Moving towards Cost Reflective Tariffs

1. Moving towards Cost Reflective Tariffs Rajkiran V Bilolikar

2. Changing Power Sector With the advent of the Electricity Act 2003 and various policy initiatives thereof, it has now become mandatory for the Electrical utilities to gradually reduce the cross subsidy and move the tariffs in the State towards the “Cost of Supply”. Traditionally, in the Indian context, tariffs for domestic and agricultural consumers have been heavily subsidised either by the state through subsidies and subventions or through cross subsidisation by other consumer categories, primarily the consumers using electricity at high voltages.

3. EA 2003 : Section 61 (Tariff Regulations) • The Appropriate Commission shall, subject to the provisions of this Act, specify the terms and conditions for the determination of tariff, and in doing so, shall be guided by the following, namely: • the generation, transmission, distribution and supply of electricity are conducted on commercial principles; • The factors which could encourage competition, efficiency, economical use of the resources, good performance and optimum investments; • safeguarding of consumers’ interest and at the same time, recovery of the cost of electricity in a reasonable manner; • the principles rewarding efficiency in performance; • multi-year tariff principles; • that the tariff progressively reflects the cost of supply of electricity and also reduces cross-subsidies in the manner specified by the Appropriate Commission;“[that the tariff progressively reflects the cost of electricity, and also reduces and eliminates cross-subsidies within the period to be specified by the Appropriate Commission;]

4. Tariff Policy 2006 • The Policy aims at • Ensuring availability of electricity to consumers at reasonable and competitive rates while ensuring financial viability of the sector and also attracting necessary investments • Promoting consistency and predictability in regulatory approach • The Policy Provides • Platform for competitive power purchase • Platform for competitive bidding • MYT Framework • Basic framework of service standards • Policy Lay down • A timeframe for rationalization of electricity tariffs and reduction of the cross subsidies within a band of ±20% by the end of year 2010-11

5. Cost of Supply • The tariffs for various categories of customers should be, as far as practicable, equal to the costs imposed by that category of customers on the system. This is what is currently understood as Cost of Service (CoS) • It has now become necessary to compute the cost to serve to individual consumer categories and the gradual reduction of the cross subsidies existing between the consumer categories today • - A move towards cost reflective tariffs

6. Focus of Reforms • The focus of the reforms envisaged by the Electricity Act, 2003 (EA 2003) is to establish competitive environment for economical and financial viability of the power sector. • The prices at every stage of the value chain of the sector should reflect marginal cost. Cross subsidy which is another form of subsidy affect economic efficiency and environmental performance

7. Status of Reforms and Restructuring

8. Gross Generation (MU) The T&D losses for the whole of India during 1995-96 was about 22 percent which has increased to about 25.6 percent by 2009-10. As far as figures for 2009-10 are concerned, the States which have relatively high T&D losses are Jammu & Kashmir (63%), Bihar (38%), Chhattisgarh (38%), Jharkhand (38%) and Madhya Pradesh (35%). The States having relatively low T&D losses include Punjab (19.7%), Himachal Pradesh (14.7%), Andhra Pradesh ( 18%) and Tamil Nadu (18%)

9. Sector wise share

10. Sector wise share

11. Cost of Power Supply • The cost of supply of electricity in India represents the cost incurred by the utility to supply electricity to ultimate consumers • The Components considered for calculations include – • O&M Expenditure • Establishment and Administration cost • Interest Payment Liability • Depreciation • Fuel Cost • Expenditure on Power Purchase

12. Cost of Power Supply • The share of each component remained relatively constant from 2007-08 to 2011-12 • The expenditure on power purchase was the largest component of the total cost of supply – with a share of 70% in 2009-10 • In the four years from 2007-08 to 2011-12, the overall unit cost of supply increased by 21% • Maximum increase was in the interest payments (65%), followed by increase in establishment and administration expenses (24%), power purchase (21%) and depreciation (21%) • The O&M expenses and other miscellaneous expenses decreased by 36% each during the same period

13. Expenditure on Power Purchase • The share of expenditure on power purchase in the total cost of supply has increased from 39 percent in 1998-99 to 70 percent in 2009-10. • The expenditure on power purchase expressed in terms of expenditure incurred per unit of electricity sold, has increased from 152 paise/kWh sold in 1998-99 to 334 paise/kWh sold in 2009-10

