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Power Sector Financing in India

and key Issues


By
Yasir Altaf

Abstract

The Indian Power Sector has been weighed down by the political and regulatory environment along with the
inefficiencies of the State Electricity Boards (SEBs) and chronic shortages and pressures to meet demand.
This has deterred private investment from flowing into the sector. The government's first stab on this i.e. the
1990s strategy of bringing in global sponsors to build Independent Power Producers (IPPs) was not
particularly successful and Dhabol plant left a bad taste in everyone’s mouth. But with the passage of
Electricity Act 2003, new rays of hope have opened for growth. The Electricity Act has an overall positive
impact on the profitability of the power sector and encourages investment and efficiency. The new power
strategy visible in India has much more of a domestic flavour even though bidding is open to foreign players.
The government is keen to attract significant private capital into its power sector, which is facing a huge
demand-supply gap. Badly affected states such as Maharashtra have 19% energy shortages, and this can
rise to 27% peak power shortage levels. This power shortage is holding back industrial growth and
corresponding economic development, and the World Bank has estimated that if India is to sustain current
GDP growth levels in the 8% to 9% per annum range, it will need to add 160,000 MW of generating capacity
over the next 10 years. The basic template evident is domestic sponsors raising cash on the stock market,
and using this source of funding as the project equity component for competitive bids. In this new
environment, Project Finance will be the key financing mechanism for growth. Also the investment will have
to be directed towards all the components of the electricity delivery chain i.e. Generation, Transmission and
Distribution. This would help India to overcome the bottlenecks in the long neglected Transmission and
Distribution segments. The financing also needs to move to the next level of Public Private Participation with
the Financial Institutions providing equity to the sector and not just debt. The sector also needs incentives in
the form of lower duties, tax holidays and measures such as a higher return on equity (RoE) to attract more
investments. Payment risks associated with SEBs which has been a major concern for IPPs have overcome
to some extent with SEB restructuring and improvement in the security and payment mechanisms
arrangements. But a word of caution needs to be attached to this optimistic view as the efficacy depends on
the commitment of the Centre and State machinery to the reforms process. Except for the limited success by
a few generation companies in accessing the debt market, transmission and distribution utilities have not
managed to raise debt successfully from the open market. The availability of easily accessible debt from
government backed financial institutions like the Power Finance Corporation (PFC) and the Rural
Electrification Corporation (REC) has had the effect of "crowding out" the development of a private debt
market. It is therefore important that these institutions scale down their activity, and confine themselves to
the smaller and weaker utilities. The state utilities are too cash strapped for internal resources to be of any
significance. Given the excellent commercial potential of merchant power plants, the equity market is a good
source of raising funds. In any case, the Indian equity and especially debt market is too narrow and does not
have the required depth and breadth to finance these huge requirements. It is therefore inevitable that
Foreign Direct Investment (FDI) be incentivized, so as to meet the huge investment requirements.
1 Introduction ............................................................................................................... 5
2 Emerging Scenario.................................................................................................... 7
2.1 Power Market Dynamics ................................................................................... 7
2.2 Industry Structure .............................................................................................. 8
2.3 Generation......................................................................................................... 9
2.4 Transmission ................................................................................................... 10
2.5 Distribution ...................................................................................................... 11
2.6 Demand Supply Position ................................................................................. 11
2.7 Financing Requirements ................................................................................. 12
3 Project Life Cycle .................................................................................................... 14
3.1 Project Finance ............................................................................................... 14
3.2 Operational Agreements ................................................................................. 15
3.3 Project Development ....................................................................................... 16
3.3.1 Development Period ................................................................................ 16
3.3.2 Construction Period ................................................................................. 16
3.3.3 Operating Period ..................................................................................... 17
4 Power Generation ................................................................................................... 18
4.1 Engineering, Procurement & Construction Capability ..................................... 18
4.2 The Power Purchasers.................................................................................... 18
4.3 Project Economics........................................................................................... 20
4.3.1 Fuels Supply............................................................................................ 20
4.3.2 Capital costs ............................................................................................ 20
4.3.3 Wholesale Tariff Structure ....................................................................... 21
4.3.4 Capacity Allocation for Central Generating Stations ............................... 23
5 Power Transmission................................................................................................ 24
5.1 Private Sector Investment in Transmission Sector.......................................... 25
5.1.1 Mode of Investment by Private Investors ................................................ 26
5.1.2 Tariff based bidding process for transmission ......................................... 27
6 Power Distribution ................................................................................................... 29
6.1 Key issues facing the sector............................................................................ 29
6.2 Privatization of Distribution.............................................................................. 32
6.2.1 Privatization of Distribution in Delhi ......................................................... 32
6.2.2 Impact of Privatization on Distribution ..................................................... 33

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7 Project Financing .................................................................................................... 34
7.1 Types and Sources of Finance........................................................................ 34
7.1.1 Debt ......................................................................................................... 34
7.1.2 Equity....................................................................................................... 36
7.2 Trends in Power Sector Financing .................................................................. 37
7.3 Key Power Financing ...................................................................................... 37
7.3.1 Financial Closures ................................................................................... 38
7.3.2 Central Sector Project Financing............................................................. 38
7.3.3 State Sector Project Financing ................................................................ 39
7.3.4 Private Sector Overseas Financing ......................................................... 39
7.3.5 Qualified Institutional Placements ........................................................... 39
7.4 Major Financiers in Power Sector ................................................................... 40
7.5 Policy development for Private Investment ..................................................... 40
7.5.1 Electricity Act 2003 .................................................................................. 40
7.5.2 Private Power Policy................................................................................ 43
7.5.3 Mega Power Policy.................................................................................. 43
7.5.4 Policy Reforms for Investment in Transmission ...................................... 43
7.5.5 Regulatory Reforms................................................................................. 44
7.5.6 Distribution Reforms and Privatization .................................................... 45
7.6 Framework for Private Investment .................................................................. 46
7.7 Status of Private and Foreign Investment in Power Sector ............................. 51
7.7.1 Private Investment in power sector ......................................................... 51
7.7.2 Foreign Investment in power sector ........................................................ 53
7.8 Issues and Concerns....................................................................................... 54
7.9 Enabling environment for the private sector .................................................... 55
8 Risks associated with Indian Power Sector............................................................. 57
8.1 Project Evaluation and Risks........................................................................... 57
8.2 Risk Mitigating Mechanism.............................................................................. 58
8.3 Impact of the Global Slowdown ....................................................................... 60
9 Conclusions and Recommendations....................................................................... 62
9.1 Generation....................................................................................................... 62
9.2 Transmission ................................................................................................... 63
9.3 Distribution ...................................................................................................... 63
10 References/Bibliography ..................................................................................... 65

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4
1 Introduction
India is now the second fastest growing economy in the world. Despite the current
economic slowdown, India is expected to grow at approximately 7-8% this fiscal year.
Current estimates suggest that India’s economic growth may slow to 7% as the global
economy recovers from the slowdown. The expanding base of industries and services
the main drivers of economic growth is exerting pressure on India’s weak infrastructure.
The power sector remains a key infrastructure concern and India’s continued economic
growth will depend critically on its ability to meet the growing electricity demand.
Economic growth is only one aspect of the Indian story. Development and poverty
reductions are the other imperatives. Improved access through better grid connectivity,
increased certainty of electricity supply and price affordability all play an equally
important role in shaping the politics and economics of the sector. India’s pattern of
energy demand, consumption and growth, must therefore be understood in the context
of its dual objectives – as a basis for sustaining economic growth and as an instrument
for poverty reduction. Over the last few years, the story on India’s economic growth has
been underlined by the story of India’s power sector.
The power sector has long experienced capacity shortfalls, poor reliability and quality of
electricity and frequent blackouts which has been a major impediment to economic
growth. Despite reforms introducing private participation during the 1990s, the India’s
electricity sector has remained dominated by the state. State utilities remain the
dominant institutions within India’s electricity industry, controlling well over half of the
electricity supply and the vast majority of distribution.
Electricity as a subject is in the concurrent list of the Constitution of India. It means that
both the Union and State Governments can formulate policies and laws on the subject,
but the responsibility of implementation rests with the States. Distribution of electricity in
particular comes in the domain of the states.
There are a number of significant problems in the Indian power sector that appear
intransigent. For example, agricultural subsidies continue to stifle reforms. There is a
pressing need for the Indian government to implement a national policy on farm tariffs.
At present political "generosity" such as the free grant of electricity to farmers needs to
stop in order to make the sector financially more viable and attractive investment. A
further bottleneck to progress is lack of adequate fuel resources and poor port facilities
in the country. Although a number of initiatives in the coal sector should assist the supply
of fuel for power generation, the quantum and reliability of the gas supply remains a
concern.
Overall however, after a number of false-starts, the Indian power sector is in the midst of
a positive hue and much of that stems from a series of measures sought to liberalize
generation, form regulatory commissions, unbundle electricity boards, create
transmission as a separate business and introduce distribution reforms. Despite the
piece meal approach, these reforms finally coalesced into the Electricity Act 2003.
Although the implementation of the Act is far from complete, and progress is patchy
across the states, a critical mass of reforms has been achieved and comprehesnive
regulatory framework is now in place. This will go a long way in persuading private
players and foreign investors to come off their sidelines and participate in the
development of one of the world's largest infrastructure markets.

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India is facing a major challenge as it seeks to upgrade the entire electricity delivery
chain. Given the various constraints on government, primarily the financial ones, private
participation in power sector is likely to increase sharply. Government of India (GoI) has
recognized the importance of changing its policies and creating an environment
conducive to sustainable private sector involvement. But the pace of the reforms of
needs to be accelerated, and private developers need to develop more flexible,
innovative, and realistic project designs and concepts.
This paper covers an overview of the electricity delivery chain and analyzes the
financing of the Power Sector in India. The paper begins with an overview of the
industry, the emerging market scenario and the financing needs. It then illustrates the
current situation with respect to the financing of power projects in Power Generation,
Transmission and Distribution and the risks as seen by the lenders in Power Project
Finance in India. The provisions of the Electricity Act 2003 and their implications on the
sector financing are then dealt in with detail. All the observations on the future trends in
the financing of the Power Sector in India are highlighted. The paper concludes with
observations on the future trends in the financing of the Power Sector in India.

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2 Emerging Scenario
2.1 Power Market Dynamics
The restructuring of power systems across the globe started with the redesigning of its
power markets. The power market design determines the level of efficiency,
transparency, and flexibility offered to the market players. In India, electricity reforms
started with the re-evaluation of Electricity Supply Act, 1948 and the Indian Electricity
Act, 1910 which led to The Electricity Act, 2003. The Electricity Act, 2003 has been
brought about to facilitate private sector participation and to help cash strapped SEBs to
meet electricity demand. The Electricity Act, 2003 envisages competition in electricity
market, protection of consumer’s interests and provision of power for all. The Act
recommends the provision for National Electricity Policy, rural electrification, open
access in transmission, phased open access in distribution, mandatory SERCs, license
free generation and distribution, power trading, mandatory metering, and stringent
penalties for theft of electricity.
One more welcome step the Indian electricity market has seen is the implementation of
Availability Based Tariff (ABT) which brought about the effective day-ahead scheduling
and frequency sensitive charges for the deviation from the schedule for efficient real-
time balancing. ABT is discussed in more detail under wholesale tariff structures in the
chapter on Power Generation.
Figure 2.1: Power Market Structure in India

POWER MARKET STRUCTURE

Long-term PPAs

IEX
Day-ahead
Scheduling
RLDCs
Intra-day bilateral
Contracts

Real-time balancing Upper price cap on UI,


through UI & load Congestion charge
shedding 3 Rs/kWh

To promote power trading in a free power market, Central Electricity Regulatory


Commission (CERC) approved the setting up of Indian Energy Exchange (IEX) which is
the first power exchange in India. IEX has been modeled based on the experience of
one of the most successful international power exchanges, Nordpool. The exchange has
been developed as market based institution for providing price discovery and price risk
management to the electricity generators, distribution licensees, electricity traders,
consumers and other stakeholders. The participation in the exchange operations is
voluntary. At present, IEX offers day-ahead contracts whose time line is set in

7
accordance with the operations of regional load dispatch centers. IEX coordinates with
the National Load Dispatch Centers/RLDCs and SLDCs for scheduling of traded
contracts’ to get up-to-date network conditions. The day-ahead market of IEX offers
double sided auction and discovers the price incorporating the supply and demand side
bidding. The exchange, as of now, offers only day-ahead contracts of an hourly time
blocks. However, the exchange has plans for future to offer the adjustments contracts
and long-term contracts like forwards and futures to hedge the risk against the
uncertainty in electricity market. Putting together ABT mechanism, IEX and other market
stakeholders, the Indian power market operations can be described as shown in fig.2.1
Power market in India is also following the decentralized market model. The Indian
power market has now achieved all its segments of (i) Bilateral markets constituting
long-term, medium term and short-term markets; (ii) Multilateral market i.e., power
exchange (IEX) presently covering day-ahead segment and (iii) real-time multilateral
balancing market i.e., Unscheduled Interchange(UI).
2.2 Industry Structure
Public sector institutions continue to play the dominant role in the electricity supply and
delivery chain in India, primarily through central and state level government owned
utilities. Figure 2.1 depicts the interactions between the various players in the Indian
power market. The Ministry of Power (MoP) is the Central government institution
responsible for overseeing India’s electricity industry. Several authorities and agencies
operate under the MoP, among them the Central Electricity Authority (CEA), assists the
MoP on technical and economic issues.
Figure 2.2: Indian Power Market Institutional/Operational Framework

Ministry of Power, GoI Appellate


CENTRAL SECTOR Tribunal for
COMPANIES Electricity

Generating Companies
CEA R&D Central
NTPC, NHPC, NEEPCO
CPRI, NPTI, Electricity
and NPCIL
PSTI Regulatory
CTU - PGCIL
NLDC Commission
Finance - PFC
Rural Electrification State
(REC) RLDC Electricity
MOP, State Government Regulatory
Commission

Electronic Trading Platform State IPPs SLDC Forum of


(Multiple Power Exchange) Regulators

State Sector
Mega IPPs
Trading Companies Generation
Transmission Pvt. Distribution
Distribution

The Central Electricity Regulatory Commission (CERC) is an independent statutory body


with quasi-judicial powers. The CERC has a mandate to regulate interstate tariff related

8
matters, advise the central government on formulation of the national tariff policy and
promote competition and efficiency in the electricity sector. The CERC regulates Central
government owned utilities both in generation and transmission.
The State Electricity Regulatory Commissions (SERCs) have jurisdiction over state
utilities in generation, transmission and distribution. Independent Power Producers
(IPPs) are regulated by CERC / SERC depending on whether they sell power to one or
more states.
Regional Load Dispatch Centers (RLDCs) are responsible for managing the central
transmission system, whereas State Load Dispatch Center (SLDCs) manage the intra-
state and some inter-state systems. Central generating stations are contracted to state
utilities and are dispatched by RLDCs. State owned generating stations sell power to
their own state distribution licensee and are dispatched by SLDCs. Distribution licensees
can also buy power from mega power projects, IPP, traders and through the power
exchange.
The central government, through public companies, owns and operates one-third of total
generation capacity and interstate transmission lines. At the state level, SEBs own and
operate most of the remaining two-thirds of the generation capacity, as well as the
majority of intrastate transmission and distribution systems. Although the central
government institutions, particularly after corporatization, have fared better, the SEBs
increasingly faced the threat of bankruptcy during the development of India’s IPP
program in the 1990s. At a time when new generation capacity and distribution
infrastructure was desperately needed, the near insolvency of the SEBs created a
serious impediment to private investment in the electricity sector. Public funds had also
contracted. Without funds to invest in the development of the electricity sector, economic
growth far outstripped electricity consumption growth during the 1990s. Despite the
opening of generation to IPPs in 1991, the private sector provided less than 10,000 MW
of total generation capacity through the 1990s. Through 2003, IPPs accounted for little
more than 5000MW of new capacity since the introduction of private participation more
than a decade earlier.
2.3 Generation
The current installed capacity is approximately 143 GW with coal being the primary fuel
source. Despite significant recent additions, there is a significant stock of aging plants
that have poor performances. The sector also suffers from, fuel shortages, inadequate
transmission evacuation system, regulatory uncertainty and payment security concerns.
Concerns about the sector paved the path for reforms.
Of this the central and state sector accounted for approximately 89% [MOP, 2004]. The
statistics point to high perception of risk lack of enthusiasm on part of the private sector
with regard to power generation in India. In the Central Sector, National Thermal Power
Corporation (NTPC) is a player of global scale. The State Electricity Boards also operate
generation facilities to serve their demand. Private Sector comprises of many players
like Tata Power Company, Reliance Energy, GVK, GMR etc.
Despite reforms introducing private participation in the early 1990s, India’s electricity
sector has remained dominated by the state owned entities and has been unable to
attract adequate private investments. Electricity Act 2003 introduced another wave of
liberation aimed at create a legal and structural framework for a competitive market.

