metadata: authors: 0: author: Singh,Anoop
1: author: Jamasb,Tooraj
2: author: Nepal,Rabindra
3: author: Toman,Michael A.
count: South Asia
docna: 0: docna: Cross-border electricity cooperation in
            South Asia
docty: Policy Research Working Paper
subtopic: Rural and Renewable Energy,Hydro Power,Power & Energy Conversion,Energy Policies & Economics,Water and Energy,International Trade and Trade Rules,Energy Demand,Energy and Environment,Energy and Mining,Renewable Energy
teratopic: Public Sector Development,Governance,Macroeconomics and Economic Growth
abstracts: cdata!: South Asian countries, facing challenges
            in efficiently meeting growing electricity demand, can
            benefit from increased cross-border electricity cooperation
            and trade by harnessing complementarities in electricity
            demand patterns, diversity in resource endowments for power
            generation, and gains from larger market access. The region
            has witnessed slow progress in expanding regional
            electricity cooperation and trade, and undertaking needed
            domestic sector reforms. Although bilateral electricity
            sector cooperation in the region is increasing, broader
            regional cooperation and trade initiatives have lagged in
            the face of regional barriers and domestic sector
            inefficiencies. Deeper electricity market reforms are not a
            necessity for further development of cross-border
            electricity trade, but limited progress in overcoming
            regional and domestic barriers will limit the scope of the
            regional market and the benefits it can provide.
repnme: repnme: Cross-border electricity cooperation in
            South Asia
display_title: Cross-border electricity cooperation
            in South Asia
listing_relative_url: /research/2015/06/24687043/cross-border-electricity-cooperation-south-asia
topicv3: Energy and Extractives m1326595 507,Trade m1326924 698,Power Systems m1327093 508,Power and Electricity Sector m1327094 515,Hydropower and Dams m1327326 527
publishtoextweb_dt: 2015-06-26T00:00:00Z
historic_topic: Public Sector Development,Governance,Macroeconomics and Economic Growth
no_of_pages: 42
author_keys: 0: author_key: 585140
1: author_key: 605816
2: author_key: 2008906
3: author_key: 166060
model_extractions: WPS7328 Policy Research Working Paper 7328 Cross-Border Electricity Cooperation in South Asia _Anoop Singh Tooraj Jamasb Rabindra Nepal Michael Toman_ Development Research Group Environment and Energy Team June 2015
Policy Research Working Paper 7328

# **Abstract**

- South Asian countries, facing challenges in efficiently meet ing growing electricity demand, can benefit from increased cross-border electricity cooperation and trade by harnessing complementarities in electricity demand patterns, diversity in resource endowments for power generation, and gains from larger market access. The region has witnessed slow progress in expanding regional electricity cooperation and trade, and undertaking needed domestic sector

reforms. Although bilateral electricity sector cooperation in the region is increasing, broader regional cooperation and trade initiatives have lagged in the face of regional barriers and domestic sector inefficiencies. Deeper electricity market reforms are not a necessity for further development of cross-border electricity trade, but limited progress in overcoming regional and domestic barriers will limit the scope of the regional market and the benefits it can provide.

This paper is a product of the Environment and Energy Team, Development Research Group. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at mtoman@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Cross-Border Electricity Cooperation in South Asia**

Anoop Singh,Tooraj Jamasb, Rabindra Nepal, and Michael Toman Keywords: electricity, regulatory reforms, regional cooperation, South Asia JEL classification: L94; Q49; R58
# **Cross-Border Electricity Cooperation in South Asia**<sup>**1**</sup>

# **1. Introduction**

Access to reliable, affordable and cleaner energy is a high priority to facilitate further economic development and improved welfare of the population in the South Asia region (SAR).<sup>2</sup> Access to adequate and high-quality energy is part of a larger effort toward reducing adverse impacts of infrastructure scarcity in the region (Andres, Biller and Dappe 2013a, 2013b; Ghosh Banarjee et al, 2015). In SAR, poor access to electricity combines with unreliable supply due to chronic electricity shortages and unexpected interruptions.<sup>3</sup> Shortages and unpredictable availability of electricity also have led to costly and environmentally harmful investment in small-scale back-up generators (World Bank 2013a, 24).

Strengthening cross-border electricity cooperation in South Asia can be part of the solution for providing adequate and reliable electricity availability. One reason is that there are complementarities in electricity demand and resource endowments among these countries due to diversity of primary energy resources and differences in seasonal patterns of supply and demand. In addition, increased electricity cooperation and trade among countries can bring economies of scale in investments, strengthen electricity sector financing capability, enhance competition and improve sector efficiency, and enable more cost-effective renewable electricity penetration (Timilsina et al, 2015; Singh et al., 2013; ESMAP, 2010;Srivastava and Mishra, 2007; Thakur, 2004).For example, Nepal and Bhutan have comparative advantages in hydropower

> 1Anoop Singh (corresponding author; anoops@iitk.ac.in) is an Associate Professor in the Department of Industrial and Management Engineering at the Indian Institute of Technology Kanpur; ToorajJamasb <u>(tooraj.jamasb@durham.ac.uk) is a Professor in Energy Economics in the School of Business at</u> Durham University; Rabindra Nepal <u>(r.nepal@uq.edu.au) is a Research Fellow in the School of</u> Economics at The University of Queensland; Michael Toman <u>(mtoman@worldbank.org) is Lead</u> Economist and Manager of Environment and Energy Unit, Development Research Group, World Bank, Washington, DC. This research was supported by funding to the World Bank from the UK Department for International Development and the Australian Agency for International Development.

> 2In this paper, the South Asia Region (SAR) refers to Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka.  Afghanistan and Maldives also are in this region as it is defined by the world Bank, but we do not cover them in this paper..

