RETAIL TARIFF OF ELECTRICITY (can leverage economic growth through better regulation)

1. RETAIL TARIFF OF ELECTRICITY(can leverage economic growth through better regulation) Sher Singh Bhat

2. VALUE CHAIN OF ELECTRICITY INDUSTRY

3. ELECTRICITY TARIFF • Tariff (Retail): • Rate at which the electricity is sold to end users • Unique features of Electricity: • Unlike other commodities, it cannot be stored. • Hardware inter connection between the producers and users • Significance of Pricing Policy : • Due to unique features pricing to maintain system discipline • Pricing is most effective DSM tool. • Consumers may contribute to peak chopping, load shifting , over all load reduction or demand enhancement according to pricing • Significance of Regulation: Regulation may ensure • Development of Efficient pricing policy by players on the value chain • These policies scrutinized and honored in principle by Regulation.

4. OBJECTIVES OF PRICING OF ELECTRICITY • Enable generation, transmission, distribution and supply companies of electricity to conduct the business on commercial principles; • To encourage competition, efficiency, economical use of the resources, good performance, and optimum investments; • To safeguard consumers’ interest and at the same time, recover the cost of electricity in a reasonable manner; • To provide incentives for efficient use and conservation of energy.

5. APPROACHES TO TARIFF DETERMINATION • Revenue requirement on cost basis • Cost determination by • Historical cost method • Estimated Cost Method • Marginal Cost Method

6. METHODS OF COST DETERMINATION • Historic Cost Method • Expenses determined on the basis of expenses incurred in the test year • TY is generally the last accounting year for which information is available. •  Estimated Cost Method • Test year is a 12 months future period when the tariff shall be operational. • All possible changes in future socio-economic set up are taken into account • Marginal Cost Method • Expenses required to be spent (in future) to produce and sell one more unit of electricity are taken into account. • It provides clear signals to both sellers and the consumers on the true value of the electricity consumed.  • MC based ‘Revenue Requirement’ can significantly vary from year to year and this may not accepted by the consumers. • Moreover, estimation of marginal cost is difficult and requires effective information system which most of the licensees do not have. Most regulatory commissions use the historical cost method.

7. METHODS OF TARIFF REGULATION • Cost Based Regulation (CBR) • Rate of Return (ROR) • Performance Based Regulation (PBR) • Price Cap • Revenue Cap • Profit Sharing

8. METHODS OF REGULATION • Cost-based Regulations (CBR): popular method (RoR) • Rate of return (RoR) regulation • The method enables a utility to collect all its prudently incurred expenses, in addition to a regulated return on prudent investment. • RR= CoP + EC+ MC+ AC +D +I + T +[RB x RoR] •  RR = Annual revenue requirement of the utility •  CoP = Cost of power purchased •  EC = Employee Cost; MC= Material Cost ; AC= Adm. and General Cost •  D = annual depreciation expense;  I = Interest on various loans •  T = annual taxes paid by the utility •  RB = the rate base i.e. Fixed assets in case of the state utilities • RoR = allowed rate of return on investment (debt and equity) = Reasonable return ( ? in case of state utilities) • Demerits: • By linking prices to the actual costs in the preceding year, efficiency and inefficiency of the utilities will be passed on to the consumers. No incentives or disincentives to utility. •  Limitations: • Asymmetry of Information; Tendency to over invest

9. CASE: Cost based tariff for NEA • Historical Year 2008/9 • Total Operating Costs (TOC): 20893.89 MNR • Operating Expenses 16184.19 MNR • Interest on long term loan 2809.46 MNR • Forex Transaction Losses 800.24 MNR • Dues written off (street light) 980.00 MNR • Other expenses (prior year adj.) 120.00 MNR • Rate Base : 40835.69 MNR Plant & Machinery + CWIP + Investments • RR = TOC + ( RB*ROR) = 20893.89 + ( 99053.46* 0.03) = 23865.49 MNR • Total sale of electricity “S” = 2308.91 GWh • Average per unit tariff = RR/S =NR 10.34 • Applied Tariff during the year = NR 6.71 • Required hike = 54 %

10. METHODS OF REGULATION • Performance Based Regulation (PBR): • Outcomes are rewarded instead of controlling behavior by Regulator. • Unlike in CBR (ROR), it provides incentives to utility for improving efficiency and reducing costs. Such incentives later on shared by consumers also. • Utility is given a set of financial and operational criteria on which its profit depends. • Different approaches to PBR viz. price cap, revenue cap, profit sharing methods etc. Maximum prices or revenue are established for a period of say 5 years. The regulated utility can retain profits within the cap. •  Advantages • PBR brings in the feature of stability to the tariff structure. • PBR is less susceptible to the risk of over-investment by the utility. • Retaining profits by firm incentivizes to produce efficiently. • Some of these benefits are also shared with consumers. • Limitations • Some time it may be necessary to reset X in RPI-X+UC at regular intervals. So there is tendency for PBR to converge over time to RoR based regulation. • Projection often becomes difficult and the power sector is not an exception.

11. ELECTRICITY TARIFF(NEA) AND PBR • Total Costs = Controllable + Non controllable • Controllable: • Staff Costs: • By restructuring, reducing overtime, using technology • Improving staff efficiency • Taking agency services for some areas after retirement of staff • Preparing a staff cost reduction action plan • Operation and maintenance • Doing most jobs by regular staffs • Best use of tools and plants • Effective preventive maintenance • Controlling on adding unnecessary facilities as these increase O&M Costs • Power purchases ( partly) by best use of own plants • Uncontrollable: • Interest (GON domain) • Depreciation • Royalty (GON domain) and Taxes • Forex Transaction losses etc.

