Industry Risk Score : Power Distribution

Executive Summary

Power distribution sector is the weakest link in the entirepower value chain.DespiteIndia converging towards a power surplus situation, intermittent power outage still haunts the country. This clearly indicates issues in the power transmission and distribution infrastructure.

Large-scale capacity additions on the back of overestimation of demand and inefficient power procurement planning,have led to idle capacity for power generation companies and high fixed cost payments by distribution companies (discoms) to the generators despite not using the power. Also, since power demand is seasonal, discoms have surplus power some times and deficit at other times. To meet power requirements during deficit periods, ailing discoms resort to load shedding. Shorter duration power procurement agreements (PPAs) and increased access to short-term power markets may benefit discoms interms of lower rates, helpbridge the demand-supply gap and also help avoidpenal obligations to generators in relation to contracted capacity,during surplus power situations. Further, adoption of scientific forecasting for estimating demand while signing PPAs should reducefixed cost charges on unused power under PPAs, can supplementpower demand estimates.

Competition is currently low with state-owned utilities dominating the sector. However, competition is necessary to eradicate legacy issues and structural inefficiencies in the sector. Private sector participation is likely to increase with the content and carriage separation strategy being encouraged by the government. However, recent experience in Uttar Pradesh, where the State Power Corporation employees opposed the privatisation of power distribution in 5 cities, demonstrates the practical difficulties in privatising power distribution in the country. Short-term bulk power procurement markets are gaining traction as an important means for meeting short-term variable power requirements, thus complementing the current widely used long-term markets for procurement.Acuitéforesees strong growth potential in the power exchanges.
Legacy issues related to high aggregate technical and commercial (AT&C) losses, inefficient power procurement planning and power thefts are the key factors weighing down the financial profile of discoms. In addition, inability to efficiently recover subsidies from state governments and pass on input price fluctuations in retail tariffs, further exacerbates the financial stress on the discoms. Implementation of advanced metering infrastructureis in progress, but at a slow pace. Acuité does not see these risks to abate in the shortterm, given the sluggish reform implementation and political bottlenecks.

The objective of the governmentreforms is to reduce thefinancial pressure on discoms by reducing cross-subsidies and commercial losses and shoring up their abilityto provide affordable, reliable and uninterrupted electricity access to customers.However, reform implementation is likely to be time bound and take another two to three years to materialise.

Key Risks& Attributes

  • Inefficient power procurement planning which currently focuses largely on power availability and peak power demand
  • Power pilferage magnifying losses
  • High level of backed down power due to un-requisitioned power
  • Increase in private sector participation due to policy action towards segregation of content and carriage businesses
  • Build-up of subsidy dues owing to inadequate or untimely subsidy payments from state governments
  • Short-term marketsare developing at a fast pace
  • High regulatory oversight, but developments are favourable
  • High capital expenditure plans for reducing losses, installing meters and better demand estimation tools

Demand & Supply Scenario


Technically, the overall power demand-supply gap in India might have dropped to historical lows,but several pockets of the country stillface power outages. The power surplus/deficit calculation is an outright differential in the total power requirement raised by discoms and the total power supplied. Paradoxically, this calculationmasks the seasonal power outages and latent demand for power in un-electrified rural areas of the country.

As per the CEA data, all India energy deficit and peak deficit wereat a meagre-0.7% and -2.1%, respectively, in FY 2017-18, with nil deficit in some regions. The deficit numbers were in similar range during FY 2016-17 as well. However, during April 2016, 46% of the cities/locations (including urban and megacities) experienced power outages of over 15 hours a day,  andaround25%locations experienced 30 interruptions (each greater than 15 minutes)in a day and close to 20% experienced average daily power outage of 30 or more minutes during the peak evening hours.As per the latest estimates of CEA, the all India energy and peak power demand supply position willturn positive at 4.6% and 2.5%, respectively, inFY 2018-19, reflecting a higher energy surplus position. However, this may not eliminate intermittent shortages.For example, discoms in Andhra Pradesh, Telangana, Haryana, Punjab and Rajasthan have a net surplus, butthese states still face power shortages at specific times / days / months. Discoms resort to load shedding during deficit times and at different locations due to lack of finances to shore up the capacity and/or laxityin the usage of sophisticated stopgap arrangements for procuring power.

Not just routine power outages, but rapid increase inun-requisitioned power supply (backing down) isalso adding tothe financial woesof discoms.Due to the nature of take-or-pay power procurement contracts, discoms have to bear fixed cost charges on the backed down power, despite not utilising that power. Moreover, since backing down takes place on a merit order basis (i.e., giving priority to power generated at lower variable cost to meet the demand) of electricity generated, discoms end up paying higher fixed cost charges on the contracted but idle capacity, thereby also impacting customer tariffs. Backing down also leads to a negative cascading impact on the other segments of the power sector, particularly on the generation and allied sectors (impacting stock pile or payment cycle).Backed down power for Rajasthan, Punjab, Maharashtra, Madhya Pradesh and Gujarat stood in the range of 15% to 30% of the total contracted capacity during FY 2015-16, resulting in fixed cost payment of 16% to 36% of the total fixed cost payment to generators for these sates. This is likely to continue on the back of ambitious capacity expansion plans in the generation sector specifically in renewable energy (almost two-folds by 2022) against power demand which is not expected to catch up with supply.

