Round Table

Power Sector Reforms in

India: Distribution Reforms

D
istribution reforms in India began in the mid-
90s, and followed the World Bank’s model of
privatisation. This goal required intermediate
steps of unbundling and corporatisation of vertically
integrated state utilities. So far, Orissa and Delhi have
already privatised their distribution companies, while
Karnataka and Andhra Pradesh have undertaken ag-
gressive steps in the same direction (Exhibit 1).
cess. In 1993 the Government of Orissa commenced
an extensive reform programme of the electricity sec-
tor, to improve the quality of electricity supply and
stimulate economic growth in the region. The broad
objectives of the reform programme were as follows:

To distance the power utility from government
control with the objective of creating autonomy

To attract large amounts of private finance

The Orissa Experience

To introduce competition.
D V Ramana
To achieve the above objectives, the Orissa Power
Orissa was the first state to initiate the reform pro- Sector Restructure Project was designed to undertake
the following:

Exhibit 1: Distribution Reforms: An
To establish a separate act i.e. the Orissa Elec-
Overview tricity Reform Act

Orissa Delhi AP Karnataka
To un-bundle and corporatise the Orissa State

Electricity Board (OSEB)
Unbundling Yes Yes Yes Yes
Corporatisation Yes Yes Yes Yes
To develop an autonomous power sector regu-
latory body
Privatisation of
Distribution Yes Yes No No
To privatise the generation business and the
distribution business.

IIMB Management Review, March 2004 71

Process
The reform process began with the enactment of the
Orissa Electricity Reform Act in 1995. The Act was
designed to address the fundamental issues respon-
sible for the poor performance of the industry in the
state. The new legislation was enacted for the pur-
pose of restructuring the electricity industry, for tak-
ing measures conducive to increasing the efficiency
of each activity i.e. generation, transmission, and dis-
tribution of electricity, for opening avenues for pri-
vate participation and for establishing the Regulatory
Commission. The Act allowed for the transfer of the
assets, liabilities, staff and statutory obligations of
the OSEB to the successor companies.
Unbundling and Corporatisation
Section 23(I) of the act prescribed the method by which
the power sector would be restructured. As a conse-
quence, the Grid Corporation of Orissa Limited (Gridco)
and Orissa Hydro Power Corporation (OHPC) were reg-
istered as government companies. Accordingly, the
following steps were taken:

The electricity business was divided into three
separate activities viz. generation, transmission,
and distribution

The business of generating of hydel power was
transferred to OHPC

The thermal power stations were transferred to
the existing Orissa Power Generation Corpora-
tion (OPGC)

The transmission and distribution business was
transferred to Gridco.
furcate the field level activities into engineering and
commercial. The commercial function comprised rev-
enue management, accounting, customer management
and the engineering function comprised system op-
eration, repairs and maintenance, and other technical
activities. Coupled with the bifurcation, commercial
procedures were implemented. This small intervention
improved the business environment at the division level.
Introduction of Profit Centre Accounting: Under this,
Gridco was divided into Cost Centres and Profit Cen-
tres. Transmission divisions were treated as cost cen-
tres and the distribution divisions were treated as profit
centres.
Introduction of Revenue Improvement Action
Programme (RIAP): The programme focussed on the
reduction of non-technical losses, thereby improving
the financial position of Gridco. One of the major con-
tributions of RIAP was the quantification of the actual
T&D losses. The energy lost and energy billed in the
year 1996-97 worked out to billed: 54%, non-technical
losses 28% and technical losses 18%.
The finding of high T&D losses against the reported
22% in various forums and published sources was an
eye opener to both the shareholders and the manage-
ment.
Privatisation of Distribution Business
Since the weakest link in the industry value chain is
the distribution of power to the ultimate consumers,
the government decided to transfer it to private play-
ers. Some of the indicators of performance of the dis-
tribution business just before the privatisation are
given in Exhibit 2.

Prelude to Privatisation
Exhibit 2: Selected Performance Indicators
Three important steps taken
under before privatising the dis- LT/HT Billing as % of Input (units) 51 to 60%
tribution business: Collection as % of billing (amount)
Introduction of Commercial LT consumers 48 to 54%
Function at the Field Level: HT consumers 75 to 86%
OSEB was managed principally
by engineers, therefore, the EHT consumers 91 to 99%
management had a strong tech- Effective % of input collected 43.3%
nical bias and it was standard Outstanding Debtors (Sales days)
practice for engineers to under-
take commercial, administration LT consumers 499
and other non-engineering HT consumers 121
jobs. One of the major
EHT consumers 64
organisational changes intro-
duced during the ISP was to bi- Source: Gridco’s Management Accounts

72 Power Sector Reforms in India: Distribution Reforms

Experiment With Management Contract for the transitional period. Assets were valued higher,
losses and industrial consumption were overstated.
In October 1996, Gridco entered into a management The Kanungo report was an eye opener on many of
contract, a ‘Distribution Operations Agreement’, with these aspects. There was inadequate government sup-
BSES, one of the leading private players of the indus- port and this distancing resulted in the failure of this
try. Under the contract, BSES was given the manage- model.
ment of one of the four zones viz. Central Zone in con-
sideration of a fee plus incentives based upon mea- However in all fairness, it must be recorded that the
surable improvements in collections and metering. Orissa experiment provided a powerful demonstration
However, the experiment failed and Gridco revoked the effect.
contract in May 1997. This experiment demonstrated
that it is not possible to improve the performance of The lessons from Orissa were thus very clear:
an organisation just by asking private entrepreneurs
There was a need for full and sustained politi-
to run the day-to-day operations without giving over- cal, administrative and financial support to the
all control. distribution companies in their efforts to im-
But, on the positive side, Gridco was determined to prove and run the electricity distribution busi-
transfer control to private hands which forced the gov- ness.
ernment of Orissa to take the bold step of divesting its
This support would enable them to disconnect
share in all the four distribution zones. illegal consumers, reduce theft and improve
collection efficiency.
P K Kukde

