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How Can India’s Energy Sector Recover Sustainably from COVID-19?

Publication Overview

How Can India’s Energy Sector Recover Sustainably from COVID-19?

This International Institute for Sustainable Development (IISD) & Council on Energy, Environment and Water (CEEW) three-part commentary series takes a deep dive into how India’s energy sector is coping with the impacts of COVID-19 and what this means for the sustainable energy transition. We explore three key themes.

  • Part 1 – Financial Sustainability: Bailing out India’s electricity sector
  • Part 2 – Environmental Sustainability: Tracking COVID-19 support for fossil fuels and renewables in India
  • Part 3 – Social sustainability: Energy affordability and pricing reform in India

This workstream is linked to global efforts to track government support for fossil fuels and renewables in light of COVID-19, as reported in the Energy Policy Tracker launched in July 2020 by IISD in partnership with 13 other organizations.


Part 1 – Financial Sustainability: Bailing out India’s electricity sector

Download: Impacts of COVID-19 on the Electricity Sector: How can states make the most of the stimulus on offer?

Since India entered lockdown in late March 2020, IISD’s energy program has been tracking, on a weekly basis, the impacts on different parts of the energy sector, demands for assistance from stakeholders, and responses from the government.

Amid the lockdown, the power sector has, so far, been successful in ensuring continued supply to essential services and households. However, it has also faced some of its biggest challenges. Electricity distribution companies (DISCOMs)—who buy electricity from generators and sell it to consumers—were already struggling with finance and performance issues before COVID-19. Now, they sit in a vortex of major risks and losses that have occurred across the supply chain. In order to support economic recovery and to enable a sustainable energy transition, it is essential to stabilize the basic financial viability of the power sector. The central government has already intervened with a major stimulus package worth INR 90,000 crore (~USD 12.1 billion) and proposals to revise core electricity sector regulations—but is it enough?

On June 30, 2020, IISD and CEEW convened 30 participants from India’s energy think tank community to discuss these challenges in a closed-door roundtable. This commentary synthesizes highlights from IISD’s tracking efforts and the roundtable discussion.[1]

DISCOMs Were Already Struggling With High Costs, Poor Billing-Collection and Large Subsidies

India’s DISCOMs have had financial and service performance problems for a long time, and, despite a bailout package in 2015, there have been few improvements. In particular, DISCOMs in many states have outstanding dues on payments to power generators: in IISD and CEEW’s recent review of government energy subsidies, we reported around INR 80,900 crore (USD 10.8 billion) of outstanding dues in late 2019. This grew to INR 1,26,000 crore (USD 16.8 billion) as of May 2020, a 56% increase.

There are many causes, but three stand out at the current time. First, the cost of power procurement has not come down. This is largely due to off-target demand forecasting and surplus power generation capacity. Some states also emphasize the ongoing cost of the first investments in renewables, when tariffs were more than double the conventional supply. Second, DISCOMs continue to struggle with inaccurate and delayed billing, particularly on account of the large growth in consumers under the 2017 SAUBHAGYA household electrification program. Third, electricity tariff structures in many states simply do not cover full costs, including margins to invest in infrastructure and operations. Residential and agricultural consumers, on average, pay far below the average cost of supply. Some of the revenue gap is borne by higher tariffs for industrial and commercial consumers (“cross-subsidies”), some is covered by large subsidies from state governments (estimated at INR 63,700 crore (~USD 8.5 billion) in 2019), and the remainder accumulates as DISCOM losses.

High costs and unsteady revenues already represented a lack of resilience in India’s power system—and COVID-19 has brought this into stark relief.

COVID-19 Amplified Existing Risks and Created Specific, New Ones

As illustrated in our roundtable briefing slides, the national lockdown from March 25 exacerbated these existing issues, largely due to a catastrophic drop in power demand—around 9% on average across India in March alone, rising to 23% in May.

For DISCOMs, this resulted in a large decline in revenues, and for various reasons, they were unable to reduce their costs by an equivalent degree.

Among electricity generators, renewable energy enjoys a “must-run” status—DISCOMs have to buy electricity from them before any other source.[2] In recent auctions, the per kWh cost of renewable energy has fallen lower than coal (even including storage), so it would be easy to assume that this would reduce costs for DISCOMs. But in many states, older renewable facilities, built many years ago, are producing power at above the average cost of conventional generation. At the same time, DISCOMs can’t fully reduce costs associated with coal power. DISCOMs’ power purchase agreements (PPAs) for coal are typically split into two parts: first, a “fixed cost” payout, which is due regardless of how much electricity is purchased, and second, a “variable” payout, which is due based on the volume of electricity purchased. This left DISCOMs taking on all renewable power, regardless of whether it was low-cost or high-cost, and continuing to pay fixed charges to coal power plants, even if they were not being used at all.

