Privatization Of The Indian Power Sector Economics Essay

The power sector in India has witnessed tremendous improvements the last 4-5 years, the path forward however isn’t smooth. There are many challenges to overcome mainly due to the implementation problems faced in our country and the gap that exists between what is actually planned what is implemented. This term paper highlights some of these gaps and attempts to analyze the problem. We analyze the risks prevalent in the industry, and the steps required to overcome these. The government contribution and control over this sector has been immense and needs to be studied in great detail. We have then taken the case of the Orissa State Electricity Board and draw conclusions on how it was implemented and also identify the key lessons that would benefit in the future implementations of a power sector privatization.

CURRENT SCENARIO IN INDIA

The power sector on the whole can be divided into three parts Generation, Transmission and Distribution. India has the fifth largest generation capacity in the world with an installed capacity of 152 GW as on 30 September 2009 [1] , which is less than 5% of the global power generation. The installed capacity of India as of July 2008 was 167278.36 MW. The power generation in India is basically fuel based of which thermal power generation dominates. The graph below shows the various means used to generate power and also that thermal power for which coal is a prime input.

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Though the emphasis has always been there on the power sector through government spending and the five year plans, the implementation of power projects have always been a concern. The planned targets have hardly been achieved. The Indian government has allocated huge budgets and set ambitious goals to achieve in the 11th plan, which if successful could lead to a huge expansion in the power generation. However, over the years we have always seen a mismatch between the planned targets and the achievements. This trend can be observed from the graph below –

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Already the targets for the first few years of the 11th five year plans have not been achieved. Some of the reasons can also be attributed to the shortage of fuel for generation of power. Even in the transmission and distribution sector there has been investments planned to handle the additional capacity.

DOMINANCE OF STATE AND CENTRAL UTILITIES

There was a general belief that the power sector had to be vertically integrated with the generation, transmission and distribution being controlled by a monopoly player. Since, power was vital for the economic growth, it had to be in the hands of the government. So in India also, the entire power sector was controlled by the government through the State Electricity Boards and Central Agencies. The power sector had a very low share of private players operating. The graph below shows the distribution of the installed capacities –

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In the generation space, out of the overall capacity of 152 GW, the share of central and state utilities stands at 49.8 GW and 76.6 GW, respectively; and that of private sector stands at 25.8 GW. Even, of the 78.7 GW planned capacity additions during the 11th five-year-plan, central and state utilities together are estimated to add nearly 63.7 GW [5] . Similarly, transmission and distribution is also dominated by Power Grid Corporation and State Electricity Boards.

The conditions prevalent earlier and presence of high regulations, this sector was not favorable for the private players to enter into this sector. There were entry barriers, extensive licensing rules set up by the government which prevented private players in participating in the industry. Also, the cost of setting up a generation plant or a distribution network was quite high.

Also, due to the vital nature of power, Government had to cross subsidize the power between different consumer classes. This made the market inefficient and hence, a deterrent to the private players. However, during the recent times, there has been a trend reversal and the private players have made an entry into this sector. We have seen huge corporate houses like the ADAG Group, Birla Group foraying into this industry in India. We have also seen a few success stories with the private players in this setup. One such case will be discussed later in the paper.

KEY CHALLENGES AND DRIVERS FOR SUCCESS

The industry as a whole faces some challenges which need to be addressed before we see great improvements in this sector. The below table summarizes the challenges faced and some of the measures that could be adopted to overcome the challenges.

The issues that could creep up are given in the resulting issues column along with the key drivers for success.

