Unbundling trouble

The World Bank's scheme for unbundling Orissa's power sector has created more problems than it has solved and cannot serve as a model for restructuring the electricity sector elsewhere in the country.

EIGHTEEN months into World Bank-administered shock therapy for Orissa's electricity sector, the Grid Corporation of Orissa Limited (GRIDCO), the unbundled transmission and distribution company, has notched up a loss of over Rs.250 crores and is headed for financial ruin. It had a clean balance sheet as on April 1, 1996. A review of the unbundling process is particularly necessary at the present time because Haryana, Andhra Pradesh, Gujarat and Rajasthan, among other States, are embarking on similar exercises, and the Orissa experiment is being held up as a model.

The restructuring exercise has its origins in a $350-million World Bank power sector loan negotiated by the Government of Orissa and counter-guaranteed by the Government of India. The loan came with stringent conditions. These included splitting up of the Orissa State Electricity Board (OSEB) into units handling generation, transmission and distribution. Each of them was to undergo a process of corporatisation, commercialisation and eventual privatisation.

The Orissa Electricity Reform Act took effect on April 1, 1996. Under this Act, the OSEB was divided into the Orissa Hydro Power Corporation (OHPC) and GRIDCO. The OHPC inherited the assets and liabilities of the hydel generation units of the erstwhile OSEB, while GRIDCO and the transmission enterprise inherited the transmission and distribution networks along with their liabilities. GRIDCO was initially to handle distribution functions as well until separate distribution companies were set up.

The Orissa Power Generation Corporation (OPGC), which was already independent of the OSEB, was to build and operate the two state sector thermal power projects - Ib Valley Phases I and II. Future thermal generation projects were to be entrusted with independent power producers (IPPs). An autonomous three-member regulatory commission was established with a mandate to issue licences, set tariffs, aid and advise GRIDCO and plan for future power requirements. No budgetary support was envisaged for any of the enterprises except the regulatory body, whose expenses were to be charged to the State fund for the time being. However, to enable the enterprises to start on a clean slate, all losses were written off and their assets revalued and liabilities readjusted.

INASMUCH as the unstated rationale for the unbundling exercise was to isolate the problem areas - transmission, with its high technical losses, and distribution, with high technical and commercial losses - from the profitable activities of the erstwhile Board and focus on tackling the problem areas, the exercise can be said to have achieved its objective. However, the very methodology adopted for this isolation exercise appears to have left little leeway for GRIDCO to tackle the problems it is faced with, and this threatens its very viability.

The methodology in question, germane to the determination of power tariffs in the State, centres on the revaluation of OSEB assets transferred to GRIDCO, particularly the adjustment of the debt component. There were three alternative bases for the revaluation of assets: the replacement cost, written-down value and the historical cost. In 1994, a team of consultants recommended by the World Bank and the Overseas Development Administration of the U.K. (now renamed the Department for International Development, or DFID) and led by KPMG and others, including Price Waterhouse, National Grid plc and McKenna, recommended that the depreciated replacement cost method be adopted to revalue the assets of the OHPC and GRIDCO.

While there can be little doubt that this is in tune with internationally accepted norms and procedure, whether it should have been applied to GRIDCO at this juncture is a moot point. This is because the revaluation method transferred all liabilities of the erstwhile Board system to the unbundled entities even as its assets were revalued to cover these liabilities.

GRIDCO's assets, which on the date of transfer (April 1, 1996) had a book value of Rs.1,183 crores, were revalued at Rs. 2,395.8 crores. Of this, Rs.326 crores formed GRIDCO's equity, which was wholly owned by the Government of Orissa. Of the long-term loans, Rs.497.7 crores were from financial institutions, including the Life Insurance Corporation of India, the Rural Electrification Corporation and the Industrial Development Bank of India. The OSEB owed Rs.465.5 crores to various parties, including the National Thermal Power Corporation (NTPC) for the purchase of power.

GRIDCO owed Rs.400 crores to the Government of Orissa; the amount was converted into partially convertible bonds issued to the Government with a moratorium on interest liability for five years. Loans from the Power Finance Corporation accounted for Rs.101.2 crores and partially convertible bonds issued to the Pension Trust Fund constituted a liability of Rs.150 crores. Other liabilities included dues of Rs.225 crores to the OPGC, Rs.35 crores to the OHPC and Rs.100 crores to Nalco. Thus, at its formation, GRIDCO had a large equity base as well as a term loan component of Rs.1,148.9 crores and immediately payable substantial sundry liabilities. Having a large asset base doubtless has its advantages in terms of the ability to raise resources, but the advantages have to be weighed against GRIDCO's debt liability.

