India has made significant strides in the power sector over the past few years. The country is the fourth 4th largest country in the world in terms of generating capacity, and achieved close to zero energy deficit in FY17. In distribution, the Government’s ambitious UDAY programme has seen widespread adoption with 27 States and UTs signing up for financial restructuring. Similarly, the transmission sector has been energised with significant expansion, a vast improvement from the days of the infamous blackout in 2012.
However, a few challenges still need to be addressed if India is to achieve its ambitious vision for the power sector — 24×7 power for all, 175 GW of renewable capacity, and viable and self-sustaining distribution companies (discoms).
First, the power sector continues to underperform with stagnating returns and limited new investments. Second, there is significant stranded capacity on account of demand not growing as fast as generating capacity, leading to declining plant load factors (PLF) for conventional plants. The situation is likely to become more challenging as ‘must-run’ renewable capacities come online.
The third issue, and the focus of this article, relates to stressed discom financials. Even though discom finances are expected to show improvement, we expect total losses in FY17 (as per UDAY MoUs) to be at around ₹25,000 crore for 27 States/UTs which have signed up for the UDAY scheme. Strained discom financials have a cascading impact on the overall sector: there is continued load shedding due to high aggregate technical and commercial (AT&C) losses and high unmet ‘latent’ demand. So, despite being surplus in power, India’s per capita power consumption of 1,000 kWh per annum lags countries such as Brazil (2500), China (3600) and South Africa (3900) (figure 1).
Today, one of the key issues facing discoms is the significant quantum of capacity tied up in long-term Power Purchase Agreements (PPA) with durations of 12-25 years. Many PPAs are legacy high-priced, long-term contracts that continue to drain the financials of discoms. Such PPAs will continue to hinder UDAY’s objectives.
Smart procurement option
We believe that ‘Smart Procurement’, which involves buying power from short-term sources (bilateral contracts/exchanges) in lieu of generating plants which have higher variable costs, presents a highly viable and attractive option.
Smart procurement follows the principle of pure merit-curve-based scheduling and dispatch of power, within a specific State. Simply put, State discoms should procure power from short-term markets rather than buy power from expensive (high variable cost) plants with whom they already have a long-term PPA.
We estimate that smart procurement could have generated savings of approximately ₹6,600 crore in FY17 (Figure 2). Given the clear financial benefits, we propose three key recommendations for discoms:
Optimal balance between long-term and short-term contracts: Steadily increasing penetration of short-term power markets is a global trend, but India lags here significantly. Intelligent allocation of total energy demand to long-term PPAs and meeting incremental or peaking demand through short-term markets is required. States can meet 80 per cent of their annual energy requirements from long-term contracted capacity, which is equivalent to 60-70 per cent of peak demand. This reduces the payment of fixed capacity charges, improving discom financials. However, the majority of States have tied up more than the requisite capacities in long-term contracts, which has resulted in significant demand risk being passed on to discoms.
Strict adherence to the merit order in terms of variable costs: If discoms across the country replaced a quantum of the expensive power bought from PPAs with power from the exchange, they could have saved approximately ₹3200 crore in FY17, given that the prices on the exchange were lower than the variable costs for multiple PPAs signed by State discoms. The savings would not have come at the cost of generating plants, given that these plants would continue to operate at the ‘technical minimum PLF’ and discoms would continue to pay fixed capacity charges to the generators to cover for their minimum guaranteed return on equity.
Phased de-commissioning of select plants: Inefficient plants should be shut down as new capacities (including renewable ‘must-run’ plants) come online. Given the supply surplus situation, we recommend that the most expensive plants in terms of variable costs be shut down, with the option of re starting select plants once power demand ramps-up.
The government can go about shutting down plants in phases, beginning with the old, most inefficient plants and then focusing on other high-cost plants. Across the 10 States we assessed, 20 old, inefficient plants could be de-commissioned immediately, while 11 other high-cost plants could be de-commissioned over a phased period. Shutting down these 31 plants alone could have saved discoms approximately an additional ₹3,400 crore in FY17.
In sum, India needs to move towards a balanced mix of long-term and short-term contracts.