This situation is likely to be further exacerbated by the fast growing and cheaper renewable energy segment as it gets priority in the merit order system, thus increasing the backing down of the contracted thermal power, which is expensive. In FY 2018-19, the CEA anticipates a surplus of 1.9%, 14.8% and 22.9% in the western, northern and north-eastern regions, respectively, thus reflecting higher fixed cost incidence on discoms. Since almost three-quarters of the total overheads of discoms relate to power procurement, these contracts bear a significant impact on net cash flow from the operations of discoms.

Various alternative mechanismsare being explored to deal with risks related to backing down events. Some such mechanisms are sale of surplus power in the short-term markets, exporting power to other discoms which are facing power deficit, levying extra surcharge on customers migrating to open accessor captive options to compensate the discoms, and better tools for demand forecasting. However, these mechanisms are difficult to implement and cannot be utilised as standard solutions to the problem faced by discoms.

Discoms are running under losses due to below-cost sale or sale at free or subsidized rates to certain sectors such as agriculture and rural areas, making financial viability of discoms questionable. They also have obligatory long-term power procurement contracts, which comprise more than 75% of the total cost and are expensive, persistently low operational efficiency due to high aggregate AT&C losses, pilferage and uncompetitive tariff structures.

Acuitéviews the demand and supply risk to be high, despite the net surplus power position of discoms. Large-scale capacity additions on the back of overestimation of demand and inefficient power procurement planning have led to idle capacity and high fixed cost payments by discoms. The risk is further accentuated by their weak financial health.

Nature & Extent of Competition


The sector is largely vertically integrated with distribution licensees performing a unified distribution function that includes both owning of wires as well as retail power supply. Competition is low with state-owned utilities largely dominating the sector.Private players can enter only through multiple licences. Five states­­– Maharashtra, Bihar, Odisha, Uttar Pradesh and Rajasthan – have private players operating through distribution franchise models.Pure play privatesector models in distribution have shown only limited success in metro cities such as Mumbai, Delhi and Kolkata.

Open accessis also allowed on grids directly for certain consumers (with over 1MW usage), generally industrial consumers. While this is a cheaper source and allows for more competition, additional charges levied on the consumers havedampened the use of this facility.

Competitiveness and profitability are expected to improve through the short-term procurement markets (typically less than a year and used for addressing peak load deficit or seasonal deficits)through power exchanges (Indian Energy Exchange Ltd and Power Exchange of India Ltd), or bilateral contracts between inter-state trading licensees or discoms. However, short-term markets are still in the nascent stage, accounting for just about 10% of the total power procured in 2017 and exchanges accounting for slightly over a quarter of the total short-term markets.The short-term markets have gained traction only in the last five years, reflecting rise in transaction volumes, particularly in the power exchange market. The short-term markets, particularly the power exchange platform,have potential to grow, particularly interms of volumes, given lower prices and theirability to meet short-term gaps.

The amendment to the Electricity Act, 2003, is likely to transform the vertically integrated structure of distribution sector to a multi-buyer and multi-seller model with a clear-cut separation of content (retail supply) and carriage (wires) functions and encouraging the participation of private players in the supply business.

Acuitébelieves competition risk in the sector to bemoderatein the nearterm.The reforms introduced in the sector should take another two to three years to materialize poststructural anomalies (such as high AT&C losses, power pilferage, and reduction in cross subsidy)are cleared. Private sector participation is likely to increase with focus on the content and carriage separation strategy. Short-term markets may increasingly becoming competent.

Input Related Risk


Inefficient power demand estimation and high power purchase costs are the key input related risks for the power distribution sector. Over three-quarters of the cost of discoms comprise power procurement related cost, which, in turn, is used to determine the tariff. In the last 20 years, it has been observed that the actual power demand has most of the times hasgreatly deviated from the estimated demand on average. In addition, factors such as seasonality, magnitude of latent demand from unelectrified segments and the dynamic nature of the generation sector in Indiawere inefficiently factored while forecasting.
AT&C losses stand at ~22% at Indian discoms, significantly worse compared withthe global average of ~9%. Power pilferage leads to illegal and unbilled power consumption, substantially increasing AT&C losses; Uttar Pradesh, Rajasthan and Jharkhand are the major laggards. To tackle this problem, discoms in various regions have started installing smart metering techniques. However, widespread usage of these meters is yet to pick up. Some towns in Madhya Pradesh, Rajasthan and Maharashtra have started fitting smart boxes to the electricity feeder, which is equipped with a mobile SIM card to remotely monitor the activity of individual boxes. While this technique will not completely eradicate the problem of theft, it is likely to mitigate the concern to some extent.


