Policy Group Quarterly – December '08 1

No.2/ December 2008

The city of Pune has adopted a bold and innovative model of power supply, which has brought some relief to its residents, albeit at a higher cost. The approach, involving cooperation among different stakeholder groups, has not been free of controversies, but has been dynamic enough to evolve by responding to the emerging pulls and pressures through even more innovative measures. While the initiative has caught the imagination of some other cities and triggered exploration of local solutions, it is worthwhile examining whether such solutions for the city dwellers in India--who are willing to pay a premium for reducing or eliminating power cuts in their respective cities—are viable. This note explores the experience of Pune to gain some insights.

The country is currently facing a significant power shortage for both energy and peak to the tune of 10% and 15% respectively, and the deficit has been growing by a percentage point each year since 2003-04. Load shedding (that is, shutting off power supply during some parts of the day in a given area) has been adopted by the power distribution utilities to manage the power deficit. While this mechanism protects the grid from collapsing, it inflicts huge social and economic costs on the consumers. Although some industries have responded by setting up captive plants, such a solution is often inefficient, expensive and a cause for environmental concern.

The long term solution lies in addressing the tworelated problems of lack of commercial viability of distribution companies, primarily due to high transmission and distribution (T& D) losses, and sluggish growth in generation capacity. Important reform initiatives taken in recent years in recognition of these problems have shown positive results, but have been slow to deliver.

The question then arises: can there be interimsolutions to mitigate the looming power crisis? The ‘Pune Model’, as it is popularly known, is one such solution initially introduced as a pilot scheme to make Pune Urban circle free of load-shedding. The ‘Pune Model’ has evolved since, and is being replicated in other Distribution Circles in Maharashtra.

What is the ‘Pune Model’?

The ‘Pune Model’, introduced in June 2006,involved industries with under-utilized captive power plants (CPPs). The idea was that these industries would generate and consume additional captive power to the extent of the scheduled load-shedding, so that equivalent grid power is made available to other consumers. To get uninterrupted power, the consumers would have to bear the incremental cost of generation by CPPs to the extent of the difference between the variable cost of generation by CPPs and the average HT industrial tariff. The model works through cooperation and coordination among the consumers of power, owners of CPPs, power

distribution utility and Regulatory Commission. The principles under which the model was proposed are given below:

Users must be willing to pay a premium for reduced or no load-shedding and the incremental cost should be borne by the beneficiaries (i.e. consumers) and not by the distribution company or the government;

Load shedding mitigation should not be at the expense of any community;

There must be enough idle captive powercapacity to meet the entire unmet demand or at least a significant part of it;

It should operate within the framework of governing laws and regulations.

How was the Model introduced in Pune?

By 2005-06, Maharashtra, which once boasted of surplus power availability, was reeling under an acute peak power deficit of 23% (i.e. 3700 MWs). Pune, like many other cities in the State, faced regular load shedding for about 2-4 hours a day.To make Pune free of load shedding, the Confederation of Indian Industries (CII) Pune Chapter, under the leadership of Pradeep Bhargava, made an innovative proposal (see below) to the Maharashtra Electricity Regulatory Commission (MERC) for its approval.

The CII Proposal

The CII, in consultation with Maharashtra State Electricity Distribution Company Ltd (MSEDCL), estimated a shortfall of 90 MW in the worst case scenario in Pune, while the top 30 industrial undertakings of Pune – which is home to majorindustries such as Tata Motors, Bajaj Auto, Bharat Forge, Kinetic Engineering and DaimlerChrysler India – had unutilized captive capacity in excess of 100 MW. CII proposed that these 30 undertakings would utilize their idle captive capacity to generate and consume power equivalent to the shortfall in Pune Urban Circle following the schedule of operation (i.e number of hours and capacity utilization) as directed by MSEDCL. By so doing, these industries would cutdown their demand for grid power (equivalent to the shortage in the city), which would

Innovative Partnership Approach to Mitigating Load Shedding: The ‘Pune Model’ and Beyond

PPoolliiccyy GGrroouupp QQuuaarrtteerrllyyThink Infrastructure.

