Economics in Power Sector

Business Economics Assignment Group 4 Section A
Economics in Power Sector
GROUP 4 SECTION A: NIKHIL GANDHI MUJAHID MASHIR AMIT SHARMA DEEPAK GUPTA AZHAR DIWAN LEENA SINGH M R SHANKAR ROLL NO : 50 ROLL NO : 45 ROLL NO : 10 ROLL NO : 19 ROLL NO : 24 ROLL NO : 39 ROLL NO : 47
Power Sector- Introduction .................................................................................................. 4 Power Sector - Role in ECONOMY ........................................................................................ 4 POWER SUPPLY STRUCTURE................................................................................................. 6
Objectives ..................................................................................................................................... 8 Generation .................................................................................................................................... 9 Target 2012 ................................................................................................................................... 9 Transmission and Distribution ..................................................................................................... 10 Key concerns ........................................................................................................................... 10 T&D losses ............................................................................................................................... 10 Technical losses ....................................................................................................................... 10 Commercial losses ................................................................................................................... 10
PRODUCTION COST: ........................................................................................................... 11

PRODUCTION COST OF THIS INDUSTRY ........................................................................................ 11 COAL BASED ............................................................................................................................ 11 OIL & GAS Based ...................................................................................................................... 11 HYDRO BASED.......................................................................................................................... 11 NUCLEAR BASED ...................................................................................................................... 11 COST SOURCES OF THE INDUSTRY ............................................................................................... 11
FACTORS INFLUENCING THE COST OF GENERATION .......................................................... 13

Fuel ............................................................................................................................................. 13 Cost of Fuel ................................................................................................................................. 13 Fuel Comparisions: ...................................................................................................................... 14 COMPUTATION OF TARIFF ........................................................................................................... 15 Method ................................................................................................................................... 15 FIXED COMPONENT ..................................................................................................................... 15 Variable Component ................................................................................................................ 15 Unscheduled Interchange Charges ........................................................................................... 15
Formula Used .......................................................................................................................... 16 Interest on working capital ...................................................................................................... 17 Depreciation Charges .................................................................................................................. 17 O&M charges........................................................................................................................... 17 Return on equity ...................................................................................................................... 18 Incentive for Thermal Generation ............................................................................................ 18 Tax........................................................................................................................................... 18 Fuel ......................................................................................................................................... 18 Discounting rate ...................................................................................................................... 18
HOW TO GET COMPETITIVE ADVANTAGE ?? ...................................................................... 19
Power Sector- Introduction

The power sector has registered significant progress since the process of planned development of the economy began in 1950. Hydro -power and coal based thermal power have been the main sources of generating electricity. Nuclear power development is at slower pace, which was introduced, in late sixties. After US-INDIA nuclear power treaty for civilian purpose, nuclear power generation has come to the fore. The concept of operating power systems on a regional basis crossing the political boundaries of states was introduced in the early sixties. In spite of the overall development that has taken place, the power supply industry has been under constant pressure to bridge the gap between supply and demand. The Power Sector has been receiving adequate priority ever since the process of planned development began in 1950. The Power Sector has been getting 18-20% of the total Public Sector outlay in initial plan periods. Remarkable growth and progress have led to extensive use of electricity in all the sectors of economy in the successive five years plans.
Power Sector - Role in ECONOMY