> 3The countries in the South Asia region are home to around 1.57 billion people (23.7% of global population), while covering only around 4% of the global landmass. Around 493 million people lived devoid of any electricity access across South Asia in 2009, despite electricity sector reforms in the region (IEA, 2011). In 2010, average per capita electricity consumption in the region was recorded to be 563 kWh as compared to the world average of 2977 kWh (Singh et al., 2013).

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production that can only be realized with cross-border trade. Those countries also experience significant declines in hydroelectric generation during the winter season, and thus would benefit from improved access to thermal-based electricity generation from neighboring countries.

Efforts to expand cross-border electricity cooperation and trade in SAR need to be address several barriers. Some of these reflect elements of the regional-level political climate, while others arise due to limited scope and extent of domestic electricity sector policies and renovations. Review of the reform process and identification of barriers to cross-border electricity trade are the main objectives of this paper.

The remainder of the paper is structured as follows. Section 2 reviews the status of cross-border electricity cooperation in SAR. Section 3 identifies key regional-level barriers to expanding cross-border cooperation and trade in SAR. Section 4 discusses the extent to which current domestic sector policies impede greater cross-border electricity cooperation. Section 5 summarizes the findings of the paper and offers some policy recommendations for moving ahead on increased cross-border trade and cooperation.

# **2. Current Status of Cross-Border Electricity Cooperation in South**

# **Asia**

Increased regional electricity cooperation can be seen as part of a larger interest in expanded trade and cross-border market integration. General interest in regional economic cooperation has existed for some time in SAR; it predates the formation of South Asian Association for Regional Cooperation (SAARC) in 1985. The agreement for a South Asian Free Trade Area (SAFTA) signed in 2004 envisioned a transition toward a common market. Tangible expressions of the interest in regional energy cooperation followed soon after the formation of SAFTA. The South Asia Regional Energy Coalition (SAREC) in 2006 was formed to promote advocacy initiatives by leading policy-oriented business associations in South Asia. The SAARC Energy Centre (SEC), established in 2006 as a Special Purpose Vehicle (SPV) with its base in Islamabad, Pakistan, also has had a focus on regional energy sector cooperation in South Asia.

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In late 2014, SAARC member states agreed to a “framework agreement” for regional cooperation in electricity.<sup>4</sup> The agreement contains broad-ranging provisions for the establishment of a regional market for electricity, including nondiscriminatory access to transmission, market-based pricing of electricity exchanged, and establishment of a body for coordinating regional power integration and trade. It remains to be seen how extensively or rapidly these provisions will be put into practice.

At present simple bilateral arrangements for power transmission and trade are predominant. In particular, bilateral generation and transmission arrangements between Nepal-India, India-Bhutan and most recently India-Bangladesh dominate regional electricity cooperation in South Asia (Singh et al., 2013; Srivastava and Mishra, 2007; Paudyal, 2013). Table 1 summarizes the current state of cross-border arrangements for electricity sector cooperation in South Asia. These bilateral relationships are mostly based on government-to-government relationships, with a limited to minimal role played by the private sector.<sup>5</sup>

# **_2.1. Nepal-India Electricity Cooperation_**

Nepal relies heavily on energy imports from India, which includes importing energy products like electricity, diesel generations and petroleum products and inverters. The history of bilateral electricity cooperation between Nepal and India dates back to as early as 1920s. The Kataiya powerhouse, and Trishuli, Devighat and Phewa hydropower projects were some of the initial government-to government hydroelectric schemes implemented in Nepal with the financial and technical assistance from the Government of India (GoI). Development of the 1 MW hydroelectric project in 1968 at Pokhara with the Indian assistance laid the foundation for how broader electricity sector cooperation between Nepal and India. This was followed up by a 21 MW plant at Trisuli (1969), 15 MW plant on Western Gandak

> 4See http://www.saarc-sec.org/userfiles/SAARC-FRAMEWORK-AGREEMENT-FOR-ENERGY- <u>COOPERATION-ELECTRICITY.pdf.</u>

> 5The private sector is starting to become more involved in cross-border power projects.  A number of Indian investors are developing large power projects in Nepal, part of which can serve the export market.  A number of power generation projects in Bhutan as well Nepal are witnessing participation of private investors, including those from within South Asia. As of December 2014, 161 mostly small hydro projects (totaling about 2000 MW) have been developed and are under development in Nepal. Most of the small projects are being developed by the private investors.

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(1979) and 14.1 MW plant at Devi Ghat (1983). By 1971, Nepal and India had signed a Power Purchase Agreement with limited low-capacity exchange at various locations along the Nepal-India border. Under this border town exchange program, electric utilities in Nepal and India (Bihar) provide access to electricity to the towns that are accessible easily from across the border through a number of 11 kV and 33 kV crossborder interconnections.

|**_Participants_**|**_Cross-border electricity trade_**|
|---|---|
|**_India – Nepal_**|Nepal imported 793GWh electricity in 2013 from India over multiple<br>interconnections.|
|**_India-Bhutan_**|Electricity import from Bhutan to India was 5556 GWh in 2013-14<br>(4627 GWh in 2012-13) from Hydro power stations at Tala, Chukha and<br>Kurichu with a total export led capacity of 1416 MW.<br>As per an umbrella agreement between the two countries, India assures<br>a minimum of 5000 MWelectricity import by 2020.|
|**_Pakistan-Iran_**|Pakistan imported 419 GWh electricity in 2014 from Iran, up from 375<br>GWh in thepreviousyear.|
|**_Afghanistan-_**<br>**_Central Asia_**|Import of 2,246.2 GWh electricity from Iran, Uzbekistan, Turkmenistan,<br>and Tajikistan in 2011. CASA-1000 expected to enhance this trade.|
|**_Pakistan-India_**|Pakistan has submitted a draft MoU to India on importing electricity<br>using a 1200 MW interconnection. There are also possibilities of CASA<br>to be extended to India.|
|**_India-Sri Lanka_**|Feasibility studies for a 400-kV India-Sri Lanka have been conducted to<br>support import of up to 1000 MW electricity from India.|
|**_India-Bangladesh_**|In 2013, power systems of India and Bangladesh were interconnected<br>through a HVDC line that can support electricity export of up to 500<br>MW (expandable to 1000 MW in future) from India to Bangladesh<br>based on negotiated price andmarket based price.|

