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Cover Story | July 2018

Captive Threat!

The recent draft amendments by the Ministry of Power for group captive power has not gone well with the captive power players. The amendments are blessings in disguise for state distribution companies (DISCOMs), as it was on their complaints that the government has acted upon. But, the private stakeholders, especially in the wind and solar power segments, would have to increase their investments in these plants to comply with the revised norms.<br /> <br /> The Ministry of Power has recently proposed draft amendments to the provisions related to the ownership of captive generating plants. A captive user, owning at least 26 per cent stake in a power generating company and consuming at least 51 per cent of power generated by that company, is entitled to non-discriminatory open access and exemption from payment of cross-subsidy surcharge (CSS). <br /> <br /> Within the purview of the said definition, several investment structures have evolved over the years to enable maximum returns for captive power generators and consumers, while minimising the actual upfront investments of consumers. The proposed amendments intend to enforce the investment requirement of 26 per cent of the issued and paid-up share capital with voting rights which, in turn, is to be estimated using a normative debt-to-equity ratio of 70:30. The proposed amendments have already received flaks from all corners, especially from those players who have invested heavily in captive power plants. <br /> <br /> Group captive power plants-based on coal, solar, and wind-are operational in large numbers in the states of Karnataka, Haryana, Rajasthan, Maharashtra, and Tamil Nadu. The concept was evolved by industries to avoid cross-subsidy charges levied on inter-state electricity sale and is seen as a threat to state DISCOMs.<br /> <br /> A majority of companies owning such group captive power plants, particularly 5 GW renewable energy capacity in Tamil Nadu, might have to restructure their equity and shareholding pattern before April in the coming year.<br /> <br /> When asked about the reason for the amended guidelines, a Power Ministry official, on the basis of anonymity said, 'Many states had complained and raised questions regarding the misuse of group captive projects; hence, the central government has obliged.'<br /> <br /> So before POWER TODAY gets into the nitty-gritty of the draft amendments, let us look at why the government felt the necessity to change the rules.<br /> <br /> <span style="font-weight: bold;">Experts speak</span><br /> According to experts who do not wish to be quoted, a proposed amendment in Electricity Rules 2005 is an attempt to bring clarity on various operational issues that were showing in the last 12-13 years. The underlying objectives of Electricity Rules 2005 were to attract bulk consumers to set up power projects, primarily to overcome severe deficit scenarios that rose with the Electricity Act 2003 and to entice competition in the sector. Electricity Act 2003 provided specific exemptions to captives or group captives, particularly, complete exemption from cross-subsidy surcharge and additional surcharge. <br /> <br /> Over the past 13 years, there has been significant growth in plain vanilla captives (more than 25-30 GW) as well as group captive projects (5-7 GW). While the consumers of plain vanilla captives who own 100 per cent equity of project or own 26 per cent and consume 100 per cent power of the project are unlikely to be affected by the proposed amendments, it is likely that the group captives have significant implications (refer Implication of draft amendments). <br /> <br /> Since the government has called for suggestions from stakeholders and experts, Indian Captive Power Producers' Association (ICPPA), in its note to the Ministry of Power has taken a strong objection to the draft amendments. According to ICPPA, rules made under a Parliamentary Act cannot have any violations of the Act, whereas the proposed draft amendments violate Electricity Act 2003 and various other Acts. <br /> <br /> 'Therefore,' says<span style="font-weight: bold;"> Rajiv Agrawal, Secretary, 'ICPPA </span>solicits withdrawal of all proposed amendments and also that of 'Proportionality Rule'. Penalising all captive consumers for violating 'Proportionality Rules' by 'one of many consumers' goes against Article 14 of the Constitution of India.' <br /> <br /> Commenting on the proposed changes, <span style="font-weight: bold;">Sabyasachi Majumdar, Senior Vice President and Group Head, ICRA,</span> said, 'The implementation of these amendments would impact many group captive projects, especially in the wind and solar power segments. Captive power consumers would have to increase their investments in these plants to comply with the revised norms.'<br /> <br /> He further adds, 'This may reduce the returns on the process of procuring power under the captive route against the grid tariffs, which may necessitate higher tariff discounts from the captive power producers. However, in case the consumer does not opt for the additional investment, the power sale arrangement would be converted to a third-party procurement and attract CSS.'<br /> <br /> Sharing his view, Former Chairman of Central Electricity Regulatory Authority (CERC) said, 'In order to keep the upfront investments by the consumers at a minimum, several mechanisms have been adopted by captive power units, including keeping the actual paid-up share capital low by infusing the promoter capital in the form of preference shares and hybrid investment structures.'<br /> <br /> In addition, investments from consumers were through shares of a relatively lower face value carrying no voting rights. This has been contested by the distribution utilities, given that they are losing the high-paying industrial and commercial sale to such group captive power sale arrangements. Overall, the proposed amendments to captive power rules, if implemented, would adversely impact savings in power costs for captive consumers and returns for captive generators. In addition, captive power plants also remain exposed to regulatory risks pertaining to revision in open access charges and amendment to the banking provision in wind power projects.<br /> <br /> <span style="font-weight: bold;">The draft amendments </span><br /> The Under Secretary to the Government of India, has penned a letter to the Central Electricity Authority (CEA), the Central Electricity Regulatory Commission (CERC), principle secretaries of power in all states and union territories, DISCOMs, generation companies (GENCOMs), and public sector units under the Ministry of Power, informing them of the draft amendments and inviting their comments on the same. The comments and objections were allowed to be submitted until June 6, 2018.<br /> <br /> The amended guidelines are called the draft Electricity (Amendment) Rules, 2018 and will come into effect from the date of publication in the Official Gazette (except Sub-clause C of Clause 2, Rule 3). This sub-clause will come into force with effect from April 1, 2019 and will apply to all power projects seeking captive status.