The power sector is witnessing significant changes, with record capacity additions taking place in the renewable energy sector, renewable tariffs declining sharply and power shortages coming down significantly. Disruptive changes are also taking place in the areas of energy storage, electric vehicles and rooftop solar. Power Line presents the views of leading industry consultants on the current state of the sector and its future outlook…
What have been the most noteworthy achievements of the power sector in the past one year?
The past year has seen advances in terms of reduced costs of renewables. While such a sharp decline in tariffs may be difficult to sustain, the reduced costs and large-scale deployment of renewables can make India an important market, thereby creating a virtuous cycle.
The approval of a new coal allocation policy for the power sector, SHAKTI or the Scheme for Harnessing and Allocating Koyla Transparently in India, is one of the most noteworthy achievements in the power sector in the recent past. This would enable the signing of fuel supply agreements (FSAs) with existing holders of letters of assurance from Coal India Limited (CIL) and the introduction of a transparent bidding-based mechanism to allocate fresh coal linkages. The implementation of the new coal linkage policy is a positive development for domestic thermal power generators with a combined capacity of around 28 GW in the private independent power producer (IPP) segment. Hitherto, these were adversely affected by the lack of FSAs. This includes both units with power purchase agreements (PPAs) and those without them.
Secondly, the progress in the implementation of the Ujwal Discom Assurance Yojana (UDAY) with the participation of 26 states and one union territory, and the refinancing of the majority of the debt on the discoms’ books as agreed to in the UDAY MoUs is a major achievement for the sector. This will enable the discoms to improve their liquidity profile and reduce the gap between the cost of supply and revenue realisation. However, the sustainability of this improvement is dependent on the ability of the discoms to improve their operational efficiency and align tariffs with the cost of supply.
There have been a few achievements, of which the Rewa Solar Park stands out for setting new benchmarks in scale and innovation, and also for managing a complex transaction process. It has reset the risk perception by offering investors protection against the common problems of offtake, curtailment and delayed payments. These renewable parks are important to us because they can reduce infrastructure costs and enhance value through storage or hybrid technologies. The next generation of challenges, viz. the conditions of must-run and variability, too are better managed with large projects. Currently, 40 per cent of the renewable capacity addition comes from parks, and there is potential for a lot more. The success of the Rewa Solar Park has given the government the confidence to double the target for solar parks from 20 GW to 40 GW and has cited it as a model for other states.
One of the noteworthy achievements during the year has been the significant decline in the price of renewable energy to Rs 2.44 per kWh (solar) and to Rs 3.46 per kWh (wind) through successful auctions. Auctions have been initiated in the wind space, leading to a much-delayed demise of the feed-in tariff regime. Besides, the bidding process for renewable energy is getting tightened through proposed equipment quality parameters and new bidding frameworks. Other important developments are the allocation of coal linkages under the SHAKTI scheme, steady growth in coal production, and implementation of UDAY in a large number of states. In addition, demand-supply statistics demonstrate that India has become power surplus, there is a renewed focus on electrification and greater transparency in the power sector through digital initiatives such as Vidyut PRAVAH (Electricity Price Availability and Highlights) and DEEP (Discovery of Efficient Electricity Price).
Quite a few significant developments have taken place in the power sector in the past one year such as the adoption of UDAY by a large number of states, investors’ continued interest in renewable energy and the sustained reduction in the cost of renewable energy. On the power market side, a small but important beginning of the ancillary market is significant. While it remains to be seen if UDAY can really bring about a transformation in the utilities, it is certain that it has been a lifesaver for the banks. As a result of consistent generation capacity addition, the “reported” power shortages have come down substantially. However, it must be realised that these shortages or the system “surplus” are only at the wholesale level and that we still have significant planned as well as unplanned supply disruptions at the consumer level. This is in addition to the fact that there are still millions of people who are not covered by the power grid. So, despite some good achievements, there is still huge unfinished business.
What are the top three disruptive trends that are likely to transform the power sector over the next few years?
The top three disruptive trends in the power sector are the emergence of rooftop solar, energy storage and electric vehicles. These technologies will come together and provide enormous control to customers, thereby shifting the energy market away from producers and traditional suppliers. The entire grid network architecture and operations will also go through a transformation.
