A fork in the road for state electricity reforms

AKSHAY JAITLY

India is moving towards the creation of a centralized national electricity market, particularly for renewal energy. This is a consequence of steps taken by the Union government on the one hand and a growing market for power sales excluding the state government owned power distribution companies (Discoms) on the other. The Discoms’ poor financial position incentivizes them to try and protect every rupee of revenue, even at the cost of breaching contracts with private power producers. Their expensive and unreliable power supply is driving their best source of revenue – commercial and industrial (C&I) consumers out of their networks. This will worsen their financial condition. They have a way out – reforming their power sectors. This is not an easy option but international climate finance and privatization of state assets provide solutions.

India is uniquely situated in the climate change world. It is a large emerging economy and a large emitter of greenhouse gases. It also has legitimate claims for receiving financial assistance from rich countries under the rubric of climate justice. India’s aspirations for rapid growth will require increasing amounts of energy and as it becomes richer, its people will consume more energy per capita. It must at the same time build a credible path to decarbonization.

India’s path to decarbonizing the power sector will involve an interplay between main central themes – central planning and the use of markets. As India is a federal republic, the states have the right to legislate on key issues, such as electricity.  Also, many decisions taken towards decarbonization will be affected in their implementation by the unique political economy of each state.

With this background, and its stated policy of ‘one nation one grid’, it appears that the Union government has opted to take matters into its own hands, by adopting an increasingly centralized approach to the power sector. A number of factors are at play.

Commercial and Industrial (C&I) consumers use about 50 per cent of the total electricity generated in India, the majority of which still comes from fossil fuel based power plants. Most of this power is currently purchased from Discoms. In many states, this supply is intermittent and unreliable – sometimes tolerable for individual consumers, but always disruptive for businesses. Further, Discoms run a differential pricing system, with C&I customers paying higher prices to subsidize agricultural and poorer customers. Finally, some C&I customers have climate sensitive ESG equity investors, and need to demonstrate they are switching to using renewable energy.

The combination of these factors create incentives for C&I customers in each state to find a reliable and cheap (preferably private) renewable energy supplier somewhere in India and buy directly from them, thus avoiding the exaggerated prices charged by the Discom and freeing themselves from their often unreliable service.

As a result of the concept of ‘open access’, embodied in the Electricity Act, 2003 which is detailed in enabling regulations,1 Discoms must grant, for a fee, ‘open access’, in which a buyer and seller of electricity are able to privately negotiate transactions, and have guaranteed access to the network of the Discom for the transport or electricity within or outside the state. In practice, many Discoms continue to impede the grant of open access, as they would like to continue to retain their best paying customers.

The Inter State Transmission System (ISTS) is an emerging national electricity grid that runs across the entire country. It connects to numerous end-points who are either generators or consumes. There are rules and capacity constraints which determine whether an entity gets on to ISTS. Once an entity is physically on ISTS, they can buy and sell directly from others on ISTS. If buyers or sellers are situated near an ISTS connection point, these transactions have the capacity to bypass the regulatory mechanism of the states in which the buyers and sellers are located.

Then there are the General Network Access (GNA) Regulations,2 not fully in force yet, which would replace the current inter-state open access framework to connect to the ISTS, making such transactions even easier.3 These regulations would provide greater freedom to generators and consumers in terms of where they inject power into and draw power from the system. Generating stations already connected or intending to connect to the intra-state transmission system will be allowed to connect to the ISTS network – this was not allowed previously and will lure more power producers out of the state system.

So regulatory changes are making it easier for renewables generators to frictionlessly transport electricity across state borders. This is being helped by expanding the network itself. The Union government has plans to significantly expand the reach of the ISTS to make transmission of renewable energy easier, with detailed plans being drawn up to integrate 500GW of renewable energy into the grid by 2030.4 In December 2021 alone, 23 inter-state transmission system (ISTS) projects were initiated by the government, at a cost of Rs 159 billion.5 

Electricity transmission doesn’t usually come free. But to encourage inter-state renewable energy sale and purchase, solar generation is currently charged zero rates for transmission charges or losses6 for a period of three years. Consequently, a solar generator can sell to any buyer in India with no friction from transportation. These zero charges have been expanded and carried forward to cover all renewable energy commissioned till 30 June 2025.7 

Further centralization is envisaged by the proposed amendments to the Electricity Act 2003 through the Electricity (Amendment) Bill, 2022.8 The bill augments the powers of the National Load Despatch Centre at the cost of the Regional and State Load Despatch Centres, enhances the rule-making powers of the central government in a number of areas, gives the Central Electricity Regulatory Commission (CERC) powers to make regulations for grant of open access to larger consumers and permits a present or former Secretary to the Government of India to be the chairperson of the CERC (not permitted earlier). There are many other examples of this centralizing tendency.

