Term Paper for Macroeconomics.pdf

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TERM PAPER OF ECONOMIC ANALYSIS-II

ELECTRICITY PRICES IN INDIA

Fundamental Drivers & Probable Trends

BYManoj Kumar Pradhan

Roll No: 37PGDM-PT, 2008-2011

XAVIER INSTITUTE OF MANAGEMENT,BHUBANESWAR

Email Address:

[email protected]

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INTRODUCTION:The electricity economy is far from its peak. In fact, three powerful trends are accelerating itsgrowth. The first is the population explosion the growth in the number of people needingelectricity. The second is the electrification of everything the growth in the number ofdevices that require electricity. And the third is expectation inflation the growth in the sense

of entitlement that turns electrical conveniences into essentials demanded by all. Hence this paper tries to understand the future needs of electricity with respect to the present status, theresources required for it and the options available and the direction needed to be taken.

This paper presents a view of the likely cost of electricity to suppliers in India in the next decade, but it does not attempt to make any estimate of increases in overall system cost, for example ofgrid expansion or balancing costs, and thus in the price charged to consumers . Furthermore, weare concerned only with the macro trend in prices, which we judge to be sharply upwards. In thisregard the study is intended to go beyond intuitive pessimism and provide a reasoned account ofour assessment. While the Renewable Energy has been developing elements of this analysis forsome years, it is not possible for us, or perhaps for anyone, to do more at present than indicate

the probable direction and an abstract order of magnitude (trivial, significant) of pricemovements. However the general outlines of the matter may be derived very simply byreviewing the state of affairs in and around the Indias electricity supply industry, and thenreasoning from the presumption that the future determinants of prices to suppliers, aside fromcapital and operating costs, are 1. Fuel costs and 2. The opportunity for profit arising from thevalue of lost load. Our view, which is given in detail in the following chapters.

OVERVIEW:Expanding electrification and scaling up electricity services is critical to both the economic andsocial development of India. The current state of electricity services across India can be said to

be acute, if not in a crisis mode. The immediate manifestations of this crisis are severe

shortcomings in: a) access to electricity for rural and urban poor, b) generation capacity thatcannot meet peak demand and c) reliability of supply, in terms of predictability of outages andquality of power supply.

National statistics tell a story of problems afflicting generation, transmission, and distribution ofelectricity. Shortages in energy demand and peak power demand have been around 8% and 12%on average between 2000 and 2003. Industry, farmers and households have invested in asubstantial amount of equipment and capital in the form of captive power plants, generators,inverters, and voltage stabilizers to address issues of supply and its quality. India, with anaverage annual per capita electricity consumption of 400 kWh, is far behind countries such asChina (900 kWh), Malaysia (2500 Kwh), and Thailand (1,500 kWh).While large-scale reforms have repeatedly been attempted in the past, Indias achievement in thefield of rural access to electricity leaves much to be desired. India is home to 35% of the global

population without access to electricity ( Table 1 ) and only 44% of all rural Indian householdsare electrified. According to the 2001 Census, 6.02 crore households use electricity as the

primary source of lighting out of a total of 13.8 crore households in the country.The planning commission report on integrated energy policy estimates the countrys demand for

power at 778000MW in 2031, at 8percent GDP growth. ( Integrated Energy Policy ExpertCommittee Report, Planning Commission, August 2006 ). With population estimated to increaseto 1.47 billion ( Registrar of Census ) in 2031, per capita power consumption would be close to

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Chinas current per capita demand for power and about one-seventh of USs current per capitaconsumption electricity. Tabel-1 in the annexure shows how India compares with worlds percapita electricity consumption in 2004 ( International Energy Agency report, 2006 ) An installed capacity of 7788000MW in 2031 means an addition of about 650000MW over thecurrent installed capacity of 128000MW. This implies that the nation would have to add a

capacity 26000MW each year for the next 25years.

