India’s power sector is a leaking bucket, the holes deliberately crafted and the leaks carefully collected as economic rents by various stake holders that control the system. So goes one of the most telling analogies in the report by the Deepak Parekh Committee on the power sector. The report went on to say “The logical thing to do would be to fix the bucket rather than to persistently emphasize shortages of power and forever make exaggerated estimates of future demands for power. Most initiatives in the power sector (IPPs and mega power projects) are nothing but ways to pour more water into the bucket so that the consistency and quantity of leaks are assured”.
Much water has leaked since then. Many studies and suggestions on the ills of the power sector have done the rounds. But the sad fact is that the bucket continues to leak. It’s time to realize that a leaking bucket can never be an Akshaya Patra. After all, continuously milking an underfed cow can only lead to catastrophic consequences. Unfortunately, prudence and diligence is often sacrificed on the altar of political and populist expediency.
Reform as a panacea
To be fair, it’s not that nothing has been attempted to stem the rot. Power sector reforms has long been seen as a dire need. Reforms kicked off in the mid 1990’s when some State Governments, led by Odisha, enacted legislations to restructure the erstwhile Electricity Boards. The Electricity Regulatory Commission Act 1998, provided for the formation of State Electricity Regulatory Commissions, thus, at least on paper, creating a Chinese wall and distancing the Government from the role of tariff determination. The Electricity Act 2003, was another major act that kindled hope of bringing about the much needed change in the sector. However, the actual progress on the ground has been slow and lackluster. The proof of the pudding, as they say, is after all in the eating.
The power of Power
Consequent to the reforms and the subsequent unbundling of the power sector, the power distribution companies turned into the vital last leg in the power chain, after the generation and transmission companies. Perhaps, more importantly, the DISCOMs became the direct interface with the individual consumers, direct bulk consumers excepted. That power distribution is important for a growing economy like India would be stating the very obvious. Suffice it to say that strong, efficient and service oriented distribution companies are needed to enable economic growth and to support the rapidly improving lifestyle of the people. The consumption pattern is changing with the share of domestic and agricultural sector consumption going up from 8.36% and 11.36% respectively in 1973-74 to 21.79% and 17.95% in 2011-12, while the industrial consumption has dropped from 68.02% to about 44.87% during the same period. The rapidly improving lifestyle is often illustrated by the fact that the per capita consumption of power, which was a low 172 units in 1979-80 grew at an annual rate of 6.7 % to 329 units in 1989-1990 and further increased to 883 units in 2012. This still pales in comparison with the world average of 2890 units. The fact that even other emerging economies like Russia and Brazil have an average consumption of 6460 and 2384 units respectively indicates the potential for far higher consumption patterns in India in the future. Will our utilities be able to measure up to this task given its current financial position is the moot point?
Genesis of the problem
Distribution companies are today faced with a double edged sword being crushed on both fronts: revenue and expenditure. On the revenue side, years of dilly dallying have led to a situation where the tariff has not been revised for several years – as much as 3 to 5 years in many states. It’s only in the last two to three years, with most DISCOMs on a precipice, that the inevitability of periodical tariff revisions got due attention and thankfully it has now started to happen. But, the damage has already been done. Let’s however draw comfort that the stable doors are being now bolted before all the horses have bolted.
On the expenditure side, the galloping cost of power has played havoc with the DISCOMs financials in the absence of a provision for automatic mechanism to pass on the rise in cost of supply to the consumers. The average cost of supply per unit of electricity sold has been progressively growing over the years at about 3.5% per year, from 263 paise per kWh sold in 1998-99, to 355 paise per kWh sold in 2009-10. With the expenditure on power purchase constituting 70% of the total cost of supply, the effect of not passing on such increases for years together can only be imagined.
Non availability of fuel and its rising costs has not only bled many power generation companies, but also put many upcoming projects in a state of limbo as it became financially unviable. The recent instance of APTEL’s (Appellate Tribunal for Electricity) order allowing two generating companies to secure higher price for the power sold from one of their plants on account of the higher fuel cost, could have been the boost required to get most of these projects back on the rails. However, it cannot be denied that the unintended effect would be that the beleaguered DISCOMs would end up paying a still higher rate for its power purchases. An interesting recent related development was the Gujarat Urja Vikas Nigam Ltd’s (GUVNL) demand to seek lowering of the tariffs contracted for some solar plants in the state. Their probable rationale could have been if generating companies can go the regulator to raise the tariff on grounds of rise in input costs, the state utilities can do the same and seek tariff reduction as the cost of building these plants are now much lower than when the tariff was fixed. That’s two sides of the same coin!
