Implications of free transmission of renewable energy

by Akshay Jaitly and Ajay Shah.

Inter-state electricity transmission

Transporting electricity across long distances requires investments in the transmission system where high voltages are used to minimise losses. An emphasis on renewable electricity generation requires significant new transmission capacity to transport electricity from the natural locations for generation (e.g. Himalayan hydel, or SPV in Rajasthan) to the centres of consumption in the peninsula. In an announcement in December 2021, 23 inter-state transmission system (ISTS) projects have been initiated by the government, at a cost of Rs.159 billion.

As with other elements of the electricity system, investments in transmission would ideally be done through the price system, where the price for transmission is discovered on a market. Once the price system is in motion, present or anticipated high prices would create incentives for investment in transmission. The structure of the Indian electricity market does not permit this: as this announcement of 23 projects shows, we effectively have a centrally planned system where officials control the resource allocation, and only bring in private firms as vendors playing a defined role in a centrally planned system. Transmission investments and prices are largely government controlled, and not discovered through the price system, which always involves misallocation of resources.

In the remainder of this article, we discuss the outlook on ISTS and its implications for renewable energy. To summarise ISTS, it is an electricity grid that runs across the entire country. It connects to end-points who are either generators or users. There is a process, and there are rules and capacity constraints, which determine whether a given person gets on to ISTS. Once a person is physically on ISTS, they are directly buying and selling from others on ISTS; these transactions are immune to the policies of the local discom. There is one constraint: the buyer and seller on ISTS cannot be within the same state.

Special prices for transmission of renewables

The CERC (Sharing of Inter-State Transmission Charges and Losses) Regulations, 2010 had some remarkable clauses: 7(u) and 7(v) established that for a period of three years, solar generation would be charged zero rates for transmission charges or losses. This suggested a world where a solar generator could sell to any buyer in India with no friction from transportation. These zero charges have been expanded and carried forward to cover all renewable energy commissioned till 30 June 2025. For renewable energy projects commissioned prior to 30 June 2025, for a period of 25 years, there will be no charge for transmission. For projects commissioned from 30 June 2025 onwards, the charges come back in gradually, to a level of 100% of the normal charge for projects commissioned after 1 July 2028. This creates a special deal for any renewables project that gets to the finish date by 30 June 2025.

Open access through discoms: In the present legal system, discoms are supposed to give out ‘open access’, where a buyer and seller of electricity are able to privately negotiate transactions, and have guaranteed access to the transportation services of the discom for the transport or electricity within or outside the state. In practice, this de jure situation does not map out into the de facto: many discoms refuse to provide or otherwise impede these services, as they would like to continue overcharging their best customers.

Open access through ISTS: Transmission across the state border through the ISTS seems to offer an increasingly viable way out of this barrier. It appears that when a renewables generator connected to the ISTS network sells to a third party outside the state who is also connected to the ISTS network through a PPA, neither of the two discoms can impede the transaction. This has been possible for a while, but the expansion of ISTS mentioned above will make such transactions more accessible to a wider range of sellers and buyers.

We could thus have generator $A$ in Dahanu (at the north end of Maharashtra) who is unable to sell to a buyer $B$ in Palghar (40 kilometres away), but she would be able to sell to a buyer $C$ who is across the state border in Vapi (at the south end of Gujarat, 70 kilometres away), assuming that connectivity to ISTS exists.

Implications

There are two kinds of ‘free’ in the title of this article. One refers to transportation of electricity without paying for it. Another refers to economic freedom: rational transactions under open access which are impeded and disincentivised within and across states (between a renewables generator and a buyer) and those using ISTS that are seemingly encouraged across the state border. What are the implications of these two kinds of free coming together?

There is no free lunch. When transportation is subsidised for renewables, someone has to pay for this. This can either be an explicit on-budget subsidy, or it can be a within-sector subsidy. In the Indian case, when government-owned transmission utilities undercharge transmission for renewables, this comes with higher prices for fossil fuel generators. Such tax-and-subsidy policies normally require sophisticated public finance analysis, which is not visible, thereby elevating the risk of unanticipated effects.

The ability of renewables generators to frictionlessly transport electricity across state borders is likely to significantly impact upon the distorted pricing being run by discoms. The paying customers (C&I) in any state have a strong incentive to cut the discom out of the transaction and directly buy from any generator. In addition, some C&I customers have ESG equity investors, and need to demonstrate they are using renewable energy. Both imperatives create incentives for C&I customers in each state to find a renewables generator somewhere in India (but not in their own state, where ISTS transactions are absent), and buy directly, thus avoiding the exaggerated prices charged by the discom and freeing themselves from their often unreliable service.

