This article has been published by Mondaq at Moving Towards ESG Compliance: Harnessing Captive Power – Oil, Gas & Electricity – Energy and Natural Resources – India (mondaq.com)

The integration of Environmental, Social, and Governance (“ESG”) principles into corporate strategy has become increasingly important.

The integration of Environmental, Social, and Governance (“ESG”) principles into corporate strategy has become increasingly important. The global shift towards sustainable practices has placed ESG factors at the forefront of corporate strategy. In India, there has been a regulatory push for ESG compliance, by the Business Responsibility and Sustainability Reporting (BRSR) framework introduced by Securities Exchange Board of India (SEBI) and the Carbon Credit Trading Scheme (CCTS) introduced by Ministry of Power and notified by the Central Government which shows that the current government has a clear agenda i.e., to ensure that industries adopt greener energy solutions.

Various large organisations in India, as part of their efforts to be ESG compliant, have already started relying on green energy as primary source to meet their power needs. For example, Mahindra group recently announced that it will develop a 150 MW hybrid renewable energy (solar + wind) project. Similarly, Ambuja Cements has proposed to invest around INR 60 million in renewable energy projects. These illustrations show a trend amongst corporates to ‘go green’.

One of the primary struggles faced by companies to adopt green energy is that green energy is generally more expensive than conventional sources. This is also why power distribution companies bend in favour of conventional sources of power to meet their demands. In such a situation, large corporates have turned to use of captive power i.e., self-generated power as a means to embrace green energy in their road to being ESG compliant. Captive power generation from green energy sources, with its inherent flexibility and potential for reducing carbon footprint, stands out. The rise in captive renewable energy projects in recent times reflects a growing recognition of the benefits of self-generated power.

The regulatory standards to be met by a Captive Generating Plants (“CGPs”) are still evolving. While discussions around CGPs and the regulatory standards had taken a back seat, it has once again come in the fore-front. The Supreme Court recently addressed long standing interpretational issues in provisions of the Electricity Act, 2003 (“Electricity Act”) and the Electricity Rules, 2005 (“Electricity Rules”) pertaining to CGP.¹ This was also considered by Appellate Tribunal for Electricity (“APTEL”) as seen in its recent clarification on the issues pertaining to self-consumption, and exemption to pay certain charges.²

In the above backdrop of increasing shift to captive power, it is essential to understand the fundamentals, the regulatory standards required to maintain the status of CGPs, principles of proportionality, and the exemptions granted to a captive user.

Understanding the fundamentals of CGPs

CGPs generate electricity primarily for self-consumption. According to the Electricity Act, a CGP is a power plant set up by any person, cooperative society, or Association of Persons (“AoP”) to generate electricity mainly for their own use. This means CGPs must be established for self-consumption of the electricity.

Self-Consumption/Own-Use

Captive use of power is distinct from the supply of power. Under the Electricity Act, the term ‘supply’ is defined as the sale of power to a licensee or consumer [Section 2(70)]. Consequently, electricity consumed by a captive user is considered self-consumption, not ‘supply’ of electricity. In a recent judgment³, APTEL clarified that a CGP owned by the captive user is primarily for self-consumption which does not fall under meaning of ‘supply’ as it does not involve the sale of electricity.

The mandatory twin test for different categories of CGPs

Understanding the eligibility criteria for CGPs is essential for industries using self-generated power. Rule 3 of the Electricity Rules outlines what constitutes a CGP, focusing on two main requirements. Firstly, the captive user must hold a minimum of 26% ownership in the CGP. Secondly, the captive user is obligated to consume not less than 51% of the total electricity generated by the CGP. This consumption must be determined on an annual basis. In this regard, it is pertinent to note that the remaining 49% or less (i.e., the power left after minimum 51% self-consumption) can be sold to consumers.

While the twin conditions of consumption and ownership are mandatory for setting up a CGP, the standards differ slightly, with additional compliance required for certain category of users. Categories of CGPs can be broadly classified into two types i.e., single user CGP and group user CGP. A single user CGP is a power plant set up by an individual to generate electricity primarily for its own use. On the other hand, a group user CGP is established by a cooperative society or an AoP. This type of CGP generates electricity to meet the needs of its members. The group captive model is more complex and requires certain additional regulatory standards to be met.