Think IDFC.

New Initiative in Focus

The ‘Pune Model’

Infrastructure Development -Turning Points

External Developments and India’s Infrastructure

Policy Group News & Events

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Policy Group Quarterly – December '08 2

consequently be available to MSEDCL for distribution to other consumers, thereby eliminating the need for load-shedding. The question then was would such a switch from grid supply to self supply be economically viable for the industries? CII submitted that the CPPs in question were fired by liquid fuel (LDO and HSD) and had high generation costs (i.e. variable cost exceeding Rs.10/Kwh) in comparison to their purchase from the grid, making its exploitation uneconomical. To induce industries to switch from grid supply to self supply (an otherwise uneconomical proposition), it was therefore proposed that these industries be compensated for the additional generation from captive capacity by an amount equivalent to the difference between the variable cost of generation by CPPs and the average HT tariff (grid supply). Finally, the compensation costs to the industries were proposed to be borne by the consumers of Pune Urban Circle in exchange for the benefit of no load shedding.

The proposal was approved by MERC in January 2006 (see Box 1) and after several months of public consultation process the initiative was made operational from June 2006 with the terms and conditions approved by MERC.

Issues in Replication and Sustainability of the Model

The model, designed for introduction in Pune, had obviously taken into account initial conditions prevailing in Pune, such as large local captive capacity, low distribution losses (16.5%), and favorable consumer mix. A higher share of sales to industrial and commercial establishments relative to residential consumers would lower the incremental cost of the scheme as residential consumers are subsidized. However, the model did not have the flexibility to be successfully adapted to cities that lacked such initial conditions. Therefore, a major roadblock was experienced when the ‘zero load-shedding’ Pune Model was sought to be extended to other areas such as Navi-Mumbai, Nagpur, Aurangabad, Nasik, which either had high distribution losses or lacked adequate captive capacity.

More significantly, the model did not have the flexibility to respond quickly to a change in demand. This became evident in less than one and a half years after its introduction in Pune when, from the latter half of 2007, the CPP support proved to be inadequate in the face of rapidly growing demand. The CPPs in Pune were also finding it difficult to adjust to the constantly varying schedule of operation. The MSEDCL, committed to ensuring zero load-shedding in Pune, was forced to begin procurement of (costly) power from other sources tomeet the emerging deficit, even though the MERC Order of May 16, 2006 allowed MSEDCL to resort to such a practice only as stand-by in an emergency situation and not on a regular basis. The MSEDCL’s procurement of additional grid support, however, did not last long. Following stakeholder opposition to the diversion of grid power exclusively for Pune Circle, the MERC in March 2008 directed the MSEDCL to stop procuring additional grid power for Pune. The distribution licensee -- in this case MSEDCL – has a universal service obligation and cannot discriminate in favour of some consumers or particular areas within its licensed area.

Evolution of the ‘Zero Load-Shedding Pune Model’

Responding to the public appeal to find a mechanism to continue with zero load-shedding status in Pune, MERC suggested the appointment of a distributed generation based distribution franchisee (DGBDF) by MSEDCL for Pune through a competitive bidding process. The DGBDF would not only undertake power supply based on performance linked contracts, but also bring in enough power to alleviate the deficit situation. The Electricity Act 2003 allows a distribution licensee to appoint a franchisee for a particular area within itslicensed supply area to distribute and supply electricity on its behalf. The DGBDF could harness available captive power, source power from the power trading companies in the short term or even set up a decentralized power generating unit based on gas, liquid fuel or renewable energy sources. In view of the time consuming process of selection of a franchisee and the need to reinstate zero