GRIDCO had immediate liability for repayment of principal and interest on Rs.600 crores, after accounting for the moratorium on the bonds issued to the Government of Orissa and the Pension Trust Fund. Even assuming that GRIDCO did not pay the Government of Orissa any dividend, the company was doomed from the start because of the crippling interest and principal liability - these account for about Rs.240 crores a year and do not even include interest on sundry liabilities. Although it could be argued that the debt-servicing and repayment liability existed even in the earlier Board system from which it was inherited, the OSEB faced less pressure on this count considering the fall-back mechanism available to it in the form of subsidies and budgetary subventions. Besides, payments to hydel stations for power generated by them were never taken seriously since they were part of the same Board system. But in an unbundled situation, the same liabilities without the financial backing of the State Government rendered GRIDCO vulnerable.

Sources in GRIDCO who were closely associated with the restructuring exercise told Frontline that had the Government of Orissa revalued GRIDCO's assets at book value and paid one last-time subsidy to liquidate some of the more pressing loans, GRIDCO would have been in better shape financially. This arrangement could have been in effect during the transition phase when GRIDCO remained a government company and the asset revaluation could have been undertaken just prior to privatisation or transfer of management control to private parties.

GRIDCO has another problem. It is forced to draw about 770 million units at a steep Rs.2.55 a unit from NTPC stations at Kaniha and Kahalgaon with a combined generation capacity of 2,000 MW. Thirty per cent of the power purchased by GRIDCO comes from the NTPC and this accounts for 42 per cent of GRIDCO's power purchase bill. GRIDCO lacks the network to channel all this power to consumers. Yet it is forced to pay for it, since there are technical problems in disconnecting the seven points through which the power flows. NTPC power drives up the frequency to unacceptable levels, damaging Orissa's transmission equipment. Even the regulatory commission advised GRIDCO to go slow on NTPC power.

T&D LOSSES AND TARIFFS

The Board used to get a mandatory 3 per cent return on net assets. A process of bridging by the Government through subsidies balanced the books of the OSEB despite the gap between power supplied and power paid for. Now the situation has changed. While fending for itself, GRIDCO has to charge tariffs that reflect its revalued costs. The revaluation of the OHPC's assets compounded the problem: tariff for power supplied to GRIDCO will now reflect the revalued costs. From a book value of Rs.413.33 crores, the OHPC's assets have been revalued to Rs.1,320 crores. This entails an increase in the purchase price of OHPC power from around 10 paise a KW hr under the Board system to 49 paise. The OHPC supplies 36 per cent of GRIDCO's power. Thus both input costs and supply costs have gone up for GRIDCO even as its transmission and distribution (T&D) losses remain high. Passing these increased costs on to the consumer would mean a steep tariff hike.

That, however, will not be easy. GRIDCO has already raised its tariff from an average 93.73 paise a KW hr in 1993 to Rs.2.21 a KW hr in April 1997 in five phases. Besides, the Orissa Electricity Regulatory Commission (OERC) will have to clear each tariff hike. At its very first hearing, held recently, it scaled down a 17 per cent increase proposed by GRIDCO to 10.6 per cent. GRIDCO has admitted to T&D losses of 47 per cent of the total power supplied. Informed sources told Frontline that the actual losses were even higher - close to 52 per cent. The Regulatory Commission held that in a situation where only half the consumers pay for the electricity supplied, steep tariff increases could not be allowed. In a ruling given on March 13, 1997 after a public hearing, the Commission advised GRIDCO to bring down its T&D losses to 35 per cent (25 per cent technical losses and 10 per cent commercial losses). The Commission said it would allow only 35 per cent T&D losses to be taken into account while computing a tariff hike.

Pegging T&D losses at 35 per cent is easier said than done. It requires substantial and speedy investments in transmission and distribution networks and a will to enforce strict discipline. Merz and McLellan/Seaboard International of the U.K., project management consultants, have been given the task of identifying investment requirements, drawing up tender specifications and awarding contracts through international competitive bidding. The pre-qualification tendering for the transmission projects is under way and for distribution projects the bid documents are being drawn up. Any delay in the disbursement of the World Bank loan and the fact that most of the engineers handling the project management work at GRIDCO are due for retirement soon might delay the upgradation of the T&D network.

