Privatization of Discoms: The SBD & Challenges ahead

The financial health of discoms is deteriorating day by day and they are finding it increasingly difficult to sustain their day to day operations and debt service obligations. Realizing that distribution sector reforms are urgently needed, a draft of SBD on privatization of discoms has been circulated with disclaimer that “it do not represents the views of the Ministry and being presented with aims of initiating discussions…”. This draft SBD while brings some clarity on the subject but also raises some serious questions on the way forward. At the best it can be described as a Work in Progress of a Consultant.

Some of the welcome key features of the SBD include

a)       privatization of discom will be of the licensee (as a company as entity) and not in parts. This is a welcome step which will ensure that there is no cherry picking by private investors. Private discoms have so far only confined themselves mostly to the urban areas where the paying consumers reside, and the subsidy burden of rural areas are still borne by the respective states.

b)      The interests of existing employees are to be protected.

c)       Successor entity will have a clean balance sheet and all the past dues including true-up of accounts will be a pass through.

d)      The net asset value on which the transfer will take place, will be decided by the appropriate commission.

e)      Existing PPA’s of discoms will be transferred to the successor or successor may sign only the Bulk Supply agreement.

f)        Besides 100% equity transfer, the SBD also proposes majority sale of equity in which 74% will be transferred (with management) and remaining 26% will be retained by the state government.

Having said that there are some major challenges which needs to be addressed before moving forward:

The biggest challenge will be how the existing power purchase agreements (PPAs) of the discoms are to be allocated to the successor? At present, the discoms have a portfolio of PPAs of comprising of various fuel sources like thermal, hydel, renewable etc and of different ages procured over period. This makes the power purchase costs of each PPA different, some are low cost due to depreciated plant value and the new ones are expensive. Further, all the govt. discoms have contracted PPAs far in excess of their average demand-load and are paying stranded capacity charges to generating companies even when they are not buying power from them. For example, in UP, the average load of all discoms is around 14000 MW but the total PPA signed by them is around 26000 MW. Similarly, the total installed capacity in the country is around 375GW whereas peak load has never exceeded 185GW. Therefore, methodology for allocation of existing PPAs to successor will play a critical role in privatization- whether successor will have to take-over all existing PPAs of discom or only some of these PPAs. If only part of the PPA portfolio is taken over, which PPAs- the lower costs ones or higher cost one or at a weighted average cost?. If all existing PPAs are not taken by the successor, the successor will have windfall gains at current tariff because the present tariff comprises of total power purchase cost including the stranded capacity for the discom. Besides, how the unallocated PPAs will be serviced by the discom after transfer of assets? Same will be the case for the Bulk Supply of power to the successor. Therefore, a greater clarity is needed on this point.

Another point is arising out of mentioning of sec.131 of the Electricity Act. In the RFP (2.2.1) of SBD relating to notification of transfer scheme. Sec. 131 of the Act provides for vesting of assets from SEBs to the State government and re-vesting to state govt. companies or other companies. Now when almost all the state governments have already re-vested the assets of erstwhile SEBs to the state discoms (company), how the state government can again invoke this provision and re-vest the assets again? Now it is a case of asset transfer under the Companies Act and not sec.131 of the Electricity Act.

RFP (2.2.9(a)) relating to incentive on collection of past arrears are confusing. It may cause disputes as most of the outstanding shown in the discoms account are bogus and billed to show reduction is losses. After using reduction in losses as a bidding parameter besides equity, asking the successor to pass on the collection will cause complications and needs clarity. Similarly, mentioning additional incentive over and above Return on Equity is vague. In any case, collection of dues is not related to Return on Equity and the latter is subject to the regulations. If the intention is to supercede the regulation and treat it as a case under sec.63 of the electricity Act, the bidding must be done on the tariff and not on equity & loss reduction because only under sec.63 the tariff discovered is adopted and not regulated by the commissions.

The most confusing part is the evaluation the financial proposal dealt in 6.3 of the RFP/SBD. It talks about either highest financial quote (premium on equity) or highest cumulative reduction in ATC losses as bid parameter. While premium on equity is a tangible consideration, how only commitment on cumulative loss reduction will be the basis of asset transfer?  Any bidder can quote any figure and may not achieve that commitment. Everyone knows the fate of such commitments given by the state discoms in the past under various Financial Restructure Plans or even much publicized UDAY scheme.

An important legal aspect completely missed out in the transaction process outlined by SBD is that of obtaining prior approval of the appropriate commission under sec-17(3)  of the Electricity Act which provides for prior approval of the commission before sale, lease , exchange etc. Avoiding this will make the whole process illegal.

Since the SBD does not have the approval of Ministry so far, one believes that the points raised above will be appropriately addressed when the final SBD is notified.

 

About the Author:

Raj Pratap Singh retired from IAS has worked at senior positions at Central & State Government including PMO and World Bank. Presently he is Chairman of UP Electricity Regulatory Commission.

Disclaimer: Views expressed in this article are author’s opinion and does not reflect any official position.