Box 1: Role of MERC in Introducing the Model

MERC admitted the CII proposal and took it through the democratic process of public hearing. As the consumers responded positively to the CII initiative, the MERC accepted the proposal on January 25, 2006 as a pilot scheme with the intent of replicating the same in other cities of Maharashtra, after evaluating performance of the pilot and incorporating learning. While emphasizing that all the incremental costs of the proposal have to be borne by only the consumers of Pune Urban Circle, the MERC stated that it would review all the costs and approve both the rate for making compensatory payment to the CPPs for extra generation during peak hours and the premium to be paid by consumers per unit of power consumed to recover the compensation payable to the industries. The MERC directed MSEDCL to make all the requisite operational arrangements, including integration of CPPs with the grid and directed CII to submit the techno-economic details of CPPs, which would form the basis for determination of the compensation rate. On receipt of this information on CPPs from the CII, the MERC conducted another public hearing and on March 2, 2006 issued an Order setting the (normative) variable cost of generation at Rs.8.24/KWh for LDO based CPPs and at Rs. 11.04/KWh for HSD based CPPs.

Determining the premium to be paid by the consumers, however, became contentious. In response to the MSEDCL’s proposal to MERC in April 2006 to set a rate of Rs.0.84/KWh as reliability charge towards recovery of incremental costs, the MERC conducted a public hearing on the proposal. A number of issues were raised by consumer organizations such as high reliability charges, accountability of MSEDCL for its inefficiency, and whether all classes of consumers including the CPP industries would be subject to the reliability charge. Taking cognizance of these issues and reviewing the information received, MERC finally approved, on May 16, 2006, a reduced reliability charge of Rs.0.42/KWh to be levied on the consumers of Pune Urban Circle excluding domestic consumers consuming upto 300 KWh/month. MERC, by exempting small domestic consumers (consuming up to 300 KWh/month) from paying a reliability charge, benefited nearly 6 lakh consumers of the total 8 lakh consumers in Pune Urban Circle. Industries were also required to pay the reliability charge without any preferential treatment. The rate and terms of reliability charge for enjoying zero load-shedding were acceptable to all stakeholders. From June 4, 2006, the model became operational.

Policy Group Quarterly – December '08 3

load shedding status to consumers willing to pay a premium, the MERC in its order of March 31, 2008 urged MSEDCL to appoint an interim franchisee. Subsequently, MSEDCL appointed the Tata Power Company as an interim franchiseewho, besides offering 40 MW of power from its DG sets, has offered to procure the deficit through its trading arm TPC Trading Company. Thus, the interim franchisee would be procuring additional power for Pune over and above the usual supply mix of MSEDCL. The MERC approved the reliability charge of Rs.0.48 /KWh in April 2008, and directed that load shedding may have to be undertaken in case of any supply interruption for a long time by the interim franchisee. MERC also directed MSEDCL to undertake reconciliation of recovery through reliability charges with the actual expenditures incurred and submit the same to MERC on a quarterly basis so that the variation could be passed on to the consumers. The Pune Model was once again revived with the appointment of an interim franchisee by MSEDCL and the attempt by CII to increase the availability of surplus captive capacity.

It is encouraging to note that the ‘Evolved Pune Model’ with an interim franchisee is now adopted in Vashi Circle (Navi Mumbai, i.e. Vashi, Nerul and Panvel) and Thane Urban Circle (Bhandup, Thane, Mulund, Wagle Estate, Kalwa sub-division). The MERC approved the reliability charges of Rs.0.35/KWh for Vashi Circle and Rs.0.43/KWh for Thane Circle, to be levied on all consumers except residential consumers consuming less than 100 KWh/month, and proportionate load shedding is carried out in these Circles depending on the power procured by the franchisee.