India is largely a power deficient country; with supply shortfall and peak energy demand shortfall about 6.2 % and 8.2 % India is largely a power deficient country, respectively. Though the generation capacity of the country has almost doubled in the last decade, it has not kept pace with the growth in demand. The capacity addition in the year 2009 was nearly about 8000 MW whereas an addition of 15% per year is required to achieve the 7-8% annual GDP growth rate set by the Govt. of India.
The transmission system planning in the country, in the past, had traditionally been linked to
generation projects as part of the evacuation system. Ability of the power system to safely withstand a contingency without generation rescheduling or load-shedding was the main criteria for planning the transmission system. The Ministry of Power, Government of India, is responsible for planning, implementation, control and monitoring of power generation, transmission and distribution; through its technical body Central Electricity Authority (CEA). Central utilities National Thermal Power Corporation (NTPC), National Hydroelectric Power Corporation (NHPC), Neyveli Lignite Corporation (NLC), Damodar Valley Corporation (DVC) own and operate power generating stations. Power Grid Corporation of India Limited (PGCIL), a central government public sector organisation, builds and operates transmission system all over the country. In the states, the State Electricity Boards (SEBs), own the majority of generation capacity in the country and also manage the power transmission and distribution systems. The Central Government has enacted a significant new legislation, called the Electricity Act, 2003 with the objective of making the power sector more competitive, self-sustaining and vibrant besides protection of consumer interests and ensuring power for all areas of the country. Electricity Act 2003 essentially seeks to provide a framework to privatize and decentralize sector completely. The central theme as envisaged in the Electricity Act a competition in the market by providing mandatory and
non-discriminatory transmission lines or distribution system or associated facilities with such line so that any licensee or consumer or a person engaged in generation. Central Electricity Regulatory Commission (CERC) has streamlined the procedure for seeking Open Access in Inter-State transmission. Open Access in transmission was introduced by the CERC in pursuance of the Electricity Act, 2003. The open access model allows the generators to el contract with distributors or large consumers without the need of an intermed the State Electricity Boards and vice versa, wherein a group of consumers ca (bulk consumers) and exercise their choice to purchase power either dim generation company or intermediaries such as traders or distribution company words under the open access regime, customers are free to buy power front their choice, even though the electric wires to their houses are owned by or company. The main merit of this model is that it provides a better platform which eventually helps bring down the cost of supply. Availability Tariff is primarily meant for long-term supply from generating stations on a contractual basis and is not directly applicable for transactions under open access and wheeling provisions in the Electricity Act, 2003. However, its third component (UI) has a great relevance. open access and wheeling generally involve two parties, one supplying a certain quantum of power to the other through the regional / state grid.
THERMAL COAL BASED GAS BASED OIL BASED HYDRO POWER NUCLEAR RENEWABLE POWER CAPACITY (MW) 86003 17221 1199 36877 4560 16492 162352 % OF TOTAL CAPACITY 52.993 11.500 0.007 22.700 2.800 10.000
POWER SUPPLY STRUCTURE
G Generation unit SLDC State Load discharge centre DECOMS - Electricity distribution companies
Structure of power supply industry In December 1950 about 63% of the installed capacity in the Utilities was in the private sector and about 37% was in the public sector. The Industrial Policy Resolution of 1956 envisaged the generation, transmission and distribution of power almost exclusively in the public sector. The Electricity (Supply) Act, 1948, envisaged creation of State Electricity Boards (SEBs) for planning and implementing the power development programs in their respective States. The Act also provided for creation of central generation companies for setting up and operating generating facilities in the Central Sector. The Central Electricity Authority constituted under the Act is responsible for power planning at the national level. GOI promulgated Electricity Regulatory Commission Act, 1998 for setting up of Independent Regulatory bodies both at the Central level and at the State level viz. The Central Electricity Regulatory Commission (CERC) and the State Electricity Regulatory Commission (SERCs) at the Central and the State levels respectively.
Further amendments in electricity Act were introduced in 2003. The provisions provided in the Electricity Act 2003 are as follows: Open access allowed in transmission: The transmission sector was opened up to private investment through the grant of a license by an appropriate authority. A captive generation unit can move power to the end-use destination (captive use) without the payment of any surcharge.
The planning, co-ordination and development of transmission systems at inter-state levels is the responsibility of the Central transmission utility (CTU), whereas intra-state transmission of electricity will be controlled by state transmission utilities (STU). The formation of a National Load Dispatch Centre (NLDC) at the national level for optimum scheduling and dispatch of electricity between Regional Load Dispatch Centres (RLDCs).
Establishment of RLDCs (they have already been set up, as specified in the Act). RLDCs have to monitor grid operations, monitor the quantity of electricity transmitted through the regional grid and exercise supervision and control of the inter-state transmission system.
The respective state governments have to establish state load dispatch centres (SLDCs), which will be responsible for optimum scheduling, dispatch of electricity and real time operations to ensure stability in respect of the intra-state transmission of electricity.
The transmission licensees have to provide non-discriminatory access to their transmission systems, on payment of transmission charges along with a cross-subsidy surcharge as specified by the CERC/SERC. NLDC, RLDC, SLDC, CTU, STU and other transmission licensees not to engage in trading of Electricity. Apart from these, some of the provisions for transmission included in the National Electricity Policy are as follows: The augmentation of transmission capacity, in view of the aggressive capacity expansion plans ingeneration. The requirement of additional transmission capacity to supplement the increase in generation capacity needs to be considered to avoid a mismatch between generation and transmission facilities.
Development of the national grid for providing adequate infrastructure for inter-state transmission of power and ensuring the optimum utilisation of generation capacity from the surplus to the deficit regions. The responsibility of network planning and development rests with CTU and STU (based on the National Electricity Plan) in coordination with all the concerned agencies specified in the Act. Network expansion has to be planned and implemented factoring in the capacity needs for open access, which is to be gradually implemented by states as per their stage-wise schedule. For a secure and reliable operation of the grid, adequate margins and redundancy levels in the transmission system should be created as per global standards and practices. A national transmission tariff framework needs to be implemented by CERC for transmission pricing. The tariff would be determined on the basis of distance, direction and quantum of flow. At present, the CERC has recommended the usage of the regional postage stamp method. A proper infrastructure network and appropriate planning are required if some other method has to be adopted.
Objectives
To provide 'Power on Demand by 2012'. To make the sector commercially sound and self-sustaining. To provide reliable and quality power at an economic price. To achieve environmentally sustainable power development. To promote general awareness to achieve consensus on the need for reforms.
Generation
Based on the projections of demand made in the 16th Electric Power Survey, additional generationcapacity of over 1,00,000 MW needs to be added to ensure 'Power on Demand by 2012'. This amountsto nearly doubling the existing capacity of about 1,00,000 MW.
Target 2012
The following sector wise capacity addition targets have been firmed up for aggregate capacity addition of 1,07,000 MW by 2012.
It is estimated that for building over 1,00,000 MW of additional power capacity and associated transmission & distribution infrastructure, nearly Rs. 8,00,000 crores of investments would be needed in the next decade. The problem of non-availability of escrow capacity with most State utilities has been holding up the financial closure of most private sector projects. In view of the current policy against giving counter guarantees and pending fructification of reforms measures, the Ministry has taken steps to set up alternate payment security mechanism for the investors as an interim resource mobilisation strategy. The mechanism has been evolved in consultation with leading financial institutions like IDBI, ICICI, SBI Caps etc. on the basis of a memorandum of agreement/ understanding to be signed with the reforming States wherein the States agree on milestone based package of reforms like restructuring of SEBs, setting up of SERCs, reduction in T&D losses, 100% metering, improvement in PLF, energy audit etc. The policy framework has also been liberalised to encourage domestic/Foreign Direct Investment in power sector. The measures taken in this regard include allowing Foreign Direct Investments in generation, transmission, distribution and power trading on the automatic route without any monetary ceiling.
Transmission and Distribution Key concerns