Firstly, the policy focus and improved cost competitiveness of renewable energy have led to significant capacity addition in this segment over the last two fiscal years. In turn, this has led to an increase in the share of renewable energy generation in the overall generation, from 5.6 per cent in 2015-16 to 6.6 per cent in 2016-17. However, the renewable energy sector has encountered a few bumps in the recent past with discoms in some states attempting to renegotiate/ cancel PPAs following the significant decline in wind and solar power tariffs in the past seven to eight months. However, such cancellations or renegotiations, if finalised by the discoms, may be legally challenged by the affected IPPs. Besides, the central government is trying to dissuade state discoms from such unilateral action on PPAs. The resolution of the PPA renegotiation/cancellation issue is crucial to retain investor interest in the sector. Over the medium term, ICRA expects capacity addition in the renewable energy sector to remain sizeable and lead to an increase in its share in the overall electricity generation to over 12 per cent by 2021-22. This would, in turn, put pressure on the utilisation of thermal power capacity and slow down fresh investments in the thermal power segment.
Secondly, distribution utilities are moving towards short- and medium-term PPAs for sourcing power from the thermal segment, instead of committing to tariffs for 25-year PPAs, in view of the subdued demand growth and falling renewable energy tariffs and to lower costs as agreed under UDAY. This could lead to a disruption in financing for the sector, given the long gestation period of thermal power projects and the high debt component. Financiers may have to come up with innovative lending products to fund power projects with PPAs for 5 to 10 years, instead of 25 years. Thermal power generators should also look to diversify their customer profile with a mix of discoms and industrial customers and also a mix of PPAs, that is, short-term, medium-term and long-term PPAs. On the other hand, the discoms will not have long-term supply security and will remain exposed to volume and tariff risks in the electricity market when demand picks up.
Thirdly, the distribution segment is likely to witness a rationalisation of the tariff structure with fewer tariff categories. This would bring in greater transparency for consumers and provide better control on operations for the distribution utilities. The central government is in discussions with the state governments in this regard. This is in view of the complex tariff structure across states, with multiple categories and subcategories, and the high level of cross-subsidisation by industrial and commercial consumers.
Demand growth will be the most disruptive development for the sector. As such, the current situation of surplus capacity is somewhat misleading. As we have seen recently, even a small fall in the available generating capacity due to maintenance or monsoons can trigger shortages and high spot prices. Similarly, a modest spurt in demand can disrupt the market. The conditions for a robust and sustained demand growth are in the making. Specifically, an upsurge in consumer numbers from rural electrification, higher per capita use urban and commercial applications, and electrification of public and personal transport will drive the next wave of demand growth.
Energy storage is expected to be a key disruptive technology trend. If storage costs fall to a reasonable level, the energy dynamics may shift more in favour of intermittent sources of power such as wind and solar and also towards off-grid sources such as rooftop/captive power projects. A second disruptive trend is the emergence of electric vehicles, as they can create a huge demand for power. This would have a very beneficial impact on the overcapacity situation in the country and particularly on the stranded thermal power capacity. Further, electric vehicles may lead to a convergence between oil and gas companies and power utilities. The last disruptive trend could be if last-mile competition is allowed, whereby all consumers are allowed to switch retail suppliers. This would particularly have an impact in areas where private distribution companies are functioning as the wire losses in these areas are already low. In government-owned distribution systems, the regulators would hopefully continue to set low targets for wire losses, thereby making switching of suppliers viable for consumers.
The first disruptive trend, in my view, is the “much faster than expected” progress of renewable energy towards grid parity. Even after recognising the issues relating to the intermittency of renewable energy, the shift to renewable energy is unlikely to slow down. One must realise that renewable energy hugely improves the energy security of countries that have largely been dependent on imported fossil fuels. Thus, many countries are likely to pay a premium for renewable energy. This will be supported by the second trend – the mainstreaming of energy storage technology. It is expected that like renewable energy, energy storage technologies will make rapid progress in improving efficiency and reducing costs. This will significantly help deal with the intermittency of renewable energy. The third disruptive trend – again as a result of the first two – will be the proliferation of distributed generation. Generation will move closer to the consumer. At the same time, energy efficiency gains and the rise in demand from new technologies (like electric vehicles) will make the demand equations more complicated.
What are the biggest unresolved issues and challenges in the power sector?