While pursuing this aggressive growth targets, it is essential that India manage its electricitydemand at a level sustainable in the long run and in affordable price. All these depend upon thegeneration mix available for us, that is Thermal (Coal & Gas), Hydel, Nuclear, Renewable(Wind, Solar, Biomass etc). The generation mix, in turn will be influenced by factors likeGDP growth, Natural resources availability, Availability of technology, Environmentalrequirement, Government regulation & Policy and the most important of all ElectricityPricing mechanism.

POLICIES:

National electricity policy 2005 aims at Total village electrification by 2010 Per capita availability of electricity of 1000 units by 2012 Installed capacity of over 200,000 MW by 2012 Spinning reserves of 5% by 2012 Minimum lifeline consumption of one unit per household per day Inter-regional transmission capacity of 37,000 MW by 2012 Energy efficiency/conservation savings of about 15% by 2012 Quality and reliable power supply by 2012.

Electricity Tariff Policy was notified by Government of India in January, 2006. The mainfeatures are:

Tariff of all Generation and Transmission projects in Private Sector throughCompetitive route Public Sector to complete transition in five years.

Reduction of cross subsidy to (+) (-) 20% in next five years. Emphasis on facilitating Open Access in Distribution; clear formulation on cross

subsidy surcharge. Transmission Tariff framework sensitive to distance and direction. Strict implementation of Performance Standards. Agriculture Tariff to leverage sustainable use of Ground Water Resources Time bound introduction of MYT.

The broad goals of Rural Electrification as set out in the draft Rural Electrification Policy,referred to as AARQA goals, are as follows:

Accessibility electricity to all households by 2012 Availability adequate supply to meet demand by 2012 Reliability- ensure 24 hour supply by 2012 Quality- 100% quality supply by 2012 Affordability- pricing based on consumer ability to pay

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From the above policies it can be seen, those four main fundamentals will drive electricityeconomy; they are per capita electricity consumption, subsidy, affordability and sustainablegrowth. All the fundamentals of growth are linked by on common force, which is electricity

price.

ELECTRICIRY PRICES: Historically, tariffs in India have been governed by socio-economic and political considerations.Energy intensive industries that consume HT power have the lowest cost to serve at around Rs.2

per unit, but their average tariff is around Rs.3.50 per unit, more than 70% above the cost ofsupply. On the other hand, the agriculture sectors cost to serve is above Rs.2 per unit, but it getsfree power or pays a nominal charge of Rs.0.20 per unit. Domestic consumers pay tariffs in therange of Rs.1 per unit to Rs.5 per unit when their cost to serve is around Rs.3.50 per unit. Cross-subsidisation does exits, but the true magnitude of this gap has been realized only in the last fiveyears.Out of total electricity generated, only 55% is billed and 41% is regularly paid for (GOI, 2001) .

Electricity is either stolen, not billed, or electricity bills are not paid.For 1991-1999, the elasticity of electricity consumption with regard to GDP was 0.97 when itwas 2.1 for Korea and 0.99 for the OECD on an average. Actually, the low 0.97 figure is areflection of an increasing gap between supply and demand, the continuously deterioratingquality of power, and a low level of access to electricity. It is also the result of large investmentsmade by the manufacturing sector in standby and stand-alone facilities to compensate thesedeficiencies. High structural needs of the Indian economy would justify that such a figureexceeds 1.0, unless drastic improvements in energy efficiency took place. Current retail prices ofelectricity represent less than 75% of real average costs. There is also a large amount of cross-subsidisation between consumer categories. The amounts disbursed in subsidies are partlycovered by cross-subsidies, which in turn burden less-favored consumers, like industry. In 1999-2000, the prices paid by domestic customers, 149 paise/kWh (3.3 U.S. cents/kWh7), and bycustomers registered as being from the agriculture sector, 25 paise/kWh (0.6 U.S. cents/kWh),were far below the overall average price (208 paise/kWh). This occurred at the expense ofcommercial consumers (354 paise/kWh), industry (350 paise/kWh, 7.8 U.S. cents/kWh) andrailway hauling (411 paise/kWh). All this amounts to a mass of implicit subsidy. The financial

burden thus created undermines the economic efficiency and viability of the electricity supplychain and is not in the long-term interests of consumers.

