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April 18, 2024
Captive generating plants operate to bring in choice for customers in what is otherwise a monopoly market. Since most locations in India have a single electricity supplier, companies may not have the ability to negotiate what may be one of their larger cost centers. Of course, some may be able to set up power plants on their own property, like solar panels on warehouses, but this can be quite limiting. For one, the ideal place (i.e., most economical) to set up a power plant may be quite a distance from the place where that electricity is consumed. Companies do not want to buy up expensive land in urban areas just to set up solar panels as it would defeat the purpose of lowering their costs. That’s where open-access allows them to cheaply transport their electricity by utilizing existing infrastructure. For more information on the C&I play, please refer to our paper “C&I Green Open Access-play: The next big investment destination for infra funds?.”
At the outset, captive plants are granted open access (i.e., non-discriminatory access to existing transmission infrastructure) as a right and are also exempt from paying crosssubsidy and additional surcharge payments. These payments add up to a substantial portion of the overall electricity bill.
Therefore, while the final cost to the consumer depends on their expenses in setting up the captive plant etc., there is an inbuilt structural cost advantage.
Merely sourcing electricity from a plant that one has an ownership stake in does not qualify as a captive plant. There is a specific “two-fold requirement”1 :
i. At least 26% of equity of the plant should be owned by the captive user; and
ii. At least 51% of the electricity produced by the plant should be consumed by the captive user.
To understand the ambiguity, we have to take a step back to look at the industry. A lot of capacity in the industry, especially in the green captive space, has been added through the group captive model. To overcome challenges in capital, and for operational efficiency consumers (usually small scale industries) were grouped together by developers setting up such captive plants. Taking advantage of a statutory provision, this group of smaller consumers bought up minor stakes in the captive plant through an SPV. In aggregate they fulfilled the two-fold requirement and thus were able to source cheaper and (usually) greener electricity.
Such grouping of smaller consumers to form a “group captive” was challenged by some states, which were naturally not keen to see more customers move away from stateowned DISCOMs where the higher tariffs paid by these consumers subsidized the larger network.
Such group captive model is also attractive for investors since it allows for a larger, more distributed market for C&I platform plays. For more information on the C&I play, please refer to our paper on “C&I Green Open Access-play: The next big investment destination for infra funds?.”
In short – Yes. Shareholders of an SPV can now claim to be group captive users2 –
By clearly laying out that such structures are within the scope of being considered a captive plant and eligible to claim benefits under the Electricity Act, and by confirming the clear criteria that are to be maintained, the Supreme Court decision has laid to rest this latent ambiguity that was a major hindrance to the wider adoption by C&I consumers of sourcing power from captive sources.
The captive user classification is subject to certain criteria which are in line with the requirements under the statute and which are also fairly intuitive and reasonable:
a.
Rule of Proportionality. Where there is more than one owner, as in the case of group captive plants, by law, there is a rule of proportionality in consumption that must be followed3 . This is in the form of a clear quantitative threshold of the “1.96 ratio”4 , i.e., for every percentage of equity ownership the electricity consumed by that equity owner should be 1.96% (effectively maintaining the 26% equity: 51% consumption ratio).
Therefore, this ensures that as a group, the “two-fold requirement” is fulfilled and that there is no gaming of the requirements since each person claiming the captive user benefit also has to meet the same “1.96 ratio”. A variation not exceeding 10%, determined on an annual basis, is allowed which should suffice for most operational exigencies (can be due to either higher or lower consumption or a mid-year equity holding change).
b.
Change in Shareholding. In case of any increase/decrease in shareholding during the year, the consumption is calculated on a weighted average basis, i.e., it must correlate to the average shareholding held by the user in that year.
Effectively, this is another anti-abuse mechanism. Since the captive user gets the benefit of lower costs throughout the year, only testing the equity requirements at the end of the year may be counterintuitive. It also led to ambiguities when there was a change in shareholding with some companies exiting the SPV, a normal occurrence in any business.
For instance: a shareholder held 50% of the SPV for the first 10 months of the year but then sold 40% of the equity, yet consumed 19.6% of the electricity produced by the SPV.
In such a scenario, allowing captive user classification may go against the spirit since it is clear that the 1.96 ratio has not been met (on a cumulative basis for the year) and the sell down of equity may just be a device to display compliance at the end of the year.
Thus, in case of any increase/decrease in shareholding in year, the consumption is calculated on a weighted average basis, i.e., it must correlate to the average shareholding held by the user in that year (in this case, the consumer would then not be able to claim captive user status and will have to pay the higher charges thus leading to a level playing field).
This is a requirement that must be maintained throughout the financial year and not only at the end of the year. By making it clear that it is not a ‘point in time’ test, it also brings in clarity to enable secondary transactions in captive plants.
The key ingredients required for a successful business is certainty in regulation and a sound business model. In the case of captive plants, especially green captive plants, the sound business rationale has been present for some time. Not only do they, almost uniformly, provide cheaper electricity while providing a stabilised high-yield play for investors but also contribute to a greener future by driving growth in renewables. Couple this with the ability for even small companies to access this benefit and it also leads to a social good, since it bolsters the economy. This diverse base also derisks investors in the sector by which then leads to a virtuous cycle of greater investor participation leading ultimately to lower costs for end users.
1 Rule 3(1)(a) of Electricity Rules.
2 Refer to Dakshin Gujarat Vij Company Limited v. Gayatri Shakti Paper and Board Limited and Another, Civil Appeal Nos. 8527-8529 of 2009.
3 Second proviso to Rule 3(1).
4 Since a 10% variation is permitted, the unitary qualifying ratio must be within a range of 1.764% to 2.156% calculated on a weighted average basis.
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