Table 1: Existing and some proposed cross-border electricity trade arrangements in South Asia Source: Compilation from Singh et al. (2013), NTDC (2014), ERLD (2014) The two countries signed a treaty in 1996 for integrated development of the Mahakali River basin, including Sarada barrage, Tanakpur barrage and Pancheshwar projects. In July 2001, the GoI nominated the Power Trading Corporation (PTC) as the nodal agency to deal with matters relating to power exchange with Nepal (Mittra, 2012). PTC is also the sole agency from the Indian side for finalizing commercial and technical arrangements/systems with the Nepal Electricity Authority (NEA) and coordinating with associated Indian agencies. A power trade agreement was signed between Nepal and India in October 2014 to expand the bilateral electricity trade between the two nations. The completion of two double-circuit transmission corridors 5
between Dhalkebar-Muzaffarpur (90 kms) and Hetaua-Duhabi (40 kms) (partly funded by the World Bank), coupled with the operation of a combined 20,000 MW capacity of hydropower projects undergoing feasibility study in Western Nepal is expected to increase the electricity trade between India and Nepal.

Generation capacity addition in Nepal significantly lags behind growing electricity demand, making Nepal a net importer of electricity from India (Figure 1). Electricity imports now account for nearly 20% of the total availability. Given the existing demand-supply mismatch in Nepal, it may continue to import electricity from India through the upcoming interconnections in the short-term. However, it can become a net exporter of electricity as the country develops its vast hydroelectric potential.

Figure 1: Changing Balance of Electricity Trade between Nepal and India Source: NEA (2013) <!-- Start of picture text --> 900 25<br>Import of electricity from India<br>800<br>Export of electricity to India 20<br>700<br>600 Share of electricity import in total<br>availability<br>15<br>500<br>400<br>10<br>300<br>200<br>5<br>100<br>0 0<br>2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013<br>(P)<br>So: NEA (2012, 13) Year<br>(GWh)<br>Percentage share<br>Import and Export of Electricity from India<br><!-- End of picture text -->

# **_2.2. Bhutan-India Electricity Cooperation_**

Bhutan conducts 80% of its total trade with India; electricity trade constitutes 45% of Bhutan’s total exports. Electricity is Bhutan's principal export commodity and the largest revenue earner (ADB, 2013). In 2011-12, earnings from export of electricity to India accounted for 11.4% of the country’s GDP (Singh et al., 2013). The bilateral arrangements between India and Bhutan started with the Jaldhaka Agreement in 1961. The first hydroelectric plant (Joshina) of 360 kW capacity was commissioned in 1967 6
under the grant assistance of the GoI. Bilateral electricity connections from West Bengal and Assam were set up to electrify bordering villages and towns in Bhutan in the 1970s and 80s. The Chukha agreement was signed in 1974 for the joint development of a 336 MW hydropower plant (construction completed in 1988) in Bhutan between the GoI and the Royal government of Bhutan (RGoB) with financial assistance from India. Another agreement was signed between the GoI and RGoB in 1994 for the joint development of the Kurichhu hydropower plant (60 MW) in 1994 while the construction was completed in 2001-2002. Similarly, the Tala agreement was signed between the GoI and RGoB in 1996 while the construction of the Tala hydropower project (1020 MW) was completed in 2006. In 2006, an umbrella agreement was signed by the two countries to facilitate and cooperate in hydropower development and trade through public and private sector participation. Under this agreement, India agreed to import at least 5000 MW from Bhutan by 2020 (Singh et al., 2013). The PTC is the nodal agency responsible for the purchase and sale of power from Bhutan to India.

Apart from gaining significant export income, a minimum 12% royalty from power projects prompted the Royal Government of Bhutan to target 100% electrification in the country by the end of 2013, while ensuring continuity of lifeline electricity consumption to its population. Access to thermal power from India during the dry winter season highlights mutual benefits of interdependency of the two power systems.

# **_2.3. India-Bangladesh Electricity Cooperation_**

In January 2010, Bangladesh and India signed a memorandum of understanding (MOU) to exchange electricity through a cross-border interconnection leading to development of a 400 kV, 30-km double-circuit HVDC line from Bheramara (Bangladesh) to Baharampur (India) and a 500 MW 400/230 KV back-to-back HVDC substation at Bheramara. The link has an initial capacity of 500 MW, which can be later expanded to 1000 MW (Singh et al., 2013). An electricity purchase pact was inked between NTPC VidyutVyapar Nigam in India and Bangladesh Power Development Board (BPDB) in Bangladesh in early 2012 for the import of electricity to Bangladesh. The 25-year government-to-government electricity purchase deal involves providing 250 MW of coal-fired electricity from India to Bangladesh. On 7
December 4, 2013, the full transmission power capacity of 500 MW was achieved (Brady, 2014). The Asian Development Bank (ADB) financed the project under an India-Bangladesh power exchange initiative.

# **3.  Barriers to Cross-Border Electricity Cooperation**

The scope and extent of cross-border electricity cooperation varies across regions (Pineau, Hira and Froschauer, 2004; Oseni and Pollitt, 2014). Regional electricity cooperation for market integration typically evolves in the wake of bilateral crossborder electricity trade arrangements. The more advanced arrangements incorporate shared generation assets and multi-country trading through integrated competitive markets.

