Analysis of Rule 3 of the Electricity Rules, 2005

Deciphering Captive Status: An Analysis of Rule 3 of the Electricity Rules, 2005 under Indian Law

Introduction

The Electricity Act, 2003 (hereinafter "the Act") heralded a new era in the Indian power sector, aiming to consolidate laws relating to generation, transmission, distribution, trading, and use of electricity. A significant feature of this reform was the promotion of captive generation, allowing entities to set up power plants primarily for their own consumption. Section 9 of the Act empowers any person to construct, maintain, or operate a captive generating plant (CGP) and associated lines. The definition of a "captive generating plant" is provided in Section 2(8) of the Act as a power plant set up by any person to generate electricity "primarily for his own use," including plants set up by co-operative societies or associations of persons for their members. To operationalize this, and to prevent misuse of the benefits accorded to CGPs (such as exemption from cross-subsidy surcharge under the fourth proviso to Section 42(2) of the Act[25]), the Central Government, in exercise of its powers under Section 176 of the Act, notified the Electricity Rules, 2005 (hereinafter "the Rules"). Rule 3 of these Rules lays down the specific criteria that a power plant must satisfy to qualify as a CGP. This article undertakes a comprehensive analysis of Rule 3, its constituent elements, and its interpretation by various judicial and quasi-judicial bodies in India, drawing upon relevant case law and statutory provisions.

The Legislative Framework: The Electricity Act, 2003 and Rule 3 of the Electricity Rules, 2005

The foundation for captive generation is laid by the Electricity Act, 2003. Section 2(8) defines a CGP, and Section 9 facilitates its establishment. Rule 3 of the Electricity Rules, 2005, provides the quantitative and qualitative benchmarks for a plant to attain CGP status.

Rule 3(1)(a): The Twin Conditions for Qualification

Rule 3(1)(a) stipulates two primary conditions for a power plant (other than certain hydro plants) to qualify as a CGP:

  1. Ownership Criterion: The captive user(s) must hold not less than twenty-six per cent of the ownership in the power plant. "Ownership" is defined in Explanation 1(a) to Rule 3 as equity share capital with voting rights in the case of a company or body corporate, and proprietary interest and control in other cases.
  2. Consumption Criterion: Not less than fifty-one per cent of the aggregate electricity generated in such plant, determined on an annual basis, must be consumed for the captive use.

The Rule includes provisos for co-operative societies (where conditions are met collectively by members) and associations of persons (where captive users must hold at least 26% ownership in aggregate and consume at least 51% of electricity generated in proportion to their shares in ownership, with a variation not exceeding ten per cent). The term "annual basis" is clarified by Explanation 1(b) to mean a financial year.

Judicial Interpretation of Key Elements of Rule 3

The application and interpretation of Rule 3 have been the subject of considerable litigation, leading to clarifications from various Electricity Regulatory Commissions, the Appellate Tribunal for Electricity (APTEL), and higher courts.

The Twin Conditions: Ownership and Consumption Thresholds

The judiciary has consistently emphasized the mandatory nature of both the 26% ownership and 51% consumption criteria. In Sai Wardha Power Co. Ltd. v. Maharashtra Electricity Regulatory Commission, APTEL reiterated that both requirements must be fulfilled to claim CGP benefits.[21] The ownership threshold is generally assessed at the outset, while consumption is verified annually.[23] The Appellate Tribunal in Tamil Nadu Power Producers Association v. Tamil Nadu Electricity Regulatory Commission affirmed that the phrase "no power plant shall qualify...unless..." in Rule 3 makes these conditions necessary, and that the 51% consumption is to be checked annually, implying a different timeframe for checking the 26% ownership condition, which can be verified preliminarily.[25]

The 51% consumption criterion has often been a point of contention. In Tata Sponge Limited v. Orissa Electricity Regulatory Commission And Others, the impact of denial of open access on the ability to meet this consumption threshold was considered.[22] The determination of consumption is crucial, as failure to meet this can lead to the denial of CGP status and consequent levy of charges like cross-subsidy surcharge.[18]

Verification and Timing: "On an Annual Basis"

Rule 3 explicitly states that the 51% consumption requirement is to be "determined on an annual basis." This has been interpreted to mean that the assessment of captive status, particularly the consumption part, is conducted at the end of each financial year.[18, 23] The Maharashtra Electricity Regulatory Commission (MERC), as noted in Sai Wardha Power Co. Ltd. v. Maharashtra Electricity Regulatory Commission, held that cross-subsidy surcharge should be levied after ascertaining captive status by verifying generation and consumption data on an annual basis at the end of the financial year.[18]

The issue of retrospective verification has also arisen. In the Tamil Nadu Power Producers Association case, APTEL dealt with contentions regarding retrospective verification, emphasizing that enjoyment of exemptions is based on pre-requisites and preliminary verification of ownership is necessary for according open access to a captive user.[25]

Aggregation v. Unit-Wise Assessment for Multi-Unit Plants

A critical interpretative challenge arises with multi-unit power plants: whether the Rule 3 criteria apply to each generating unit individually or to the power plant in aggregate. In JSW Energy Ltd. v. Karnataka Electricity Regulatory Commission, one of the grounds raised was whether consumption should be considered unit-wise or on the aggregate generation of multiple units for determining captive status under Rule 3.[16] More definitively, in TAMIL NADU GENERATION AND DISTRIBUTION CORPORATION LIMITED v. THE CHETTINAD CEMENT CORPORATION PRIVATE LIMITED & Anr, APTEL held that each power plant/generating plant must be treated separately for ascertaining compliance with clauses (i) and (ii) of Rule 3(1)(a). It was clarified that reading 'power plant' in the plural for aggregation purposes would be repugnant to the context of Sections 2(8) and 9 of the Act and Rule 3(1) itself.[24] This implies a stringent, non-aggregated approach to compliance.