12. ELECTRICITY TARIFF(NEA) AND PBR • Total Revenue = Improvable + Non improvable • Improvable • Reduction of losses thereby increase in sales • 26.4% to 22% within next five years • Redefine the consumer categories • Increase in miscellaneous income by best use of infrastructure and facilities like land, OFC, poles and towers, transformer and workshops, soil and rock lab and available equipment, pole plants, vehicles and heavy earth movers, engineering and expert services, rechargeable works, surveying and survey equipment • 6.5% ( study sold) to 7 % within 5 years • Establish external services and other incomes department • Prepare an action plan for other incomes and target a figure • Non-improvable: Sales * tariff

13. LIMITATIONS • Commission cannot allow a 54% Tariff hike based on CBR in one go. It is not fair to recover all revenue requirements through increase in tariff. • Aim is to • First improve the cash flow to continue operations • Then improve the balance sheet as whole • Possibility and recommended Action • A combination of CBR and PBR to be adopted

14. ELECTRICITY TARIFF(NEA) • Base tariff (year 2008/9) NR 6.71 • Required tariff for RR of this year (2010/11) NR 10.34 • Tariff regulation method • Combination of CBR and PBR • Tariff fixed now with 30% hike at NR 8.73 per kWh • 3% Escalation for five years • PBR benchmarks for five year • ATC loss 22% (reduction by 1% every year) • Miscellaneous income 7 % of total revenue • Visible reduction in staff and other controllable costs 3% in five years • NEA to retain profits of improvement during the period • Tariff revision after five years. In case of major change in costs, utility may apply for revision within five years also. • Profit retain factor “X” from improvement to go below 1 after five years so that benefit of improvement is shared by consumers • If at least one PBR is attained and progress is noticed in others, then Commission would allow new Tariff after five years

15. Revenue and Tariff

16. TARIFF AND SYSTEM OPERATION • Tariff is an important tool of system discipline • For that purpose tariff design is frequently changed according to availability, demand and system requirement • These frequent changes shall be suspected and not welcomed by consumers • For that COMMISSION is there. People believe on commission because in the commission there are people on whose capability and knowhow about the sector they have no doubts. • If a decision by COMMISSION is supported by people well-known for their experience and contribution in power sector, everybody believes it.

17. TARIFF DESIGN • Dimensions • Class Factor Dimension ( for social justice) • consumer categories and • sub categories • Time Factor Dimension (for system discipline) • Seasonal : dry and wet • Time of the day: off peak, peak • Voltage Factor Dimension (for loss accommodation) • High voltage (66 k V and above) • Medium Voltage ( 11 and 33 k V) • Low Voltage ( 220 V or single phase, 400 V or 3 phase) • Type of Charge Dimension ( for capital and running cost recovery) • Connection or demand charge • Energy charge • Power factor charge • Quality Factor Dimension ( for service quality) • Premium supply • Normal supply

18. TARIFF DESIGN • Peak sensitivity of customer class: • Domestic highest say 75% • Then Commercials say 10% and then other classes • Non commercials have least sensitivity • But we use Peak tariff to industries only • Seasonal Sensitivity of customer classes • Domestic highest • Demand or connection cost sensitivity of customer classes • On individual basis • Industrial and 3 phase connections highest • On collective basis • Domestic highest And so on.

19. TARIFF DESIGN • Cost allocation factor is calculated for each class on collective basis • These costs are allocated on sensitivity, total demand of capacity and energy of category • Thus total cost is distributed among categories • Then category cost is distributed among subcategories for each cost allocator • Then individual consumer tariff for each sub category is designed accommodating the cost allocators • Cross class subsidies should be discouraged as it leads to more political interference. If government wants to subsidize certain category or sub-category government should pay the subsidy.

20. TARIFF, COMMISSION AND NEA • NEA is state owned utility and hence responsible to people and growth of sector with minimum profit motive • ETFC, by virtue of its function is responsible towards people and industry as well. • Both have same objective and target and hence should work together in the best benefit of people. • Presence of NEA in ETFC would make it more effective • However NEA has realized that even if NEA is not given space in ETFC, it could contribute in the process by providing relevant information in appropriate format to ETFC with detailed analysis. • In the latest organizational restructuring, NEA has established Revenue Department that will regularly work out on the tariff issues and keep in touch with ETFC.

21. REQUIRED • Commission needs to be convinced with the costs allocated • Commission needs to be convinced that efforts have been initiated where there are chances of improvements • Who is to initiate the efforts • GON on issues of governance • GON on issues of financial restructuring • NEA on cost reduction, loss reduction, over all organizational efficiency improvement • A practical and convincing target on the issues • Even an improvement of 0.01% shall benefit people that is ultimate desire of Commission • People in commission are answerable to public

22. FACE PAGE STATEMENT • A 3% escalation proposed long back could have earned 30 BNR additional fund for NEA • NEA would have started 500 MW plant after KGA • There would not have been any load shedding today • Yes, a better regulation leverages economic growth • Of course it doesn’t mean that NEA should not improve

23. CONCLUSION • RETAIL TARIFF REGULATIONS SHOULD • Facilitate and leverage sectoral and economic growth • Allow utility to recover reasonable costs of service • Safeguard justifiable interests of the consumers • Commissions decide in larger interests of the country

24. THANKS