Regional agreements for power sector cooperation and trade can take time to achieve. For example, realization of the Central American Power Market (SIEPAC for its Spanish initials) took 23 years from the time the feasibility study was completed. Similarly, electricity sector cooperation in the Greater Mekong Sub-region (GMS) also witnessed a timeline spread over two decades, and still continues to evolve.

Slow progress of cross-border electricity trade can be attributed to technical, operational, political and commercial issues. These vary according to socio-economic and political circumstances in the region. A number of electricity cooperation initiatives around the world have faced some common challenges, even in sophisticated OECD electricity systems (ESMAP, 2010). For example, transmission and trade cooperation arrangements, such as the Southern Africa Power Pool and the West African Power Pool, have failed to realize their full potential without development and timely implementation of a long-term transmission plan, and differing expectations of electricity prices by buyers and sellers (Singh et al., 2013).

Arguably, the current state and magnitude of electricity cooperation and trade in SAR is far less than the potential considering the regional diversity of energy resource endowments and differences in demand patterns across countries in the region (Wijayatunga and Fernando, 2013; Singh et al., 2013,Timilsina et al, 2015). We focus in this section on three regional-level barriers. In the next section we consider 8
how weaknesses in domestic sector policies also impede cross-border cooperation and trade.

# **_3.1. Dynamic and Uncertain Regional Political Climate_**

Historical animosity or lack of trust has often frustrated the process of regional cooperation in South Asia, including regional power sector cooperation. While there are encouraging signs, political rhetoric for electricity cooperation has not consistently translated into the political will and action for cooperation in South Asia (Paudyal, 2013). Internal political conflicts also have slowed down the process of regional electricity sector cooperation. In addition, the government-to-government model for cross-border trade typically involves lengthy political as well as technical negotiations, diminishing economic gains.

Regional cooperation is perceived by some as a threat to national safety and energy security, as reflected in debates over power trade between India and Pakistan (Mukherji and Chaturvedi, 2013). In another case, inability of the Bangladeshi government to provide a guaranteed supply of natural gas for a proposed USD 3 billion power project investment in Bangladesh by an Indian company resulted in the latter abandoning the business venture altogether (Rahman et al., , 2012). On the other hand, entry of Chinese investment has prompted India to explore electricity cooperation with Sri Lanka and Nepal (Chaturvedi, 2013; Mittra, 2012).

The ability of the cross-border trade of electricity to address public interest, social and environmental concerns has been questioned (Williams and Ghanadan, 2006). For example, large-scale development of water resources in Nepal and Bhutan will generate significant economic rents. Debates over the distribution of such rents can generate conflicts and opposition to large-scale resource development initiatives.

# **_3.2 Absence of a Platform for Cross-Border Regulatory Coordination_**

Increased electricity cooperation and trade in the region requires national regulators to pay more attention to harmonization and coordination of their regulatory practices. Technical aspects such as rules and procedures concerning transmission access and its pricing, congestion management, operational codes and protocols for system operation, energy accounting and payment thereof, and data transfer protocols need to 9
be gradually harmonized for seamless and stable operation of the transmission systems.<sup>6</sup>

## **_3.3. Tariff and Non-Tariff Market Barriers_**

Like other commodities and services, trade in electricity is hindered by export tax, import duty and transit tax. The South Asian Free Trade Agreement (SAFTA), when signed, did not give special treatment to energy, particularly electricity trade. Although signing in 2014 of the SAARC Framework Agreement for Energy Cooperation (Electricity) during 18th SAARC Summit in Kathmandu has given impetus to expanded regional power trade, more needs to be done for implementation of a regional agreement for free trade of electricity. For example, electricity import licensing restrictions in India that limit participation to specifically identified (socalled nodal) agencies also limit entry in cross-border trade and hinder the development of power exchange (Singh et al., 2013).

Power sector trade-related reforms also are inter-dependent with wider reforms, and failure to harmonize inter-sector reforms can lead to power sector reform measures being ineffective (Nepal and Jamasb, 2012b). For example, India and Sri Lanka are yet to sign a free trade agreement, while India also has been reluctant to waive imports duty for imported construction equipment and materials to Nepal from a third country. Similarly, Pakistan is yet to grant Most Favored Nation (MFN) status to enhance trade with India.

# **4. Impact of National Electricity Sector Policies on Cross-Border Cooperation and Trade in South Asia**

In addition to regional-level barriers to increased cross-border electricity cooperation and trade in SAR, weaknesses in domestic sector policies also create impediments. To build the case for this assertion, in this section we review the status of sector policies and performance in SAR.

> 6 Establishing a SAARC level Transmission System Operator (TSO) or Coordination Forum of System Operators is an option as national transmission grids get increasingly integrated. HVDC interconnections, while costly,  allow some flexibility due to asynchronous operation of the interconnected power systems.

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# **_4.1 Overview of Power Sector Reforms in South Asia_**

Countries in the South Asia region initiated national electricity sector reforms following somewhat different timelines, as shown in Table 2 below.<sup>7</sup> The process of reform in the power sector was undertaken to address several ongoing problems: the fiscal burden of price subsidies and low revenue collection rates, and the economic burden of low service quality, and high network losses experienced under largely state-owned and controlled systems (Newbery, 2002, Singh, 2006). One of the objectives of sector reform in SAR (as elsewhere) is to attract more domestic and foreign private sector investments (Singh, 2007). Other objectives include reducing dependence on state support and ensuring affordable and reliable service quality (Lama et al., 2002).To accomplish these aims, it is ultimately necessary to manage sector activities in a more economically efficient and competitive manner.<sup>8</sup> As indicated in Table 2, the single buyer model (SBM) ( _one buyer and many sellers_ ) dominates the wholesale generation market arrangements across the region. Only India has introduced a degree of competition in wholesale markets for electricity, and a day-ahead market (Singh 2010; Thakur et al., 2005). Vertically integrated incumbent electric utilities in Pakistan and India have undertaken functional unbundling (Singh et al., 2013). Most of the larger states in India have unbundled the erstwhile State Electricity Boards (SEBs) into separate corporatized entities for generation, transmission and distribution. Due to a provision of the Electricity Act of 2003, the bulk power procurement activity of the unbundled transmission utilities has been separated out from the provision of transmission.

