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Research | March 2011

UMPPs for Orissa's power generation?

In the concluding portion of a two-part series, a paper by students of IIM (Bangalore) speaks of how ultra-mega power projects (UMPPs) can turn Orissa—a power deficit state—into a power supplier.

To meet the growing needs of the Indian economy, it is estimated that generation capacity is to double itself in every 10 years for the next three decades at least. As such there is need to develop large capacity projects at the national level to meet the requirements of states and nation as a whole. Development of ultra mega power projects (UMPPs) is one step in that direction. The Government of India has taken an initiative to facilitate development of a few UMPPs of about 4,000 MW capacities using supercritical technology, under a tariff-based competitive bidding route. Power Finance Corporation (PFC), a Government of India undertaking, has been designated as the nodal agency by the government to conduct the bid process of UMPPs. For this, PFC incorporates a special purpose vehicle (SPV) for each project and power from the project is allocated by the Ministry of Power (MoP) in consultation with state representatives. The SPV is authorised by the procurers to undertake the bid process on their behalf.

Of the nine UMPPs initially identified, one was proposed to be setup at Bedabahal (See map) in Sundergarh district. Since this project falls into the build own operate (BOO) category, the state is not required to pay for this project. The proposed 4,000 MW UMPP that is being set up may be commissioned by 2013. Orissa will get about 1,300 MW (32.5 per cent of the total generation) power from this project. The rest of the power will be sold to other states which will help to earn revenue for the state. About Rs 16,000 crore is proposed to be invested in this UMPP which includes installation of the generating station and infrastructure to evacuate power from the project. A special purpose vehicle (SPV) called Orissa Integrated Power (OIPL), a wholly-owned subsidiary of PFC, was incorporated for this purpose in August 2006.

This UMPP project is a pit-head power project that will use indigenous coal as fuel. Ib valley coalfields, located about 30-40 km from the project site, has been allocated to meet the captive needs of the UMPP. These include three coal mines namely: Minakshi, Minakshi -B and dipside Minakshi with a reserve of 880 million tonne. A request has also been made to the coal ministry for allocation of Chaturdhara coal block. About 3,399.91 acres of land in eight revenue villages of the Sadar block under Sundergarh Assembly segment have been demarcated for this project. While 2,450.33 acres of land is required for the plant and colony, 949.58 acre is meant for the ash-pond. Out of the surveyed 3,399.91 acres of land, while 2,107.470 acre comes under the privately-owned category, 321.423 acre is government land. Allocation of 150 cusecs from Hirakud has been proposed to meet the project requirements.

The SPV in co-ordination with the MoP and Central Electricity Authority (CEA) will undertake all activities necessary to obtain the appropriate clearances, for example, environmental clearances for coal mines and water resources followed by selection of a project developer through a tariff-based international competitive bidding process. The SPV will then be transferred to the successful bidder who will then be responsible for implementation of the project. A draft for the long-term power purchase agreement (PPA) between the project developer and distributor will be proposed by OIPL that stipulates rules and guidelines for smooth transmission and distribution of power generated through this UMPP.

Of late, the project has got into trouble over environmental issues. The proposed ash-pond will affect 329.20 acres of forest land. The survey reports further reveals that the proposed project will affect 59.38 acres of forest land and 24.96 acres of public roads. Further, the environment ministry said that two of the three coal blocks associated with Bedabahal UMPP are in 'No go' areas where mining activity is not permitted. Of the three coal blocks allocated for this UMPP, Minakshi B and dipside of Minakshi, fall in the prohibited region, which is considered too green by the environment ministry to permit mining. Coal is crucial for the UMPP and valuation of the project and bids will greatly depend on availability of fuel sources. To mitigate this problem, an inter-ministerial group has already come out with a temporary arrangement that is expected to bring out several captive coal blocks from the assigned 'No go' areas. But this has to be evaluated further by the environment ministry before operationalising it.

