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Captive Power Generation : What are the Economics ?

V Ranganathan Damodar Mall

Electric power generation is a state controlled subject. Of late, however, government has liberalized captive power generation for the user industry for bridging the demand-supply gap. The fact that private industries use captive power answers the question of financial viability. For, the benefit in terms of prevention of marginal loss of production outweighs the cost of captive diesel power generation. Industries which have a high value added for electricity input will naturally insulate themselves through standby power. From the national point of view, the issues are somewhat different. Here the objective of the policy maker will be efficient resource allocation. The alternatives differ for short and long runs. In the short and medium run, power cut is given and the alternatives may be to impose a uniform power cut on industries impose an 'optimal' power cut, minimizing production loss and unemployment allow for captive power generation. In the long run, power cut is not a constraint, since extra capacity or reserve margin can be provided for. Growing demand and persistent funds constraint are not sufficient arguments to necessitate the continuance of power cuts, since utilities can segment the market and equilibriate the demand and supply by increasing tariffs. Thus, the long run alternatives are whether to satisfy a certain level of peak demand by additional grid capacity or by captive power. The alternatives have to be compared at the margin and therefore it is not the average cost of electricity at the high tension (HT) terminal or the HT tariff that is relevant, but the marginal (average incremental) cost of electricity. This has to be compared with the cost of captive generation at the given level of demand for captive electricity. In

Galloping demand for power and mounting constraints in its generation have forced electricity boards all over the country to impose power cuts. User industries have been forced to go for captive power plants to tide over the situation. In this article, V Ranganathan and Damodar Mall compare captive power and grid power costs in Karnataka. At the observed low utilization of between 6 and 20 per cent, captive power cost is Rs 1.95 while grid power cost is only 31 paise per KWH. The authors argue that the user industries should pursue the options of cooperative generation of power or become a financing partner with the electricity boards for assured and reliable power supply. V Ranganathan is Associate Professor and Damodar Mali is a student of the PostGraduate Programme in Management at the Indian Institute of Management, Bangalore.

cost-benefit terms, the benefit of captive power generation is not the saving in loss of production but the saving by not producing grid electricity since this is the next best alternative. Unit based captive power generation means pressure on costlier and scarcer fossil fuels, loss of economies of scale, and a built-in capacity underutilization. However, it involves much reduced lumpiness in investment and affords quick capacity addition. This article investigates the economics of captive diesel power generation along these lines with specific reference to Karnataka.

energy costs consumer costs. Marginal capacity costs are basically investment costs of generation, transmission, and distribution associated with supplying additional kilowatts. Marginal energy costs are fuel and operation costs of providing additional kilowatt hours. Marginal customer costs are per unit incremental costs directly attributable to consumers including costs of hook-ups, metering, and billing. Relevant operations and maintenance costs as well as administrative and general costs must be allocated to these basic categories.

Marginal cost of grid electricity for Karnataka is computed from the plans, projections, and financial statement of the Karnataka Power Corporation and the Karnataka Electricity Board. An operational definition of marginal cost as average incremental cost over a planning horizon is used, along the lines followed by the World Bank for computing marginal cost for the Andhra Pradesh Electricity Board. The refinements incorporated in this article are computation of marginal cost at various voltage levels and arriving at an equivalent marginal cost which is weighted average of capacity, energy, and service related costs and which is useful for comparison purposes. We hypothesize that most of the captive diesel generation capacity is grossly underutilized. We will also compare the cost of captive diesel generation with the cost of grid electricity. Diesel generation sets can be found in different capacity groups and at varied levels of utilization. For a common norm as regards usage and costing, a representative sample of data from different installations is required. We mailed a questionnaire to around 175 captive power installations covering all regions of Karnataka for generating primary data.