Partial unbundling has been undertaken in Bhutan, as well as Sri Lanka. By law, Bhutan has designated a government entity to be the single buyer of electricity for all power projects, including the private ones. The electricity sector in Bangladesh is

> 7 The appendix contains more details on national sector policy changes in individual SAR countries. 8 Market reform approaches have been influenced to a greater or lesser extent by the “standard sector reform” model, which gained prominence in policy and analytical circles in the early 1990s. The standard model for electricity reform involves the following reform sequence and steps (Victor, 2005; Jamasb, 2006): i) establishment of an independent sector regulator; ii) corporatization of state-owned enterprises; iii) establishment of laws for electricity sector liberalization; iv) unbundling (or vertical separation) of the main industry segments (generation, transmission, distribution); v) implementation of more incentive-based regulation of electricity networks, to induce improved performance; vi) establishment of a wholesale electricity market; vii) privatization; and viii) introduction of independent power producers (IPPs).

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horizontally unbundled with separate entities, catering to the requirements of the rural and urban areas. A legislative initiative has been advanced to unbundle the Nepal Electricity Authority. However, the fate of this remains unclear due to the persistent political uncertainty in the country.

Table 2: Status of major reform elements in South Asia <u>Source: Compiled by the Authors.</u>

|**_Country_**|**_Nominal_**<br>**_generation_**<br>**_market structure_**|**_Initi_**<br>**_ow_**<br>**_p_**<br>|**_ation of pr_**<br>**_nership an_**<br>**_articipatio_**<br>|**_ivate_**<br>**_d/or_**<br>**_n:_**<br>|**_Introduction_**<br>**_of legally_**<br>**_independent_**|**_Transmission_**<br>**_Arrangement_**|
|---|---|---|---|---|---|---|
|||Genera-<br>tion|Trans-<br>mission|Distri-<br>bution|**_regulator_**||
|**_Bangladesh_**|Multiple sellers,<br>single buyer|1992|||2003|Unbundled<br>transmission<br>owner|
|**_Bhutan_**|Multiple sellers,<br>single buyer|2008||||Vertically<br>integrated|
|**_India_**|competition with<br>organized trading,<br>but includes SOEs|1991|2000|1999<br>(Orissa);<br>2002<br>(Delhi)|1996<br>(Orissa);<br>1998<br>(national)|Unbundled<br>transmission<br>and<br>independent<br>system<br>operator<sup>9</sup>|
|**_Nepal_**|Multiple sellers,<br>single buyer|1992|||1994/2011|Vertically<br>integrated|
|**_Pakistan_**|Multiple sellers,<br>single buyer|1994|1995|1998<br>(KESC)|1995|Unbundled<br>transmission<br>owner|
|**_Sri Lanka_**|Multiple sellers,<br>single buyer|1996|||2002/2009|Vertically<br>integrated|

The ownership of the generation segment is mixed. There is private sector participation in the form of IPPs in Bangladesh, India, Nepal, Pakistan and Sri Lanka. However, the bulk of generation assets remain state-owned, and many of the IPPs constitute small-scale and costly plants that started operation as a response to crises in electricity availability, particularly in Bangladesh and Pakistan.

Transmission and distribution remain largely under government ownership across the region. In India, private investors are permitted to invest in creation of transmission

> 9 System operator continues to be bundled with the transmission utility at the state‐level.

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infrastructure under a license. A number of transmission links have been created in this manner including those between Bhutan and India, which have been constructed under a joint ownership agreement between the private investors and the government of India. The Indian states of Delhi and Orissa,<sup>10</sup> and one distribution area in Pakistan (in Karachi) are the only examples of privatized electricity distribution in the region.

Independent regulatory commissions have been introduced in the majority of SAR countries. The process is still pending in Nepal (Nepal and Jamasb, 2012a), and remains partially implemented in Bhutan. More generally, the reform process has been slow in most of the SAR countries. In Sri Lanka, for example, a new Electricity Act was enacted only in 2009. Even in India, where the reform process has operated for almost two decades, politics and reform remain intertwined (Dubash and Rao, 2008; Tongia, 2007).

In India, market-oriented reform has had to face a number of challenges, although market-oriented activity including short-term competitive power markets is increasing (Littlechild, 2013). There is evidence that reform in India since the early 1990s has improved operational efficiencies (Cropper et al 2011), though effects are not necessarily realized immediately (Sen and Jamasb, 2012). While the country has embraced deeper market reforms that improved competition in the generation sector, the distribution sector continues to exhibit serious operational inefficiency as well as financial losses (Pargal and Ghosh Banarjee, 2014).<sup>11</sup> Losses also are serious in Bangladesh and Pakistan, where prices remain below cost-recovery levels and, in Pakistan, rate increases approved by the regulator are overridden by the legislature.

