With the state electricity boards’ financials beginning to improve, do you think independent power producers (IPPs) will come back?

Sanjeev Aggarwal
The SEBs are finally realizing the importance of improving their efficiency and setting their house in order. We are seeing a renewed focus in various state utilities on reducing technical and commercial losses. It is impossible for the utilities to ignore the threat of open access and competition. The utilities are now equally aware of the need to reduce power purchase costs, which typically range from 70 per cent to 80 per cent of their total expenses. Considering the lack of internal finances within the utilities and the state governments, there is no reason why they would not like to encourage IPPs, provided the price is right.

There is some movement from the developers’ side as well. They are recognizing that to have a sustainable long-term project they would need to have prices that can be passed on to the consumers. IPPs also need to realize that distribution licensees are regulated entities that work under certain socio-political compulsions and, irrespective of the improvement these utilities make, they are unlikely to be in a position to buy power at unsustainable prices.

In the recent past, some of the utilities have been able to bring down IPP tariffs with a sop of regular payments. So, with the improvement in the utilities’ financials, the developers are also willing to reduce tariffs. With the inclination from both sides, we expect that IPPs would be able to make a comeback.

P.N. Bhandari
IPPs cannot be revived by just pushing projects more vigorously and monitoring them more closely. Unless the root problems are effectively tackled, mere cosmetic changes in policies cannot revive the projects. IPPs withdrew after realizing that the SEBs were financially weak, their escrow capacity very limited, and that financial closure of projects was doubtful as the lenders were skeptical about the paying capacity of the SEBs.

In the recent past, things have been improving. The Electricity Act, 2003 has ushered in liberalization in many crucial areas. Generation, except hydel, has been delicensed. Tariff fixation is to be undertaken by the regulatory commissions. In a nutshell, we are moving in the right direction.

But the question is, is this sufficient for the private sector to make heavy investments in generation? I may sound like a prophet of gloom, but we have miles to go before the SEBs can inspire confidence about their financial viability. The SEBs will continue to be politically exploited and, unless they are privatized, there is very little hope of their working on commercial lines. Distribution privatization is moving at a snail’s pace.

Hence, in spite of the “feel good” factor in the power sector, the SEBs are unlikely to attract substantial investment in generation. For a breakthrough, we have to completely change our strategy. I am glad that the suggestion given by me in my article titled “Privatization in Generation”, in the July 2003 issue of Power Line, has been picked up by the Government of India. I had canvassed that the SEBs should be bypassed and central utilities like the National Thermal Power Corporation (NTPC) should directly enter into power purchase agreements (PPAs). Financial closure would be no problem, as NTPC is very strong technically as well as financially. Since there would be no earmarked state quota for this power, NTPC would not be under compulsion to supply power, payment or no payment, to any utility.

These central utilities can also invite tariff-based international competitive bids, whereby they can enter into PPAs with parties offering the lower tariff. Projects lying in cold storage could be revived by the generators themselves, by bidding under such a revised process.

The union government is also reportedly toying with the idea of having such plants on a build-own-operate-transfer basis. This would be a big folly. When the government is wedded to divestment in a big way, taking back private projects under its umbrella would be putting the clock back. One of the major reasons for moving towards privatization is lack of public funds. If we are comfortable with government-run plants, why private at all? When we are moving towards privatization in a big way, bringing such projects under government control after 20 years would be anachronistic.

K.V.Ramesh
The one-time settlement of SEB dues, though likely to help bottom lines, does not by itself solve the problem of availability of revenues. The reform process being pursued by the SEBs is outside the lenders’ control and in no manner seeks to assure availability of money for payment of invoices from the IPPs. In fact, this accentuates the financial problems for a period of time as it leads to creation of new entities that have financial liabilities of the SEBs and no comparable source of revenue to address the problem. IPPs have been demanding direct sales to power trading companies, heavy usage customers and more than one SEB. This has finally been provided for under the Electricity Act, 2003. The concept of power trading was introduced in the mega power projects policy to provide a mechanism for direct sale by the concerned IPP implementing the mega power project to a party other than the SEB.

Mohit Saraf
Marginal improvements in the financial position of the SEBs would not be enough to attract IPPs. For this, the SEBs will have to prove that they are capable of honouring their contractual commitments. This would require deep systems changes, for instance, reduction in transmission and distribution losses, universal metering, and tariff rationalization. Unless the SEBs start operating as prudent profit-making organizations, it is unlikely that IPPs will flock to them for business. In the short run, investment in generation can be expected on account of the newly established liberalized regime. Generating companies would welcome not having to bear the utility risk. Now there is no licence requirement for setting up a generating company. In addition, generating companies are free to sell power to any licensee without payment of a cross-subsidy surcharge. This would inevitably mark a shift from a single-to a multiple-buyer business model. However, till new transmission networks are added or the existing ones modernized, open access would remain a distant dream.

S. Thangarathnam
SEB finances are no doubt improving in most states. There is a noticeable shift in the tariff policy, from one based on socio-economic considerations to that of a critically analysed cost-plus return-based tariff. However, the subsidies extended over a period of time to various consumer categories cannot be eliminated overnight and has to be done in a phased overnight and has to be done in a phased manner. The state governments are also not in a position to make good the subsidy fully to the SEBs. It is also visualized that on account of the various efficiency measures initiated by the commissions, such as reduction in line losses, increased collections and reduced outages, the cost would obviously reduce over a period of time.

In addition, the incentives offered by the government and the availability of gas will reduce the cost of generation, which will ultimately reduce the cost of supply to the SEBs. In light of this, the SEBs’ financials are bound to improve over time and IPPs make a comeback.