14. Average Tariff • The average tariff here represents the tariff charged by the utilities to the ultimate consumers per unit of electricity sold. • The average tariff has increased from 187 paise/kWh in 1998- 1999 to 333 paise/kWh in 2009-10 implying an annual increase of 7.1 percent

15. Unit Cost – Revenue Comparison • Though the average tariff has increased in the past few years, the rise has not been commensurate with the increase in the cost of supply • As a result, the gap between the cost of supply and the average tariff has been widening over the years • The gap has increased from 76 paise/kWh in 1998-99 to 145 paise/kWh in 2009-10. It is expected to decline to 107 paise/kWh in 2011-12

16. Unit Cost – Revenue Comparison The level of recovery measured in terms of sales revenue as a ratio of cost has declined from 71.5% in 1998-99 to 69.6% in 2009-10

17. Uncovered Subsidy and Cross Subsidisation • The level of commercial losses of the utilities depend largely on the effective subsidies incurred towards sales to agriculture and domestic sectors, efforts to neutralize them through cross subsidization and the level of subventions provided by the State Governments.

18. Commercial – Profit and Loss • The commercial loss is the gap between total revenue receivables and total expenditure in a given year • The total revenue includes subvention given by the State Government in lieu of subsidized power supplies to domestic and agricultural sectors The total expenditure includes payments towards depreciation and interest payable to the State Government as well as financial institutions. The commercial losses (without subsidy) increased from Rs.20,860 crore in 1992-93 to Rs.60,223 crore in 2009-10. These losses are projected to reduce to 56,458 crore in 2011-12

19. Net Internal Revenue • The net internal revenue (IR) refers to the surplus left with the utilities after meeting the revenue expenditure and loan repayment obligations • It includes depreciation and the subvention provided by the State Government • If the utilities function on commercial lines, as is statutorily required, the IR should have been positive in the normal course However, in practice IR have been negative in all these years. The net IR had increased from( -)8,954 crore in 1998-99 to (-) 31,362 crore in 2009-10

20. Revenue Arrears • The revenue arrears outstanding of various State utilities have been increasing over the years • These arrears have increased from Rs.20,382 crorein 1998-99 to Rs.55,430 crore in 2009-10

21. Major Drawbacks • The inefficiencies of generation and transmission are passed on at cost plus basis to the distribution Companies • Open Access remains a dead letter • Periodic tariff increases to meet ever increasing costs have not taken place and therefore DISCOMs are unable to cover costs from tariff • Unable to control operational inefficiency and its impact on tariff • Gap between average cost and average revenue • The aggregate net losses of Distribution utilities have been Rs. 82000 Crore • Over 70% of the loss is financed by Public Sector Banks

22. Drawbacks and Solution • Neither the Distribution utilities are in a position to pay banks nor the banks are in a position to realize the dues • Current income is significantly below revenue expenditure What Next? State Government should agree for regular tariff increase to enable the distribution utilities, with immediate effect to meet its current expenditure Tariff Rationalization Cost Reflective Tariffs??

23. Role of Regulator - Shortcomings • Infrequent revision of tariffs • Variations in the actual and estimated values of major expenditure items like Power Purchase cost, O&M Cost, and Capital Expenditure, their reasons and treatment • Variations in the estimated and actual revenue, their reasons and treatment • Gap between the total validated expenditure and total estimated revenue • Effect of prescribed and achieved milestones for loss reduction and collection improvement • Failure to revise and fix tariffs with due frequency • Gap between Regular Accounting and Regulated Accounting

24. Way Forward • The Power Purchase cost actually incurred should be recognized and allowed during truing up • Major part of the power purchased by the distribution utilities comes from the long term PPAs, therefore cost of power to be purchased from such generators can also be estimated based on the latest available tariffs of such suppliers • Generation Tariffs usually have an in-built formula to take care of changes in the fuel cost of the generation company. The similar pass through structure should be followed for distribution companies • O&M expenses should be linked to CPI

25. Role of Regulator - Way Forward • Road map of T&D Loss reduction • regulator should use all possible tools • Basic tariff + loss surcharge • Entire validated costs of the distribution company should get recovered and tariff should be prepared accordingly • Avoid regulatory assets • Avoid Government Influence • Irregular revision of tariffs, uncovered revenue gaps, unrealistic efficiency improvement • Regulatory Autonomy

