Janmali ManikalaCounsel
Rohit VenkatCounsel
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Background
Distribution companies (Discoms) play a key role in the power sector, contracting with power-generating companies and supplying power to end-consumers. For almost two decades, Discoms have struggled to meet their contracted obligations under long-term power purchase agreements (PPAs). A recent statement of the Power Minister in Parliament revealed that the total outstanding amounts payable by Discoms are approximately INR 1,00,000 crore (USD 1200.71 million). Recent trends indicate that the per unit cost of power will gradually reduce and this is only going to add to the woes of the Discoms.
In the context of an ever-increasing demand for power, other factors contributing to volatility in the sector include coal prices, fluctuations in energy demand and the impact of developments in the renewable energy sector translating to lower tariffs. With no immediate resolution in sight, Discoms are under increasing pressure to renegotiate expensive long-term PPAs.
A number of complex issues account for the dire financial condition of Discoms. These include: (a) delays in issuance of tariff orders for Discoms by regulatory authorities i.e., delays in determination of cost reflective tariff to be paid by consumers to Discoms resulting in a mismatch in revenue and costs; (b) failure of state governments to honour subsidy payments; and (c) state-owned power consumers failing to clear their power bills.
In the context of an ever-increasing demand for power, other factors contributing to volatility in the sector include coal prices, fluctuations in energy demand and the impact of developments in the renewable energy sector translating to lower tariffs. With no immediate resolution in sight, Discoms are under increasing pressure to renegotiate expensive long-term PPAs.
To alleviate some of these problems, the central government has introduced performance-based incentive schemes for Discoms, such as the Ujwal DISCOM Assurance Yojana (UDAY). If implemented successfully, this would improve the credit rating of Discoms as power purchasers. However, few Discoms have been able to meet the associated conditionalities to take advantage of the payment security mechanism envisaged under the scheme and therefore its positive impact on the sector is yet to be seen.
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Challenges with long-term PPAs
According to the monthly data published by the Economic Division, Central Electricity Regulatory Commission, 89.4% of power procured by Discoms is under long-term contracts. The fixed price element of long-term PPAs has not changed since the first model PPA was issued by the Ministry of Power (MoP) under the competitive bidding guidelines in January 2005. While the electricity market has been constantly evolving and maturing, leading to efficiency gains including a reduction in costs, Discoms are locked in for a 25-year period with static prices and scope only for an upward revision of tariffs.
When Discoms renege from existing contracts or seek to renegotiate tariffs, this jeopardises long-term investments for power-generating companies. The most recent case is that of Discoms in Andhra Pradesh seeking a reduction in tariff (discovered through a competitive bidding process) for solar power. Similarly, in Punjab, a bill has been passed to facilitate renegotiation/termination of long-term PPAs with private generators.
These recent developments in Andhra Pradesh and Punjab clearly show that Discoms are finding existing contracts too expensive. They struggle to justify the price at which power is being procured today, especially when the tariffs discovered under recent procurements are far lower than in older PPAs. With tariffs being fixed for 25 years in many PPAs, Discoms are unable to take advantage of lower electricity prices. They are also unable to justify the continued payment of fixed costs even when they are not drawing power. This has led to numerous disputes and private players increasingly losing confidence in the sector. Consequently, the number of stressed assets in the power sector has risen significantly.
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Way forward
The inflexibility of long-term PPAs is anachronistic in a modern, dynamic power sector with new classes of buyers and sellers, the growth of renewable energy and the need to prepare for an energy transition. PPAs need flexibility, allowing for prices to respond to changing market conditions. Shorter PPAs of 10 to 12 years may be considered initially, with a gradual reduction of terms, to allow Discoms to reassess their demand curves and accordingly contract the power required.
One possible option for Discoms is to enter into long-term PPAs only for base load requirements i.e., the permanent minimum load of power required to be delivered to consumers. Power required on account of seasonal fluctuations (or peak demand) could be sourced under short term contracts, including buying power on power exchanges (i.e., electronic platforms for trading in power).
The Standing Committee on Energy, in its fourth report released in March 2020, recognised the issue of tariff under long-term PPAs being static and the consequent negative impact on Discoms. MoP has also stated that it is looking for a solution to this problem and a policy paper is expected.
However, what approach the MoP will take when re-looking at existing PPAs as well as the structure of these agreements remains to be seen. Two key considerations appear to be the payment of capacity charges irrespective of supply of power and the increase in costs, should there be any delay in commissioning the assets.
One possible option for Discoms is to enter into long-term PPAs only for base load requirements i.e., the permanent minimum load of power required to be delivered to consumers. Power required on account of seasonal fluctuations (or peak demand) could be sourced under short term contracts, including buying power on power exchanges (i.e., electronic platforms for trading in power). In the medium term, the government could also consider creating capacity markets for peak demand.
Long-term contracts account for nearly 90% of all power procurement in the country with the balance being short-term procurement on the open market. It is imperative that this ratio be re-balanced so that the gains of the electricity market can be passed onto the ultimate consumers.
The MoP has recently proposed a new mechanism - market-based economic dispatch of power, to bring down the cost of power purchase for Discoms. This mechanism allows for a pooling of power purchase costs at the national level rather than each state/Discom executing PPAs for power procurement specific to their demand forecast. The objective is to bring down power costs by meeting the overall demand of the country from the cheapest sources first, before despatching power from more expensive sources.
Lenders will need to get comfortable with shorter-term PPAs. Therefore, the MoP must ensure that a balance is struck between the bankability of a project (from developers/lenders perspective) and the ability of Discoms to procure power at market-comparable prices. Any attempt which fails to meet these dual objectives would render the exercise flawed.