How privatization would solve the problem of increasing generation capacity would be discussed in the next couple of sections. Fuel availability is a grave concern with the industry dependent on gas and coal. Some of the players already have bought coal mines outside India, but the demand-supply gap still exists. There have been some problems in this regards as well. The main international market for coal supply to India – Indonesia might change its regulations towards foreign countries. The planned targets from captive coal mines in India have also not been achieved. The only other option in this regard is to look at other forms of energy such as the nuclear energy. This however, has a long way to go before it becomes the main supplier of power in India. The plant equipment shortage also exists as the government projects are usually with the already burdened public sector units like BHEL which is struggling to complete projects on time. This has impacted in the capacity building plans of Government another reason why the government should move towards privatization. Setting up large generation, distribution units require land which is difficult to acquire due to bureaucracy and other government regulations.

With regards to manpower shortage, there is a general notion that talent shortage in the power and infrastructure sector is a long term problem and is likely to continue to push up project costs and risks. The flow of has been gradually reducing up as candidates have sought an alternative and more lucrative career options. The Government, which sponsors a majority of the capital projects has not done enough to address this issue. Training the graduates is the most viable option even though this could push up the project costs to a certain extent.

DRIVE TOWARDS PRIVATIZATION

From the above discussion, we can clearly observe the need to try out something different to benefit the power sector and the option available in the sight is privatization. Some of the evident advantages of privatization are –

Implementation issues of power projects could be solved

Technological advancement through increased R&D spend to gain competitive advantage

Increased investment – Foreign investments

Improves revenue realization making the service more efficient

More players to cover up for the deficit

It is usually assumed that private players would execute the projects with greater efficiency and hence, the implementation issues could be resolved. There would be greater investments in this sector to derive the best and gain a competitive edge while making the business viable. Hence, the technology used currently could undergo a revamp and make great advancement through greater spend in research and development. The foreign player who are currently keen on investment in India’s growth story could bring in better technology, investment and the expertise to carry out large power projects. This would also bring in greater efficiency and as a result of privatization we could see greater number of player competing. The power deficit currently faced by the country could be addressed due to the existence of large number of players and also there could be a gain for the consumers through price wars and existence of a competitive market.

PAVING THE WAY FOR PRIVATIZATION

The government has also realized that there is a scope for improvisation and sees the advantages of privatization. Since, this is a heavily regulated sector Government regulations play a huge role in driving the privatization. It has now undertaken some actions that could pave the way ahead for the privatization of the sector and encourage greater investments from the private sector. Some others like the Land Acquisition Bill are yet to be passed but currently facing some political resistance. The reforms taken by the government are –

Electricity Act, 2003 is an historic legislation, which not only integrates the previous three Acts, but goes beyond in trying to create a competitive environment.

Consumer is the central point of this legislation and the main features are:

Promoting competition for benefit of the consumers.

Effective mechanism for redressal of consumers’ grievances

Regulatory oversight for transparency

Measures to control theft of power

Special measures for power in rural areas

Facilitates Investment by creating competitive Environment

Entry Barriers removed/reduced

Generation de-licensed

Freedom to captive generation including group captive.

Recognizing trading as an independent activity.

Open access in transmission already in place.

Open access to consumers above 1 MW within five years commencing from 27th January, 2004 (date of enforcement of amendment of Electricity Act).

Multiple licenses in distribution.

Regulatory Commissions – to develop market; fix tariff

The key reforms that were a turning point towards privatization were

Removed the need for license

Competition through international competitive bidding

Unbundling – Transmission viewed as a separate activity

The other policies and key reforms undertaken were

Unbundling of SEBs

Tax Benefits

National Tariff Policy of 2006

Allocation of captive coal blocks to private companies

Accelerated Power Development and Reform Program (APDRP) for distribution, permission for trading of power, etc.

The Ministry of Power had signed an MOU with the International Energy Agency in April, 1998 for cooperation in the power sector [6] . With some of these steps undertaken, the government has paved way for privatization and the power sector is set to grow at a rapid pace. We have seen success in the case of Orissa State Electricity to an extent as well as the Delhi Distribution Privatization.