Baseline data was required to be reasonably cor-
The state of Orissa was the first to proceed with a
rect.
reform programme in response to the World Bank’s
offer. While its estimated percentage of T & D losses
Multi-year regulation was called for to reduce
was high and collection of bills was low, the state had regulatory risk and uncertainty.
the advantage of a relatively small agricultural load
and hence it needed a lower agricultural subsidy. Elec- Following the lead of Orissa, six other states embarked
tricity sector reform in Orissa was on the process of reforms, through
termed as the ‘World Bank model’. models largely resembling the Orissa
The Orissa model. The lessons learned in Orissa
It was believed that private finance experiment provided a and elsewhere in the country have
would develop new generation and en- been constructively applied in the
hance availability of existing capacity. powerful
Delhi model.
Private participation in distribution was demonstration effect.
expected to improve service quality The lessons from D V Ramana
and increase financial performance. To
make distribution more attractive 75% Orissa were — the Cost of Service-based Tariff:
of the shared financial liabilities were need for sustained Will it Help in Rationalising the
transferred to the publicly held trans- Tariff
political,
mission sector. Generation was made
more attractive by increasing the price administrative and CESCO is a distribution company of
charged to Transco, which however financial support to Orissa, not doing well, but is an inter-
was not allowed to pass on the price esting case where there is a possibil-
the distribution ity of forcing the government to show
increase to the distribution companies.
Thus Transco built up enormous liabili- companies, correct its support for the sector. We are of
ties that undermined its long term vi- baseline data and the view that the government cannot
ability. wash its hands of the power sector.
multi-year regulation.
Revenues from privatisation were not Despite the privatisation and so called
ploughed back into the sector but absorbed into the reforms the overall performance of the company has
government budget for other purposes. Subsequently been far from satisfactory. The company continues to
substantial tariff increases were imposed on the pub- incur losses and the net worth got eroded over the
lic but with few improvements in service, leading to period. One of the reasons for the dismal financial per-
growing public discontent. Provisions were not made formance is the gap between the actual and approved

IIMB Management Review, March 2004 73

 the exercise raises several ques-
Exhibit 3: Sales Mix of CESCO tions about the present tariff
setting practice and provides
Sales Mix Units sold (MU) some directions in tariff manage-
ment. It also makes a case for
Segment FY 99 FY 00 FY 01 FY 02 FY 99 FY 00 FY 01 FY 02
the state government to pro-
LT 59% 69% 63% 71% 1173 1332 1379 1552 vide subsidy to the sector.
HT 19% 18% 17% 18% 367 338 387 394
Power Sector Reforms in
EHT 22% 13% 20% 12% 435 320 453 266 Delhi
Total 100% 100% 100% 100% 1975 1990 2219 2212
Jagdish Sagar

T&D losses. The actual losses are in the range of 50% Background
to 43%, whereas the Commission approved 34% to 35%.
A large chunk of such loss is commercial and revenue The Delhi Vidyut Board (DVB) was set up in 1997 as an
related. Another reason for the increased financial SEB replacing the Delhi Electric Supply Undertaking
losses is the change in the sales mix (Exhibit 3). (DESU). It is one of the largest urban utilities and a
purely distribution one. Some features of Delhi’s power
From the consumption pattern of CESCO we could see supply situation are:
that the large consumers were withdrawing from the
EHT segment (the most profitable one), both in terms
Very high and rapidly growing per capita con-
of absolute and relative consumption. The change in sumption — 1382 kwh per capita per annum in
the sales mix impacts the loss levels. Decrease in EHT/ 2001-02
HT consumption and increase in LT consumption nega-

A high rate of load and consumption growth
tively affects all the performance indicators, viz. loss
percentage, collection percentage, and overall finan-
Sharp variation between peak and off-peak load,
cial performance due. with sharp seasonal variation, and consequent
peaking shortages during peak seasons
The issue was whether the tariff design was respon-
sible for the change and whether Cost of Service (COS)
Limited local generation
based tariff could address this lopsided consumption
pattern.
The advantage of negligible agricultural load is
offset by the presence of a large population of
Based on the data of one year (Exhibit 2) and on the unauthorised colonies and jhuggies; an un-
basis of the model given by the National Association stable cityscape and a constantly changing ur-
of Regulatory Utility Commissioners (NARUC) we cal- ban scene.
culated some tentative numbers and wanted to throw
it open to the public at large in Orissa and the stake- From 1959 to1999 the utility was restrained from sup-
holders. Exhibit 4 shows the COS and the gap be- plying power to unauthorised areas, which compelled
tween the tariff and COS. the growing population of such areas to steal it. In
2001, DVB estimated that about 14% of Delhi’s power
The actual numbers for the year 2002 of approved tar-
iff shows a the gap between the realisation and the
COS for the LT category to the extent of 291 crores Exhibit 4: Cost of Service and Average
(2.91 bn) and for EHT category consumers the gap is Realisation
around Rs 1.13 crores (11.3 mn).
Total COS Reali- Gap Total
COS per sation per Gap
The problem that we encountered while calculating
(Rs cr) unit per unit unit (Rs cr)
the COS was the quality of the data. At the consumer
level or a category level the distribution company does LT Total 503 3.46 2.54 -0.92 -291.21
not have the maximum demand data. As a result we
had to compute COS on the basis of certain assump- HT Total 112 2.99 3.91 0.92 38.12
tions based on macro data at the CESCO level, the EHT Total 151 3.13 3.1 -0.02 -1.13
maximum demand consumption per month. Though Total 766 3.3 2.87 -0.44 -254.21
the basis of computing the COS can be questioned,