Of the $350-million loan contracted with the Bank - most of it for T&D upgradation - only $15 million have been disbursed. GRIDCO is planning to raise Rs.300 crores from the domestic market to meet the counterpart funding required for the Bank loan and to meet other pressing investment requirements pending disbursal of the loan. Even with the $350 million (Rs.1,300 crores) loan and Rs.400 crores DFID loan, GRIDCO will have to raise Rs.1,300 crores from domestic sources such as the Power Finance Corporation and the LIC in the next five years to meet investment needs. Just how it will manage these in its current precarious financial position is the big question.

The project management consultancy for transmission upgradation is being funded by a loan from the DFID, which insisted that British consultants be hired. Of the oe75 million DFID assistance earmarked for the reform project, as much as 50 per cent will go towards consultancy fees.

Distribution losses are largely commercial losses arising from non-metering, theft and non-collection of tariff. GRIDCO sources told Frontline that large industrial units and some commercial establishments in towns accounted for a substantial part of the theft of electricity. Bringing these establishments, many of which enjoy political patronage, into the billing system needs determination, integrity and independence on the part of GRIDCO leadership, besides effective cooperation from on-site engineers and linesmen.

Massive investments in meters will also be needed. At present, meters are installed at all interconnection points in the 10 circles to monitor supply and billing. This will have to be extended to the 42 divisions and 120 sub-divisions to identify and tackle pilferage. Because of non-cooperation from consumers as well as field staff, thousands of meters that were procured remain uninstalled. GRIDCO is now planning to categorise its consumers on the basis of the voltage of supply in order to make metering easier and pilferage difficult.

Notwithstanding these measures, without a change in work ethics and work culture, dramatic improvements in metering and collection cannot be expected. That will require training and reorienting the workforce as well as professionalising management.

As mentioned, GRIDCO's losses now stand at Rs.250 crores; in a confidential note submitted by GRIDCO to the OERC in December 1996 (which is available with Frontline), GRIDCO's Finance Director estimates that the deficit in 1997-98 is likely to be Rs.797 crores. This figure may turn out to be lower because of GRIDCO's decision to purchase less power in 1997-98 and the marginal improvements in tariff collections. Nevertheless, GRIDCO is losing Rs. 40-45 crores a month. The average monthly realisation of GRIDCO is around Rs.85 crores - up from Rs.75 crores last year. Its monthly power bill is Rs.75-80 crores and wage bill Rs.18 crores. Debt servicing costs Rs.20 crores and maintenance Rs.10 crores. Thus, as against a monthly expenditure of Rs.125 crores, the company's receipts are no more than Rs. 85 crores. Tariff increases to increase income will be difficult since the regulator is unlikely to allow another increase in a single financial year. Hence, savings will have to effected from tightening distribution and stepping up collections.

GRIDCO Finance Director R. Misra hopes that with the installation of meters at the junior engineer level, monthly collections will go up to Rs.115 crores. This would still leave the newly-accumulated deficit of more than Rs.250 crores unbridged.

THE PRIVATISATION INITIATIVE THAT FAILED

As an interim step before the separation of distribution functions and subsequent privatisation, GRIDCO divided its distribution network into four zones and offered the Central zone (comprising the relatively lucrative areas of Bhubaneswar, Cuttack and Dhenkanal) for private management contract to Bombay Suburban Electric Supply (BSES) for a period of three years from September 1996. BSES runs the distribution network in Mumbai. BSES was to be paid a management fee of Rs.4.2 crores a year. It was to manage the utility and improve billings and collection. Although no definite targets were set, BSES was allowed generous incentives to improve receipts over a certain minimum and there were to be no penalties for non-performance. Its performance was to be reviewed every six months.

When the first six-monthly review came up in April 1997, GRIDCO found that BSES had notched up a negative incentive of Rs.28.02 crores, indicating a decline in performance in the hands of private management. During this period, GRIDCO claims to have pumped in Rs.22 crores towards the necessary investments in the system. M.Y. Rao, Chairman and Managing Director of GRIDCO, said: "The repairs and maintenance norms stipulated by BSES were much higher than those of GRIDCO and we made provision accordingly, but still there was no improvement in performance. Further, the performance figures furnished by BSES did not even tally, and we had already paid Rs.2.12 crores to BSES towards management fees. Last year, when we (GRIDCO) were managing the zone, we paid incentives to our own staff for better performance. This year, with BSES in the saddle, performance turned negative." M.Y. Rao terminated the management contract on April 30, 1997.

This was a setback for the reform programme and almost brought the entire programme crashing down. GRIDCO was accused of not complying with ODA conditionalities and breaching its agreement with the World Bank. However, M.Y. Rao stuck to his guns and said that there was nothing in the contract that required GRIDCO to obtain prior clearance from the Bank before cancellation, and that he was well within his rights to terminate the contract for performance failure. He told Frontline that the failure of the BSES contract merely confirmed his view that the private sector was not necessarily superior to the public sector in terms of efficiency.