ORISSA STATE ELECTRICITY BOARD PRIVATIZATION

INTRODUCTION

Orissa is the 9th largest state in India, and is the eleventh largest by population. The coast line and the natural reources of Orissa form its greatest strengths. At the same time, Orissa’s contribution to the GDP of India has been less than 2 percent. Infact, the rate of development in Orissa has been very less with GDP growth touching a maximum of 7%(YoY) in the early 1990s.

As a result, the state’s overall growth was crippled and being majorly an agricultural economy, it faced a major challenge in terms of development. The state remained poverty stricken and the government was looking at opportunities through which development could be achieved, to lift the state from its present problems.

NEW ECONOMIC REFORMS

In the year 1992, the government of India, opened up its markets for international trade and investment. State governments and government owned enterprises were encouraged to seek the support in terms of finances and technology to improve the sick state of their enterprises.

It was around this stage that several sectors saw a flurry of investments in various sectors. Governments became more open to the idea of sharing their monopoly, especially in sectors which their expertise was limited.

The government of Orissa during that period considered power reforms as one of the primary means of getting out of this trap. By inviting expertise into their power sector, they looked to this opportunity as a means of providing quality service and at the same time encourage development.

THE POWER SECTOR IN ORISSA

The power sector in Orissa was managed entirely government at all three stages, viz. production, distribution and the transmission. The Orissa State Electricity Board managed the entirety of the above operations. An absence of cost plus tariff led to low revenue and higher loan capital. OSEB’s tariff level was low and industrial sector’s share in total consumption declined from 69% in 1960/61 to 31% in 1996/97. There was high T&D loss in the form of technical and commercial losses (unauthorised connection, faulty meters and misclassification of consumers).

The power sector in Orissa suffered from

high transmission and distribution losses,

inadequate accountability for various segments (generation, transmission, and distribution),

poor financial performance, poor quality of service and manpower related issues

There was a pressing need to solve the financial problems of Orissa State Electricity Board (OSEB) as well. There was also a pressing need to meet the projected demand of funds for investment in generation, transmission and distribution system. The National Economic Policy announced in 1991 envisaged liberalisation and private participation in infrastructure development, and this looked like the life line for the government itself.

Beginning of Power Reforms in Orissa

The first comprehensive restructuring and reform exercise was carried out by Orissa State Electricity Board (OSEB) in India and was the pioneer in South East for the same. Several leading management consultants and multilateral agencies like World Bank, Department of International Development (DFID) – Government of UK, Asian Development Bank. The experience of Orissa would in future prove to be useful for the formulation of reforms in other states aspiring to do the same.

Restructuring the Power Sector

The World Bank agreement for Power Sector restructuring in Orissa consisted of

â€¢ Unbundling and corporatization of OSEB

â€¢ Privatization of generation, Grid Corporation, and distribution

â€¢ Creating Competition for new generation capacity

â€¢ Establishing a Separate regulatory body

â€¢ Tariff Reform

At the core of the reform process was to envisage more autonomy for the host utility and involvement of the private sector in power sector development. The role of the government would thereby be more passive and there was a need for the Orissa government to shift from its earlier active role.

Reform Process

The reform process that was started in Orissa was carried out in a phased manner. The initial stage was setting up of the regulation commission namely the Orissa Electricity Regulatory Commission. It was decided that the setting up of this board would be of utmost importance and thus the roles were defined.

The role of OERC was to:

Take measures to ensure that an efficient electricity industry is set up in the State

Issue licenses for transmission and distribution and set tariff

Safeguard the interests of consumers

Ensure that monopolization was removed from the system

Reforming of electricity tariff at the bulk power, transmission, and retail levels

Reform Phase I

The first phase of the reforms was to be started with the unbundling and corporatization process of the various departments in the erstwhile OSEB.