74 Power Sector Reforms in India: Distribution Reforms

consumption was going unbilled to the unelectrified or other external agencies. This urgency was an addi-
colonies and jhuggie basties (squatter settlements). tional reason for adopting the business valuation meth-
In addition to this, DESU and later DVB were notori- odology. The revenue potential of each of the discoms
ously subject to the usual factors, attributable to po- was gauged on certain assumptions about reasonable
litical interference and the low priority accorded to tariff increases; targetted efficiency improvements (for
commercial performance, which affected other SEBs. the business to become self-sustaining within five
During recent years, DESU/DVB suffered from a poor years); costs; and the transitional assistance commit-
public image, for its quality of service, consumer rela- ted by GNCTD. Such a methodology is in any case
tions and commercial performance more appropriate to the purpose and
alike. The best known thing about DVB also obviates the impact on retail tar-
was its T&D losses. However, I think Delhi Vidyut Board iff that overvaluation can result in.
our statistics were simply more hon-
has suffered from a Meeting investor concerns: The
est than those of other SEBs. More-
over there has been too much simplis- poor public image. dearth of interested investors was
tic thinking about this problem. It is compounded by the Orissa experience.
viewed as a moral issue rather than the The best known thing Unless the concerns of potential in-
managerial problem that it really is. But about DVB was its vestors were addressed, there would
even when (down to the early 1990s) be little chance of success.
DESU’s T&D losses were at relatively T&D losses. There has
acceptable levels, the retail tariff had The experience in Orissa (1999) high-
been too much lighted the importance of reliable open-
been insufficient to cover its costs.
Delhi’s T&D losses were 12% in 1976 simplistic thinking ing data, as the level of T&D losses
– they increased sharply between 1976 (difference between units supplied
and 1980, but were still in the low twen-
about this problem. It and units for which bills are raised)
ties, and went up very sharply from is viewed as a moral there turned out to be vastly different
1993-94 – and that was the year that from what had been stated, with di-
Delhi first got an elected assembly. issue rather than a sastrous consequences for the inves-
Before that Delhi had a different ad- managerial problem. tors. Fortunately in Delhi, with me-
ministrative structure. There is a cor- tered billing of consumers, the basic
relation there, in my opinion. DVB problem, arising from the unreliability
had become a good boy in the last few years, paying of billing figures, was not nearly as serious as in SEBs
95% or so of its power use altogether. with extensive flat-rate billing; nevertheless there was
some margin for error. Hence the adoption of Aggre-
The Reform Process gate Technical and Commercial (AT&C) losses (differ-
ence between units supplied and units for which pay-
The new Government of the National Capital Territory ment is realised), rather than T&D losses, as the crite-
of Delhi (GNCTD) elected in December 1998 brought rion of commercial efficiency.
out a Strategy Paper in February, 1999, the main fea-
tures of which were the setting up of a regulatory com- Regulatory uncertainty: The mere establishment of
mission; unbundling (starting with the establishment an independent Commission was initially perceived as
of a generating company); disinvestment of distribu- an adequate solution for the problem of the political
tion; interim measures to improve DVB’s performance; executive taking regulatory decisions, but the devel-
and a commitment to protect the interests of staff. opments in Orissa made it apparent that the question
However, the reform package as finally implemented in of realistic loss reduction targets would have to be
fact evolved empirically with the process over the next addressed if investor interest was to be sustained.
three years and did not strictly follow the sequencing
Multi-year tariff packages have commonly been an in-
originally envisaged. gredient of successful privatisation elsewhere but our
laws in India do not envisage it and require annual
Key Issues filing. This being so the solution initially proposed
The key issues were as follows: was multi-year tariff setting principles premised upon
pre-determined T&D loss reduction targets. (The
Time frame: Since the government was understand- AT&C loss concept had already been conceived by
ably anxious to show results of its reform programme the consultants but at this stage the T&D loss
before the end of its term of office, the resultant time concept was applied to be consistent with the
frame was not long enough to involve the World Bank Commission’s own formats for tariff filing.) Along with

