In developed markets, transmission assets are owned by utilities
Until a few years ago, private investment in the power sector was primarily limited to power generation. Transmission was exclusively in the hands of central government-owned Powergrid Corporation of India (PGCIL) and state electricity boards (SEBs). However, given the deficit in transmission capacity, and the capital-intensive nature of the business, the government has decided to follow the PPP route to add capacity. Hence, we are seeing increasing interest from private players in transmission.
Favourable government policies have helped spark private sector interest in the sector. Initially, PGCIL called for tenders for transmission projects. However, since competitive bidding was made mandatory from January 2011, Power Finance Corporation and Rural Electrification Corporation act as nodal agencies for inviting tenders for central transmission projects. Some state governments such as UP, Rajasthan and Haryana have proactively called for tenders to award transmission projects within their states. In any case, state-level projects are expected to transition to mandatory bidding from January 2013.
India is one of the largest transmission markets globally. An estimated investment of $56 billion is required in Plan-XII in transmission, with about 30% expected to come from the private sector. Projects worth about $4.3 bn at the central level and $3.7 bn at the state level are currently under execution by private players, either alone or in partnership with state utilities/PGCIL. Favourable policies on increasing the security of receivables have further acted as a boost. In contrast, developed economies such as the UK and Spain face uncertainties over an impending change in tariff regulations, where regulators are expected to announce less favourable tariff policies than the ones in place.
Although the erstwhile ?regulated? transmission regime allowed a post-tax equity return in the mid-teens or higher, the current era of ‘competitive bidding’ has seen bids anywhere from low to mid-teen equity returns. The returns are similar to what has been observed in other emerging markets like Brazil, where transmission projects are awarded on a competitive bidding basis.
In contrast, developed economies such as the UK, Spain and the US, to name a few, currently follow a ?regulated return? model. Although returns in these countries are currently attractive (in the range of 9% to 11% in dollar terms), they have been trending down over the past few years. Further, many transmission companies are state-owned in Europe. For example, government-owned National Grid and Red Electrica are the sole players in England and Spain, respectively (although competitive bidding in transmission is being introduced in the UK). In the US, although more than 70% of transmission assets are privately-owned, most new transmission lines are set up by power generators themselves.
Also, the US does not follow a bidding approach to award transmission projects and it is the responsibility of the transmission service provider to identify the need for a new transmission network and get it approved by the respective regulator. Another point to note is that regulation in the US is fragmented, with local authorities deciding on allowed returns.
One needs to look at the nature of players in India to understand the reason for the seemingly low bid returns. An overwhelming number of bidders in transmission are EPC (engineering, procurement and construction) companies or those otherwise present in some part of the transmission value chain, which are looking at securing their order books. Apart from PGCIL, most of the bids have been won by two private players. The other winners are relatively smaller EPC companies.
Globally, it has been noticed that private EPC companies get involved in ownership of transmission assets in emerging markets, such as India, MENA and Latin America. On the other hand, it is pure play utilities that typically own these assets in developed markets such as the US and Europe. The other category of transmission line owners in India is generators, which typically enter into a JV with PGCIL to set up transmission lines primarily to secure power offtake from their own plants.
Overall, although returns in transmission are lower compared to generation, the operational risks associated with such projects are also lower.
Recent bids, both at central and state levels, have attracted quite a few foreign players, given the combination of asset returns and addition to EPC order book—100% FDI is allowed in power transmission. Foreign players such as Elecnor, Isolux Corsan, Inabensa, and CLP have been bidding for projects either alone or in partnership with local players.
A similar condition was observed in Brazil in the late ’90s, when the opening up of the sector attracted many private sector participants, including foreign players from Spain, Italy, Colombia and China.
As the private transmission market matures in India, with the current thrust given by the government, we expect to see a rise in mergers & acquisitions opportunities, with the total available size being anywhere between $2 bn and $4 bn in the next three to five years. Brazil has already seen several players sell part of their transmission portfolios to utilities, including foreign state-owned ones. Enough action lies ahead for Indian players, too.
Shyamal is partner-Infrastructure Practice, Ernst & Young. Lakra is a senior professional member in the same vertical. Views are personal
