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Private power projects -- Third-party sales: A viable option?

S. Padmanabhan

INDEPENDENT power producers (IPPs) have been demanding that they be allowed to sell power to third parties -- large consumers -- directly, instead of selling to the electricity boards. The majority of State electricity boards (SEBs) are believed to be no n-viable customers and the banks consider them non-bankable. The IPPs and the supporters of privatisation believe the IPPs would become bankable if they are able to sell the power they produce directly to large users -- private and public sector companie s.

Electricity boards, on the other hand, have been protecting their customer base and have not allowed even small power producers -- wind power, captive power and small hydro power generators -- to sell power to third parties. Curbs such as refusal to sell additional power and increased wheeling charges on third-party buyers were introduced in Andhra Pradesh, Karnataka and Maharashtra, where third-party sale was permitted for these small, particularly non-conventional energy producers. Permission to large power producers to effect third-party sales has not been given so far.

Consequent upon the Dabhol Power Project crisis, the Central and the State Governments have been thinking of relaxing this policy to permit Dabhol Power to look for third-party users in the private and public sector in addition to entering into cross-bor der power sales agreements with States outside Maharashtra.

Over the last 54 years, electricity boards have been set up to build transmission and distribution infrastructure, produce electricity, sell to consumers -- industrial and general public -- and collect a tariff for such use. Like any other infrastructure area, this industry has also been heavily subsidised by the Government for socio-economic reasons. In addition, this has been politically exploited by all the parties to the detriment of the State and Central economies.

The impracticality of duplicating transmission and distribution infrastructure gives the electricity boards the monopoly to transmit and distribute power throughout the country, and the sellers of power have to deal with a single buyer concept which, giv en the arrogance of a state monopoly, creates delays and controversies. Hence, the clamour for third-party sales approval.

Electricity boards have, broadly, two types of consumers: domestic and commercial consumers; and industrial consumers.

Third-party sale definitions so far have not extended to the first group -- domestic and commercial. While this segment offers the best profitability, and the revenue collection levels are almost 100 per cent, the sale of power to them can be dealt with only by privatising the distribution business -- by dealing with the community as a whole. This leaves only the industrial consumers in this debate.

Whether third-party sales are viable, particularly for large volumes, depends on the technical, commercial and legal issues governing the supply and sale of electricity to consumers.

The reasons why a third party would like to buy from a private source other than electricity boards are better price; stability in supply; better quality; flexibility in purchase; and lower fixed charges. If these are not mitigated, there is no reason fo r the buyer to shift from electricity board supplies. A look at the issues:

The electricity boards have been receiving the power from producers at the generation point and delivering the same to the user location -- own or third party -- by charging a wheeling charge. For non-conventional energy sources, the wheeling charges are 2 per cent and, for the others, it varies from 10 per cent to 15 per cent, depending on the distance carried. This charge is supposed to recover for the electricity boards a small portion of the fixed cost of the transmission investment and the loss in transmission. The wheeling charges were subsidised heavily by the electricity boards to support the growth of power from non-conventional energy sources and to help captive producers evacuate their excess production.

The transmission losses of the electricity boards being in excess of 15 per cent, the boards may not be able to absorb the losses and the subsidy in the event of large producers being allowed to sell power to large users. The wheeling charges would be 20 -25 per cent, taking into account the transmission losses and the recovery of fixed investment. Why should the electricity board subsidise wheeling for the producer? Will users find it economical to buy from a private producer if this wheeling charge is added to the tariff?

Unless the user and the producer are in the same or contiguous location, where they could set up their own transmission facilities -- called ``inside-the-fence-facility''-- all power will have to be transmitted through the general grid and will be subjec t to the problems that affect the grid. The supplier will have to synchronise the facility with the grid in terms of frequencies and other factors to maintain supply discipline with other producers. This would also mean that the supplier is subject to th e decisions of the State or regional grid manager. Problems such as power tripping would occur as it occurs now. Therefore, there will not be any perceptible improvement, if any, in the quality and stability of power than what is being supplied by the el ectricity board to the third-party buyer so long as the electricity board remains the grid manager. Being the largest producer in any State, electricity boards alone have the capability to manage the grid.