High dependence on fuel prices and network constraints during peak hours result in volatility in electricity prices, particularly traded on exchanges or bilateral markets. However, this pricing risk is being managed through hedging of spot prices, which can in turn be traded. Additionally, discoms have the leeway to manage risks related to input price fluctuations through FAC/FCA/FPPCA adjustments,wherebyfluctuations in input prices can be passed on to consumers through retail tariff adjustments. Tariff fixation varies from state to state and is determined by the respective state electricity regulatory commission (SERC). Most of the times, these adjustments made after with a lag, thereby increasing the accumulation of outstanding liabilities and carrying cost. Thus, the absence of timely adjustments in the tariff structure increases stress on working capital of discoms.

Acuitéviews input related risk as high due to high transmission and distributionlosses, inefficient power procurement and power thefts.Upgradation of metering infrastructure is likely to yield results over a period of time. Therefore,immediate respite from these riskscannot be anticipated in the shortterm.   

Regulatory Risk


The sector is highly regulated by government agencies. The state electricity regulatory commission (SERC) is the main regulatory authority for distribution licensees. It regulates the tariff determination criteria by ensuring sufficient cost coverage of the discom, provided it meets other performance standards. The key risks emanate from the fact that the SERC may enforce stricter performance criteria for the discom or may even forbid the coverage of certain cost components to be factored during tariff determination.

Under the provisions of the Electricity Act, 2003, discom licensees are required to submit application for true-up of expenses, review and aggregate revenue requirement and expected revenue from charges (ARR and ERC) and tariff petitions in case of tariff revision. The SERC may or may not allow tariff revisions depending on its satisfaction over the rationale in the tariff petition filed by the licensees. Since the sector is highly regulated by government agencies, political interference could result in manipulation of tariff hikes.

Under the amendment to the Electricity Act, 2003, the government might penalise discoms for gratuitous load shedding and denying power to legitimate applicants, going forward. The new tariff policy is likely to cap cross-subsidy at 20% and further, discoms would not be allowed to pass more than 15% AT&C losses arising from theft, to consumers. This will translate into an overall reduction in the tariffs and constrain margins.

Subsidy support is provided by state governments to discoms in case of certain category of consumers, increasing revenue dependence on the state governments. AT&C losses can inflate if subsidy and other such state dues are not released in time. Direct subsidy transfers to consumers may improve revenues of discoms. Besides, if the policy in relation to segregation of content and carriage businesses, is enforced, the sector is likely to become increasingly competitive.

Acuité views regulatory risk in the distribution sector to be high. The sector is on the path of deregulation,but various amendments are still pending.Enforcement of these reforms should streamline legacy issues in the sector in the medium to long term.

Technology Risk


Technology upgradation or adoption of innovative tools in the distribution sector should improve efficiency gains of discoms.Tools include dynamic power demand forecasting tools, smart metering or GPS tracked boxes in the electricity feeder,which could also help monitor meter tampering, power theft and non-payment of electricity bills, thereby aiding AT&C losses reduction. While the replacement cost is not extremely high for such meters, the progress of installation of such tools has been slow.

Acuitéviews technology risk to be low to medium in the sector. However, technology upgradation has been slow and needs to be accelerated to improve efficiency.

IRS Definitions

Acuité Industry Risk Scores are assigned on a six-point scale, with 1 indicating ‘High Risk’ and 6 indicating ‘Highest Safety’. The intermediate scores are defined in the table below:

Industry Risk Score Risk classification of the Industry
ACUITE IRS 1 Highly Unfavourable
ACUITE IRS 2 Unfavourable
ACUITE IRS 3 Neutral
ACUITE IRS 4 Marginally Favourable
ACUITE IRS 5 Favourable
ACUITE IRS 6 Highly Favourable

Data Sources & Credits

  • Confederation of Indian Industry
  • Ministry of Power
  • Power Grid Corporation of India Limited




Acuité IRS should not be treated as a recommendation or opinion that is intended to substitute for a financial adviser's or investor's independent assessment of whether to buy, sell or hold any security of any entity forming part of the industry. Acuité IRS is based on the publicly available data and information and obtained from sources we consider reliable. Although reasonable care has been taken to ensure that the data and information is true, Acuité, in particular, makes no representation or warranty, expressed or implied with respect to the adequacy, accuracy or completeness of the information relied upon. Acuité is not responsible for any errors or omissions and especially states that it has no financial liability whatsoever for any direct, indirect or consequential loss of any kind arising from the use of Acuité IRS.

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