January 4, 2012
January 4, 2012
Darkness At Noon: Financial Status Of Power Discoms
A Discussion On Shunglu Panel Recommendations
January 4, 2012
No Light Yet: Shunglu Panel Suggests Steps To Boost SEB Finances
P
ower utilities run by central and state governments dominate the
entire value chain of the power sector in India. While private
sector participation in power generation has risen substantially over
the past few years, state electricity boards continue to own nearly
95% of the distribution network.
SEBs have been in existence for 40-50 years, but they have become
unviable and unprofitable due to heavy accumulated losses and liabilities. Poor service delivery, mainly due to inefficient planning
and sluggish execution of capital works, inadequate maintenance,
low plant load factor, high transmission and distribution losses, erratic supply to consumers, has resulted in perennial financial losses.
The distribution segment is plagued by high aggregate technical and
commercial (AT&C) losses. These losses include loss due to theft,
non-billing, incorrect billing, inefficiency in collection, leakage in
transmission and distribution system. Average AT&C loss for utilities selling directly to consumers stood at 27.2% in 2009-10.
SEBs’ inability to recover costs of power supply and high AT&C
losses is resulting in huge financial losses. The financial health of
state electricity boards is in a distressed state also because of delayed
payment of subsidies and problems related to fresh coal linkages.
One of the major ailments plaguing distribution companies is the
mismatch between tariffs and cost of generating power. While high
losses affect revenue, insufficient or no revision in tariff is another
major factor that has affected performance. The distribution arms of
SEBs succumb to political pressures and do not file a petition for
tariff revisions and take a big hit on their books.
According to the latest report released in November by governmentowned Power Finance Corp Ltd, aggregate SEB losses in 2009-10 (April-March) was `63,548 crore (without accounting for subsidy). This is 18% higher over the previous year. According to the Finance Commission, losses of state electricity boards are projected to reach `1.16 lakh crore by 2014-15 from current levels.
Worsening health of power distribution companies is making it increasingly difficult for them to service their debt. This has also
raised alarm bells in the banking sector and most lenders are now very cautious in extending loans to the power sector as a whole.
In fact, finance ministry has asked banks to stop providing working capital finance to utilities that have large losses and said it is
critical to determine end-use of the funds. Some financiers have started insisting on incorporating stringent clauses — such as automatic pass-through of fuel costs and filing tariff petitions every year — in their loan agreements with SEBs.
Against the backdrop of mounting losses in the power distribution segment, Prime Minister Manmohan Singh approved a high level
panel on Financial Position of Distribution Utilities to look into the financial problems of the SEBs/distribution utilities and to identify potential corrective steps, particularly in relation to their accounting practices. The panel was appointed in July 2010 and is
headed by former comptroller and auditor general V.K. Shunglu.
The committee submitted its report to the government last month.
January 4, 2012
Terms Of Reference Of The Panel







Review accounts of SEBs and state distribution companies as on March 31, 2010, or earlier, if updated accounts for the year
ended March 31, 2010, are not available.
Review their financial position as on March 31, 2010, and in particular, losses incurred and projected distribution losses over the
period April 2010 to March 2017.
Review Electricity Tariff including the role of (i) state governments; (ii) state tariff regulator; and (iii) SEBs'/state distribution
companies in periodic tariff revision.
Assess system improvement measures accomplished in distribution of power, in particular, in urban areas as well as future
needs/plans.
Examine geographical and spatial compulsion and determine their operational impact.
Review organisational and managerial structure, manpower, employed and future requirements/plans.
To recommend plan of action to achieve financial viability in distribution of power by 2017.
Here are observations of the panel on key terms of reference that set the scope of the report.
Review Accounts of SEBs
T
he committee restricted its analysis to distribution utilities. This was done because poor operational efficiencies of these utilities
end up affecting performance of generation and transmission utilities.
The financial analysis is based on 15 states that account for 91% of total power consumed in the country.
The statement on sources and uses of funds by SEBs over five years (FY06 to FY10) shows an increase of `2.48 lakh crore. Incremental funds were mainly driven by current liabilities and loan funds (other than from state government). Increase in funds was
mainly set off by higher accumulated losses, rise in fixed assets and a sharp increase in other current assets.
The committee’s observations about the financial statements are as follows:

In case of certain SEBs — including Uttar Pradesh, Rajasthan, Andhra Pradesh — components of sources and uses statements
are highly opaque. It appears that a part of the losses are hidden under the head “other current assets”. UP alone accounts for
40% of increase in total current assets.

A substantial increase in debtors has been noted. Although average debtor days have contracted to 36-645 days in March 2010
from 54-933 days in March 2005, some states registered worsened performance. (refer below Table). It must be noted that financial well-being of a distribution utility largely depends on its ability to lower collection days. More importantly, the moot point
is whether debtors nearly two years old can be classified as good.