<br /> When contacted, an official at the Ministry of Power told PT, 'These amended draft guidelines will apply to all projects that are planning to go captive irrespective of the source of energy. It means even captive renewable energy projects will come under the ambit of the amended guidelines.'<br /> <br /> The draft has set requirements for captive generation projects as follows:<br /> For a project to be considered captive, minimum 26 per cent of the project ownership should be from the captive user, and at least 51 per cent of the power generated must be utilised for captive use.<br /> <br /> In such a scenario, aggregate energy generated will be computed as the total electricity generated in the power plant minus the auxiliary consumption (consumption of energy by various components to keep the project running).<br /> In case of a hydro project, any free power supplied by the hydro-generating station to the state government will be excluded from calculating the aggregate electricity generated.<br /> <br /> In case of renewable generators, banking of power, which is redeemed for consumption by captive users, will be included to determine aggregate electricity consumption on an annual basis. The redemption of banked energy will be permitted within the same financial year.<br /> <br /> Variation in consumption in proportion of shares in ownership of the solar and wind power projects exceeding 15 per cent and up to 30 per cent will be agreed upon and allowed by the state government.<br /> <br /> In case of a generating station owned by a company formed as a special purpose vehicle, a unit or units of the station is identified for captive use. Electricity required to be consumed by captive users will be determined with reference to the generating unit or units in aggregate identified for captive use and not with reference to the generating station as a whole. Also, share capital in the form of equity shares to be held by captive users in the generating station will not be less than 26 per cent of the proportionate equity share capital of the company related to the generating unit or units identified as the captive generating project.<br /> <br /> It will be the obligation of captive users to ensure that their consumption is maintained at the above percentages. In case the minimum percentage of captive use is not complied within any year, the entire electricity generated will be treated as if it is a supply from a generating company.<br /> <br /> The appropriate state commission will certify whether a generating station or power project is captive generating. The generating station or power project will file the annual statement of generation and consumption to the appropriate commission.<br /> Where captive consumers are connected with the grid, distribution licensees will collect the consumption data and submit it to the corresponding DISCOMs, where the generating station or power project is located for compilation and submission to the appropriate commission for approval of status of the captive generating project.<br /> Any generating station set up as an independent power project (IPP) will not be considered for benefits of a captive generating project on or after <br /> the commencement of Electricity (Amendment) Rules 2018.<br /> <br /> If a generating station set up as an IPP has been taken over by the lenders or by its consortium due to non-performance and is likely to be declared as a non-performing asset (NPA), it may be considered for benefits as a captive generating project, if it is applied for by the developer.<br /> <br /> An IPP, not availing any benefit as an IPP and does not have a PPA, can be considered for benefits as a captive generating project, if it satisfies the criteria for being a captive power project (CPP) as per the Electricity (Amendment) Rules 2018. Such conversion of status will be allowed only once.<br /> <br /> A group captive generating project will be allowed to claim the status of captive generating project up to the period during which the shareholding pattern by captive users is maintained with two changes only, during a financial year. The status of the captive generating project in such cases will cease to exist from the third change in the shareholding pattern in the financial year.<br /> <br /> In case of a captive generating project to be included as a part of the integrated business of a company, the generating station will have to be carved out as an independent legal entity in the form of a SPV to qualify as a group captive generating project.<br /> <br /> <span style="font-weight: bold;">Way forward</span><br /> There are certain ambiguities and restrictions over conversion of existing group captive power plants (GCPs) which the government should look into. One of the ambiguities felt at the time of commencement of Electricity Rules 2005 is that little attention had been paid to the financial engineering aspect. The dire need at that time was to promote as much of electricity generation as possible.<br /> <br /> However, with operational experience of more than 13 years, a relook at the ownership test is a step in the right direction, feel experts. However, this may need to take into account that a significant amount of capital has already been invested in operational GCPs. It must also be noted that the willingness of consumers to invest in GCPs has increased considerably.<br /> <br /> A balanced approach on both sides can be helpful. However, there must be a clear dictate from the government that GCPs which adhere to the proposed amendments should not be left frustrated for lack of permissions from DISCOMS.<br /> <br /> Enabling inter-state group captives is one of the most important factors which may help the industry tide over the flurry of NPAs (refer POWER TODAY May 2018 Cover Story). With significant increase in regulatory surcharges, such as cross-subsidy and additional surcharges, bilateral sale of power is almost unviable in most of the states. With projects allowing converting to group captives, power can be sold, which may help them repay bank dues and recover equity returns also.<br /> <br /> <span style="font-weight: bold;">Implication of draft amendments</span><br /> <ul> <li>Various provisions of Companies Act provided statutory rights of 26 per cent ownership to consumers irrespective of capital deployment. Accordingly, some of the GCPs have used structured financial instruments, which reduce the capital infusion requirement from consumers, but provide all the statutory rights available to 'Significant Minority Shareholders'. Now many of these projects may have to restructure the equity of their existing projects to reflect the requirements in the proposed Electricity Rules 2018.</li> <li>GCP projects have to carefully plan capacity deployment with various shareholding consumers on account of restrictions of frequent switching of consumers.</li> <li>Operational issues such as treatment of banked energy, auxiliary consumption, and free energy have been clarified. Earlier these issues were points of dispute between DISCOMs and the generators.</li> <li>One of the most important stumbling blocks of the advent of inter-state group captives has been limited clarity on the validating agency for group captives. Proposed amendments have clarified on this front as well.</li></ul>
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