Applying the insolvency code to the power distribution sector
- Prasanth Regy, Consultant, NITI Aayog & Srikant Nagulapalli secretary, energy department, the government of Andhra Pradesh
Recently, the Union ministry of power has asserted that State-owned power distribution companies (discoms) come under the ambit of the Insolvency and Bankruptcy Code (IBC). The ministry believes that if such an entity were to default on its payments, it can be admitted to the Corporate Insolvency Resolution Process under the Code. However, the resolution of these discoms raises many complex issues.
A firm is said to be insolvent if it is unable to make payments that are due, such as the repayment of a debt or payment to a supplier. Insolvency is an indicator that there is something wrong with either the firm’s business model or its financial structure. If its business model is fine, then the insolvent firm may be able to become profitable if it undergoes financial restructuring. This process, called resolution, may involve a new party taking over and running the firm, and the creditors taking a ‘hair-cut’. The socially desirable outcome in this case is that the losses should be fairly distributed, the economic value of the company should be preserved, and the firm remains a going concern. If the business model itself is flawed, then financial restructuring cannot help. In this case, the desirable outcome is that the firm should be wound up, the remaining physical and financial assets of the firm should be liquidated and the proceeds fairly distributed among its creditors.
This is the process mandated by the IBC, and which the power ministry now argues is applicable to discoms. Most state-owned discoms have been making heavy losses, and they require ongoing support from state governments in the form of grants, loans, and guarantees. After the outbreak of Covid, the Union government announced a liquidity support of ₹90,000 crores, which was enhanced later. In spite of all this support, the total net worth of state-owned discoms is about negative ₹62,000 crores.
If discoms are admitted into the resolution process under the supervision of the National Company Law Tribunal (NCLT), it might provide an opportunity for the State government, if it so desires, to let a private party (whoever succeeds in the resolution process) take over the discom. The discom would emerge from the resolution process with a sustainable financial structure. The state government will be spared the need to support the discom on an ongoing basis, freeing up valuable fiscal space it can spend on education, health, or other priorities.
But the application of the IBC process to discoms is not trivial, because discoms have several features that distinguish them from other firms. Discoms are monopolies who provide an essential service, electricity. Hence, it is important that even if the firm is undergoing the insolvency process, there should be no disruption in the supply of power to customers. There are many other uncertainties in the process as well, such as whether the new private party will require a new distribution licence, how the NCLT and the state electricity regulatory commission, both quasi-judicial bodies, can avoid stepping on each other’s toes, and what happens if the resolution process is not successful. As mentioned above, the usual process is for the bankrupt firm to be liquidated, but this path may not be feasible in the case of a discom.
The discom can be seen a combination of two businesses: the network operator business (operating and maintaining the distribution network) and the supply business (buying power from generators and selling it to retail customers). The network business is a largely risk-free regulated business, and as such, it is not a loss making business. Most of the staff in distribution companies are recruited for network business. Prior to any change of management, it would be necessary to take the existing staff into confidence and provide assurances regarding their terms of employment.
The supply business is where the losses in the power sector are parked. One reason is the exercise of monopoly powers in signing of long-term power purchase agreements either at a higher cost or in excess of requirement. The resolution process can help the discom to renegotiate such agreements under the supervision of the NCLT. Another reason for the losses is the inability of state governments to pay for their electricity consumption or subsidised consumption. A mechanism is required to provide comfort to the private party that it will be able to realise receivables from the State Governments.
Thus, there is a case to unbundle the network business and the electricity supply business. The network business may continue to be a monopoly because of physical constraints in laying multiple power lines under limited right of way. To prevent monopolistic price gouging, stringent regulation of the operational expenditures of the network business will be required. But in the supply business, the monopoly can be removed and consumer choice can be brought in by enabling supply competition. Unless this is done, the discom will become a private monopoly, which could lead to rising electricity prices and to conflict with the state government.
Successful resolution of discoms can happen only if the state government itself takes the lead. Discoms are highly regulated entities. Unless the state government is able to provide confidence to private parties through a favourable policy environment and through confidence that the state regulator is independent, no private party would be willing to take over a state discom.
To summarise, while the IBC process may theoretically be applicable to state-owned discoms, its practical applicability will depend on untangling the crossed web of policy uncertainties. IBC can be a safe route to transfer the sector to more efficient management, provided the network business and the supply business are unbundled and supply competition is brought in. The recent Electricity Amendment Bill contains enabling provisions for such competition, but the successful resolution of state-owned Discoms depends primarily on the state government’s ability to create a supportive policy environment.
(Prasanth Regy, Consultant, NITI Aayog & Srikant Nagulapalli secretary, energy department, government of Andhra Pradesh)