26. Cost Reflective Tariffs - Way Forward To attribute costs to different categories of customers based on how those customers cause costs to the utility; To provide a comparison of the allocated costs with revenues from existing tariff; To illustrate the Extent of existing cross-subsidisation between consumer categories

27. APTEL - 11 Jan 2012 If strict commercial principles are followed, then the tariffs have to be based on the cost to supply a consumer category. However, it is not the intent of the Act after the amendment in the year 2007 (Act 26 of 2007) that the tariff should be the mirror image of the cost of supply of electricity to a category of consumer The cross subsidies may gradually be reduced but should not be increased for a category of subsidizing consumer

28. APTEL - 11 Jan 2012 APTEL has advised to initiate a simple formula which could take into account the major cost element to a great extent reflecting the cost of supply. There is no need to make distinction between the distribution charges of identical consumers connected at different nodes in the distribution network. It would be adequate to determine the voltagewise cost of supply taking into account the major cost element which would be applicable to all the categories of consumers connected to the same voltage level at different locations in the distribution system

29. APTEL - 11 Jan 2012 As segregated network costs are not available, all the costs such as Return on Equity, Interest on Loan, depreciation, interest on working capital and O&M costs can be pooled and apportioned equitably, on pro-rata basis, to all the voltage levels to determine the cost of supply Segregating Power Purchase cost taking into account voltage-wise transmission and distribution losses will be a major step in the right direction for determining the actual cost of supply to various consumer categories. All consumer categories connected to the same voltage will have the same cost of supply

30. APTEL - 11 Jan 2012 – Unsolved issues Based on the above points as specified in APTEL order, it is very clear, that the cross subsidies needs to be reduced and not to be eliminated. As, accurate data is not available, a simple formulation based on certain assumption can be carried out to calculate Cost to Serve of different categories of consumers. However, there is no clarity that the Cost to serve and Cross subsidy impact to be calculated needs to be at macro level or at micro level, i.e. to be determined at category of consumers level or at sub-category level also

31. Summary Conclusion Consumer tariffs to reflect efficient cost of supply but can be differentiated only on grounds specified in Section 62(3) Cross subsidies to reduce gradually without tariff shock to consumers SERCs are required to notify a road map along with intermediate milestones for cross subsidy (reduction) to be within ± 20 % of the average cost of supply.

32. Summary Conclusion The cross subsidies can exist for BPL categories of consumers for life line consumption but consumption in excess of this lifeline consumption is to be charged at full cost. Paying capacity can be one of the factors for determination of tariff payable by BPL categories. The tariffs payable for this lifeline consumption should be 50% of the average cost of supply. The State Government can provide subsidy to any disadvantaged consumer groups for increased access to electricity provided that this subsidy amount is provided in advance as per the Section 65 of the EA 2003

33. Thank YouRajkiran V. Bilolikar,Assistant Professor, Energy Area,Administrative Staff College of India, Bella Vista, Raj Bhavan Road, Hyderabad - 500082T: +91 40 6653 4390F: +91 40 6653 4356M: +91 9704087888rajkiran@asci.org.in Source: ERM

34. Section 62(3) of EA 2003 Provides for the factors on which the tariffs of the various consumers can be differentiated. Some of these factors like load factor, power factor, voltage, total electricity consumption during any specified period or time or geographical position also affects the cost of supply to the consumer. Due weightage can be given in the tariffs to these factor to differentiate the tariffs

35. National Electricity Policy Clause 5.5.1 reads that there is an urgent need for ensuring recovery of cost of service from consumers to make the power sector sustainable Clause 5.5.2 stipulates that consumers below poverty line, who consume below a specified level, say 30 units per month, may receive a special support through cross subsidy. Tariffs for such designated group of consumers will be at least 50% of the average cost of supply. This provision will be re-examined after five years Further, the National Electricity Policy provides for reducing the cross subsidies progressively and gradually

36. National Electricity Policy Clause 5.5.1 reads that there is an urgent need for ensuring recovery of cost of service from consumers to make the power sector sustainable Clause 5.5.2 stipulates that consumers below poverty line, who consume below a specified level, say 30 units per month, may receive a special support through cross subsidy. Tariffs for such designated group of consumers will be at least 50% of the average cost of supply. This provision will be re-examined after five years Further, the National Electricity Policy provides for reducing the cross subsidies progressively and gradually