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Figure 2.3: Installed Capacity Share by sector
14%

34%

52%

Private State Center

To maintain the projected economic growth, India needs to add 100 GW of new capacity
by 2012. The growth in capacity must be matched with efforts to i) optimize utilization of
unevenly distributed fuel resources with proper evacuation system; ii) diversify fuel
sources with cheaper and cleaner fuel from huge hydro and other renewable energy; iii)
build raw material and infrastructural support; iv) adopt new generation technologies;
and v) renovate and modernize program of existing plants.
The target for new capacity additions has created a platform for approximately 100
billion USD of investments across different segment of the generation sector. Although,
the system is still in a transitory phase, deepening reforms and a new policy framework
have to create an optimistic outlook.
The developers opting to set up a MPP might pose a challenge in financing the project
and have to do so at their own risk. Setting up a merchant plant would necessarily mean
balance sheet financing by the developer, as financial institutions/lenders as a rule, may
not be comfortable with projects that don’t have long-term PPAs. Indigenous lenders are
not yet comfortable carrying the risk of non-recourse financing on merchant plants.
To facilitate the development and restructuring of the electricity market, with the
objective to fill in the demand supply gap and provide additional generating reserve, the
Ministry of Power has issued the approach and guidelines on the development of
merchant power plants (MPPs). MPPs are planned with the objective to fill gaps in the
peak loads.
The total funds requirement for the generation segment during the 11th Plan has been
estimated to be approximately 100 billion USD, of which central sector requirement is
49%. However, lack of financing and higher interest rates are likely to impede funds
mobilization. But at the same time interest from foreign investors and the renewed
interest of multilateral agencies in the electricity sector has been strong. There has been
resurgence of international interest in the Indian power sector.
2.4 Transmission
Transmission plan in India has always been generation based. It is therefore not going to
help because there are bound to be imbalances. Even today, CTU and STU’s are very
conservative in agreeing to create more than the desired transmission capacity and
freely allowing interconnectivity. Investments in the Transmission sector have been
therefore been inadequate due to the heavy emphasis on generation capacity. In most
states, the existing distribution network has been formed by expanding and

10
interconnecting smaller and disjointed networks. Consequently, there are several
deficiencies in the Transmission system, such as high losses and low reliability. The
major player in this sector is the government owned Power Grid Corporation of India.
The total transmission system in India at 765/HVDC/400/230/220 kV corresponding to
1,32,329 Mega Watts (MW) of installed generation capacity at the end of March 2007
was 198,089 circuit kilometers of transmission lines, 251,439 MVA of AC substation and
8,200 MW of HVDC substation capacity.
2.5 Distribution
India’s distribution sector has traditionally been a leaking bucket with the holes
deliberately crafted and the leaks carefully collected as economic rents by various
stakeholders that control the system. The logical thing to do would be to fix the bucket
rather than to persistently emphasize shortages of power and forever make exaggerated
estimates of future demands for power. Most initiatives in the power sector (IPPs and
mega power projects) are nothing but ways of pouring more water into the bucket so that
the consistency and quantity of leaks are assured. The Distribution arm of the Power
Sector had been the domain of the SEBs for a very long time which gave rise to financial
problems due to lack of collection of dues. The SEB’s financial difficulties led to
problems in the upstream for power generation. To alleviate this situation Distribution
Companies are beginning to be privatized in some states, most notable among them
being Delhi. Reliance Energy and Tata Power Company were the first private sector
players to make a foray into power distribution in the country.
2.6 Demand Supply Position
Over the last five years, from FY 2003-FY 2007 India’s electricity demand has grown by
over 6 percent annually 1 . The steady increase in electricity demand is attributed to the
country’s rapid economic growth. Over and above India’s visible electricity demand
growth, there is significant latent demand that remains under-represented. The demand
projections have discounted the Places where electricity cables have not reached yet
and industries that would come up if supply of electricity is guaranteed. Shortage is likely
to be a major driver for new capacity development in future. Energy demand deficits
have increased from 7 percent to 10 percent in the past five years, indicating that a high
latent demand for electricity exists in India. This latent demand increases the potential
for demand to grow even in periods of slow economic growth. Figure 2.6 illustrates the
peak and energy deficit between FY 2003 and FY 2007.
As the figure below shows, India has constantly been plagued with a demand supply gap
in the Power sector. Such a gap is a major hindrance to the growth of a developing
economy like India. The Government of India set up the Mission 2012: Power for All to
eliminate shortages by 2012. Therefore, electricity demand and the investment required
in the sector over XI plan are likely to grow even if GDP growth declines.

1
Power sector reports, CEA

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Figure 2.4: Peak and Energy Shortages FY 2003 - FY 2007

18% 16.9%
16% 15.9%
13.9%
14%
Demand Deficits (%)

12.2%
12%

10% 11.6%
8.4% 9.8%
7.1% 9.6%
8%

6% 7.3% Peak demand deficit %

4% Energy demand deficit %

2%

0%
2003-04 2004-05 2005-06 2006-07 2007-08

Source: CEA

2.7 Financing Requirements


The Working Group on Power has estimated that Rs. 1,031,600 Crores will be required
by the Power sector to meet the target of 78,577 MW capacity additions and
development of related transmission and distribution infrastructure by the end of XI plan
(FY 2007 - FY 2011). The question of generating this huge amount of funds therefore
assumes prime importance. The planned additions in all the three sectors will be missed
if significant steps are not taken to ensure a more congenial environment in the sector to
bring in more investments.
The investment in generation, transmission, distribution and rural electrification should
ideally be in the ratio of 4:2:1:1. This implies for each rupee invested in generation a
similar investment is required in Transmission & Distribution (T&D). Nevertheless, in
practice actual investment in T&D so far has been 30 percent. As a result there is a
severe gap in transmission capacity at state levels. The ratio for Central and State
sectors has gradually improved over the various plan periods, but the Private Sector
remains a gaping hole. The private investment in T&D segment has not been enough
and needs to be roped in for balanced distribution of power across the regions.

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Table 2.1: Investment Requirements in XI Plan
Overall Investment requirement in XI Plan (Rs Crore)
Particulars State Central Private Total
Generation 1,23,792 2,02,067 85,037 4,10,896
Distributed Generation 20,000 20,000
Renovation and Modernisation 15,875 15,875
Transmission 65,000 75,000 1,40,000
Distribution and Rural Electrification 2,87,000 2,87,000
Human Resource Development 462 462
Research and Development 1,214 1,214
Demand Side Management 653 653
Total Power Sector 4,91,667 2,99,396 85,037 8,76,100
Renewables and Captive generation 22,500 93,000 1,15,500
Merchant Power Plants 40,000 40,000
Total Investment Requirements 5,14,167 2,99,396 2,18,037 10,31,600

While this could well be the investment needed, the absorption capacity, availability of
financial resources and the viability of utilities are likely to act as constraints in realizing
these investment projections. Hence the question of generating this huge amount of
funds therefore assumes prime importance. Significant steps to ensure a congenial
environment in the sector for bringing in more investments have to be taken up as lack
of financing and higher interest rates are likely to impede funds mobilization. But at the
same time interest from foreign investors and the renewed interest of multilateral
agencies in the electricity sector has been strong. There has been a resurgence of
international interest in Indian Power Sector.

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3 Project Life Cycle
A typical Power Project Structure is a web of contracts. The Power Plant Promoters
setup a project company via the Special Purpose Vehicle (SPV) route i.e. the project
company is a distinct legal entity. The Company enters into two sets of agreements-
Project Finance and Operational.

Table 3.1: Power Project Structure in India

TYPICAL PROJECT STRUCTURE

MULTILATERAL, SPONSOR SPONSOR SPONSOR


BANK SYNDICATE
BILATERAL, ECAS A B C

NON RECOURSE DEBT EQUITY


Inter-Credit Agreement
Letter of Credit, Shareholder Agreement
Escrow Account

LABOUR
Merchant Power

Input PROJECT COMPANY


COAL or GAS Output
Supply Contract POWER SUPPLY
Power Plant
Off-take Agreement

Construction,
Equipment,
Operating and Host Government:
Maintenance Legal System,
Contracts Property Rights,
Regulation and Permits,
Concession Agreements

3.1 Project Finance


A Power Plant is financed via the Project Finance route. Project finance is usually
defined as limited or non-recourse financing of a new project through the establishment
of a separately incorporated vehicle company.
The reliance on non-recourse debt represents one of the key differences between
project finance and traditional corporate finance. In corporate finance, the primary
source of repayment for investors and creditors is the sponsoring company, backed by
its entire balance sheet, not the project alone. Even if an individual project fails, creditors
will still retain a significant level of comfort in being repaid depending on the overall
strength of the sponsor’s balance sheet. In project finance, on the other hand, if the
project fails, investors can expect significant losses even if it is sponsored by a AAA-
rated company or government. Limited or no recourse to the sponsors’ balance sheets

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and exclusive reliance on the project’s assets and cash flows make the credit risk faced
by the lenders very project-specific, with little scope for diversification.
Furthermore, loan repayments are subject to potential liquidity constraints facing the
project company, especially during the construction phase. On the other hand, the
possibility of funding projects with 70% and more non-recourse debt is attractive to the
sponsors for a number of reasons. Project finance allows them to share in potentially
large revenues while committing relatively little equity. Moreover, deconsolidating
projects off balance sheet makes it possible for the sponsors to preserve their corporate
debt capacity and keep their cost of funding low. A further reason for the sponsors to
consider project finance is that the risks of the new project will remain separate from
their other activities, avoiding any potential “risk contamination”.
Project finance has been especially used to fund large-scale capital-intensive projects
generating hard currency cash flows, for example from internationally traded
commodities (e.g. power plants). In fact, this type of projects allows sponsors to enjoy
the benefits of non-recourse debt and extensive contracting, while minimizing the related
risks to lenders. In particular, structuring large projects – as opposed to several smaller
deals - reduces overall legal and transaction costs thanks to economies of scale.
Furthermore, financing projects with considerable capital assets that produce hard
currency cash flows increases collateral value and reduces lenders’ exposure to
exchange rate risks.
On the other hand, financing large-scale hard currency generating projects leaves
lenders naturally more exposed to political risk and sovereign risk in general. Host
governments might have a keen interest in the high-profile projects being funded and
might fail to renew concession agreements, change regulations or even expropriate
project assets and cash flows to gain political rents or access to hard currency during
economic downturns. In order to cope with these risks, project finance is making
increasing use of larger syndicates and third-party guarantees, in particular political risk
guarantees.
Large-scale capital-intensive projects usually require substantial investments up front
and only start to generate revenues after a relatively long construction period. Therefore,
matching debt repayment obligations with project revenue cash flows implies that, on
average, project finance is characterized by much longer maturities compared to other
forms of financing.
3.2 Operational Agreements
EPC Contract: The Company then enters into an agreement with an Engineering,
Procurement and Construction (EPC) contractor for setting up the physical facility for the
Power Plant.
Fuel Supply Agreement: The Company also enters into a long term Fuel Supply
Agreement (FSA) to ensure fuel availability. As the paper explains later, fuel is the most
important component in ensuring the viability of the project.
Power Purchase Agreements: Off take of the Power generated by the plant is
guaranteed by a Power Purchase Agreement (PPA) with a TRANSCO. Some power
may be utilized for merchant sales to industrial houses.
Government Clearances: The Company also has to get the requisite clearances for the
government with regard to property rights, permits and environmental concerns.

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3.3 Project Development
From a planning and financing perspective, there are essentially three stages of
independent power project (IPP) development: development, construction, and
operation. The sources of funds, in general, are different for each stage. The risks
associated with the completion of each stage are also different and hence, the cost of
the capital is different.
3.3.1 Development Period
During the development stage, one cannot be certain that a "financeable" project will
result. The project must first be defined in terms of the buyer's needs, the site, the fuel
availability and the permitting requirements. Then the feasibility work is done. This
generally consists of engineering, cost estimation and environmental work, as well as
the development of preliminary project pro formas. The developer must then obtain
contracts, secure the site, and complete the permitting for the plant. The contract that
sets the direction for the rest of a project's development is the power purchase
agreement.
It is during the development period that the greatest "value" is being created because
efficient planning and engineering capability decide on the viability of the project and
also the tariff competitiveness of the power produced is decided by the engineering
excellence of the plant. The source of funds generally used during this period is equity.
The developer and owner of the project provide these funds.
The sources of financing for independent power projects are scarce because the risks of
development are high. Until the project reaches financial closing for construction, there
are a multitude of risks that could reduce the value of the project to zero. These risks
include:
Permitting risk
Political opposition to the project
Inability to secure fuel and fuel transportation under long-term contract
Inability to obtain a financeable power purchase agreement, either
because the power price is too low or the terms are not acceptable
Regulatory disapprovals and Change in law
3.3.2 Construction Period
A project enters the construction stage when it has met all the requirements necessary
to put together a non-recourse project financing. This means that all of the contracts are
negotiated and signed, the permits are granted, and the technology and equipment are
selected. There is limited to no recourse to the developer if there is a problem. This is
the nature of non-recourse project finance.
The majority of the construction funds are through debt. The period of greatest risk for
them is just before the plant is completed, because they have almost their entire loan
outstanding and the plant is still not producing revenues. The Project Cost also includes
provision for Interest during construction and a margin for working capital finance both of
which are capitalized.

16
3.3.3 Operating Period
The primary financial management issue throughout the project life cycle is to minimize
the financial and operating costs of the project. Once a project reaches commercial
operation, a developer/owner has many options in terms of additional financing. For
example, institutional buyers such as insurance companies and pension funds, as well
as the public markets (which do not take construction risk), can now participate. The
project now has real operating and financial data that can be used to assess the plant's
performance and financial expectations. The key is planning and constant attention to
the project finance debt market.

17
4 Power Generation
There are three major options for generating electricity: thermal, hydroelectric and
nuclear. Thermal power plants can be based either on coal or on natural gas, including
liquefied natural gas (LNG). In general, power plants with the lowest variable costs (fuel
costs) should be employed to meet the base demand, while those with higher variable
cost for the peak demand.
Coal-based power plants have lower variable costs than those based on naphtha or
natural gas. However, coal-based power plants have high capital costs (resulting in high
fixed costs). In addition, these plants are less flexible in terms of varying their output with
the variation in demand. Hence, coal-based plants are largely used to meet base
demand. This results in lower fixed costs per unit, due to the higher PLF. Gas and
naphtha-based power plants have higher variable costs and are more flexible in terms of
varying their output. Hence, these plants are better suited for meeting peak demand.
4.1 Engineering, Procurement & Construction Capability
To achieve investment grade or near investment grade rating, the following criteria for
Engineering, Procurement and Construction (EPC) Capability are critical and should be
analyzed.
Table 4.4.1: Criteria for EPC
Criteria Observations

Projects with longer construction schedules will only be able to


Conservative achieve investment-grade or near-investment-grade ratings when
construction schedule vendors and contractors are able to demonstrate overwhelming
capacity to manage the accompanying risk.

Strong turnkey The contract should shift substantially all construction risk to
construction contracts contractors and vendors.

This will be demonstrated by a rating or financial guarantee in the


form of a letter of commitment or surety bond providing for the
Adequate capacity to
payment of contract damages and penalties in sufficient time to
perform on contract
maintain cash flow required for debt service. Power project
obligations
construction also should be a major part of the long-term business
strategy of key contractors and equipment suppliers.

Strong third-party The trustee should be experienced in the administration and


trustee structure for management of power project construction, preferably as a
management of lender, and should retain an experienced engineer independent
construction funds of any other interest on the project.

4.2 The Power Purchasers


Dealing with the SEB Risk:
The biggest risk as seen in the Indian Power Sector Financing has been the weak
financial health of the State Electricity boards which are the primary purchasers of the

18
power generated in the country. The Transmission and Distribution losses have taken a
toll on the SEBs and as a result they have huge outstanding payments to be made to the
power generators. For example, Aggregate Transmission and Commercial Losses for
Uttar Pradesh, Jharkhand and Bihar are above 40%. This repayment risk has been the
bane of the sector and has deterred many potential investors from coming into the
sector.
Traditionally, a major issue has been to mitigate the risks associated with the SEBs
through widespread SEB restructuring and improvement in the security and payment
mechanisms. The lenders and the private investors view the SEB risk differently. The
lenders believe that the reforms path followed by successive central and state
governments has ensure that the repayment risks are going down but the private
investors still believe that the risks imposed on them make the required return on capital
too high to allow the project to take off.

