Role of Innovation: Next wave of market reforms to help manage risks

Next wave of market reforms to help manage risks

Anish De, Partner, Head of Strategy and Operations, Infrastructure, Government and Healthcare, and Leader, Oil and Gas, KPMG India

The Indian electricity sector presents a rare growth story, making it attractive for new investment capital. It also presents formidable challenges and a tendentious legacy that will be difficult to resolve. We stand at that juncture where we can evolve the sector structure and manage its operations more responsibly.

India has already made significant commitments. Under COP 21, it has voluntarily committed to reducing the emission intensity of its GDP by 33-35 per cent by 2030, as compared to the 2005 levels. It has also committed to having in place 40 per cent of its electricity generation capacity from non-fossil fuels and has set out on the path of rapidly adding renewable energy  capacity. There is talk of further increasing the ambitious goal of 175 GW of renewable energy capacity by 2022.

India has also made major strides in providing electricity to all its citizens through the Saubhagya scheme that fulfils a long-standing promise for such a basic need. Irrespective of whether there are better distributed generation-based alternatives to extending the main grid, the fact remains that electricity as a basic service must permeate universally, and only the grid can do that. Also, the main grid as well as distributed generation and minigrids can coexist. India needs to make the two work together.

However, that is only a part of the story. The other part, and a less positive one, is the inability to address the deep structural and operational inefficiencies that have plagued the sector. However, the power system is set to witness continuous disruption in renewable energy, energy efficiency, distributed generation, storage and a range of information technology and operational technologies. To benefit from the innovations,  we have to set our house in order.

We need to steady the ship and steer it forward. At the outset, we need to set clear goals, stand by them and find the means to realise them. I will start with the environment and climate. India’s present electricity generation mix is overwhelmingly dominated by fossil fuels and, in particular, by coal. The large capacity addition compounded by the relatively higher load factor of coal-fired power plants and a fall in load factors in gas-based plants caused a massive increase in the contribution of coal (from 52 per cent to 58 per cent) to primary energy consumption  between 2010 and 2015. We now need to set clear goals for arresting and reducing the carbon content in power generation and also the use of water, which has been grossly undervalued and due to which signs of severe stress are emerging. This is not just about global commitments; we owe it to our own people.

Much of the reduction will have to come through renewable energy. Integrating such a large quantum of renewable energy is a staggering problem. To put it in context, peak demand in the system would be of the order of 350 GW (double of the present-day demand), but the renewable energy installed capacity would be disproportionately higher since the capacity utilisation factors of renewable energy are lower than those of fossil fuel-based  plants. If we take the COP 21 commitments as a basis for planning, serving the load through a combination of non-fossil fuels (40 per cent) and fossil fuels (60 per cent), the overall capacity would have to be of the order of 850 GW, which is a significant increase over the present level. The additional 500 GW of capacity would cost about Rs 30,000 billion at today’s prices. Finding the money itself is not an insurmountable problem. However, ensuring that the money earns adequate returns and is not exposed to excessive risks is a challenge. The present condition of sector finances coupled with widespread insolvency in the generation segment does not inspire the required confidence.

There are many issues that need to be  resolved to stabilise the power system, but at the core of it is the solvency of the sector throughout the value chain. India’s uncontained rot in the distribution segment has spread across the chain and has brought the generation segment (and its financiers) to a state of imminent collapse. While this contagion has to be handled, the core needs to be fixed, more so because in the evolving distributed generation-based regime, the stage is shifting even more towards the distribution segment.

It is essential that the structure be fixed first. The Electricity Act, 2003, brought about landmark changes but stopped short of separating network and supply (carriage and content). Discoms, by and large, have proved to be inept in the supply (content) function, and have not paid enough attention to network (carriage) augmentation and management. The time has now come to make the separation (with sufficient safeguards) clear to ensure that there is distinct focus on each part. The content part should progressively be private sector play. The entire arrangement should be managed by newly devised distribution system operators (DSOs). The role of the DSO would be akin to that of the transmission system operators. It would, however, be more extensive to cover resource forecasting, scheduling and schedule management, active network management for managing variability in demand and supply, and a host of other operational needs. This would call for building entirely new skills. Towards the end of this article, I come back to this vital issue of skill development in the sector, the need for which is nowhere as great as it is in the distribution segment.

Innovation in content provision has to be accompanied by the deepening of energy markets (including fuels, not just power) since markets act as a glue to hold the sector together to ensure demand management, price signalling, and bringing about efficiencies that a rule-based command and control system cannot. The Central Electricity Regulatory Commission has initiated activities for the next wave of market reforms through the proposed real-time markets. Progressively, ancillary services markets, capacity markets, and eventually financial products (futures, derivatives) have to be introduced to bring about innovation and flexibility and help manage commodity risks.

Flexibility and integration through markets would, however, not obviate energy infrastructure creation and maintenance, and the fact that infrastructure has to be paid for. As the patterns of use change, traditional methods of cost recovery are failing. With cost recovery jeopardised, investments that were traditionally seen as safe are now in the high risk category. How do investors finance expensive energy infrastructure projects in such times with a nominal possibility of use of 40-50 years that could potentially become redundant in 10?

Especially given the public good and human rights dimensions, the policy and regulatory risks are compound. In addition, there are practical challenges to investments. In times of low use, depreciated assets with high operating costs are more favourably placed than new assets. This makes new investments more challenging, often defeating the basic purpose of some of the policies being formulated. In a high renewable energy regime, where capacity utilisation of conventional generation assets falls, it may be more feasible economically to burn dirty diesel or prolong inefficient but depreciated coal plants than build new efficient gas-based or supercritical assets.

Of course there are no easy answers, which is why it is necessary to delve deeper into the causes of the challenges and allocate risks appropriately between investors, ratepayers and taxpayers. The present system is often skewed and unbalanced, especially when private capital is involved. Public finances just cannot take the load of the huge investments required in the sector, and yet some of the recent policies only further increase the skew in favour of state-owned enterprises and against private capital. Indeed, present-day electricity regulation has come to provide cover to the state sector through cost-plus regulation access, effectively discriminating against private capital that must deal with a severely restricted or even foreclosed competitive market. There is a choice to be made here. If the field of play remains grossly uneven and too much risk is put on investors, then investments will disappear, because finally investors do have the choice to not invest.

We need to embrace new technology and this has to go beyond the hardware for generation, transmission, distribution and storage into more innovation around intelligent network management, blockchain-based applications, grid balancing through storage and demand response, hyper energy efficiency, and applications innovations before and after the meter. As the power sector is a potential hotbed of innovation, we must consciously invest in innovation and applications research. The present environment of state dominance in the sector unfortunately often comes in the way, and these bottlenecks need be removed as far as possible.

The removal of impediments will truly take place only when knowledge and skills permeate. The electricity sector in India has been a large employer of people, often by design. Estimates are hard to come by, but in aggregate as on date the sector provides direct employment to 1.5-2  million men and women and indirect employment to a whole lot more. Increased automation and new-age innovation will require a set of different skills. In the case of renewables, the variability of generation will demand a very different level of sophistication in technology and skills for forecasting, operations and maintenance of the grids and the various interconnected assets. These new skills require an altogether different level of technology orientation and attitudes across the sector. It is certainly a challenge for utilities and asset operators and their existing staff. However, if the knowledge and skill required are successfully developed  then the transformation that we seek in the Indian power sector will take place.