UDAY: Quietly Disentangling India's Power Distribution Sector

When Union Power minister Piyush Goyal in late 2015 announced the Ujwal DISCOM Assurance Yojana (UDAY), with a quirky acronym that spans English and Hindi, it was received with cautious optimism in several circles. {Note: "DISCOM" = (electricity) DIStribution COMpany.} But the scheme, powered by the indefatigable power minister and his persistent staff, with the cooperation of states, has quietly made several important strides. 15 states have agreed in-principle to join the scheme: Andhra Pradesh, Rajasthan, Jharkhand, Madhya Pradesh, Uttarakhand, Himachal Pradesh, Punjab, Jammu & Kashmir, Haryana, Gujarat, Chhattisgarh, Uttar Pradesh, Bihar, Odisha and Maharashtra. Note that this list includes several states ruled by non-NDA governments. MoUs are being finalized between the centre and state. As of early March 2016, Rs 1.94 lakh crore debt (~US$29.8 billion), or 45% of total outstanding debt of DISCOMs in the country (see below), is expected to be covered under the UDAY scheme. More needs to be done to get closer to full coverage, but this is remarkable progress, especially since UDAY is a voluntary scheme that the states make an explicit choice to participate!

Plight of the Electricity Distribution Sector:

Clearly the electricity distribution sector is the weakest link in the electricity supply chain in India, sitting on an accumulated loss of Rs. 4.3 lakh crores (almost US$70 billion), and adding up Rs. 60-65,000 crores of losses each year (i.e. US$9-10 billion/year!). Caught between populist state governments who expand subsidies during election campaigns (eg: free power, ultra-low subsidized tariffs for some customers), high technical losses (due to inability to invest, estimated at 10% of units), high non-technical losses (inability to control power theft estimated at 15% of units), the state electricity boards (SEBs) and DISCOMs stopped contracting for power from generators on one hand, and handed out severe unscheduled power cuts to homes and businesses on the other. And they provide a meagre 2-3 hours of supply late nights (i.e. 21-22 hours of NO power) for the "free" power sector, usually irrigation pumps. Since the same (long) feeder provides power to both villages and the irrigation pumps, even "electrified" villages often face the plight of 6 hours of power / day. This is adding financial stress for power generators who are waiting for PPAs (power purchase agreements), and a load of hidden economic costs for residential, commercial and industrial end-users.

Interestingly India today has several thermal power plants at low plant load factors (PLFs of ~60%) which means excess generation capacity is available, that raises average cost per unit of power. There is short term overcapacity of supply... But what is remarkable, is that, at the same time we have shortages on the other side, i.e. power cuts for consumers! This dubious duality is because the intermediary discom is financially bleeding, has accumulated debt, and is unable to channel a flow of funds from consumers to generators to efficiently deliver reliable and affordable electricity service.

Over years, apartment complexes, malls, small businesses, and telecom towers have been investing in diesel generators as backup for reliable power, and driving up imports of oil, affecting current account deficit (CAD) and balance of payments. The Economic Survey estimates 72 GW of diesel gensets, growing at 5GW a year! This DG growth indicates the hunger for reliable power and its economic value (given that diesel power is 3-4X costlier than grid power), and will only taper when the public sees more reliable power available. Perhaps this DG investment can instead be harnessed for distributed solar and electric vehicles (see articles part 1, part 2, part 3 on this topic, and how electric scooters etc can improve the conditions of the grid)?

What are the key highlights of the UDAY scheme?

1. States shall take over 75 per cent of discom debt outstanding as of September 2015, over two years - 50% of DISCOM debt shall be taken over in 2015-16 and 25% in 2016-17. Government of India will not include this incremental debt in the calculation of fiscal deficit of respective States in the financial years 2015-16 and 2016-17.

2. States will issue non-SLR including state development bonds (SDL) in the market or directly via private placement to the respective banks / Financial Institutions (FIs) holding the DISCOM debt to the appropriate extent. DISCOM debt not taken over by the State shall be converted by the Banks / FIs into loans or bonds with interest rate not more than the bank’s base rate plus 0.1%.  {Note: SLR = Statuatory Liquidity Ratio, i.e. the share of bank deposits kept in safe government securities G-Secs (which yield lower than the bank base rate usually) by all commercial banks - public and private. By Non-SLR, it means that these bonds are considered slightly less safer. } Alternately, this debt may be fully or partly issued by the DISCOM as State guaranteed DISCOM bonds at the prevailing market rates which shall be equal to or less than bank base rate plus 0.1%.

3. Reduction of Aggregate Technical & Commercial (AT&C) losses to 15 per cent by 2018-19. Reduction in difference between average cost of supply and average revenue realized (ARR) by 2018-19. Quarterly updates to tariffs by state regulators, and they have been asked not to pass on inefficiencies as tariff increases. States shall take over the future losses (presumably inefficiencies) of DISCOMs in a graded manner. Banks/FIs not to advance short term debt to discoms for financing losses, i.e. discoms are further financially incentivized to be efficient.

4. In return, State DISCOMs will comply with the Renewable Purchase Obligation (RPO) outstanding since 1st April, 2012, within a period to be decided in consultation with Ministry of Power.

5. Incentives: States accepting UDAY and performing as per operational milestones will be given additional / priority funding through Deendayal Upadhyaya Gram Jyoti Yojana (DDUGJY),Integrated Power Development Scheme (IPDS), Power Sector Development Fund (PSDF) or other such schemes of Ministry of Power and Ministry of New and Renewable Energy. Such States shall also be supported with additional coal at notified prices and, in case of availability through higher capacity utilization, low cost power from NTPC and other Central Public Sector Undertakings (CPSUs). States not meeting operational milestones will be liable to forfeit their claim on IPDS and DDUGJY grants.

