Electricity Distribution: Issues in multiyear tariff and Private Investment

1
Electricity Distribution Issues in multi-year
tariff and Private Investment
Dept. of IME, IIT Kanpur Short-term
Course Challenges and Implementation Issues post
Electricity Act 2003 Regulatory, Policy
Technical Solutions April 10-14,
2004 This document can be downloaded
from www.iitk.ac.in/ime/anoops

• Prof. Ashok Banerjee
• Indian Institute of Management Lucknow

2
Privatisation of Distribution

• In 1999, the Govt. of Orissa privatised the
  distribution assets of GRIDCO selling a
  controlling equity share in four companies.
• A number of other states, including Delhi, AP,
  Karnataka and UP have followed suit.
• The Prime Ministers Economic Council has also
  recommended that the privatisation of
  distribution be implemented by state governments
  to reduce high levels of theft and other
  non-technical losses seen today in India.

3
Privatisation of Distribution

• However, operators of these distribution assets
  have expressed concern at the lack of clearly
  defined paths for the prices that they are
  allowed to charge to customers.
• SERCs in India have thus far set prices on an
  annual basis, although some performance-based
  incentives have been introduced.
• This reflects SERCs concern that the existing
  information base does not support the development
  of sufficiently accurate multi-year tariffs,
  making it likely that either excess profits would
  be made or companies would make high losses and
  ask the regulator to reopen the price control.

4
Distribution Provisions in the Electricity
Act,2003(Act,2003)

• Distribution licence may be granted to two or
  more persons for distribution of electricity
  through their own distribution system within the
  same geographical area.
• A distribution licensee will not require a
  licence to undertake trading in electricity.
• Open access to be allowed.
• Open access to all generators (excepting captive
  users) will be subject to a surcharge on the
  normal wheeling charges.

5
Distribution Provisions in the Electricity
Act,2003(Act,2003)

• The charges for electricity supplied by a
  distribution licensee
• may include -
• (a) a fixed charge in addition to the charge for
  the actual electricity supplied
• (b) a rent or other charges in respect of any
  electric meter or electrical plant provided by
  the distribution licensee.

6
Distribution Provisions in the Electricity
Act,2003(Act,2003)

• Where the State Commission permits a consumer or
  class of consumers to receive supply of
  electricity from a person other than the
  distribution licensee of his area of supply, such
  consumer shall be liable to pay an additional
  surcharge on the charges of wheeling, as may be
  specified by the State Commission, to meet the
  fixed cost of such distribution licensee arising
  out of his obligation to supply.
• Such surcharge shall be utilised to meet the
  requirements of current level of cross subsidy
  within the area of supply of the distribution
  licensee.
• However, such surcharge and cross subsidies shall
  be progressively reduced and eliminated.

7
Distribution Provisions in the Electricity
Act,2003(Act,2003)

• If the distribution licensee fails to supply the
  electricity within a specified period, he shall
  be liable to a penalty which may extend to
  Rs.1,000 for each day of default.
• A distribution licensee may, with prior
  intimation to the SERC, engage in any other
  business for optimum utilisation of its assets.
  However, a portion of the revenues derived from
  such business shall be utilised for reducing its
  charges for wheeling.

8
Inter-state transmission provisions in the
Electricity Act (Act,2003)

• Transmission utilities are required to provide
  non-discriminatory third party access to their
  systems.
• GOI earlier notified POWERGRID as the CTU.
• Act,2003 does not categorically identify
  POWERGRID as the CTU.
• Act,2003 also states that the central government
  may transfer and vest any property, rights,
  employees of the CTU to another transmission
  licensee.

9
Inter-state transmission provisions in the
Electricity Act (Act,2003)

• Transmission license will be granted to private
  participants by the CRC (Commission). The CTU may
  recommend to the Commission its view about the
  granting of liecnse. But such recommendations
  will not be binding on the Commission.
• Presently the responsibility of systems
  maintenance and inter-state load despatches rest
  with POWERGRID (through RLDCs).

10
Inter-state transmission provisions in the
Electricity Act (Act,2003)

• The Act,2003 intends to separate systems
  maintenance and planning from the transmission
  utilities. It provides for setting up of an
  independent NLDC.
• RLDCs may eventually be carved out of CTU.
• However, the Act,2003 retains the principal
  functions (planning and co-ordination) of the
  CTU.

