Unless the financial health of distribution utilities (DISCOMS) can be revived, progress on energy transition can flounder
High economic growth rates, post-COVID-19, give credence to India being on the path to upper middle-income level status. Being the largest, young, population globally, a diversified economy, an industrial policy which finances the viability gap in high-tech green manufacturing and supportive domestic business sentiment, also factor in while understanding the flow of investments to India.
The Achilles’ heel remains the demand for green electricity. The initiation of a carbon trading scheme can enhance the incentive to buy green. But unless the financial health of distribution utilities (DISCOMS) can be revived, which despite four rounds of fiscal support remain mired in inefficiency and low performance, progress on energy transition can flounder.
Distribution and retail supply are presently intertwined except for large industrial customers who are free to access power directly from generators or self-generate. This makes distribution the prime intermediary between the final customer (the market) and the generation of clean electricity. Unless this end-of-pipe reform is rolled out prior to 2030, transition targets can be compromised.
Distribution and retail supply are presently intertwined except for large industrial customers who are free to access power directly from generators or self-generate.
An early resolution of the problem of insolvent DISCOMs is not envisioned. This is evident from the recent recommendation of the Central Electricity Authority (CEA) that state governments should prepare resource adequacy plans till 2030 ensuring that 75 percent of power demand is de-risked through long-term (25 years) power purchase agreements. Another 10 to 20 percent through medium-term arrangements with only the residual between 5 to 15 percent left for short-term arrangements (through trade in power exchanges) versus 12.5 percent, presently. This implies that we are chained to shallow power markets for the next two decades which could be disastrous.
The CEA guidelines are prudent from the viewpoint of a resource planner. The parlous finances of the distribution utilities in the late 1990s, when private power generation was being promoted, led to the practice of signing power purchase contracts supported by state government guarantees (most of distribution was state government-owned). Private generation projects could never have been financed on the strength of DISCOM balance sheets.
Not much has changed. New variable renewable electricity capacity—solar and wind power—comes with a payment guarantee from the Solar Energy Corporation of India, a listed Union government undertaking. Any less would expose private RE generators to payment risk from DISCOMs which would escalate the price charged, negate the declining price trend of renewable energy (RE) which makes it attractive versus fossil fuel and pressure already uncertain distribution utility finances.
Temporary “plug the gap solutions” can keep RE growing, which is critical for meeting decarbonisation objectives. But for how long can new clean energy capacity depend on government guarantees? Over the next two decades till 2040, India needs 530 GW additional variable RE capacity versus the available 137 GW. Contingent liabilities of state governments, including guarantees, have increased from 2 percent in 2015-16 to 3.7 percent of state GDP well above the 0.5 percent of SGDP recommended by an RBI Report on State Government Guarantees, January 2024. In contrast, guarantees given by the Union government were reduced from 2 percent of GDP in 2017-18 to 1.1 percent of GDP in 2022-23, which is a healthy trend. Government fiscal capacity needs to be rechanneled to front-line research and development (R&D) and manufacturing, instead of being tied up in the marketing of a mature industrial service like RE.
The parlous finances of the distribution utilities in the late 1990s, when private power generation was being promoted, led to the practice of signing power purchase contracts supported by state government guarantees (most of distribution was state government-owned).
The electricity supply industry remains dominated by the public sector. About half of generation utility capacity was privately owned in 2021-22 and private variable renewable electricity is expanding. The Union government-owned generation companies are also going green to adapt to the future. Transmission is primarily publicly owned but around one-half of new transmission projects are being executed by private investors on a competitively bid basis, in the Inter-state grid. State electricity regulators are emulating this trend in state grids. In distribution only eleven of about fifty-five licensed distribution utilities (DISCOMS) are private. Curiously, the structure of ownership of a DISCOM, has a weaker correlation with performance than expected, though all 11 privately owned distribution utilities are within the top half of 53 DISCOMs on performance metrics and six of the 10 DISCOMS with the highest rating of A+ are private. Privatisation is not a panacea, nevertheless, it is an option for fiscally constrained governments.
The “problem child” is the distribution segment. This is an unaffordable problem to achieve energy transition targets. The Union government has already rolled out an expansive performance-linked support scheme—Revamped Distribution Sector Scheme, which injects Rs 0.97 trillion of central financial assistance into DISCOMs for installing 240 million meters and upgrading infrastructure.
The needed regulatory framework should incentivise them to become profitable companies, with balance sheets supporting prudent debt financing for new investments and aspire to the highest standards of corporate governance by getting listed on stock exchanges.
The State Electricity Regulatory Commissions are mandated to reform DISCOMs. More than two decades after the Electricity Act 2003 was passed, DISCOMs continue to struggle with distorted tariffs, unpaid government bills, and burgeoning regulatory assets—amounts approved by the regulator for recovery through tariffs but not passed through—like an un-cashable cheque. In FY 2023, only five states allowed a revenue increase higher than the increase in power purchase cost. This reluctance to follow even a minimalist, regulatory strategy for retail tariff determination by recovering the cost of service plus return on investment, condemns DISCOMs to subsistence-level survival. The needed regulatory framework should incentivise them to become profitable companies, with balance sheets supporting prudent debt financing for new investments and aspire to the highest standards of corporate governance by getting listed on stock exchanges.
Three reform steps can lead to healthier DISCOMs. First, amend the Electricity Act and rules to bar tariff regulators from disallowing normative economic costs and return on investments, to ensure that tariffs reflect the cost of supply to users. Subsidy if any, should be directly provided by the concerned government to the beneficiaries via bank transfers. This framework will provide the base for profitability and create managerial incentives for higher technical and commercial efficiency.
Second, to enlarge the autonomy of electricity regulators, legislate a dual mandate with the Union and the state governments sharing the oversight over regulatory commissions, including the Central Electricity Regulatory Commission. The GST council is based on this principle of collective or cooperative federalism, and it functions very well. Dual oversight is sure to improve the quality of regulatory decisions. Also, consider that the grid is the key electricity asset of the future and must function as a unified network.
The GST council is based on this principle of collective or cooperative federalism, and it functions very well.
Third, once DISCOMs are financially stable (possibly over the next decade) liberalise the bulk of it and retail electricity markets by introducing progressively higher levels of competition and choice. Already, about 13 percent of electricity demand is met via self-generation and will increase to 16 percent by 2031-32. Demand above 100 KW can already be met via “direct access” but only to RE generators to promote RE linkages.
Markets diminish the regulatory space to divert business cash flows for social objectives. They function efficiently only if their ability to set price signals is not constrained administratively. They create new competing entities, forcing DISCOMs to perform or undergo the bankruptcy process. Disruptive change is often viewed as a messy option, unworthy of the moniker of “steady sailing” which governments and citizens prefer. Sadly, doing anything less would only jeopardise the energy transition.
Sanjeev Ahluwalia is an Advisor at the Observer Research Foundation
The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.
Sanjeev S. Ahluwalia has core skills in institutional analysis, energy and economic regulation and public financial management backed by eight years of project management experience ...
Read More +
PREV
