INDIA POWER SECTOR: CHALLENGES & INVESTMENT OPPORTUNITIES

PLENARY SESSION IV: FINANCING OPTIONS

New Delhi May 12, 2006 Salman Zaheer Lead Energy Specialist The World Bank

STRUCTURE OF PRESENTATION
Indian Power Sector Investment requirements (2007-12) Overview of market conditions
India International Investors

Potential role of the World Bank Group (CAS 2005-08) Concluding Remarks

Investment Needs over 2007-12 period reasonably well established..

Installed generation capacity to increase by about 60,000 MW (from 125,000 MW to 185,000 MW)
Of this about 20-30,000 MW hydro

Investment program estimated to cost US$100 billion

Generation US$60 billion (Rs. 2,70,000 crores) Transmission & Distribution US$40 billion (Rs. 1,80,000 crores)

In addition:
About 20,000 MW of existing thermal capacity to be rehabilitated and modernized Distribution networks to be upgraded and MIS strengthened Human resources to be revitalized

And:
A low carbon growth strategy to be followed with international support (Post G8+5 meeting at Gleaneagles in 2005)
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Indian market environment also broadly known..

Industrial, commercial, urban household demand increasingly commercialized. Willing to pay cost-recovery tariffs provided:
Service is Efficient not willing to pay for theft and utility inefficiency Service is demand responsive willingness to pay declines with outages, voltage fluctuations, billing hassles, etc.

Industrial and commercial demand now about 43-45% of total consumption.

60% of Indian firms rely on costly captive or back-up self-generation (compared to 21% in China)

Urban household demand about 20-25% of total consumption

Urban consumers becoming wealthier and more service conscious

Rural including agricultural - demand not ready for commercialization. Still needs effective government support 4

Some barriers to commercialization..

Governance of distribution utilities
Over 40% of energy supplied into state transmission systems is lost, not billed, incorrectly billed or payment not collected Reducing to 20% would save Rs. 15-20,000 crores/y ($3.3-4.4 billion) of generation cost (@Rs. 2/kWh) or generate 25% more revenue if billed at the average tariff (Rs. 2.77/kWh) Sector is a conduit for about Rs. 20,000 crore ($4.5 billion) of poorly targeted and poorly accounted subsidies each year (from budget & cross-subsidies) Even in advanced reforming states, only 55-65% of electricity sales metered

State regulatory commissions are still finding their feet

Tariffs are distorted and do not cover costs Industry tariffs are high by international standards (about USc 8-10); agricultural tariffs (accounting for 25% of consumption) are well below cost Data quality is improving but progress on energy accounting/audits is slow Regulations on service quality and service obligations yet to be enforced Limited outreach efforts to enhance public participation

Fuel supply bottlenecks

Early stages of competition and liberalization
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India market environment ..(3)

Government of India policy response is appropriate:
Electricity Act, 2003 National Electricity Policy (March 2005) National Tariff Policy (January 2006)

Correct focus on:

Governance Competition Commercialization Rural services Private participation

Key challenge:
Ramp up pace and quality of policy implementation
What must be done to move from about $6 billion to $20 investment/year?

Overcome concerns and resistance at state level

Accelerated reform of distribution still a critical bottleneck

Resolve fuel supply bottlenecks Engage the private sector Remain conscious of international commitments clean energy
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Indias carbon emissions

500 453

Million metric tons of carbon

450 400 350 300 250 200 150 100 50 0

The power sector accounts for about 60% of carbon emissions Projected emissions rise amounts to 7% of global increment

337

251

156

1990

2000

2010

2020

Source: EIA International Energy Outlook 2003 (base case)

Energy and carbon intensity of the economy is lower than in China, but not declining nearly as fast

Indias vs Global investment requirements - a large Growing Gap between demand and supply? Financing required for the Power Sector in Emerging Markets 1990 - 2020
160.0

Cumulative Sum ($Bn) $2,300 Bn High Investment Demand Scenario (3%) Gap covered by public financing, self -financing, donor funding, and rationing. $1,900 Bn

Total Power Investment ($Billion)

140.0

120.0

100.0

80.0 60.0

Low Investment Demand Scenario (2%)

40.0 20.0

Private Capital Mobilized in Power Sector

0.0

2000

2004

1990

1992

1994

1996

1998

2002

2006

2008

2010

2012

2014

2016

2018

Historic
Source: : World Bank, IEA, Deloitte Touche
Tohmatsu Emerging Markets Group

Future
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2020

World Bank role in India: Conforming with Country Assistance Strategy (2005-08) Continue to support state level reforms
Critical for mobilizing the volume of investments needed to meet Indias demands in an affordable manner

Support rural access to spur rural development Show-case mechanisms for scaling-up a low-carbon power generation program Continue to support expansion of the national transmission system to facilitate access and trade

Continue to provide analytical, advisory and capacity building support

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Bank assistance strategy builds on past engagement in power sector. Pre-1990s: Investments in thermal and hydropower generation at the central and state government levels Expansion of the transmission system Investments in state distribution systems 1990-Present: Investment, budget and advisory support for state level reforms (Orissa, Haryana, UP and AP) Investment support for transmission and renewable energy (through IREDA) Investment in 1500 MW Nathpa-Jhakri hydro plant 10

responds to consumer & Govt concerns; addresses investor priorities

1.