Unbundling and Corporatization

Three Government-owned corporate utilities were formed with agreement ensuring full autonomy with effect from 1st April 1996. Their roles and responsibilities were well defines with their independent boards. These were:

Orissa Hydro Power Corporation (OHPC) – responsible for hydro power generation

Grid Corporation of Orissa (GRIDCO) – responsible for transmission and distribution functions

Orissa Power Generation Company (OPGC)- Responsible for thermal power generation

OPGC Divestment

In the year 1998, 49% of the shares of OPGC were divested by the Orissa Government in favour of a mechanism to include international partners through strategic bidding. The AES bid, at Rs 6.03 billion ($ 144.5 million), was the highest among bids from firms including the UK’s PowerGen Plc, local firm BSES, and Tata, Reliance and Hindalco group companies.

By a detailed shareholders agreement, 41% of the share were transferred by the Government of Orissa to the AES corporation and another 8% were allotted to them in the name of their subsidiary in Mauritius.

Reform Phase II

In the second phase of the reform process, it was decided that the privatisation of the distribution activiites would be carried out by the company

Privatisation of Distribution Expenses

The processes were carried out in the following steps by the government of Orissa

Govt. of Orissa transferred the distribution assets and properties along with personnel of GRIDCO to four distribution companies CESCO, NESCO, WESCO and SOUTHCO

Through a process of international competitive bidding, GRIDCO disinvested 51% share to Private Sector Investors keeping a share holding 39% with it and 10% share for Employees Welfare Trust.

GRIDCO purchases power from independent generation utilities e.g. NTPC, OHPC, OPGC, IPPs, CPPs and provides it to four privatised distribution companies who in turn cater to the need of customers.

The new shareholding pattern of the various parts of the new structure is detailed below.

S No

Entity

Government (%)

Private (%)

GRIDCO

100

WESCO

51(Bombay Suburban Electricity Supply Company

)

NESCO

51(BSES)

SOUTHCO

51(BSES)

CESCO

51(AES Transpower)

OPGC

49(AES Transpower)

Impact of Reforms

There have been positive and negative aspects of the reforms that have taken place in Orissa.

Following the power sector reform, the net cash flow for Government of Orissa has improved significantly

The total electrified area in the state has increased by 13% over the last decade.

Orissa has been consistently registering a YoY increase in GDP of an average of 12% over the last 6 years

However at the same time, there have been a few questions of the entire divestment process that has been carried out by the state of Orissa. Few statistics show the real and true state of affairs in Orissa.

The T&D losses that were assumed to be 39.5%, were actually greater than 50%. OERC based their Tariff Order considering 35% T&D losses, leading to an additional T&D loss of 15% being absorbed by GRIDCO as losses.

Private distribution companies are unable to pay GRIDCO and hence have caused shadow on the overall reform exercise.

Non metered supply to most agriculture consumers made it impossible to estimate the true extent of the T&D losses

Even though 100% Collection Efficiency was assumed by FY98, the actual collection was 83% in FY99

Political Context

However, despite all the reasons given by the government to go for a divestment, there have been questions on the actual motives of the same.

The restructuring activity carried out by Orissa government on the compulsive directions from the World Bank, which at that time indicated that it would fund projects only where restructuring was carried out as a prerequisite.

The then chief minister of Orissa, Biju Patnaik clearly saw the impending bankruptcy looming in the power sector. He found the World Banks’ proposals as the only way out.

Thus we can see that political gains were also on the top of the governments at that time and thus there were several vested interests as well.

CONCLUSIONS

The state of Orissa was the first to proceed with a reform programme in response to the World Bank’s offer. While its estimated percentage of T & D losses was high and collection of bills was low, the state had the advantage of a relatively small agricultural load and hence it needed a lower agricultural subsidy.

To make distribution more attractive 75% of the shared financial liabilities were transferred to the publicly held transmission sector. Generation was made more attractive by increasing the price charged to GRIDCO, which however was not allowed to pass on the price increase to the distribution companies. Thus GRIDCO built up enormous liabilities that undermined its long term viability.

Revenues from privatisation were not ploughed back into the sector but absorbed into the government budget for other purposes.

Subsequently substantial tariff increases were imposed on the public but with few improvements in service, leading to growing public discontent.

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