The Indian T&D system is characterised by exceptionally high losses, over 30 per cent, as compared to developed countries, where losses are around 10-15 per cent. Losses in retail distribution account for a significant proportion of the total losses in the Indian T&D system.
T&D losses
Transmission and distribution losses can be classified into two main categories:
Technical losses
The technical component of T&D losses has an inverse relationship with the voltage configuration of the T&D system. bulk power of high voltage (400, 220, and 132 kv), over long distances, is estimated to result in a loss of 4-5 per cent of the total energy transmitted, while distribution at low voltage levels is estimated to lead to a loss of 15-18 per cent of the total energy transmitted.
Commercial losses
Commercial losses occur due to non-metering, non-billing or pilferage of power. These losses can be largely attributed to faulty meters, reading errors, unmetered supply and unauthorised connections. As a result of inadequate metering arrangement, it is difficult to estimate the extent of the loss and attribute it to a specific reason. Reasons for high T & D losses: A weak and inadequate T&D system A large-scale rural electrification programme (due to low voltage distribution lines). Numerous transformation stages: This results in a high component of transformation losses. Improper load management Pilferage and theft of energy
Given the large distribution network, multiple transformation stages and large-scale rural electrification in India, the optimal level of T&D losses has been recommended at around 15 per cent. Lack of investment is one of the main reasons for the weak and inadequate T&D infrastructure in India. Ideally, investment in the T&D sector should match that in generation. However, in India, the emphasis has been on adding generation capacity and rural electrification and the average outlay for T&D in the Five Year Plans has been approximately 25-30 per cent of the total outlay for the power sector. In addition, the ratio of the lengths of low-tension (LT) and high-tension (HT) lines has increased significantly over the past three decades. As losses are inversely related to voltage, the higher share of flow-voltage lines results in higher T&D losses.
PRODUCTION COST: Supply Many projects have been planned but due to slow regulatory environment, the supply is far lesser than demand. Currently, India needs to double its generation capacity to meet the potential demand. The long-term average demand growth rate is 6% and is expected to grow at faster rate. Barriers to entry are high, as entering this business requires heavy investment initially. The other barriers are fuel linkages, payment guarantees from state governments that buy power, retail distribution licensed etc. Not very high as government controls tariff structure. However, this may change in future Bargaining power of retail customers is low, as power is in short supply. However government is a big buyer and payment by government can be erratic.
Demand Barriers to entry
Bargaining power of suppliers Bargaining power of customers
Competition Not high currently. The Electricity Act 2003 will encourage investments, thereby increasing competition.
PRODUCTION COST OF THIS INDUSTRY
COAL BASED
COST of production: - Rs. 2.50 to 3.50 per unit cost of generation.
OIL & GAS Based