# **_4.2 Performance of National Electricity Policy Reforms_**

The reforms in the electricity sector in most of the SAR countries have been aimed mainly at enhancing operational performance, with relatively less emphasis on being “market-oriented”. India remains an exception by opening up the sector to competition and adopting market-oriented policies. To accomplish the objective of

> 10All four electricity distribution companies in Orissa were privatized (three distribution companies to BSES Ltd, now Reliance Energy Ltd., and one to AES of USA). Due to regulatory and legal issues, however, AES exited the business and the control of that company fell back to the state government. 11Wolak (2008) argues that India’s institutions for electricity regulation themselves need significant restructuring to support restructuring of the country’s power sector.

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improving operational and financial performance of the sector, it is important that reforms include cost-reflective electricity pricing and effective targeting of electricity subsidies to improve the financial viability of the sector, as well as gradually opening up the sector to increased competition.

The lack of cost reflective pricing in SAR has been a major contributor to financial problems of national power sectors. The inability of the sectors to generate sufficient surplus has affected the ability of the electric utilities to invest in capacity additions for electricity generation, transmission, and distribution. It also has stunted incentives for private sector entry in generation, even if the entry barriers for the same have been lowered or removed. Poor financial and operational performance in the electricity sectors of SAR countries reflects weaknesses in the structure and governance of the sector (Bhattacharya, 2007).

Many of the anticipated benefits of reforms have been realized only to a limited extent, if at all. The performance indicators summarized in Table 3 provide evidence supporting these assertions.<sup>12</sup> The specific problems include the following:

# _(i) Insufficient investment in generation capacity._

The pace of growth in investments in power generation across the SAR remains slow; it does not match the growth in electricity demand of existing consumers, or to the new consumers gaining electricity access. The result is a large number of rolling power outages (Nayar et al, 2012). For example, some rural areas in Pakistan experienced load shedding and blackouts up to 20 hours a day in 2012, while Nepal also experienced up to 14-hour daily power outages in 2013 (Sovacool et al., 2013). Against a peak demand of 6500 MW, Bangladesh experienced load shedding of 10001200 MW in 2011 (GoB, 2014a). Sri Lanka, which remains significantly dependent on hydro-electric generation, is prone to electricity shortages during droughts, even though the average shortages remain as low as two hours a day. Peak demand and energy shortages in India declined from 11.51 % and 17.97 %, respectively, in 199697, to 4.2 % and 4.5 %, respectively, by 2013-14, while the share of private investment grew to 34% by the end of March 2014 compared to a meager 3.6 % at the

> 12 Kessides (2012) shows that these conditions persist in a number of developing countries, even after more than two decades of sectoral reforms and restructuring.

14
end of November 1994. Without that increase in private investment, power shortages could have been higher.

Table 3: Power sector performance indicators in South Asia (selected countries)

||Installed<br>capacity<br>(MW)|Peak<br>demand<br>met(MW)|Peak<br>demand<br>(MW)|IPPs/Private<br>Sector share<br>in installed<br>capacity<br>(%)|Electricity<br>access rate<br>(%)<sup>*</sup>|Technical<br>losses (% of<br>generation)|Per capita<br>electricity<br>consumpti<br>on (kWh)|
|---|---|---|---|---|---|---|---|
|Bangladesh|8537|6434|8349|16.35|60|14.36|213|
|India #|243028|126793 $|131943 $|34.0|75|23.65|917|
|Nepal|720|569.6<sup>**</sup>|1094.6|33.33|76|25.03|106|
|Pakistan|23412|13445|18467|35.56|69|17|450|
|Sri Lanka|3312|2112<sup>***</sup>|2146|33.15|85|14|490|

_Sources_ : Bangladesh (BPDB, 2014); Nepal (NEA, 2013); Sri Lanka (CBSL, 2013), India (CEA, 2014); Pakistan (Kessides, 2013),<sup>*</sup> IEA (2011),<sup>**</sup> excludes electricity imports capacity from India,<sup>***</sup> based on 1.2 GW hydro plant not running during drought seasons, # As on March 2014, $ For March 2014 There are estimates indicating that inadequate power supply imposes significant costs on South Asian economies. For example, the cost of load shedding to the Pakistani economy was estimated to be PKR 1,272 billion (Pakistani Rupees) in 2011-12, equivalent to 6% of the economy (Saeed, 2013). Table 4, based on data from World Bank enterprise surveys, provides an assessment of the direct loss of economic output by electricity users due to electricity outages in South Asian countries, along with additional statistics indicating the degree of service unreliability in the region.

# _(ii) Low operational efficiency and service quality._

Technical losses (both transmission and distribution) are estimated to average 14– 25% of electricity generation in the region (Smith, 2004). The technical losses are particularly high in Nepal, Afghanistan and Pakistan. The poor physical condition of the transmission and distribution (T&D) networks in the face of networks investment inadequacy is one of the important causes of high network losses (Palit and Chaurey, 2011). Lower T&D losses have been achieved by the relatively more efficient distribution utilities in India, and in Bangladesh and Sri Lanka. This indicates in turn thatmuch of the observed T&D losses of 35-40% across states in India are due to nontechnical reasons. Lack of metering of all consumers remains a challenge for the 15
utilities and the regulatory commissions to arrive at an accurate estimate of network losses, and to separate out non-technical from technical losses (Singh, 2006).

Table 4: Loss of economic output due to electrical outages and impact unreliable electricity supply on busineess activity <u>Source: World Bank (2013) and Nayar et al. (2012)</u>

|Country|Economic value<br>lost by enterprises<br>due to electrical<br>outages<br>(As a % of sales)|Average time of<br>outages per month<br>(hours)|Percentage of<br>firms citing<br>electricity<br>availability or<br>reliability as a<br>major or severe<br>constraint for<br>growth|Percentage of<br>firms owning<br>generators|
|---|---|---|---|---|
|Afghanistan (2007)|6.4|280|66|71|
|Bangladesh (2007)|10.6|113|78|52|
|Bhutan (2009)|4.3|8|6|18|
|India (2006)|6.6|---|32|41|
|Nepal (2009)|27.0|226|76|16|
|Pakistan (2007)|9.2|69|74|26|
|South Asia overall|10.7|139|53|43|

The non-technical electricity losses due to power theft can involve fraud (meter tampering), stealing (illegal connections), billing irregularities such as non-payment, and corruption (Smith, 2004). In April 2014, power was cut off in 18 government buildings in Pakistan including the Presidential residence because of nonpayment of electricity bills. In Bangladesh, electricity theft was estimated to be at 14%. In India, a third of electricity is lost through non-technical losses each year (Min and Golden, 2014).

