India’s thermal power generators are gearing up for a ‘rebundled’ future

As large firms in the power sector pick up distribution and transmission assets, the life of their thermal power assets will increase. The rest of India will fare less well. 

Matter begins: 

In November last year, Chandigarh invited bids to buy its power DISCOM. Most of the companies that participated in the auctions were private firms— Sterlite Power, Renew Energy, Adani Transmission, Tata Power, Torrent Power and Eminent Electricity power. There was, however,  an exception. State-owned NTPC too registered bids through its subsidary NTPC Electric  Supply Company (NESCL).

It wasn’t the first time NTPC, India’s biggest power generator, was looking beyond generation. A few months earlier, in May 2020, it had evinced interest in picking up Reliance Infrastructure’s DISCOMs in Delhi— BSES Rajdhani Power and BSES Yamuna Power. Yet earlier, in 2019, along with state-owned distribution company PowerGrid, it had set up the National Electricity Distribution Company, a pan-India power distribution firm.

It isn’t the only thermal power company that’s looking beyond generation either. The Adani Group, India’s biggest private thermal power producer, is moving into power transmission and distribution as well. In late 2017, it acquired Reliance Infrastructure’s DISCOMs in Mumbai. More recently, it has acquired Essel Group’s Warora-Kurnool transmission line, moving towards its target of having 20,000 km of transmission lines by the end of 2022. It also has bid for the Chandigarh discom.

More than discrete transactions

These transactions are the building blocks of a larger aspiration NTPC and Adani are chasing – to become vertically integrated power producers, spanning everything from coal-mining to power generation to transmission and distribution.

Backwards integration came first. In 2004, NTPC picked up a large coal block called Pakri Barwadih near Hazaribagh, Jharkhand. As for Adani, starting out as a coal importer, the group picked up coal mines in Indonesia and Australia, entered contract coal mining in India, and now owns its own coal blocks in India. 

What we are seeing now is forwards integration into transmission and distribution. They are not the only ones. A clutch of other firms in the power generation space, like Greenko, Torrent, ReNew, Sterlite and Tata, are trying too. But, in terms of scale – spanning everything from coal, generation, transmission and distribution – Adani and NTPC stand out.

The rise of vertical integration 

As the first report in this CarbonCopy series on Coal said, firms in India’s coal-based power sector, which accounts for most of India’s power generation, are in trouble.

Not only is the country suffering from massive over-capacity in its power sector— an installed generation capacity of 375 GW vs current offtake of 190 GW— thermal power units are struggling to compete with renewables. “On an average, the cost of thermal power today is around ₹4.5. Renewables, in contrast, now come for about ₹3/3.5,” said Vinay Shrivastava, the recently-retired executive director (western region) of India’s Power System Operation Corporation, a state-owned enterprise which manages India’s electricity grid.

That is partly because the fixed and variable costs of running a thermal power project are rising at a time renewables are getting cheaper. Between overcapacity and DISCOMs dropping thermal for solar in the day, coal-based plants, designed to run as base load plants, are seeing their plant load factors fall as low as 40% and 50%, corroding their economics. Additionally, delayed payments from cash-strapped DISCOMs are worsening their cash flow problems.

The second story in our series examined Coal India’s response to worsening financials of the coal-based power sector— which accounts for no less than 73% of all coal consumed in India. The company aims to reduce its dependence on the sector through diversification into energy-intensive manufacturing businesses like Aluminium smelting and polysilicon manufacturing for solar cells.

What NTPC and Adani is doing is different. Apart from horizontal expansion into renewables, they are betting vertical integration will boost the viability of their thermal power units. 

How does vertical integration help?

Consider the issue of owning coal blocks, for example. A power plant with its own coal mine can not only control its quality of coal better— a persistent complaint against coal supplied by Coal India— its cost of coal will be lower too. That is one reason why many power plants were abandoned in the 2000s. They could not compete with rivals with captive coal blocks.

A similar argument can be made for integrating transmission infrastructure too. Not only does the business enjoy a fixed 15.5% RoE, it also offers generators their own pipeline to large load centres. “Right now, transmission lines have to be booked. If a line is fully booked, you will have to curtail your production or ship power to markets whose lines are free,” said Anand Mishra, a senior executive at Avantha Power. “Having your own line solves that problem.”

What about discoms? Can a power generator sell power to its own discoms?

The answer is yes. DISCOMs source most of their power from long-term power purchase agreements signed with a handful of generating units. To find a place in the merit order dispatch (DISCOMs’ ranking of power suppliers according to variable price), all a power producer has to do is make sure its unit is competitive within that set. “A firm can do financial engineering in such a way that its Variable cost to the DISCOM finds place in the merit Order,” affirmed POSOCO’s Ex Executive Director Shrivastava. 

He cited an instance from NTPC, which he now advises. “Any plant with variable cost above ₹2.75 will not get scheduled whole year. NTPC has plants in Kudugi and Solapur, with high Variable cost which run for (just) two/three months in a year. NTPC is figuring out a way to mix their power with cheap renewables to bring down the variable cost.”

