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Setting up power plants in a hurry leads to higher costs.
The glitter in the India story has notably diminished because of electricity shortage across the country. With a wide gap between demand and supply, many States are in the grip of a severe power crisis.
A metropolitan city like Chennai has scheduled power cuts for two hours a day coupled with monthly day-long cuts, euphemistically termed, "maintenance work. As for the power situation in interior areas, the less said the better. Cities outside the State capital have prolonged cuts, affecting day-to-day life, industrial production and other economic activities.
Why has the situation come to such a pass? The delay in augmenting capacity to keep pace with demand seems to be a major reason. With the Government unable to meet the entire demand for new capacity creation, the private sector is being increasingly called upon to add to generation capacity. For example, the Twelfth Five Year Plan envisages a planned capacity addition of about 76,000 MW, of which 56 per cent is expected to come up in the private sector.
Despite the reliance on the private sector, there have been consistent delays in bringing new capacity to the grid. However, the current crunch in power capacity has predictably resulted in a knee-jerk reaction which is to bring in capacity as quickly as possible to the power network.
Power plants are long term assets, and investments need to be cost-competitive in the long term. In the rush to create capacity quickly, are we tending to be short-sighted? Can the bungling in timely planned capacity creation be remedied with accelerated addition to capacity? Or would it tie us in knots? The findings of a research study done at IIT Madras provide thought-provoking insights.
First, there is a negative relationship between cost per capacity and the estimated time taken to commission the project. Cost of power can be broadly divided into two categories: cost of capacity creation (plant construction) and operating costs (running costs) of the power plant. The proportion of capacity creation costs and running costs differs on the type of power generation and the scale of operations.
However, capacity creation costs are incurred upfront, and are recovered through the tariffs charged on the power generated by the plant. All things being equal, high costs incurred in capacity creation would result in high cost of power. This will impact the competitiveness of the overall economy.
The graph presents the trend line using data from 113 private power projects, after accounting for the type of generation and scale of operations. It can be clearly seen that shorter commissioning time is strongly associated with higher cost. Given the enduring impact of such decisions, long-term, well-planned capacity additions are preferable to hurried actions that lead to quick, but sub-optimal results.
Second, better governance and monitoring at the project level have a clear impact on capacity costs. How did we identify projects that were better governed? In recent years, private equity (PE) investors have shown substantial interest in infrastructure. Given the active role played by them in monitoring their project investments, we considered projects with PE investments as ones with a higher degree of active external monitoring. Our analysis yields compelling evidence on the relevance of PE investors.
We studied the unit capacity costs for projects with and without PE investment. Since unit project costs can significantly vary with capacity, type of power generation, and location of the plant, the mean unit capacity costs were calculated after matching projects on these three dimensions. Projects with PE investment have significantly lower average capacity costs ($1.09 million/ MW) compared to projects that do not have PE investment ($1.91 million/ MW).
Third, we found that active monitoring at the project level also affects the time taken to commission the project. It was found that the average time taken to complete the project was higher for projects with PE investments.
We analysed expected dates of commissioning from 59 projects, that included 24 projects with PE investment. The results indicated that the average expected time for commissioning was higher for projects with PE investment (2.83 years) as compared to those that did not have PE investment (2.17 years). To a certain extent, this increase in time taken can be attributed to better diligence and adherence to good governance practices that are demanded by external PE investors.
NO QUICK FIXES
Finally, it can be said that planned capacity additions to meet the demand growth would be help us generate power competitively in the long term. While quick-fix capacity creation solutions can alleviate the short-term power shortage, it would have a negative effect on long-term competitiveness.
Active project level monitoring has a strong positive effect. Projects with PE investment have lower average unit capacity costs as compared to projects that do not. Of course, there are short-term costs to such active monitoring, which is reflected in the higher expected time taken to commission for projects with PE investment. However, it can be said that the long-term benefits of lower capacity costs would outweigh the increased time taken for commissioning.
Rajan and Behera are Associate Professor and Research Associate, respectively, in the Department of Management Studies, IIT Madras.
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