Legal protection and framework defining investor rights

63% of firms rated it a deal-breaker ranked 1 of 12 factors contract enforceability clarity in market rules [Brazil , Guatemala ] protection to do business labor laws, property rights; laws that work enforceable exit strategy [Separately ranked 4th]

2.

Payment discipline and enforcement

40% of firms rated it a deal-breaker ranked 2 of 12 factors Both generation and distribution investors considered it important we cannot fix it on our own government support essential. worsening payment discipline strong negative.

3.

Guarantee from Government or Multilateral

36% rated it a deal-breaker overall rank 5 of 12 support needed till the business becomes commercial why should we take on the risk of a bankrupt business? Interestingly not a determinant for success best and worst experience.

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What 50 global investors have reported on why investments succeeded or failed

1. Retail tariff level and cash-flow discipline 65% of firms rated it critical - First overall rank for success or failure we have learned enough to avoid countries with unsustainable retail tariffs Government assurances to raise tariffs or provide subsidies not very comforting. Tariff levels should be high enough without subsidies 2. Fair adjudication of tariff adjustments and disputes 50% of firms rated it a critical determinant of failure. Second rank in case of failure. new regulators show little appreciation of investor needs. Regulators showing an increasing tendency to change rules and targets on which investment decisions are made. 3. Operational Control and Management Freedom 60% of firms rated it a critical success factor. Second overall rank Key to deriving value from investment economies, cost reduction Unanimous verdict that public-private operational partnerships are not important (lowest ranked)

4. Regulatory commitment sustained through long-term contract 50% of firms rated it a critical determinant of failure. Third overall rank a contract is a contract if the contract looks cozy it probably is need to make sure that the contract is on firm economic and financial ground

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How Satisfied are Investors? A Country Assessment

Being a small country is not a liability

Multiple entrants (over 4) No dissatisfied investors Latin America Bolivia, Jamaica, Panama, Costa Rica, Guatemala, Nicaragua, Dominican Republic Africa Kenya, Morocco

Respecting contracts under stress

Thailand, Philippines

Czech Republic, Colombia, Argentina, Indonesia, China, Pakistan, India

Regulators perceived to be exercising excessive discretion and risk on the increase

India, Colombia, Brazil Are regulators just doing their job or are investor expectations unrealistic?
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What conditions are important?

Minor
Rated Dealbreaker 63% 36% 40% 13% 15% 19% 19% 8% 10% 4% 4% 13% Relative Rank 1 2 5 7 3 4 6 9 8 10 11 12

Major

Critical Deal-breaker

Legal Investors LegalProtection Protection of of Investors' Rights Consumer Payment Discipline Govt/Multilateral Guarantee Government Efficiency Judiciary's Independence Clear Rules for Exit Investment Grade Debt Rating
Transition to Competitive Market 3.11 3.11 2.98 2.91 2.83 2.83 2.68 2.66

3.57

Corruption Index Ranking Domestic Borrowing Competitive Selection

Possibility of Vertical Integration 2.00

2.49
2.43

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Global market environment Feedback from Power Investors Roundtable (World Bank 2004)
The Target Group Firms that invest their own equity outside their home countries
Local/domestic firms not included Lenders not included they follow the equity sponsor

The Target Universe 65 firms in final survey. An ever decreasing number:

7 mergers 7 exits from emerging markets 2 went into receivership

The Survey Instrument

A 7-page standardized survey to all firms Sent by email/fax follow-up phone calls.

The Response Rate

48 valid responses a 75% response
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International Power Investors Firms Targeted

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. ABB Equity Ventures AEP AES Corp Alliant Energy International Alsons Consolidated Resources Amata Power Banpu Public Co. Ltd. BG Group BP Global Power CHI Energy (Energia Global) Chilectra Cinergy Global Resources CLP Power International CMS Energy Corporation Cogentrix Energy Commonwealth Development Corp. Covanta Energy Delma Power Duke Energy Dynegy E.ON Energie Edison Mission Energy 23. El Paso Energy 24. Electricite de France International 25. Electricite de Portugal 26. Elyo 27. Endesa 28. EIF Group 29. Entergy Power Group 30. Eskom Enterprises 31. FondElec 32. Fortum 33. GE Capital Global Energy 34. GMS Power 35. HEI Power 36. Hydro Quebec 37. Ibedrola 38. Independent Power 39. InterGen 40. International Power 41. Keppel FELS Power 42. Korea Electric Power Company 43. Marubeni Power 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. Mirant Mitsui & Co. NRG Energy Panda Energy PPL Global PSEG Global Reliant Energy Rolls-Royce Power Ventures Saur International Scudder Latin America Fund Sempra Energy Siemens Power Ventures Sithe Energies Statkraft International Steag AG Tomen Power Tractebel TransAlta TXU Corp Union Energy Union Fenosa Wartsila NSD
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The fundamentals have not changed - Factors that enable and attract investment
Well-managed reform: Increasing ability of utility to generate internal cash for investment through
cost reductions timely tariff adjustments to recover the cost of supply, and efficient collection of posted tariffs