11
Private Sector Participation in Transmission

• While the Act,1998 provided for private sector
  participation under the overall supervision of
  CTU, the Act,2003 created favourable environment
  for such participation.
• Private transmission licensees will no longer be
  under the direct supervision of CTU.

12
Why do we need private capital in transmission?
13
Models for Private Sector Participation

• Joint Venture (JV)
• Joint Venture Agreement (JVA)
• Independent Power Transmission Company (IPTC)
• Transmission Services Agreement (TSA)
• (The Act,2003) favours this route)
• Lease Operate Transfer (LOT)
• Lease concessions of the existing assets.

14
New Approaches to Infrastructure Developments

• Build-operate-transfer (BOT)
• Build A private company agrees with a government
  to invest in a public infrastructure project
  (e.g., power station).
• Operate The private developer then owns,
  maintains and manages the facility for an agreed
  concessionary period (e.g., 20 years) and recoups
  its investments through charges.
• Transfer After the concessionary period the
  company transfers ownership and operation of the
  facility to the government or state authority.

15
New Approaches to Infrastructure Developments

• Build-operate-own
• The private sector builds, owns and operates the
  infrastructure facility for the entire life of
  the project.
• Build-operate-lease-transfer (BOLT)
• The private sector builds by taking the project
  on lease, operates during the lease period and
  transfers it back after the lease period to the
  government or state authority.

16
Issues in Project Costs

• Installed capacity.
• Capital costs.
• Financial closure
• Debt-equity mix.
• Construction period.
• Time overrun.
• Costs overrun.
• Guarantees.

17
(No Transcript)
18
(No Transcript)
19
(No Transcript)
20
(No Transcript)
21
(No Transcript)
22
(No Transcript)
23
Price regulation of distribution in India

• Prior to privatisation in Orissa, India had
  substantial experience with private ownership and
  operation of distribution systems, with private
  electricity companies regulated as licensees
  under the Sixth Schedule of the Electricity
  (Supply) Act, 1948. This Schedule sets out that
  on a year-to-year basis, the profit earned by an
  operator should not exceed a reasonable return.
• The definition of reasonable return is set in
  relation to prevailing government interest rates
  and the asset base.

24
Price regulation of distribution in India

• Reform legislation from the 1990s has allowed
  regulators to incorporate other factors into
  pricing decisions to provide for incentives.
• The new legislations explicitly allow regulators
  to deviate from the Sixth Schedule to promote
  efficiency, reflect the cost of service, and
  safeguard consumers.
• In practice, SERCs have followed the format of
  Sixth Schedule closely, but have deviated
  substantially in that the full cost of supply are
  not reflected in tariff orders (Table 1).

25
(No Transcript)
26
Towards multi-year tariff

• Although, SERCs have not yet adopted multi-year
  tariff orders, this issue has been discussed in
  various recent tariff orders and the UPERC, for
  example, provided incentives based on sharing of
  revenues if the company were to beat a set of
  pre-defined loss targets.
• Two key concerns relating to multi-year tariff
• The quality of information base used by SERCs in
  their price reviews, in particular loss levels
  and
• The efficiency improvements generated by private
  distribution companies.

27
Some Examples of the Concerns

• Most states see metered sales less than 50 of
  total sales.
• In its tariff order of May 2000, the APERC said
  it was not possible to estimate the level of
  losses and to fix an appropriate loss target, and
  that the only reliable target to use was the
  level of billing.
• The OERC Order of 2001 says that the
  authenticity of the loss level projected by the
  licensee has not been supported with verifiable
  data.

28
Towards multi-year tariff

• Two strategies can be followed
• The allocation of costs between controllable and
  uncontrollable elements, and the use of a
  pass-through mechanism for the latter.
• Variants on the basic incentive mechanism through
  sliding scale (profit-sharing) and revenue
  controls.
• Over 30 of the costs of an illustrative Indian
  distribution company can be considered as
  controllable.
• Providing incentives to reduce these costs can
  have a significant impact on prices.

29
(No Transcript)
30
Cost elements and the degree of control

• Demand Very limited.
• Generation and transmission costs Very limited.
• Losses Substantial.
• Labour costs Some
• Material costs Some
• Rent and rates Very limited.
• Depreciation Limited
• Required Profit Some
• Investment costs Some

31
Refinements to the incentive regime

• The regulatory system can be designed such that
  excessive profits are not earned.
• Probability of excess profits can be controlled
  by
• ensuring companies only benefit from controllable
  cost savings
• limiting the profits of the company through a
  profit-sharing regime
• re-basing an element of the control to capture
  costs diverging from levels forecast in the
  review.