SUBSIDY: Figure-III charts the growth in agricultural and industrial tariffs for 25years to 2000 in AndhraPradesh, one of the largest states in India. We may consider this as a representative of trendsthroughout India. While Industrial tariff has increased more than ten-fold (a compound averagegrowth rate of 11% per year), agricultural tariffs hardly increased at all over the same time spanfor a compound average growth rate of less than 2% per year. Figure-IV shows what thesetrends have done to the consumption mix. In mid-1970s agriculture used 18% of total electricityat a time when highly profitable sales to industrial customers were 58% of the total. As a result,the financial burden was much lighter than in the year 2000, when agriculture sales accounted foralmost 40% of the total and industrial sales were only 24% of the mix.

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On a national basis, the balance tipped towards loss-making sales to agriculture, triggering theneed for an Rs.40, 000 crores subsidy to the power sector. One of the inferences is that industrialelectricity users are increasingly adopting captive generation to satisfy their electricity needs,although at a higher cost but leaving the utility generation company in a mess. This situation iscrowding out the electricity needed to support the countrys economic growth.

COSTING:Generally electricity tariff is based on two components like fixed cost and variable cost. Thecomponents of fixed cost are interest on term loan, interest on working capital, depreciation,return on equity, income tax, O&M, insurance and other cost. The components of variable costare primary fuel cost, secondary fuel cost and fuel transportation cost. A recent modification tothe mechanism is to include unscheduled interchange for grid stability is called availability-basedtariff (ABT).Hence it can be seen that fuel is the single most critical issue today for creating additionalcapacity. Whether it is coal or gas or anything else, fuel is the biggest hurdle. Fuel costcontributes approximately 55% to the total tariff.

FUEL OUTLOOK IN INDIA:Coal: In India coal is the primary source of fuel. The burgeoning coal demand is already acommon knowledge. At current economic growth rates, most estimates place total annual coaldemand at around 630-650 million tones by 2012, with about 70% from the power sector. By theturn of the next decade this demand is likely to grow to 1.1-1.2 billion tones, with power sectoraccounting for about 700 mtpa (Coal vision 2005 & ICF estimates using the India Integrated

Planning Model ). In India as in other energy import dependent markets, domestic coal priceswill take their cue from imported fuel prices that swing to balance local demand and supply asgiven in the Figure-II. With gas supplies relatively fixed, increases in domestic coal supplyimpact imported fuel, which often set the marginal electricity prices. There is lot of inefficiencyin the coal sector owing to monopolistic structure of the market. There is no pricing policy or

proper classification of the coal. Whatever is currently practiced is largely from the pre-independence era still followed with UHV and high heating value (HHV) issues on the calorificvalue. All the above complication with increasing prices and environmental consideration willset a decreasing trend in national coal demand as seen in the Figure-I .

Natural Gas: The power sector accounts for almost 35% of the total gas consumption in India.In 2006-2007 the sector consumed 40million metric standard cubic meters per day (mmscmd) ofgas against a requirement of 68.19mmscmd. The current overall demand-supply gap is about90mmscmd. By 2011-12, the demand for gas is expected to increase to 282mmscmd anddomestic supply is expected to lag by 115mmscmd. The demand for natural gas is expected togrow at a CAGR of over 12% and consumption of natural gas is likely to be 400mmscmd by2027. The demand supply gap can be bridged by more investment in gas exploration andsecuring fuel supply from international sources like Iran-Pakistan-India pipeline and Myanmar-India pipeline. Transportation constraints will limit availability for natural gas. But consideringIndias strategic interest alternative to gas & oil needs to be developed.

Entry into force of the Kyoto Protocol, recent international price hikes for fossil fuels &uranium, concerns about energy supply security and surging demand for energy in key

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developing country like India, are causing policy makers to reassess the nuclear poweroption, in addition to the various renewable energy potions.