M.Y. Rao said: "Managing distribution here is a different ball game altogether. The BSES' metropolitan experience is of little value here." In his view, BSES, which had the backing of the Bank, did not take its task seriously, sent "a C-grade team much smaller than the one required to tackle the problems in the zone" and was "smug" in the knowledge that as and when the Central zone was privatised after the three-year contract period, it would get it on a preferential basis without having to go through a bidding process, thanks to an agreement signed earlier.

Now, however, this agreement will no longer apply and BSES will have to compete with others to bid for the zones as and when they are put up for sale. In addition, GRIDCO has demanded that BSES pay a penalty of Rs.10 crores for having failed to perform. BSES shares fell 52 points on the Bombay Stock Exchange on the day the contract was cancelled.

BSES, for its part, accuses M.Y. Rao of acting hastily and not giving it enough time to achieve a turnaround. BSES representative in Bhubaneswar Rama Rao told Frontline that BSES never had any control over the staff assigned to it and there was no way that it could have improved performance unless it had leeway in the deployment of the technical workforce. He also disputed the base period data that were used to compute the so-called negative incentive.

REDEPLOYMENT OF HUMAN RESOURCES

There is little doubt, however, that there has been fierce opposition to the restructuring and reform exercise in Orissa from the workforce of the erstwhile OSEB as well as engineers, who incidentally, were employees of the State Government and not of the Board. The Orissa Electrical Engineers' Service Association (OEESA), which has 1,400 graduate and diploma engineers for members, had appealed to the State Administrative Tribunal (SAT) against being transferred to GRIDCO and the OHPC, which are to be eventually privatised. When their petition was dismissed by SAT, they went on appeal to the Supreme Court, which granted an interim stay.

OEESA general secretary S.K. Bidhar told Frontline that in transferring them to these corporations, the Government had altered the conditions of their service to their disadvantage. The association wants the earlier Board system restored but with separate profit centres.

In May, the Supreme Court lifted its interim stay on transfer of staff and allowed GRIDCO to proceed with the job. Accordingly, the provisional transfer and allocation of staff and engineers, which began in April 1996, was completed in August this year. The Government of Orissa absorbed 100 engineers and the OHPC 300, and the rest were assigned to GRIDCO. M.Y. Rao maintains that not a single job was lost and that there has been no deterioration in the conditions of service of the 2,900 persons who were reassigned to GRIDCO. According to him, satisfactory redeployment of human resources was GRIDCO's most significant achievement, but this claim is disputed by the unions. The Supreme Court will again hear certain constitutional issues raised by the OEESA in September, but M.Y. Rao believes that this is unlikely to upset the redeployment.

PRIVATISATION AGENDA

The World Bank has mandated phased privatisation of each of the unbundled entities. By April 1999, all the four distribution zones are to be controlled by private managements.

Therefore, as a first step, GRIDCO is in the process of drawing up the articles of association of the four companies that will take charge of the zones. GRIDCO has already applied to the Company Law Board and the OERC for the exercise. The valuation of the assets to be assigned to each distribution company is being done by Lovelock & Lewes. In December, GRIDCO will apply for the OERC's approval for the tariffs that it plans to charge in the four zones. GRIDCO will initially ask for identical tariffs for all the four companies. By 1999, by when all the assets and liabilities are to have been transferred, differential tariffs are expected to be charged.

GRIDCO plans to disinvest up to 51 per cent of its equity in the distribution companies in phases; another 10 per cent will be offered to employees. In this context, it is noteworthy that the Disinvestment Commission has recommended 51 per cent government control in central power utilities. Although M.Y. Rao is unhappy with the privatisation experiment, he has little leeway under the terms of the contract signed with the Bank. M.Y. Rao, who is known for his independence, is due to retire in October and will be replaced by another government nominee. His departure from the reform scene in Orissa may spell significant changes in the reform process, more in tune with the Bank agenda.

Curiously, the World Bank has been silent on GRIDCO's role as a trading enterprise after the separation of the distribution functions. Trading in power is a high-risk activity for a transmission company and is actively discouraged. Even National Grid plc of the U.K. does not engage in trading. As things stand, it appears that GRIDCO will engage in trading even after the distribution companies are formed, and this bodes ill for its already delicate financial health.

Meanwhile, the Bank appears to be pushing ahead with the reform and privatisation agenda relentlessly, with Orissa the guinea pig for its methods of restructuring and "reform". It is not clear whether GRIDCO will emerge alive from the experiment.