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Cover Story | July 2018

A Change in the Offing!

The draft amendments for captive generation plants go a step beyond the 2016 amendments and, if notified in the same form, will have far-reaching implications on the structure and operation of CGPs.<br /> <br /> Industrial or commercial energy users may install power generation facilities for their own consumption. Known as captive generation plants (CGPs), these are fairly prevalent in India. Depending on whether they produce conventional fuel or renewable energy, they can avail CGP benefits, such as exemption from cross-subsidy charges and purchase of power at more efficient rates. The CGP model is conducive for power generators as well since the plant has a firm, power off-take arrangement tied up with captive consumers (long-term in most cases). As per current reports, around 47 GW power in India is currently generated through CGPs. <br /> <br /> The key qualification criteria for a CGP is provided in the existing, Electricity Rules, 2005, No. 3, which states that at least: (i) 26 per cent of ownership in such power plants has to be held by captive user(s) and (ii) 51 per cent of the aggregate total electricity generated by such power plants, determined on an annual basis - that is, at the end of the relevant financial year (FY) - shall be consumed by captive users.<br /> The Ministry of Power (MOP) sought to amend the existing rules pertaining to the CGPs by introducing draft amendments and asked for comments from interested parties in June 2018. The MOP had earlier proposed amendments on similar lines in October 2016. However, these changes were not notified and thereafter, draft amendments with stricter criteria and compliances were issued. The proposed amendments go a step beyond the 2016 ones and, if notified, they will have far-reaching implications on the structure and operation of CGPs. Importantly, the draft amendments will be applicable to the existing CGPs, as well as power plants which seek the benefits of captive status in the future. The major impact will be on group CGPs (i.e., CGPs which are owned and set up by two or more captive users).<br /> <br /> Some key features of the draft amendments proposal are as follows:<br /> <br /> <span style="font-weight: bold;">Ownership</span><br /> One of the primary features of a CGP is that 26 per cent of the CGP is required to be &quot;wned&quot; by captive users. As per the existing rules, ownership is tested on the basis of &quot;equity share capital.&quot; As a result, group CGPs are often structured based on the number of shares held by the CGP users, such that the group CGP users satisfy the 26 per cent ownership test. <br /> <br /> The draft amendments now seek to stipulate that the ownership test will be based on the issued and paid up share capital in the form of equity share capital with voting rights (excluding equity share capital with differential voting rights). Hence, if the draft amendments in its present language are notified, the ownership test will be on the value of equity capital along with voting rights, instead of basing ownership only on the number of shares. The proposed changes in the draft amendments also include the introduction of a normative debt:equity ratio of 70:30 for each CGP to calculate the actual investment of captive users. The draft amendments by way of illustration specify that for every Re 1 billion of project cost, a single captive user will need to contribute at least Rs 78 million, representing 26 per cent of the 30 per cent equity component.<br /> <br /> While all other changes in the draft amendments are to be effective immediately upon notification, the changes specifically with respect to ownership of CGPs are to be effective from 1 April 2019. Importantly, ownership-related amendments will be applicable to all existing CGPs and therefore, existing group CGPs will need to comply with the requirements stated above, and may have to alter their existing structures significantly. It needs to be seen how the already-commissioned CGPs, where the project capital and equity have been deployed, will rejig their equity structures. <br /> <br /> <span style="font-weight: bold;">Certification</span><br /> The existing rules do not specifically provide whether each CGP is required to be certified, and whether such tests are to be done at the end of each financial year (FY) prior to availing CGP-related exemptions. While some states such as Tamil Nadu have an existing framework in relation to certification, most states do not have such a framework. Thus, to make it abundantly clear that the CGPs need to be certified annually, the draft amendments stipulate that the appropriate state commission will be the relevant authority to certify CGPs, which would be based on annual statements of consumption, generation, and other details sought by the commission. <br /> <br /> The draft amendments, however, also propose that the Central Electricity Authority would be required to provide monthly consumption and generation details of each CGP on its website, and if such data is not provided, the plant will lose its CGP status. This adds another layer of monitoring and scrutiny on the CGP.<br /> <br /> <span style="font-weight: bold;">Proportionality of usage</span><br /> The existing rules require consumption of each captive user to be in proportion to their actual shareholding in the CGP. However, the proportionality test is restricted to up to 51 per cent of the consumption of power. That is, while the captive users have to consume power in proportion to their shareholding of up to 51 per cent of the total power generated by the CGP, whether any power that is consumed by the captive users over and above this 51 per cent threshold also needs to be in proportion to the shareholding of the captive users in the CGP is a grey area. The draft amendments propose that the proportion of consumption of electricity by each captive user vis-a-vis their shareholding in the CGP will not just be linked to 51 per cent of the power consumption, but will instead be tested on the entire power consumed by captive users even in excess of the 51 per cent threshold. <br /> <br /> <span style="font-weight: bold;">Shareholding change</span><br /> The captive users, under the existing rules have the flexibility of changing their shareholding and consumption pattern in relation to the CGP any number of times, as long as the overall 26 per cent ownership and 51 per cent consumption tests prescribed in the rules continue to be met. This is advantageous, since it permits captive users to rejig their shareholding and consumption: if a captive user requires more power during peak months and, at the same time, another captive user decides to shut down their unit for annual maintenance, power meant for the latter is supplied to the former. There is also the added flexibility of captive users commercially deciding to rework their ownership/consumption, if additional captive users are inducted or existing captive users decide to terminate their power purchase from the CGP. Thus, due to the action of one or some of the captive users, the CGP status of the plant is not allowed to be affected. <br /> <br /> However, the draft amendments have sought to restrict this by recommending that the inter se shareholding pattern of the captive users in a group CGP can only be changed up to two times in each FY, and that the plant will cease to avail of all CGP-related benefits from the date of the third shareholding change in a FY. We anticipate pushback from various stakeholders to this change as well. <br /> <br /> <span style="font-weight: bold;">IPP to CGP</span><br /> Currently, there are many examples of independent power plants (IPPs) remodelling themselves as CGPs, which is done for a variety of commercial reasons. The existing rules do not restrict such recast of IPPs to CGPs; however, the draft amendments have proposed that IPPs shall be allowed to avail of CGP status only in exceptional circumstances, and only if permitted by the appropriate commission. Materially, the draft amendments do not clarify whether existing CGPs, which had originally been IPPs, would also require specific permission from the commission to continue as CGPs.<br /> <br /> <span style="font-weight: bold;">Concluding thoughts</span><br /> It is clear that the MOP intends to impose hard hitting changes on CGPs with the draft amendments and the primary target of the MOP is the group CGPs with flexible ownership structures. While some changes, especially in relation to ownership and annual reporting are much required, in our view, the changes that are notified should introduce points that promote CGPs and reduce the need for multiple compliances and additional requirements.<br /> <br /> <span style="font-style: italic; font-weight: bold;">Author:</span><span style="font-style: italic;"> Akhil Bhatnagar, Partner and Abhimanyu Ghosh, Associate Partner, Khaitan &amp; Co.</span><br />
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