NUCLEAR:Out of the 132,329 MW that we have installed, electricity based on nuclear power plants is only

3,900 MW, which is about 2.95% our total installed capacity. The major share is coal, which hasabout 65% of installed capacity followed by Hydro, which is about 26.19% (Central Electricity Authority, 2006-07 ). Using nuclear energy to generate electricity is only one of our options andnot the only one. What option we choose and in what proportion depends on the money requiredfor setting up these plants and the cost of electricity from these sources. Once the initial cost istaken care of, the nuclear power becomes cheap on a marginal cost basis.Cost of nuclear electricity generation in India, remains competitive with thermal [electricity] for

plants located about 1,200 km away from coal pit head. When full credit is given to long termoperating cost especially in respect of fuel prices, nuclear power could play a key role inadvancing climate mitigation and widening the number of nations currently committed to GHG(Green House Gas) emission limitations. In the India specific study, it was found out that nuclear

power was anyway the least-cost option for sites more than 1200 km from the nearest coal mine.In India Thorium is far more abundant in nature than uranium. India is the 2 nd largest source ofthorium after USA. Hence the future holds a lot of promise for thorium-based generation.

WIND POWER:India was ranked fourth in the world in terms of wind power capacity in the year 2007. The wind

power capacity was 8000MW in 2007. The wind based capacity growth rate was almost 30 percent in last eight years. The center for wind energy technology (CWET) initially estimated thetotal potential for wind power generation at around 45000MW. The union government envisagesa annual capacity addition of up to 2000MW in the next two plan periods. According to a Britishwind energy association report, the average generation cost of onshore wind power was around

3.2pence/kWh as of 2005. In 2006 the cost of wind energy was estimated to be comparable tothat of new coal or natural gas based generating capacity in the US. The cost of wind energy wasestimated at $55.8/MWh, coal based power at $53.1/MWh and natural gas based power at$52.5/MWh. Electricity from wind has become 50% cheaper than it was 20years ago. A typical 1MW wind turbine would generate about 28 to 30 lakhs units of electricity which costs Rs. 4.5 to5.0 Crores. With the present power cost, the simple payback period would be about 3 4 years.

These estimates shows that although wind power may be more expensive than conventional power as of now, it may nevertheless feature prominently in investors power plant portfolios, primarily because wind based power plants are not subject to the volatility of fossil fuel pricesand supply. Compared to the uncertainty associated with the costs of conventional power, therelative constancy of wind power justifies a relatively higher cost per kWh.

HYDRO:Small hydro is the best option for low cost off-grid power. A cluster of small hydro can also beconnected to the grid. There are three class of small hydro as mentioned in the Table No: 4.Government of India defines small hydro as hydel plant having a generating capacity of up to25MW. The estimated potential of all theses types put together is at least 15000MW. China is theworld leader in small hydro with an installed capacity of 45000MW. It has helped China become

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a leader in the Carbon credit market. Schemes with rating of up to 25MW are eligible for creditunder the clean development mechanism.

SOLAR POWER:India receives solar energy in the range of 5 to 7 kWh/m2 for 300 to 330 days in a year. This

energy is far more than the total energy consumption of the country today. Solar Photovoltaic power generation potential is 20MW per Sq.Km. Solar thermal power generation potential is35MW per Sq.Km. The cost of PV will reach grid parity with traditional utility electricitygeneration by 2015.

BIOMASS:The non conventional like small hydro, wind and solar has certain limitation like rain fall andhilly region, wind velocity and high initial coast of solar power with the dependence onradiation. But in a country like India biomass has several advantages. It uses agricultural wastelike stalks of cotton and rapeseed. CDM benefit can also be got. It can be run throughout the year

by stocking the fuel.

ENVIRONMENT:Massive growth in generation will be affected by externalities like rehabilitation, compensation,impact on agricultural land/forest land, impact on hydrological system, impact on public health,global warming and amount of ash generated. As per the expert in Europe, the estimated amountof damage due to CO2 and other externalities is Rs.4.2/kW and Rs.2.77/kW. Hence the totaldamage is Rs.6.97/kW.

