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ELK Asia Pacific Journals – Special Issue
ISBN: 978-81-930411-0-9
RISK MANAGEMENT IN POWER SECTOR
Dr. KIRAN.R.,
Senior Professor & Head.
Department of P.G. Studies,
Teachers Academy Centre for P.G.
Studies, Bangalore-560 043
PADMAVATHI .S.
Professor & Head. Department of
Destiny,
Teachers Academy Centre for P.G.
Studies, Bangalore-560 043
Virupaxi V. Betageri.
Assistant Professor Department of
P.G. Studies,
Teachers Academy Centre for P.G.
Studies, Bangalore-560 043
Abstract
In India risk management in the energy sector is its infancy stage, but is expected to gain
significance due to deregulation and privatization. In an arena where so much is it stake,
there’s little margin for error. Exposure market volumetric credit, delivery risk power trading
business. The application of advanced hedging and risk management techniques have led to
increased trading volumes, complexity and risk. For emergence of competitive market risk
management techniques are to be available. So that these competitive market, to hedge against
volatility in purchasing power from the spot market to hedge against volatility in purchasing
power from the spot market by signing a futures contract or that pays the buyer is the price of
power in the market is higher than an agreed level. Risk has uncertainty associated with it.
The electricity act 2003 allows for trading of electricity i.e. purchase of electricity for further
sale.
INTRODUCTION:
India is the second largest country in terms of population (over 1.027 billion), and the seventh
largest in terms of geographical area (3.78 million sq.km) second largest in terms of
purchasing power parity (PPP) development. The successes in funding infrastructures are a
sine quinoa of economic development. The successes in funding infrastructure projects like
power are mainly department on three Rs-Reform strategies, Regulatory frameworks, and
Risk mitigation techniques. Electricity is the fulcrum of economic development. Power
(electricity) is critical infrastructure for the economic development of a country.
REGULATORY FRAMEWORK:
It covers three acts that govern Power sector. The Indian electricity power sector. The Indian
electricity act, 199 corporation (NTPC) and sells power to various state utilities (SEBS).The
central government also established companies such as BHEL and power grid corporation of
India (PGCIL) for manufacturing of electrical equipment (turbines, transformers, boilers) and
for reaction and maintenance of of Interstate transmission lines respectively .Power trading
Corporation (PTC) was formed.
REFORMS:
Reforms in the power sector commenced by opening up electricity generation, supply and
distribution to the private sector. The reforms in Electricity sector have proceeded in three
phases and are still ongoing:
They are: Generation and IPPs (1991) The 1991 reforms launched the first phase that
focused on increasing investment in power generation. Structural Reform and independent
Regulation (mid 1990s). Distribution Reforms (APRDRP) 2001 for generation of power
from coal,thermal engineering stations. NTPC accounts for 25% India’s total installed
capacity deals with functioning and regulation of the private licensees where as the Indian
ELK Asia Pacific Journals – Special Issue
ISBN: 978-81-930411-0-9
supply act 1948 deals with supply act 1948 deals with establishment and functioning of state
government owned integrated monopoly utilities (within the state ) called state electricity
boards (SEBS).The central government in 1970 established National power. Electricity act
2003: The overall objective of the Act is to develop the electricity industry, promotion of
competition, protecting interests of consumers and supply of electricity to all areas.
Accelerated Power Development & Reforms Programme (ARDRP), introduced in February
2001 is being used in a structured way in the areas of Distribution reforms and transition
phase in financing of state Electricity Boards undertaking reforms.
PRESENT SCENARIO OF POWER:
1. Installed generation: Installed generation capacity has increased from 1,352 megawatts
(MW) in 1947 to over 1,25,000 MW.
2. Power Generation: Power Generation from capacity plants increased from 1.5 billion kilo
watt hour (kWh) in 1950-51 to 55 billion kWh making India the 4th highest captive power
user in the world.
3. Per capita consumption of electricity is only 350 kWh per annum much lower than the
world average of over 2,000 kWh.
4. The country has electrified all its towns and 86% of its villages. Out of India’s 6, 00,000
villages, 80, 000 (14%) are still without electricity.
RISK: In finance definition of Risk refers to the likelihood to receive a return on an
investment that is different from the return we expected to make. Thus risk includes not only
the bad outcomes, that are lower than expected, but also good outcomes, that is returns that
are higher than expected. Risk has uncertainly associated with it. No Risk, No gain holds
true for any business. There is a trade-off between risk and profitability. No risk will mean
low profitability. High risk can bring high profitability. Riskless investment may virtually be
profitless too.
BUSINESS RISK-CHARACTERISTICS
The investment risk that a normal business possess of the following types of risk.
