Analysis – Draft Amendment to Electricity Rules 2005

The Ministry of Power (MoP) has proposed changes to the Electricity Rules 2005. The proposed changes focus on rules relating to “Captive Power Plants”. More specifically, the changes proposed will impact the structures commonly known as “Group Captive” projects. Group captive projects are an important way in which renewable energy (RE) capacity is set up (its important to note that the Group Captive structure is also used by conventional power plants).
What is the change proposed?
At present, a power project is considered ‘captive’ if consuming entity or entities consume at least 51% of the power generated and owns at least 26% of the equity. Various capital structures have evolved to qualify as captive under the rules. For example, a major portion of the capital could be preference shares, with only a small portion being equity capital. Thus, owning 26% of the ‘equity capital’ actually translates to a very small amount relative to the overall investment in the project. Further, equity shares of different face values are issues with the lower value shares being subscribed by the consumers while the higher value shares being owned by the investor.
The proposed change requires 26% or more ownership of the “paid up equity share capital”. Thus, equity structures with different face value of shares will no longer be tenable as ownership will have to be 26% or more of the total value of equity capital.
However, it appears that the structures where a large majority of the capital is brought in as preference shares are likely to still qualify under the draft rules. This is because the draft refers to “equity capital” alone, not preference capital or total paid up capital.
What will be the impact of the change?
Group captive structures are a very important tool used by companies investing in RE capacity. This is because once a project is classified as captive, cross subsidy cannot be made applicable to power generated from it. This important protection to captive projects stems from the Electricity Act and an order of the Supreme Court.
 
In the current environment where states vary in cross subsidy significantly every year (often with the intent to make open access unviable), such a protection is critical. Without such a protection projects that are build with a life of 20-25 years face huge uncertainties as PPA’s that are viable at present may suddenly become unviable if the state imposes high cross-subsidies.
The proposed change will make group captive structures more difficult as it will require the consumer to put up significantly more equity. This will likely result in less such structures coming up and consequently less investment in RE capacity overall.
Why is the change proposed?
As mentioned in the document of MoP, the rule “is being misused by issuing shares of small face value which actually do not represent the monetary share of the capital of the plant”  (emphasis added)
However, we believe that this needs to be looked at in the larger context of the regulatory environment that an RE plant operates in. Many states misuse their power to set cross-subsidy surcharge (CSS) rates and change them drastically every year (please refer to the CSS article below) often making open access unviable. Further, related provision to cross-subsidy like limiting such rates to 20% of the applicable tariff category or progressive reduction over time are not adhered to. The National Tariff Policy also suggested a change in the way CSS is calculated. However, states have not adopted the suggested methodology.
In this context, making it far more difficult to make group captive structures will result in increasing the risks faced by RE projects. The direct consequence of such a change will be reduction in new investment in the RE capacity.
How soon can the changes be effective?
Electricity Rules are made by notification by the Central Government (s. 176). This is unlike the Electricity Act or its amendment, which requires the approval of the parliament. As a result, the MoP can modify the rules by notification very quickly after it receives comments and has the opportunity to consider them. Comments are due on the draft rules by November 1, 2016.