Are price caps on short-term power justified?

Many state electricity regulatory agencies have proposed price ceilings on the short-term procurement of power, beyond which the relevant discoms will not be allowed to true-up their tariffs against power purchase expenditures. A case in point is the Karnataka Electricity Regulatory Commission (KERC), which has proposed a price cap in the range of Rs 6/kWh on such transactions.

• Proponents of such regulatory intervention argue that India is a poor country and all efforts should be made to ensure that access to electricity for the masses should be at the cheapest rates possible. Recognizing that in a nation with such immense power deficits, sellers would have immense market power, such entities argue that buyers, i.e. discoms will have no bargaining chip whatsoever, to the detriment of end-consumers. Thus, a price cap would ensure that power generators are unable to extract obscene rents from discoms, ensuring reasonably priced power to the populace.
• On the other hand, we have the power ministry`s recent push for merchant power plants, which are set up with no long term assurances for the sale of power through power purchase agreements. These plants, in order to be viable, would require prices for power commensurate with the increased revenue risk to their developers, without which they would be unable to obtain financial closure. Thus, a major avenue for capacity addition would be lost to the government.8As an alternative to an outright price cap, a differential price cap, based on cost plus principle, with appropriate assumption for Return on Equity, plant capacity utilization and fuel cost may be considered. Such a price cap would be applicable only for portfolio sellers and coal, lignite and hydropower-based plants, and not to any liquid fuel or gas based generation, which uses more expensive fuel and is subject to input price volatlity.
• This cap may be applied only to the OTC market, as it is not possible to implement a differential price cap with the price discovery mechanism existing in power exchanges.