In case of a CGP set up by a cooperative society, the members of the cooperative society must collectively satisfy the twin conditions. This means that if the cooperative society members collectively hold 26% of the ownership of the CGP and consume more than 51% of the electricity generated, the power plant is treated as a CGP, and the members are considered captive users. On the other hand, in case of a CGP set up by an AoP, the consumption must be proportionate to the shares of members of AoP in the ownership of the CGP.

Apart from CGPs set up by the cooperative societies, and AoPs, the role of a Special Purpose Vehicle (“SPV”) is also crucial in the framework of CGPs. An SPV is a legal entity that owns, operates, and maintains a generating station, with no other business activities.⁴ As the number of SPVs for electricity generation has increased, a key question has arisen i.e., whether an SPV qualifies as an AoP and thus must comply with the proportionality requirement. This was recently clarified by the Supreme Court that proportionality principle as envisaged under the Electricity Rules, specifies an unitary qualifying ratio.⁵ The unitary qualifying ratio is the consumption requirement divided by the shareholding requirement, that is, 51% divided by 26%. This means that the owner of every 1% shareholding of the CGP should have a minimum consumption of 1.96% of the electricity generated by the CGP, with a variation of +10% being permissible.

Clearing the confusion regarding the applicability of proportionality principle on SPVs, the Supreme Court also observed that SPVs cannot consume the electricity themselves, they exist to allow their shareholders, typically companies or body corporates, to become captive users. Further SPVs, while being companies, are also considered as an AoP under the Electricity Rules, and hence companies, body corporates and other persons, who are shareholders and captive users of a CGP set up by an SPV, must adhere to the proportionality principle. It is also important to note that the minimum threshold of ownership, which is 26%, is to be met and satisfied throughout the year and not at the end of the financial year alone.

Right to open access and exemption from additional surcharges and cross subsidy surcharges

Captive energy users enjoy several benefits under the Electricity Act. One key advantage is the right to open access which allows CGPs to deliver electricity to their captive users via the grid without being liable to pay additional surcharges and cross subsidy surcharges.

The Supreme Court has clarified that under Section 42(4) of the Electricity Act, the additional surcharge applies only when the State Electricity Regulatory Commission (“SERC”) permits a consumer or class of consumers to receive electricity from someone other than the distribution licensee of their area of supply.⁶ However, no such permission is required for captive users. Under Section 9 of the Electricity Act, captive generation and distribution to captive users are permitted by operation of law, and therefore, captive users are not liable to pay the additional surcharge under Section 42(4). Further, Section 42(2) of the Electricity Act makes it clear that the cross subsidy surcharge cannot be imposed on a captive user availing open access for carrying the electricity for self-consumption.⁷

As such, due to the distinct nature of the captive users from general consumers, additional surcharge and cross-subsidy surcharge is not payable by captive users. However, it is important to note that wheeling charges must be paid for captive users for using the distribution system.

Conclusion

Indian companies and multinationals have recently demonstrated an exigent need to meet ESG credentials. The ability to source clean energy through captive power projects can play a pivotal role in this effort. By replacing or supplementing conventional energy sources with clean energy, businesses can significantly reduce greenhouse gas emissions and contribute to the broader goal of carbon neutrality.

In addition to meeting ESG credentials, captive energy can also result in significant savings on overall energy costs for the companies. The flexibility, cost benefits, and exemptions from surcharges, make captive power an attractive option for businesses who aim to move towards ESG compliance. However, the corporations must remain vigilant and adhere to regulatory standards such as the proportionality principle as explained above. By navigating the regulatory compliances carefully and adhering to the evolving principles, businesses can maximise the benefits of captive power while contributing to the ESG goals.

Footnotes:

1. Dakshin Gujarat Vij Co. Ltd. v. Gayatri Shakti Paper & Board Ltd., 2023 SCC OnLine SC 1276.

2. M/s. Porwal Auto Components Ltd. vs. Madhya Pradesh Electricity Regulatory Commission, Appeal 241 of 2021

3. Porwal Auto (Supra).

4. Explanation 1(d) to Rule 3, Electricity Rules, 2005.

5. Dakshin Gujarat Vij Co. Ltd. v. Gayatri Shakti Paper & Board Ltd., 2023 SCC OnLine SC 1276.

6. Maharashtra State Electricity Distribution Co. Ltd. v. JSW Steel Ltd., (2022) 2 SCC 742.

7. Ultratech Cement Ltd. v. M.P.ERC, 2022 SCC OnLine APTEL 117.