IIMB Management Review, March 2004 75

 Exhibit 5: Delhi: Unbundling and Privatisation Process
1. All the assets and liabilities
of DVB are acquired by GNCTD
GNCTD
3. All the assets are trans-
ferred from GNCTD to suc-
cessor entities.Assets will
be assigned a value
equal to serviceable
liabilities.
Genco Transco
the Aggregate Revenue Requirement (ARR) and tariff
filing for 2001-02, DVB proposed such five-year T&D
loss reduction targets to Delhi Electricity Regulatory
Commission (DERC), but there was little appreciation
of the need for a multi-year package and the DERC
was unable to accept the proposal. Hence the solution
was adopted, whereby efficiency improvement targets
were pre-set for five years, and simultaneously
legitimised, by making them (rather than a premium on
the price of equity) the bidding criterion, and building
them into the package by means of policy directions
with incentivisation for over-achievement (as failure
to achieve the target would entail substantial loss).
The essence of the policy directions is, thus, simply
to bind the Regulatory Commission to the bid levels
accepted by the Government.
Transitional assistance: Transitional assistance was
a key issue. It was necessary in this period to balance
three things – realistic expected efficiency gains, pos-
sible tariff increases, and transitional assistance until
the benefits of greater efficiency were realised. DVB’s
losses in the last financial year of its existence
amounted to nearly Rs 1200 crore (12 bn). Since effi-
ciency improvements would make the sector viable only
at the end of a five-year period, it would be necessary
either to raise the tariff sharply or to provide interim
government assistance for the transitional period. It
made sense for the government to consider substan-
tial assistance for the interim period to maintain tariff
increases at reasonable levels. By retaining the single-
buyer model for five years, the government would as-
sist Transco to supply power to the discoms at lower
rates, the assistance being returned subsequently
through loan repayments after the losses had come
76
Legend
DVB Assets
Liabilities
2. All the assets and liabilities of DVB are trans-
ferred to Holding Company, entire Equity of
Holding Company is issued to GNCTD
Holding Co.
4. Equity and Debt in
the successor entities,
equal to the value of
serviceable liabilities
is issued in favour
of the Holding
Company.
D1 D2 D3
down. Moreover, there is little scope for generation
competition. Such assistance was also a device for
ensuring a common retail tariff throughout Delhi for
this five-year period (which was necessary keeping in
view the disparities in opening loss levels of different
companies). Further, those areas with the high losses
are also where the poorer people live, and you would
necessarily have a much higher tariff in one of the
three companies because of the much higher level of
the losses there. This would, very understandably, be
politically unacceptable. The total assistance was pro-
jected at Rs 3450 crores (34.50 bn) for five years; the
annual quantum diminishing each year.
Reform structure: The process of unbundling and
privatisation is compendiously depicted in Exhibit 5.
Choice of objectives: privatise or corporatise? It is
technically necessary to corporatise an SEB before it
can be disinvested. The issue is the place in the re-
form scheme of this intermediary stage (of having gov-
ernment-owned companies) and consequently the time
frame for disinvestment in relation to corporatisation.
Should we try to create working, viable companies
first, to establish the ground for a successful disin-
vestment? The experience so far does not appear to
warrant it. In Delhi, the government was clear in its
mind about the objective of privatisation, and it was
possible to skip the intermediate stage of having gov-
ernment-owned distribution companies. Mere
corporatisation was thought unlikely to address the
real problem. Moreover, there was the danger of the
political will relapsing with partial achievement. Shell
companies had been created in advance, but the trans-
fer scheme, whereby DVB’s assets and liabilities were
Power Sector Reforms in India: Distribution Reforms
formally vested in the government and then transferred
to the successor companies, was operationalised
simultaneously with disinvestment (from July, 2002).
Personnel Issues
A major consideration in the early stages was the pos-
sible consequences of employee unrest, particularly
during the summer months. DVB had a history of very
strong trade unionism. It was a major advantage that
union leadership and most employees came to under-
stand that reform was inevitable, and also popular with
the general public, and therefore opposing it would
neither halt the process nor win any public sympathy.
Rather, the leadership was able to see that cooperat-
ing with the reform process would help them secure
their future interests. However, this atmosphere of
cooperation could not be maintained without the as-
surance of job security. The Tripartite Agreement pro-
tected the existing employees from the threat of re-
trenchment and secured their existing conditions of
service and committed GNCTD to establish a Trust for
their retirement benefits; GNCTD contributed Rs 860
crores (8.6 bn) to make up the initial funding require-
ment of the Trust of Rs 1329 crores (13.29 bn), and
guaranteed the Trust’s discharge of its obligations.
In conclusion, the main lesson is that tariff increases,
loss reduction through expected improvements in com-
mercial efficiency, and transitional financial assistance,
are the three crucial inter-related issues in privatising
distribution from a situation of high opening losses.
It is absolutely necessary to evolve a viable package
that balances these considerations in a manner that is
perceived as acceptable to all the stakeholders con-
cerned, in the particular local situation. Secondly, re-
form cannot be left to regulatory institutions without
sufficient government guidance and involvement for
which policy directions existing in all Indian reform
laws appear to be an appropriate instrument. Another
lesson that might be drawn from the Delhi experience
is that flexibility during the process may be necessary
– assuming that the objective of privatisation is not
lost sight of. And finally, the high level of public ex-
pectation has already become apparent and poses a
major challenge to the new companies.
What has been our experience since July 2002 when
we handed over?
One is, there has to be a focus on system change rather
than on fire fighting, which we in the government are
always doing. This means that it is going to take time
to achieve results and for benefits to be tangible to
the public. We have had our share of teething troubles
with the introduction of new systems.
IIMB Management Review, March 2004
We also saw some residual issues, partly because of
the simultaneous unbundling plus privatisation. There
are contractual issues – no matter how carefully you
draw up your documents, there are always points and
issues that come up later that need to be resolved. If
we had to do this over again, then we would probably
draft our documents a little differently.
P K Kukde
The key issues in the Delhi model were:

Government commitment and sustained support

Improved base-line data on loss levels.

A limited and circumscribed level of past period
receivables

Full and continuing involvement of the Regula-
tory Agency

Rational and fair valuation of assets – valua-
tion based on revenue stream

Clean balance-sheets assured to discoms

Material stocks, loans to personnel to be based
on actuals after audit

16% ROE assured if agreed loss reduction
benchmarks achieved. 17% reduction in the T&D
losses are expected phase-wise in five years.

Continuing but reducing subsidy (via BST) on
the scale of past losses incurred. The govern-
ment has agreed to subsidise the generating
company to the extent of Rs 3450 crores (34.5
bn) in five years.

Capital support from government via Acceler-
ated Power Development and Reform Programme
(APDRP), and from Power Finance Corporation
(PFC).

