What ails the Power Distribution Business in India- Fleecing Industrial Customers

Slumping Volumes in Electricity Business-

Policy Reforms for Addressing What Ails the Industry?

Driving away most valuable customers is the recipe for disaster

Electricity sales in India recorded negative growth for the fourth consecutive month in November 2019. In October, electricity demand fell by whopping 12.4%. In contrast, during a span of 180 months, in the 15 years since 2004, electricity demand on year-on-year basis had fallen only four times. Annual growth in 2019-20 has also now slipped in the negative. Does it portend serious trouble in electricity business and for that matter for the growth of Indian economy?

What ails the electricity business in the country?

Can a business which fleeces its highest paying and most valuable customers thrive or for that matter even survive for long? Electricity supply business in India is essentially in the hands of state electricity distribution utilities (DISCOMs). These utilities have been pursuing a policy of excessively over-charging their industrial and commercial consumers for long, while providing no assurances of supplying reliable and uninterrupted power. Indian electricity sector has been, until very recently, in major supply deficit. Only recently, it has now turned in excess supply mode. Despite this fundamental shift, the DISCOMs have not changed their policy of fixing above-market power supply rates for industry.

Industrial customers had long disliked this treatment. They decided to go for building their captive power plants to escape. They have continuously reduced their purchase of power from DISCOMs.

DISCOMs have long tried to use this strategy of overcharging industrial customers to cross subsidise their other buyers. This policy was also responsible for making Indian industry non-competitive, but seemed to work for some time in partly sustaining the convoluted model of electricity supply and pricing in India. Now, with captive power generation capacity reaching a critical mass and industry no longer remaining dominant buyer of DISCOM’s electricity, it is making the electricity distribution companies (DISCOMs) still worse, may be possibly writing last chapter before their final collapse.

Electricity Supply to industry

India consumed 1,196 billion units of electricity in 2018-19. Industrial consumption was 492 billion units (41%). Share of industry in electricity consumption in India was quite high at 71% in 1947. As India industrialised during first and second plan period (1951-61), industry’s share in total power consumption went up further, peaking at 75% at the end of 1960-61, when the second five-year plan completed. With policy attention shifting to agriculture in sixties, share of industry in power consumption started declining though it was still high at 72% at the beginning of 1970s.

Expansion of electricity supply to agriculture and later, from the early eighties, to residential consumers, led to relative share of industry fall steadily in seventies and eighties. By the end of 1970s, industry’s share in electricity consumption fallen to 62% and to a little over 51% in 1989-90. Industry’s share of electricity consumption fell by more than 20% in 20 years. This trend continued unabated with industry consuming only 46% at the end of 10^th plan in 2006-07.

Share of industry as consumers of electricity in India is only marginally above 40% in 2018-19. The data for 2019-20 is still not available, but if the trends in Index of Industrial Production (IIP) are any indication (manufacturing growth has declined continuously for last three months and is in negative territory for the seven months of the current year), the share of industry seems to  have fallen below 40% by now.

Not only is the Industry having a paltry share in total electricity use, but it is voting with its feet in buying electricity from the DISCOMs. The industry has been steadily building captive generation capacity and off-late buying power from the energy exchanges.

Industry started investing in captive power generation to meet its electricity demand in late seventies, the time when State Electricity Boards (SEBs), predecessors of DISCOMs, were diversifying towards agriculture and residential consumers favouring them with lower tariffs. For the first time, industrial enterprises built about 2,600 megawatt of captive power generation capacity (1,849 MW thermal and 559 MW diesel) during the 5^th plan period in seventies. Captive power capacity had grown to around 17,000 MW by the end of 9^th plan in 2001-02. The investment in captive power plants received big boost thereafter with captive power plant capacity reaching as high as 58,000 MW at the end of FY 2018-19.

Having installed large captive power generation capacity, the industry is buying smaller share of power it uses in its manufacturing process from DISCOMs.  In 2017-18, captive power generated reached 180 billion units. Industry had used a total of 469 billion units in 2017-18. Power produced by industry itself (captive power) made up about 40% of its total power used. Captive power generated by industry in the country accounted for 16% of the total power consumed in India in 2017-18. Excluding power captively produced and consumed by the industry in 2017-18, only 289 billion units of power was supplied by the state utilities to the industry, which was only about 25% of total power supplied and used in India in 2017-18. Electricity purchase by industry from DISCOM is fast tapering off in India. With economic slowdown and manufacturing degrowth during the current year, it would be no wonder if power purchase by industry from DISCOMs fall further this year. 