Accumulated losses (without subsidy) during the five years surged to `1.8 lakh crore, mainly due to a gap in average cost and
revenue of `0.6 per kilowatt-hour.

Actual AT&C losses are far higher than reported by Central
Electricity Authority because these figures do not include operational losses, such as overstatement of agricultural consumption (that is either subsidised or free in case of some
states).

In some states, most of the energy billing statements is outsourced and energy consumption data are allowed to be stored
in the server of the company to whom the service has been
outsourced.
March 2010
March
2005
36 to 645
days
54 to 933
days
Madhya Pradesh
241 days
198 days
UP
317 days
199 days
Bihar
606 days
1,006 days
Average collection
period (range)
January 4, 2012

Nearly 70% of the SEB losses are financed by public sector banks.
Of these, government guarantee as a collateral security is to the
extent of 42%.
Outstanding Bank Loans To Distribution
Utilities (` crore)
Total
Loans
Loans
backed
by state
guarantee
% of loan
backed
by state
guarantee
Public Sector
Banks
49,131
20,740
42
pdating accounts and getting them audited in time is of utmost
importance. This is because only audited accounts are considered
to be true and are used as the basis for tariff determination. Delays in
finalisation and audit of accounts results in utilities continuing to charge
outdated tariffs and are unable to recover revenue shortfalls.
Other Commercial Banks
2,190
917
42
Cooperative
Banks
530
-
-
Functions of state electricity boards were mandated to be separated as
generation, transmission and distribution in 2003. It is observed that
separation is only namesake and not in substance. Revenue collection
and financing are common and only presentation of accounts is shown
separately. Hence, poor performance of one function affects performance of the entire SEB.
Total
51,851*
21,657
42
While it is evident that distribution utilities are not in a position to repay
the balance outstanding, the state government, which is the owner,
needs to infuse capital or repay banks. Given that states owning the
high loss-making distribution companies are themselves in a deficit,
line of funding has dried up.
Review Electricity Tariffs
U
* Total outstanding bank loans at `58,500 crore. However,
loans break-ups for UGVCL, CHEMCOM, CSPDCL, APDCL and
UHBVNL are not available.
The Committee’s Recommendations
Following are the recommendations made by the committee:

Instead of waiting for audited accounts to set tariffs, regulators should undertake setting tariff on the basis of best available data.

Tariff determination for the coming year is based on certain projections made. Since these projections are bound to undergo
changes, regulators should not be unduly rigid and disallow variations in cost.

Like in the case of generation utilities, retail tariffs should have an in-built formula to pass on rise in fuel costs to consumers.

Since T&D losses are not uniform across a state, consumers in an area that has a high default rate should be charged more compared with those consumers in the area of lesser default. It is suggested that a loss surcharge be levied area-wise and be shown
separately in the bill of each consumer.

Integration of operational, commercial and financial data via computerisation in one single system has seriously commenced.
This needs to done to logically delineate functions to be performed by distribution company itself and outsourced company.

A franchise model for reduction of losses has been suggested in a study conducted by Crisil Infrastructure Advisory. The study
of different models of ownership including government, public-private partnership, private and franchise was undertaken and
franchise model was suggested on the following grounds:

A satisfied customer is a paying customer and satisfaction depends on quality of power supplied, regularity of power
supplied and redressal of customer grievances.
January 4, 2012



Competitive process in public-private partnership is not very rigorous.

A licensee needs to enumerate distribution assets in the relevant area for valuation and payment for these assets by the
new owner. This ensures there is clarity on the type of fixed assets owned by distribution companies, information about
which is currently not maintained.

The franchisee is not expected to pay anything upfront as he needs to work as an agent of the licensee and only needs to
ensure that the required capital expenditure is undertaken.
Agriculture consumption in the country is an estimated figure furnished
by state governments to the Central Electricity Authority, However, a
number of variations because of geological conditions are observed.
Ironically, certain regions where water tables are at a much lower depth
and where cropping intensity is high display much lower per pump of
energy consumed. This is a reflection of agriculture consumption being
overstated in certain states. Hence, it is important for pumps to be metered.
A special purpose vehicle must be set up by RBI to purchase liabilities
of distribution companies. This is because states whose distribution
utilities are in huge losses and are unable to generate any revenue surplus need a line of finance.
Category-wise Electricity Sale FY 11
Interstate, 2%
Railways,
2%
Others,
8%
Domestic,
24%
Commercial
8%
Industry,
33%
Agriculture
23%
It is proposed that part of the guaranteed loans can be redeemed by RBI permitting state governments to draw down upon guarantee redemption fund set up by certain states as required by the 12 th Finance Commission. For the balance amount, a SPV can
be set up as a corporate entity. The SPV would be entitled to purchase loans of banks, provided certain conditions are met. In
case of non-compliance of the terms, the amount defaulted would be debited to the state government’s account held with the
central bank.