What does UDAY mean, really? What efficiencies are expected?

First it is important to realize that the UDAY scheme is a voluntary scheme that states join with the centre. From a financial point of view, UDAY gives a limited-term incentive for states to move a huge off balance sheet item onto their state balance sheets. Why would states do it? Their DISCOMs are paying 13-15% interest, but the same debt can be serviced at 8-8.5% on state balance sheets (interest savings of tens of thousands of crores/year).

Once it comes onto state balance sheets, it is governed on the long run by the fiscal constraints of the state. Yes, this does reflects socialization of the losses of the DISCOM by state tax payers. The losses imposed by the electricity thief is being borne by the honest tax payer.  But, it is the job of the state and DISCOM to invest in technology and collection to ensure the thief doesn't get away again: there are incentives for this. Also, now state politicians will have to think twice before promising generous subsidies in the future since that will have to be financed within the 3% state-level budget deficit on the long run (i.e. tradeoff with other subsidies, or increase collection efficiencies, and technical efficiencies). The centre is using its power over the nationalized banking system to limit working capital financing of "bad" losses or "inefficiencies." The scheme is also positioned not as a bailout, but a financial re-structuring with incentives for the states to bring a de facto commitment back on their balance sheets de jure, along with incentives to drive efficiencies.

The Ministry of Power estimates that a combination of financial efficiency (lower debt rates will save Rs. 44,000 crores), technical / collection efficiency (AT&C loss reduction to 15% will save Rs. 33,000 crores), better coal linkages (supply of domestic coal and coal swapping to save Rs. 36,000 crores), energy efficiency initiatives and demand side management (eg: LEDs, appliances, pumps to yield Rs. 58,500 crores) and industrial efficiency savings (eg: perform-achieve-trade PAT for energy conservation in industry for Rs. 7600 crores) totalling projected savings of Rs. 1.8 lakh crores.

If you analyze the projected savings above, only a part of it is from financial savings. The technical / collection efficiency gains require DISCOM / state level reforms, capital investment and operational excellence by DISCOMs. The Power ministry is tying some incentives of support to this (i.e. "carrots"), and adding some penalties (i.e. "sticks") directing centrally controlled banks NOT to fund future inefficiency losses to DISCOMs directly. Coal linkages, centrally procured LED schemes are also other carrots which will be provided conditionally on good operating behavior by DISCOMs.

The financial sector will see lower rates of interest, but the NPAs from the sector will be alleviated, giving space for banks to grow their loan books (eg: to fund renewables). ICRA has a cautious report on UDAY's projected financial sector impacts. Similarly CRISIL also points out that UDAY is a mixed bag for the financial sector on the short run, but on balance, the work-out of NPAs, avoidance of loss financing, and incentives for efficiencies will be a positive on the long term. The coal ministry expects that once the wave of restructuring happens in the first half, it will lead to more power purchase agreements and coal inventories going down at power plants.

Technical loss reduction can come from multiple sources: reducing the length of feeders reduces resistance, lowers the current carried (i^2 R loss reduces due to both factors), smart meters are being planned for higher usage customers and broader rollout later (which, using data analytics, could allow limited triangulation of where un-metered loss is occuring & drive enforcement against non-technical loss, i.e. theft), and simple enforcement of billing and collection of payments will help. Analysis of data from meters and SCADA can also lead to better demand prediction and proactive supply contracting at lower rates in advance. Since the interest burden is off the DISCOM books (i.e. taken off the cost structure of discoms and socialized), slightly higher tariffs on higher usage folks could lead to average revenues exceed average costs. Quarterly tariff increases could make increases more palatable to consumers. Distributed solar at low penetration levels could also offset part of peak consumption.

Will UDAY work?

Time will tell whether the state governments will exercise the fiscal prudence, and whether the incentives for UDAY efficiencies above will work. Especially the operational reviews and actions to drive technical efficiencies, discipline by banks not to fund losses, broader coverage of the base and collection efficiencies (lower theft etc) will be key indicators. Vigilance and execution appear to be key - UDAY seems to be well designed from the point of view of incentives, and using all the carrots and sticks in the arsenal of the central government on a concurrent topic.

If this works out, the government would have succeeded in replicating the Gujarat model of affordable tariffs (with a progressive structure), high collection efficiency, low power theft, high industrialization (reasonable commercial / industrial tariffs), separation of feeders for pumps, and profitable discoms ... lending huge credibility to their 24 x 7 power promise by 2019. I am optimistic they will get there, and quiet progress made in UDAY sign-ons is a big positive.

Twitter: @shivkuma_k

ps: If you like this post, consider reading some of the companion articles: "Distributed / Rooftop Solar in India: A Gentle Introduction: Part 1","Rooftop Solar in India: Part 2 {Shadowing, Soiling, Diesel Offset}", "Rooftop Solar in India: Part 3: Policy Tools... Net Metering etc..." "Solar Economics 101: Introduction to LCOE and Grid Parity" , "Solar will get cheaper than coal power much faster than you think..", "Understanding Recent Solar Tariffs in India", "How Electric Scooters,... can spur adoption of Distributed Solar in India," "Solar + Ola! = Sola! ... The Coming Energy-Transportation Nexus in India", "UDAY: Quietly Disentangling India's Power Distribution Sector", "Understanding Solar Finance in India: Part 1", "Back to the Future: The Coming Internet of Energy Networks...", "Tesla Model 3: More than Yet-Another-Car: Ushering in the Energy-Transportation Nexus", "Understanding Solar Finance in India: Part 2 (Project Finance)", "Ola! e-Rickshaws: the dawn of electric mobility in India", "Understanding Solar Finance in India: Part 3 (Solar Business Models)" . 

pps: List of all my LinkedIn Articles