_(iii) Weak financial performance_ . Electricity losses translate to lost revenues to the power companies and poor service quality, Revenue inadequacy, due to both nontechnical losses and distorted tariffs, remains one of the grave concerns of the stateowned electric utilities in South-Asia. In Bangladesh, for example, accounts receivable, due to the electricity bills not paid, was equal into 8.7 months of unpaid electricity consumption in 1999- 2000. This improved to about 2 months by 2013-14 in a decade of electricity reform experience (GoB, 2014b). For its part, the Nepal Electricity Authority incurred a financial loss of Nepalese Rupees (NPR) 4 billion in 16
2012 due to overstaffing, weak management and heavy electricity leakage despite the tariff hike (NEA, 2013).<sup>13</sup> During the 1990s, amounts due by the State Electricity Boards in India to central power sector utilities, coal companies and the railways rose to INR 414.7 billion (GoI, 2001). In 2002, following a one-time tripartite settlement, amounts due began to be securitized by the respective state governments (Singh, 2006).<sup>14</sup> However, mounting debts now face state electric utilities. The accumulated financial losses of the power sector in India increased from INR 190 billion in March 2005 to over INR 1070 billion by March 2010 (GoI, 2011). Total receivables for the power sector utilities swelled from INR 3100 billion in March 2005 to over INR 5600 billion in March 2010 (GoI, 2011). In some states the arrearages were the equivalent of well over a year of unpaid power consumption.<sup>15</sup> In Pakistan, the sector is suffering from a growing “circular debt” problem. The circular debt arises when an operating entity facing problems with outstanding receivables holds back payments to its suppliers and creditors (Kessides, 2013). The lack of payments affects various government departments, generation and distribution companies under the control of KESC and PEPCO, domestic and international fuel suppliers, and refineries in the Pakistani power sector. They affect the fiscal position of the government as a whole.

The circular debt in the power sector had reached PKR 537.5million in 2011, with the potential to lead to shutdown of generation plants and further worsening of demandsupply imbalances in the power sector (Javaid, 2012). The new government at the time settled the existing circular debt through a one-time government subvention of PKR 480 billion in July 2013. However, the issue re-emerged soon afterwards, highlighting the fact that the underlying causal factors had not been effectively addressed. A report commissioned by the Planning Commission of Pakistan identifies the main source to be a difference between the “tariff differential subsidy” (TDS) the government claims to pay to distribution companies versus the amount actually

> 13One US Dollar= NRS. 97 and PKRS. 98 (as of May,2014) and one INR. = 160 NPR.

> 14 See also Dossani (2004) for discussion of the reorganization of the Indian distribution sector.

> 15 Additional details are in Pargal and Ghosh Banarjee (2014).

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disbursed. A second cause is the T&D losses that distribution companies are allowed by NEPRA for tariff determination are lower than the actual levels (GoP, 2013). State Electricity Regulatory Commissions (SERCs) grapple with a similar situation in India (Singh, 2006).

_(iv) Limited involvement of the private sector_ . Attracting foreign and domestic capital through private sector participation in the power sector was one of the major objectives of reforms in SAR (Victor and Heller, 2007). Hence, IPPs were allowed to sell electricity to the grid under state supported long-term contracts in the SAR. Reforms in the region thus have had some success in attracting private sector participation in power generation. For example, in both Nepal and Sri Lanka, IPPs’ share of installed generation capacity increased from 21% in 2004<sup>16</sup> to around 33% in 2012 (see Table 3 above). In India, the share of the private sector in the electricity generation capacity has grown to more than 34% by the year 2014 (CEA, 2014). In Pakistan, the share of the private sector increased from 30% in 2004-05 to 49.34% by June 2013 (GoP, 2013). In Bangladesh, the share of private sector in total generation capacity was 40% in July 2014.<sup>17</sup> Nonetheless, many IPP projects built rapidly to address electricity shortages are small in scale and not cost-effective.

Privatization of electricity distribution remains a politically sensitive decision in the region. The Indian state of Orissa was home to the first experiment, in 1999, with privatization of electricity distribution in the region. The initial hiccups in this exercise postponed further attempts at privatization elsewhere. Privatization of electricity distribution in Delhi, in 2002 was remodeled based on the experience in Orissa: it incorporated performance milestones based bidding criteria with declining government support. Evidence indicates that these and other privatized distribution companies have considerable decreases in technical and commercial power losses (IDFC, 2010). Privatization of electricity distribution in Karachi faced political hurdles, making it difficult to implement similar process elsewhere in the country.

> 16See Bhattacharya (2007) for the 2004 data on IPPs’ share in generation capacity.

> 17Most of the private sector investments in the electricity sector in South Asia are based on the private sector choosing to invest by itself, though there also have been some Public-Private Partnerships (PPPs). The PPPs have mainly occurred in the power generation segment under build-operate-operate (BOO) arrangements such as in India.

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Nonetheless, there is little happening at present in moving toward broader privatization in the distribution segment.

