Growth needs more electricity

by Akshay Jaitly and Ajay Shah, Business Standard, 18 September 2023

The Indian electricity sector is poised at a special moment. Despite what policy makers in India might have desired, thermal electricity capacity has stalled. CEA data shows thermal capacity rose from 100 GW in 2005 to 300 GW in 2018, and essentially stalled there. The CMIE Capex projects completion data similarly shows a stall from 2019 onwards.

The infrastructure financing community in Bombay knows that it is no longer possible to obtain financial closure for a thermal power plant. We are now in a globally integrated financial system, and the ESG revolution has closed off pathways to finance for new carbon-intensive electricity generation, worldwide. Other than the possibility of something being built with pure government money, there will now be no new fossil fuel electricity generation plant in India.

We are, then, at a turning point where essentially all capacity growth must come from renewables. The electricity sector is, however, designed for the old world, of thermal domination. When additions of thermal capacity go to zero, this poses problems.

Capacity addition in solar and wind is taking place. The CMIE Capex data shows identifiable project data for completions at a rate from 2015 to 2023 of about 4 GW/yr for solar and 2 GW/yr a year for wind. This raises concerns about the extent to which the electricity sector is on a trajectory consistent with strong economic growth. This perspective helps us understand some of the difficulties seen at the peak demand in summer.

Going under the hood, there is much variation across the states. Some states, like Gujarat and Rajasthan, have fared well on adding solar capacity. Other important consuming states like Karnataka, Maharashtra and Tamil Nadu have not.

Policy makers in each Indian state need to think about this question: Is the growth of renewables consistent with the possibility of high economic growth? This is because there will be no important new thermal assets, and all new generation capacity will only be renewables. It is also because exporting industries will increasingly demand that their comprehensive supply chain must switch to renewables in order to fare better on carbon border taxes in export destinations.

One choke point is the engineering transformation of the grid that is required for decarbonisation. Renewables are a problem for the traditional conception of the electricity grid and market. They have been grudgingly accepted to a certain extent, but in many places, grid operators frankly do not want more renewables. Economic policy thinkers in each Indian state need to establish the finite project of the transformation of distribution, transmission and market structure that is required to cross this hump. The present wary crouch, standing still in the old structure, creates conditions for poor private investment in renewables.

The second choke point is the level of trust in the eyes of private persons. In the best of times, investment is a leap of faith. A generation project requires a trusted and predictable environment for the coming 20 years. The Indian electricity environment suffers from a significant extent of government failure including non-payment of bills, reneging on contracts and interference in private professional transactions (i.e. restrictions on "open access"). The Indian private sector is comfortable building renewables capacity in some states, like Gujarat and Rajasthan, but is wary of most other states.

In many Indian states, electricity policy does not bubble to attention; there are other and more fundamental choke points that need to be addressed. But in many states, there is a flourishing private market economy, and economic success is within striking distance. Strategic thinking in economic policy in these states needs to ask: will this aspiration for economic growth hit a choke point on account of availability of renewables (either because the exporting supply chain wants renewables or because no new fossil fuel capacity will now arise)?

For many politicians, the mood has been to kick the can along, to perpetuate the status quo with subsidies that are financed using deficits and debt (partly on the budget and partly in PSUs). The electricity sector is then a fiscal problem, because these same resources have other, and superior, applications in public finance.

However, kicking the can along has a deeper problem. When the fundamentals of distribution and electricity market structure are not fixed, the grid is not ready for decarbonisation. A large chunk of policy work, and financial investment, is required to make this one-time transition. The old world of renewables investment -- where grid operators grudgingly gave renewables the top priority even when it did not make economic sense for them -- is increasingly running out of steam. Going further with renewables now calls for deeper changes in distribution and market structure. This will require creative solutions to distribution, such as shifting to private distribution companies for each urban region.

And then, comes the question of reassuring the private sector. Market mechanisms need to be devised so that private-private contracts increasingly arise, so that a private producer experiences the superior contract performance of a private counterpart. Private generators want to see a Commercial/Industrial buyer or a private distribution company as the buyer. Long term PPAs are counter-productive: what is required is a market mechanism with time-of-day pricing which will create incentives for storage and demand side responses.

Distribution companies are monopolies and require regulation to curtail monopoly pricing. This will call for the construction of regulatory capacity. When regulatory capacity is weak, the private sector will demand a higher risk premium for establishing (say) a Bangalore electricity distribution company.

For many states of India, electricity policy is thus bubbling up into a major question in the overall economic strategy of the state. The status quo involves a certain chance of electricity becoming a choke point for the possibility of high economic growth. Each state needs to look at this new situation, and devise an electricity reform that addresses their local requirements and local political economy.

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