There are two main reasons which explain why this is happening. First, any Union government has the inherent instinct to garner more power for itself. Second, the states have largely failed to reform their power sectors to resolve the distortions caused by issues relating to the Discoms dis-cussed above.

Arguably such centralization goes against the principle of sub-sidiarity. If decisions are not taken at the appropriately decentralized level, they will tend to be sub-optimal and not welfare maximizing. Further, it is possible that aspects of these moves towards centralization encroach upon the constitutional rights of the states and may be subject to legal challenge. This would be undesirable but that is a discussion for another day. What is clear however, is that this is not good news for the states.

This move towards centralization is likely to exacerbate the difficulties that the states face with respect to their power sectors. The fragile state of Discom finances is well known. As it becomes easier for their best paying C&I customers to migrate out of their networks, they will be left to service largely their worst paying and subsidy receiving customers, with dwindling sums of money to do so.

The states haven’t sat on their hands. They had the choice to act positively and undertake the reforms that would improve their financial position but instead chose to take defensive, often illegal, moves to protect themselves.  They resist the migration of high paying C&I customers out of their network;9 fail to honour contractual commitments, including not paying for power they purchase10 and attempt to reduce the burden of what they perceive to be unfairly high tariffs, whether or not those tariffs were determined by transparent competitive bidding processes, in one case by passing a law enabling themselves to renege on their contracts.11

Most of these moves are patently illegal and mean that investing in or engaging with the power sector in a state is a hazardous task. However, in the moment, these actions are rational. Discoms, backed by pliant state regulators, are doing whatever they can to try and protect their fragile bottom lines.

The states of India need not keep fighting this excruciating losing battle against the growing logic and reality of the emerging national market for electricity on the one hand and the judicial system enforcing the law against it on the other. In fact, there is a way for them to benefit from
the emerging centralized national electricity network, and also increase their own attractiveness for power sector investment, particularly in renewable energy and associated services.

This route will require them to undertake the difficult task of power sector reform. Such reform will cost money to implement and will create losers, which could include subsidy recipients, employees in public sector companies in the power sector, coal mine workers etc. For any such reform to be successful, their losses must be compensated. If these reforms are made part of a climate-focused energy transition for a state, then interesting avenues to finance them may open up.

The Just Energy Transition Partnership (JETP) is an emerging financing mechanism, aimed mainly at helping certain coal-dependent emerging economies undertake energy transitions in accordance with principles of climate equity. The first such JETP emerged from COP26 in Glasgow, with South Africa being promised US$ 8.5 billion for transition finance from France, Germany, the United Kingdom, the United States, and the European Union.12 

At COP27 in Egypt, South Africa spelt out the details of its plan to implement its JETP, with coal plant decommissioning featuring heavily, plus new investments envisaged in renewable energy, electric and other clean energy vehicles and green hydrogen.13 It turns out that the US$8.5 million promised under the JETP is only the tip of the iceberg – the total investment required to implement the plan is US$ 98 billion. The original JETP can therefore be seen as an enabler or catalyst for further, far larger investment in South Africa’s energy transition and to compensate and rehabilitate those who will lose out in that process, primarily workers in the coal mining and thermal power sectors.

Indonesia’s JETP was also announced recently.14 This envisages an amount of US$20 billion in transition finance over 3-5 years, half from donor nations and half from named private financial institutions in the developed world. While the details of Indonesia’s plan will come in a few months’ time, its JETP announcement also mentions coal plant retirement.

The best model for India’s JETP is open to debate. It is theoretically possible to conceive of an Indian JETP that also involves decommissioning some existing coal plants and restricting the development of new ones. However, indications from ongoing negotiations are that India is resisting reference to coal phaseouts, focusing instead on transition finance for investments in ‘renewable energy infrastructure, green jobs and technology transfer.’ In any event, while some JETP funds could make their way to the states for state-specific transition finance needs, it is more realistic to assume that they will be used to further the Union government’s centralized plans for the sector. Let’s therefore assume that the states will not get anything from the JETP kitty.