As an alternative to the DGBDF, the CII Pune Chapter has proposed ‘The Partial Open Access Model’ as a short term solution to mitigate load shedding, till such time that generation capacities are set up near or in local areas. Open access, as defined in the Electricity Act 2003, is about network (T&D) licensees granting non-discriminatory access of their network to electricity producers and consumers, in accordance with the regulations specified by the Regulatory Commissions. In this model it was conceived that the open access consumers would procure power for self consumption from outside sources, so that grid power is released to the extent of their consumption, and for this the open access consumers have to be compensated for the increase in the power procurement cost. Similar to the initial ‘Pune Model’, it was proposed that the incremental cost to be paid to the open access consumers could be recovered through reliability charges specified by MERC. Similar arrangements are proposed for the MIDC area in Thane seeking zero load-shedding status for the industries in the MIDC area.

Key Lessons

With the ‘Pune Model’ evolving into a more widely implementable solution to the acute power deficit situation, and more and more cities seeking to adopt this model not only in Maharashtra but also elsewhere including Gurgaon (Haryana), Noida (Uttar Pradesh), and Coimbatore (Tamil Nadu), some key lessons can be drawn from the experience thus far:

It is possible to find local short term solutions to the power deficit situation, provided the civil society, industry and utilities act as partners, with each having defined obligations and benefits.

The real long term solution to achieving zero load-shedding canonly be achieved by adequate capacity addition and reduction oflosses.

Any single approach may not be enough to alleviate the growing power deficit, but a combined effort is needed which includesdrawing upon existing surplus captive capacity, energy conservation, demand side management, loss reduction through efficiency improvements, tapping surplus power elsewhere through a ring fencing arrangement, andpromotion of distributed generation.

Consumers in urban and industrial areas with rising income are often willing to pay a premium for more assured supply of electricity. The initiative to establish a strong linkage between willingness to pay and quality and reliability of supply should preferably come from the civil society.

The state electricity regulator’s acceptance of the model removes uncertainties about the framework of the model and helps in making it operational.

Low distribution losses, high collection efficiency and a relatively high share of industrial and commercial consumption are critical factors for the success of this initiative, as they would keep the reliability charge low and acceptable to the beneficiaries.

Operational arrangements of implementing such initiatives, such as metering, billing, integration with the grid may be complex, but not impossible to put in place and should not be considered as a deterrent for any initiative.

Under this model, it is possible to design rates, which are conducive to energy conservation. The reliability charges applicable to consumers above 300 KWh/month in Pune, for example, provide the incentive to consumers to reduce their consumption below the threshold level.

Success and sustainability of such initiatives would depend on effective monitoring of the arrangement by the regulatory commission, media and consumer organizations.

Although sourcing power for consumers willing to pay a higher price may be good economics in a competitive framework, but in an acutely power deficit situation this could also mean less power available for some other consumers. It is possible that, lured by the demonstrated willingness of urban consumers to pay a better price for an assured supply, an increasing proportion of the capacity addition may be siphoned off by cities seeking uninterrupted power supply, and chances are that the rural electrification programme will take the wires to the villages but energy flows will remain meager.

Looking Ahead

In sum, the ‘beauty’ of the ‘Pune Model’ lies in a community coming together to use idle captive capacity and willing to pay a premium for the additional power. With demand outstripping captive capacity, the model was extended into a DGBDF. Ultimately, the evolved Model will be successful only if it can go beyond purchasing additional power to actually creating additional supply. Going forward, it needs to be explored whether distributed generation based on renewable energy can supplement existing capacity. Many questions need to be addressed regarding viability (including incentives for renewable-based urban DGBDF), supply reliability and so on, but innovative approaches may provide sustainable and environmentally-friendly solutions to bridge the deficit in cities.

Policy Group Quarterly – December '08 4

External Developments and India’s Infrastructure

The current global crisis has underlined the severity of infrastructure development risks which are external in origin. The optimism regarding the pace of infrastructure development that prevailed until a year ago has been eroded, as reflected in the sharp decline in the infrastructure stock index (see Fig. 1).

