Expert Speak - Electricity Regulation: Way Forward - An article made by Shri Prashant Chaturvedi, Secretary, MPERC

Power sector reforms over the years have probably produced more sound than light. Though the investors are waiting to enter the power sector, yet the commercial sustainability of Distribution Companies remains under doubt. The Central Government has appointed 'Shunglu Committee' to find out the ways and means to make electricity distribution commercially viable. The Committee on "Financial Position of Distribution Utilities" to be headed by former Comptroller and Auditor General (CAG), V K Shunglu would look into the financial problems of the State Electricity Boards (SEBs) and suggest potential corrective steps, especially in relation to their accounting practices.

Electricity distribution business still remains a bundled business in terms of wire business, demand aggregator and retail supply all rolled into one. For any generator, who is putting in a huge investment, demand aggregation is possible only through the Distribution Companies (Discoms). Even open access to the consumers would be through the wires of Discoms. Unless these Discoms see their way out of the red, the return on the new investments in the Power Sector would also be jeopardized. Therefore, constitution of such a Committee by the Central Government on the financial position of the Distribution utilities is a welcome step. The Committee, however, will only make the recommendations. Unless the State Electricity Regulators also focus their attention on the Distribution sector and address the relevant issues, the problems may never get resolved.

Electricity Regulators in many states have now been functioning in the country for more than a decade. To make them more effective, these regulatory commissions have been given more power than their counterparts in other sectors, e.g., telecom. Given the scenario, it is hard to believe that the telecom sector is much ahead of the electricity sector in terms of performance. A CAG report indicated that 24 utilities across 10 States had accumulated losses of Rs 21281.72 crore (2009-10). According to a study conducted by MERCADOS for 13^th Finance Commission, Discoms are likely to incur losses of Rs 68643 crore during 2010-11. There are issues like governance, organizational structure and electricity thefts. The question thus remains as to what difference the Regulators made over a decade of their existence to bring a change in the prevailing scenario? Out of the 39 utilities, the net worth of 22 utilities was negative during 2008-09. A closer look indicates that the average realization is far behind the average cost of supply (on subsidy received basis) in states like AP, Assam, Haryana, Karnataka, MP, Maharashtra, Orissa, Rajasthan, UP and Uttaranchal. Delhi, Gujarat and West Bengal are a few exceptions.

In a situation where there is a revenue gap per unit, reducing energy supplies leads to the reduction of the business losses. However, in such a case, the lone sufferer is the consumer as his supply hours are reduced. The basic idea of the Electricity Act 2003 was to install an independent Regulator and assure legitimate cost recovery for the Licensee. The CAG report observes that there was a 32.7 percent deficit in recovery of the cost of supply for Discoms during 2008-09. Moreover, in five states, the tariff was not revised for the past five years or more and for seven states the tariff revision did not take place for the last one to five years. CAGR of power purchase cost was 3 to 13 percent higher than CAGR of approved cost of supply in 10 different States. Prior to constituting the Regulatory Commissions, the State Governments were keeping the electricity tariff low at one pretext or the other. If the State Commissions also do the same thing, then what is the purpose of these Commissions? One must remember that a regulatory cost is added after the constitution of Electricity Regulatory Commissions, which is borne by the consumers.

Looking at the numbers in CAG report and MERCADOS study, time has come to attempt a mid course correction in Regulation of Electricity. The attention should be on Electricity distribution and not in terms of micro-management but resorting to economic regulation. Ideally, Regulator should create the same environment as a perfect competitive market would do. At the same time, the regulation must take into account the ground realities. The performance based regulation of Electricity distribution is no exception. The targets for Discoms should be realistic and achievable. Even R. V. Shahi in "Indian Power Sector- Challenges and Responses" emphasised this issue and mentioned that Regulatory Approach should be such that determination of improvement targets by Regulatory Commission needs to be done on a realistic/achievable basis.

Another issue is to discard 'One size fits all' approach. The approach adopted by CERC for Transmission and Generation Companies may not be suitable for Regulating Discoms. CERC's approach to Tariff determination typically applies to CPSUs, because other private investors are required to bid competitively under Section 63 of the Electricity Act 2003. CPSUs have deep pockets while state-run Discoms suffer from cash-flow constraints. The Electricity Regulators must differentiate between the two and allow the variation in terms of business model. Even in the private sector, a cash rich company may operate on a capex model, whereas the other companies may opt for opex model. While a cash rich airline may invest heavily in procurement of aircrafts, the other Company may run with leased aircrafts. Irrespective of the capex or opex model, the basic concept of cost recovery should be applied by the Electricity Regulators. In terms of business model, the policy should be of comparing apples with apples.

It is further suggested by some experts that the same kind of incentives may not be appropriate for private and Government utilities. The Capex based incentive may result in gold plating by Private Discoms, whereas loss reduction based incentive may be ineffective for Government run utilities. The customised performance based incentives should be offered to the Discoms. The risk in Distribution business is high and the uncontrollable factors are numerous. Right from risks in project execution to bad debts, the Discoms are at a higher risk than Generators or Transcos.

Moreover, the Discoms projects are scattered across the geography. The resistance from local politicians or public may either change the scope of project or may result in the abandonment of the project. The availability and expertise of contractors is an issue for Distribution projects. The collection of bills and bad debts are other risks of the business. The risk premium cannot be ignored for the Distribution business.

In the ARR (Annual Revenue Requirement) projected by the Discoms, 70-75 percent expenses may be power purchase expenses. Unless a realistic approach is adopted which is consistent with the provision of Electricity Act and Tariff Policy, the cost recovery shall remain an issue. The CAG report clearly indicates that CAGR of tariff increase is far behind the CAGR of power purchase cost. Short term power purchase is always costly than the Long term power purchase and yet it cannot be avoided as the Discoms operate on a real time basis, where the demand variation may take place due to several reasons. SERCs are yet to adopt a pragmatic approach in this matter. Transparent Price discovery mechanism in terms of Power exchange is available for more than two years. Yet many Discoms have not been able to use it for short term power purchase. The Regulators should allow day-ahead power purchase on power exchange and also fix a price band for other short term power purchases.

The reduction of AT & C (Aggregate Commercial and Technical) losses may not wholly be in control of a Discom as these losses depend on many factors. A holistic approach and close coordination with the state governments only can result in cutting down the losses on a sustainable basis.

In a sector, where the services are monopolised and the growth of business is guaranteed, the cost recovery is the main issue. An issue which is responsible for making the distribution companies sick. The Electricity Regulators need to take into account the ground realities as explained above. Supporting the Discoms does not mean covering up the inefficiencies. However, having numerous theoretical performance benchmarks ultimately results in neither monitoring nor achieving any of the benchmarks. It is better to have limited and achievable key performance parameters, which can both be monitored and implemented.

Constituting a Committee by the Government is the right approach; however the Electricity Regulators need to come forward to address the financial problems of the Electricity Distribution Sector. A visionary and long term view may make the Electricity Distribution viable, failing which not only the private investment would be jeopardized but the domestic and agriculture consumers may also be subjected to reduced supply hours and inconvenience.