Lenders’ Risks are Mitigating:


PSU FIs have never had a problem in lending to Power Projects supplying power to
SEBs. Commitment from Central Government on the speed of reforms was a comforting
factor. When they lent to the power projects, they worked on the projected financial
health of the SEBs assuming the reforms would go ahead. But they did identify that
there was a huge single party risk as power was not tradable. This component still
remains in many projects and they do have their mitigating mechanisms for that. They
ensure that they have the following three:
Irrevocable revolving Letter of Credit by the SEB in favor of the IPP
A designated prime area escrow account
State Govt. guarantee
Private Players still wary:
It was Andhra Pradesh that kick-started the entry of Private Investors back into the
power sector after the Dabhol debacle as the state was the furthest on the reforms path.
The SEBs have primarily started dealing with the PTC with no long term PPAs with the
IPPs. This may reduce the risk to a certain extent. But the confidence of the lenders is
not echoed by the private investors. Many instances can be sighted to support their
argument. For example Reliance Energy has not been dealing with any SEBs except in
Kerala. The experience of REL with SEBs has not been very comforting. Their payments
have been delayed in the past and the BSES Kerala plant has not been running at the
required PLF. The problem in dealing with the SEBs is the low level of consumer
awareness about the need to pay. IPPs have been insisting on an Escrow Account
whenever they negotiate a power purchase deal with the SEBs like Reliance Dadri plant.
Notwithstanding, substantial foreign private sector equity and finance will not stream into
the Indian power sector, until the major payment risks and power tariff issues are
mitigated. Foreign investors and financers require sanctity of contracts (including the
purchase of, and full payment for, contracted power), honored-payouts for purchased
power under binding guarantees (i.e., payment (i.e., counter guarantees) and debt (i.e.,
sovereign guarantees) security mechanisms), and the knowledge that invoices will be
paid in full and regularly without requiring litigation to ensure each payment.

19
4.3 Project Economics
The cost of power generation varies, depending on the type of fuel used. The choice of
fuel for a power plant is influenced by a number of factors such as the relative cost of
generation, availability, transportation constraints, and environmental hurdles. The
capital costs of power plants also vary significantly, based on the source of energy,
infrastructure, plant size, technology and equipment and interest during construction
(IDC).
4.3.1 Fuels Supply
As pointed out earlier, power plants with the lowest variable costs (Coal) should be
employed to meet the base demand, while those with a higher variable cost (Gas)
should be employed to meet the peaking demand. This will result in a minimum overall
variable cost of power.
Cost:
The delivered price of any fuel can vary significantly depending on the source of supply
(imported or indigenous) and the distance of the plant from the source of supply. Power
plants located near coal mines (pit-head plants) are able to generate power at a fairly
lower rate than plants that need to transport coal over long distances.
Supply:
An interruption in the fuel supply can lower the plant’s PLF, resulting in a higher overall
cost of power. Given the fuel supply constraints faced by existing power plants, banks
and financial institutions insist on a regular fuel supply arrangement (FSA) before
funding private sector power projects, especially those proposed to be funded on a non-
recourse basis. As a result, private power producers want to have legally enforceable
fuel supply agreements with fuel suppliers and fuel transporters where the power
producer would pay a premium on the price of the fuel, to ensure its adequate and
regular supply and would also guarantee a minimum off take of fuel from the fuel
supplier.
4.3.2 Capital costs
Power projects are highly capital-intensive and have a gestation period of 4-6 years. The
fixed component of the power tariff is linked to the capital cost of the project. Hence, the
capital cost of a power project is a very important determinant of the total cost of
generation. The capital costs of power plants also vary significantly, based on the source
of energy, infrastructure, plant size, technology and equipment and interest during
construction (IDC). Hence, it is not possible to set standard benchmark costs for power
plants. However, the capital costs of most projects in the private sector are assumed as
shown in the table above.
Table 4.4.2: Power Project Costs
Power Project Cost
Project Type Rs(Crores)/MW
Coal 4-5
Gas 3.5-4
Hydro 5-6

The various factors that affect the cost of setting up a power plant are discussed below.

20
Table 4.2: Factors affecting Costs
Factors affecting cost
Factor Remarks

The cost of setting up a coal-based plant is lower than nuclear plants and higher
Source of than those based on natural gas, naphtha and fuel oil. The high cost of coal-
energy based plants is attributed to the additional equipment required, such as coal-
handling and ash-handling plants.

The availability of water, transportation infrastructure, and power evacuation and


Infrastructure
transmission facilities influence the location of a power plant.

A larger plant costs less, in terms of cost per unit of capacity. Larger units also
Size
have better thermal efficiency and lower O&M costs.

Equipment costs account for 75-80 per cent of the total cost of a thermal plant.
Technology
However, depending on the choice of technology and equipment, the capital cost
and equipment
of two projects of the same size and using the same fuel can be different.

The long gestation period, and the capital-intensive nature of power projects,
Interest during
results in accumulation of the interest on debt till the commissioning of the plant
construction
which implies that delays in the implementation of a project could raise project
(IDC)
costs significantly.

The itemized cost break-up for a typical power plant is shown below
Table 4.3: Total Cost Break-up
Total Cost Break-up
Item Rs. Million per MW Percentage of total cost
Land and Site Development 0.3 - 0.5 1.0 - 1.5
Civil works including foundation 2.4 - 2.7 8.0 - 9.0
Plant and machinery 16.5 - 21.5 55.0 - 58.0
Consultancy fees 0.3 - 0.9 1.0 - 3.0
Preliminary & pre-operative exp. 3.6 - 4.5 12.0 - 15.0
Contingencies and escalation 4.8 - 5.1 16.0 - 17.0
Margin money for working capital 0.2 - 0.3 0.5 - 1.0
Total 30 - 45 100

4.3.3 Wholesale Tariff Structure


The term Availability Tariff -- in the Indian context -- stands for a rational tariff structure
for power supply from generating stations on a contracted basis. In the Availability Tariff
mechanism, the fixed and variable cost components are treated separately. The
payment of fixed cost to the generating company is linked to availability of the plant, that
is, its capability to deliver MWs on a day-by-day basis. The total amount payable to the
generating company over a year towards the fixed cost depends on the average
availability (MW delivering capability) of the plant over the year. In case the average
actually achieved over the year is higher than the specified norm for plant availability, the
generating company gets a higher payment. In case the average availability achieved is
lower, the payment is also lower. Hence the name ‘Availability Tariff’. This is the first
component of Availability Tariff, and is termed ‘capacity charge’.

21
The second component of Availability Tariff is the ‘energy charge’, which comprises of
the variable cost (i.e., fuel cost) of the power plant for generating energy as per the given
schedule for the day. It may specifically be noted that energy charge (at the specified
plant-specific rate) is not based on actual generation and plant output, but on scheduled
generation. In case there are deviations from the schedule (e.g., if a power plant delivers
600 MW while it was scheduled to supply only 500 MW), the energy charge payment
would still be for the scheduled generation (500 MW), and the excess generation (100
MW) would be remunerated at a rate dependent on the system conditions prevailing at
the time. If the grid has surplus power at the time and frequency is above 50.0 cycles,
the rate would be lower. If the excess generation takes place at the time of generation
shortage in the system (in which condition the frequency would be below 50.0 cycles),
the payment for extra generation would be at a higher rate. Likewise, if a state /
customer draws more power from the regional grid than what is totally scheduled to be
supplied to him from the various CGSs at a particular time, it has to pay for the excess
drawal at a rate dependent on the system conditions, the rate being lower if the
frequency is high, and being higher if the frequency is low. The deviation from schedule
is technically termed as Unscheduled Interchange (UI) in Availability Tariff terminology.
Figure 1.13 illustrates how and when the UI mechanism works.
Figure 4.1: Availability Based Tariff Framework

The payment due to the generation company by the buyer in any year is computed as
follows:
Total payment due = Fixed charges + variable charges + UI charges, where

Fixed charges comprise:


1. Interest on long-term debt
2. Depreciation
3. O&M expenses (including insurance expenses)
4. Return on equity
5. Incentive return on equity

22
6. Interest on working capital
7. Taxes
Variable charges comprise:
8. Cost of primary fuel
9. Cost of secondary fuel
UI charges comprise:
10. Cost of secondary fuel
4.3.4 Capacity Allocation for Central Generating Stations
CGSs were built to create economies of scale and to ensure an economically efficient
mix of energy sources, such as hydroelectricity and coal. CGSs were also designed to
complement the limited investment capacity of State Electricity Boards (SEBs). CGSs
serve more than one state, generally in the same region. As illustrated in Figure 1.14,
plant capacity is allocated in three parts:
1. 10% of the capacity is reserved for the state in which plant is situated.
2. 75% of the capacity is allocated among the various states as described below.
3. 15% of the capacity is reserved as unallocated for discretionary use as follows:
Given to states on need basis.
In the absence of emergency requirements, this share is split up among
the states in the ratio of their planned allocation
The allocation of 75% capacity is done as follows:
4. Center notifies each state about the available capacity and terms and conditions
5. States inform center about requirements
6. Center allocates capacity based on response of states
7. Once the capacity is allocated, it is fixed for the life of the plant
8. States may or may not draw their allocated share of power, but they still continue
to pay the fixed charges for their allocated share
In case of reduced availability of power for any reason, the share of all states in the
allocation is reduced in the proportion of their original allotment.

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5 Power Transmission
The transmission network in India currently reaches about 80% of the population. The
transmission infrastructure formerly consisted of five regional grids that were not
interconnected into a national grid. In 1998, restructuring efforts of the transmission
system began with the creation of the Powergrid Corporation. The state-owned
Powergrid (PGCIL) is responsible for transmission of about 40% of the electricity
generated in India. India has successfully established links between the regional grids.
In order to accomplish the planning objective for 2012, it is imperative to create an
investment framework for timely and adequate evacuation infrastructure and
transmission facilities. As per the Working Group for Power constituted by Planning
Commission, the estimated investment of around USD 36 billion is required in XI Plan for
completion of National Grid, its associated transmission system and state level
transmission infrastructure. Out of this, an investment of about USD 14 billion would be
required in central sector transmission systems alone and the balance in state and
private sector projects.
The actual investments in the X plan was around USD 12 billion out of which USD 5
billion was spent in central sector and the rest in state sector. While the investment
needs of XI plan have tripled, the absorption capacity, availability of financial resources
and the viability of utilities are likely to act as constraints in realizing these investment
projections.
Figure 5.1: Figure: XI Plan Investments in Transmission (USD Billion)

The investments by Central Sector have been more or less up to the mark in the past
and central sector is likely to meet the targeted investment in the XI plan. The state
sector investment has encountered constraints in terms of limited internal financial
resources, assured return on investment and funding of projects in North Eastern Region
(NER), Bihar, Jharkhand and J & K. The enabling conditions for raising the requisite
resources and sustaining the investments remain testing for state sector. The SERCs
need to promote investments in networks through appropriate pricing and regulatory
arrangements. Inadequate consideration on the above aspects can seriously restrict the

24
ability of the state sectors to raise investments. This can lead to shrinking of the state
level plans with consequent impact on central sector growth. The policies and measures
initiated so far have to be consolidated and carried forward to achieve the optimum
transmission targets.
The private sector participation is expected to increase as is evident from various Joint
Ventures (JV) formed between PGCIL and various private companies and also few
projects being developed by private companies through IPTC route. This would translate
into higher investment by private sector going forward. The Ministry of Power has
formulated guidelines to encourage competition in development of transmission projects.
These guidelines include:
1. CERC and SERCs to grant transmission licenses
2. Agencies to identify transmission projects for tariff based competitive bidding
3. CTU to fund preparation of detailed project reports.
4. The developer and concerned utilities to sign Transmission Service Agreement
(TSA) for payment of transmission charges on the basis of competitive bidding
and approval by appropriate Commission.
5. TSA to include an arrangement for payment security consisting of revolving letter
of credit of required amount and escrow arrangement.
6. Ministry of Power to appoint a committee to identify projects to be developed,
facilitate bid preparation invitation, and evaluation, finalization and signing of TSA
between the developer and the concerned utilities, and enable further
development of the project.
7. RLDC to assist the developer in case of default in payment.
8. CEA to monitor the progress of the project to ensure the timely completion.
The transmission forms a vital link of the electricity delivery chain. The different elements
of transmission such as policies, regulatory framework, open access, transmission
losses, transmission charges, private participation etc pose a challenge to the evolving
Power Sector in India. Merely adding transmission capacity to the existing infrastructure
may prove inadequate. It becomes equally imperative to revisit the individual elements in
order to remove the constraints in financing. The transmission network is the heart of a
competitive market. In today’s scenario, the transmission sector runs the risk of getting
trapped between competitive generating and distribution sectors. A lot requires to be
accomplished in this sector to realize the vision Power for All by 2012.
5.1 Private Sector Investment in Transmission Sector
More or less, transmission utilities in India are publicly owned, though private ownership
is permitted under the Electricity Act 2003, as long as common carrier principles and
open access are followed. Although, the Act is conducive for private players, the private
investment so far has been abysmally low with only few takers. The investor enthusiasm
has been subdued partly due to slow evolution of subsequent regulatory and policy
reforms. Moreover, the suspicions for investors are kept alive due to inadequate
experience of authorities in many states in dealing with private sector, past experience,
environmental clearances, technical and bureaucratic hurdles and delayed project
development. Despite this, the initial response of the domestic and foreign investors to
the policy of private participation has been optimistic. Planning Commission has
estimated USD 8 billion worth of investments to be pumped into the transmission

25
through Private Participation by 2012. This is about one third of the investment expected
from Private Players in the generation sector.
The efforts of MoP to attract private investment continue. In order to overcome the
apprehension and facilitate private investment, concept of Special Purpose Vehicles
(SPVs) on the lines of UMPP’s has been introduced. The SPVs comprising of Power
Finance Corporation Ltd (PFC) and Rural Electrification Corporation (REC) as the nodal
agencies will look into the contentious issues such as initial and detailed surveys,
feasibility reports, environmental clearances, obtaining transmission license and ‘Right of
Way’ (RoW), site identification and land compensation. Fourteen Ultra Mega
transmission projects worth USD 5 billion on build-own-operate (BOO) basis have been
identified underneath this scheme for developers under competitive tariff based bidding.
With the need for approvals obviated, successful bidders can focus on planning and
executing the projects. However, so far, expressions of interest have been invited for
only four projects and there has been delay in awarding these projects. As against the
original plan of finalizing developers by end of 2007, even requests for qualification have
not been invited.
5.1.1 Mode of Investment by Private Investors
The Electricity Act facilitates two modes for private hands in transmission projects. First,
through Independent Private Transmission Company (IPTC), where full fund has to be
mobilized by the private entrepreneur and the second through Joint Venture Company
(JVC), where equity participation between CTU or STU and private party is allowed. The
selection of private party is made by CTU or STU or both through competitive bidding.
However, the minimum qualification for grant of license requires implementation
experience of similar projects, operation and maintenance of transmission
lines/substations at appropriate voltage levels and financial requirement of net worth.
Most Indian private players neglecting a few do not qualify for the same, unless and until
they tie up with some International players.
The Joint Venture route for private participation is expected to be more favorable among
the potential investors. The Joint Ventures will have the expertise of PGCIL, thus
allowing better management of critical commercial issues like payment security and
operational issues like obtaining right of way (RoW), environmental clearances, etc. It is
being envisaged that about 70% of the total investment in private sector can be through
JV route while rest will be IPTC.
The first success story of JV was the Tala transmission line (49:51 JV between PGCIL
and Tata Power). Subsequent to this, a JV was formed between PGCIL and Jai Prakash
Hydro for power evacuation from Karcham Wangtoo hydropower project in Himachal
Pradesh. Another 26:74 JV between PGCIL and Reliance Energy was formed to develop
transmission lines associated with Koldam and Pārbati hydro projects again in Himachal
Pradesh. A JV has also been signed between Torrent power and PGCIL.
Contracts have been awarded to private parties through IPTC routes too such as to Tata
power for building 400 kV single circuit Kishenpur-Thathar-Wagoora transmission line
and Reliance Power for strengthening of Western Grid. A quick review of the CERC
orders for the above two projects through the IPTC route indicates several issues that
have delayed the execution of the two projects.

26
Box 1: The Tala Experience – India’s first private sector transmission project

Tala Transmission system is the first Private sector transmission project in India,
which has already set precedence for other projects to follow.
PGCIL established this first Public-Private joint venture in transmission sector with M/s
Tata Power in 2001. Powerlinks Transmission Limited, the joint venture company
(49:51 between PGCIL and Tata Power) implemented the major transmission lines of
Associated Transmission System of Tala hydro electric project in Bhutan, East-North
inter connector and northern region at about USD 34 billion. Tala received excellent
response from International Funding Institutions like IFC, including multilateral
financing from private sector arm of ADB, Manila and Indian Financial Institutions like
IDFC and SBI.
The Joint Venture Company received its transmission license from CERC, the first
such license in Indian power sector. Financial closure of the project was achieved in
May 2004. A debt of USD 233 million has been tied up with the consortium of
multilateral and domestic financial institutions. Tala Transmission System was
completed successfully in August 2006. PGCIL envisages implementing some more
transmission projects in Joint Venture with private sector.