A key unresolved issue in the sector is stressed assets. Stressed assets primarily arise from three factors – lack of adequate demand for power due to low levels of economic/manufacturing activity, inadequate contracting of power by utilities despite load shedding, leaving generation capacities open and unable to recover costs, and the tendency of discoms to repudiate contracts or renege on them. Another issue is poor customer service among utilities, which is a bane for the sector and the root cause of most problems.
The all-India electricity demand growth remained subdued with an annual growth rate of 2.6 per cent and 4.3 per cent in 2016-17 and 2015-16 respectively. This is due to the weak financial profile of the discoms as well as weak industrial demand. While demand growth has seen some pick-up in the first four months of 2017-18, its sustainability remains to be seen. This has, in turn, resulted in slow progress in the signing of long-term PPAs, leading to stranded thermal power capacity. As per ICRA estimates, about 26 GW capacity in the private IPP segment (commissioned and under-construction capacity at advanced stages of development) is without long-term PPAs. The utilisation of thermal power capacity at the all-India level is subdued with a plant load factory (PLF) of 59.9 per cent in 2016-17. Within the thermal segment, the utilisation of the gas-based capacity is lower with PLF at less than 23 per cent over the past four years. This is due to the non-availability of natural gas from domestic sources and the high cost of generation using imported regasified liquefied natural gas.
On the tariff compensation issue for coal-based power projects the Supreme Court order has ruled out tariff compensation for imported-coal-based projects affected by changes in mining regulations in Indonesia. However, the Supreme Court has issued a favourable order allowing tariff compensation for domestic-coal-based projects affected by a shortfall in the supply of coal by CIL, leading to dependence on costlier imported coal. However, the timelines for approval and realisation of this compensation remain unclear.
The distribution business is still a huge drag on the sector, and fundamental reforms are needed to improve the operating performance, which is well below the efficient benchmarks. UDAY has given discoms some breathing space, but few are using their improved financial position to initiate reforms. It is encouraging to see some states take steps to contract district-level franchisees, or outsource metering-billing-collection functions, and roll out smart meters. Still, these individual actions are not sufficiently comprehensive or coordinated to spur a sustainable turnaround. The central and state governments have a lot more work to do to turn around the discoms.
The biggest unresolved issue in the sector is that the distribution companies continue to be owned by the state governments and hence continue to work on non-commercial and inefficient lines. Recent government data seems to claim that there is some improvement in transmission and distribution losses and tariff under-recoveries in certain states, but in others, things have not really changed. Even in states where the data suggests improvements, data quality concerns remain as, in some of these states, proper metering and preparation of up-to-date accounts are not carried out. Additionally, existing thermal power projects continue to be cannibalised by new renewable energy projects, which seem to be enjoying greater government attention. For instance, while the renewable energy policy framework facilitates upfront PPA access to renewable projects, thermal projects continue to face a drought of long-term PPAs. CIL’s coal quality also continues to fall, although third-party sampling is helping address certain quality concerns. Coal auctions for the power sector are continuing to face policy headwinds.
Another major unresolved issues is the need for capacity building in some electricity regulatory bodies, as a number of crucial regulatory decisions are getting overturned by the Supreme Court such as the Mundra project’s compensatory tariffs, the Sasan project’s commissioning date, etc. A large number of regulators continue to not increase tariffs on a regular basis inter alia due to state government pressures. Regulators are also not stepping in to protect the sanctity of contracts when discoms seek to renege on PPAs, delay payments and not pay interest, or when discoms back down single-part tariff-based projects and not pay them compensation.
Most of the “critical” unresolved issues in the power sector pertain to the distribution utilities and their interface with consumers. The enforcement of “universal service obligation” in the true sense (relating to power supply and not just connections), rationalisation of tariffs to reflect the cost of supply for each consumer category, elimination of cross-subsidy, and moving to the direct benefit transfer model for payment of subsidies are all critical issues that can help the utilities and the sector survive. Unless these are depoliticised and tackled on a priority basis, the power sector will continue to struggle and “24×7 power for all” will remain a dream. Till new business models emerge, at least in the short to medium term, commercially viable and customer-oriented utilities are the need of the hour. The biggest challenge facing the power sector is the subdued growth in power demand, which has resulted from a combination of existing connected consumers moving away to explore cheaper and more effective supply options and the inability of the utilities to bring unconnected consumers into the grid. This can only be tackled by turning utilities into commercially viable entities with strict quality of service standards.
(The views of Kuljit Singh are his personal views and not those of EY)