Fig. 1: Performance of FTSE-IDFC India Infrastructure Index vis-à-vis Sensex

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Profitability of infrastructure companies, which started dropping in October-December 2007, has been exacerbated by the global economic slowdown. In the four quarters ending September 2008, the profit growth of 86 listed infrastructure companies has fallen to 17% from 57% a year ago. This is largely due to factors such as high and rising commodity prices initially, and high cost of funds (including through rupee depreciation) and flagging demand, more recently.

Like in other sectors of the real economy, the transmission of the crisis to India’s infrastructure is happening through financial and trade channels. The liquidity squeeze and stock market decline have had a severe impact on the funding for infrastructure projects. Lending rates have risen, especially since early July 2008. The spread for AAA rated10-year corporate bonds over sovereign bonds has also shot up by about 3 percentage points between end-March 2008 and end-October, making borrowing very expensive for the corporate sector. Infrastructure has been no exception. During April-August, commercial bank lending to infrastructure slowed down to Rs. 7,094 crore in 2008 from

Rs. 12,184 crore a year ago. Similarly, the depressed equity market has forced infrastructure companies to shelve their capital-raising plans through IPOs (see Table 1). Also, the declining profitability of infrastructure companies has meant deceleration in internal resource generation, which has constrained their ability to meet equity requirements.The silver lining is that PE deals have remained robust due to attractive valuations.

Table 1: Capital Raising by Non-Financial Infrastructure Companies

YearIPO/FPO PE

No. of Issues

Rs. croreNo. of Deals

$ mn

2006-07 11 5649 40 2782

2007-08 20 19008 77 7824

2008-09 2 845 48 3805Sources: NSE, IDFC-SSKI database, Grant Thornton & India Infrastructure

Research 2008.Notes:1. Data for IPO & PE is upto 31 October 2008. 2. Reliance Power Ltd. alone has raised half the funds (Rs.10,260 cr) in IPO for

2007-08.

As regards the trade channel, the impact has been via weakening demand and fall in commodity prices. While the latter is beginning to reduce the cost of projects, its positive impact is being offset by the former. Weak demand has hurt the transportation sector the most. Export traffic at major ports has declined from 22.7 thousand tonnes in March this year to 13.6 thousand tonnes in September. There has also been a sharp decline in the number of passengers handled at Indian airports. In contrast, there is no evidence of demand constraint for the power and telecom sectors owing to the huge deficit in the power sector and untapped potential in the telecom sector.

While concerns are rising about project deferrals and delays in execution, the scale of the impact will depend to some extent on the mitigating initiatives taken by the Government. There are encouraging signals that the Government intends to make infrastructure development the centre-piece of its counter-cyclical economic growth strategy. Amongst the measures being considered is a proposed dedicated infrastructure fund of Rs 50,000 crore.

Infrastructure Development – Turning Points

IDFC Power Advisory Group: IDFC Power Advisory Group (PAG), set up with the objective of reviewing issues and exploring policy options in the power sector, prepared two papers relating to: (i) the development of power markets and (ii) captive coal blocks allocated to power plants. The first paper examines the factors impeding the development of merchant power plants, the trading of power and the use of open access and the second paper identifies the various provisions in the existing policies, procedures and guidelines that have contributed to the sluggish development of captive coal blocks. In both papers, PAG has made pragmatic recommendations.

Writers’ Workshop at IIM (Ahmedabad): The last quarter saw yet another milestone in the journey towards India Infrastructure Report (IIR) 2009, with the theme “Land: A Critical Resource for Infrastructure” in terms of a two-day Writers’ Workshop. Organized by the Policy Group of IDFC in collaboration with IIM (Ahmedabad) and IIT (Kanpur), the workshop provided a forum for the contributors to the IIR not only to get feedback on their respective observations, perceptions and ideas from their peers but also to take forward the debate on an array of issues relating to land acquisition, rehabilitation and land market imperfections, which are proving to be major impediments to infrastructure developments in India.

Policy Group – News & Events

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