HYDRO BASED
NUCLEAR BASED
COST of production: - Rs. 3.50 to 5.00 per unit cost of generation. COST SOURCES OF THE INDUSTRY Total Charge = Annual Fixed Charge
+ Annual Variable Charge
Annual Fixed Charge
Depreciation +ROE +Interest on loan + O & M expenses +Interest on Working capital
+ Cost of Secondary Fuel +Income tax Annual Variable Charge = Cost of Main Fuel
Sl no 1
Description Land & Site Development
% of project cost Project specific (0.5% - 1%)
2 3 4 5
Plant & Equipment Civil Works Taxes & Duties Erection, Testing & Commissioning
55% - 65% 7% - 8% 10% - 13% 4% - 5%
6 7 8 9 10
Preliminary & Pre operative Expenses Finance Charges Contingency IDC & Margin Money for Working Capital Total Capital Cost of the Project
2% - 3% 0.5% - 1% 2% - 4% 9% - 13% 4 to 5 Crore per MW
FACTORS INFLUENCING THE COST OF GENERATION

Let us analyze the factors which affect the cost of power generation.
Fuel
There are three major options for generating electricity: Thermal, hydroelectric and nuclear. Thermal power plants can be based either on coal, on natural gas (including liquefied natural gas)or on naphtha. Power plants can also be based on other hydrocarbon fuels like fuel oil and diesel but such plants smaller in size and are primarily used for captive power generation. The demand for power varies with the time of the day and the season. A part of the demand is always present (known as base-load), while the balance fluctuates with the time of the day (known as peaking demand). The choice of fuel for a power plant depends on the type of demand that the plant is expected to meet. In general, in order to minimize the variable costs, power plants with the lowest variable costs (fuel costs) should be employed to meet the base demand, while those with a higher variable cost should be employed to meet the peaking demand. Coal-based power plants have lower variable costs than those based on naphtha or natural gas. However, coalbased power plants have high capital costs which result in high fixed costs. In addition, these plants cannot vary their output with variation in demand. Hence, coal-based plants are largely used to meet base demand. This results in lower fixed costs per unit, due to higher PLF. Gas and naphtha-based plants have higher variable costs and are more flexible in terms of varying their output. Hence, these plants are better suited for meeting peak demand Hydroelectric plants have very low variable costs of generation and are the most flexible in terms of varying output. However, the total amount of energy that hydroelectric plants can produce is dependent on the rainfall. Hence, hydroelectric plants are used exclusively to meet peaking demand.
Nuclear power plants have the highest capital costs and the lowest variable (fuel) costs. Hence, these plants are ideal for meeting base-load demand.
Cost of Fuel
The delivered price of any fuel can vary significantly depending on the source of supply (imported or indigenous), and the distance of the plant from the source of supply. In India, coal is generally transported
from mines to power plants through the railways. However, the high cost of transportation results in a significant increase in per unit cost of coal. As a result, power plants located near coal mines (pit-head plants) are able to generate power at a fairly lower rate than plants that need to transport coal over long distances
Fuel Comparisions:
COMPUTATION OF TARIFF Method