A related issue is the modernisation, expansion and routine maintenance of the transmission facilities: Why should the electricity boards continue to do this for the benefit of competing utilities? Will the new investment be recoverable at a reasonable r ate of return for its investment when in today`s conditions, they are getting much lower returns than the new IPPs? These questions have to be addressed and a viable answer found as to why electricity boards and PSUs, such as NTPC, take the blame and los ses when the IPPs prosper.

The most critical issue, however, is financial. The PPA has the take-or-pay provision and, in all the agreements between the electricity boards and the IPPs, there are no serious penalties if the IPP informs the grid in advance that it is not able to pro duce power. The IPP does not offer any security to cover non-supply or any defaults. However, the third-party buyer would insist on continuous power supply on a 365-day 24-hour basis and expect to be compensated for the loss of profits if the IPP is not able to supply -- with or without notice.

It must be noted that a third-party sale contract would alienate the buyer from the electricity board, with the former reducing or cancelling demand from the board to avoid payment of minimum demand charges. Electricity boards also would not like to plan contingent obligations from customers who go away from their fold. The third-party buyer would depend solely on the IPP. Would the IPPs be able to give supply-or-pay guarantees, or penalties and loss of profits for breach of contracts? The performance o f IPPs depends also on outside factors such as transmission failures, and the electricity boards will not give any guarantees. Supply-or-pay contracts would result in higher project costs for the IPPs and may be unbankable as a result of higher cash rese rves needed to be give such guarantees to private buyers.

Lastly, the IPP would expect from the third-party buyers the same kind of security mechanism (if not more) for the purchase commitments. Take-or-pay involves paying deemed generation (minimum charges representing debt service, depreciation) in the event of being offline, providing letters of credit, corporate guarantees, escrow cover on their cash flows to 125-150 per cent of the guaranteed offtake.

Today, the buyers do not provide any such security to the electricity boards, neither do they pay any significant fixed charges. There is no pressure on the working capital of the buyer under this arrangement. However, the IPPs will become unbankable if they do not receive proper security enhancements from their buyers. Third-party buyers will have serious working capital problems if they have to provide the kind of security now provided by the electricity boards to IPPs. The buyers will have to create huge cash reserves for letters of credit, escrows, deemed generation guarantees and guarantees for penalties arising out of failure to take the power. No third-party buyer would want to increase its working capital investment and incur higher debt and in terest costs for such a contract. Can the IPPs survive without the take-or-pay contracts? Will they be ready to put electricity on tap for the corporate buyer just because they have no confidence in the electricity boards? Lastly, is there a third-party market consisting of large industrial users?

The market for large third-party direct purchase from the IPP does not really exist. In addition, for large industrial consumers -- refineries, fertiliser plants and steel mills -- power is generated as byproduct. These industries and several others prod uce waste gas of high temperature (flue gas, ballast gas) which is used to generate power.

For instance, in Mumbai, all the refineries are power surplus and they export power to the grid. All other industries have significantly added to their captive generation through diesel sets and, as such, there is not a single creditworthy customer who w ould sign a take-or-pay contract for 100MW or more. For a company such as Dabhol, it would not be economical or practical to identify third-party buyers for any consumption less than 100MW. Smaller users are unbankable and will expose Dabhol to significa nt payment risk. Dabhol is only an example; the same applies to any IPP.

Third-party sales are good for smaller power projects in a situation where the user requires only a part of the demand. Fulfilling 100 per cent needs will be risky. The only solution is to go back to the power sector reforms. This is a slow and painful p rocess, which we have necessarily to go through for our survival. Till such time, the IPPs are safe and secure only in the hands of the electricity board, subject, of course, to the condition that the Centre continues to help the States meet their paymen t obligations.