In addition, PFC has set up two special purpose vehicles—Sakhigopal Integrated Power Company and Ghogarpalli Integrated Power Company—to facilitate the development of two additional UMPPs, which are proposed to come up closer to the sea and will have a generating capacity of 4,000 MW each. The state will get 50 per cent of the power generated from the two new UMPPs. Five possible locations have been shortlisted for the purpose. It includes Kirtania in Balasore district, Dhamara in Bhadrakh, Paradip in Jagatsinghpur, Astharanga in Puri and Ganja in Ganjam district. These are also going to be indigenous coal-based projects. Ghogarpalli, dipside of Ghogarpalli, Sakhigopal-B, Alaknanda and Bankhui are coal blocks that have been earmarked for the projects and are expected to produce a total of 2,240 mtpa of coal. The units will make use of sea water to meet their requirements.

There is a proposal to set up two transmission corridors to evacuate power from these projects. This includes a 765 kV line connecting Jharsuguda with Dharamjaygarh (near Raipur in Chhattisgarh) and an 800 kV DC line connecting Angul with Barnala in Punjab. While the project cost of the 765 kV Jharsuguda-Dharamjaygarh power corridor is estimated at Rs 5,000 crore, the cost of the 800 kV DC line from Angul to Barnala will cost about Rs 10,500 crore. These power corridors are proposed to be set up in joint venture between the PowerGrid Corporation of India (PGCIL) and CEA. PGCIL will mobilise the required funds for the project and it will be recovered through transmission tariffs and from power sold outside the state.

Possible flaws in PPAs for UMPPs

The PPA draft for Sundergarh UMPP project has several issues. Followings are a few of them along with suggestions on how to rectify the articles.

Article 1.1A: Any additional cost arising out of the changed unit configuration will be to the account of the seller and no adjustment in the tariff will be permitted. The seller can change the unit configurations. This article can be exploited by the contractor, ie, it may revise its contracted capacity or quality parameters to a lower value, ie, it will win the bid for 4,000 MW UMPP but may revise the configuration to 3,500 MW if the cost of power plant equipment suddenly surges or it may degrade the quality parameters while keeping the contracted capacity same. If the seller is permitted to change configuration without penalty clauses, it may exploit the situation.

Suggestion: The seller ought to put all these parameters (likely revision, etc) in the bidding process itself, but once the seller wins the bid, he should stick to it or pay penalties for deviation.

Article 4.4.3: If a procurer does not avail of power up to the available capacity provided by the seller corresponding to such a procurer's allocated capacity, the seller can sell to others and the amount realised in excess of energy charges will be equally shared by the seller with the concerned procurer. During this period, the seller will continue to receive the capacity charges from such procurers. If the seller sells such available capacity to shareholders of the seller or any direct or indirect affiliate of seller or shareholders of the seller without obtaining the prior written consent of the procurer, the seller will be liable to sell such available capacity to such entity at tariffs that are not less than the tariff payable by the procurer whose capacity is being sold pursuant to this article. In this period, the seller will continue to receive the capacity charges from such procurers. But this article has a serious flaw. The seller sells power to the government at a cheaper rate because the government provides subsidised coal to UMPP projects. While selling power outside, the seller should recover the true economic cost of coal from the third party and pass on the same to the government or it may degenerate into a scam. The seller generates power using subsidised coal and sells it to its affiliate at the contracted price—so the government ends up subsidising the power cost for private players.

Suggestion: The collect 'ad-valorem based coal royalty' should be collected if the seller sells electricity to a third party.

Article 4.6: The liquidated damages clause (maximum possible claim) in case of delay hardly serves as a deterrent. The clause is as follows:
Liquidated damage = A x (1+0.5n); Where, A = (CCum x dm x DR) 'n' – number of bidders, 'CCum' – contracted capacity in MW, 'dm' – delay in days and 'DR' – Rs 10,000/MW/day

This is an arbitrary formula and underestimates the potential loss to the government for the delay caused. Our recommendation is to base the liquidated damage clause based on the 'true economic opportunity cost' of the delay, ie, the government may have to buy electricity from neighbouring states due to the delay. The seller should compensate for that.