Capacity Costs
Additional Generation Capacity The trend for the past decade shows a 7.5 per cent yearly growth rate in the peak demand for Karnataka. With 1984-85 as base, the peak demand will go up from 1800 MW to 3710 MW in the decade ending 1994-95, an addition of 1910 MW (see Table!). In a mix of hydro and thermal power generating stations, a hydropower station is at the margin in KW terms because of its investment structure. Therefore, to estimate the marginal capacity addition cost, the average incremental cost for the hydro portfolio in the plan is computed. A total hydel capacity of 802 MW is planned to be added at a cost of Rs 731.12 crore (Table 1). The corresponding average incremental cost/KW is: 731.12 X 107 Rs---------------- = Rs 9116/KW 802 X 103 A typical storage hydroelectric station has two major components of cost: dam cost and power house cost. Only the latter is capacity related which is about 55 per cent of the total cost. ThereVikalpa

Marginal Cost of Grid Power

Three broad categories of marginal cost are: capacity costs 48

Similarly, other maintenance costs yield a relatively stable norm on a capacity rather than operation level basis. Maintenance cost = Rs 300/KVA/year = Rs 375/KW/year Total KW related cost = Rs 508 + 52 + 375 = Rs 935/KW/year

Thus, the opportunity cost of captive power is much higher than the actual cost escalation introduced by using diesel-based power. No power source is as bad as "no power." To assess the quantitative correlation between the power supply patterns and output levels, several other factors (seasonally, raw material availability, competition, etc.) that are different for different industries have to segregated. As an illustration, the grid power supply, captive power generation, and the output level for one of the responding industries have been plotted in Figure 1. While the captive generation profile tries to fill the peaks and valleys in the grid supply, the output level still seems in tune with the grid supply profiles. Some respondents have suggested that there should be tax reliefs for units installing captive power plants, thus making the 'felt' pinch of diesel power generation slightly more tolerable.

One KW installed on an average generates 1500 KWH every year (see Table 3). At this realistic norm of 160 KWH/KW, the equivalent capacity cost works out to Rs 935/KW/year = 935/1500 = Re 0.62/KWH This is very high as compared to the capacity cost of grid power. At an ideal utilization of, say, 10 hours a day (3600 KWH/KW), the cost component will come down to 26 paise/KWH. Therefore, the total costs are Re 0.62 + Rs 1.33 = Rs 1.95/KWH (at 22 percent [actual] utilization) and Re 0.26 + Rs 1.33 = Rs 1.59/KWH (at assumed ideal utilization)

The cost comparisons (HT) can be summarized as follows:

Grid power Captive power (at observed utilization)

Captive power (at

8.4 62.0 26.0

23.4 133.0 133.0

32.8 195.0 159.0

Other Findings
To get information about the opportunity cost of captive power, we asked the respondents whether output will be affected if there is no power cut at all. A more or less unanimous answer was that the installed captive capacity can fully take care of even a very high level of power cut and, therefore, an unrestricted grid supply will only marginally affect the output level. Vol. 12, No. 2, April-June 1987

ideal utilization)

While the higher energy component of the captive power cost is well known, the disparity in capacity costs is equally high. Given the present installed capacity of 300,000 KVA (approximately 240 MW) in Karnataka, the resources going into feed this

overcapitalization alone are to the tune of Rs 2.2 crore a year1 even if the utilization rates are assumed to be the same for both alternatives. Given the fact that 7 per cent of the total power generation in the country is through captive sets, the inference is clear. Also, there is more idle capacity in smaller installations and, as compared to the state-sector power stations, the captive power sources are only half as utilized. In this context, the question of licensing of cooperative captive generation (of the order of 220 MW, etc.) in the private sector comes up. While FICCI and other organizations have been making a case for it, the issue is deadlocked because of differences in the perception of the problem by the government and private industry. The government looks at power cut as neces'Difference between capacity costs (Rs)/KW/Year = Rs (508 418) = Rs 90. Rs 90 X 2,40,000 KW = Rs 2,16,00,000/year

sitated by lack of funds. Private industry looks at it as inefficiency of the electricity boards, and believes that it would perform better if the government gave it funds for private power generation. This argument is highly questionable and has little empirical basis. The practical way out would be that either the private sector seeks approval for cooperative generation committing its own resources without approaching the government or financial institutions or becomes a financing partner with the state electricity boards and provides additional finance for assured and reliable power supply. For the economy, a rupee invested in a captive plant is much more wasted than if it is put into a large power plant. This should reduce the hesitation in expediting power generation programmes in the state sector. If the scarce funds do not go into a relatively efficient power plant, they will be tapped in idle diesel generating sets since there is no other alternative.

Vol. 12, No. 2, April-June 1987