SBD: A useful first step in power reforms

Power ministry is setting the stage for much-needed investments and efficiencies into the sector through privatisation of discoms - with a framework in the form of a draft Standard Bidding Document

Reforming the structure, operations and finances of electricity distribution companies (discoms) remains the great unfinished business of the power sector. 

The Ministry of Power is finally attempting to bite the bullet — setting the stage for the much-needed investments and efficiencies into the sector through privatisation of discoms — with a framework in the form of a draft Standard Bidding Document (SBD). The endeavor is to have the private sector step in and take over these hugely challenged state utilities. As the subject is in the domain of state governments and state regulators, the SBD will not be binding; the states are required to willingly come on board.  

What then are the key features of the draft SBD? The operational framework is to ensure a minimal government role by seeking 100 per cent and 74 per cent equity participation by the private sector for urban and urban-rural options, respectively. This by itself is significant, as it is a long-delayed acknowledgement of the crucial role private-public partnership is required to play in this arena.

The SBD envisages the existing set of discoms of a state (most states have more than one discom), being potentially on the divestment block as they exist. This bypasses the problem of having to carve out the most lucrative areas in a state —most often large urban areas with the most paying customers. However, precisely because of this, investor interest might well be limited, given that within a single discom, there could be vast areas (typically rural) which are far less commercially attractive.

In some of the bigger states, the existing entities are also quite large and unwieldy; and so, states may have to take a call on how to further split up some of the existing entities into further multiple-licence areas in a way that elicits investor interest and yet embraces attractive and less-desirable areas together.

In this context, it would be worthwhile to consider the franchise model in select areas — where outright sale may not be the desirable option. Franchisees have demonstrated their ability to bring about significant loss reductions. And the franchisee option is much simpler to operationalise quickly as it does not involve selling the family silver.

 The SBD makes it clear that the entity to be handed over would have a clean balance sheet, free of accumulated losses and unserviceable liabilities. At the same time, the existing reality is that many consumer segments in discoms are hugely subsidised by state governments. It is important, therefore, (and to ensure there is no consumer backlash with sudden spikes in tariffs) that the state continues to provide financial “transition support” to the new privatised entities in a clearly spelt out diminishing glide path. 

The SBD needs to further address the issue of enlarging the catchment area of qualifying bidders — as India has a relatively limited set of players in electricity distribution, transmission and generation (greater than 1,000 Mw) who may be interested in this space. Provisions to allow for more creative consortia formation would also serve to enlarge the pool of potential bidders — particularly international investors, both technical and financial.

A complicated dimension of the handover is the way in which existing power purchase agreements (PPAs) are to be honoured. The SBD provides for all PPAs to be transferred to the newly privatised entity. This may leave it little flexibility to procure cheaper power and thus drive consumer tariffs lower — a key reason for the privatisation in the first place. If the discom can pick which PPAs to take on and which to forego, two points become important: First, that any reductions in power purchases costs that result from rebalancing the portfolio of PPAs are passed on to consumers; and second, a mechanism to handle the stranded capacity for PPAs that are moved out of the new entity. Linked to this, of course, is the “moral hazard” issue of not reneging contractually on signed PPA contracts, which a few states have done recently and kicked up a furore amongst the investor community.

Above all, the key issue is the support of the concerned state government and the state regulator vis-à-vis issues like transition support, staff union resistance handling, law and order matters emanating from billing, collections and disconnections. These are key risk factors with investors and would need to be addressed. A commitment to reduce losses depends on a substantive upgrade of the run-down distribution infrastructure. The new discom owner has to infuse fresh capital expenditure to harness the technical efficiencies desired; concomitant with the assurance that such expenditure can be recovered through increased tariffs and not disrupted by inimical populist forces. State regulators must approve all such genuine expenditure as tariff pass-throughs. The SBD is silent on this crucial issue of capital expenditure.

Whilst the draft SBD is a desirable first step, preliminary investor reactions point to the need for clarifications and reformatting in a number of crucial aspects such as eligibility criteria, evaluation of the financial proposals, credible dispute resolution mechanism, bidding parameters, absorption of existing staff (known to be bloated), incentives on collection of past arrears, termination modalities et al.

Discom privatisation will be the most complex of economic reforms, given the level of cooperation and communication required between consumers, feisty power sector unions, vested interests, investors and governments at all levels. 

If it does go through, it will be the biggest such reform in decades. 

The writer is the chairman of Feedback Infra