Need for New Paradigm in Electricity Regulation

1. Energy Conclave – 2010, IIT Kanpur International Symposium on New Paradigms for Energy Policy and Regulation 8th January 2010 Need for New Paradigm in Electricity Regulation Ajay Pandey Professor, IIM Ahmedabad http://www.iitk.ac.in/reg

2. Historical Overview of Regulations in the Sector • In the late 19th and early 20th century, the sector was in private hands without regulations. • Faced with difficulty in mobilizing capital, the firm demanded monopoly rights with regulation. • Post second world war, the sector was nationalized in most countries with US being prominent exception where regulation took care of “natural monopoly” issue. • Economic regulations till 1960s in the sector (and in other sectors) were essentially “cost-of-service” regulations. • Starting in 1960s, the disadvantage of “cost-of-service” regulations were widely recognized such as padding up of costs, lack of incentive for efficiency, information asymmetry and regulatory capture. • Move since then has been towards incentive regulations wherever feasible.

3. Reforms in the Sector • Since 1970s, the reforms in the sector are based on the recognition of the following: • Competition is feasible in generation and supply even if “wires” remain natural monopoly • Public sector ownership leads to loss of efficiency • Private sector regulated monopolies also lack the incentives for efficiency and consumers do not gain from incentive regulations. • Reforms = Competition in generation (and Supply)

4. A Quick Review of Reforms in India: Legal • Major Driver was EA 2003 to attract investment and to allow competition • Generation delicensed • Independent Regulations and Regulators • Open Access allowed under regulatory guidance and facilitated through separation of LDCs • Transmission separated for open access • Liberal definition of and open access to captive generation • Reduction in Cross-subsidization envisaged, subsidies to be paid by the state government • Anti-theft provisions and special courts • Trading allowed and development of markets under regulatory guidance envisaged

5. A Quick Review of Reforms: Policy and Regulatory • Generation • Competitive procurement mandated • Risk reduction for generation investments and scale economies through UMPP • Electricity exchanges started and trading increased • Transmission • Open Access of Transmission system allowed • Transmission pricing being reviewed • Distribution • Open access allowed for qualified consumers • Privatization and distribution franchisee models experimented • Extent of cross-subsidization mostly coming down

6. Broader Issues facing the Sector • Distribution remains financially unviable in most states • Pace of loss reduction and reforms uneven across states • Despite interest in adding generation capacity from the private sector, energy shortages continue and price of traded electricity remains higher than LRMC • Quality of supply for most consumers served by state-owned entities remains poor • States are unwilling to- • Accept independent regulations • Stop influencing consumer tariff • Let go the SEB/ successor entities • Allow generation for exports without payoffs • Enforce anti-theft measures and 100% metering • Pay for the costs of all of the above • In short, while some competition has begun to emerge in generation, distribution is still relatively unaffected and inefficiencies remain

7. What should be the regulatory objectives in the sector? • Development of a competitive national wholesale market to optimally use energy sources and to promote competition in generation- Wholesale Market Design. • To prevent gaming in the wholesale market- Market Rules and Surveillance. • Investment in and Operation of Transmission and Distribution network to promote quality of supply and competition upstream and downstream- Open Access and Rule-based system operation. • Competition in supply through open access or separation of DNO from supply- Consumer choice and economic tariffs

8. Regulatory Challenges Ahead • While MYT and incentive-based regulatory approaches have worked for private sector (Delhi) and even for distribution franchisee model (Bhiwandi), their effect on State-owned utilities has been mixed and marginal. • Distribution losses need to come down faster than the actual experience so far. • Quality of power and access remain an issue for want of investments in the sector. • In the absence of financial viability of discoms, the investment in transmission and distribution at the state level remains dependent on central assistance and funding support. • Competition envisaged through open access should take shape and not remain on paper • Promoting efficiency and protecting consumer interest (that of paying consumers) including prevention of gaming opportunities for private sector players in the market

9. Obstacles in Effective Regulation of the Sector in India • Shortages make the regulations difficult as they have to reconcile conflicting objectives of promoting investments and keeping tariffs (and/or traded power) in wholesale market under control. • The sector, because of less than perfect physical control on all players connected to the grid, is prone to free rider problem and players can easily create negatively externality for others. • Traditional regulatory mechanisms either rely on monetary incentives and disincentives or non-monetary punitive measures where responsibility can be assigned. As purely economic regulators, the ERCs have no recourse to the latter instrument. • With state-owned enterprises exhibiting non-commercial orientation and responsibility at the operational level diffused with widespread problems, effectiveness of traditional regulation is expected to be limited. • Economic regulators can only handle state-owned utilities effectively when state is neutral in the sector. Here, the sector is dominated by such entities.

10. What is different in our context? • Constitutionally and historically, states are important stakeholders. • State governments have been involved in all aspects of the sector on non-commercial basis and state-owned utilities also behave in a similar fashion. • Electricity, though a private good, has been converted over time in public good due to state ownership of utilities. • Public or consumers do not demand quality and reliable supply for historical reasons. • Such demand in any case is not disputable as long as state is supplying electricity besides free-rider problem. • Extensive theft and low tariff for some segments leads to lack of investment and need for rationing. • Rationing as a consequence is based on discretion which is politically expedient and is dictated by pork-barrel politics.

11. What is the current strategy on distribution side? • Essentially, there are four elements but all of them are aimed at tightening the budget constraint: • Fiscal incentives and disincentives for loss reduction such as tariffs (MYT) based on reducing loss trajectory and APDRP • Payment security for power purchased or overdrawn • Open access to qualified buyers to induce competition • Reduce cross-subsidies • While fiscal incentives and disincentives do work for a commercial entity or private economic agent, their effect on state-owned utilities is uncertain and can result in cutting down on investments and resorting to rationing as has been the case in the past.

12. What are the options? • Separate DNO from supply with DNO privatized. Supply can be competitive and state utilities can supply-likely to be opposed and likely to have the same fate as open access with separation of STU and SLDC on paper! • Continue with tightening the budget constraint- will result in slow pace of reforms as has been the case with mixed response across states and consumers continuing to suffer due to lack on investments! • Incorporate access, quality and reliability of supply in regulatory framework along with tightening the budget constraint through current strategy.

13. Access, Quality and Reliability in Regulatory Framework • Inadequate investment and rationing allows relaxing budget constraint at the cost of consumers. • The only way to prevent pork-barrel politics in the sector is to raise expectations of the consumers in terms of access, quality and reliability of supply. • This can not be done immediately but surely path can laid out and the tariffs can be inversely related to these parameters just as they are for loss. • Legally, it is provided for in the EA 2003 and does not require legal changes. • It would require institutional mechanisms for monitoring and verifying and these parameters besides better mechanisms for consumer complaints and grievance on these parameters.