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How can the sun shine on electricity distribution utilities?

India has set an ambitious target of achieving 450 GW of installed capacity of renewable energy by 2030—this is more than five times the current installed capacity of 82 GW.[1] One of the main stakeholders in this energy transition are electricity distribution utilities (discoms). Discoms act as an interface between electricity generators and end consumers by purchasing energy from generators and supplying it to agricultural, industrial, commercial, and residential users. Since discoms play such a vital role in this network, their financial health is critical for the ecosystem as a whole. Any stress on their finances is transmitted across the value chain in the form of delays or defaults in payments to generators, which may also result in bad loans (NPAs) for banks. Due to this interdependence, continued losses on the part of discoms could jeopardise India’s renewable energy mission. Hence, rapid action at the structural level is required to restore discoms’ financial health. In addition, a systemic shift can help establish a robust power sector.

In FY 2018–19, cumulative losses for discoms stood at over INR 280 billion (USD 4 billion).[2] This trend has become entrenched despite several government interventions, the most recent being the Ujjwal Discom Assurance Yojana (UDAY) scheme, aimed at alleviating losses by imposing guidelines to improve discoms’ performance.[3] To better understand the impact of this intervention on the financial health of discoms, we analysed two utilities—the Maharashtra State Electricity Distribution Company Ltd (MSEDCL), which recently turned profitable, and the Telangana State North Power Distribution Company Ltd (TSNPDCL), which continues to run at a loss every year. Our analysis spanned both cost and revenue streams in the pre- and post- UDAY phase. 

Like any trading company, in order to make profits, a discom must increase its revenue and decrease its expenses. In the case of discoms, revenue majorly comprises of electricity bill while expenses comprise electricity procurement costs and overheads.[4] However, since discoms in India operate in a regulated market, their capacity to increase revenue is limited as tariffs are fixed according to the state’s policy and consumer demographics. Since all utilities face this limitation, one way to improve performance is to minimise costs, including those associated with electricity procurement, overheads, and energy losses.[5]

We studied the revenue generated by, and the costs associated with, every unit of electricity supplied during the period FY15 (pre-UDAY) to FY18 (post-UDAY). The analysis revealed differentiation on two counts—the spread and the operational and financial efficiency of discoms.

A)     The cost of power purchase (for every unit of electricity supplied) is made up of the following:

  • Cost per unit of electricity purchased  
  • Cost of energy loss (the difference in units purchased and those supplied)

B)     Overheads per unit of electricity supplied, including operational and management costs, employee costs, and other costs

C)     The cost of finance per unit of electricity supplied, comprising interest and other costs towards loans, and the interest towards deposits by consumers and others

D)     Costs towards depreciation and amortisation of assets deployed per unit of electricity supplied


Table 1: Revenue and costs per unit of electricity supplied in MSEDCL and TSNPDCL

Source: CEEW-CEF analysis; annual reports of MSEDCL and TSNPDCL.

Spread is the difference between the average revenue per unit sales and the average power procurement cost.

  • In the period FY15–FY18 (pre- to post-UDAY), MSEDCL increased its spread by over 30 per cent, from INR 2/unit to INR 2.62/unit, respectively, by keeping the cost of power purchase constant while increasing the average revenue charged.
  • In Telangana North, an increase in revenue has been offset by an increase in the power purchase cost, which resulted in an 8 per cent decrease in the spread to a mere INR 0.66/unit from FY15–FY18—about a fourth of the spread of MSEDCL over the same period.

Thus, MSEDCL has both rationalised its overall tariff and managed its procurement cost over this period. However, TSNPDCL’s inability to balance its increased power purchase costs and tariffs has resulted in a comparatively smaller spread available to cover expenses related to supply and operations.

For TSNPDCL, the relatively small increase in the average revenue compared to the increase in the power purchase cost can be attributed to an increase in the share of agriculture in total sales, which increased to 46 per cent (an increase of 600 basis points in total share of electricity sales from FY15) in 2018 as agriculture is relatively low paying, , this did not translate to increased revenue. For MSEDCL, the sale towards agriculture stood at around 27 per cent of total sales in 2018.