Suggestion: The liquidated damage clause should be set as: Liquidated damage = D * dm * p

Where 'D' – Deficit power due to delay per day; 'dm' – no of days of delay; 'p' – price of electricity from the next best alternative source.

This formula will reflect the shadow price of electricity and not some arbitrary logic. In addition to setting a liquidated damage clause, the government should also commit to pay the seller a reward (a proportion of savings through cheaper electricity prices due to earlier commissioning of the project) if the seller completes the project before commercial operation day (COD).

Article 5.2: This clause mentions that the rehabilitation package has to be funded by the seller. But this is socially sub-optimal. The government should take responsibility of the rehabilitation of displaced people due to the project since the seller may exploit the poor.

Suggestion: The government should ask bidders to quote their rehabilitation package as a part of their bid amount. The government should use this fund and rehabilitate the poor with the option of providing additional funding if the package promised by the seller isn't adequate even after coming through a bid process.

Article 5.4: As per this clause, if a conflict occurs between the Indian and international standards in terms of quality of work, Indian standards will prevail. But this is not in the best interest of the project. In the case of conflict, the best standard, as identified by an expert committee should prevail. Superiority of Indian standards may produce a sub-standard quality project—especially in technology-intensive projects.

Article 5.5: As per this clause, the seller should get all the consent and licenses. Since this can be best done by the government, it should complete all approval processes before calling for a bid. This will improve its bargaining position in the PPP.

Article 6.3.4: As per this article, if the tested capacity on the day of commissioning is less than the contracted capacity, the reduction in tariff will be as follows: Reduction in tariff = Rs 0.25/KWH * (Contracted capacity – tested capacity).

For a 10 per cent reduction in tested capacity, the reduction in tariff is at best symbolic - 0.25*10 per cent = 0.025 rupee/kwh. If the contracted capacity is 4,000 MW, a 10 per cent reduction implies a reduction of 400 MW. So the seller should be asked to compensate for the deficit electricity in terms of their true economic opportunity cost as is defined above against a recommendation for Article 4.6 till the seller commissions the contracted capacity. Article 1.1A (seller can change unit configuration) combined with Article 6.3.4 can be exploited by the seller to commission below the contracted capacity and change the contracted capacity clause to the tested capacity thus avoiding the obligation of commissioning the deficit capacity. The seller should be made to pay a hefty fine if it doesn't want to commission the deficit capacity.

Project appraisal framework

Project appraisal is based on financial, economic, social and environmental considerations. The final project appraisal will aim to monetise each of these considerations to the extent possible. Problems in monetising arise in the case of pressing environmental issues which are too critical to be overcome by compensatory measures. The following framework is a basic guideline of issues to be considered in the appraisal.

Financial viability

The financial considerations deal with profit maximisation for the company bidding for the UMPP. The exact nature and magnitude of costs being unknown, it is not possible to estimate the maximised profit in this project. However, the international competitive bidding process ensures that bidders have a chance to estimate the profit potential of the project and from that the net present value. This will help them arrive at a price that will maximise profits for the company.

Economic analysis

UMPPs in essence facilitate economic efficiency by reducing costs due to economies of scale and by the discovery of the lowest price possible for the end-consumer through international competitive bidding.

For the price discovery to happen, a significant number of competent players have to bid for the project. Otherwise the economic efficiency of UMPPs will not be realised even though the government has facilitated open competitive bidding in the international market.

The proposed location of the Sundergarh UMPP provides opportunities for further reduction in cost due to its pit-head location. The advantage of pit-head site in cost reduction over coastal sites comes into the picture when cost of transportation of coal is greater than the cost of transmission of electricity. The price realisation for the end customer due to the UMPPs is expected to come down to Rs 2 from the current price of Rs 3.06 (this has been calculated using a weighted average method as the prices have slabs at different levels of consumption).

The UMPPs will be a boon for the state government in terms of sales tax realisations. Exporting coal directly leads to low mineral royalties for the state. Moreover, the state does not gain directly from the export of coal as customs duties are levied by the centre.