Among consumers, many households and businesses were struggling with the economic crisis created by the lockdown, not to mention the shift to online payment facilities, and some received assistance. All consumers were offered a three-month moratorium on payment dues during the lockdown, along with the choice, in some states, to pay bills in the form of equated monthly instalments over a three-month period. Industrial and commercial tariffs usually include a fixed and a variable component—but to help businesses cope, the fixed cost charge was waived in some states and deferred in others. Consumers were also offered options to defer payments. Some states, like Maharashtra, announced that tariff hikes would not be implemented as planned. This only increased the short-term pressure on DISCOM revenues.

How Has the Government Intervened, and Will It Be Enough?

Two main central government policy measures have already been announced: (i) an INR 90,000 crore (~USD 12.1 billion) stimulus package and (ii) permission to expand state government borrowing limits.

  • Stimulus package: The package offers a loan to DISCOMs to pay off generators, on the condition that they and state governments undertake various ambitious reforms. States are required to guarantee the entire loan amount and to ensure that subsidies are paid to DISCOMs monthly or quarterly, instead of once per year. State government departments are also required to install smart meters or prepaid meters in all state government departments to ensure timely payment of electricity dues to DISCOMs. There was a general consensus in the roundtable discussion that, unless DISCOMs have sufficient funds to address root problems, they will find themselves back in the same position a few months down the line. The package is difficult for states, whose finances are already stretched from COVID-19-related shocks. The package has also been criticized by some better-performing DISCOMs as coming at a higher interest rate than loans available from the market.
  • Expanding state borrowing limit policy: Permission to expand borrowing limits is also subject to conditions, namely: (i) implementing a Direct Benefit Transfer (DBT) cash transfer system for electricity subsidies in at least one district by the end of the year and (ii) DISCOMs bringing down losses associated with the cost of supply and revenue collection. Piloting a DBT system is a highly challenging reform to achieve by the end of the year, as it includes steps such as linking consumer profiles with bank accounts and tackling ownership and inheritance issues, as elaborated in a recent editorial by Prayas. Similarly, reducing DISCOM losses will be extremely challenging. Considering that states may need to expand borrowing limits for numerous non-energy reasons during this pandemic, linking the expansion of borrowing limits to electricity sector reforms is hard to understand.
  • Leeway in process for scheduling power: As of last year, power companies were instructed to not supply power until a bank guarantee or a letter of credit (for the entire value of power supplied) was opened by DISCOMs to guarantee payment. DISCOMs that failed to comply were denied access to spot markets. During the COVID-19 crisis, a reduction of 50% in the guarantee mechanism was allowed. Further, surcharges for late payment have been reduced from 1.5% of bills to 1%, for the period March 24 to June 30, 2020. Again, however, these measures do not tackle root problems and risks for DISCOM revenue uncertainty.

More recently, a number of significant proposals have been made to adjust the national tariff policy and to potentially increase the bailout package to INR 1.25 lakh crore (~USD 16.8 billion).

The status of these proposals is not yet clear. However, this commentary by CUTS International emphasizes the importance of careful implementation of subsidy reform for vulnerable consumers and notes again the important interlinkages with good design and implementation of DBTs.

How Could Assistance be Improved?

In our roundtable discussion, the following measures were discussed as a way to help the electricity sector build back better:

  1. Renewed efforts by DISCOMs for metering, billing, and collection efforts:  DISCOMs must continue the ongoing efforts to achieve universal metering of all consumers, particularly agricultural and rural residential consumers. In order to ensure timely delivery of accurate bills, DISCOMs need to strengthen their management systems, keep a check on erroneous bills, expand their human resource base, and provide appropriate incentives to meter readers. Billing based on metered units should be mandated to bridge the trust gap between consumers and DISCOMs, which in turn will lead to timely payments. For more details, see CEEW’s latest work on Jobs, Growth and Sustainability: A New Social Contract for India’s Recovery. Moving forward, DISCOMS could prioritize the installation of smart meters in high loss-making areas. For an elaboration on these topics, see the Centre for Study of Science, Technology and Policy’s elaboration of how lockdown has affected DISCOMS in Karnataka and the Centre for Policy Research’s Dr. Ashwini Swain on DISCOM finance problems and why smart metering may be one important piece in the solution.
  2. Better target subsidies: Due to poor targeting, DISCOMs in many states are providing subsidies not only to the poor but also to wealthier, high-consuming households. IISD has already set out options for electricity subsidy targeting in India, and, in a few months, will be publishing a major study on how to take a socially responsible, evidence-based approach to targeting based on in-depth research in Jharkhand. It is vital to carefully plan and pilot targeting and cash transfer systems. Serious efforts are also required to depoliticize electricity pricing: as long as tariffs are driven by political factors, DISCOMs will continue to be required to absorb losses, constraining their capacity to provide 24/7 energy access sustainably.
  3. Rethink the role of fixed-cost components in consumer billing. DISCOMs have to pay fixed costs to generators—but their revenues have fallen disproportionately because most consumer charges are made up of variable costs. Some kind of adjustment is needed to better align tariffs and billing with a transparent understanding of costs while keeping in mind the implications of a higher fixed cost component on poor households that consume lower power and on the impetus for energy efficiency. This will not just be a short-term issue. Experts predict that the economic fallout from COVID-19 will dampen GDP growth for years, creating a mismatch between demand and capacity. Brookings India has published a paper on the short- and long-term changes that DISCOMs need to make post-COVID-19, which elaborates on the implications of such fixed-cost asymmetries.
  4. Let DISCOMs adjust their power procurement costs to match revenues. There are three parts to this recommendation. First, looking to the future and assessing oncoming uncertainties, DISCOMs should consider how to procure power more flexibly than the rigid structures of existing PPAs. DISCOMs should look at spot markets to balance additional demand instead of entering PPAs that they can’t afford. Second, risk must be more reasonably apportioned across the power supply chain and not largely borne by DISCOMs alone. There should be recourse measures under any PPA, such as a force majeure clause, that allows parties to arrive at a renegotiated consensus on power purchase costs during an economic crisis. Third, as suggested by Rasika Athawale of the Regulatory Assistance Project, DISCOMs may want to fast-track the retirement of older coal power plants if a clear medium-term mismatch emerges between demand and supply. This could, for example, involve negotiations over a one-time settlement with debt-equity investors—the equivalent of an exit penalty to leave a lease early. Such negotiations need holistic thinking about other socioeconomic parameters, such as rehabilitation and usage of the assets recovered (such as land) and reskilling of workers, among others.
  5. State and central government-owned generation companies should discuss better risk allocation—so that all risk is not clustered on DISCOMs. While India’s policies so far have been geared toward creating investor confidence in the energy sector, there is a need to acknowledge that this is an extraordinary circumstance, warranting a reevaluation of risk apportionment for a temporary period (until the end of the pandemic). For example, investors in generation companies could be asked to take a cut on their return on equity, while banks could be asked to take a cut on the interest rate on loans, particularly if they are already the beneficiary of government efforts to relieve impacts in the banking sector. Regulations for cost-plus-based tariff determination from 2019 to 2024 fixed the return on equity rate at 15.5%. Reports suggest that authorities are examining the legality of reducing the fixed cost component of regulated projects, which could affect this return-on-equity component. Also, state-owned thermal power companies should have the capacity to take on more delays in payments from DISCOMs for power supplied.

Conclusions

The current crisis presents an opportunity for policy analysts to convene and lend a common voice to long-pending structural changes needed in the power sector. Without these, the sector will continue to struggle, even once the COVID-19 crisis is over, and will remain equally vulnerable to future shocks—ultimately undermining energy access, economic development, and a sustainable energy transition. IISD and CEEW’s roundtable discussion aimed to contribute to this by bringing together a number of energy policy think tanks from the state and national levels in India. We hope that the tracking of impacts and the proposed policy interventions will be helpful not only for India but also for other countries whose utilities are struggling with the combined impacts of demand shock and legacy issues of financial unsustainability.

 

[1] This discussion was held under Chatham House Rule: as a result, individuals and organizations are not cited unless they explicitly requested acknowledgement upon reviewing a draft of this commentary. On that basis, participating organizations included the Regulatory Assistance Project, CUTS International, the Centre for Study of Science, Technology and Policy (CSTEP), Prayas Energy Group and the Institute for Energy Economics and Financial Analysis (IEEFA).

[2] This resulted in an increase in the share of renewable power generation for the months of lockdown as compared to the same months in the previous year. See the Central Electricity Authority’s monthly report for April to see the growth in renewable energy generation in April 2020 as compared to April 2019.

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