Model structure assures returns which in turn
makes entity creditworthy.
Post Privatisation Approach
The approach adopted in Delhi has been multi-
pronged and may be better understood against the
time frame i.e. short term, medium term and long term:
Short term goals: Consumer friendly measures, con-
sumer grievance redressal, consumer education.
Medium term goals: Revamp the billing and collection
process to make it fast, efficient and consumer friendly;
ensure that all meters work and put in place a credible
77
energy audit system and MIS; identify network weak- N M Rothschild & Sons, and the model we are working
nesses and implement a reliability improvement plan with is a hybrid model that has many features specifi-
including refurbishing of test and repair facilities; cally tailored to Karnataka’s and India’s situation. Over
rationalise the human resources by training and rede- four-fifths of our consulting effort is by Indian con-
ployment bringing in needed skills; and define and sultants. The design includes features of management
plan implementation of long term goals contracts, concessions and full-scale unbundling of
wires companies into a UK-type privatisation.
Long term goals: Harnessing technology to catch up
with global standards – Web enabled consumer ser- The main thing in the distribution business is to tackle
vices for applications, billing, payment and informa- the risk. One of the things that I do as a transaction
tion, major network replacements including conver- designer is to ask myself, ‘Would I put a quarter of my
sion to LT less HV distribution system, Supervisory pension into this deal?’ And if the answer is ‘no’ then
Control and Data Acquisition System (SCADA) and I know that something is wrong.
Geographical Information Systems (GIS) for improved
reliability and up-time, shaping the human resources If you look at ground realities, the operating losses
to be productive, honest, consumer oriented and right- are growing. Tariff structures are not aligned with cost
skilled. and tariffs are approximately 30% below cost recovery
in Karnataka. There is uncertainty about the evolu-
Since the take-over of North Delhi by the Tata Power tion of tariffs. In the beginning it was suggested that
Company, the short term goals listed above have been rural tariffs could be adjusted to reach a reasonable
achieved. We have started revamping cost recovery basis, but now it would
the substations and putting in mini- It was suggested that appear that the rural areas are not go-
mum standards of safety. We have ing to face continuing increases to-
noticed a change in the attitude of our rural tariffs could be ward real full cost recovery. This
consumers – they are becoming adjusted to reach a would be a matter of concern to inves-
friendlier. Energy audit systems have tors in the private sector. For the dis-
been implemented. We are doing our
reasonable cost tribution business as a whole, the con-
best to control theft, which is of a very recovery basis, but dition of assets and the customer base
profound nature in Delhi. The T&D now it appears that is uncertain. In Karnataka, the gov-
losses were 47.1% the day the reforms ernment has tried a number of pilot
were put into place, and we have to rural areas are not initiatives and experiments during the
reduce it by 17% in five years. The going to face two years but none of them have suc-
AT&C loss was 53.5% in Delhi. ceeded to expectation in enumerating
continuing increases customers, in registering unregistered
Our Capex plan for six years is ear- toward real full cost connections and so forth. An asset
marked at Rs 1249 crores (12.49 bn).
Initially about 50% of the amount will recovery — a matter condition analysis showed that the
condition of assets in the rural areas
be spent in the first two years, and the of concern to of the state is much worse than in the
remaining 50% will be phased out in urban areas. Most investors would be
the last four years. With this capital investors in the
concerned about this fact because it
investment, Delhi hopefully should private sector. means you know relatively little about
have a beautiful power supply. rural distribution assets but you will
need to invest heavily in a market that may not sup-
Allen Eisendrath port this investment. Customer resistance and theft
are major problems. And we know that the experience
The Karnataka Distribution Privatisation in other countries suggests that when you force cus-
Design tomers to pay their bills, when you have universal
metering, when collection effort is strong, people gen-
I am going to go through the background and the build-
erally cut their consumption by one third. There could
ing blocks of the privatisation transaction design that
actually be a big shift in demand. Industry could increase
we worked on with the government of Karnataka. The
and rural areas might constrain their consumption.
initial proposal to unbundle the urban areas separately
from the rural areas was rejected by the government, Just to put a finer point on the idea that distribution is
so we came back with a design that would fit an urban- a risky business, when you see the figures for the cost
rural combined zone approach. The consortium con- to deliver in Karnataka, in the year 2001 (Exhibit 6)
sists of Deloitte, CMS Cameron McKenna, IDFC and only 2% of the total cost is the profit associated with

78 Power Sector Reforms in India: Distribution Reforms

the distribution wires business. The rest, 23%, is the
distribution cost, which you control if you are a dis-
tributor, but 70% generation and 5% transmission cost
is not under your control. The point is that you do
not control the majority of costs in the business.
IDFC did a quick analysis using the financial restruc-
turing plan and they found that if you change the as-
sumptions in the business plans slightly (due to unex-
pected events such as droughts and so on), you
quickly wipe out the return on capital base. If you
start at a 16% return, and reduce the tariff growth by
1% per year due to decisions by the regulator, you
have a negative 17% return on equity. You can wipe
out your full equity in one single year if your loss
level is somewhat higher at the start than was expected.
As was noted in the Delhi case, privatisation cannot
fix the sector immediately. It takes years to get tariffs
to balanced levels. There are major information and
service gaps. Even in Delhi, which had reliable meter-
ing, there are still some issues related to the quality of
information. In Karnataka, only 37% of the load is
metered, which means that you have a lot of uncer-
tainty, particularly with agricultural consumption. Fur-
ther, there is a need to reduce the uncertainty associ-
ated with the condition of assets, to find out who
your customers are and whether your employees are
actually going to work with you or against you.
In many other privatisations that have been carried
out, for example in the UK or Argentina, policy makers
had raised tariff levels to a cost recovery point before
the transaction occurred. This is not possible in
Karnataka, which means that the investors are buying
a business that has cash losses from the day they set
foot in it. So there needs to be a transition period, as
there was in Delhi.
Giving strong incentives to reverse losses while im-
proving the quality of service is the cornerstone of
our design. We do not want them to lose a lot of money
in the first years because the bankers and investors
will not tolerate it. We want realistic rates of return
and we want a fair risk allocation – an allocation of
risks to those who can control and afford them.
Broadly, we are proposing isolating the wires busi-
ness from the supply business as was done in the UK,
Australia, Singapore and other places. This is a very
conventional way to step into a restructuring
programme. We are giving a reasonable transition
period and setting the cost to enter the market at a
minimum. We don’t want investors to have to pay a
lot of money upfront because the investor is buying a
business that, as it is today, has a negative value. Fun-
damentally, the profitability of the utility business is
determined by the regulators and government policy.
We want there to be a high probability of recovering
the operating and capital costs in the transition years.
And then we want it to automatically transition into a
conventional incentive-based cost of service regula-
tory approach.
The key elements are that the private operator owns
and runs a distribution business and gets to earn a
distribution margin during a five-year transition
period. The distribution margin consists of two streams
of earnings. A Base Revenue is an annual payment
for each year of the transition. It will equal approxi-
mately 100% of the new operator’s operating cost,
capital expenditure and minimum equity rate of return.
The Base Revenue includes a set of rules and indices
that ensure that the operator faces strong pressure to
control operating costs.

Key Features of
Transaction Exhibit 6: Breakdown of Karnataka’s Electricity Cost

The overall design

objectives of the 120%
Karnataka transac- 123456789012345678901234567
100% 12345678901234567890123 2%
123456789012345678901234567
12345678901234567890123
Percentage of Total

tion are to move to a 12345678901234567890123 123

12345678901234567890123
12345678901234567890123 23% 123
123456789012
123
Cost to Deliver

80% 12345678901234567890123 Distribution Profit

viable electricity 12345678901234567890123 123
123456789012
12345678901234567890123 5% 123
123
sector as quickly as 123456789012 Distribution Cost
possible, allow for a
60%
123456789012 123
123
123456789012 12
123 Transmission Cost
reasonable transition 40% 12345678901270% 12 Power Purchase Cost
123456789012
period, and to give
123456789012
as strong incentives 20%
123456789012
as possible to the 0%
123456789012
private operators to Type of Cost
reduce technical and
commercial losses.