By using the local coal inside the state through UMPPs, the state can realise sales tax on coal by its sale to the power producer.

Social aspects

The project appraisal in underdeveloped states like Orissa will place a lot of importance on the social cost-benefit analysis of any large-scale project. The employment generation capacity of the project and displacement of inhabitants at the proposed site is a major trade-off that needs to be done before the project can start.

On the positive side, the Sundergarh UMPP is expected to generate employment for 8,000 persons. This figure has been arrived at by finding the correlation between plant capacity and number of employees. The thumb rule is that for an 'x' MW project, '2x' persons will be employed. The plant capacity of 4,000 MW helps us arrive at the expected number of employees. However, the number will vary depending on the amount of automation used in the plant and the operating procedures of the company that bids successfully for the project. A high-level pannel headed by CM Naveen Patnaik has the following reservations for employees in the UMPP. About 90 per cent of the unskilled workforce will be from the locality. Moreover, 60 per cent of the skilled workers will have to be locals as well as 30 per cent of the junior managers. No such reservations have been made at the senior management level. The social cost of the project manifests itself in terms of displacement of inhabitants from their land. Land acquisition is a burning issue in Orissa for development projects. The proposed UMPP is projected to displace over 1,000 people from their lands and even with justified compensation measures such as equivalent land and employment in the project, appropriate compensation will be a problem, as is the norm in land acquisition.

Both the benefits and the costs have to be monetised properly for the project evaluation to be comprehensive.

Environmental considerations

The Sundergarh UMPP will directly affect 388 acres of forest land (inclusive of the ash pond requirements) and 25 acres of public roads. Monetising this loss is possible if the environmental impact assessment (EIA) is properly conducted. The SPV formed for the UMPP bears the responsibility for the EIA and it is a prerequisite for the bids. The details of the EIA reveal that a major environmental threat is the allocation of coal mines. Two out of the three mines allocated fall in the 'No-go' category, which prohibits mining until they can be cleared to a 'go' category. This has proven to be a bottleneck for the UMPP as the bidding dates are being postponed due to unavailability of the clearance. The mines under the 'No go' category account for 35 per cent of the total area of mines allocated to the project.

A burning environmental issue in the proximity of the proposed site is the pollution of Bheden river. The proposed UMPP will not directly affect the river in any way. It will use water from the Hirakud dam rather than the Bheden river and effluents generated will be disposed to an ash pond developed near the plant. But the setting of the UMPP will lead to the growth of a plethora of related industries around the project location. Similar small (and at times illegal) industries are already functioning near other industry locations in Sundergarh. The effluents generated from these small industries are polluting the Bheden river and the environmental aspect is enormous as the river is a source of water for 1.5 lakh inhabitants of Sundergarh. It is projected that if the industrial growth continues at the current rate, pollution of the river will make 50,000 inhabitants water refugees. Monetising the adverse impact on the environment will be a critical factor during project appraisal to a large extent. There are certain 'deep green' issues such as the Bheden river which cannot be dealt with by monetisation and subsequent compensation.

 In conclusion, Orissa is at present a net electricity buyer worth Rs 1,300 crore even though it has the potential to meet not only its own demands but to supply electricity to all other states. To meet the deficit, the state has signed as many as 27 MoUs with independent power producers (IPPs) to add 32,090 MW by 2016. But progress made in these MoUs has been very poor which might still lead to a deficit in the state. The surprising fact is that Orissa has the highest store of 'F' grade coal suited for power production but it is still power deficient. This could be due to unfavourable mineral royalty policies. The competitive nature of UMPPs with access to vast reserves of coal creates the possibility of low tariff power (Rs 2 per unit). However, the current project in Sundergarh is facing difficulties due to environmental concerns over the allotted coal mines. Apart from that, there are concerns regarding the framing of the PPA by the state as many clauses may lead to future conflicts. So care should be taken during appraisal of UMPP projects, considering the financial viability, the economic benefits, the social benefits and costs and also the environmental effects. Only after considering all these benefits and costs can the UMPP serve its real purpose and ensure that Orissa becomes a net power supplier in future.

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