The most common method of pricing power is a two-part tariff formula, where the tariff consists of a fixed component (also known as the capaci`ty charge) and a variable component. Further another component is taken during the computation of tariff known as unscheduled interchange charges. In India, under the twopart tariff policy, independent power producers (IPPs) are offered a guaranteed post-tax return of 14 per cent on equity, at a PLF of 80 per cent. In addition, there is a provision for additional return on equity as an incentive for generation above this normative level.
FIXED COMPONENT
The fixed component of the tariff is mainly dependent on the capital cost of the project. In addition, the terms of the Power Purchase Agreements (PPAs) regard O&M expenditure, rate of incentive (for an improvement in performance), financial structure of the project, and the security package for credit enhancement (which would have an impact on interest rates) as factors affecting the fixed component. The fixed component of the tariff ensures that the power producer is able to recover the fixed expenses and earn a return on investment, irrespective of the actual generation. Hence fixed charge comprises of : 1. Interest on long-term debt 2. Depreciation 3. O&M expenses (including insurance expenses) 4. Return on equity 5. Incentive return on equity 6. Interest on working capital 7. Taxes
Variable Component
The variable component of the tariff covers the variable cost of operation of the power plant and also comprises the primary and secondary fuel cost and other costs (if any) that are directly dependent on the level of generation. The tariffs vary across projects when variable costs are compared due to the differences in the fuel cost, transportation cost, and due to differences in the thermal efficiency. Hence, variable charges comprise of : 1. Cost of primary fuel 2. Cost of secondary fuel (if any)
Unscheduled Interchange Charges
Variation between actual generation or actual drawal and scheduled generation or scheduled drawal is accounted through UI charge. The UI for a generating station is equal to its actual generation minus scheduled generation and is calculated for each 15-minute time block. The UI rates are shown in table below
Formula Used
The payment due to the generation company by the buyer in any year is computed as follows: Total payment due = Fixed charges + variable charges + UI Assumptions for the calculations
Interest on Long Term Debt A debt-equity ratio of 2.33:1.00 has been assumed. This is also the norm mandated by the UMPP projects guidelines. This is the most common norm followed by Indian financial institutions for funding private sector power projects. Further, a break-up of the loan component into domestic debt and foreign debt has been assumed. Representative interest rates have been assumed for rupee and foreign currency debts. The repayment period is assumed to be 12 years after the commencement of commercial operations by the power project. The interest and the principal is assumed to be payable on a quarterly basis.
Interest on working capital

Working capital for a coal based/ lignite-fired generating station has been calculated on the following basis: Fuel inventory is assumed at one and half months for pit-head generating stations and 2 months for non-pit-head generating stations corresponding to target availability. O&M expenses are assumed for 1 month. Receivables are assumed at 2 months of fixed and variable charges for sale of electricity calculated on target availability. Maintenance spares at the rate of 1 per cent of the historical cost escalated at the rate of 6 per cent per annum from the date of commercial operation. Working capital has been assumed to be on a normative basis and the rate of interest applicable will be the short-term prime lending rate of the State Bank of India. A bank finance of 75 per cent of the gross working capital requirement has been assumed (a 25 per cent working capital margin has been assumed).
Depreciation Charges
Depreciation is assumed to be allowed overthefair life of theassetsat the rate notified by CERC. The life of the project has been assumed as 25 years. 90% of the capital employed is considered for depreciation. Land cost should not be considered for depreciation.
O&M charges
Normative operation and maintenance charges have been assumed as per CERC guidelines and appreciated at the rate of 4%. The O&M rates are shown in the table below.
Return on equity
The return on equity has been calculated on the original equity of the project, at the rate of 14 per cent per annum on a PLF of 80 per cent.
Incentive for Thermal Generation

The Target Availability (TA) has been specified by the Commission based on the performance that can be achieved by the utility which will determine the level of fixed charge recovery. The Commissions present orders lay down 80% availability level for full fixed cost recovery. In case of performance below this availability level, pro-rata reduction in recovery of fixed charges is provided. As regards the incentive, the provision is that it will be @ 50% of fixed charges in paise/kwh on actual generation beyond 77% PLF upto 90% PLF subject to a ceiling of 21.5% paise/kwh. Beyond 90%, the incentive rate is reduced to half. This rate has been assumed as per CERC guidelines.
Tax
Tax is treated as a component of fixed costs and the guaranteed return on equity is on a post-tax basis. A tax rate of 33 per cent is assumed for calculations.
Fuel
A PLF of 80 per cent is assumed for calculating fuel requirements. The calorific value, SHR and fuel prices have been suitably assumed, depending on the type of the fuel. No increase in the price of fuel has been assumed for the entire life of the project. This is because a rise in cost of fuel will be a pass through cost.
Discounting rate
In order to compare two projects, a levelised tariff over the life of the project is calculated, by discounting the tariffs over the life of the project. A discounting rate of 10.6 per cent has been assumed as mentioned by CERC for the period of October 2006 March 2007.
HOW TO GET COMPETITIVE ADVANTAGE ?? Unit Capacity Total number of units Project Schedule Plant Availability Calorific value of Fuel Fuel Cost & its escalation Heat Rate Auxiliary power Consumption Secondary Fuel Oil Consumption O&M Expenses and its escalation Parameters Increases Effect on Tariff (Cost of Supplying) Increases
Project Schedule
Plant Load Factor
Decreases
Calorific value of Fuel
Decreases
Fuel Cost
Increases
Fuel cost escalation @p.a
Increases
Heat Rate
Increases
Auxiliary power Consumption
Increases
Secondary Fuel Oil
Increases
Consumption O&M Expenses Increases
O&M escalation@ p.a
Increases

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Business Economics Assignment Group 4 Section A