The curious case of India's discoms

Power distribution is the weakest link in the entire value chain of the Indian power sector.

Dominated by conventional sources of energy (coal, diesel, gas, nuclear and large hydro) and a progressive shift towards renewable sources (wind, solar, bio and small hydro), India’s power sector is saddled with various issues, including electricity demand slowing in tandem with economic growth during 2019, and exacerbated by the impact of COVID-19 in 2020.

Ailing state-owned power distribution companies (discoms) continue to hamper the efficient functioning of the generation and transmission sectors.

As of May 2020, discoms have accumulated massive overdue payments to generators of Rs116,340 crore (about US$16bn), creating an immense liquidity crunch across India’s entire power sector.

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Various government reforms have been repeatedly initiated to improve the sector’s operational and commercial performance but are yet to make a sizeable or sustained impact. Discoms continue to incur huge financial losses, a clear reflection of massive subsidies, largely unfunded by the state governments. To help state owned discoms pare their mounting losses, the central government has offered financial packages to bail out beleaguered state electricity discoms from time to time. However, success has been limited.

Meanwhile, another bailout package is currently being approved of Rs90,000 crore (about US$12bn) of subsidised debt funding for the discoms from state-owned lending agencies — the Power Finance Corporation (PFC) and Rural Electrification Corporation (REC) — which will allow discoms to cover some of their current overdue payments and effectively infuse liquidity into the sector.

The absence of competition, unsustainable cross-subsidies, economically inefficient tariff setting processes, expensive thermal power purchase agreements (PPAs), and a lack of modern technology and infrastructure development are adding to discoms’ losses.

India has set ambitious long-term targets for its electricity sector, including 450 gigawatts (GW) of renewables by 2030, representing a total of 55% of planned capacity. As a prerequisite for the country to achieve these renewable targets and sustain its economic growth goals, the crippled power distribution sector must be made profitable.

This dire health of discoms is increasing the risk for renewable energy generators and their financial backers, restricting them to participate only in bids for which they can gain an adequate counter-party risk profile sufficient to raise the capital cost for setting up new domestic energy capacity to meet energy demand growth.

There are policy changes being proposed at the central level which can act as guiding principles for states to adopt. However, power distribution is entirely the states’ domain and various states are on different paths of reforms. As such, a state level analysis of issues is required, and solutions ought to be designed to cater to their needs and level of preparedness.

In this report, the three states of Maharashtra, Rajasthan and Madhya Pradesh have been shortlisted for a detailed analysis. These states represent discoms at different stages of operational and financial performance, preparedness and appetite for reforms, penetration of renewable energy, technology adoption, and so on. The states have undertaken various reform measures and have adopted several good practices to improve their operational and financial performance, however, each is still struggling with high aggregate technical & commercial (AT&C) losses and an increased debt burden.

Discoms still struggle with high losses and an increased debt burden.

This report highlights how performance has changed over the years and presents areas where opportunities for reform exist. Further, the analysis provides a benchmark for discoms in other states to replicate the success already demonstrated by these discoms, and/or to implement the recommendations proposed as part of this study.

Based on our state-by-state analysis, we have produced broad recommendations to reduce financial and operational inefficiencies across the Indian discom sector.

(These recommendations are further elaborated in the Conclusion and Recommendations section of this report).

Our recommendations include:

1. Resolve issues surrounding legacy contracts and close inefficient plants. The closure of inefficient, highly polluting, end-of-life coal plants surplus to a state’s needs will result in significant savings from fixed charge payments for such assets and will also reduce pollution and carbon footprints. A recent report by The Energy Resource Institute (TERI) reveals demand for electricity in India is expected to be 7-17% lower by 2025 due to a downward revision in India’s GDP growth on account of the COVID-19 economic shock. This slowdown has major implications for capacity planning, accelerating the need to retire inefficient end-of-life coal plants to reduce carbon emissions and also increase the remaining, efficient, plants’ load factors. (PLF)
2. Reduce cross-subsidies. Discoms needs to address the issue of cross-subsidies and reduce their reliance on recovering revenue from commercial and industrial (C&I) consumers. Increasing cross-subsidies has continued to undermine the competitiveness of industries in India. The implementation of Direct Benefit Transfers (DBTs) and solar irrigation pumps, and the adoption of policies that favour the uptake of solar rooftop systems will help to reduce crosssubsidies.
3. Reduce AT&C losses through digitalisation. Existing electricity meters must be progressively replaced by smart meters, including smart prepaid meters. This will help discoms understand and manage their load better and will reduce metering and billing losses and theft, while also facilitating distributed rooftop solar and storage.
4. Revise tariffs. Tariffs must be revised. Not many states have increased their tariffs in the last few years. While a price shock is undesirable, particularly during the COVID-19-induced recession, regulators must require an annual tariff revision to allow discoms to keep up with inflation. The annual revision should continue until aggregate and technical (AT&C) losses are reduced, and ever-lower renewable energy tariffs can come to the rescue at sufficient scale to allow some deflationary offsets on the average cost of generation. Rationalisation to reduce tariffs for high-paying commercial and industrial (C&I) customers could encourage customer retention.
5. Increase competition. Increased private competition should be promoted to improve the distribution sector’s performance. The Government of India (GoI) could mandate discoms with high losses to either privatise operations or allow the entry of suitably qualified and capitalised private distribution entities willing to invest in upgrading infrastructure. Increased competition would encourage generators, distributors, and electricity supply companies to develop technologies to increase efficiency, lower costs, and make supply more reliable.
6. Move to a National Pool Market. India’s electricity market should move gradually to a National Pool Market and optimise generation nationally. This would get the best return from the huge investment in the national generation fleet and drive ACS down, forcing the least efficient and outdated facilities to close, reducing overcapacity clearly evident in the thermal power sector.
7. Implement renewable energy tariffs with indexation. Discoms could procure new renewable energy capacity by designing a new tariff structure in which the developer bids for levelized tariffs. The initial tariff could start from a lower base in the first year and allow inflation indexation over the length of the contract, in such a way that developers’ returns on investment remain entirely unchanged from the current tariff structure with no indexation.

We also offer state-specific recommendations that could assist ailing businesses to turn around and become profitable. 

While most of the recommendations are general, such as the deployment of smart meters, solar for irrigation, and the implementation of policies favouring open access to encourage consumers to switch to renewable energy, we provide three specific recommendations that each state should prioritise to enable discoms to improve their financial viability.

Please view full report PDF for references and sources.