States will therefore have to either resort to traditional public finance to pay for these reforms, and financially better off states may have some funds available for this, or, more efficiently, funds could be raised through the privatization of power sector assets owned by the states.

This option requires the states to look hard at fundamental reform of their respective power sectors. Elsewhere,15 a state-by-state path towards power sector reforms has been outlined. This would involve a phased privatization of state power sector assets in generation, distribution and transmission. Details of any such reform will be critical and have to be designed by each state taking into account its assets in the power sector and the requirements of its own political economy. Privatization will have to be accompanied with regulatory reform, correcting only for market failure, with simultaneous investment in state capacity by improving the quality and training of regulators.

Taking this route has many potential benefits for states. First, it will prevent the erosion of the value of their power sector assets, particularly for the Discoms with the flight of C&I customers, avoidingthe fate suffered by BSNL and MTNL in the face of more efficient private telecom providers. Second, it will provide funds to finance the implementation of the reform and to compensate the losers from it. Third, once regulators are regulating only for market failure, a whole range of value enhancing transactions will become possible in areas such as demand and flexibility management, electricity derivatives and more, taking advantage of emerging technologies of digitization and artificial intelligence. Finally, reformed states will attract not only power sector investment but also new investment from high paying C&I consumers looking for a stable and competitive electricity market to purchase from.

Such a model does not prevent states from pursuing welfare objectives by giving subsidies to categories of consumers through mechanisms such as direct benefit transfers. They also remain free to offer incentives for energy transition investments.

Post-reform, power producers may sell power to C&I consumers within the same state. Such consumers, as has been seen in states with privatized Discoms, will be more willing to enter into transactions with such private Discoms. Alternatively, power producers could sell into the ISTS grid using open access, as envisaged by the GNA Regulations. And consumers in the state would have the option to purchase power from outside the state using open access and by connecting to the ISTS network.

Most reform in the power sector is difficult. However, considering the emerging reality – that there is an emerging centralized national grid and that the power sector assets of the states will lose value as a consequence of this, the states need to act. By making themselves more attractive for energy transition investments through privatization, the states have a way out of their predicament, in a manner consistent with the goals of the central government and that will bring them long-term benefits.

Footnotes:

1. CERC (Grant of Connectivity, Long-term Access and Medium-term Open Access in Inter-State Transmission and related matters) Regulations, 2009 (CERC Regulations 2009).

2. Central Electricity Regulatory Commission (Connectivity and General Network Access to the inter-State Transmission System) Regula-tions, 2022, to give them their full name.  https://cercind.gov.in/regulations/175-Notification.pdf

3. https://trilegal.com/wp-content/uploads/2022/06/CERC-Connectivity-and-General-Network-Access-to-the-Inter-State-Transmission-System-Regulations-2022.pdf

4.https://cea.nic.in/wp-content/uploads/notification/2022/12/CEA_Tx_Plan_for_
500GW_Non_fossil_capacity_by_2030.pdf

5. https://economictimes.indiatimes.com/industry/energy/power/centre-approves-23-new-inter-state-power-transmission-system/articleshow/88169551.cms

6. The Central Electricity Regulatory Commission (Sharing of Inter-State Trans-mission Charges and Losses) Regulations, 2010 https://indiankanoon.org/doc/12654804/

7. https://mercomindia.com/waiving-ists-catalyze-growth-open-access/

8. https://prsindia.org/files/bills_acts/bills_parliament/2022/Electricity%20(A)%
20Bill,%202022.pdf

9. https://www.bqprime.com/opinion/how-a-beleaguered-discom-fought-a-losing-battle-on-capitve-power

10. https://akshayjaitly.substack.com/p/discoms-and-state-regulators

11. https://www.bqprime.com/opinion/punjab-ppa-bill-indian-power-sectors-vodafone-moment

12. https://ukcop26.org/political-declaration-on-the-just-energy-transition-in-south-africa/

13. https://www.thepresidency.gov.za/content/south-africa%27s-just-energy-transition-investment-plan-jet-ip-2003-2027

14. https://ec.europa.eu/commission/presscorner/detail/en/statement_22_6892

15. https://www.xkdr.org/paper/the-lowest-hanging-fruit-on-the-coconut-tree-india-s-climate-transition-through-the-price-system-in
-the-power-sector