However, in both these instances it is all back to square one. The APTEL order on tariff hike has been recently stayed by the Supreme Court with a direction to APTEL to re-hear and expedite the case and APTEL has also upheld the decision of the Gujarat Electricity Regulatory Commission (GERC) to turn down GUVNL’s demand. There is however a positive side to the whole drama. At a time when private investment is most needed in the sector, a contrary decision, particularly in the Gujarat case, would have been the classic case of winning the battle but losing the war as it would have cast doubts on the consistency in policies and the integrity of agreements which is now a major concern among investors. However, the new government at the Centre seems to have realized the need for drastic action and the recent ordinance on coal mine allotments, the proposal for pooling of domestic and imported fuel prices etc may give many stuck power projects a new lease of life. The new minister of power at the Centre seems to have sent the right signals to the market that he means business and wants to get the projects back on the rails, but then there could be many a slip between the cup and the lip. For example, with the Chairman of APTEL due to retire in Nov 14 and a new one yet to be named, it’s safe to assume that the tariff hike issue will continue to hang fire for some more time.
The recent episode of a state regulatory commission approving a tariff hike by re-introducing the power price adjustment cost (PPAC) surcharge on the 13th of Nov 14 only to withdraw it in less than 24 hours is indicative of the malady. That the state in question is poll bound may have been a coincidence but it does raise uncomfortable questions. It may be noted that the PPAC was originally introduced in 2012 to help distribution companies recover some of increase in fuel cost, but was withdrawn later.
Utility Financial Performance
Other contributing factors
Though rising fuel costs and inability to raise revenues was the major reason for the damage to the DISCOM’s financials, there were other contributing factors too. According to the annual report 2011-12 on working of State power utilities, the number of employees in India, per million units of energy sold was about 5 in 1990-91, while it was 0.2 in Chile, Norway and the US. The manpower cost of DISCOMs which kept on rising over the years put further pressure on the financials. Rising inflation, improvement in standards of living and the pay panel recommendations made this a fait accompli. Indeed, given the growth in the other sectors of the economy and rising pay packets elsewhere, DISCOMs had a problem in attracting personnel with key skills who could bring the much needed fresh energies and drive into the lethargic system. So much so, many DISCOMs had to resort to the policy of hiring personnel on contract basis. The fact that the average number of employees in India per thousand consumers had however declined from 0.51 in 2007-08 to an estimated 0.45 in 2009-10 perhaps is a consequence of this shortage rather than a planned reduction in personnel due to higher productivity. Nevertheless, the fact that manpower cost had increased at around 24% between 08-09 and 2011-12 while power cost rose 20.5% during the same period ensured that the manpower costs was also a major contributor in the beating down of the financials.
Coupled with this was the handout of free electricity and subsidized power to certain sections. The annual report on state power estimates that the gross subsidy on domestic and agriculture sectors had increased from a level of Rs 48,024 crore in 2007-08 to around Rs 71,016 crore in 2011-12 . The effort to recover the losses on account of the subsidized power supply to domestic and agriculture consumers led to a scenario of cross subsidization, with industrial and commercial consumers paying a tariff higher than the cost of supply which in turn rendered them less competitive. The industrial and commercial consumers therefore found it more prudent to set up their own captive plants to de-risk and free themselves from the clutches of the utilities. With open access now being available to select high value consumers and the proposed amendment to the Electricity Act that plans to separate wire (distribution infrastructure) from content (power) set to offer retail consumers, the option of choosing their power supplier, the writing on the wall is clear. Over time, it was evident that the revenue earned through such cross subsidization was not keeping up with the level of subsidy giveaways. The scope of robbing Peter to pay Paul is getting negated. In many cases the reimbursement of the subsidy portion due from the Government, never came in, and even when they did, it was far too late causing severe cash flow mismatches and consequently undermining the operational capability of the utilities.