Keeping the financial house in order:

Improving access to debt financing from domestic/international debt markets by maintaining profitable operation + acceptable debt service ratio

Reducing risk & maintaining a healthy regulatory environment: Attracting domestic & foreign equity funding creating and maintaining sector structure, regulatory and legal environment conducive to minimization of country/project investment risk
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The evolving World Bank program balances pragmatism with the fundamentals
Support service improvements in 2-4 states
Improve efficiency, service quality and governance of state utilities

Support rural access to spur rural development

Complement or supplement the Rajiv Gandhi Rural Electrification Program to ensure demand-responsiveness and sustainability of rural services

Show-case mechanisms to scale-up low-carbon power generation

Develop hydropower potential in an environmentally and socially sustainable manner Strengthen capacity of 1-2 state governments to manage and utilize hydro resources in an efficient and responsible manner Reduce barriers for rehabilitating thermal power plants and improving their fuel efficiency (part of low carbon growth agenda) Promote renewable energy development (through IREDA/MNES)

Continue to support expansion of national transmission system to facilitate access and trade Continue to provide analytical, advisory and capacity building support
Build awareness and consensus around sector reform issues governance of publiclyowned distribution utilities, open access, etc. 18 Improve regulatory effectiveness in infrastructure services

World Banks Assistance Program(2)

Current portfolio consists of the following operations:

Project
Powergrid II Powergrid III Rajasthan Power Renewable Energy II

Loan Amt
$450 m $400 m $178 m $112 m

Balance
$ 60.6 m $400.0 m $ 38.3 m $ 45.1 m

Closing Date
June 2006 July 2011 June 2006 March 2007

Under Preparation: Rampur Hydropower 412 MW approx. $400 m (2006-07) Thermal Power Rehab 600 to 1000 MW ($120-140 m IBRD; $40-60 m GEF)

Being Identified: State utility development & reform dialogue with 3-4 states Rural electricity services dialogue with Ministry of Power Hydropower development dialogue with Ministry of Power and 2 states Establishment of institute for regulation and competition

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International Finance Corporation also has an active power portfolio in India

Allain-Duhangan 192 MW hydropower first for IFC on merchant basis Powerlinks - Tala Transmission Project Tata Power & Powergrid JV Mini hydro IHDC (2-5 MW projects); considering windpower Considering financing private distribution companies (NDPL) TA (with North American Rural Electrification Cooperatives Association) to PFC for rural electrification Worldwide, IFC has a power portfolio of US$2.5 billion (11% of business) Good performance to date Invested (since 1990) in 14,815 MW of generation capacity and US$15.2 billion in aggregate project costs. The portfolio currently has:
7 distribution clients; 5 transmission clients; 61 projects in 33 countries
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World Bank Group risk mitigation guarantees - to leverage private investment

IFC
IFC Guarantees (partial credit structures usually for local financing) Interest Rate and Currency swaps

MIGA
Political Risk Insurance expropriation transfer restriction breach of contract war & civil disturbances

IBRD/IDA
Guarantees partial risk partial credit

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IBRD Loans - Lending Terms

(As per currently applicable waivers to Indian Portfolio)

LIBOR-based, Variable spread loan

6 month LIBOR Spread over LIBOR Commitment Fee

Interest
USD loans Yen loans 5.03% 0.18% 0.07% 0.15% 0.18% 0.07%

Front-end Fee

0.04%

0.04%

Total World Bank Interest Rate 5.32% + currency exchange rate impact deemed export/import duty exemption* Principal Moratorium 5 years

0.44%

*Applicable to ICB procurement funded from loans provided by multilateral agencies.

5 years

Repayment period (incl. moratorium)

20 years

20 years
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In closing.

World Bank is committed to helping India meet its power sector objectives:

Improve efficiency and quality of electricity distribution key to unblocking internal resources Expand rural access Enable electricity trade and transmission of power Develop hydropower and other renewable energy potential in an environmentally and socially sustainable manner Reduce barriers for rehabilitating thermal power plants and improving their fuel efficiency other financial support for a Low Carbon Growth strategy being formulated

Policy framework has improved considerably regulatory frameworks are also becoming more competent and transparent. However:

Scale of investments needed cannot be mobilized unless enterprise level reforms, particularly of distribution companies, are ramped up Private or public companies cannot fix cash inadequacy without government help

AND We know from painful experience that a policy environment that is unfavorable for the private sector will be unfavorable for the public sector too! 23
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