For timely completion of National Grid, there is no choice but involving the Private Sector
in transmission. The limited fiscal space for increasing investment by the central as well
as state governments also accentuates the need for private sector in transmission. An
appropriate policy framework for private participation in the sector is necessary but not a
sufficient condition to improve the climate for private investment. Over the longer run, the
incentive for transmission utilities to invest in and maintain networks depends on the
transmission pricing. The fundamental challenges such as transmission pricing and
losses, political acceptance and support, maintaining transparency in project
implementation, delays in regulatory approvals, inadequate legal and commercial
framework and consistency in policy matters throughout the execution of PPPs need to
be addressed.
5.1.2 Tariff based bidding process for transmission
Central Electricity Regulatory Commission decided to get implemented two projects
forming part of Western Region System Strengthening Scheme-II through 100% private
sector participation based on international competitive bidding. In compliance to CERC
order, POWERGRID submitted Process & Procedure for selection of Bidders for
implementation of transmission lines associated with WRSSS-II projects B & C through
100% private sector participation via IPTC route to CERC in September 2005 which was
approved by CERC expeditiously.
Taking note of all the hiccups and delays in awarding and execution of the above
projects clearly demonstrates that clarity about process, scope and obligations play
important role in the success of the process. However, the eventual success of the
projects also demonstrates attractiveness of the competitive bidding route for infusing
more private investment in transmission sector.
Tariff coming out of the bidding process is found to be significantly lower than two
benchmarks based on estimated capital cost of the projects. It is concluded that
minimization of uncertainties and consequent reduction in risk perception of the bidders

27
lead to success of the bidding process. This success also establishes competitive
bidding as a viable option for private sector participation in transmission sector.
Simpler technical and financial bids are more likely to be perceived as fair by the public
and by other bidders. In this context, the decision of the CERC to change the complex
and somewhat ambiguous method of evaluating the bids based on the tariff calculated
from the cost and financing data submitted by the bidders to a simpler and unambiguous
method based on the tariff quoted by the bidders seems to have contributed significantly
in the success of the bidding process. Certainty and predictability plays an important role
in the success of the bidding process. Ambiguity and uncertainties in the bidding process
and provisions of the agreements, which are part and parcel of bid documents, greatly
contributes to the risk perception of the bidders. If uncertainties are too many or
perceived to have significant consequences, some of the conservative bidders may even
decide not to participate in the bidding process. Others may assume consequences of
uncertainties and ambiguities to have maximum possible cost impact and accordingly
may end up quoting much higher tariff.
Table 5.1: SWOT Analysis of Transmission Sector
SWOT ANALYSIS
STRENGTH WEAKNESS
Won confidence of World Bank, ADB High Capital Investment in Projects and
and other International Funding agencies heavy dependence on debt financing

Monopoly business & Govt. Protection Investment approvals required from GOI
Mismatch in Generation Project and
Transmission highway would enable setting up Transmission System adversely affect
of large size pit head stations having lower financial Strength
cost of energy Lack of Profit centre concept at regional level
Investment towards fuel transportation
Issues pertaining to transmission pricing
infrastructure could be avoided. and loss sharing
Delays in regulatory approvals and awarding
of the projects

OPPORTUNITIES
OPPURTUNITIES THREATS
Introduction of Private Sector participants Poor health of Consumers ( SEBs ) and recovery
to induct Financial resources can affect development of transmission systems
Innovative methodologies need to be adopted and hence future development
for recovery of transmission charges of Uncertainty in addition of planned generating
Highways Capacity
National Grid to be established through Lack of commensurate long term Funds
Govt. support as basic infrastructure, to meet Transmission Requirement
similar to National Road Highways Possibility of losing monopoly status in times
Existing Infrastructure for diversification to come and subsequent competition
into telecom Cost dependency on Exchange rate variation
Working in Regulatory regime

28
6 Power Distribution
Out of the three sectors of electricity delivery chain, the distribution sector in India has
been the most daunting sector. More than 80 % of the total energy consumption is
distributed by the public sector while the balance is distributed by the private sector.
The distribution sector is segmented into urban and rural parts. Both segments are
distinct with different challenges and concerns. The urban distribution is distinguished by
high consumer density coupled with higher rate of demand growth. The consumer mix is
mostly commercial, residential, and industrial. Rural distribution segment is
characterized by wide dispersal of network in large areas, high cost of supply, low
consumer paying capacity, large number of subsidized customers, un-metered flat rate
supply to farmers, non metering due to high cost and practical difficulties, low load and
low rate of load growth. The consumer mix in rural areas is mainly agriculture and
residential.
The biggest challenge of the distribution sector is the high Aggregate Technical &
Commercial (AT&C) losses. The current AT&C losses are in the range of 18% to 62% in
various states with a National average of 30%. The poor condition of distribution sector
has attracted the policy makers and regulatory attention. The need to improve this sector
was realized was felt at the beginning of X Plan and is ongoing in the XI Plan.
6.1 Key issues facing the sector
The problems in distribution sector such as lack of investment, commercial orientation,
high AT&C losses and distorted tariff policies have accumulated over the years. The key
issues effecting overall performance of the distribution sector are more or less common
across India. The critical issues facing the distribution sector are highlighted below
Issues related to high AT&C losses:
The biggest challenge of the power sector is the high AT&C losses. Both technical and
non-technical factors are contributing to high AT&C losses. More than 80% of the total
technical loss and almost the entire commercial loss occur at the distribution stage. The
average AT&C losses which primarily include theft, poor billing, collection inefficiency
and network losses currently exceed 30% for the country as a whole. Such high losses,
coupled with tariff distortions, have made the distribution companies financially unviable,
thereby constraining their ability to either fund their own investment needs or attract
private capital.
Table 6.1: Reasons for high AT&C Losses
Reasons for high AT&C Losses
Technical Losses Commercial Losses
overloading of existing lines and substations low metering/billing/collection efficiency
lack of up gradation of old lines and equipments theft, pilferage and tampering of meters
low HT: LT ratio Low accountability of employees
poor maintenance of substations lack of energy accounting and auditing
non-installation of sufficient capacitors

29
The all India T&D loss for the period 2002-07 has registered a drop of 6% while AT&C
losses have dropped by only 2%. The current AT&C losses in the range of 30% of the
power generated is one of the highest in the world.
Table 6.2: Average National T&D and AT&C Losses (%)
Average National T&D and AT&C losses (%)
Fiscal Year T&D AT&C
2002-03 32.54 32.54
2003-04 32.53 34.78
2004-05 31.25 34.33
2005-06 30.42 34.54
2006-07 28.61 32.07
2007-08 26.91 30.46
Source: CEA

The current AT&C losses are in the range of 18% to 62% across various states. The
average national AT&C loss is about 30%. There is wide variation of losses among the
states and discoms within the states. The major portion of losses is due to theft and
pilferage which is estimated at about USD 5 billion annually. Apart from theft, the
distribution sector is plagued with billing of only 55% and collection efficiency of 41% in
almost all states.
Table 6.3: State wise AT&C Losses
State wise AT&C Losses
Less than 20% Between 20-30% Between 30-40% Above 40%
Goa Andhra Pradesh Karnataka Delhi
Tamil Nadu Gujarat Kerala Uttar Pradesh
West Bengal Assam Bihar
Himachal Pradesh Rajasthan Jharkhand
Maharashtra Haryana Madhya Pradesh
Tripura Meghalaya Arunachal Pradesh
Punjab Chhattisgarh Manipur
Uttaranchal Mizoram Nagaland
Source: CEA

In financial terms, the commercial losses excluding subsidy have increased from USD
91 million in 1990-91 to USD 524 million in 2004-05. These losses have been attributed
to low metering efficiency, un-metered supply, theft and pilferages. MoP has estimated
that 1% reduction in T&D losses would produce savings of over USD 170 - 190 billion
and reduction of T&D loss to around 10% will generate an additional capacity of 10,000-
12,000 MW.
To improve the financial viability of utilities and reduce T&D losses, Accelerated Power
Development and Reform Program (APDRP) was launched in 2001. Under the APDRP,
MoUs (Memorandum of Understanding) and MoAs (Memorandum of Association) were
signed with state governments for linking government support to upgradation of
distribution network and progressively reducing the AT&C losses.

30
Issues related to state governments:
The distribution sector in India is for the most part under the purview of state sector .The
state sector has not shown proactive commitment in the reform process. The unbundling
and restructuring of State Electricity Boards (SEBs) conceived in 1990’s has been
delayed and some states are still undergoing unbundling. The limited financial support to
unbundled utilities during transition period has further delayed the reform process.
The poor financial support received by the state sector for providing subsidized power to
domestic and agricultural consumers coupled with inadequate administrative support in
curbing theft have adversely affected the revenue recovery. The frequent change in
policies by some state governments with regard to subsidies and free power to farmers
has also impacted the cost coverage of utilities.
Issues related to regulatory process:
Although, twenty one states have unbundled and formed SERCs so far, but some of the
SERCs are inadequately staffed with poor infrastructure. The unbundled distribution
licensees have also not been able to fully implement regulations and directives due to
financial resource constraints, lack of skilled human resources and inadequate
awareness. The tariff filings are often delayed due to lack of competency and resources
in discoms. In several cases, discom’s have to revise their filings on account of data
gaps or improper information. There is no transparency in data which leads to delay in
filing petitions and responding to queries from the regulator.
Issues related to corporate governance:
The focus of distribution companies for efficiency improvement is diverted mainly
because most of the distribution companies formed as a result of unbundling of SEB’s
are still not fully autonomous. The unbundling is limited to operational and technical
segregation only. Segregation of accounts, cash flow, human resources is not complete.
Successor companies are highly dependent on their parent company for financials, cash
flow, human resources, investment decisions and other administrative matters.
Reinforcement of existing network in the form of new transformers, new lines and
augmentation of existing transformers and lines commensurate with load growth is poor.
Also, the existing distribution networks are ageing which resulting in poor reliability,
increased Renovation and Modernization (R&M) expenses and poor quality of supply.
The distribution system has low HT:LT ratio. The consumer awareness about Demand
Side Management (DSM) is limited which results in to higher consumption and increased
losses.
Commercial and operational issues:
Ministry of Power (MoP) has estimated commercial losses at about USD 5 billion per
year. The commercial losses are primarily due to improper energy accounting, billing
processes, faulty metering, under-billing, theft, pilferage of energy and lack of
accountability within the organization. Many states have undertaken 100% metering
programs, but so far only 87% of the total consumers are metered. The low level of
collection efficiency is attributable to lack of accountability, inadequate collection
facilities, limited usage of IT and technology, billing errors and political and
administrative interference. The utilities are not able to conduct energy audit due to
inadequate metering and data collection system in place. Discoms do not have proper

31
load monitoring and control mechanisms which results in random control of the demand
and often leads to loss of revenue.

Issues related to technology:


The utilities especially in rural areas maintain manual records of consumers and as
result do not have complete record of all consumers resulting in revenue loss.
Electromechanical meters, manual reading of meters, manual bill preparation and
delivery and inadequate bill collection facilities leads to delay in revenue collection and
revenue leakage. Monitoring of consumer energy metering systems is critical to overall
revenue collection. Asset database is crucial in efficient management of assets and
claiming depreciation under annual revenue requirement. Almost all distribution
companies do not have real-time monitoring system for demand management. Most
discoms do not have distribution control centre for managing load shedding and
instructions from SLDC.
Issues Related to Private Participation
The experience of private participation in distribution has not been to the expected level.
However, the Electricity Act provides adequate signals in terms of attractiveness of this
segment for private investment. The Act provides for parallel and second distribution
licensee in same area of supply, which enables setting up parallel distribution lines in
specific areas. Private participation impediments can be largely attributed to the risks
involved. Until risks related to measurement of operational parameters such as losses,
regulatory risks and political risks are not minimized, the privatization opportunities may
be limited.
6.2 Privatization of Distribution
The Private distribution companies have already been operating in various parts of the
country, namely Calcutta Electric Supply Company (CESC) in Kolkata, Ahmedabad
Electricity Company Limited in Ahmedabad, Surat Electricity Company Limited in Surat,
Tata Power Company and Bombay Sub-urban Electric Supply Company Limited in
Mumbai and Noida Power Company in Greater Noida. These companies have been
functioning smoothly over a period of time.
Consequent to enactment of the Reform Acts, Orissa and Delhi have privatized
distribution in their States. Distribution was privatized in Orissa in 1999 and in Delhi in
July 2002. The Reforms act provide for constitution of Electricity Regulatory
Commission, restructuring of electricity industry and increasing avenues for participation
of private sector for taking measures conducive to the development and management of
the electricity industry in an efficient, commercial, economic and competitive manner.
6.2.1 Privatization of Distribution in Delhi
Delhi Electricity Reform Act was notified on 8th March 2001. In terms of the provisions of
the Reforms Act and on the basis of the recommendations of the consultant, the
Government of NCT of Delhi unbundled Delhi Vidyut Board (DVB) into six successor
companies viz.,
GENCO (Indraprastha Power Generation Company Limited) for generation of
electricity,
TRANSCO (Delhi Power Supply Company Limited) for procurement,
transmission and bulk supply of electricity,

32
Three distribution companies namely, DISCOM 1 (Central-East Delhi Electricity
Distribution Company Limited), DISCOM 2 (South-West Delhi Distribution
Company Limited) and DISCOM 3 (North-North West Delhi Distribution Company
Limited); and
One holding company (Delhi Power Company Limited).
Major equity of DISCOM 1 (Central East Delhi Electricity Distribution Company Ltd.) has
been divested to BSES Yamuna. Major equity of DISCOM 2 (South- West Delhi
Distribution Company Ltd.) has been assigned to BSES Rajdhani. Tata Power took over
the major equity of DISCOM 3 (North- North West Delhi Distribution Company Ltd.) as
North Delhi Power Limited.
6.2.2 Impact of Privatization on Distribution
Delhi is seen as the future model for privatization of distribution in the country and the
impact of the privatization was immediate on the performance. The Delhi power scenario
in itself has been rated the best in the country according to CRISIL and ICRA [CRISIL
and ICRA, 2004]. Prior to privatization, the Aggregate Technical and Commercial
(AT&C) loss level was 50.7 per cent. A loss reduction path of 17 percentage points was
charted for the private distribution companies over a period of five years. These private
companies have strong incentives to outperform these targets, since the loss reduction
would be equally shared between consumers and the distribution companies.
Distribution has been a tough business from the borrowers experience unless there is
adequate support from state govt. The non-financial aspects of the Discom business
include a constant need to keep pace with everything related to business in terms of
technology, regulatory changes, legal issues etc. Past experience has suggested that it
is tough to get appreciated. The financial aspects of the business include a necessary
time of 3 years for the business to stabilize. The returns are also not that attractive
compared to the risk involved. What makes business sense to the players is the fact that
they can takeover Discoms to protect their generation. So we can expect players like
Reliance Energy and Tata Power to move aggressively to take over Discoms in UP and
Maharashtra, where they have generation interests.

33
7 Project Financing
The Indian economy is poised for higher economic growth in the years to come. This will
require large investment in the infrastructure sectors including the power sector. The
National Electricity Plan of India aims to provide access to electricity to all households by
2010 and to meet all shortages by 2012. This will require an investment of around USD
200 billion to finance generation, transmission, distribution and rural electrification
projects.
During the 1990s, up to 80% of power sector funding came from the public sector,
followed by the private sector (10–15%) and official development assistance (5–10%).
Increasingly, both the central and state governments are facing the need to meet
competing budgeting requirement from other social sectors such as health and primary
education. The need for enhanced fiscal discipline and macroeconomic stability is also
placing a limit on borrowing capacity of the government both at central and state level.
Given the limited fiscal space for budgetary support for such investments, greater private
sector participation is inevitable. Inefficiency, administrative bottlenecks and poor and
inadequate infrastructure facilities, in particular continued shortage of electricity in India
under public ownership has necessitated enhanced private participation in the sector.
Power sector reforms have been initiated in India with the aim of creating an enabling
environment for private investment thereby helping to bridge the gap in public
investment. Persistent power shortages, inadequate public investment and the economic
crisis faced by India in the early 1990s led to the opening up of the power sector to
private investment and major policy initiatives were undertaken to encourage private and
foreign investment. The investment climate was further strengthened through gradual
restructuring of the state electricity boards (SEBs) and initiation of regulatory reforms at
the central and state level. More recently, enactment of the Electricity Act 2003 includes
enabling provisions for enhancing competition in the sector and to improve the
environment for private participation. The abolition of the single buyer model and phased
access to consumers has unlocked substantial potential for private investment in the
sector.
7.1 Types and Sources of Finance
7.1.1 Debt
Given the capital-intensive nature of power projects, mobilization of long-term debt
becomes critical to the development of power projects. Project finance debt is generally
secured by projects assets such that after paying operating expenses, debt and debt
service is paid from cash flows. Debt typically constitutes up to 70% of the power project
costs in India. The type of debt used in power projects finance structures has been
varied. The following are some of the sources of debt available to power projects
developers:
Government:
Traditionally, the main source of debt has been the government. Both the central
and state governments lend the money to utilities from time to time for expansion
plans or working capital. They extend loans for longer tenure and at lower
interest rates than commercial rates.
Multilateral Agencies:

34
In the past, multilateral agencies have funded expansion plans of central utilities
such as NTPC, NHPC or PGCIL. In the mid-nineties, they switched their focus
from lending to support power sector reforms in states aimed at mobilizing
investments and increasing economic efficiency. The have funded restructuring
and reforms efforts of SEBs. The tenure of these loans typically ranges from 15-
25 years, with moratorium of five years. However, the investments yielded limited
results, with the state governments faltering on the milestones attached to the
funding. Subsequently, the agencies discontinued lending to state reform
programmes. In the last couple of years, these agencies have shown greater
confidence in the sector, mainly due to Electricity Act 2003 and follow-up policies.
Majority of the funds from these agencies are still provided to Central Public
Sector Undertakings (CPSUs).
Commercial Banks and Financial Institutions
Commercial banks and Financial Institutions (FIs) have consistently increased
lending to power sector in the last 4-5 years. Most of the lending has been
skewed towards the generation segment. With the opening up of the T&D
segment to the private sector, commercial lending is likely to increase in future.
For generation projects, the standard tenure of loans is 13-14 years, which
included construction period and repayment period of 10 years.
Earlier the lending use to be under recourse financing, but in the last 4-5 years,
the lending institutions have become more liberal and comfortable with lending to
bankable power projects.
Although, commercial banks and FIs continue to increase their exposure to the
power sector, individual exposure of banks to the sector remains limited. This is
mainly because they are still constrained by financing limits as per prevalent
prudential norms prescribed by the Reserve Bank of India (RBI).
Niche Institutions
There are also niche institutions such as Power Finance Corporation (PFC) and
Rural Electrification Corporation (REC), which provide loans specifically to power
sector. While PFC provides loans for all kinds of investments, REC focuses
mainly on rural electrification. The state sector’s reliance on these institutions for
debt is very high mainly due to the competitive rates and liberal terms and
conditions offered by them.
In the recent past, due to their experience and expertise in the sector, these
institutions have been competing with commercial banks. Moreover, since issues
like asset-liability mismatch and exposure limits are not applicable to PFC and
REC, it is easier for these institutions to lend to the sector.
Insurance Companies
Insurance companies like the Life Insurance Corporation of India (LIC), General
Insurance Corporation of India (GIC) have extended financial support to the
power sector. There are limits on the investments prescribed by the Insurance
Regulatory and Development Authority of India (IRDA). Life insurance and
general insurance companies have to invest at least 15% and 10% of the fund
respectively to the infrastructure and social sectors.
External Commercial Borrowings

35
External commercial borrowings (ECBs) were quite a popular means to raise
finances until some time back, especially for large projects funding. These loans
are raised at Libor-plus rates, which are generally lower than the interest rates in
the domestic market. ECBs have declined of late due to RBI restrictions on
foreign funds flows for rupee expenditure and due to an increase in borrowing
costs as a result of the sub-prime effect.
Export Credit Agencies
Loans from export credit agencies are cheaper than commercial loans and are
generally used when equipment needs to be imported from a particular country.
These are likely to gain importance in the medium term mainly fuelled by the
requirement of importing super-critical units in the eleventh and Twelfth plan
periods, and until this demand is met by the domestic market.
Bonds
Several utilities and state power corporations have resorted to issuing bonds to
raise funds. These are generally subscribed by provident and pension funds,
gratuity trusts, insurance companies, mutual funds, individual, etc. These bonds
typically have tenure of 7-8 years.
7.1.2 Equity
The equity in power projects, like in other projects, is driven by the rate of return that is
expected from the investment apart from acting as a cushion to project finance. In the
power sector, the return on equity is fixed at 15.5% on 30% of the equity investment.
The sources of equity are promoter’s equity, internal accruals, equity funds and strategic
equity investors. Raising funds from capital markets is also becoming increasingly
popular. The following are some of the sources of equity available to power project
developers:
Promoter’s Equity And Internal Accruals
Most project developers invest some amount of the total project cost as
promoter’s equity to be able to earn the minimum return on equity and raise the
required debt. Many CPSUs, including National Thermal Power Corporation
(NTPC) are increasingly relying on internal accruals for investing equity in new
projects.
Primary/Capital Markets
In recent times, power sector companies have been raising funds from primary
markets through Initial Public Offerings (IPOs). Almost all IPOs of power
companies in the last two to three years have met with an overwhelming
response from investors or have been performing well in the stock markets.
Some of the successful IPOs have been those of CPSUs like NTPC, and PGCIL,
private developers like Suzlon Energy, JP Hydro and Reliance Power and
infrastructure companies like GMR, GVK and Lanco. Many power companies are
expected to launch their IPOs in the coming years. NTPC is also planning to
come out with a follow-on public offer.
Qualified Institutional Placements
Another source of equity, which is increasingly being tapped by power sector
companies, is private placement with qualified institutional investors. For
instance, GVK Power & Infrastructure Limited (GVKIL) and Kalpataru Power

36
Transmission raised USD 300 million and USD 85 million respectively through
this route in May 2007 and September 2006 respectively. PTC India also raised
around USD 29 million through this route in January 2008 by allotting shares to
institutional buyers like LIC and Morgan Stanley, among others.
Equity Funds
Specialized equity funds such as India Development Fund by Infrastructure
Development Finance Company (IDFC) have been set up to invest in equity in
private sector power sectors. The India Power Fund by PFC which was expected
to be launched in 2004 is however, yet to start operations. India Infrastructure
Finance Company Limited (IIFCL), Citigroup, Blackstone have also instituted a
USD 5 billion India infrastructure financing initiative for investing in infrastructure
projects. The Anil Dhirubani Ambani Group and Singapore’s Temasek Holdings
constituted the Reliance India Power Fund with equal contributions.
Others planning to set up infrastructure funds, which would pick up equity in
power projects as well, include a USD 2 billion infrastructure by ICICI bank, the
USD 1 billion Macquarie India Infrastructure Opportunities Fund by Macquarie
and International Finance Corporation (IFC), a USD 1 billion India focused
infrastructure private equity fund by Standard Chartered and IL&FS Investment
Managers and a USD 2 billion India Infrastructure Fund by JP Morgan and
Chase Company. PTC India’s investment arm PTC Financial Services also plans
to pick up equity in power projects through an Energy Equity Fund.
7.2 Trends in Power Sector Financing
Increased investor confidence resulting in commitment and disbursement of
more funds
IPP revival triggered by increased investor confidence
Gradually increasing interest rates leading to increased project costs
Increased availability of longer-term debt
Skew towards investment in generation continues
External Commercial Borrowings (ECB) loses sheen as RBI tightens norms
As local capital market mature, more companies are opting for IPOs
Lenders no longer demand government guarantees, counter guarantees.
Bankable and competitively priced projects are able to raise funds easily.
Project financing criteria relaxed by financiers for new types of projects.
Promoter’s track record is a important consideration
7.3 Key Power Financing
Power companies continue to raise funds through a variety of vehicles including public
offers, bond issues and debt syndication. Multilateral agencies have shifted back to utility
finance. Commercial Banks and FIs have also increased lending to the sector apart from
PFC and REC. The IPP segment has seen renewed vigour.

37
7.3.1 Financial Closures
Over the last year and a half, over 8,000 MW of private sector power projects have
achieved financial closure. Some of those projects are as under:
1,200 MW Rosa power project in Uttar Pradesh being developed by Reliance
Energy Limited.
500 MW Teesta VI hydro project in Sikkim being developed by Lanco Infratech.
1,200 MW imported coal based power project at Ratnagiri, Maharashtra being
developed by JSW Energy.
330 MW Shrinagar hydro projects in Uttarakhand being developed by GVK.
1,015 MW coal based Nagarjuna power project at Mangalore, Karnataka being
developed by Lanco Infratech and Nagarjuna Group.
1,000 MW Karcham Wangtoo hydro project being executed by Jaypee Group.
1,200 MW Teesta-III hydro project being executed by Teesta Urja Limited.
540 MW captive thermal power project at Chandrapur, Maharashtra being
developed by KSK Energy Ventures.
1,000 MW lignite based power project in Rajasthan being developed by JSW
Energy.
7.3.2 Central Sector Project Financing
In the past, NTPC and PGCIL have raised funds in the form of equity and debt. Their
equity component includes internal accruals, government budgetary support and joint
ventures (JVs), while the debt component comprises private placement of bonds, market
borrowings from FIs and niche institutions and loans from multilateral agencies. The
following are the details of some of the recent financings:
NTPC
In September 2006, NTPC entered into a loan agreement of USD 300 million with Asian
Development Bank (ADB) under latter’s complementary finance scheme for Sipat and
Kahalagaon Stage II projects
In February 2007, NTPC received a grant of USD 12 million from the ministry to
implement 14 distributed projects. The grants were given under the Ministry of
Power’s Delivery through Decentralized Management (DDM) scheme.
In March 2007, NTPC signed a loan agreement of USD 100 million with KfW to
part finance the expenditure on R&M of NTPC plants. This is the first loan
provided by KfW directly to NTPC.
In July2007, NTPC signed a MoU with ADB to set up a JV for renewable power
generation. NTPC and other government entities will hold 50% stake, while
strategic investors will hold the remainder. ADB is expected to acquire 20% stake
at a later stage. The JV is expected to hold a portfolio of about 500 MW of
renewable generation over the next three years, the initial focus being wind
power and mini and micro hydro power projects.

38
PGCIL
In 2006-07, PGCIL undertook capital investment of USD 1.5 billion. Of this it
mobilized USD 1 billion through private placement of bonds and the balance from
internal resources and multilateral agencies.
In the past, World Bank has extended USD 450 million as loan to PGCIL for
Power grid System Development Project II in 2001 and USD 400 million for
Project III in 2006. Other multilateral agencies such as ADB and JBIC have
extended a USD 400 million in 2004 and USD 3.14 billion in 2005 respectively to
PGCIL.
For funding its future projects, PGCIL is negotiating with the World Bank and
ADB for loan assistance of USD 600 million each.
7.3.3 State Sector Project Financing
During the period 2006 through December 2007, the state sector funded their power
sector programmes mostly with loans from PFC and REC or grants from the
government. Some of the details are as follows:
Tamil Nadu – In April 2007, REC signed a MoU with Tamil Nadu Electricity Board
for providing a loan of USD 3.8 billion over the next five years for augmenting
power sector capacity and transmission & distribution schemes.
Jammu & Kashmir – In March 2007, the government agreed to give a USD 900
billion special power reforms grant to J&K over three years.
Haryana – The Haryana Power Generation Corporation (HPGC) entered into
loan agreement with PFC and REC in May 2007 for construction of 1,200 MW
thermal power plant at Hissar.
7.3.4 Private Sector Overseas Financing
During the period September 2006 through December 2007, a few Indian companies
made some overseas investment. Some of these are as follows:
Suzlon’s acquisition of REpower – In May 2007, Suzlon Energy completed the
acquisition for German wind turbine maker REpower for Euro 1.34 billion. The
lead financiers for the acquisition were ABN Amro, SBI and ICICI Bank
TPC’s acquisition of PT Kaltim Prima Coal (KPC), PT Arutmin Indonesia and
other related coal trading companies owned by PT Bumi Resources Tbk - TPC
completed its acquisition of 30% equity in Indonesian assets for USD 1.1 billion.
It took a bridge loan facility of USD 950 million from a group of banks led by
Barclays Bank.
7.3.5 Qualified Institutional Placements
During the period September 2006 through December 2007, many private sector
companies raised money through QIP route. Some of these financings are as follows:
GMR Infrastructure Limited raised USD 950 million through a QIP of 9%
equity stake in December 2007 for various energy projects, airport project
and Special Economic Zone (SEZ).

39
Suzlon Energy raised USD 520 million through QIP of shares to repay a part
of debt raised to fund the acquisition of REpower and Belgian gearbox maker
Hansen Transmission International in December 2007.
CESC Limited raised USD 150 million through its QIP issue in December
2007 to fund its upcoming power projects.
7.4 Major Financiers in Power Sector
Power Finance Corporation
Rural Electrification Corporation
World Bank
International Finance Corporation
Asian Development Bank
Japan Bank for International Cooperation
Kreditanstalt fuer Wiederaufbau
Department of International Development
India Infrastructure Finance Company Limited
Infrastructure Development Finance Company
Life Insurance Company
Punjab National Bank
ICICI Bank
IDBI Bank
State Bank of India
SBI Capital Markets
7.5 Policy development for Private Investment
The economic crisis faced by India in 1990–91 provided an opportunity for unshackling
the economy by de-licensing a number of sectors. This led to the opening up of the
infrastructure sectors including power to enhanced private participation. The power
sector has witnessed various phases of policy developments. The earliest phase, which
began in the early 1990s, was aimed to improve the policy climate for private
investment. Later on, the emphasis was placed on regulatory reforms leading to the
establishment of independent regulatory commissions. The enactment of the Electricity
Act 2003 led to deepening up the reform process through the introduction of a
competitive regime in the Indian power sector. These policy and regulatory
developments are further discussed below in terms of specific policy milestones.
7.5.1 Electricity Act 2003
The conceptual framework underlying this new legislation is that the electricity sector
must be opened for competition. The Bill moves towards creating a market-based
regime in the power sector. As stated earlier, the Bill seeks to consolidate, update and
rationalize laws related to generation, transmission, distribution, trading and use of
power. The new Electricity Act, 2003, effective June 10, 2003, consolidated all previous

40
electricity laws in India. The enactment of this new statute was a welcome step for
foreign investors, as well as for private domestic players, for a number of reasons
including but not limited to, the following:

A power generating company has been allowed to establish, operate and


maintain power generating stations without obtaining a license on fulfillment of
certain conditions.
The Act allows private participation in transmission and distribution facilities
subject to licensing by the Central Electricity Regulatory Commission (“CERC”).
Licensors are to provide non-discriminatory open access to their transmission
and distribution systems for use by any licensee, generating company and
consumer, subject to the payment of certain charges.
Independent Power Producers (“IPPs”) and captive power generators have been
allowed to sell directly to any licensee or consumer on terms and conditions
agreed to between the parties, subject to the payment of certain charges.
The Appellate Tribunal for Electricity (“Tribunal”) has been established for
hearing appeals from decisions from the CERC and State Electricity Regulatory
Commissions (“SERC”s). The Tribunal will have powers similar to that of a civil
court.
The Act provides for re-organization of State Electricity Boards (“SEB”s) through
corporatization and unbundling
The benefits of the Bill are several however, all of these not likely to materialize in the
medium term. Until such an interim period when the free and open market systems are
developed, the role of the regulator will become very crucial. The role will be important
especially when promoting competition, fixing reasonable charges for transmission,
generating tariffs, fixing wheeling and cross-subsidy charges and in protecting the
consumers from the rising prices of electricity, more so in times of shortage.
According to the Industry Experts, SEBs will have to fall in line as they need to survive in
the heightened competition. The SEBs and other govt. utilities do not have an option to
just die out. The unbundling and privatization of the SEBs will continue. The SEBs T&D
revenues are set to improve with the advent of power trading. Being the sole owner of
the Transmission networks, they will have cash inflows in terms of wheeling charges and
access charges.
All new contracts being signed are primarily agreements with the Power Trading
Corporation as direct MOUs with the SEBs have a long lead time (18 months in some
cases) due to legal and other wrangles. This keeps the window open for Merchant
Power and Trading. But wholly merchant power based plants are also not viable. They
require that the borrowers have an agreement for at least a part of their generation, say
60%. Dabhol experience has also taught the Indian Power sector to not indulge in MOUs
but rather go for competitive biddings at all stages. This has further increased the
confidence in the system.
There have been setbacks on the way, like the free power promise to farmers in Andhra.
But to mitigate such risks, sponsors are obliged to take the first hit. As for the Act and
state utilities falling in line, the market really sees no option for them and has confidence
in the reforms process. But the full impact of the Electricity Act will take at least another

41
3-4 years with the clear policy on things like wheeling charges to take another 6-9
months.
The restructuring of the SEBs has been slower than expected. The private investors
believe that this is an inevitable process but it will take time, until which time dealing with
an SEB would remain a risky business proposition. Reliance thus would like to set up
power generation plants for supply to its own distribution circles. Dahanu plant supplies
to Mumbai and the Dadri plant is for power to Delhi and the prospective distribution
circles in Uttar Pradesh.
As for the reforms in the power sector, IPPs have seen a marked improvement in the
collections from urban areas mainly due to the increased awareness. The tariff policy
has delineated the roles of State govt., the utility (Private Generators) and the Consumer
(SEBs) in determining tariffs. The competitive bidding guidelines ensure that the private
players get their due tariffs. The govt. is looking to withdraw from direct investments in
the sector primarily due to a resource crunch and the establishment of the Regulators
has brought in a Quasi-judiciary setup, which will hopefully ensure a fair business model.
The Electricity Act has brought in a more commercial approach among all players, as
they have to compete in order to survive. The Act has proposed incentives for efficiency.
But lot more needs to be done. Things like tariff policy, wheeling charges, surcharge for
subsidy need to be clearly defined before the benefits of the Act are realized.
The competitive guidelines ensure that the financial health of the IPPs is not
endangered. The regulations ensure that an escrow account is provided for the IPP by
the state utility. The minimum off take is also guaranteed by the agreements. In case of
inadequate purchase or default on payment, the guidelines provide the IPP with an
option to cut-off the power supply with immediate affect, a drawdown on the escrow
account and merchant power selling. The power market as that is, the IPPs are very
sure of finding buyers for their power in case the SEBs default and even with the
wheeling charges, they believe the power supplied will be economical. The power
generated is at Rs.1.60 per unit plus wheeling charges of 25 paise on an average. The
total of Rs. 1.85 is lesser than Rs.2.10 that states of Karnataka and AP pay.
The Power sector still needs a more investor friendly regulatory setup. The private
investors still face a lot of problems when dealing with regulators for clearances and
security mechanisms etc. For example in Orissa, there was no change in tariffs and then
they were revised negatively this year. IPPs want transparency and consistent
interpretation of regulations in between states. IPPs want a more prudent commercial
and financial support system with the power sector being declared a priority sector. The
regulators also need to maintain a balance between all the stakeholders.
Numerous private players are looking for project financing, for both SEB supply and
Merchant Sales. But purely merchant sales are viewed with some reservations and it is
preferred if off-takers are identified and a proof of existing demand is furnished. SBI for
example requires that the power generators have an agreement for at least a part of
their generation, say 60%. The rest can be for merchant power.
With the advent of Power Trading as a provision of the Act, licenses for the same have
been awarded to Tata Power, Adani Group, Reliance Energy Limited and NTPC. This
also involves problems associated with open access and the regulatory framework is yet
to be decided upon. Unless things like wheeling charges, surcharge for subsidy and
access charges are decided on power trading cannot happen. Open Access has its own
problems. The biggest problem is of measuring usage of electricity and the ideal location