It was but natural that in such a situation the gap between revenue (excluding subsidy) and average cost of supply increased from 76 p in 98-99 to Rs 145 p in 2009-10 according to the annual report 2011-12 on working of State power utilities. The average cost coverage ratio (CCR) of DISCOMs, which measures the % of cost of supply that is recovered through revenues (excluding subsidy) fell from 81.5% in 2008 to 75.7% in just 2 years. A recent statement by the new Power Minister indicates that the accumulated losses of the DISCOMs is nearly Rs 3,00,000 crore with an addition of Rs 60,000 to 70,000 crore every year! Power finance corporation (PFC) report had estimated that 8 states together accounted for 80% of the accumulated loss in the sector and that some of these states had a cost coverage ratio of just around 56%. It is clear that the continuous under recovery type of lifestyle of the DISCOMs had assumed cancerous proportions and would be soon beyond cure unless the rogue cells are immediately targeted and controlled. It is pertinent to note that even the CCR of Gujarat which had the highest CCR in the country was just under 1 – still below the minimum threshold.
Consistent poor collection record has also resulted in the utilities carrying on its shoulders the heavy burden of accumulated baggage of revenue arrears. These arrears have increased from Rs 20,382 crore in 1998-99 to Rs 55,430 crore in 2009-10. Prudent accounting norms would have meant that many of these arrears are written off, but the hole that it would burn in the account books can only be imagined.
The Rajiv Gandhi Grameen Vidyutikaran Yojana which was launched in March 2005 with the objective of electrifying over one lakh un-electrified villages and to provide free electricity connections to 2.34 crore rural households. This program despite its best intentions is in part creating problems for electricity utilities. Contractors entrusted with work under the scheme, regularly charge the new lines without even consulting the DISCOMs and therefore no load management was possible, besides leading to more unbilled consumers. To add to the problem most of these connections are unmetered leading many of the beneficiaries to assume that free electricity is given to them by the Government as a right. Once used to free electricity, it’s quite natural that the beneficiaries will find ingenious ways of ensuring that it continues to be free for them. A laudable scheme indeed, but faulty implementation is indirectly propagating undesirable practices unfortunately.
Compounding the problem further was the fact that DISCOMs had to resort to borrowing from Banks to bridge the yawning gap in its finances. DISCOMs are estimated to have a total debt of Rs 3,04,000 crore. Driven to the wall, some DISCOMs had the ignominy of resorting to the ultimate financial horror strategy of raising fresh borrowings to service interest on the earlier ones. Banks’ exposure to DISCOM’s was estimated to be around Rs 1,90,000 crore in March 2012. The precarious condition of DISCOMs finances meant that the Banks had its own share of concern on further lending to the DISCOMs. With the road to further borrowing narrowing, most DISCOMs were truly on the verge of being cooked in its own broth – a victim of its own doing.
In the absence of a proper rating methodology to assess the performance of State distribution utilities, in July 2012, the Ministry of Power formulated an integrated rating methodology on a range of key metrics. This was also expected to incentivize/ dis-incentivize the utilities according to their performance and also help the Banks and other Financial Institutions to better assess the performance of the utilities and give quicker funding. The first rating results were published in March 2013. As expected the utilities did not come out with flying colours. Out of 39 utilities rated, only 6 companies got A grade or better and 22 got below average rating, leaving the balance 11 with moderate ratings. The study further pointed out that only 21 utilities could submit their audited accounts for FY 2011-12 which is a pointer to the state of affairs in the DISCOMs.
Consequential or Ancillary loss
The pressure on the financials had its impact on the almost every aspect of distribution operation. High levels of maintenance expenditure are required to keep the ageing and heavily loaded distribution infrastructure system up and running. It’s but natural that in such a cash strapped environment, there was not enough resources to go around. Maintenance and loss control activities naturally suffered as the limited resources went more into breakdown restoration activities etc. It was therefore more a case of fire fighting.
The financial crunch of DISCOMs had several other effects. Indian Power Industry is characterized by heavy Aggregated Technical and Commercial losses (AT&C) losses. In some DISCOMs it was as high as 62% to 73%. Even on a combined average basis the AT&C loss is around 27% to 30%, compared to the level of 6% to 8% in developed countries. Though there has been some decline in the average losses in recent times, these losses is almost criminal considering that the country is still power starved.
