Challenges Facing the Power Sector

1. Challenges Facing the Power Sector “India the Next Decade” Chatham House 27th June 2005 Mike McWilliams Director, Scott Wilson

2. The Key Questions Electricity is one of the key drivers for economic growth and poverty alleviation: • How to supply electricity at a reasonable price to rural India? • How to ensure reliable supplies at competitive rates to Indian Industry? paraphrased from Indian Power Policy document of 12th February 2005

3. The Scale of the Challenges • Rural Electricity Access: target to increase from 50% rural access to 100% in 7 years – bringing electricity to 80,000 - 100,000 villages and 10 million households; • Generation Expansion: at least 100,000 MW of new capacity required within 10 years (X and XI 5-year plans); • Transmission and Distribution Expansion: massive investment required in new inter-regional transmission, and to replace ageing regional and distribution networks; • Loss Reduction: up to 40% of generation lost in transmission or power theft – target should be 10%; • Restructuring of 50 to 60 State Electricity Boards and other agencies into commercially viable businesses.

4. Is the Rural Access Target Achievable? • The target requires grid connection of 10,000 villages per year; • During the 1980s villages were electrified at an average rate of 22,000 per annum; • Although the more remote villages are left, new renewable technology facilitates non-grid electrification; • With concerted effort and appropriate budget allocation the target can be met, although the pace of rural electrification has been slow in recent years.

5. Is 100,000 MW of New Generation Needed? • Existing installed capacity around 130,000 MW: provides 600kWh per capita gross (domestic consumption around 350 kWh per capita) for 1.1 billion population (c.f. UK has 80,000 MW installed providing 6500 kWh for 60 million population); • Target for 1000 kWh gross per capita by 2012 – will require some 70% more installed capacity (= 90,000 MW); • However current GDP Growth of 7% pa; elasticity ratio for electricity demand estimated (by Power Ministry) at 1.5; hence demand growth of 10% expected; • 10% pa increase over 10 years implies increase of 2.5 times over 10 years (=210,000 additional MW); • Requirement for 100,000 MW over 10 years may be conservative.

6. Is 100,000 MW of New Generation Realistic? • From a physical resource perspective – YES: • India has 120,000 MW of untapped hydroelectric resource; • coal and lignite resources are plentiful; • gas and oil supplies are limited; • imports of fuel and electricity are viable. • It is planned to redress the thermal : hydro balance from the existing 25% hydro : 71% thermal (+4% nuclear and wind) to nearer 40% hydro. • Non-conventional renewables and hydro will play a role in environmentally sustainable generation.

7. Network Expansion, Loss Reduction & Restructuring • Inter-regional transmission expansion is the responsibility of the Power Grid Corporation, with focus on 30,000 MW of transfer capacity from the coal-rich East to the power hungry West; • Unbundling of the SEBs is in hand; commercial viability will come from withdrawal of unsustainable subsidies, full metering of supplies and improvements in distribution and revenue collection; • Loss reduction and theft prevention could yield more than $4 billion pa revenue; • Tariff reform is progressing – this is essential since the provision of free or highly subsidised electricity to farmers leads to waste of electricity and water, and financial losses to the SEBs; however this is politically sensitive, especially at State level.

8. Resources for Expansion • Generation expansion will require completion of say 25 powerstations of 500 MW average capacity per annum; • With 4 year construction period, 100 stations must be under construction at any time, and as many again at the planning stage; • currently responsibility for new plant divided between the Central Government agencies and the States; neither has the capacity to manage this level of construction. • The solution must be to involve the private sector.

9. Finance for Generation Expansion • Generation expansion will require some $ 10 – 15 billion pa, with perhaps half as much again for transmission, distribution and rural electrification. • It is unlikely this can all come from public funds: such massive spending would dwarf spending on social development (eg 2005 education budget is $4 billion). • Again the answer must be private investment.

10. What are the Impediments to Private Investment • Attempts to attract private investment since 1992 have been largely unsuccessful: • Main problem is imbalance of the “Risk : Benefit” profile; • Bureaucracy is still a problem; • Security package (in the absence of sovereign guarantee) depends on creditworthiness of the off-taker – usually the SEBs. • Poor liquidity in the local market is a reducing problem, but foreign investment is still required.

11. How to promote private investment? • Restructuring and commercial viability of the SEBs will improve the situation, but cannot happen overnight; • Improving the “Risk : Benefit” profile by increasing financial returns would push up the cost of power, defeating the objective of affordability and competitive rates; • Innovative commercial solutions are required, such as: • Hybrid Public-Private concessions with risk sharing; • Pooled “insurance” fund to back security packages; • Exchange rate protection for foreign investment.

12. Hybrid Public-Private Risk Sharing The objective of the hybrid model is - ..... To create a model for financing and execution of Power Projects (with a particular focus on hydropower). ..... To allocate the project risks to the parties (owner and contractor) best able to carry them ...... By sharing the risks, projects become financable at lower cost.

13. The Hybrid Concept – hydropower example • Client (eg NHPC) defines key project parameters to suit the power system requirements and optimise the use of the site; • Client handles environmental clearances and permits, water rights, land acquisition, resettlement etc; • Client awards a concession to Hybrid Concessionaire (SPV) for a fixed monthly payment over 15 to 20 years; • SPV finances and constructs the scheme; • Client sells energy under locally negotiated agreements to PTC, SEBs or major consumers.

14. Benefit of Hybrid Model to the Client • Client ensures optimum development of the site (a unique resource) to the benefit the power system; • Client operates the project to meet the system needs, including accessing non-energy benefits; • Client does not need to raise finance; • Overall cost less than for BOT model.

15. Benefits of Hybrid Model to SPV • SPV has fewer risks outside its control (market, hydrology, geology, permits etc); • risks carried by SPV are those it can control (timely completion, cost overrun, quality and technical performance); • More secure revenue stream facilitates project finance.

16. Development of the Hybrid Concept • We developed the hybrid model after working for World Bank on a discussion paper – Financing of Private Hydro (WDP420); • The concept has been proposed for power projects in Turkey and Cuba; a number of its components have also been incorporated in a Ugandan PPA; • An analogous model is used on highways in India; • We presented the Hybrid Model to the Indian Ministry of Power in October 2001, at which time it was agreed that it would be tested on a pilot project; discussions have continued since then.

17. “Insurance Pool” to Back PPAs • The creditworthiness of PPA Off-takers – mainly SEBs – is a significant impediment to private investment; • Even after restructuring for commercial viability of the SEBs it will take time for the markets to gain confidence; • We have suggested a Government backed fund to which viable SEBs would have access to back their PPAs and Hybrid Agreements; • Defaulting SEBs would have to replenish the fund before having access for future projects; • The fund would be independently managed to provide confidence to both developers and off-takers.

18. Summary • India has ambitious growth requirements for its power sector; • These targets can be met with the involvement of the private sector and foreign investment; • This will release Government funds and management resources for social development; • Innovative commercial solutions are required to facilitate private investment; • Restructuring of the SEBs for commercial viability and a reduction in bureaucracy are also needed; • Through joint public and private enterprise the power development targets can be achieved.