IIMB Management Review, March 2004 79


Exhibit 7: Karnataka Transaction Summary: Estimating the
Required Transitional Tariff
Rupees Per Unit
Average Cost of Service
3.07
Loss or Subsidy
2.03
AverageTariff
2003 2004 2005 2006
Then there will be an Incentive Charge, which is the
paise per rupee billed and collected above a minimum
collection requirement. In order to limit government
subsidies, we advised the government to set a mini-
mum collection requirement and to fix the transitional
tariff so that they could estimate the gross revenues
from the unit charge. The minimum collection require-
ment will be a percentage of the previous year’s col-
lection, somewhere between 100% and 150%. Its spe-
cific level depends on how potential investors react
to the design.
Operators will have to meet specific service standards
and provide specific information to the government
and the Karnataka Electricity Regulatory Commission
(KERC). This approach is different from the Delhi ap-
proach because given the rural area, with 40% of the
load being agricultural and unmetered, the informa-
tion is not nearly as good as it is in Delhi. The service
standards are set at higher levels for each year of the
transition period. There will also be penalties if the
operators don’t meet their service standards and in-
formation requirements.
In order to protect rural consumers, there will be whole-
sale and retail allocation rules which will allocate whole-
sale electricity between discoms, specify minimum
supply to consumer categories and allocate electricity
shortfalls and overages so that both the government
and the operator are compensated for additional
supply going to subsidised customers.
Transition tariffs will be rebalanced and increased to
cost recovery.
After the five-year transition period , an incentive-
based cost of service regulatory system will apply,
using a multi-year tariff and independent setting of
efficiency improvement requirements.
80
While it may sound draconian
to say that supply to below av-
erage cost customers or rural
areas will be limited and even cut
Transition Date off if necessary, we realised that
we would just be continuing
what the government is already
doing to meet its financial con-
straints. Currently the Govern-
ment of Karnataka (GoK) man-
ages its rural feeders in order to
keep its cash balances in order.
It makes perfect sense to apply
a similar set of rules under a
2007 2008 privatised condition.
Exhibit 7 shows the process
that Delhi is going through, that we are proposing for
Karnataka. You start out with an average cost reserve
of around Rs 3.07 and the average tariff in Karnataka
is around Rs 2.03. Over a period of time you expect
that tariffs will increase on the average in real terms,
and you also expect that the operator will get more
efficient and at some point those lines cross. The slope
of those two lines is determined by two different fac-
tors – the slope of the tariff increases is essentially
policy judgment based on what people can bear and
what you think is a reasonable approach to tariff in-
creases. The slope of the Average Cost of Service line
is a function of the incentives of the private operator –
mainly the incentives that they have to reduce their
combined losses.
The GoK will sell 51% of the equity share capital of the
discom to the private sector. Equity will be offered at
par value and it will be sold to the bidder who offers
the lowest incentive charge.
What does the government need to do to make this
structure biddable? They need to set Base Revenue
and minimum collection charge at levels that attract
strong competition, fix retail tariffs and cap the return
on equity. We are going to work with KERC to estab-
lish regulatory rules and procedures, both for the dis-
tribution margin (DM) period, and the post DM pe-
riod, and we are also going to design a cap on physical
supply to low tariff customers. We are going to advise
the Government on these decisions and we will continue
to help them run scenarios and build a comprehensive
financial model of the transaction and its risks, but the
government is the seller and will decide final offer
terms.
There are a number of challenging design issues that
we have still to solve. One is, in setting base revenue,
what are the reasonable levels of Capex and Opex?
Power Sector Reforms in India: Distribution Reforms
How well can the consultants and the government es- the Karnataka Power Transmission Company Ltd.
timate the required Capex? One possibility would be (KPTCL). KPTCL will set up a unit in the transmission
to make Capex a regulated pass through. It is done company, and then be the single buyer for what is
worldwide. As to the setting of transitional tariffs, will generated.
politics or economics be the guide? We hope there
will be some kind of a balance. Average rates will have Q: That means the distribution company has abso-
to be on an upward slope. lutely no risks. If they fail to collect, the government
will give them the base revenue also.
Base Revenue can be set between 0% and 120% of
estimated Opex and Capex. Its specific level depends AE: This brings me back to a fundamentally important
on what investors require to enter the market. This point. We have been falsely accused of pushing all of
depends on perceived and actual risks the risk on to the government. How-
in the market. Obviously, it should be ever I am trying to make a point here
set at an ‘optimal’ level, one that at- When the government that when the government sets the
tracts multiple qualified bidders, but sets the base revenue base revenue and the minimum collec-
not so high as to eliminate incentives tion charge, it actually determines the
to reduce losses and increase rev-
and minimum risk allocation. If the government sets
enues. collection charge, it the base revenue at zero, the opera-
tors would have to earn all of their al-
One of the problems with our design is determines the risk lowable charges out of their incentive
that the longer the transition period, allocation. If the base charge. If that were the case, then the
the more difficult it becomes to prop- operators would have 100% of the col-
erly predict what base revenue should
revenue were zero, lection risk. On the other hand, if the
be. Based on extensive discussion operators would have investors refuse to bid under those
with potential bidders, the GoK and our to earn their allowable conditions, then the government may
consortium members, we have con- need to set it at 90% of expected Opex
cluded that a five-year transition pe- charges out of their and Capex, or even higher than a 100
riod is required. incentive charge. – allowing a small equity return in the
base revenue. Then the operators ba-
It is important to have an effective in- Then they would have sically share their risks fairly evenly
centive-based regulatory methodology 100% of the collection with the government.
and procedure for the post-DM pe-
riod. The ‘X’ setting procedure is used risk. Q: Where is the incentive for the dis-
by the regulator to set the annual effi- tribution company to invest in infra-
ciency gains that are built into the multi-year tariff. structure in this model? My question is not about im-
Orissa had major problems with that. In the Delhi situ- proving the management of collection. A certain
ation the operators are probably concerned that the amount of political will to increase collections should
regulator will come out with difficult efficiency targets see us meeting the required targets. What is needed
after the transitional period. This is a matter that needs is a component where the distribution company is
to be solved by the regulator. forced to invest in distribution infrastructure where
there is a probably not that significant a margin to
Discussion improve.