SUMMARY:Even though India has huge potential of fossil fuel (coal), as a primary source of fuel, fossil fuelhas certain inherent limitation due to its effect on environment and the limited life of the fuel.According to 2004 statistics of the International Energy Agency, India is amongst the lowemitters of CO2 on a per capita basis ( Table-2 ), but in absolute term CO2 emissions aresubstantial from India too. Serious consideration needs to be given to theses emissions. It would

be impossible to increase electricity generation through fossil fuels beyond certain limit. ThoughIndia has certain reserve of natural gas, it is not enough to plug the demand supply gap and it cannot depend upon imported oil due to strategic consideration. Hence the limited availability offossil fuels and the growing dangers of climate change are making a strong case for renewableenergy by the day. Currently almost 8% of the total commercial energy requirement of thecountry is being met via renewable sources. The government is targeting to increase thecontribution to 10% by 2012. The total estimated potential for power generation from renewablesources such as wind, small hydro, biomass and solar energy in the next 25 years is 183,000MW(Table-3 ). Another major source of generation is Nuclear Energy, which can be used usingthorium as the fuel.

CONCLUSION:Coal will retain its prime importance due to its abundance availability in India and natural gaswill relegated to a distance place. Hydro will able to maintain its present share due the adoptionof small hydro plant (SHP) concept. The major gainer will be nuclear and renewable energy likewind, solar, biomass etc. In a possible scenario, when installed capacity of 778000MW might

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consist of 25percent coal, 5percent gas, 20percent hydro, 20percent nuclear, 20percent wind and10percent others, electricity consumption will be 2809kWh per person. This is for a populationof 1.47billion. The change in generation mix can be seen in the pie charts of the Annexure . Atarget of meeting per capita demand of 2809kWh per person in 2031 would certainly leave us

just above todays world average per capita consumption.

RECOMMENDATION:

FUTURE PRICING MECHANISM: With allocation of captive / industrial coal mines to generating plants, it is essential in the

interest of the consumer that the CERC be empowered to fix a reasonable transfer priceof coal to be later loaded on the electricity tariff. To achieve efficiency and economy intariff it is essential that all elements of cost that goes into the making of tariff are underthe control of a single regulator, particularly when coal is the major cost component.

The five major elements of cost plus tariff namely capital cost, interest, return on equity,depreciation and operation maintenance expenses are applied to regulated enterprises in

power generation, transmission and distribution. This can also be extended to coal. There will be green pricing and it will be the fourth component to the present three part

tariff that will be cost incentive depending upon the proportion of electricity suppliedfrom renewable source by power generator.

Transmission pricing should anticipate the emergence of an interstate and intrastatecompetitive power market. Generally speaking, this pricing should be based on thefollowing principles:

The transmission system operator should provide access to the grid withoutdiscriminating among types of users;

There should be no discrimination among customers when connecting newcustomers to the transmission network;

Use-of-system charges should not restrict, distort or prevent competition in thegeneration, supply or distribution of electricity.

FUTURE GENERATION MIX:o Mandatory for Distribution Company to buy electricity from renewable sources so that it

accounts for 50% of grid power by 2031 and promoting renewable energy through preferential tariffs.

o Mandatory for fossil fuel based generating company to ensure at least 5% of theirgeneration is through renewable sources.

o India with its large populations and fast growing economy need to develop an acceleratedexpansion of nuclear power into its national energy supply portfolios with thorium as the

fuel.o Develop small/independent standalone generating systems for small villages considered

non-electrifiable based on renewable energy like biogas, solar and wind.o Use of efficient and high-end biogas technology, R&D on geothermal & tidal generation

and emphasis on clean industrialization.o Develop grid-connected system with emphasis on nuclear power plant of 20MW capacity

as a standalone system for medium size towns (after fully developing thedecommissioning technology for each type of generation)

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o Pursue a unique growth strategy focusing on conservation of energy and thus managedemand to a level that is much lower than world standard.

o Use of clean development mechanism like dual fuel, waste heat recovery and usage ofcombined heat, power and cooling solution

o In case coal based power plant, which will remain the main stay of electricity generation,

super critical technology and ultra super critical technology will be used. The increasedefficiency associated with the supercritical plant leads to an actual reduction in the totalcost of electricity generated in cents/kWh, relative to a conventional plant of today.

o Advanced clean coal technologies like PFBC and IGCC are expected to be used widely by independent power producers to comply with the environmental norm.

