MULTI YEAR TARIFFS (MYT), DISTRIBUTION MARGIN (DM) AND PRIVATIZATION IN KARNATAKA

1. MULTI YEAR TARIFFS (MYT), DISTRIBUTION MARGIN (DM) AND PRIVATIZATION IN KARNATAKA SAFIR Workshop - R. Sridharan

2. Some preliminaries • Means and Ends • Part of a large jigsaw • Need to look at the whole picture SAFIR Workshop - R. Sridharan

3. Distribution Margin • A method of providing a predictable, performance based payment for electricity distribution services to an ESCOM during a transition period • 2 components, Base Revenue and Incentive Charge • Base Revenue = Cost of operating the distribution business PLUS a reasonable minimum equity rate of return (below market expectations) SAFIR Workshop - R. Sridharan

4. Distribution Margin • Incentive Charge – Predefined proportion of collection above the Minimum Collection Requirement (MCR) that the licensee can retain • Bidding for the equity of Discoms on the basis of Incentive Charge • MCR – if not achieved, the discom pays penalty SAFIR Workshop - R. Sridharan

5. Distribution Margin • Specific Service Standards to be established for the Transition period • Progressive, gradual transition to international standards • Cap on returns or sharing mechanism for the equity return of discoms • Power purchase by discoms at BST set by KERC – deficit in cash flows to be filled by Govt SAFIR Workshop - R. Sridharan

6. Risk Allocation • Still under preparation • Expected that discom would bear a reasonable share of the risks • Most risks to be allocated either entirely to the discom or shared between the discoms/Govt. SAFIR Workshop - R. Sridharan

7. MYT - A Wide Spectrum • A “just and reasonable” return • Specific rates of return on capital • Specific numbers, benchmarks • General principles • Related to output prices or input costs SAFIR Workshop - R. Sridharan

8. MYT in Karnataka • Legal clarity felt necessary • Amendments propose Transition Period contract between private investor and Government • To override all other provisions of law • To be based on successful bid or resulting from negotiations • Not to be amenable to any amendment or modification once private investor is in • With right to investors to obtain specific performance or full compensation SAFIR Workshop - R. Sridharan

9. Transition Contract contents • DM mechanism • Mechanism for allocation of wholesale supplies and compensation to licensees for shortages • Mechanism for allocation of supplies by licensees to consumer classes • Incentives for efficient capital expenditure • Compensation for loss caused by open access SAFIR Workshop - R. Sridharan

10. Transition Contract contents • Principles and procedures for determination of tariffs to move towards average costs while meeting service quality standards • Specific values for different elements of tariff and tariff formula • Targets fro gradual elimination of cross subsidies • May include profit sharing mechanism SAFIR Workshop - R. Sridharan

11. Transition Contract • To be incorporated into licence • Oversight of implementation of contract with ERC, but all decisions only with the Govt • Govt entitled, in its discretion, to consult the ERC on all or any aspects of the contract • Transition Period not to exceed five years SAFIR Workshop - R. Sridharan

12. Three Different Problems • Regulatory Uncertainty – about norms to be used and their levels • Incentive effects of norms • Risk sharing between investors, consumers and government SAFIR Workshop - R. Sridharan

13. The Information Problem Attempted Solutions SAFIR Workshop - R. Sridharan

14. Delhi MYT Scheme • Uses AT&C Loss • Input Energy and Cash Collection are the only reliable figures • Uses intermediate data as well • May result in anomalous results SAFIR Workshop - R. Sridharan

15. Delhi MYT Scheme SAFIR Workshop - R. Sridharan

16. Karachi MYT Scheme • Apparently simple • Tariff changes on account of Fuel price, Purchased power and O and M • Clawback for excess return • Norms not specifically mentioned • Has it facilitated privatization? SAFIR Workshop - R. Sridharan

17. UP – Reference Utility Model • Enormously data intensive • Data from utility records used • Numerous assumptions • A virtual utility? SAFIR Workshop - R. Sridharan

18. Retail Tariffs • No MYT scheme can ignore absolute levels of retail tariffs • Impact of Power Purchase Costs • Sharply increasing cost of new power SAFIR Workshop - R. Sridharan

19. The Information Problem – a view • “On price setting, what has become absolutely clear is that it is not a science, but an art and is dependent on a number of factors not envisaged at the time of the design of the basic price control system. It has been demonstrated above that the hoped for degree of stability has not been obtainable, and the late amendment of the distribution price control proposals was such as to create a real crisis of regulatory legitimacy. This is not to say RPI-X formula does not have advantages, but rather that they lie in efficiency incentives rather than in the promise of stability; no formula can be immune from public and political pressure where the providers of basic services are seem to be making excessive profits. SAFIR Workshop - R. Sridharan

20. The Information Problem – a view ( contd) • The circumstances of the amendment of the proposals illustrate vividly two problems concerning regulatory procedures. First, statutory consultation on licence amendments has not been treated as offering any serious possibility of affecting outcomes, and secondly even wide statutory powers to gain information are not sufficient in themselves to prevent regulators from being seriously misled; what is additionallyneeded is some forum for competitive debate and analysis of information offered, and here OFTEL procedures offer important lessons”. (Tony Prosser. (1997) Law and the Regulators. Oxford. Clarendon Press. Page 179, emphasis added). SAFIR Workshop - R. Sridharan

21. Incentive Effects of MYT • Levels at which norms are fixed is crucial • The Delhi sharing scheme – will reported AT&C loss be lower than the minimum? • Hygiene and Motivation factors • Comparative strength of incentives SAFIR Workshop - R. Sridharan

22. Risk Sharing in Privatization • Government behavior – will risk sharing bring desirable changes? • How “imminent” is the collapse of the system? • Will norms emerge out of competitive bidding? • What role should regulators play? SAFIR Workshop - R. Sridharan

23. Process – a view • “This” (how decisions taken at the time of privatization determined the parameters within which regulators had to work) “is also true as regards the chief regulatory controls on the privatized enterprises. The licenses contained lengthy conditions determining the environment in which the enterprises were to operate. These conditions were not set by the regulator, but by the minister after private negotiations with the enterprise; for example, in setting the licence conditions for British Telecom, the Post Office Users National Council, which had previously represented consumer interests, was not allowed to participate. SAFIR Workshop - R. Sridharan

24. Process – a view • These conditions were of absolutely fundamental importance in determining the operation of the enterprises; in particular the conditions limiting price increases have proved the most controversial issue in the whole of utility privatization. As will be demonstrated in later chapters, there is ample evidence to suggest that conditions were set too generously in an attempt to assist the privatization process, and much of the work of regulators has been to tighten the controls and avoid the prospect of unduly large profits being made by the companies” (Tony Prosser. (1997) Law and the Regulators. Oxford. Clarendon Press. Pages 47-48). SAFIR Workshop - R. Sridharan

25. The way ahead • From Regulatory Uncertainty • To Regulatory Certainty • Via a Regulatory Holiday • Leading to Regulatory angst? SAFIR Workshop - R. Sridharan