Q: You mentioned about the equity….Opex and
Capex…the incentive and the cap on the profits. The
operators actually collect a lot of revenue from the
consumer, what happens to this money?
AE: That is a good question. One of the good things
about this model, from the point of view of private
operators is that they are the ones who go out and
collect the revenues. They have it in their own ac-
counts and have significant control over them. There
are clear rules as to how much they are allowed to
retain. Every month they take out what they are
allowed, and the rest is remitted to the single buyer –
AE: If you look at the Capex plans of the Delhi
privatised operators, they emphasise two principal
objectives. One is better service to customers, on the
theory that happy customers pay their bills. And the
second is improving technical efficiency, by replacing
inefficient equipment, restructuring the network, put-
ting in smart meters and so forth.
Our view is that the government should get out of
managing the electricity business and should let the
private sector make its own judgments as to whether
they want to put more money into commercial
efficiency, or into technical efficiency.

IIMB Management Review, March 2004 81

And what we think is going to happen is that the pri- meter manually and record the reading in a meter read-
vate operator is going to optimise his total plan, not ing book (MRB). There are thousands of such books,
just the Capex investment, but the Opex also. That entries and meter readers. You don’t have access to
idea is fundamentally underpinning successful reforms or control over what he is recording. The data is then
that have occurred in the UK, Australia, New Zealand, taken into a computer database (by a different agency),
Singapore and so forth. The idea is to let good man- and from there the bills are printed and distributed.
agement manage, give them overall efficiency targets The whole process takes about 45 to 90 days depend-
and let them decide whether they want new transform- ing on the efficiency of the system. In remote rural
ers or more fault detection bands, or a better commer- areas it takes more than 90 days.
cial billing system.
When your own process takes 45 to 90 days, you can-
Since the presentation was made, the design was completed not pay the distribution costs on time. We introduced
and the Government of Karnataka is currently holding dis- ‘electronic spot billing’ in the whole state of Andhra
cussions on how to proceed. As we completed the design, Pradesh – every consumer, rural or urban, gets his bill
several investors expressed strong interest in bidding on on the spot. We have introduced a small hand-held
the distribution companies using the DM design. In addi- machine called the Common Meter Reading Instrument,
tion, a series of modifications to the design have been com- which is 2½ kgs in weight and costs around Rs 11,000.
pleted to ensure that it is consistent with the requirements of It has an attached printer and a GSM modem – you can
the Electricity Act 2003 and to respond to concerns and connect to the central server where the database is
suggestions raised by KERC. located, on the spot. It supports around 2000 records
at one go. This in itself compresses the 90 day trans-
T V S N Prasad action to one day and the cash flow improves tremen-
dously.
Andhra Pradesh: Interventions in Billing and
Collection With the GSM modem, we can see what the meter reader
is doing at any point of time, as his entries get up-
There are four power distribution companies in Andhra dated in the central database almost on a real time ba-
Pradesh — Central, Northern, Eastern and Southern. sis. A meter reader does 80 houses a day, on an aver-
The Central Power Company has an annual turnover age, so if 80 people get their bill on one day, even the
of Rs 3600 cr (36 bn)and serves around due date gets staggered, cash collec-
5 million consumers. The geographi- In Andhra Pradesh tion becomes much easier as there are
cal area spread is around 90,000 no long queues for payment.
square km with around 1.5 lakh km of every consumer, rural
LT line, and 71,000 km of 11KV line. or urban, gets his bill With the GSM modem, we have also
started on the spot payment on a pilot
I would like to speak on a few inter- on the spot. A small basis, which hooks to the server of the
ventions that we made in billing and
collection. We focussed on the tech- hand-held machine relevant bank, checks the balance of
the consumer and payment can be
nology and the process. Transmis- called the Common made within 30-40 seconds.
sion or distribution companies are not
given power on credit by the genera- Meter Reading Once you have a database, other com-
tor — most of the PPAs stipulate that Instrument mercial services like issuing new con-
distribution companies get a rebate nections, change of title and so on be-
only if they pay within three days. compresses the 90 come easy. The first step in the reform
After three days, the penalty sets in. day transaction to one scheme is to have a database, which
But the practice in our country is to means networking. Updating through
grant two months’ credit to domestic day and the cash flow spot billing machines and maintenance
consumers. The cash flow has not improves of the database on the net is impor-
been designed to make prompt pay- tant. All our consumer records are on
ments to generators. There is an tremendously. the Internet – all 5 million consumers.
inbuilt inefficiency in the billing pro- Data can be accessed any time and gets
cess itself. However, once you have started unbun- updated automatically. Such transparency brings in
dling and start focussing on issues, certain interven- accountability and is also a helpful management tool,
tions are possible. helping both the consumer and the administering au-
thority. Many people are now actually paying their
The general practice is for the meter reader to read the bills through the Internet. It is very easy because we