Policy of over-charging and forcibly retaining industry to pay for losses in other segments is now failing

Average power generation cost is around ₹4 per unit. Average cost of power to industries in India is ₹7-10 per unit, varying amongst the states depending upon the type of industrial customers and so on. Power is sold to agriculture at less than ₹1 per unit; in many states at still cheaper rates or completely free of cost. Most states also keep electricity supply rates at around average cost of power generation or lower for their residential customers. It is the industry, which has been used to cross subsidise the agriculture and residential consumers. Industry is the productive sector of the economy. Indian industry and businesses have to compete with the global suppliers as most of the goods produced by Indian industry face global competition these days. However, Indian industry find it difficult to compete with these products. Power tariffs are partly responsible for making Indian industry non-competitive.

Setting up captive power plants cannot be a normal choice of an industry. If electricity is available at competitive rates and reliably (many industries cannot afford any load shedding), industry would concentrate on their core area of competence and business, rather than getting into power generation. However, when the state utilities adopt a deliberate policy of fleecing them, by overcharging and also don’t assure uninterrupted quality power, the industry is forced to establish captive power plants.

State DISCOM don’t want to let go their ‘creamy’ customers. But they do it by forcibly retaining them. Several policies have been designed and implemented only with this object in mind - not letting their creamy customers go away.

One such major policy is the policy of levying a cross subsidy charge. The DISCOMs and the electricity Regulators levy ‘cross subsidy charge’ on industries and businesses on the power they buy from private sector producers or other cheaper sources. Most state DISCOMs levy heavy ‘cross subsidy surcharge’ ranging from ₹1 to ₹3 per unit of power purchased using open access. Rajasthan levies ₹2.63 per unit on industrial consumers of 132 KV and above. The objective is quite clear. DISCOMs want to make the net cost of such electricity for the industrial entity as close, if not higher, to the cost at which the concerned DISCOM supplies to the industrial units. DISCOMs want to hold the industrial entities in their respective states ‘captive’ to them.

Many industry and business enterprises, especially MSMEs, do not have load which can justify investing in a captive power plant. All these manufacturing enterprises and there are millions of them, consequently are not able to escape from the clutches of DISCOM,

Another policy measure makes the lives of industrial units establishing captive power plants quite difficult. Effective cost of captive power plants go up if their capacity utilization falls for any reason. These units therefore want to sell their surplus power to other industrial consumers. But these units are not allowed to sale power to anyone other than to the state DISCOM. DISCOMs thus become the monopoly power purchaser for the surplus power of these units. The DISCOMs offer them a pittance for their power.

Despite all these constraints and extortionary policies, DISCOMs are not succeeding in selling power to the industry.

Private Sector Power Generation Is Quite Substantial

Considerable power generation capacity has been installed in the private sector in last 10 years. Private sector power plants generated 504 billion units out of total 1,372 billion units generated in India in 2018-19. It accounted for about 37% of the total power generated in the country. This is despite the fact, a number of power generation plants in the private sector are facing existential issues and have become non-performing assets for Banks. Private sector generation had less than 10% of share in power generated in 2002-03. Private sector power generation overtook state power generation and central power generation in 2015-16 for the first time when it generated 408 billion units as against 390 billion units generated by state generators and 370 billion units generated by central government generating stations.

The Industry has set up over 58,000 MW of captive power capacity which is over 15% of entire power generation capacity in the country. Indian power system, on an average, generates 1,50,000-1,60,000 MW of power. If Industry were able to use all its captive power capacity, it amounts to roughly 1/3^rd of entire power generation in the country. So much is the cost and consequence of irrational electricity pricing policies followed by DISCOMs.

Industry has Started Buying Power from Energy Exchanges

In the environment of ‘surplus’ power in the country, private sector generators are finding it difficult to sale their power to DISCOMs and recover money. They are increasingly resorting to energy exchanges to sale their power. Industrial consumers are also seeing this as one source of power purchase where they can buy relatively cheaper power. Energy exchanges are thus providing a relieving mechanism to both private sector sellers and also buyers. There is also bilateral sale purchase through short term contracts. There were over 4,300 ‘open access’ industrial consumers in the Indian Energy Exchange, the major electricity market in India, which made up more than 90% of buyers in the Exchange. Extent of power purchased by such industrial open access consumers varied from year to year. In some years it exceeded 60% of the power bought on the exchange.