32
Framework for choosing he appropriate approach

• Incentives for efficiency savings.
• Incentives for regulatory gaming.
• Political acceptability.
• Ease of implementation
• What new information is required each year
• The new incentive framework should address above
  issues.
• A system based on a revenue cap with cost
  pass-through for non-controllable costs would
  seem most appropriate given its stronger ability
  to allow real incentives for the company while
  controlling for political acceptability.

33
Revenue-based tariff

• If revenues were forecast for 5 years, the only
  annual adjustments would be to incorporate
• inflation
• efficiency savings (the X factor)
• over-or under-recovery of revenue compared to
  control
• mechanical correction for out-turn uncontrollable
  costs being different from forecast

34
Multi-year Tariff An adaptive Model
35
Effectiveness of the Model Three situations

• Out-turn demand diverges from forecast demand.
• Planned investment announced at the price review
  not undertaken.
• Losses prove easier to deal with than anticipated
  by the regulator.

36
Incorporating incentives for losses in the Model

• Two options for increasing the incentive for loss
  reduction
• any increases in revenue that are not associated
  with an increase in electricity purchases by the
  distributor can be kept by the company as higher
  profits, and
• a separate item relating to measured losses is
  introduced in the formula whereby losses are
  directly calculated and incorporated in the Model.

37
Incorporating incentives for losses in the Model

• The first approach tries to separate the two
  elements of movements in revenue, namely
• Increases or decreases in the level of demand,
  and
• improved collection of bills or reduction in
  technical losses.
• To distinguish between the two revenue drivers,
  the level of electricity purchases may be used.

38
Revenue Split

• Revenue can be split into four elements
• The number of units of electricity purchased by
  the distribution company.
• The generation and transmission price per unit of
  electricity purchased.
• Distribution costs.
• Losses (both technical and commercial).

39
Multi-year Tariff An adaptive Model
40
Multi-year Distribution Tariff a five-year
tariff model

• The basic pricing formula should be CPI-X rather
  than rate of return.
• In adopting CPI-X, distributors should submit
  forward-looking revenue benchmarks reflecting the
  requirements of the distributors over the next
  five years.
• These benchmarks are based on assumptions about
  efficient levels of expenditure that the
  distributors would need to incur over the
  five-year period to meet the target levels of
  service reliability and quality, expected demand
  growth and the cost of capital financing.

41
Forward-looking Revenue Benchmarks

• In order to establish each distributors
  benchmark revenue requirement, the following data
  need to be collected from each distributor
• the target levels of service to be delivered over
  five-year
• expected demand over the same period
• corresponding capital and operating expenditure
  benchmarks
• incentive allowances reflecting improvements in
  efficiency made in the first regulatory period
  and
• the cost of capital financing, including the cost
  of capital, the cost of tax, regulatory asset
  values, and depreciation or the return of capital.

42
Multi-year Distribution Tariff a five-year
tariff model

• These benchmarks are used to derive X factors
  which, together with the consumer price index,
  determine the annual percentage change in average
  tariffs.
• That is, average prices for the use of the
  distribution system will change by the CPI, less
  the X applying in that year.

43
The X Factor

• The regulator will define the real reductions in
  average distribution charges expected over the
  next five year.
• However, the actual price reductions seen by
  different classes of customer in first year will
  depend upon distributors decisions regarding the
  structure of their tariffs under the price
  controls established by the regulator.

44
(No Transcript)
45
(No Transcript)
46
(No Transcript)
47
(No Transcript)
48
The X Factor Example
49
Multi-year Tariff

• The forward-looking revenue benchmarks are
  established independent of past revenues on the
  basis of current and prospective electricity and
  capital market conditions.
• Returns generated by favourable market conditions
  (e.g., unanticipated demand growth, reduction in
  cost of capital) during the first regulatory
  period are not captured in the process of
  establishing the revenue benchmarks for next
  regulatory period.

50
Multi-year Tariff

• Under the CPI X price cap approach, the
  distributors retain the benefits of these
  favourable outcomes (and incur the costs of any
  unfavourable outcomes) that occur during the
  period covered by the initial price caps.
• However, the benefits of favourable outcomes
  enjoyed in the past regulatory period is to be
  passed on to the consumer in the first year of
  the next regulatory period (X0).

51
Determination of X0 Example