# **4.3.** **_Implications of Limited National Sector Reforms on Development of CrossBorder Electricity Cooperation and Trade_**

Domestic power sector reforms have an important bearing on the prospects for success in cooperation, cross-border and ultimately regionally (Belyaev, 2011). In particular incomplete domestic power sector reforms can create barriers for facilitating wider electricity cooperation. Some of these barriers are easy to infer from the discussion in the previous subsections. Domestic policy distortions, including investment recovery rules and subsidies in pricing, reduce incentives for expanding generation investment for increased cross-border trade and limit the reward for expanding transmission capacity. Underpriced electricity does not provide effective signals to attract private domestic and foreign investment, as the scope for earning a reasonable rate of return on the capital employed is low. Moreover, investment risks will be higher when erstwhile partners in cross-border investment and trade are in a weak financial condition and may not be able to deliver on promised levels and quality of service.

Weak laws and policies may provide electric utilities with substantial potential to exercise domestic market power. This, in turn, can create barriers to entry for new players in a regional market, even to the point of making competition unsustainable (Green, 2003). Market power issues remain important, as reforms have on many occasions failed to adequately address them (Newbery, 2002). The strong opposition to opening of domestic markets to foreign imports and the resulting interest in anticompetitive policies and practices should not be underestimated (ESMAP, 2010). Weak markets due to regulatory distortions can also complicate long-term contracting for power and make financing cross-border electricity trade more challenging, in particular by creating regulatory risks and limiting options for trading partners.

As previously noted, effective cross-border trade requires institutional capacities for tracking electricity flows, maintaining grid integrity, collecting and transferring revenues, and resolving disputes, among other functions. Inefficient and inertia19
bound domestic electricity sector policies and regulatory institutions impede establishment of the desired quality of cross-border coordination.

# **5. Conclusions and Implications**

Expanded electricity cooperation in SAR can play an important role in long-term economic development of the region. This paper has analyzed the existing state of electricity cooperation in SAR, and considered barriers to increased cross-border cooperation and trade. Some policy, institutional, and political barriers operate at the regional level: lack of confidence and trust, trade-restrictive policies, and challenges in creating effective regional bodies for cross-border coordination.

In addition, political instability and uncertainty and political economy related issues that have limited reforms in regulation of the sector at the national level and led to disappointing sectoral performance also adversely affect opportunities for crossborder electricity cooperation and trade in the region. Sector performance in South Asia continues to be characterized by chronic revenue inadequacy, deteriorating fixed assets and equipment, poor service quality, and severe problems of theft and unpaid bills. Slow progress in addressing these problems also has slowed progress toward achieving greater electricity cooperation and trade in SAR.

Initiatives to engage in cross-border trade of electricity predate the onset of modern domestic power sector reforms. Domestic market reforms are not a precondition for developing cross-border electricity trade, as demonstrated by existing electricity trading arrangements in South Asia. However, power sector reforms in participating countries provide a significant boost to the development of a well-functioning regional electricity market with substantial shared gains for the countries of the region.

Conversely, stronger regional cooperation and trade in electricity can help strengthen domestic sector performance. Cross-border electricity cooperation can help bolster competition in national markets under market-based reforms.<sup>18</sup> It can also improve

> 18For example, Nordpool, as the largest advanced integrated regional wholesale electricity market in the world, has performed well in terms of economic efficiency and competition and provides a good

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the functional efficiency of both electricity producers and national regulators, which need to respond effectively to partners in other countries as well as domestic circumstances.

The absence of an SAR level body with adequate resources and influence to help coordinate these elements hinders the intensification of electricity cooperation and trade in the region beyond individual bilateral transactions. A minimum degree of regulatory harmonization is needed for open access to and nondiscriminatory allocation of transmission, without which a power market providing customer choice and competitive returns to private investors cannot flourish. This includes congestion management and transmission pricing. Cross-border electricity trade is also hampered without a system for energy metering, accounting, clearing and payment.

Participation in cross-border electricity trade need not expand all-at-once and at all levels, but can develop in a somewhat piecemeal fashion, with greater opportunities for expanding trade in nations that have adopted widespread electricity market reforms. Policies toward regional electricity integration in SAR can follow a threetrack approach based on the existing status of the power sector reforms. In the short term, increased bilateral arrangements between countries based on increased interconnections and cross-border trade can be achieved. This will require agreements based on relatively simple rules for operating the bilateral interconnections between countries.

In the medium term, increased sub-regional integration also involving third parties (such as trade between Nepal and Bangladesh with India as a transit country) can grow. This level of electricity cooperation will require harmonizing access rules, grid codes and protocols and electricity transmission charges. Participating countries also can access short-term power markets in India (and elsewhere as they develop) to meet domestic requirements, as Nepal and Bangladesh already are doing to their advantage.

Intensifying bilateral electricity cooperation in the short and medium term can catalyze and harmonize electricity reforms in the region in the long term. However, example of a fuller integration of multiple national electricity systems into a regional market (Glachant and Levque, 2009).

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deeper cooperation arrangements are best pursued in the presence of a regional market for power; an organization or forum for cross-country coordination that can help sustain agreements on market access, among other elements; and an institutional mechanism for coordinating and maintaining transmission in an effective and nondiscriminatory manner. Deeper levels of electricity cooperation in turn will depend on a greater degree of harmonization of reforms in national electricity markets, a gradual process. The different stages of regional cooperation can co-exist and gradually converge as sector reforms in the region progress. It must be emphasized, however, that gains from regional cooperation will be limited without development of market institutions and coordination institutions/forum, in addition to the desired domestic policy reforms.

Strong political will and policy continuity remain crucial for achieving higher levels of electricity cooperation considering the lengthiness of the cooperation process. Dismantling political barriers in South Asia to regional electricity cooperation and installing greater economic rationalization in the domestic electricity sectors is indeed challenging but certainly possible.

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