Are the recent government efforts, including relaxation of FI norms, adequate to encourage the IPP Cause?

Sanjeev Aggarwal
The government has come out with sops in various direct and indirect taxes. While there is no end to the concessions that the government could possibly provide, one would expect that the developers make optimum utilization of these concessions and be willing to pass on the entire benefit to the consumers.

It is encouraging to note that banks are willing to look at projects in a new light away from the traditional watertight contractual structure in place, in any economy it is hard to sustain projects that are not built on sound fundamentals. Banks need to put proper checks and balances in place to ensure that the fundamentals are correct and the project is not appraised on the bases of government guarantees. The better projects should get better rates. With tariffs going down and banks looking at IPPs in a new light, IPPs can definitely expect brighter days ahead.

One issue that the government should address is regulatory uncertainty for such projects Given the long-terms nature of these contracts, it would be desirable for the regulators to bring about certainty in their tariff philosophy. This single step would provide enduring confidence to investors and lenders alike.

P.N. Bhandari
Relaxation in FI norms will have a marginal effect, if at all. The basic issue is of lenders’ trust and confidence. Norms are only an enabling mechanism. If the lenders are not convinced about financial viability, they would avoid decisions to escape the charge of bad loans.

K.V.Ramesh
The government recently decided to permit 100 per cent foreign equity for automatic approval for companies undertaking power projects, provided the foreign equity does not exceed Rs.15 billion in the categories of hydroelectric plants, coal/lignite-based thermal plants and gas-based thermal plants. Further liberalization in parameters for automatic approval in foreign collaboration in power projects would result in quick decisions for promoting more investment in this core sector.

Further, FIs and banks would no more insist on government guarantees or escrow cover for funding private power projects. The exiting of government guarantees and escrow requirement is in itself a landmark decision.

With the Ministry of Power providing a major thrust to the Accelerated Power Development and Reform Programme and Reform Programme and to rural electrification, and the 50,000 MW Hydroelectric Initiative, the entire sector is set for reform.

Mohit Saraf
The FIs have recently agreed to waive the requirement of government guarantees or escrow cover for project funding. Funding would henceforth be granted if the project has strong fundamentals and credible promoters. This move should enable IPPs to achieve financial closure. Obviously, strong fundamentals would imply that only projects that can establish that they will generate at least cost would be considered for funding. Similarly, promoters’ credibility should be interpreted only as meaning their creditworthiness. The FIs should not use the reference to promoters’ credibility as an avenue to demand promoters’ guarantee in lieu of state guarantees, which they have agreed to waive. If limited recourse funding is not provided, only select IPPs will be able to take off and investments in IPPs would continue to stagnate.

S. Thangarathnam
It will take some time to assess the impact of the recent efforts of the government. These incentives will certainly spur investment in the sector, particularly for IPPs. Coupled with the above, an improvement in SEB finances will ensure payment of IPP bills in time, which, in turn, will mitigate the risk factor.

The government is expediting 18 private power projects totaling 8,000 MW to achieve financial closure by March 2004. Does the target seem feasible?

Sanjeev Aggarwal
While the government is doing what it can be bringing all those concerned to one table, it is now for the developers to put the fundamentals right. One aspect that should not be overlooked is the regulatory angle. The regulators would need to go through the entire process for tariff approval and power purchase. Therefore, the time-frame should account for the regulatory process. Further, the lenders would require a complete contractual structure in place before they can really put their money on the block. Therefore, the developers need to hasten tying up all their contracts, including the PPA, fuel supply agreement, and EPC contract, and should approach the regulators at the earliest for any approvals required.

P.N. Bhandari
As mentioned earlier, generation projects have not progressed because of certain basic conceptual flaws. If the SEBs are not financially strong, the projects will always be in trouble, even after commissioning. If the SEBs default, it would trigger lengthy litigation. In many cases, the SEBs have deliberately defaulted, forcing closure of plants because they realised that the power was too costly. Therefore, caution and not speed is important in such large investments. Let us not repeat our past mistakes. Once the basic flaws are cleared, not merely 18 but many more projects would move very fast.

K.V.Ramesh
The decision of the FIs to enable financial closure of 18 IPPs by March-end is indeed a welcome move. A back-of-the-book calculation shows that funds amounting to Rs.350 billion could be pumped into the economy over the next three to four years. Of the 8,000 MW, projects worth 5,000 MW would be able to achieve financial closure by February-end. Around 2,500 MW of projects being catalyzed by the Power Trading Corporation are also part of the projects identified for financial closure by March-end.

Mohit Saraf
An ambitious target is a good beginning and will hopefully galvanise the official machinery into action and expedite financial closures. It seems unlikely, however, that the government will actually achieve the projected target within the aggressive deadline it has set for itself. We certainly see a distinct possibility hat increasing numbers of merchant power plants will achieve financial closure based on good fundamentals and the possibility of selling power to distribution/trading licensees without payment of surcharge.

S. Thangarathnam
The incentives introduced by the government will definitely expedite the flow of investment and targeted financial closure of power projects. Some of the tangible and noteworthy incentives are:

• Lower customs duty of 10 per cent for power projects as against 25 percent.

• Income tax holiday for 15 years.

• Assured purchase and payment for electricity generated by IPPs for sale to SEBs and other distribution licensees by central undertakings.

The above measures will certainly reduce the project cost and the cost of power. In addition, the revival of the economy, availability of money in the market, land on interest regime are expected to help achieve the targeted 8,000 MW financial closure by March 2004.