Vertical Integration will be a huge advantage for companies like Adani and NTPC, he said. Horizontally diversified (into cheaper renewables), they can pick up DISCOMs where their units can find their way onto the Merit Order Dispatch, sign LT PPAs, and tie up their unused generating capacity. Without this, said Shrivastava, the groups would have had to sell their power, at lower rates, on the exchanges with all the accompanying uncertainties.

Add to that the possibility of a private enterprise running a DISCOM more efficiently, with fewer pressures to cross-subsidise. “The DISCOM at Agra has been handed over to Torrent. They are able to sell 20% more electricity after spending ₹100 crore on tightening up leakages,” said Shrivastava. “The UP engineers association did a review of the Agra experiment and found downtime had come down from 3 hours to 14-15 minutes a day.”

At this time, state DISCOMs are dragging the power sector down. Despite efforts by successive Governments, DISCOMs owe as much as about ₹1.3 lakh crore in outstanding dues to generators. This is a problem. All revenues for India’s power sector flow from DISCOMs. When they are low on money, money flows are affected right up the value chain.

Now think of a vertically integrated power producer with PPAs accounting for 60% of its power. If it has its own DISCOM, it could sell surplus power there, get paid without large delays, and enjoy superior economics than its peers.

The return of rebundling 

In 2003, the country had broken state electricity boards into their component functions of transmission, generation and distribution companies. Explaining the logic at the time, RV Shahi, who was the power secretary at the time, told CarbonCopy: “It was not a workable arrangement. It was hard to fix performance, underperformance. It is very hard to pinpoint responsibility in aggregated entities. And so, what we did is we unbundled each.”

What we are seeing now, however, is transmission, distribution and generation clumping together again. As with India’s abortive Gas push, the implications of vertical integration in the power sector run deep – and need a wider discussion.

In a market where vertically integrated players are more efficient than standalone players, expect a move towards an oligopoly. “Profitability of standalone players will come down,” said Mishra. “Only players who can control the chain will survive.” What will happen to the rest? “They will shut down or slowly get sold to bigger firms,” he said.

And then, there is cherry-picking. Cross-subsidisation is a central leitmotif of India’s DISCOMs. Urban consumers cross-subsidise rural ones. Industry subsidises agricultural customers. Large cities are more profitable for a DISCOM than the hinterland. One could go on.

As DISCOMs get privatised, a two-tiered system, similar to what India has seen with City Gas Distribution, will take shape. Competition will be keener for larger (or more efficient) power centres than smaller ones. Take Chandigarh’s DISCOM, for instance. As litigants challenging the move told the Punjab and Haryana High Court: “The division was revenue surplus for the past three years. It was economically efficient, having transmission and distribution losses less than the target of 15 per cent fixed by the Ministry of Power.”

This creates an outcome where, in the short term, state DISCOMs will struggle as their most remunerative markets are privatised. The impacts will fall on their residents in the form of greater load-shedding, or higher power rates. Effectively, power distribution in the country will cleave into two categories: higher service delivery in circles controlled by ‘rebundled’ players; dramatically lower service in areas serviced by state DISCOMs. 

Much like Mumbai and Maharashtra today. Maximum city, delinked from the state DISCOM, barely sees any power cuts. The rest of the state does. “If a vertically integrated electricity business picks its business (metro cities, commercial and industrial consumers), it will reduce inefficiencies and become more competitive but, from a sectoral point of view, this is terrible,” said Kanika Chawla, Programme Manager at Sustainable Energy for All.\

There are questions on whether this is federally permissible. “It should be left to the State government to determine the type and mode of ownership change they want to adopt if privatisation is considered by them,” wrote Richa Mishra in the Hindu BusinessLine.

A question of financing – and time-lines

This asymmetry in competitive advantage is showing up in money flows.  As returns from renewables outstrip those from coal, Adani and NTPC continue to attract funding. 

NTPC is raising cash through short-term bonds— short duration loans are one way for lenders to limit long-term exposure to coal. As for Adani, not only have its renewables businesses raised investments from the likes of Total and foreign banks, it is pushing ahead with thermal power projects like the one at Chhindwara, Madhya Pradesh.

Essentially, India has overcapacity in the thermal power sector. By introducing fresh synergies, vertical integration allows firms like NTPC and Adani to sweat their assets longer, and prolong their use of coal. In that sense, standalone players will go to the wall first. NTPC and Adani will be the last. In the short to medium term, their thermal power plant portfolios, riding on distress sales by independent players, will probably grow. 

The bigger question: How long can vertical integration keep thermal power projects cost-competitive against renewables, especially once storage comes in? That is hard to say. Neither NTPC nor Adani responded to CarbonCopy’s requests for an interview.

But the sectoral story will be one of attrition. No new players will enter this market. Instead, it will see consolidation.