Apart from electricity theft and pilferage, one of the more important reasons for this high loss was the improper metering of energy consumption due to the defective meters and even absence of meters in many cases. Strapped as they are for finances, most DISCOMs were not in a position to replace the defective meters in adequate numbers, or install meters in case of unmetered consumers. As regulations allowed consumers to be charged on the basis of average of past three months consumption, most of these consumers were happy that they could consume electricity without any impunity, safe in the knowledge that they be charged a fixed bill! Indeed this led to a peculiar situation where consumers vied with each other to have their meters declared “defective” thus enabling them to enjoy almost free power to their heart’s content! Trust some Indian ingenuity to start working in this scenario! Some of these consumers saw a business opportunity and became a mini, albeit, illegal distributor themselves by supplying power to their neighbours. Add some vested interests and we soon had “advisors” offering their services, for an unofficial fee of course, to ensure that meters are declared defective. The rot goes deep indeed.
It is an acknowledged fact that if the DISCOMs could replace the old electro mechanical meters that still adorn most houses with the more accurate digital meters the loss at the metering side could be cut significantly. Though replacement of such meters is being done, the slow progress, mainly on account insufficient meters, which in turn is on account of financial crunch, is resulting in mounting losses day after day. With smart metering technology now available, India could directly skip into the new generation meters.
Having said so much about the difficulty in meeting operational expenses, need we say more about the capability of DISCOMs in making adequate Capex demands to meet the burgeoning demand for power? The already old and weak infrastructure is groaning at the seams. Most transformers are already heavily loaded and long past its efficient life and incapable of taking the further load needed to meet the increased demand. Clearly to expect heavy investment from the DISCOMs in the current scenario would be akin to asking for the moon.
Given the high borrowings and high liabilities of the DISCOMs, it was apparent that a drastic surgery or restructuring was required. The Government’s Financial Restructuring Package (FRP) made an attempt to clean the Balance sheet of the utilities but the plan seems to have fizzled out. Under the FRP for state-owned DISCOMs, States were to take over 50 per cent of the outstanding short-term liabilities as on March 31, 2012 and convert them into bonds which would then be issued to banks backed by state government guarantees. The Centre was to provide, as incentive, 25 per cent capital reimbursement of principal repayment by the state on the liabilities taken over by it. Banks were also required to restructure the remaining 50% of the debt. Though only eight states accepted the scheme, most of them were also not able to meet the requirements under the FRP. The underlying reason for its failure is not far to seek. There was no real business restructuring in the package except for a repacking of the old debt with a new one. The fundamental issues that lead to the financial mess in the first place wasn’t really addressed.
Faced with the non-disbursal/delayed disbursal of subsidy amounts by the government, for power supplied to the agricultural sector, some DISCOMs have been forced to curtail power supply to the sector. Agricultural subsidy has grown to 64% of total subsidy in 2011-12 from 37% in 2007-08 and subsidies of around Rs 48,500 cr remain unrecovered. Thus the move of granting subsidized power which was supposed to aid the sector ended up hurting it more. It is a no brainer that unequal cash flows cannot continue forever and that economics will eventually come to play. With agriculture sector in India consuming more than 22 % of the power sold and contributing only 8% to the revenue, and subsidy not flowing in time, it was a disaster waiting to happen.
The International Energy Agency estimates India will add between 600 GW to 1200 GW of additional new power generation capacity before 2050. This added new capacity is equivalent to the 740 GW of total power generation capacity of European Union in 2005. Investment required for electrification in India is estimated to be around $ 6.4 billion. It remains to be seen how a cash strapped sector, with poor access to bank funding can meet this minimum requirements given the current state of power generation projects in the country.
It’s should be clear from the foregoing that the Deepak Parekh’s ‘leaking bucket’ analogy may in fact be a mild understatement. It’s not just a bucket that’s leaking, it’s actually a leaking dam. A tiny leak in a dam, if unplugged promptly, soon grows into a gigantic one. And if fresh such leaks continue to erupt, the end cannot be too far off. Inadequate or piece meal responses can only have catastrophic consequences. As the popular fictional story goes, the little Dutch boy may have saved Holland by plugging the leak in the dike with his finger. But try to plug a huge leaking dam with your fingers, you will soon run out of fingers!