42
of metering. Discipline has been a problem in the Indian power sector, and for this ABT
and UI for traders also needs to be clearly spelt out.
India needs to do a lot of groundwork and ensure that there is a countrywide market
exposure available for the participants to diversify the risks. For this the need for
Transmission infrastructure is highlighted. Also needed is a proper settlement and
balancing mechanism. Open Access will take another 3 to 5 years to come into full
effect, as is the case with all other provisions of the Act.
7.5.2 Private Power Policy
In 1991, the government of India amended the Electricity Supply (Act) 1948 to allow the
entry of private investors in power generation and distribution. A tariff notification issued
in 1992, provided for a two-part tariff structure covering fixed and variable costs. It
provided for a 16% rate of return on equity at 68.5% PLF for thermal plants and (coal /
lignite/ gas) at 90% availability for hydro power plants. The achievement of higher
efficiency levels translated into higher rate of return for investors.
7.5.3 Mega Power Policy
In 1995, the government strengthened its policy for private investment in generation
projects over 1000 MW and which would supply electricity to more than one state,
terming them as Mega power projects. The policy was intended to introduce a
competitive bidding for awarding the projects. CEA, PGCIL and NTPC were to provide
catalytic support to private investors by identifying potential sites, arranging the
transmission of power and for preparing feasibility report respectively. The policy did not
propose any fiscal concessions. Some of these shortcomings were addressed in the
revised policy of 1998 (Revised Mega Power Policy). Nineteen projects, 14 in the public
sector and 5 in the private sector, were declared to be mega power projects. To alleviate
risks to private investors on account of payment security, PTC was setup to purchase
power from the identified projects and to sell it to identified SEBs. This included the
adoption of a new package of security mechanism consisting of Letter of Credit and
recourse to state government’s share of Central Plan Allocations. Establishment of
Regulatory Commissions and privatization of distribution in cities with a population
exceeding one million were included as pre-conditions in the policy. Import of capital
equipment for such projects was exempted from customs duty. The projects were also
granted income tax holiday for 10 years and, which could be claimed in any block of 10
years within the first 15 years. The policy was further liberalized by according mega
project status to all inter-state thermal projects of 1000 MW and above, and to all inter-
state hydro projects of 1000 MW and above. These projects were now able to secure
duty free import of capital goods.
Due to concerns over transparency associated with MOU-based projects, the
government issued norms for tariff-based bidding for thermal power projects in 1997.
Further, this role was handed over to respective regulatory commissions. These norms
were to serve as guidelines, and the regulatory commissions were to issue terms and
conditions for tariff and retain purview over the PPAs for sale of power to the respective
state utilities.
7.5.4 Policy Reforms for Investment in Transmission
In addition to generation, the sector also requires substantial investment in the
transmission network. In order to meet the projected requirement for additional power
generation capacity of 100,000 MW by 2012, the Ministry of Power estimates that the

43
investment requirement for the inter-state transmission network will be USD 17 billion. A
significant proportion of this (USD 12 billion) is expected to be undertaken by
POWERGRID, the Central Transmission Utility (CTU). The remainder (USD 5 billion) is
expected to come from by private investors.
As a means to encourage private investment in transmission networks, the Electricity
Laws (Amendment) Act 1998 was enacted. This facilitated the infusion of private sector
investment in transmission through grant of transmission licenses. Guidelines for private
sector participation in the transmission sector were introduced in January 2000. These
guidelines envisage two routes for private sector participation: Joint Venture (JV) route,
wherein the CTU/STU owns at least 26% equity and the balance is contributed by the
Joint Venture Partner (JVP) and the Independent Private Transmission Company (IPTC)
Route, wherein 100% of the equity is owned by the private entity. A joint venture
between PGCIL and Tata Power has successfully commissioned a 1200-km
transmission line to transmit power from Bhutan to the Northern grid in India.
7.5.5 Regulatory Reforms
An appropriate policy framework for private participation in the power sector is a
necessary but not a sufficient condition for to improve the climate for private investment
in the sector. Major hurdles faced by the private investors included frustrations in
receiving administrative approvals, payment risks with financially weak SEBs/distribution
utilities, lack of sovereign guarantees, political instability and the partially liberalized fuel
markets, especially for the coal sector.
The government realized that in order to attract much-needed private investment into the
power sector, the separation of the distribution segment of the power sector should be
carried out to improve its performance. Led by similar developments in a number of
countries around the world a process of reform was introduced in the state of Orissa. It
became the first state to unbundle the electricity board into five corporatized entities—
one each for generation and transmission, and one each for the three distribution zones
in the state. An independent regulatory commission (Orissa Electricity Regulatory
Commission) was also set up to oversee the functioning of the transmission and
distribution companies. Orissa later privatized its power companies. Subsequently,
Haryana and Andhra Pradesh also followed the twin strategy of unbundling and
regulatory reform. In 1998, the Central Electricity Regulatory Commission (CERC) was
set up under the Electricity Regulatory Commissions Act, 1998. The main functions of
the commission include regulating the tariffs of generating companies owned or
controlled by the Central Government or those serving more than one state, as well as
inter-state transmission and tariffs of transmission utilities.
At the state level, the State Electricity Regulatory Commissions (SERCs) introduced a
transparent procedure for tariff filing, its review, and the adoption of an order under
which the utilities would fix transmission and distribution tariffs for various consumer
categories. The process of tariff determination has become more transparent and
participatory due to public announcement of tariff filings by the utilities. This process
includes organization of public hearings and invitation for public comments thus bringing
credibility to the process. In order to alleviate consumer concerns regarding quality
improvement and better response by the utilities to their complaints, the SERCs have
not only undertaken steps toward the formulation of complaint handling procedure by the
utilities but also a system for themselves so that consumers can bring their concerns
before the commission. Twenty-five states have set up regulatory commissions out of
which twenty-one are functional, and 20 of these regulatory commissions (the SERCs)

44
have issued tariff orders. The smaller states (Manipur, Meghalaya and Nagaland) in the
North East have established a Joint Electricity Regulatory Commission. Thirteen states
have unbundled and corporatized their previously integrated SEBs. Orissa and Delhi
have privatized distribution. The bitter public experience and its political concerns have
led other state governments to take a more cautious approach toward privatization. The
independence of regulatory institutions remains undermined by indirect control over the
appointment of the members of the regulatory institutions and by delaying financial
independence to such institutions. The regulatory environment has nevertheless
reduced uncertainties associated with ad hoc behaviour by the electricity utilities under
political influence. The concerns regarding regulatory uncertainty and lack of incentives
in the rate of return regulation have been addressed through adoption of a multi-year
tariff (MYT) framework by the CERC. The Electricity Act of 2003 prescribed adoption of
MYT principles by all regulatory institutions. Some of the SERCs have initiated a
consultation process for introducing the same. However, its effective implementation
would be influenced by availability of reliable historical data which is crucial to designing
appropriate incentives.
7.5.6 Distribution Reforms and Privatization
Most of the ills of the Indian power sector find their origin in the distribution segment. The
distribution segment has lagged both in terms of operational efficiency as well as
financial performance. The slow pace of investment generation as well as distribution
segment can be attributed to the severe cash flow problem associated with the under-
recovery of costs and poor collection efficiency. Poor operational efficiency further
aggravates the situation.
Recognizing the need to accelerate reforms in the distribution sector the central
government introduced the Accelerated Power Development Programme (APDP) in
2000–01 to restore the commercial viability of the distribution segment. To encourage
reforms in the distribution sector, it was rechristened the Accelerated Power
Development and Reforms Programme (APDRP) during 2002–03. Additional emphasis
was placed on milestones for reforming the ailing distribution segment in the states. The
main objectives of the programme include improving the financial viability of state
utilities, reducing of aggregate technical and commercial (AT & C) losses, improving
customer satisfaction, and increasing the reliability and quality of the power supply. The
scheme also encourages the establishment of SERCs, metering of 11 kV feeders and of
all consumers, and energy audits at the 11 kV level. A number of state utilities gained
from the APDRP scheme by reducing cash losses and securing equivalent grants from
the central government. The reform linked investment component also motivated
restructuring and initiation of regulatory reforms in various states.
The privatization plan for distribution zones in Delhi specified a five-year tariff profile,
agreeable to the regulator (Delhi Electricity Regulatory Commission). This helped in
mitigation of regulatory risk by ensuring tariff certainty and performance milestones for a
five-year window. Even so, the privatization scheme was made possible by a substantial
subsidy budgeted by the state government over the five year period. This would not be
easy to replicate in other states. The Planning Commission has estimated that if the
privatization of distribution in other states is carried out in line with the Delhi model, it
would translate into a huge viability gap financing. In the privatized distribution zone of
Orissa and Delhi, T&D losses remain above 33% and 25% respectively. Given the not-
so-successful experience to date, the Planning Commission has suggested alternatives
such as last mile privatization involving metering, meter reading, billing and collection.

45
7.6 Framework for Private Investment
Policy reforms in the Indian power sector and regulatory initiatives have resulted in the
emergence of a framework for private investment in generation, transmission,
distribution and trading activities as outlined below. Available information related to
market entry, pricing framework and policy and regulatory framework have been
synthesized from appropriate policy and regulatory documentations, and is presented in
the tables below.
Table 7.1: Framework for Private Investment in Power Generation

S. # Market Characteristic Policy and Regulatory Framework

1 • SEB / Distribution licensees.


Customers • Customers accorded open access by respective SERCs.
• Traders .
• De-licensed thermal and captive generation.
• CEA’s concurrence required only for hydro projects over a
specified capital cost.
2 Entry
• No licensing for generation and distribution in rural areas.
• Built Own Operate (BOO) as well as Built Operate Transfer
(BOT) framework.
• Open access of inter-state and intra-state transmission.
• Phased open access of distribution network as specified by
the respective SERCs. Access to large customers
available in some states as early as April 2005.
Market (Customer)
• Provision for multiple distribution license (EA, Sec. 14).
3 Access
• Distribution licensees to purchase a percentage of the total
consumption of electricity in the area of a distribution
license from electricity generated using renewable
sources. Such percentage to be specified by the respective
SERCs. (EA, Sec. 86 (1) (e)).
• New IPPs—Competitive bidding as per guidelines for
competitive procurement by distribution licensees (EA,
Sec. 63).
• New IPPs—Non-competitive projects for sale to distribution
licensees, to be determined by CERC / SERC as the case
may be. As per terms and conditions of CERC/SERC, as
the case may be. (EA, Sec. 21 (1) (a)).
• Existing plants owned / controlled by CPSUs and state
owned generating companies (including new plants to be
Pricing Framework for
built up to next five years or as decided by regulatory
Sale to Distribution
4 commission as envisioned in the NTP), as per the terms
Utilities
and conditions of CERC/SERC.
• Existing IPPs and one time capacity extension up to 50%
as per existing or agreed PPA and terms and conditions of
CERC/SERCs, as the case may be.
• Distribution companies to buy a certain percentage of their
power purchase from renewable sources. Price determined
by the SERCs.
• Transactions due to real time imbalances as per the
frequency-linked charge for unscheduled interchange (UI)
under the ABT framework.
Pricing Framework for • For direct sale by any generating company / trader to
5
Sale to Open Access customers granted open access as per mutual agreement.

46
S. # Market Characteristic Policy and Regulatory Framework

Customers (EA, Sec. 49), subject to cross-subsidy surcharge and


additional surcharge to be determined by the respective
SERC.
• Rate of Return on Equity—15.5% (post tax)
• D/E Ratio—70:30
Financial Conditions for • Target availability for recovery of full capacity (fixed)
Tariff Determination for charges—85%
6
Generating Companies • Incentive—25 paise/kWh for ex-bus scheduled energy
corresponding to scheduled generation in excess of ex-bus
energy corresponding to target Plant Load Factor of 85%.
• Operational and financial norms notified by CERC.
• No direct subsidy burden—To be provided directly to the
Subsidy
7 distribution licensee by the respective state government, if
it desires to subsidize a consumer or class of consumer.
• Only in case of sale to open access customers—Cross-
subsidy surcharge and additional surcharge.
• Cross-subsidy surcharge to be eliminated by SERCs in
Cross-subsidy
8 phases. Cross-subsidy surcharge not applicable in case of
consumer switching to another distribution licensee. i.e., if
generator also secures distribution license of the area, it
avoids payment of cross subsidy or additional surcharge.
FDI
9 • 100% foreign equity permitted; through automatic route
• Private Power Policy 1991
• Mega Power Policy 1995 (Revised in 1998 and 2003)
• Electricity Act 2003
Policy Framework
10 • National Electricity Policy
• National Tariff Policy
• National Electricity Plan
• Ministry of Power guidelines
• Relevant regulations issued by the Central Electricity
Regulatory Framework Regulatory Commission as per applicable jurisdiction
11
• Respective State Electricity Regulatory Commissions as
per applicable jurisdiction.
• Appellate Tribunal for Electricity
• Central Electricity Authority (CEA)
• Inter Institutional Group to facilitate financial closure of
projects
Other Related
• Central Transmission Utility (CTU)—Power Grid
12 Agencies
Corporation of India Ltd.
• State Transmission Utilities (STUs)
• Regional Load Dispatch Centers (RLDCs)
• State Load Dispatch Centers (SLDCs)
• Regional Power Committees
• Power market development and emergence of Merchant
Power Plants.
Future Developments • Initiative for Nine Ultra Mega Projects for 36,000 MW
13
capacity.
• Scope for Regional Power Projects for import of electricity
in the country

47
Table 7.2: Framework for Private Investment in Inter-State and Intra-State Transmission
Market
S. # Policy and Regulatory Framework
Characteristic
1 • SEB / Distribution licensees for short-term and long-term
transmission of electricity;
Customers
• Open access customers for short-term and long-term
transmission of electricity
• Licensed by CERC (inter-state transmission) / SERCs (intra-
state transmission)
• Two routes for private sector participation:
2 Entry o Joint Venture (JV) route, wherein the CTU/STU owns at
least 26% equity and
o Independent Private Transmission Company (IPTC) Route,
wherein 100% equity is owned by the private entity.
• In concurrence with Central Transmission Utility (CTU) (inter
Market Access
3 state) / State Transmission Utility (STU) (intra-state) / RLDC /
SLDCs
• CERCs Terms and Conditions for Tariff—current conditions
applicable till March 2009.
4 Pricing • Regional postage stamp basis with normative D/E ratio of
70:30
• Guided by National Tariff Policy
• Rate of Return on Equity—14% (post tax)
• Target Availability for recovery of full transmission charges (AC
system—98%; HVDC—95%).
• Incentives—on prorate basis for availability above the target
Framework for
availability for the transmission system.
5 Return
• Return on Foreign Equity—Equity invested in foreign currency
is allowed a return in the same currency and payment is made
in Indian Rupees on the exchange rate prevailing on the due
date of billing.
• Operational and financial norms notified by CERC.
Subsidy
6 • No direct subsidy burden
Cross-subsidy • No direct cross-subsidy burden (indirect influence through
7
revenue stream of the distribution licensee)
• 100% foreign equity permitted through Independent Power
FDI Transmission Corporation (IPTC) route.
8
• As JV with local CTU/STU holding up to 26% stake in the
transmission company
• Guidelines for Private Investment in Transmission, 2000
• Tariff based Competitive-bidding Guidelines for Transmission
Service, 2006
• Guidelines for Encouraging Competition in Development of
Policy Framework Transmission Projects, 2006
9
• Electricity Act 2003
• National Electricity Policy
• National Tariff Policy
• Ministry of Power guidelines
• National Electricity Plan
Regulatory • Relevant regulations issued by the Central Electricity
10 Framework Regulatory Commission as per applicable jurisdiction
• Respective State Electricity Regulatory Commissions as per

48
Market
S. # Policy and Regulatory Framework
Characteristic
applicable jurisdiction.
• Appellate Tribunal for Electricity
• Central Electricity Authority (CEA)
• Empowered Committee constituted by Min. of Power
• Central Transmission Utility (CTU)—Power Grid Corporation of
Other Agencies
11 India Ltd.
• State Transmission Utilities (STUs)
• Regional Load Dispatch Centers (RLDCs)
• State Load Dispatch Centers (SLDCs)
• Regional Power Committees
• A transmission pricing that takes into account distance and
12 Future Developments direction in addition to the quantum of power flow (National
Electricity Policy).

