Payment Cover: Letter of credit provides financial assurance to gencos

Letter of credit provides financial assurance to gencos

In a major positive for the power generation segment, the new letter of credit (LC) mechanism has kicked in from August 1, 2019. The order requires discoms to open and maintain an adequate LC as payment security and pay fixed charges even if power is not despatched under power purchase agreements (PPAs) with gencos.

While state-owned power generators like NTPC Limited already have a similar payment security mechanism with the Reserve Bank of India, private power firms have had no such mechanism resulting in payment delays by discoms, adding to their stress and resulting in defaults on loan servicing. As per latest data from the PRAAPTI portal, the outstanding amount due to power generators was almost Rs 465 billion as of June 2019, as compared to Rs 355 billion a year ago. A new Central Electricity Authority (CEA) report notes that as of July 31, 2019, discoms’ dues outstanding to renewable power gencos were almost Rs 82.31 billion, with Andhra Pradesh, Tamil Nadu and Telangana accounting for the highest dues. In view of this, the Ministry of Power (MoP) order has been welcomed by the industry as it is set to bring in financial discipline in the distribution segment.

“We would like to thank the Ministry of Power for taking action on this long-standing issue of delayed payments by the distribution licensees to the generators. Looking at the current situation where state distribution utilities keep monthly energy bills unpaid for months on end, a transformative step like this was the need of the hour,” says Ashok Khurana, director general, Association of Power Producers.

Anil Razdan, former union power secretary, agrees with this. “Of late, the outstanding dues from discoms had begun to balloon, and could lead to more stressed assets and non-performing assets in the power generation sector. Their money is public money and must come back into the system. This measure should have been in place a few years earlier. In fact, it needs to be tightened. The business of power is an economic activity, and must be operated on principles of economic and financial discipline. What is bought and consumed must be paid for. Power generators and financial institutions were not set up for charity,” he says.

Details of the order

In its June 28 order, the MoP has noted that despite provisions in the PPA that require discoms to open an LC in favour of developers, this is not followed in practice. Payment delays make it difficult for generators to pay coal charges and railway charges for rakes, which have to be prepaid. According to the power ministry, if this situation persists, generators will not be able to pay for fuel/transportation and this could lead to shortfall in electricity generation and load shedding.

To ensure strict compliance with the LC provisions, the MoP has directed the National Load Despatch Centre and the regional load despatch centres (RLDCs) to despatch power only after it is intimated by the generation company and the discom that an LC for the desired quantum of power has been opened.

The key highlights of the order and procedures to be followed under the mechanism are:

  • A written intimation has to be sent to the load despatch centre (LDC) that the LC for the desired quantum of power with respect to generating stations has been opened. The intimation shall also specify the period of supply. The intimation that the requisite LC has been opened will be given by the discom and will be confirmed by the genco.
  • The LC can be opened as per the PPA. However, discoms are allowed to open the LC for a shorter duration for supply corresponding to one week or a fortnight. Also, in case of difficulty in opening an LC, the amendments allow discoms to pay in advance through the electronic mode the amount corresponding to at least one day of electricity supply.
  • The RLDCs are required to despatch power only up to the quantity equivalent to the value of the LC. Further, the despatch shall stop once the quantum of electricity under the LC is supplied.
  • The generating company and the distribution company are required to inform the appropriate LDC as soon as the LC for the desired quantum has been opened or renewed, or an advance equal to at least one day’s supply has been deposited. The power supply to the discom will be restored at the earliest and not later than one day.
  • Further, the order instructs the LDC to ensure that the regulated entities during the period do not have access to power at the power exchanges and that they are not granted short-term open access.
  • The generating company shall be entitled to encash the LC after the expiry of the grace period, that is, 45-60 days, as provided in the PPA. If the power is not despatched, the discom shall continue to pay the fixed charges to the gencos.
  • However, on July 17, 2019, the centre issued an amendment to this clause stating that in the case of solar, wind and small-hydro power, the “fixed charge” would constitute the tariff on which the power is being purchased by the distribution licensee as it reflects the cost of installation, and operations and maintenance of the power plant. The energy generated during the non-despatch period shall be calculated on the basis of the capacity utilisation factor as declared by the generators in the PPAs. Meanwhile, for projects having more than one year of operation, the power not despatched shall be calculated on the basis of the prorated actual energy generated in the past 12 months, stated a letter from the Ministry of New and Renewable Energy.
  • In a clarification issued on July 23, 2019, the power ministry has stated that state-owned generation stations are not covered under the order. This exempts discoms from offering LCs before procuring electricity from state government-run power generating stations.

Issues and concerns

A key concern regarding the order has been whether financially crunched discoms would be able to implement the mechanism successfully or not and whether the state governments will be able to provide support for the implementation of the order given that electricity is a concurrent subject. “It is for the state governments to take this discipline forward and exercise similar control through the SLDCs. This indiscipline and imprudence has been tolerated for too long. It is hoped that the state governments will cooperate to ensure that the business of electricity is sustainable,” says Razdan.

To help address this issue, the ministry issued a corrigendum relaxing the norms and stating that the discoms would be allowed to open the LC for a shorter duration for supply corresponding to one week or a fortnight. To ensure that the discoms do not take advantage of this relaxation and instead provide revolving LCs (which would be rotated after the end of the period, say, a week, without additional replenishment) and conditional LCs (which had preconditions such as taking approval from the discom before encashing the LC, etc.), another clarification has been issued by the MoP recently, on August 9, 2019.

Meanwhile, the power ministry has stated that all discoms need to provide unconditional LCs for power purchases. Further, discoms have to ensure that the amount of the LC equals the power purchase requirement for the billing cycle. “This decision has been taken after it was brought to the notice of the power ministry that some discoms have opened conditional LCs, which require approval from the concerned discoms for encashment, etc.,” says the power ministry. Reportedly, the discoms in Rajasthan and Telangana had opened conditional LCs, which could be encashed by power generators only if they were authorised by the state.


While the new mechanism differs from the payment security mechanism mooted by the High-Level Empowered Committee in its November 2018 report on stressed assets (at the time it had suggested a bill discounting framework with discoms to address this issue), it seems to be working reasonably well.

“It has been a few weeks now since the order has been implemented and overall, the results on the ground have been good so far,” says Khurana. There are some private power producers that have flagged concerns regarding a few states misinterpreting the order, he adds. For example, the Uttar Pradesh discoms have refused to extend this mechanism to intra-state independent power producers, which is a contravention of the MoP’s order that only state-owned generation plants are being kept outside this mechanism.

Also, reportedly, some of the state  load despatch centres and RLDCs have not implemented the MoP’s order in spirit as the order and procedure clearly stipulate that the defaulting discoms are to be disallowed from escaping their obligations by arranging for alternative power sources from the power exchanges, or the short-term market. However, there are instances of such defaulting state utilities being allowed to continue drawing power from the power exchanges and such cases have been brought to the MoP’s notice.

A larger concern is that the LC mechanism would only take care of the current dues and not the historical arrears, as represented by the data on PRAAPTI. Thus, more efforts are needed to address the issue. With the government’s plans to launch another set of reforms in the distribution segment, including a revamped UDAY for addressing the issues of loss reduction, tariff hikes and the introduction of competition, the distribution segment is likely to witness ignificant change in the long term.

Reya Ramdev