The light at the end of the tunnel
However there is a silver lining in the darkness. Much is expected out of the Integrated Power Development Scheme (IPDS) scheme announced in the recent Union Budget which aims to strengthen the transmission and last mile connectivity and metering of power entailing an investment of Rs 32,600 crore. Besides the IPDS, some regional programmes for strengthening of the intra-state transmission and distribution system, have been approved or are in the process which could boost the much needed investment in much needed areas. One such programme, which was approved recently was in Arunachal Pradesh and Sikkim at a cost of Rs 4,754 crore.
A ICRA study of October 14 estimates that the aggregate capital expenditure for strengthening the distribution infrastructure approved by the SERC’s is estimated to be around Rs 44,000 crore in FY 2015 which represents an increase of around 8% over the previous year.
Encouraged by Gujarat’s success in supplying electricity through separate feeders for agricultural and rural domestic consumption feeder separation, the new Government plans to spend Rs 75,600 crore for a similar programme on a much wider scale nationally aimed at providing eight hours of quality power supply to agricultural consumers and 24 hour electricity to households. While this outlay includes expenditure towards the IPDS initiative, Rs 43,000 crore has been earmarked for the Deendayal Upadhyaya Gram Jyoti Yojana for feeder separation, The scheme when completed is expected to bill more users and reduce the technical and commercial losses due to theft. These investments and the benefits from the ongoing R-APDARP projects in various utilities will no doubt help in reducing AT&C losses significantly in the future.
While the average AT&C loss is estimated to be around 27%, it is still significantly high in many states. While populism has so far helped in preventing an increase in power tariffs, the ICRA study shows that there is another way to achieve the same objective minus the hit to the DISCOMs bottom line. For a utility with a loss level of say 25%, the ICRA study estimates that a 1% loss reduction leads to a cost saving of 11-13 paise per unit which results in a relief of 2.2% on the retail tariff assuming that the cost of power remains the same. ICRS estimates also indicates that a 1% reduction in all India AT&C loss could cut cash losses by as much as Rs 3900 crore. Thus reduction in AT&C loss levels needs to be looked at as the real alternative that can soothe both DISCOMs and consumers alike.
A recent report states that the Government is considering capping prices power generated from auctioned coal blocks so as to prevent DISCOMs from having to increase tariffs. But the generating companies are seeing the move of capping prices, while simultaneously requiring them to pay for coal blocks, and for royalty and also to absorb the developing and productions costs as absurd and unviable. Those for capping price say such ceiling would promote efficient utilization of coal while discouraging companies from bidding arbitrarily for blocks auctioned. Clearly managing the conflicting requirements will be a challenge but it’s gratifying to note that attempts are being made to remedy the situation.
The proposed changes in the Electricity act, if approved, could play a big part in making a sea change in the current scenario. It envisages breaking up the current distribution licensees further into a system business (distribution) and supply business (supply license). The distribution licensee will then be responsible to operate and maintain the distribution system to enable supply, and the supply licensee will supply the electricity through the network provided. The proposed segregation is said to be prelude in allowing multiple licensees to operate in a single area finally leading to a system of open access where retail consumers have the freedom to choose their supply licensee. This is expected to bring about competition in the sector which will eventually force the utilities to improve their services. You only have to look at how competition drove the banking, insurance, and the telecom sectors to improve their service levels to understand what competitive stimulus could do. But the path will certainly not be easy and it will take some rough riding and may have unpleasant side effects, before things pan out right. But most of all it will call for sea change in the outlook and attitude backed with a strong willingness to bite the bullet.
It is hoped the earnestness that the new Government is displaying and the growing realization that there can no more be any free lunches in the distribution sector will spur the changes in the sector. The experience of the past have clearly proved that half-baked measures without a comprehensive plan can get us nowhere and will only draw the sector deeper into the mire. That India needs a very strong power sector needs no elucidation; nor is the fact that it needs fertile ground and space to grow, backed by strong enabling measures that nurture wholesome growth. After all, you cannot grow an oak tree in a thimble.
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