Table 7.3: Framework for Private Investment in Distribution


Market
S. # Policy and Regulatory Framework
Characteristic
1 • End consumers
Customers
• Other state utilities
• Distribution License for Urban areas issued by SERCs
• Provision for Multiple Distribution License
2 Entry • Distribution (including generation) in rural areas is de-licensed.
• Distribution Licensees can appoint franchisees for operations
within their license area.
Market Access • Third party access through phased open access by SERCs.
3
• Provision of multiple distribution licensees by the SERCs.
• Rate of Return on Equity - 14% (post tax)
• Retail tariff determined by SERC under Rate of Return
Regulation.
• Multi-year tariffs (MYT) framework to be introduced by SERCs.
• Access to distribution network priced by the SERCs.
4 Pricing Framework • Third party access attracts a cross-subsidy surcharge and
additional surcharge to be determined by the respective SERC.
Cross-subsidy surcharge to be eliminated by the SERCs in a
phased manner.
• In case of multiple distribution licensees, SERCs may fix only a
maximum limit on tariffs (EA, Sec. 62(1)(d)).
• Rate of Return—National Tariff Policy specifies a rate of return
Financial condition for on equity of 14%.
5 tariff determination • SERCs can consider higher return for the distribution business
due to increased risk to investors.
• Operational and financial norms notified by respective SERC.
Subsidy • To be provided in advance by the state government to
6
subsidize any consumer or class of consumer. (EA, Sec. 65)
• Industrial and commercial consumers cross subsidize domestic
Cross-subsidy and agricultural consumers.
7
• SERCs to reduce and eliminate cross subsidy in a phased
manner (EA, Sec. 39)
8 FDI • 100% foreign equity permitted; through automatic route.

49
Market
S. # Policy and Regulatory Framework
Characteristic
• Private Power Policy
• Electricity Act 2003
Policy Framework • National Electricity Policy
9
• National Tariff Policy
• Ministry of Power guidelines (for competitive procurement and
• bidding)
Regulatory
10 Framework • State Electricity Regulatory Commissions

• Multi-year Tariff
Future Developments • Privatization of distribution utilities formed after restructuring of
11
erstwhile SEBs.
• Performance based regulation.
• Appellate Tribunal for Electricity
• Grievances Redressal Forum and Ombudsman
Other Agencies, • Accelerated Power Development and Reforms Programme
12 Programs • (APDRP)—targeted at efficiency improvement and reduction of
losses of distribution utilities.
• Rajiv Gandhi Grameen Vidyutikaran Yojana (for Rural
Electrification)

Table 7.4: Framework for Private Investment in Inter-State and Intra-state Trading
Market
S. # Policy and Regulatory Framework
Characteristic
1 • License by CERC (for inter-state trading)
Entry
• License by SERCs (for intra-state trading)
• License for annual trading volume linked to net worth of the
Market Access
2 licensee in accordance with trading regulations issued by
CERC/SERCs.
• For trading under competitive bidding, there is no regulation
of price.
• For negotiated trading transactions, the maximum trading
3 Pricing
margin on inter-state trading has been fixed by CERC at 4
paise per kWh.
• Margin for intra-state trading.
Rate of Return • No rate of return assured for trading activity
4
• Cap on maximum margin for negotiated trades.
Subsidy
5 • No direct subsidy burden
• For sale to distribution licensees. No direct cross-subsidy
burden (indirect influence through revenue stream of the
Cross-subsidy distribution licensee due to cross-subsidization of the tariff for
6
certain category of consumers)
• For sale to open access customers. Cross-subsidy surcharge
and additional surcharge determined by the SERCs.
FDI
7 • 100% foreign equity permitted; through automatic route.
• Electricity Act 2003
Policy Framework
8 • National Electricity Policy
• National Tariff Policy

50
Market
S. # Policy and Regulatory Framework
Characteristic
• Guidelines for competitive procurement by distribution
licensees
Regulatory
• Relevant regulations issued by CERC / SERCs, especially
9 Framework
those related to trading and open access.
• Market Development initiatives such as Power Exchange that
Future
would allow futures and spot trading.
10 Developments
• Regional Electricity Market encompassing electricity trade
with neighboring countries.

As per the National Tariff Policy, new projects to be undertaken by the CPSUs/state
generating companies during the next five years need not undergo the process of
competitive bidding. Tariffs for such projects would be determined by the CERC/SERCs
under the prevailing rate of return framework. This offers a window of opportunity for
foreign investors as minority stakeholders in such projects.
A number of crucial policy initiatives have been put in place to create an enabling
environment for private participation. The immediate concern for the Indian power sector
is to improve the performance of distribution utilities as this influences payment security
for private investors in generation and transmission projects. The development of a
power market would also help improve investment climate by providing efficient signals
for investment and would offer an alternative market in case of payment problem with
the state utilities.
Although policy reforms and growth prospects were able to generate interest from
private investors in the power sector in the 1990s, bureaucratic delays often frustrated
investors’ efforts and many project proposals fell through. In spite of such hiccups,
private investors have acquired a stake in the growth of the Indian power sector. The
following section reviews the state of private and foreign investment in the sector.
7.7 Status of Private and Foreign Investment in Power Sector
7.7.1 Private Investment in power sector
The economic crisis facing the country in the early 1990s opened up opportunities for
private, including foreign investment, in the Indian power sector. The Private Power
Policy 1991 opened up the path to private and foreign investment in the generation and
distribution of electricity. Private investors were offered a 16% return on equity, which
was further incentivised in the case of higher efficiency levels in terms of plant load
factor (PLF). The policy framework for private investment was further strengthened
through the introduction of the Mega Power Policy in 1995 for thermal projects over 1000
MW and hydro projects over 500 MW. This was revised in 1998 and a number of fiscal
incentives were added for large power projects. Initially, these initiatives generated
overwhelming initial interest from local as well as international private investors.
However, the insolvency of the sole buyer, the SEBs, and delay in project development
frustrated the efforts of private investors. Clearly the investors were not finding the
assured 16% return on equity to be commensurate with the risk of investing in the sector
at that time. They sought the comfort of sovereign guarantees, which were limited to
eight fast track projects, a misnomer. Enron’s Dhabol power plant, which was one
amongst them, has been riddled with controversies since it was first agreed upon. The
controversial PPA, which was lopsided in the favour of project developers, was

51
renegotiated amidst a political drama. It later fell into serious trouble when the parent
company Enron faced trouble back home. The controversy has recently been settled
after the foreign investors’ stake was purchased by a SPV created by state-owned
companies.
Growth in the power sector since independence has been primarily accompanied by
public investment through economic planning. As a result of this, most of assets in the
electricity sectors are owned by government-owned companies or the SEBs. The
erstwhile SEBs own about 55% of the generating capacity followed by the central sector
generating companies, which are owned by the central government. Since the policy
liberalization in 1991, around 8,500 MW of conventional capacity and around 9,000 MW
of renewable capacity have been added by private sector by March 2008. Most of the
distribution network is owned by the state utilities. A few urban areas, some of which
have been licensed to private companies for nearly a century, and the distribution
companies in Orissa and Delhi, are under majority private ownership. The transmission
segment is dominated by public ownership with the exception of the upcoming public-
private joint venture for importing electricity from the Tala hydroelectric project in Bhutan.
Given the limited fiscal space for increasing investment by the central as well as state
governments, and requirements for future investment, there is a greater scope for
private participation in the sector.
The geographical distribution of private power projects in the country reveals a
preference for the southern and western regions of the country.
Table 7.5: Privately Owned Generation Capacity and its Share as in March 2008
Regions Total Capacity (MW) Private Capacity (MW) Percentage Share

Northern 38,210 1,494 4%

Western 43,305 7,975 18%

Southern 39,344 9,125 23%

Eastern 19,784 1,445 7%

North-Eastern 2,340 24 1%

All India 142,983 20,063 14%

The relative dominance of states in the southern and western regions could be explained
as follows. In terms of financial and operational performance, and reform parameters,
the power sectors in the states of Andhra Pradesh Gujarat and Karnataka have been
rated amongst the best in recent years. In terms of overall investment attractiveness, the
states of Maharashtra, Andhra Pradesh, Karnataka, Tamil Nadu and Gujarat have been
rated the top five destinations by foreign investors.
Table 7.6: Top Five Rated State Utilities
Rank 2003 2004 2005 2006
1 Andhra Pradesh Delhi Andhra Pradesh Andhra Pradesh
2 Karnataka Andhra Pradesh Gujarat Gujarat
3 Haryana Goa Delhi Delhi
4 Rajasthan Karnataka Karnataka Karnataka

52
Rank 2003 2004 2005 2006
5 Maharashtra Gujarat Tamil Nadu West Bengal
6 Delhi Haryana Goa Goa
7 Gujarat Punjab Himachal Pradesh Himachal Pradesh
8 Himachal Pradesh Himachal Pradesh West Bengal Himachal Pradesh
9 Tamil Nadu Uttar Pradesh Uttar Pradesh Maharashtra
10 Punjab Rajasthan Chattisgarh Kerala

The investors perceive relatively higher risk for investment in the distribution segment,
which is characterized by inefficiency and is exposed to regulatory risk. The limited
experience of distribution privatization in Orissa and then in Delhi also fails to present
encouraging results. Distribution, being a state issue, is highly influenced by local
political dynamics. Since privatization would suggest an increase in tariffs and less
space for inefficiency, there is resistance from within these organizations. Due to the
poor financial status of most of the state utilities, the privatization of distribution requires
support by the respective state government. In the case of privatization of distribution
companies (Discoms) in Delhi, the state government committed substantial financial
support to the private investors over a period of five years against benchmarks for
efficiency improvement, in terms of the reduction of Aggregate Technical and
Commercial (AT&C) losses. Improving the financial and technical performance of the
state utilities would be an effective alternative to this financial dole. More recently, a
number of state distribution companies have shown signs of turnaround, as seen
through improvements in various financial and technical benchmarks. This is a positive
sign for prospective investors in greenfield generation assets and for future privatization
of these Discoms.
7.7.2 Foreign Investment in power sector
Liberalization of the Indian economy in the early 1990s was aimed at attracting private
domestic as well as foreign investment. The policy framework for FDI in the power sector
is designed to offer unhindered flow of capital from outside the country. It provides for
100% FDI in the power sector through an automatic route.
For the period 2000 to 2005, the actual FDI in the power sector amounts to USD 1.1
billion whereas the approvals were a staggering USD 12.9 billion. This provides a lot of
insight into the agony of foreign investors, whose efforts were frustrated during the
process of project development.
Over the last few years, the emerging growth theory has led to significant investment in
the Indian stock markets. Some of the listed power sector companies have witnessed
significant interest from the Foreign Institutional Investors (FIIs). This speaks only about
the private and the professionally managed companies owned by the central
government. The NTPC earns returns in a regulated environment and is exposed to a
very limited payment risk since the tripartite agreement on SEB dues was concluded.
The BHEL’s attractiveness is attributed to the fact it has easy access to a relatively
protected and growing market. It continues to enjoy a preference in the equipment
procurement by the CPSUs. Although this kind of portfolio investments reflect positive
sentiments toward the sector but these are not a sustainable means for attracting
financing to the sector. Such investments are also subject to volatility and do not
significantly assist in sustainable asset addition in the sector.

53
While the sustainability of large public investment in the sector is desirable, there is
growing need for investment in other social sectors like health, primary education etc.
Apart from this, the concerns for management of government finances leave much to be
desired from the private sector. In order to meet the long-term growth requirements of
the sector, the sustainability of private and foreign investment is also desirable. This,
however, is influenced by a number of factors—policy and regulatory environment, legal
framework, and financial attractiveness.
7.8 Issues and Concerns
The public sector has been the main provider of power sector infrastructure in India.
Given the exponential growth in investment requirement the public financing will not
alone be able to generate the needed levels of investments. The government strategy
for bridging the deficit has to include:
Revising policies and regulations in the power sector for enhancing private
sector participation through public-private partnerships (PPPs)
Enabling arrangements for long-term funds through all possible sources
Strengthening the capacity at all levels for promoting PPPs for power sector
development
The major issues and concerns hampering the desired growth in the power sector are as
under:
Projects delayed due to inability to achieve financial closure: Due the Tenth Plan
period, projects totaling around 5,300 MW could not take off due to a lack of payment
security as a result of which funds could not be tied up. IPPs have been attempting to
achieve financial closure for their generation projects plans, but continuing doubts about
the financial viability ensures that due diligence and related activity drags on.
Concerns about inadequacy of funding for the Eleventh Plan: As mentioned earlier,
the fund requirement of the power sector has been estimated to be around USD 200
billion to achieve ambitious targets across the entire value chain. In light of this,
availability of funds may be an issue in case all the projects fructify, contrary to past
experience, and go to the market for funds at the same time. The existing lenders,
particularly banks and FIs, would be unable to fund such massive requirement as they
are constrained by prudential and sectoral limits. In addition, the non-availability of long-
term sources of funds would hinder lenders to take long exposure as per requirements of
the projects.
Sector experts suggest that to overcome these difficulties, the debt market needs to
develop and long-term pension and insurance funds need to be channelised. Further,
the proposal to use a part of the country’s foreign exchange reserves through a SPV
floated by IIFCL could also become an important source of funding in the future. The
Working Group on Power for the Eleventh Plan has suggested modifications in the ECB
guidelines to allow PFC, REC and IDFC to borrow funds from the overseas market
under the automatic approval route and exempting debt servicing from income tax.
Lenders continue to insist on various clearances and contracts to be in place
before committing funds: Lenders are still looking at the strength of the contracts, like
PPAs, FSAs, and EPC contracts. Multiple PPAs are highly favoured by banks, especially
if they involve credible buyers. These doubts arise mainly on account of continuing
concerns over the credit quality of the customers (state utilities), bureaucratic hurdles

54
and costs involved in obtaining clearances from the authorities as also in negotiating
project contracts with them.
As for the FSAs, lenders look at the cost of the fuel, its availability, whether its supply is
assured over a period of time and the price volatility associated with the fuel. They are
also concerned whether there is an agreement in place with the Indian Railways or
ports, depending on the project requirement, to transport fuel.
Depending on the fuel type, lenders also examine the environmental impact and want to
make sure that all necessary environmental clearances have been obtained. In the case
of hydro projects, rehabilitation and resettlement plans are also examined.
As for the EPC contract, the cost of the contract, the strength and reputation of the EPC
contractor as well as the technology being used are important considerations. Lenders
are now looking beyond just the existence of the contracts, particularly with respect to
EPC contracts. One of the concerns is that there are a few good construction
companies, most of which are over booked for next 3-4 years. Lenders are now
analyzing the previous record of these EPC companies for adherence to delivery
schedules to assess if equipment delivery and construction would take place on time.
Market imbalances remain to be addressed: An area of concern is the gap between
financial closure and commencement of construction. This translates into a gap of
around 6-18 months between sanctions and disbursement. Lenders are generally not
comfortable with this as they commit sanctions at certain rates and have to hold on to
funds and the rates till the time of disbursement. Also, sector experts indicate that
interest rates for power projects are not based on logical risk-return maturity pricing and
are generally independent of tenures. This is because too many lenders are chasing too
few good projects.
7.9 Enabling environment for the private sector
In order to facilitate greater private sector participation in power sector projects, the GoI
needs to concern themselves with the following issues:
Transparency of process: Private sector investment opportunities are conditioned on
the existence of specific government policies and programs that encourage private
sector entry and a transparent system of evaluating bids and awarding contracts.
Competitiveness of bids: Transparency and public accountability are best achieved by
using a competitive bidding process to select contractors for infrastructure projects.
Appropriate allocation of risk: Risk sharing among the government, utility, lenders,
and developers is at the heart of most reservations or debate about private sector
BOT/BOO (build-operate-transfer/build-own-operate) projects.
Developer returns commensurate with risks: Quantifying the risk inherent in—and, by
extension, acceptable equity return on—large power sector projects is difficult but
essential.
Stable policy regime: Private investors in power sector, whether they are domestic or
foreign, seek a policy regime (including such elements as the tax and investment
frameworks) that is both stable and predictable.
Government guarantees and credit enhancements. Bilateral and multilateral
guarantees and credit enhancements are often critical to the successful financing of
power projects in India (including, among others, independent power provider) projects,

55
particularly during their early years and the transition from state dominance to a more
market-oriented economic system.