We will have situations where a Gujarat renewables generator will sell to a Maharashtra C&I customer, while at the same time a Maharashtra renewables generator will sell to a Gujarat C&I customer. At an engineering level, transmission between two states would only take place in one direction, and the two streams would get netted out. This would yield the efficient outcome where in each state, buyers and sellers achieve higher economic freedom, and are less controlled by the discom.

Zero or low pricing for transmission of renewables has been around for a while, but earlier there were capacity constraints in inter-state transmission which was holding back this process. The substantial expansion of the ISTS described above would help translate the threat of exit by an increasing number of C&I users into a reality. The rise of ESG investment is also relatively recent. We would hence hazard a guess that these transactions will become more important by 2023 and 2024.

In a recent paper, we argued that the Indian electricity sector in 2021 or 2022 is different from what was seen in the preceding 30 years. While electricity went along a muddled path of non-reform for decades, while private participation only came into the edges of a fundamentally centrally planned system, the stress on the incumbent system is mounting. We are coming to the point where the good old ways are untenable. Inexpensive ISTS, which enables C&I customers to buy cheap renewables from across the state border, adds to this scenario. Other recent developments are also pushing discom finances over the edge [example].

We expect that increased ISTS access will increase economic freedom, and help private investors think more in terms of market opportunities rather than regulatory constraints. But this present moment of the policy configuration will also not be seen as stable, for a 25-year horizon, by private investors. What the state giveth, it can equally take away. All in all, we expect that discom finances will weaken, the ROE in renewables will go up, but the impact upon investment will be somewhat muted owing to fears about the next string of policy actions.

Energy transition investment in India and in the world

by Akshay Jaitly and Ajay Shah.

At a time when the 20th century has returned, in terms of geopolitical conflicts, we should not take our eyes off the climate change problem. CO2 is a global pollutant, and it will be harder than ever to get the world economy to safety, so we will need to make more of an effort.

Measuring energy transition investment in 2021

BloombergNEF builds an important annual statistical picture in the `Energy Transition Investment Trends' report. The 2022 report measures global investments into the carbon transition. They break this down into two groups: the direct energy transition investments, and the investments in R&D for improved technology.

The headline numbers for 2021 are that there was \$755 billion of energy transition investment and \$165 billion in technology development, adding up to \$920 billion. Under `energy transition investment', the sub-components that are tracked by BloombergNEF are (a) Renewable energy; (b) Energy storage; (c) Electrified transport; (d) Electrified heat; (e) Nuclear; (f) Hydrogen; (g) CCS and (h) Sustainable materials.

For the Indian economy, it is largely a story of learning, purchasing and implementing the technology developed elsewhere in the world. As an example, many people all over the world invested in, and took the steps on the journey to, cheap solar photovoltaics. We in India are the beneficiaries by being able to buy solar panels or the machines that make solar panels, without needing to invest risk capital in developing the technology. We also can do M&A, like Reliance Industries’ buyout of solar cell and panel manufacturer REC Solar Holdings for \$771 million in late 2021. Hence, for the remainder of this article we focus on the \$755 billion of energy transition investments (worldwide) in 2021.

The big facts

Of the \$755 billion, there are two large components -- \$366 billion into renewable energy and \$273 billion into electrified transport. But there are also many other things going on (energy storage, electrified heat, nuclear, hydrogen, CCS, sustainable materials), adding up to the remaining \$116 billion.

Investment into the energy transition has grown well. A decade ago, this was at \$264 billion, thus giving an average compound growth of 11% per year in USD.

The report estimates that to get to net zero, these numbers need to triple to 2025 and then double to 2030. Overall, a six-fold rise is required from 2021 to 2030.

The values seen in India

Energy transition investment in 2021 in China was at \$266 billion (out of the total of \$755 billion), and in India it was \$14 billion. The Chinese GDP is about five times larger than India, but their investment in the energy transition last year was 19 times larger than India's.

If we apply the Indian share in world GDP of 3%, the value of Indian energy transition investments should be at \$23 billion. If we relate this to the Indian share in world CO2 emissions of 7%, this should be at \$53 billion. By these two normative yardsticks, then, energy transition investment in India needs to be 1.6 or 3.8 times bigger than it is.

What impedes the energy transition in India?

If we multiply the present value of \$14 billion a year by 6 x 1.6 or 6 x 3.8, we get to the estimated required investment in India for 2030 of \$134 billion or \$319 billion. Such values cannot be obtained from the fiscally stressed Indian exchequer. They can only be obtained from the private sector. But the private sector is still skeptical about energy investment in India (as is evidenced by the relatively low value of \$14 billion in 2021).

