PLENARY SESSION IV: FINANCING OPTIONS

INDIA POWER SECTOR: CHALLENGES & INVESTMENT OPPORTUNITIES

New Delhi

May 12, 2006

Salman Zaheer

Lead Energy Specialist

The World Bank

2

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

3

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)

4

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

5

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

6

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 Commercialization Private participation

Competition Rural services

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

7

India‟s carbon emissions

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

156

251

337

453

0

50

100

150

200

250

300

350

400

450

500

1990 2000 2010 2020

Millio

n m

etr

ic t

on

s o

f c

arb

on

Source: EIA International Energy Outlook 2003 (base case)

•The power sector accounts for

about 60% of carbon emissions

•Projected emissions rise

amounts to 7% of global

increment

8

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

$2,300 Bn

$1,900 Bn

High Investment Demand

Scenario (3%)

Low Investment

Demand Scenario (2%)

Historic Future

Private Capital Mobilized in Power Sector

Gap covered by public financing,

self - financing, donor funding,

and rationing.

To

tal

Pow

er I

nv

estm

ent

($B

illi

on

)

Cumulative

Sum ($Bn)

Source: : World Bank, IEA, Deloitte Touche

Tohmatsu Emerging Markets Group

Financing required for the Power Sector in Emerging Markets 1990 - 2020

India’s vs Global investment requirements - a large Growing Gap between demand and supply?

9

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 India‟s 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

10

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

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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.

…responds to consumer & Gov’t concerns; addresses investor priorities…

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12

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”

15

What 50 global investors have reported on why

investments succeeded or failed…

13

19

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?

How Satisfied are Investors? – A Country Assessment

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What conditions are important?

9 2

Legal Protection of Investors' Rights

Minor

2.98

2.91

2.83

2.83

2.68

2.66

2.49

2.43

2.00

3.57

3.11

3.11

Major Critical

“Deal-breaker”

63%

1 Legal Protection of Investors

36%

2

Consumer Payment Discipline

40%

5

Gov’t/Multilateral Guarantee

13% 7

Government Efficiency

15% 3

Judiciary's Independence

19% 4

Clear Rules for Exit

19%

6

Investment Grade Debt Rating

8%

9

Transition to Competitive Market

10%

8

Corruption Index Ranking

4%

10

Domestic Borrowing

4%

11

Competitive Selection

13%

12

Possibility of Vertical Integration

Rated

“Dealbreaker”

Relative

Rank

15

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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1. ABB Equity Ventures

2. AEP

3. AES Corp

4. Alliant Energy International

5. Alsons Consolidated

Resources

6. Amata Power

7. Banpu Public Co. Ltd.

8. BG Group

9. BP Global Power

10. CHI Energy (Energia

Global)

11. Chilectra

12. Cinergy Global Resources

13. CLP Power International

14. CMS Energy Corporation

15. Cogentrix Energy

16. Commonwealth

Development Corp.

17. Covanta Energy

18. Delma Power

19. Duke Energy

20. Dynegy

21. E.ON Energie

22. 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. Mirant

45. Mitsui & Co.

46. NRG Energy

47. Panda Energy

48. PPL Global

49. PSEG Global

50. Reliant Energy

51. Rolls-Royce Power

Ventures

52. Saur International

53. Scudder Latin America

Fund

54. Sempra Energy

55. Siemens Power

Ventures

56. Sithe Energies

57. Statkraft International

58. Steag AG

59. Tomen Power

60. Tractebel

61. TransAlta

62. TXU Corp

63. Union Energy

64. Union Fenosa

65. Wartsila NSD

International Power Investors – Firms Targeted

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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

18

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 publicly-owned distribution utilities, open access, etc.

Improve regulatory effectiveness in infrastructure services

19

World Bank‟s Assistance Program…(2)

Current portfolio consists of the following operations:

Project Loan Amt Balance Closing Date

Powergrid II $450 m $ 60.6 m June 2006

Powergrid III $400 m $400.0 m July 2011

Rajasthan Power $178 m $ 38.3 m June 2006

Renewable Energy II $112 m $ 45.1 m 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

20

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

21

World Bank Group risk mitigation guarantees

- to leverage private investment

IFC MIGA IBRD/IDA

IFC Guarantees (partial

credit structures usually for

local financing)

Interest Rate and Currency

swaps

Political Risk Insurance

expropriation

transfer restriction

breach of contract

war & civil disturbances

Guarantees

partial risk

partial credit

22

IBRD Loans - Lending Terms (As per currently applicable waivers to Indian Portfolio)

LIBOR-based, Variable spread loan Interest

USD loans Yen loans

6 month LIBOR 5.03% 0.15%

Spread over LIBOR 0.18% 0.18%

Commitment Fee 0.07% 0.07%

Front-end Fee 0.04% 0.04%

Total World Bank Interest Rate 5.32% 0.44%

+ currency exchange rate impact

– deemed export/import duty exemption*

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

Principal Moratorium 5 years 5 years

Repayment period (incl. moratorium) 20 years 20 years

23

19

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!

In closing….