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8 Risks associated with Indian Power Sector
Historically, since its commencement of economic liberalization in 1991, India’s
increasingly insatiable power needs, along with its general trend toward economic
liberalization, led to much interest among foreign investors in establishing IPP projects in
India. While dozens of projects were approved, and the foreign and Indian private
sectors constructed several such power plants between 1992 through 2004, most of the
largest projects have been stalled by considerable payment risk issues. A number of
factors in the power sector hampered IPPs from attaining financial closure. These
factors include, but are not limited to, the following:
Lack of credit worthiness of the SEBs
Substantial cross-subsidies and politicized tariff setting
Inadequate off-take and payment guarantee mechanisms
Inadequate fuel supply and transportation agreements, with the significant issues
involving how to cover risks between the SEBs, Coal /Gas supply
8.1 Project Evaluation and Risks
A credit analysis on the sponsors is conducted for every project before finances can be
arranged. These reviews are often conducted according to a process that differs from
one bank to another, but certain fundamentals are constant. Typically, a separate credit
department that uses a rigorous set of criteria to determine the creditworthiness of the
project, the sponsor, and the off taker performs the analysis.
Power has always been used as a Political handle in the country due to its widespread
economic implications both for the industrial as well as the agricultural sector. Thus the
major risks in the Indian Power Sector would be country, political and economic risks,
lending risks and project risks. Also an analysis is warranted for company management.
The following risks are typical of the Indian scenario:
Permitting risk and Political opposition to the project
Inability to obtain a financeable power purchase agreement, either because the
power price is too low or the terms are not acceptable
Regulatory disapprovals and Change in law
Following is a comprehensive list of all the risks involved in project finance for power
sector in India:
Table 8.1: Risks involved in project finance for power sector
Industry cycle
Industry
Industry prospects over the life of the loan
Customer mix and growth prospects
Market and service area Credit quality of major industrial customers
Economics of conservation and DSM
Market Share
Alternatives offered to consumers
Competitive position
Variable and total cost of production
Extent of large customers

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Adequate Availability
Fuel and power supply
Fuel costs and contracts
Percentage of Off takers Locked in
Dealing with which SEB
Operations
Transmission and Evacuation Facilities
Back to Back Overrun Penalty Contracts
Major assets as % of net plant & common equity
Asset concentration
Operating independence of major facility
Support for reasonable cash return
Regulation Quickness of decisions & Adjustment mechanism
Creative ratemaking in competitive markets
Company financial performance & credit standing
Company experience and sustainability to see project through
completion
Understanding of the Infrastructure Project space and a long
Management/Promoter
term commitment to Infrastructure Development
Company Evaluation
Sufficient capital to sustain: operating losses, shortfall in
liquidity and shortfall in receivables
Business plan, source of repayments and dependence on one
consumer
Repayment Risk Letter of Credit
Mitigant Prime Distribution Area Escrow Account
Debt Equity Ratio
DSCR
Debt Service Reserve Fund
Financials
Upfront Promoter Equity Contribution
Pass through Fuel Price Risk
Pass through Foreign Exchange Risk
Tariff Competitive Tariffs

8.2 Risk Mitigating Mechanism


To reduce the exposure to the financially weak SEBs and their business risk, the
mechanism relies on the IPP to establish multiple layers of security from the SEB and
the state government to support its power purchase agreement (PPA).
Irrevocable Letter of Credit by the SEB in favor of the IPP
A designated prime area escrow account
SEB reforms
PTC Power Purchases
State Govt. guarantee if applicable
Irrevocable Letter of Credit (LOC):
In a typical “PPA”, the generating company submits an invoice within an agreed
timeframe. The invoice is generally payable through an irrevocable revolving letter of
credit (“LOC”), issued by the concerned SEB through its banks. However, in case of a
default, the bank may simply refuse to renew the LOC, and the generating company may
end up facing the same risk.

58
The irrevocable letter of credit is an instrument issued by a bank guaranteeing payments
on behalf of its customer (the SEB) to a beneficiary (IPP) for a stated period of time and
when certain conditions are met. Although IPP developers would like to have long-term
LCs, banks have been reluctant to offer these and LCs would most likely be one-year
and irrevocable. The SEB would be required to open a LC for a value equal to three
months average IPP billing. The payment made under these LCs would be immediate if
the SEB failed to make a payment to the IPP for any reason. The bank would either
issue the LC under the working capital limits already approved for the SEB or it would
issue a new credit for this specific LC. Upon a draw under the LC, the SEB would be
required to reimburse the bank within three days. In the event that the SEB does not
reimburse the bank, the bank can refuse to revalidate the LC.
Escrow Account:
An escrow arrangement is another mechanism to protect against the SEB credit risk. It is
usually a complex arrangement, whereby an escrow agent is appointed for the specific
project. The escrow agent establishes escrow accounts, an SEB account and a
generating company account. Such agent also creates a charge and hypothecation over
the SEB receivables. In the event of a default in payment, the escrow agent transfers an
equal amount of receivables from the SEB escrow account to the generating company’s
account. It is advisable to retain some amount as security in the escrow account in order
to provide effective security to the generating company.
The escrow account would be an account opened by the SEB for the benefit of the IPP.
The escrow account would be administered by an independent escrow agent (normally a
bank). A three-party agreement would be entered into among the IPP, the SEB, and the
escrow agent, who would act as an agent of the IPP. The cash flows (receivables) of the
SEB from selected customers would be deposited directly into the escrow account
instead of being paid to the SEB. If no event of default has occurred and there are no
outstanding draws under the LC, the agent bank will transfer the funds from the escrow
account to the SEB, and the SEB will meet its IPP and other payment obligations. In the
event of default, the flow of funds from the escrow account to the SEB would be stopped
and the escrow agent would make payments from the escrow account directly to the
IPP.
However, there are a number of difficulties involved in the escrow account security
mechanism. One such problem is the simple failure of an SEB to fund the escrow
account. In such case, a hypothecation agreement can be protective, as it would shift
payments of power purchasers from the SEBs directly to the electricity generator.
SEB Reforms:
In the long run, reforms must concentrate on how the SEBs may collect more revenues
through more efficient collection mechanisms, power theft control and market-linked tariff
regimes, as well as through the privatization of the electricity distribution sector. Few
SEBs of states, such as Orissa, Delhi, Haryana, Karnataka and Andhra Pradesh,
already have taken positive steps towards (i) unbundling power generation, transmission
and distribution assets into new entries and (ii) corporatizing those entities with
leadership less subject to political whims. Distribution of electricity in the states of Orissa
and Delhi has been privatized.
PTC Power Purchases:
Innovative structures, wherein agencies such as the Government of India-owned Power
Trading Corporation (“PTC”) are intermediate buyers of power, and effective offtake risk

59
mitigation measures, also have enhanced the potential of new projects to achieve
financial closure and better ensure success. Many of these projects simply would not
have reached financial closure and achieved commercial operation within a single buyer
model.
Recently, the PTC has short-listed 35 power projects (with generation capacity
exceeding 23OOMW) for long term power purchases. The PTC also will acquire up to
15% equity in each such project. In a milestone in the evolution of India’s power sector,
the Hyderabad-based Lanco Group’s 300 MW thermal power project in the State of
Chhattisgarh became the first power company to achieve financial closure on the
strength of a PPA with the PTC. To date, all Indian private sector projects have secured
financing from banks and financial institutions on the basis of executing sophisticated
PPAs with SEBs.
The debt-equity ratio for the Lanco project is 70:30. The process of achieving Lanco’s
financial closure accelerated the creation of an inter-institutional group (IIG) of lenders.
The IIG consists of the IDBI Ltd, State Bank of India, ICICI Bank and Power Finance
Corporation. Over a dozen projects have achieved financial closure in India, since the
IIG was established in January 2004. Similarly, at least another dozen projects await the
commitment of similar funds. Many of these projects, financially closing on “all – India
finance” (i.e., no foreign lenders) basis, have reached such closings, only because
project sponsors, unlike previously, have agreed to accept fuel and other project risks.
Guarantees:
In the event that the escrow proved inadequate, the IPP could have further recourse to
the state government through the state's guarantee of SEB performance. Numerous
variations on the LC, escrow account, and state guarantees would be possible to
structure and implement.
8.3 Impact of the Global Slowdown
The Indian power sector has also been hit by the current financial crunch, with several
projects unable to achieve financial closure. The banking sources after the financial
meltdown, no longer have the risk appetite to fund projects, especially those planned on
a non-recourse basis, which are devoid of the parent’s balance sheet support. The
current financial crisis will hamper power companies’ ability, more so for the private
sector, to raise debt funds from banks, domestic and international, thereby delaying
financial closures of projects. External commercial borrowings, which are used by the
corporate sector, have dried up, as have international supplier’s credits. The latter
includes vendor credit raised by the equipment supplier that will supply equipment to the
power companies. As a result, the banks will not lend to companies that planned on
vendor credit. And even for companies that have not planned for such credit, raising
capital is going to be difficult under the current scenario.
As a matter of course, the sources of financing for the capital required by the power
sector projects are predominantly multilateral institutions, domestic banks and financial
institutions, and foreign commercial borrowings. The financial crisis currently afflicting
the world has chipped away at the global financial market as a source for the much
needed funds. It is difficult for power projects, at this moment, to obtain resources from
external sources, even though the Reserve Bank of India had relaxed the guidelines for
external commercial borrowings in October 2008. The power sector, therefore, is being
forced to increasingly rely on domestic sources and multilateral financial institutions.
Accordingly, an appropriate measure to improve the availability of funds for the power

60
sector in order to ensure that the capacity addition targets are met is the need of the
hour.
In a bid to overcome the liquidity crunch, caused by the global financial crisis, that has
affected the financing of domestic power sector projects, NTPC has urged the
Government of India to induce multilateral institutions, such as the Asian Development
Bank (ADB) and World Bank, to enhance their earmark of funds for the power sector in
India, especially through non-sovereign lending operations. Ensuring a stable source for
funds is especially important given the fact that a growth rate of 9.5% for the power
sector is envisaged during the XI plan.
NTPC has also sought a greater role for instruments that leverage risk through the
participation of commercial banks. This would include facilities such as ADB's 'A loan'
and 'B loan' provisions. This is essential if the capacity addition target for the XI plan is to
be met.
In order to ensure that growth is not hampered due to want of funds, the power ministry
has asked the Ministry of Finance to consider a hike in the limits prescribed by the
Reserve Bank of India (RBI) for domestic banks that wish to invest in power projects.
Currently, RBI prudential norms limit investments to 20% of the Tier I and Tier II capital
for individual borrowers. For the entire group, a total of 50% of capital can be invested.
In addition, banks are also required to fix sector-based limits for investments, derived
from performance of the various sectors and risk perception.
The Ministry of Power has declared that there is a strong case for enhancing such
confines imposed upon the banking sector in order to increase the funds available to the
power sector. It has, thus, appealed to the fiscal authorities to consult with the Reserve
Bank and create an enabling framework to enhance investment ceilings, so that the
relevant banks can take investment decisions based on credit quality of the venture and
their own credit appetite.
NTPC has also requested the Government of India to revisit the IRDA guidelines
stipulated for indemnity pool fund investments to increase the amount of capital available
to the crucial power sector of the country. Pertinently, a growth rate of 9.5% for the
sector is envisaged during the XIth plan period. This goal is being hampered by the
liquidity crunch in the domestic economy, caused by the global financial crisis. Access to
financial resources is important if the power sector is to contribute meaningfully to the
growth of the Indian economy.
Interestingly, the transmission sector is the only silver lining, as despite all odds, the
central transmission utility, Power Grid Corporation, has achieved an inter-regional
transmission capacity of almost 19,000 mw against the proposed 37,000 mw by end of
11th Plan. Power Grid Corporation's investment plan of Rs 55,000 crore for the entire
period has not been affected. In fact, the World Bank and Asian Development Bank are
eager to provide additional funding in addition to whatever has been released.

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9 Conclusions and Recommendations
It is necessary to appreciate that inspite of all the encouragement and reforms; the
power sector is still riddled with many gross uncertainties. Emerging economies such as
India has therefore much to do and learn about the execution of the reform processes.
The reforms process should be carried out in gradual steps and the sector should not be
left to market forces from the very outset. Financing of the power sector will involve a
thorough analysis of the risks involved and the following observations can be used for
arriving on financing and investment decisions by lenders and private investors
respectively.
9.1 Generation
Power generation is the only sector wherein the lenders insist for long term
selling arrangement, whereas in other capital intensive industry like mining,
petroleum, etc. there is no such expectation from the lenders.
Financial closure is achieved with certain tariff regulations and any change
during implementation affects investors confidence and risk perception of
the project.
Though the private sector has shown some interest in capacity addition,
however, still major part of the capacity addition, has to come from central &
state power utilities. Since neither central nor state governments are able to
provide budgetary support, all future capacities in the government sector will
have to be funded by the utilities out of their internal resources.
Utilities can generate the resources only through the tariff allowed. Therefore,
tariff norms must consider requirement of resources to be generated in the
sector.
The regulatory certainty for longer periods could attract investments.
The primary off takers of power i.e. the SEBs need to reform even if the process
at hand seems long and politically fragile.
The repayment risk from the weak financial standing of the SEBs should be
addressed with innovative payment security mechanisms.
There is still lack of alternatives in case the primary customer defaults.
Development of power markets would mitigate the risks.
Adequate rate of return considering the market expectation, risk perception and
need to attract substantial investment in the power generation.
The major road block in financial closures is the lack of confidence in the power
market structure and power utilities and payment security mechanism for
recovery from the purchasers.
Proactive support to merchant power capacity addition through facilitatory
measures such as timely fuel allocation and other clearance requirements
The perennial problem of lack of transmission infrastructure unless addressed at
war footing, will not allow generation to achieve cost efficiency.

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9.2 Transmission
With an increased awareness of transmission being the bottleneck in Indian
power scenario, a much more concerted effort on part of the governments,
PGCIL and private players is the need of the hour.
The growth in the sector has been slow to begin with, with only few private
projects taking off. The investor apprehension is due to the virgin territory of
investments.
The lender needs to get more involved in the strategic thought process of the
borrowers to gauge the risks involved.
The government on its part should identify and facilitate clearances incase of
projects for private sector participation.
Appropriate transmission pricing regime that provides right locational signals can
attract substantial investment in the power transmission.
Accountability needs to be fixed by Regulators to provide assurance about timely
processing of applications.
Augmentation of transmission capacity in line with generation capacity to ensure
a de-bottlenecked transmission system.
Transmission pricing and Wheeling Charges (including losses) need to be
addressed on commercial principles.
RoE for the sector should be based on the principles of sustainability and future
growth outlook through adequate public/private investments
The outlook is optimistic as the sector will involve huge investments in the future.
9.3 Distribution
Total revenue in the power sector (including the revenue for generators, fuel
suppliers, transmission, and distribution) has to come from the consumers,
channelised through Distribution/Supply Licensee and open access to the
consumers. Therefore, interface with consumers needs highest attention.
Preparation of Road Map for reduction of losses and cross subsidies through
efficiency improvements by way of privatization
Success and Strength of Distribution is the key for catalyzing investment in
power sector.
Power Distribution and Supply business need to be streamlined and
strengthened for catalyzing investment.
Separation of Distribution and Supply business
If power supply is to be subsidized, it should be done by the government and not
at the cost of others through cross subsidy.
Create awareness among Distribution Utilities; provide them appropriate Govt./
Regulatory flexibility and support
The Electricity Act, 2003 aims to bring in more competition in the power sector in India to
increase the efficiency of the system in general and the State Electricity Boards in
particular. Yet thus far, the pace and implementation of reform has not proved

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successful in raising tariffs to cover costs, and although some states have made
progress, work must still be done to improve abysmal bill collection rates. The
renegotiation and cancellation of PPAs in India reflected these failures of reform by
forcing heavily burdened SEBs and regulators to squeeze private investors when facing
a budgetary impasse, which was aggravated by political transitions. But unless the next
few years continue corporatizations and subsequent privatizations of the SEBs, the good
intentions may never materialize. However, with the retreat of global energy investors
and contractors, well established domestic electricity and infrastructure companies such
as Tata and Reliance have partially filled the gap and may continue to hold the
competitive advantage
The Ministry of Power needs to accelerate the development of the National Grid
because the lack of Transmission capacity is harming the cost effectiveness of delivered
power. As for financing the sector, the Inter-Institutional Group needs to start working on
the Public Private Participation model wherein the Private entrepreneurial skills are
actively supported by public funds not just in the form of debt financing but also equity
participation. Direct incentives should also be provided to the Independent Power
Producers in terms of lowering of Customs and Excise duties on project imports for
IPPs. To improve the inherent financial viability of the sector the government needs to
introduce multi-year tariff regime to improve predictability of investment outcome and
also eliminate cross subsidies that hamper rationalization of tariffs.

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10 References/Bibliography
Literature References
Central Electricity Authority (CEA)
Power Finance Corporation (PFC)
Central Electricity Regulatory Commission (CERC)
Ministry of Power (MoP)
Power Finance Corporation (PFC)
Power Grid Corporation of India (PGCIL)

Weblinks
Ministry of Power, Govt. of India (powermin.nic.in)
Central Electricity Authority (www.cea.nic.in)
Central Electricity Regulatory Commission (cercind.gov.in)
Infraline (www.infraline.com)
Crisinfac (www.crisinfac.com)
The Associated Chambers of Commerce and Industry in India
(www.assocham.org)
Confederation of Indian Industries (www.ciionline.org)
IDFC (www.idfc.com)
IDBI (www.idbi.com)
SBI (www.statebankofindia.com)
Power Finance Corporation (www.pfcindia.com)

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