Distribution companies should change over from present system of billing to prepaid meters in case of consumers like government departments and local bodies that do not pay despite getting budgetary approval for electricity charges.
PRU View
G
overnment and the policy-makers were compelled to take immediate steps because of the worsening financial situation of distribution utilities and drying up of funding options.
The Appellate Tribunal for Electricity order on November 11 considered and validated that every state
electricity regulatory commission must ensure annual revenue requirement is filed and tariff determination takes place annually. It also states that in case of a delay in filing for annual revenue requirement,
the state commission must initiate suo-moto proceedings (refer InFocus dated November 9).
The finance ministry’s directive to not lend to distribution companies unless they pare losses and raise
tariffs has led to tariff hikes across states. In the past 18 months, 22 states have raised tariffs, including
loss-making states like Rajasthan, Maharashtra and Tamil Nadu.
Reform efforts in the politically sensitive power sector would succeed only with strong backing and support of the political fraternity. Autonomy of the SEBs is of prime importance.
We believe that while recommendations by the committee have merit, some suggestions may be fraught with problems.
January 4, 2012
Here are PRU’s views on how some of the Committee’s recommendations may falter:

Setting up of an SPV that would be financed by the RBI in case of non-compliance of the terms defies the role of RBI as a central banker as it requires micro-management.

The committee recommended that a state government be penalised if SPV members think enough efforts have not been made to
improve performance of an SEB. We believe that basis of an SPV’s decision to penalise or not to penalise a state government
needs to be detailed. Also, clear guidelines must be laid down to decide the size of penalty.

The example of the franchisee model at Bhiwandi area, in Maharashtra (refer case study below) depicts that revenue collection
from the referred area was 100% successful. However, one wonders if private companies would be interested in investing in
rural areas as that require large investment and may have a low payout ratio.

Levying a separate area-wise surcharge on consumers of each state is likely to be influenced by the local political parties and is
open to litigation.
We do not expect these recommendations to turn around ailing SEBs in the next two to five years because implementation of the
recommendations needs more articulation and strong political will. However, we see tariff revision in several state utilities in 2012.
Case Study: Power Distribution Franchise Model in Bhiwandi
Under a power distribution franchise model, the state’s distribution assets are not privatised, instead they are controlled by the SEB
that in turn signs a Distribution Franchisee Agreement with a private player. The private player then distributes power and is responsible for bringing down transmission and distribution losses in that circle. The private player is also responsible for stepping up bill
recovery and other distribution-related services.
Under a power distribution franchise arrangement,
 The franchisee shall be an exclusive agent of SEB in the franchise area.
 The SEB shall supply the required power to franchisee at the quoted price.
 In case demand exceeds supply, the franchisee may procure power from other sources.
 Licensee will do minimum capital investment in the franchise area as committed in the tender
 Franchisee shall plan and implement capital expenditure to improve the system as is deemed necessary by it. Franchisee is not
liable for past arrears. In fact, the franchisee would receive incentive on collection of past arrears
The franchising model, an initiative of the Maharashtra government, and the first of its kind in the country, was experimented in the
textile town of Bhiwandi, near Mumbai. Gujarat-based private power major Torrent Power Ltd won the bid for the T&D services
for the town. It commenced power distribution at Bhiwandi on January 26, 2007.
Success of the model implemented at Bhiwandi is summarised below:
 AT&C losses contracted to 18% from 58% earlier.
 Revenue collection improved to 100% from 68%.
 Distribution transformer failure reduced to 2.25% from 40%.
The discom gained `419 crore, besides `30 crore saved on human resource and operation and maintenance.
Bhiwandi has been a win-win scenario for all: consumers, Maharashtra State Electricity Distribution Company Ltd, the state government and the franchisee.
Looking at the success in Bhiwandi, Maharashtra plans to replicate this model in other regions of the state as well.
January 4, 2012
Sonal Thakur
Senior Sector Analyst
022-61541840
Jones Koshy
Senior Editor
022-61541764
Rajrishi Singhal
Head – Policy & Research
022-61541730
Policy & Research Unit, Dhanlaxmi Bank, Trade View, Kamala Mills,
PB Marg, Worli, Mumbai 400001
Disclaimer Clause
This report is for customer ‘information’ only and does not constitute investment advice or an offer to purchase or subscribe for any investment.
This document is not intended to provide professional advice and should not be relied upon in that regard. Persons accessing this document are advised to obtain appropriate professional advice where necessary. This document is not directed to or intended for display, downloading, printing,
reproducing or for distribution to or use by any person or entity who is a citizen or resident or located in any locality, state, country or other jurisdiction where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or would subject Dhanlaxmi
Bank Limited or its associates or group companies to any registration or licensing requirement within such jurisdiction. If this document is inadvertently sent or has reached any individual in such country, the same may be ignored and brought to the attention of the sender. This document may
not be reproduced, distributed or published for any purpose without prior written approval of Dhanlaxmi Bank Limited.