 

Operational and financial efficiency – this can be described in terms of the overheads of running the business, cost of finance, depreciation and amortisation charges, and the cost of energy loss; that is, all costs other than the power purchase cost.

  • In MSDECL, the cumulative contribution towards these cost factors increased over 10 per cent from INR 2.3/unit in FY15 to INR 2.57/ unit in FY18, primarily due to an increase in the cost of finance (from INR 0.31/unit to INR 0.59/unit) and an increase in depreciation and amortisation charges by INR 0.10/unit to INR 0.29/unit (from INR 0.31/unit to INR 0.55 /unit), offsetting the decline of more than 5 per cent in the cost of energy losses from INR 1.07/unit in FY15 to INR1.01/ unit FY18.
  • TSNPDCL improved its performance by cumulatively reducing its costs by over 10 per cent to INR 1.80/unit in FY18 from 2.01/unit in FY15.

This shows that TSNPDCL took only 70 per cent of MSEDCL’s operating and financing costs to supply one unit of electricity in FY18. Meanwhile, by FY18, MSEDCL had lost all its advantages in financial cost rationalisation—possibly because the state government took over part of the debt under UDAY—and the cost has increased beyond the pre-UDAY (FY15) level.[6]

We suggest that for a utility to make profits, the tariff needs to be rationalised in line with the cost of power procurement. Since electricity is a state subject, the efficiencies in the cost of delivery as shown by the operational and financial prudence need monitoring and management.[7][8] Further, an operationally and financially efficient discom, like TSNPDCL, continues to reel under losses while an arguably less efficient utility, MSDECL, has been able to turn around and generate profits. This raises an important question regarding the design of future schemes. Can a one-size-fits-all scheme like UDAY address the varied challenges plaguing discoms? What worked for one state will not necessarily work for others. Future schemes need to address differences in operations, geographies, and consumer profiles. Additionally, as our research indicates, the current tariff design may not be efficient enough to address the operational and financial inadequacies of discoms.

 

Do you think the UDAY scheme has been successful in addressing the poor financial health of discoms in a systemic manner? What should be the way forward? Share your views and comments on the above CEF analysis at cef@ceew.in

 

References

[1] Bhaskar, Utpal. 2019. “India confident of adding 450 GW of renewables by 2030: Raj Kumar Singh.” LiveMint, October 15. https://www.livemint.com/politics/policy/india-confident-of-adding-450-gw-of-renewables-by-2030-raj-kumar-singh-11571137804129.html 
[2] Chatterjee, Anupam. 2019. “Uday scheme: Discoms’ losses rise 89% in FY19.” Financial Express, July 30. https://www.financialexpress.com/economy/uday-scheme-discoms-losses-rise-89-in-fy19/1660106/
[3] Financial reforms in recent history—2001: bailout package to reduce accumulated losses; 2012: financial restructuring package to reduce piling debt burden; 2015: UDAY to improve performance and reduce losses.
[4] The cost of procurement of electricity implies that incurred in the purchase of power; overhead costs imply those incurred on operation and management, depreciation, depletion, and amortisation, and finance costs.
[5] Cost of energy lost in the system = (cost of power purchased/total units sold) ­– (average cost of power purchased/total units bought)
[6] TSNPDCL’s cost of finance per unit of supply has declined post-UDAY.
[7] Given that renewable energy tariffs have plummeted below the new coal capacity tariffs, it is time for utilities to seriously consider what cost savings are possible with renewable integration and to what extent renewables can be integrated in the energy mix, given that their contribution for most utilities across India is low.
[8] Renewables, excluding large hydro, contributed about 7 and 10 per cent, respectively, to the energy mix in TSNPDCL and MSEDCL in FY18.



Disclaimer: "CEF Analysis” is a product of the CEEW Centre for Energy Finance, which explains real-time market developments based on publicly available data and engagements with market participants. By their very nature, these pieces are not peer-reviewed. CEEW-CEF and CEEW assume no legal responsibility or financial liability for the omissions, errors, and inaccuracies in the analysis.