1. Sovereign risk: as India is vibrant parliamentary democracy; it can never come under
autocracy. So sovereign risk in India is zero for both FDI & FPI.
2. Political risk: Even though there was political instability before 199 general elections,
now the formation of stable connection government at the cinder that survived nearly an
entire terms stiles political risk negligible
3. Risk of foreign nations: India is a nuclear weapon state; this is not in good books of
many countries. India is self reliant and self sufficient in all sectors. The threat of
sanctions will be look like a mosquito bite on an elephant, so it is purely speculative.
4. Market Risk: Commercial risk is inevitable for every product/ service that is produced or
sold. Before making any investment market research helps to avoid commercial risk with
the help of professional people Market risk arises out of dynamics of market forces like
interest rate fluctuation maturity(asset liability) mismatches, exchange rate fluctuations.
5. Operation risk: It refers to the risk associated with the in house functioning of
organization arising from the internal management systems failure.
6. Credit Risk: The risk of counter party failure in performing the repayment obligation on
due date. It arises due to internal inadequacy of credit granting mechanism.
ELK Asia Pacific Journals – Special Issue
ISBN: 978-81-930411-0-9
RISK MANAGEMENT: Risk are correlated to exposure to one risk may lead to another, so
that real mantra lies in successfully managing the risks in a proactive and integrated manner,
then automatically profits follow. Risk management practices like
a. Hedging transactions exposure
b. Bank & Financial institutions use duration analysis, Gap analysis whereas Non banking
finance companies use simulation analysis.
c. Derivatives like foreign exchange forward contracts, Swaps, options, Futures, commodity
bonds, are used in managing risks.
CHARACTERISTICS OF ELECTRICITY INFRASTRUCTURE PROJECTS RISKS
1. Infrastructure service usually involve long pay back periods that is gestation period is too
long. High risk are associated with these projects. Higher is the risk, higher the returns.
2. Large initial capital is required ; capital cost is too high the financing of infrastructure
projects is largely case flow based and not asset based; the tangible assets may not provide
adequate cover for loans.
3. Neither the assets of the projects are easily transferable, nor storable and non tradable in
nature.
The facture of non-excludability externality ,natural monopoly, inelastic demand, and
involvement of huge capital investment with long gestation period makes the infrastructure
financing different from industrial financing.
SWOT ANALYSIS:
A review of the strengths, weaknesses, opportunities and threats.Swot analysis of the power
sector scenario in India, can be observed as an back ground the specific areas of risk were
identified by the industry as well as financial community so as to make decisions related to
power plants.
Strengths:
A Market Potential:
India is 4th largest economy in world, 3 rd largest GDP, 2 nd largest emerging nation with
one billion people.
B Consumer class:
A rapidly growing consumer class has emerged since 1991. Currently consumer durables
situation reflects that there are about 75 million TV sets, projected to reach 225 million, 5
million PCs projected to reach 30 millions2 million internet subscription projected to reach
50 million, 26 million telephone lines projected to reach 125 million and 3 million cellular
phones to reach 12 million.
C Economy:
ELK Asia Pacific Journals – Special Issue
ISBN: 978-81-930411-0-9
Economy has opened its doors, LPG as the rule of the day opens economy for foreign
business especially in consumer goods. India received nearly US $ 28 million of FDI since
1991. GDP has increased.
Weaknesses
i. Capacity: Investment in transmission capacity has not kept pace with electricity domain.
ii. Quality of power: power is not accessible, affordable to all the section of the people in the
society.
iii.Supply deficit: Continuous supply deficit is the hall mark of the electricity at present.
iv. Inefficient: as per IFA, India is one of the most inefficient countries among developing
nations as far as energy usage is concerned.
BUSINESS OPPORTUNITIES:
The total market size of the power sector is estimated to be around $30 million: 1. Captive
Generation: the captive power market has been growing to the of 2000 mw each year and it is
expected that the capacity addition will be between 1500-2000 MW over next two next two
to three years. 2. Transmission & Distribution Networks: Development institutions are
insisting on up gradation are insisting on up gradation of T & D network, focusing mainly on
up gradation of metering devices and billing systems. The metering contracts from the state
electricity boards have been in the range of $20-40 million. 3. Renovation & Modernization:
the market for operations and maintenance (O & M) is very big, especially total O & M
market worth between 42-2.5 billion a year of electrical industry. Electrical industries is
worth at least dollar 4-5 million and growing very fast. In fuel supplies there are vast
opportunities ‘in India since the government has direct import of fuel of different brands for
power generation. In the control and instrumentation industry the total processed industry
grew from $ 200 million in 1988 to around $ 400 million in 2010, thus providing
considerable opportunities for control and instrumentation. Control and instrumentation
(C&I). System companies are serving the power sectors.