82 Power Sector Reforms in India: Distribution Reforms

have tied up with almost all the banks in Andhra enabled and the chief minister too keeps watching this
Pradesh. website and coming back to us with questions. We
had also teamed up with ‘e-seva’, an integrated citizen
We have taken cognisance of possible privacy issues, service centre — a single stop solution for all facilities
and have given separate passwords and log ins to con- — people can pay their water bills there, buy cinema
sumers, users and employees. We have tied up with tickets, furnish income tax returns, and renew their
our Commissioner, Commercial Taxes and devised elec- driving licenses. There are about 54 of them in
tricity indices for different products and industries. Hyderabad now.
Such integration between government departments
helps immensely and everybody benefits. Since outsourcing was proving very expensive, we
have developed in house training in our call centres.
We have a very good intranet as well, where we have a
Our call centres service rural areas as well, and people
host of other data.
call them using a cellular number.
We encourage our employees to log in and fill in per-
formance reports online. We use our IT facilities to Asset tracking is one area where we have been poor.
deal with service issues such as meter change, door So we have designed two software models, the Trans-
lock, meter not existing and so on and drill things down former Information Management System and the Meter
the company, to the circle, the division, the sub-divi- Information Management System, both intranet based
sion and then to the crew. software models to keep track of assets. All transac-
tions are recorded on it and with the latter system,
Coming to the details of our energy audit, by using every meter is kept track of. Side by side we must
the RS 232 port and ordinary telephone modems, we carry out reforms like changing to electronic meters
can access the meter boards of a cer- from mechanical ones.
tain industry, a sub-station or a trans- Through Geographical
former. We read the sub-station meter We have an accounting software,
and the consumer meter together, and Information System which helped us get our trial balance
superimpose the gaps. Since it records on the 2nd of every month, for every
(GIS) mapping, all of unit, whether at the section officer
data in such detail such as, ‘Power
failed on 29th December 2002 at 1646 Hyderabad has been level or village level.
— At 1714 it was restored’, we can sat- digitised, every single
isfy complaints and rectify problems. In order to improve benchmarking and
The RS 232 port can be used for peak transformer, every deal with other problems including that
load management, to regulate the of fictitious billing, we have divided
single pole has been domestic consumption into slabs. Last
phases of supply, and in customer dili-
gence. All the consumers are automati- coded. Trouble calls year 60% of the domestic consumers
cally graded by the database into vari- are now attended using fell in the first slab of 0-50 units, now
ous slots or quadrants — the amounts the percentage has come down to 52.
outstanding, the defaulting consum- the GIS technology. Above 300 units, we had only 2% of 5
ers, the defective meters are classified. million and now it has grown to 7%.
Fuse off calls have This speaks of better metering. When
A distribution company can harness been replaced with you don’t have metering for agricul-
the power of IT very well. Through ture, then you have to benchmark.
Geographical Information System (GIS) equipped vans.
mapping, all of Hyderabad has been Finally, our system of performance
digitised, every single transformer, every single pole monitoring. Every employee has to fill a form record-
has been coded. Trouble calls are now attended using ing his/her performance before being paid his/her sal-
the GIS technology. Fuse off calls have been replaced ary. It is not about achieving targets but keeping a
with equipped vans. Hyderabad for example, has 47 record of performance. Moreover, the system checks
such vans and has been divided into 47 zones. Using all claims registered. We grade every employee as per
cellular phones, we are able to instruct the vans about prior weightage. Again, IT can be used very well for
which pole or structure they have to attend to. Thus, performance tracking of large utilities. So many IT
we can and do address people very quickly. Our call interventions were possible because we decided to
centre is also on the Web, so people can actually see have our own mail server and our own intranet. I would
how many calls were received. strongly recommend that reform should start with hav-
Our customer service centres in Hyderabad are web ing your own IT backbone.

IIMB Management Review, March 2004 83

How do you solve the issue of power supply to agri-
culture? By evolving the right policy, through politi-
cal will, consensus, metering, but also the upgrading
of technology. Our regulator has started giving in-
centives to people who use demand side management
— people who go for frictionless foot-valve, PVC pipes,
ISI mark pump sets and so on.
Metering the pumpsets will not only bring the con-
sumption down but also help determine the technical
loss accurately. Lower capacity transformers will also
help bring down losses. Side by side, as part of the
effort to upgrade technology we have patented the
‘sub-station logic controller’, a small machine which
works on a microprocessor. This machine trips the
feeder automatically once the established duration for
power supply is over. It functions like an electronic
logbook and affords us complete supervisory control
— you can switch off 11 KV feeders from the central
level corporate office, and use it as a load dispatch
centre when you have grid shortages.
Further, we have teamed up with International Water
Management Institute and the International Crop Re-
search Institute (ICRISAT), in Hyderabad, and are
working out packages for small areas. We are trying
to ask people to shift to dry crops and commercial
crops like Bengal gram, and groundnut, instead of
paddy. There are several such possibilities which
could be explored.
High voltage distribution systems reduce current con-
sumption and loading, improve voltage, and eliminate
theft. This is the basis along which the developed
world has designed its distribution system. Hyderabad
is being converted to high voltage distribution sys-
tem. With the very useful Supervisory Control and Data
Acquisition System (SCADA) system in Hyderabad,
we have remote control over every inch of our elec-
tricity network in Hyderabad. Cities with overhead
84
lines can convert the existing LT line into a HT line, at
a low cost. The High Voltage Distribution System
(HVDS) will start paying back in 3 months.
We have also come up with a very down to earth com-
mercial parameter to measure loss since the argument
is that with electricity, nobody knows what loss is. We
calculate the AT & C loss. Right now, including the
subsidy, we are breaking even, for some months we
did have cash profits. But, come drought, the calcula-
tion would change and we would have to go for extra
subsidies. This is a continuous process.
Two reasons for our high technical losses are: high
ratio (1:6) of HT to LT lines and, higher capacity (100
and 63 KVA) transformers instead of smaller capacity
transformers. The size has resulted in very long LT
lines leading to bad voltage and subsequent high
losses.
Allen Eisendrath is with Deloitte Emerging Markets.
aeisendrath@deloitte.com
P K Kukde is Executive Director, Tata Power Com-
pany. pkkukde@tpc.co.in
TVSN Prasad was Chairman and Managing Direc-
tor, Andhra Pradesh Central Power Distribution
Company when the Workshop was held.
tvsnp@yahoo.com
D V Ramana is Professor, Xavier Institute of Man-
agement, Bhubaneshwar. ramana@ximb.ac.in
Jagdish Sagar is Chairman and Managing Direc-
tor, Delhi Transco. chmndvb@bol.net.in
Reprint No 04105 c
Power Sector Reforms in India: Distribution Reforms