The higher returns promised in the new CERC norms are offset by other changes in the rules and are available only to power projects that are completed in time.
ALOK KUMAR
Secretary, Central Electricity Regulatory Commission
‘The new norms send out a clear signal to investors, and are aimed at benefitting both users as well as producers’
The tariff regulations notified by the Central Electricity Regulatory Commission (CERC) for the next 5 years beginning 1st April, 2009 have given a clear signal to attract investment in the power sector. The CERC has rightly decided to raise the base rate of return on equity from 14 per cent to 16 per cent for projects commissioned in time. The rates for depreciation have been rationalised while doing away with the earlier instrument of Advance Against Depreciation (AAD) which was available on a case-to-case basis. The new depreciation rates take care of the debt repayment obligations of the power project developers. The power sector companies will now be able to retain the benefit of tax holiday permissible under the Income Tax Act. Earlier, the benefit of tax holiday was required to be passed on to the consumers as the return was post-tax.
One could argue that the new regulations will have limited impact on investment promotion because now the generation and transmission projects in private sector are required to be developed through tariff-based competitive bidding which is outside the purview of the CERC’s tariff regulations. This is not so actually. The Tariff Policy has now permitted new hydro power project developers to get their tariff fixed from CERC under the cost-plus regime. They are also permitted upto 40 per cent merchant power sales at market-determined prices. The provision of enhanced return on equity along with merchant-power sale is going to boost hydro power development. The rate of return notified by the CERC is adopted by the State Electricity Regulatory Commissions (SERCs) for the distribution business also. This is going to make investment in existing and new distribution companies more attractive. Renewable energy-based projects are also going to benefit as the SERCs should adopt the higher rate of return on equity for such projects. The renewable power purchase obligations of the distribution utilities are set to go up in view of the targets given by the National Action Plan on Climate Change.
However, there is one rider. Higher returns would flow to only those projects which are implemented and operated in an efficient manner. The projects are going to lose 0.5 per cent return on equity if they fail to meet the deadlines for commissioning. Similarly, the recovery of fixed cost is going to be less if the projects fail to meet the stringent operating norms set by CERC.
While talking of power tariff regulations, consumer perspective cannot be left out. Larger investments in the power sector and timely commissioning of power projects should definitely address the problem of acute power shortages. Secondly, the consumers are also going to be benefited by way of passing of only efficient costs of operations. The CERC has tightened various operating norms. For example, the norm for secondary oil consumption has been slashed by 50 per cent from 2 ml per unit to 1 ml per unit. Moreover, the CERC has, for the first time, adopted the concept of sharing the benefit of efficiency gains with consumers. Now half of the saving in secondary oil consumption is to be shared with consumers. Overall, the CERC has given higher priority to the objective of investment-promotion than to cost-cutting, which I feel is appropriate if one takes into account the need of mobilising large investment in this important infrastructure sector.
KULJIT SINGH
Head, Transaction Advisory Services, Ernst & Young
‘There are enough riders to ensure the rate of return will be lower than the 16% that most think has been allowed’
The recent CERC guidelines contain landmark provisions to take India’s power sector to greater heights by streamlining the process of tariff determination. All the changes should be viewed from the perspective of their effect on return on equity (RoE). On the face of things, the RoE has been increased from 14 per cent to 15.5 per cent, and an additional 0.5 per cent return is allowed if a project gets completed on time. Since this RoE is payable only post-commissioning, the equity internal rate of return (IRR) after accounting for zero return during construction works out to just 12-13 per cent.
At present, the debt for power projects is available at 12.5-13.5 per cent — so an equity IRR of the same rate may imply that there is either a strong expectation that debt rates will drop to around 7 to 8 per cent by the time the regulations come into effect (i.e. by April 1, 2009) or that an investor will make his required return through trading of power (not applicable to government projects) or through efficiency gains.
The increased RoE has several other offsetting changes built into it. For instance, the earlier14 per cent RoE was based on a target availability of 80 per cent which has now been increased to 85 per cent. This has been countered to some extent by paying the incentives for better performance on the basis of availability instead of on the actual load. Further, the 14 per cent RoE was based on reimbursement of actual tax liability (including on items such as incentives) but it is now based on the actual tax rate applied only on the income relating to 15.5 per cent RoE. Additional changes relate to requirement of sharing of Clean Development Mechanism (CDM) benefits with the power purchaser and discontinuation of the concept of advance against depreciation (offset to a certain extent by increase in depreciation rates) which may impact equity returns. Further, since the 15.5 per cent RoE will be based on a ceiling capital cost to be intimated by the CERC later, the exact benefit of the higher RoE is unclear.
There are several other changes made in the O&M and operating parameters such as heat rates and it is hoped that all of these would be RoE-neutral or RoE-accretive from a technical feasibility perspective.
Lastly, the current regulations provide no mechanism through which future RoE (in control periods post-2014) will be determined. The argument given in favour of not providing any market-determined formula is that there is no data in India. But if data is not available in the Indian power sector, this should be taken from other similar industries in India or from the power sector in other countries. In the present age, wherein capital is not constrained by geographical boundaries, the use of data from other countries could assist India in better positioning the appeal of its power sector and thus increasing the flow of investments here. Greater clarity on future RoE movements is even more important as CERC guidelines are now relevant for not only government projects but are also getting applied to a part of the power being purchased by State Electricity Boards (SEBs) from hydro and thermal power projects that are being set up in their states.
The author is Head, Transaction Advisory Services in the Infrastructure, Real Estate and Government Practice of Ernst & Young
The views expressed are personal