Threats : Competition became a hallmark of the power sector and privatization of power
sector not only encourages investment from private parties , FIIs ,FDI but also competition
from them. This economizes the qualitative supply of power at cheaper rates. Counter check
viability, tariff costs , fuel costs and cost of the project should account for capital cost,
interest, depreciation, project soft costs and interest during construction. Promoters costs are
to be carried out and are to be included in recurring costs, the PPA (Power purchasing
agreement) are not viable if they are not worked out properly.
RISK IN POWER SECTOR:
The growth of the economy calls for a matching of the growth of infrastructure facilities. The
growth rate for demand for power in developing countries is generally higher than the GDP.
In India the elasticity ratio was 3.06 in the first plan and peaked at 5.11 during third plan and
came down to 1.65 in the eighties. From the nineties the ratio of 1.5 was projected. Therefore
in order to support a rate growth of GDP of around 7 per cent p.a., the rate of growth of
power supply needs to be over 10 per cent annually. In order to increase power generation
quickly and reduce power shortages, power projects have to achieve financial closure and
start construction. The PPA (power purchasing Agreement) is the contract that lays out the
expectations of both the seller/investor and the buyer/off taker/utility. These include price to
ELK Asia Pacific Journals – Special Issue
ISBN: 978-81-930411-0-9
be paid, amount to be purchased, government guarantee, plant operations and support the
development of investments in power generation by IPPs (Independent Power Purchasers).
The risks in the power business usually address the private products in IPPs. Basing on the
nature of control of risk I power sector, they can be classified as three types namely;
1. Operation risk: The various risks that come under the Operation risk are site selections,
construction risk, fuel supply risk etc, risk of project not being completed on time and
within the budget leads to construction risk only. The site selected should be
environmental friendly as well as technically skilled manpower such that construction
risk is minimized.
2. Political risk/policy risk-Sometimes political uncertainty leads to chaos in the country
as well there can be change in the political that are pursued by the new government Risks
of non compliance with supplied agreements or purchase agreements by the government
of government entities leads to political risk. Political stability will minimize risk to
investors such as expropriation, renegotiation of contracts, and political violence. Fiscal
stability will increase confidence by government agencies. Investment grade sovereign
and debt ratings issued by Standard & Poor’s and other credit rating agencies take in to
account the level of political and fiscal stability and influence the availability and terms of
financing.
3. Market risk-The Market risk included demand risk, supply risk, interest risk, revenue
gurantee, gurantee of tariff rate, Sales rate risk e.t.c. the uncertainty exists in the long term
about electric rates and competitive supply results in economic risk. Thus off take risk
and competition risk are the result of the market risk. Risk management techniques allow
buyers, in a competitive market, to hedge against volatility in purchasing power from the
spot market by signing a futures contract of a “contract for differences” that pays the
buyer if the price of power in themarket is higher that an agreed upon level.
4. Foreign exchange risk- Exposure to currency risk is critical features of electricity project
investment project revenues are often generated in local currencies, while for foreign
capital where debt or equity, involves payment in foreign currency. Fluctuations in the
exchange rate of the domestic currency as well as capital controls currency convertibility
and transferability, poses risk for foreign investors and financiers.
5. Regulatory Risk: Risk of non compliance with supplier arrangements of purchase
agreements by government, government support, bureaucracy and non statutory approvals
for project risks and for enforcement of regulatory rules both at the economy cycle.
Reforms formed the ground frame work for private impingement by moving towards a
reliable source such as economy, tax reforms, functioning judicial systems, documenting
the regulatory work.
CONCLUSIONS
In a world where financial scams such as Enron became the order of the day, risk
management is the buzzword. Ironically it is not just investors and customers who have to
manage the risks but companies too. In India the risk management in the energy is in its
infancy stage, but it is expected to gain significance due to deregulation and privatization. In
an arena where so much is at stake, there is little margin for error. Exposure in terms of
market volumetric, credit delivery risk-permeates every aspect of the power trading business.
The application of advanced Hedging and risk management techniques have led to increased
trading volumes, complexity and risk. For emergence of a competitive market the risk
management techniques are to be available, so that these techniques allow buyers in a
competitive market, to hedge against volatility in purchasing power from the spot market by
ELK Asia Pacific Journals – Special Issue
ISBN: 978-81-930411-0-9
signing a future contract or that pays the buyer if the price of the power in market is higher
than the agreed level. Risk has uncertainty associated with it. The electricity act 2003 allows
for trading of electricity ie purchase of electricity for further sale.
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