, Gujrat, Karnataka, Madhya Pradesh, Orissa and
Trimbay 12 ME/SEA TPC, GAIL TGPI Uttrananchal have approved or developed draft open access rules
with time-bound implementation guidelines.
Notes: * Operational ** Under Construction ** Undergoing a revival 8. Central Electricity Authority, MoP, GoI.
http://www.cea.nic.in/data/opt2_daily_coal.htm.
expanded considerably with NELP. 164 blocks have on the opportunities. Just last month Brakel 9. “NTPC coal imports may give consumers a power shock,” The
been awarded, of which 20 have announced some Corporation of Holland expressed interest in Economic Times, 27 January 2005.

finds. A national gas pipeline grid connecting over investing US$ 1 bn on hydel projects in Himal 10. National Electricity Plan, 2005. Central Electricity Authority.
11. Planning Commission Xth Plan.
8,000 kms and able to transport about 100
12. International Energy Association, 2002.
MMSCMD is also being proposed. While gas may ... the emerging 13. “Tata Steel scouts for coal mines in Australia, NZ,” Business
hold the promise of unlocking growth in the power Standard, 26 January 2005. “Jindals eyeing coal mine in
sector, the outcome will depend on the willingness challenges to growth Indonesia,” The Economic Times, 28 January 2005.
14. Coal India Limited and its subsidiaries effectively control about
of private investors and Government to make the
initial investment in supply infrastructure.
relate to the remaining 90% of domestic coal production and distribution.

issues of regulatory Sandeep Kumar, Anurag Khetan and Bishal Thapa


CONCLUSIONS
Despite the potential offered by the India’s reform and fuel supplies are with the New Delhi office of ICF Consulting. The
authors wish to acknowledge support of Shanthi
power sector, investors have long been weary of Muthiah (ICF Washington DC office) and Harriet
the sector’s bureaucracy and regulatory Pradesh. More recently, Alstom picked up a 25% Hoexter (ICF London office).
complexity. Now with a critical mass of progress in stake in Torrent Power; AES has expressed interest
reforms, private investors have been quick to pick in re-acquiring the distribution company in Orissa www.icfconsulting.com

5  Reprinted from WorldPPower 2005