Special Purpose Vehicles (SPVs) and Association of Persons

Rule 3 provides specific considerations for an "association of persons." The application of these principles to Special Purpose Vehicles (SPVs) set up by multiple captive users has been examined. APTEL, in Sai Wardha Power Co. Ltd. v. Maharashtra Electricity Regulatory Commission, referencing its earlier judgment in Kadodara Power Pvt. Ltd. & Ors. v. Gujarat Electricity Regulatory Commission & Anr., held that the provisions of Rule 3 fully apply to an SPV. Both the minimum 51% consumption of total generation and the minimum 26% shareholding in the ownership of the CGP (in proportion to their shares in ownership for consumption by an association of persons) are required to be fulfilled.[21] The judgment in SAI WARDHA POWER GENERATION PVT LTD. v. MAHARASHTRA ELECTRICITY REGULATORY COMMISSION & Ors. further discussed the interpretation of Rule 3 for SPVs, particularly concerning the doctrine of proportionality and whether shareholding analysis is at threshold versus annually.[23]

Relaxation of Rule 3 Conditions and Force Majeure

The question of whether the stringent conditions of Rule 3 can be relaxed, especially in circumstances beyond the control of the generator or captive user (force majeure), has been adjudicated. In Godawari Power & Ispat Ltd. v. Chhattisgarh State Electricity Regulatory Commission, the State Commission had denied relaxation in the 51% consumption norm even when a steel melting shop (captive user) remained closed due to a shed collapse. The Commission reasoned that there was no provision for relaxation in Rule 3.[20] APTEL, in this case, had to consider whether the State Commission was empowered to grant such relaxation. The general stance appears to be that the Rule itself does not explicitly provide for relaxation, making it difficult to deviate from the prescribed thresholds.

Procedural Aspects and Role of Regulatory Bodies/Authorities

The verification of CGP status involves various authorities. The State Electricity Regulatory Commissions (SERCs) play a pivotal role in determining whether a generating unit qualifies as a CGP as per Rule 3.[19] In some instances, the Chief Electrical Inspector has been tasked with obtaining details of generation and consumption for this purpose, as seen in Salasar Steel & Power Ltd. v. Chhattisgarh State Electricity Regulatory Commission, where the CSERC initiated suo-motu proceedings under Rule 3.[19] The determination of CGP status is crucial as it directly impacts the applicability of cross-subsidy surcharges and other regulatory levies.[25] The Supreme Court in M/S JINDAL STEEL AND POWER LTD. v. CHATTISGARH STATE ELECT. REG. COMMN. noted that a distribution licensee shall abide by all relevant provisions of the Electricity Act, 2003, and the Electricity Rules, 2005.[7] This underscores the binding nature of Rule 3.

In M/s.Obli Powers v. The Tamil Nadu Generation and Distribution, the Madras High Court directed the adjustment of banked energy for captive users after verification of the CGP status as per Rule 3 of the Electricity Rules, 2005.[17]

Broader Context and Implications

Purpose of Captive Generation and Rule 3

The legislative intent behind promoting captive generation is multi-fold: to enable industries to secure reliable and cost-effective power, to ease the burden on the grid, and to foster competition. Rule 3 serves as a gatekeeping mechanism to ensure that these benefits accrue only to genuine captive arrangements. By setting clear quantitative thresholds, it aims to prevent entities from claiming CGP status merely to evade regulatory charges or to engage in unrestricted third-party sales under the guise of captive generation. The strict interpretation of Rule 3 by regulatory bodies and courts, such as disallowing aggregation for multi-unit plants[24] and emphasizing compliance with both ownership and consumption criteria[21], reflects this intent to maintain the integrity of the captive generation framework.

Interaction with Other Provisions and Regulatory Frameworks

The status of a CGP under Rule 3 has significant implications under other provisions of the Electricity Act, 2003, and associated regulations. Most notably, the fourth proviso to Section 42(2) of the Act exempts consumers receiving supply from their own CGP from the liability to pay cross-subsidy surcharge. This exemption is a major financial incentive and is contingent upon satisfying Rule 3.[25] Consequently, disputes often arise when a plant fails to meet Rule 3 criteria, leading to demands for cross-subsidy surcharge by distribution licensees.[18] Furthermore, CGPs seeking open access must comply with the relevant Open Access Regulations, and their captive status verification under Rule 3 is integral to this process.[25]

Conclusion

Rule 3 of the Electricity Rules, 2005, stands as a cornerstone in the regulatory architecture governing captive power generation in India. It provides precise, albeit stringent, criteria focusing on minimum ownership by captive users and minimum self-consumption of generated power, determined annually. Judicial pronouncements have consistently upheld the mandatory nature of these twin conditions, emphasizing separate assessment for multi-unit plants and specific application methodologies for SPVs and associations of persons. While the Rule aims to promote genuine captive generation, its strict interpretation has also led to challenges, particularly concerning relaxation in unforeseen circumstances and the complexities of annual verification. The consistent theme emerging from the jurisprudence is the necessity for strict adherence to the letter and spirit of Rule 3 to avail the benefits associated with captive generating plant status, thereby ensuring a level playing field and safeguarding the financial health of the distribution sector while supporting industrial growth through self-generation.

References