The present policy frameworks for the sectors that receive energy transition investments have been in place for decades. Intensification of these frameworks, or better implementation of the present policy paradigm, is unlikely to shift the needle sufficiently. For instance, persisting along this path will mean that electricity in India will continue to be unreliable, expensive and carbon-intensive.

When we look at the landscape of \$755 billion of investment in 2021, it is not, China apart, taking place in a world of central planning; it is in a world in which the government sets up the foundations through which the price system operates, and then the precise decisions about technology and business model are made locally by private persons. This is the key transformation that is required in India. The decision to put up a solar plant or build an electrolyser should be made by an individual looking at the prospective profit, not a government official who puts out a tender. The decision to put up a storage facility should be made by a private person who sees opportunities in a large gap between the highest price of the day and the lowest price of the day.

As we argue in a recent paper, the problems of the Indian climate transition are now beyond the calibrated control of officials. The government controlled system is experiencing substantial stress, owing to the contradictions inherent in it. A centrally planned system is ill equipped to think about technical and business model problems in each square kilometre of India. Government control will tend to push simplistic solutions that will drive up the cost imposed upon society for the energy transition.

Policy uncertainty in Indian e-commerce

by Megha Patnaik.

Reduced investment in India by private persons is a key part of the present growth challenge. Investment is shaped by macroeconomic uncertainty, sectoral uncertainty, and regulatory risks that firms face. In this article, we think about the risks that an E-commerce firm such as Amazon perceives in India. These include the changing FDI rules, unresolved issues of data localisation and code disclosure, the multiple reports on technology-related activities that various government agencies are releasing, and the problems of rule of law in licensing and investigation.

Economic policy uncertainty

Shrinking investment in the Indian economy is a concern. Investments in new projects fell to a 15 year low in the last quarter according to the Centre for Monitoring the Indian Economy (CMIE) Capex data which tracks large investment projects.

Firms are deterred from investing by policy uncertainty (Bloom, 2009). When firms are unclear about the future economic environment, they hold back on investing till uncertainty declines. This delays the pickup of the investment cycle, where firms generates jobs and business for linked firms, fueling aggregate economic activity. Uncertainty particularly affects long-term investments that are irreversible in nature, and for which horizons for cost recovery run into years. These can be investments in new technologies or market segments, or investments in infrastructure. Such investments are particularly important, as they can benefit other firms in the economy, fueling productivity and long-term growth in addition to their business cycle effects.

Private sector investment is adversely affected by three kinds of policy uncertainty - macroeconomic uncertainty, sectoral policy uncertainty, and regulatory risk. The role of Economic Policy Uncertainty at the macroeconomic level has been measured globally (Baker et al, 2016). In the original measure, an index is created by quantifying newspaper coverage of policy-related economic uncertainty mentions in the national newspapers, through combinations of keywords related to policy and uncertainty. Macroeconomic policy uncertainty has been applied to understand global events. Brexit-driven policy uncertainty in the UK moved closely with the GBP Real Exchange Rate in recent times, and the uncertainty surrounding US trade policy affected importing firms. This measure of macroeconomic policy uncertainty correlates strongly with stock market volatility.

Firms face much more than macroeconomic uncertainty. They also face uncertainty at sectoral, geographical and individual levels. Sectoral-level policy uncertainty can be measured through surveying firms sampled across sectors, asking them about expectations about future growth and costs at various horizons (Altig et al, 2019). For example, firms can report not just their expectations about future profits, but the distribution across the possible profit outcomes that they can expect.

An additional source of uncertainty that firms operating in India face is regulatory risk. Even when regulations are formulated, there is a lack of predictability, and excessive executive discretion, in how a stated regulation will be enforced. For example, the licensing by the RBI of 11 payment banks from 41 applicants who wanted to start payment systems was a non-transparent process inconsistent with the rule of law (Roy and Shah, 2015). Another example is the Copyright Board order of 2010 on statutory licensing fees paid by Radio stations. This order arose out of nine one-on-one disputes between radio stations and music producers, but was applied as an in rem order rather than an in personem order. Thus, music producers who weren't part of the original disputes also became governed by the order, despite the appeals by T-Series and SIMCA against the Copyright Board order applying to them. Aggarwal and Zaveri (2019) show the uncertainty induced for private persons through executive discretion in enforcement at SEBI.

Drivers of uncertainty in the E-commerce sector

In the recent Q2 earnings announcement, the Amazon CFO Brian Olsavsky mentioned uncertainty in India's e-commerce policy. He expressed hope for `stable' and `predictable' policy, for the company to continue with its investments in technology and infrastructure in India. This explicit mention about policy uncertainty in India is a unusual moment, and requires attention by policy thinkers. What is the uncertainty associated with investing in India, as seen by Amazon?

