Flickers of interest: Why private firms are hesitant to enter discom space

Power distribution, the end of the electricity value chain that involves selling to customers, has been the most problematic element of the sector. Predicated on the political compulsions of selling power below cost to large swathes of rural consumers, power distribution has been the root cause of the losses right from generation and sometimes even from the source of the fuel supply. Reform attempts by successive governments — including the current government’s UDAY scheme that ends in March 2020 — have brought no fundamental change. Even so, there are signs of a realignment led by private sector players in areas where power pricing is more flexible.

 
Earlier this month, for instance, Adani Trans-mission announced that it was offloading its 25.1 per cent stake in its Mumbai distribution business to Qatar Investment Authority for Rs 3,200 crore at a small profit over the value the group paid for the business to Reliance Infrastructure in August 2018. The agreement requires 30 per cent sourcing of power from renewable alternatives for distribution in Mumbai by 2023. The transaction is likely to be completed by early 2020, subject to regulatory and other approvals.
 
There have been a few others in the recent past. Mumbai-based private equity player Bessemer Venture Partners’ investment in Spanco Power, power distributor in Nagpur, in 2012 and Asia-focused private equity player ADV Partners’ invested in Feedback Infra, which is into power and road management services, in 2018. There would well have been more such deals, according to Sambitosh Mohapatra, partner, advisory, power & utilities, PwC, were it not for the fact that “the opportunities were very few and even within that the success stories limited”.

 

What explains this shift in private sector interest? After all, as Mohapatra points out, the performance of the distribution business remains largely in the hands of state-owned discoms. A good part of the reason lies in recent structural reforms introduced via the Electricity Act. The critical one is content carriage segregration, which separates power distribution from the generation business by allowing multiple licensees to supply power to consumers based on market-based pricing principles. This move to what is also known as open access systems (since it enables consumers to get a choice of supplier) is, in turn, expected to expand the market for large investments in networks and base systems (transformers and so on).

 
Metering, data-driven infrastructure to optimise demand patterns and so on are expected to be the growth areas, as will such non-tariff revenue sources — for instance, the increasing level and volatility of power prices also increases value of energy management services. 
 
Several markets and business models are emerging and will co-exist in India. The emergence of local island grids is one of them. It is this potential that has attracted a big player like Tata Power in direct competition with energy supply companies that are essentially small enterprises currently facing pressure from grid power given by state-owned discoms. Tata Power has floated TP Renewables in tie-up with the Rockefeller Foundation for offgrid power generation and distribution in rural areas.

 
In parallel, traditional privatisation of the distribution business, meanwhile, got a booster with the Odisha government deciding earlier this month to give licences for five circles to Tata Power under a 25-year-old contract. With this, the company will add 2.5 million consumers to its existing base of 2.5 million in Mumbai, Delhi and Ajmer. Tata Power will be responsible both for procurement and distribution of power in the Odisha circles.
 
Odisha’s is the first full privatisation of distribution companies in 17 years since the privatisation of Delhi power distribution. The state government is offering three more circles over the next six months. Explaining the private interest in the Odisha circles, Mohapatra says, “The private sector is interested in any well-structured transaction with appropriate risk return framework, reasonable size and scale of business and regulatory certainty. Political stability and administrative support were also key factors. Odisha was providing all of that.” The private operator also draws comfort from 49 per cent state government equity in the privatised entity. PwC was the transaction advisor for the Odisha deal.

 
Before this, companies such as Feedback Infra, Essel and Tata Power had explored the franchisee model. This model only privatises billing and metering part of the distribution business leaving generation to state companies. In states such as Madhya Pradesh, the franchise model hit a wall when the state government did not allow for a tariff hike for the Indore circle.
 
The political pressure on tariffs remains the key sticking point to the expansion of private sector interest in the sector. This was the focus of the 2015 Ujjwal Discom Assurance Yojana (UDAY) programmes, which asked states to take over 75 per cent of discom debt and repay lenders by selling bonds. The central assumption of this financial revival programme was that state governments would raise power tariffs. The results have been mixed, with some states retaining subsidies to rural consumers and raising the cross-subsidy from other users. Even so, discoms have not been able to eliminate the gap between the average cost of supply and the revenue realised (ACS-ARR gap) or reduce their aggregate technical and commercial (AT&C) losses to 15 per cent.

 
Nonetheless, Uday was successful in bringing down the cost of funds for discoms from 13-14 per cent to 8-9 per cent. “That’s substantial savings when we look at around Rs 2 trillion of borrowings. The scheme, however, put the onus of driving operational efficiency improvement and investments on the owners of the business — state governments. That didn’t work out at the step jump level expected but incremental gains happened,” Mohapatra says.
 
The way the power paradigm is playing out therefore is this. State government-owned discoms will have to balance the challenge of losses with the responsibility of universal electrification whereas private investors are innovating with investment models even as they keep away from the generation business.