SUBSIDY: If government wishes to subsidize some customers, those subsidies should be direct and

not undertaken in a way that leaves the power system operator trapped in the middle(delivering the power but not receiving compensation).

Create a separate entity to fund and operate agricultural sector supply such separate

entities will facilitate: decentralization, more efficient usage, and more responsiveness tothe needs of agricultural customers. Replace inefficient pumps with high efficiency pumps to reduce the amount of electricity

needed to pump irrigation water by 40-50%.

REFERENCES

1. Wind Power Economics, an increasingly attractive option by Suzlon Energy. Power LineVolume: 12, No: 8, April 2008.

2. Small Hydro, a tenable option, Power Line Volume: 12, No: 05, January 2008.3. Common Concerns, Is a single regulator for power and coal feasible? Power Line

Volume: 12, No: 05, January 2008.4. Coal Potential, identifying energy opportunities, Bishal Thapa & Ankur Bansal, ICFInternational, Power Line, Volume-11, No: 08, April-2007.

5. Planning for electricity, where are we going? Shishir Tamotia, CEO, Ispat EnergyLimited, Power Line, Volume: 11, No: 11, July 2007.

6. Industry Perspectives on increasing the efficiency of coal-fired power generation, Ian M.Torrens & William C. Stenzel, IEA, Coal Industry Advisory Board.

7. Electric Power for India, A US-India Bilateral Study8. Electricity in India, Providing Power for Millions, International Energy Agency, France9. Electricity Prices in India, Pierre Audinet, Desk Officer for South Asia and Korea, Office

of Non-Member countries, International Agency.

10. Regulatory & Policy Frame Work for development of Renewable Energy, Prof. SanjeevGhotge, Series Fellow Wisi11. Using Groundwater to Create Electricity Agricultural Demand Side Management in

India, James M.Hogan, PA Consulting, India Power, Vol.VXI No.4 October-December2008.

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ANNEXURETABLE-1: WORLD PER CAPITA ELECTRICITY CONSUMPTION

Region Per capita consumption of

electricity (kWh)World 2516Australia 11126Canada 17179Czech Republic 6224Germany 7030India 457Japan 8076Singapore 8171USA 13338

TABLE-2: CO 2 EMISSIONS IN 2004 (MT)World 26,583.00OECD 12,911.00USA 5,799.93China 4,732.26India 1,102.81

TABLE 3: ESTIMATED POTENTIAL FOR POWER GENERATIONFROM RENEWABLE ENERGY SOURCES BY 2032Sources/Systems Estimated Potential (MW)Wind 45,000Bio-power (agro residues) 61,000Co-generation bagasse 5,000Small hydro (up to 25MW) 15,000Solar Photovoltaic 50,000Waste-to-energy 7,000Total 183,000

Sources: MNRE

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TABLE-4 CLASSIFICATION OF SMALL HYDRO STATIONClass Station Capacity (kW)Micro Hydro Upto 100

Mini Hydro Upto 2000

Small Hydro Upto 2001 to 25000

Installed capacity, by fu el type and sector (MW)

Renewable, 7761, 6%

Thermal, 86015, 65%

Nuclear, 3900, 3%

Hydel, 34654, 26%

Source:Central Electricity Authority

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Future Generation Capacity Requirement a Possible Scenario by t he year 2031

Hydel, 155600, 20%Nuclear, 155600, 20%

Renewable, 233400, 30% Thermal, 233400, 30%

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Figure-III

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Figure-IV

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Term Paper for Macroeconomics.pdf