Group captive plants can solve industrial units' power woes

One out of every five individuals in the world without access to electricity resides in India. Despite low electricity tariffs, India’s per capita electricity consumption, at 940 kilowatt-hour, is one of the lowest in the world. Corresponding figures for China is 4,000 kWh and that for developed countries, 15,000 kWh!

However, even amongst those who have electricity access, the quality of supply is dismal, leading to enormous efficiency losses. A study in Karnataka noted that power outages in agricultural sector led up to 3.6% loss in State Domestic Product (SDP) and in industrial sector, up to 0.17% of SDP.

One of the most severely affected sectors is the small and medium sized industrial enterprises (SMEs). The SMEs have to close their shop floors during power outages, power holidays and load shedding. This imposes crippling efficiency losses, often turning them into ‘incipient sick units.’ With a significant size of Indian manufacturing sector hinging upon SMEs, the problem of electricity shortage severely undermines development objectives.

A recent survey conducted by the FICCI shows that over 20% of firms suffer from more than 30 hours of power shortage per week and more than a third of firms suffered  more than 20% production loss (which went up to 50% for power-dependent industries). Studies have shown firms are willing to pay more for better supply or set up their own backyard captive power plants (CPPs).

Interestingly, the Electricity Act 2003, has provisions for incentivising private generation of electricity in the form of captive power plants (CPPs). The idea is that the industrial sector which bears high costs of cross-subsidising power for other segments like agriculture, and yet faces shortages can exit the grid and set up their own CPPs. Indeed, some big firms have opted for CPPs causing their perceived proliferation. But the enormous investments required and firm-level constraints make it very difficult for the SMEs to do so.

With Vinish Kathuria of IIT Bombay, one of us conducted a primary survey (published in Energy Policy) and found these constraints to be indeed real. Following up on the insights from the study, we propose that SME clusters can create a group CPP (G-CPP), where each industrial (SME) cluster can co-generate electricity and overcome the individual firm-level constraints to set up a CPP. Despite enthusiasm among firm owners interviewed by us, such a mechanism does not exist, largely because of collective action problems.

However, this can be solved through adequate institutional frameworks. With support from governmental agencies, or through private entrepreneurship, one can develop a Special Purpose Vehicle (SPV), formed out of the industrial cluster itself and co-financed to build a G-CPP and engage in power generation for that cluster.

In India, SPVs could be incorporated as a company, trust, mutual fund, society or a firm and then continue to follow its parent laws (Companies Act, Trust Act, Partnership Act etc). By its construction, an SPV is form-ed out of membership (shareholding if it is a company) of several legal entities (firms), which acts independently of the member firms. It can acquire, hold or dispose off assets. Also, it is bankruptcy proof, tax neutral and offers possibility of being transferable.

The SPV can attract more diverse financing options since its financial health is decoupled from that of the member. The financial and governance insulation of the SPV from sponsoring investors ensures a credible commitment to the creditors. Also, the SPV can have members as shareholders eligible for dividends.

Selling electricity
An industrial SME cluster can construct an SPV vested with the task of generating and selling electricity to the members through G-CPP model. Surplus power could be sold to the state (enabling provisions exist in the Act) and the SPV makes a profit.

According to United Nations Industrial Development Organisation (Unido), India has more than 350 SME clusters. This significant number shows the gravity of the problem, and impact of the proposal.

Implementation of G-CPP should be based on an energy-dependency scale for these clusters (Energy Policy study mentioned earlier has developed such a scale), and initial engagements should be made with those clusters which are most sensitive to electricity supply. This will reduce expected risks, and increase the success rate of a possible pilot, setting a precedent for more projects in future.

We made some initial calculations based on a primary survey in IDA Bollaram, an SME cluster in Medak district of Telangana. Results suggest that such a plan could be very cost effective. We know the amount of electricity consumed by each firm, and the rate at which they are charged. The electricity charge per unit and power requirement of the firm gave us power cost to each firm for the approximate time power is supplied from the grid. For the remaining time we used the unit cost of diesel generators.

Our estimates suggest that a coal based G-CPP reaches its breakeven point in an average of about 1.5 years. Usage of cleaner fuel like natural gas or renewable sources like solar or wind, with a little higher fixed cost could offer cheaper electricity. Additionally, savings in terms of carbon credits for non-coal fuels will be remarkable.

The SMEs are the backbone of Indian economy, employing 40% of workforce, contributing to 45% of manufacturing output and 40% of exports. Yet, they contribute to a mere 17% of the GDP due to poor productivity. There’s little that the ‘Make in India’ campaign can achieve without being attentive to SMEs’ woes, of which electricity is primary. G-CPPs could provide a practical way out. 

(Goyal teaches at OP Jindal Global University, Sonepat, Haryana and Ghosh at Department of Economics, SLU Uppsala, Sweden. The article is an abridged version of the authors’ submission for The World Bank-Wharton School ‘Ideas for Action’ competition on development finance. Their submission was one of those selected in the top 5% from across 130 countries)