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Analysis | October 2011

What ails SEBs?

A report titled ‘Bailout or Blackout: SEBs on borrowed time’ by IIFL’s Institutional Equities says that the aggregate net worth of state electricity boards (SEBs) has been wiped out. The concluding part of the two part excerpt.

Types of franchising agreements
Cash flow to an incumbent utility and to a distribution franchisee is a function of the franchising agreement between the two.Such agreements are usually for 10 years, but can extend to even 15 years. The scope of a franchisee’s operations, and hence its revenues, are based on one of the following formats:

l Outsourcing
l Revenue collection
l Revenue collection with operations and maintenance (O&M)
l Input-based franchise
l Input and investment-based franchise

In all the five models, the distribution utility is a net beneficiary, through reduced AT&C losses, better O&M operations, or enhanced revenue collection. Furthermore, each of these models has minimum performance standards, failing which a financial penalty is imposed on the franchisee. This approach safeguards a distribution utility’s interests.

Among the five franchise models, “input based franchise” and “input and investment based franchise” involve the highest operating risks, as the franchisee pays a fixed amount to the utility for purchase of power and stands to benefit only if it is able to lower AT&C losses below a stated target. Nonetheless, since there is complete operational freedom to the franchisee, it is better-placed to use its expertise in AT&C loss reduction and earn profits.

States such as Maharashtra, Karnataka, Madhya Pradesh, Andhra Pradesh, Gujarat, Haryana and Uttar Pradesh have started appointing franchisees for their power distribution. However, based on available data, only three circles Bhiwandi in Maharashtra, and Agra and Kanpur in UP have been awarded to franchisees on “input based” models that involve giving complete operational freedom, and preset targets on AT&C loss reduction. All other states have implemented either revenue franchising or O&M franchising, where only certain functions of distribution operations are handed over to a franchisee.

Franchising has its limitations
As per the provisions of the Electricity Act 2003, a distribution licensee is governed by the respective Electricity Regulatory Commission (ERC), and there is no provision for regulating the operations of a franchisee. This loophole has both positive and negative implications for a franchisee.On the positive side, it is not required to publicly disclose its financials and on the negative side, there are no guaranteed returns, so it suffers if it is unable to deliver as per committed operational parameters.

Additionally, most complex models of distribution franchising (input and investment based franchisee) work best in areas where load growth is relatively low. This is so, because if load growth exceeds forecasts, a franchisee would be required to procure power from sources other than the distribution utility. As tariffs are not separately determined for the franchising areas, there is no legal provision for recovery of such incremental power costs.

Furthermore, distribution franchising would work only in smaller areas that have high losses that the incumbent utility is unable to reduce. A distribution utility is unlikely to appoint franchisees in areas where losses are low and cash flows are healthy. One of the other challenges in successful implementation of the franchisee model is availability of authentic baseline data on number of consumers, load curve, AT&C losses, etc.

Case study

Bhiwandi: A role model for franchisee operations
Bhiwandi, the textile hub of Western India, is located in the Western part of Maharashtra. It has a customer base of around 0.2m and the annual power consumption is estimated at 3,036MU (~350MW).

In FY07, it had AT&C losses of 58 per cent and billing accuracy was as low as 23 percent. The infrastructure was poorly maintained distribution transformer failure rate was 40 percent and there were bottlenecks at extra high voltage (EHV) levels. These infrastructure bottlenecks resulted in forced load-shedding of 6-8 hours.

The Maharashtra government took a bold step and decided to implement the “input base” revenue model in Bhiwandi. It selected Torrent Power (TPL) through competitive bidding and transferred the operations on 26 January 2007 to the franchisee for a period of 10 years.

The franchisee agreement required:
l Maha Discom to supply TPL power at injection points (EHV level) at a levelised tariff of Rs 2.04/unit for 10 years. This ensured assured annual revenue to Maha Discom, irrespective of TPL’s actual performance. TPL’s tariff rate is decided by the MERC;
l TPL to achieve reduction in AT&C losses from 58 per cent to 14 per cent, and step up the collection efficiency to 98 per cent in the distribution area and
l Reimbursement of capex incurred on augmentation of distribution network to TPL by Maha Discom by the 10th year (net of depreciation).
l The bidding conditions did not allow TPL to earn any assured returns, and the only way to earn profits was to quickly reduce AT&C losses.

The company adopted the following strategies to reduce AT&C losses and to improve collection efficiency: 1) Strengthening distribution network 2) Augmentation of system infrastructure 3) Enhancing vigilance and 4) Installation of appropriate metering systems. To improve customer service and address billing issues, it also set up a 24x7 customer care centre. With this focussed approach, within two years and with an investment of Rs 2.5 billion it has successfully: 1) reduced AT&C losses by 35 percent 2) Improved metering accuracy from 23 to 95 per cent 3) Reduced load-shedding by 50 per cent to 3 hours and 4) Reduced distribution transformer failure to 7.5 per cent (from 40 percent).

Non-power players seen entering the franchising business
Recently, Maharashtra Discom had invited bids for appointing input and investment based franchisees for Aurangabad and Nagpur. The invitation attracted a record number of bidders, perhaps encouraged by the success of Torrent Power in Bhiwandi. The bidding criterion was NPV of revenue earned by Mahadiscom (power purchase costs for franchisee) over the life of the franchisee agreement. It was observed that non-power companies had presented aggressive bids in both circles.

As this form of quasi privatisation does not require the local state to amend or change any policy framework, implementation should not be challenging. Moreover, such agreements benefit all stakeholders the incumbent utility, consumers, and private utility.

However, stiff resistances from employees of incumbent utilities, some of whom make “a little money on the side” from revenue leaks, present roadblocks for implementation. Such issues can be overcome only through political will.

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