By Sabyasachi Majumdar, Senior Vice-President, ICRA Limited
Electricity demand in India has turned buoyant in the current fiscal with the recovery in economic activity post the second wave of Covid-19, as well as a favourable base effect. Demand increased by 13 per cent in the first half of 2021-22 over the corresponding period of the previous year, and is likely to end the year with a year-on-year growth of 8-8.5 per cent. This would be the highest annual percentage growth in electricity demand since 2011-12. Notwithstanding the recovery in electricity demand, the all-India average thermal plant load factor (PLF) level is likely to remain subdued at below 60 per cent in the current fiscal. This is due to the subdued demand growth over the past few years, and the policy focus on increasing the share of generation from renewables, mainly solar and wind. Also, the segment continues to face challenges such as the lack of visibility in the signing of new power purchase agreements (PPAs) for thermal independent power producers (IPPs), and an upward pressure on the cost of power generation with the rise in fuel price levels and tighter environmental compliance requirements. A sustained improvement in electricity demand growth and, in turn, the thermal PLF level remain critical factors for improving the outlook for thermal generation.
Meanwhile, the outlook for the renewable energy sector is favourable, with continued policy support from the Government of India, a strong project pipeline, and the superior tariff competitiveness offered by wind and solar power projects, both in the utility and the open access segments. Thus, investment prospects in the renewable energy sector are expected to remain strong over the next decade, with a target of reaching 450 GW of renewable energy capacity by 2029-30 from the current level of 100 GW. Capacity addition in the power sector over the medium term will be driven by the renewable energy segment, led by a strong project pipeline of close to 40 GW (excluding the manufacturing-linked solar IPP tender and adjusted for cancellations) as on date. The key challenges constraining growth remain on the execution front – mainly issues with land and transmission infrastructure, as well as the slow but improving progress in the signing of PPAs and power sale agreements between intermediate procurers and state discoms. Improvements in the financing environment and the softening in the interest rate for renewable energy projects over the past 12-18 months have been positives for the sector.
Apart from execution-related challenges, renewable energy developers continue to face difficulties arising from delays in payments from state distribution utilities and grid curtailments as observed in a few states, especially for the relatively higher tariff projects. However, the presence of strong intermediate procurers such as the Solar Energy Corporation of India and NTPC Limited is supporting the addition of new capacities, aided by the presence of strong payment security mechanisms in the form of letters of credit, payment security funds and tripartite agreements between the central government, the state government and the Reserve Bank of India.
Improvements in the financing environment and the softening in the interest rate for renewable energy projects over the past 12-18 months have been positives for the sector.
Further, the demand outlook for domestic solar original equipment manufacturers (OEMs) remains favourable, with strong policy support through the imposition of customs duty on imported cells and modules, the notification of the production-linked incentive scheme, and a strong project pipeline from various schemes, requiring the use of domestic modules. Also, the non-inclusion of overseas suppliers in the approved list of models and manufacturers so far is likely to support the demand for domestic module OEMs in the near term. The policy push is expected to improve the cost competitiveness of domestic OEMs, and has led to large capacity announcements by various OEMs as well as the entry of new players. The ability of the OEMs to achieve backward integration and build economies of scale would be important for them to remain competitive against overseas suppliers on a sustained basis. The share of domestic OEMs in solar power installations in the country is likely to witness a healthy growth over the next three to five years, led by these policy initiatives.
However, the state-owned discoms continue to remain in fragile financial health, arising from their high level of aggregate technical and commercial (AT&C) losses, inadequate tariffs in relation to the cost of power supply, and insufficient or delayed subsidy support from state governments. Their overall debt burden, despite the implementation of the UDAY, is estimated to increase to around Rs 6 trillion in the ongoing financial year. Moreover, the cash gap between the tariffs and the cost of supply is estimated to remain high at about 50 paise per unit in 2021-22 (excluding UDAY grants and regulatory income). Further, the subsidy dependence for discoms at an all-India level is likely to remain high at about Rs 1.3 trillion this year, considering the highly subsidised nature of power tariffs for the agricultural sector and certain sections of the residential segment.
The outlook for the renewable energy sector is favourable, with continued policy support from the government, a strong project pipeline, and the superior tariff competitiveness offered by wind and solar power projects.
In its 2021-22 budget, the central government had announced the launch of a “reforms-based and results-linked” scheme for the distribution segment with the objective of improving the financial health and operational efficiency of discoms by reducing their AT&C losses. Subsequently, the Revamped Distribution Sector Scheme was notified in July with an overall outlay of Rs 3.04 trillion. This is inclusive of a budgetary grant/ support of Rs 976.31 billion, spread over a five-year period. Under the scheme, AT&C losses are sought to be brought down to 12-15 per cent by 2025-26 from the current 21-22 per cent. The operational efficiencies of discoms are to be improved through smart metering and upgradation of the distribution infrastructure, including the segregation of agricultural feeders and strengthening of the system.
Apart from this, a continuing area of concern affecting discom finances is the significant delay in the process of tariff determination in many states. As of now, only 19 out of 28 states have issued tariff orders for 2021-22, indicating sluggish progress. Moreover, the tariff hikes approved by the regulators remain low, with a median tariff hike of 0.6 per cent for 2021-22. Also, the cost of power supply for distribution utilities remains under upward pressure, given the dominant share (about 70 per cent) of coal in the fuel mix for energy generation, the strengthening of imported coal price levels, and the possibility of a domestic coal price revision by Coal India Limited in the near term. As a result, a cost-reflective tariff determination process and timely pass-through of power purchase cost variation remain critical needs for the utilities.
On the whole, while the focus on improving operational efficiency and ensuring the financial sustainability of discoms is indeed welcome, timely implementation of reforms in the distribution segment are critical to achieving the desired improvements. One such major reform is the delicensing initiative proposed by the central government. This can bring about significant changes in the distribution segment, facilitating competition and placing emphasis on quality and reliability of power supply and consumer services. A strong political will and support from state governments are needed to ensure implementation of this initiative. This could drive large investments in the power sector. It will not only be limited to the distribution segment, but would also increase investor interest in the generation and transmission segments.