37. National Electricity Policy Clause 5.5.1 reads that there is an urgent need for ensuring recovery of cost of service from consumers to make the power sector sustainable Clause 5.5.2 stipulates that consumers below poverty line, who consume below a specified level, say 30 units per month, may receive a special support through cross subsidy. Tariffs for such designated group of consumers will be at least 50% of the average cost of supply. This provision will be re-examined after five years Further, the National Electricity Policy provides for reducing the cross subsidies progressively and gradually

38. Classification of Costs Costs which are triggered by peak demands imposed on the system are classified as “demand related”; Cost related to level of power purchase as “energy related” and Cost related to number and type of customers as “customer related

39. Method to be adopted for Generation Cost System Load Factor Approach - treats all the generation costs in proportion to the system load factor as energy related and the remaining as demand related. Average Approach - classifies fixed costs of generation into demand and energy related using an arbitrary ratio, say 50:50. The variable costs are classified as energy costs. Marginal Cost Approach - usually takes into account market prices of capacity and energy to classify fixed as well as variable costs Specific Resource Approach - uses different classification approach for each resource (or plant); say 100% demand related for peaking units. Specific Expenditure Approach - classifies each expenditure item using one of the above methods

40. Classification of Transmission cost The transmission system is designed to handle certain peak demand and as such the costs are fixed in nature & as such they can be entirely treated as demand related. the methods of classification are as follows – 100% Demand Related – Simple but ignores that some of the transmission investment is made partly to facilitate energy transfer from generating stations or import/export of energy

41. Classification of Distribution cost The distribution system apart from serving the demand also provides various services to the customers such as metering, billing, break down repair etc. Hence, distribution costs need to be classified as partly demand related and partly customer related; Distribution related components like meters could be considered 100% consumer related; Distribution assets that are used by a single consumer (e.g., Service Lines) and cost associated with it could be classified as entirely consumer related;

42. Classification of Distribution cost 100% Demand Related - classifies all other costs as entirely demand related on the rationale that distribution networks are set up to meet the local maximum demands; Partly Demand and Customer Related - attempts to work out appropriate ratios for each component of distribution costs for classification into demand related and customer related costs

43. Cost Classification and Functionalisation

44. Allocation of Costs The functionalised and classified costs are then allocated to various customer classes of the utility based on allocation factors derived from demand, consumption of energy and number of customers such as Energy usage and a measure of demand (peak, average etc.), Load Pattern, etc. Such allocation arrives at the cost of service for each customer class The classified costs may be allocated on the basis on time differentiated allocation factors. The energy and demand related costs are split into several costing periods. The energy usage and a measure of demand (peak, average etc.) within such periods form the basis for allocation of costs

45. Allocation of Commercial Loss Commercial losses are determined as the difference between total losses and technical losses. The commercial losses shall be allocated to the customer categories in ratio of sales. Thus, no commercial losses shall be allocated to the energy transferred at lower voltage level as the consumers using such energy are not responsible for commercial losses at the higher voltage

46. Allocation of Technical Loss Technical losses at HV and LV levels are allocated to the categories in ratio of sales to customer categories connected at that voltage and energy transferred to the immediate lower voltage level. The above method for allocation of technical losses shall be done in two steps. Firstly, the losses shall be allocated to various voltages levels in the ratio of voltage level sales and transfer (to next category). Then, the losses allocated to various voltage levels shall be allocated to the respective categories in the ratio of category sales

47. Category wise Customer Weightage To address the variance in per customer service costs across categories, category wise weight-ages shall be derived to determine allocation factors for customerrelated costs. The weight-ages shall be a function of two parameters - Sales per Customer and Load per Customer. The average of these two ratios for each category shall give the ‘Category Wise Customer Weightage’. The minimum & maximum limit for such ratios will be set at 1 and 200 respectively. The average of these two ratios for each category gives the ‘Category Wise Customer Weightage

48. Computation of Cost of Supply

49. Calculation of Expenses • Classification of Power Purchase Expenses • Classification of other Distribution Expenses • Allocation of demand related cost • Allocation of energy related cost • Allocation of customer related cost • Cost of Service of each category