Distorted Pricing Policy for Industrial and Other Commercial Entities will have to Change

Policy of over-charging industrial consumers and keeping them captive have not really helped the DISCOMs as these ‘good customers’ have somehow managed to escape their clutches, albeit at still very high cost to them. Both, the DISCOMs and the industrial customers have suffered. India has also suffered as DISCOMs generate enormous losses (in excess of ₹1.5 lakh crore a year before the subsidies provided by the State Governments and not counting interest liabilities taken over under UDAY and other schemes) and Indian industry struggles to be competitive chained as it is with such high electricity costs.

DISCOMs are not good business enterprises. These are run by politicians, civilian officers and engineers, not businessmen.

Every unit of electricity does the same work whether used in industry, agriculture or residences. Pricing it differently based on user is the biggest mistake in the power business. Electricity tariff policy of the Government of India, which is supposedly binding on the State Electricity Commissions which set the tariffs, recognise this policy principle. For many years, this policy is mandates the tariffs to be set for customer not exceeding 20% of ‘average cost of supply’. This policy directive has, however been followed up more in breach.

Electricity tariff setting has also been made unduly complex. In some states, there are over 60 kinds of electricity consumers. A unit of electricity does the same work, but it has over 60 different prices. Reading tariff schedule of any DISCOM will convince anyone how chaotic and complex it is resulting into unnecessary disputes and unhappiness all around.

States also try to achieve their social goals through pricing power differently. Agriculture tariffs and residential tariffs are set at lower rates. Industrial and commercial tariffs at higher rates. Then, the state subsidies come into play and these are also delivered through tariffs. Effective tariffs are reduced factoring in these subsidies, bringing still more complexity in tariff structure.

There is a large set of consumers, most specifically in sprawling rural areas, where cost of metering is quite large, and incentives and opportunity to make meters dysfunctional quite strong. This also comes handy in manipulating consumption in agriculture and showing smaller aggregate technical and commercial losses.

India did not join the Regional Comprehensive Economic Partnership (RCEP) essentially based on realisation that Indian industry is non-competitive. It is not in a position to take advantage of markets in other countries (higher electricity cost is incidentally not neutralized unlike taxes etc. in case of even exports). At the same time, Indian industry finds it difficult to compete with imports, burdened as it is with high cost, with electricity cost being a major component thereof. Indian manufacturing is not taking off.

What needs to be done

To make it happen, to make Indian industry competitive and to make manufacturing take off, electricity pricing for industry has to be rationalised.

First, three distorting and debilitating measures need to be done away with:

a.    Cross subsidy surcharge on open access purchases need to be simply abolished;

b.    All restrictions on sale of power imposed on captive power generating units need to be removed. Allow these units to sale their surplus power to whoever buys from them;

c.    All restrictions on open access regarding purchase of power from exchange, bilaterally or otherwise also need to go.

Second, DISCOMs should start treating industry as good customers if not their preferred customers. There is no need to provide any subsidised power to them. But, the power price to these industrial and commercial consumers should be priced at rates which the market can bear, most likely the market will clear at prices which are higher than average cost of purchase but below the 20% upper corridor which the Tariff Policy has laid down.

Third, India has now become stable surplus power generator. On quite a few days this year, India used less than 25% of its capacity to generate power. It is not unusual now to see power load factor of thermal power plants remain at less than 60% and some of such plants are forced to back down some days. In such a situation, the DISCOMs, should assure a reliable uninterrupted power supply to industry. It is a shame that India still has about 15,000 MW of diesel generating capacity in the country, though it is not used as much these days. Like inverters have practically become a thing of past in Delhi with assured power supply becoming a norm, the industry would be incentivised to dismantle diesel power generating capacity in the country. This would also have positive impact on the environment.

These measures would boost power consumption in the industry. DISCOMs would get their good customers back which will bring electricity volumes to them. DISCOMs might actually be beneficiary in terms of higher sales realisation in this distortion free pricing regime than what they are today.

Much larger reforms are called for in the DISCOMs which I would write on some other day to make Indian electricity sector vibrant.

Subhash Chandra Garg

New Delhi 27^th December 2019