1. India's draft e-commerce policy rules earlier this year preventing firms from influencing prices or selling products in which they hold stakes disrupted business plans for e-commerce companies. It bring companies back to the drawing board to ensure they can comply with the current regulations while limiting losses that rose from lack of clear direction from the start. The final e-commerce policy has been held back for another year, putting existing investments of firms in this sector at risk during the interim months, and deterring further investments.
2. The uncertainty around data localisation is another deterrent. The recent announcement by a high-level government panel to do away data localisation for non-critical data, and the upcoming announcement of the position of the Prime Minister's Office on data localisation are policy announcements that drive sentiments on this debate, though none are legal instruments. Under data localisation requirements, companies would need to redesign internal algorithms to access data locally, pay up for new servers, and face costs to protect data in less-secure environments. The predictive power of firms' algorithms would weaken with fewer data points to train models on. The due process of discussions with various government bodies and stakeholders on this issue is still in process. The RBI's requirement for financial data localisation despite existing provisions (Bailey and Parsheera, 2018) for access under the Payments and Settlements Act (2007) suggest that any Indian regulator can step in with special requirements at unforeseen times.
3. A related issue is the disclosure requirement of source code under the draft e-commerce policy. E-commerce firms depend on data-driven marketing and use of collaborative filtering for customer recommendations. A code submission requirement is a coercive technique aimed at achieving `the transfer of technology and local needs' described under the proposed e-commerce policy. Technology transfers cannot and should not be coerced: they happen in an organic and legitimate manner through managers and employees developing skills and passing them onward in data communities or by workers moving across companies (Bloom et al, 2019). It is also doubtful how technological transfers can be achieved with segments of code without underlying data. Will code disclosure requirement be combined with data localisation to pass on core business value to competitors? Will companies need to invest in staff and technologies to find workarounds to be able to mask their key assets? Whether such a code disclosure requirement will come into effect remains unresolved. In mid-2020 the final e-commerce policy will describe the stand of the government on this issue, but this is not definitive either.

Multiple guidelines on the same subject can cause delays in the resolution of uncertainty. The RBI Report of the Working Group on FinTech and Digital Banking includes E-aggregators, Robo advisors and Big Data all under Fintech. E-commerce firms, which are data intensive and provide multiple services, will be included under this description. The fintech steering committee report of the Ministry of Finance is still pending. Each of these reports is a statement about how government agencies are likely to move in the future but these are not legal instruments. Government reports can only suggest but not surely state how future laws will change.

Infirmities of the regulatory processes in India also exacerbates uncertainty. As an example, data localisation requirements by RBI for payments firms were translated from an early idea into an enforced law within a matter of days. There was no due process surrounding how officials could change the law.

The last leg of the legal system -- how laws are enforced -- also suffers from concerns about non-equal application of law, as shown in the examples from RBI (Roy and Shah, 2015) and SEBI (Aggarwal and Zaveri, 2019). For a prospective investor, the risk of investing in India lies in how the law might change in the future through an undemocratic process, and in how the law will be applied to her.

Conclusion

For India to have a stable investment environment, we need to provide firms a stable and predictable policy environment. Investments from firms in various sectors will boost the investment cycle for India. Resolving policy uncertainty both at the macroeconomic level as well as in different sectors, and reducing regulatory risk through better rule of law is critical for India in the current investment scenario as well as for long term growth.

References

Aggarwal, Nidhi and Zaveri, Bhargavi. Problems with evidentiary standards for proving securities fraud in India, The Leap Blog, 23 August 2019.

Altig, David, Jose Maria Barrero, Nicholas Bloom, Steven J. Davis, Brent H. Meyer and Nicholas Parker. Surveying Business Uncertainty University of Chicago Working Paper (2009)

Bloom, Nicholas. The impact of uncertainty shocks. Econometrica (2009)

Bloom, Nicholas, Erik Brynjolfsson, Lucia Foster, Ron Jarmin, Megha Patnaik, Itay Saporta-Eksten, and John Van Reenen. What Drives Differences in Management Practices? American Economic Review (2019)

Baker, Scott R., Nicholas Bloom and Steven J. Davis. Measuring Economic Policy Uncertainty. The Quarterly Journal of Economics (2016)

Bailey, Rishab, and Smriti Parsheera. Data localisation in India: Questioning the means and ends, The Leap Blog, 22 February 2018.

Roy, Shubho, and Ajay Shah Payment bank entry process considered inconsistent with the rule of law, The Leap Blog, 1 September 2015.



Megha Patnaik is faculty at the Indian Statistical Institute, Delhi and Fellow at the Esya Centre. The author thanks Radhika Pandey and Ajay Shah for useful inputs.