Multi-Year Tariffs

in the Power Sector in India so far
(August 2003)

Why a multi-year framework (MYT or MYTP) for power tariffs?

The two general reasons:
– Incentivise efficiency improvement – Obviate regulatory uncertainty.

In India (not uniquely) the issue arose specifically in the context of efforts to privatise distribution:
– Creation of investor confidence in context of regulatory uncertainty the driving concern. – Then existing legal framework incompatible with MYT, hence MYTP.

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Role of the Government:

MYT(P) can be mandated either by Regulator or by Government.  Privatisation is necessarily a Government, not a regulatory, decision:
– The first multi-year framework was improvised (in Delhi) in a situation where the overriding concern was investor uncertainty about efficiency improvement expectations. – The power to give policy directions proved crucial in the face of Regulator’s reluctance.
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Legal Context Before the Electricity Act, 2003

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The Indian Electricity Act, 1910
Defined the responsibilities of licensees and consumers;  Gave State Government some powers to regulate;  Did not mandate any periodic tariff fixation procedure.

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Electricity (Supply) Act, 1948

SEBs were to set tariffs with reference to annual revenues (section 59).
– SEB to be guided by any Policy Directions that the State Government might issue; – CEA to decide in any dispute as to whether a particular question was a question of policy.

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Electricity (Supply) Act, 1948

Licensee tariffs to be set according to Sixth Schedule (section 57):
– ―Cost plus‖; – Tariff to be adjusted annually limiting profits to ―reasonable return‖ defined by the statute; – Up to 5% of excess profit at disposal of undertaking; balance divided between consumers and a ―Tariffs & Dividends Control Reserve‖).

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Electricity Regulatory Commissions Act, 1998

SERC to be guided by the following principles (section 29):
– Principles laid down in E(S)Act 1948; – Progressively reflect costs at adequate & improving efficiency levels; – Factors (as SERC considers appropriate) encouraging efficiency; – Interests of consumers + requirement to pay in ―a reasonable manner‖ based on average cost of supply; – Commercial principles; – National power plans.
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Electricity Regulatory Commissions Act, 1998 (continued):
SERC to be guided by any Policy Directions given to it by State Government (Section 39).  State Government’s decision final as to whether any particular direction qualified as a ―policy direction in the public interest‖.

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State Reform Acts typically required SERC to be guided, but not bound, by E(S) Act tariff principles.

Delhi Electricity Reforms Act, 2000 (section 28):
– DERC to be guided by
• Sixth Schedule; • Factors encouraging efficiency, economy etc.; • Consumer interests.

– ―When the Commission departs from…the Sixth Schedule…it shall record the reasons therefor in writing.‖ – Licensee to submit an Annual Revenue Requirement:
• Annual exercise laid down.

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Policy Directions under State Reform Acts:
All provide for policy directions.  Most provide for some external authority (High Court, CERC) to determine whether a State Government direction qualifies as a policy direction in public interest.  But DERA followed ERC Act:

– Government’s decision final.
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The Case of Delhi

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Reform Milestones:
Feb 99 - GNCTD Strategy Paper.  Nov., 99 -SBI Caps engaged as Consultant.  Dec., 99 -Regulator Appointed.  Oct., 2000 –Delhi Electricity Reforms Ordinance.

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Reform Milestones:
Oct 2000 –Tripartite agreement between staff, DVB and Government, on same day as Ordinance.  Jan 2001 –Investors’ Conference.  Feb 2001 – RFQ issued

– Bought by 31 parties.

Feb 2001 –DVB applies for MYTP along with its ARR.  May 2001 –DERC rejects MYTP.

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…continued:
Mar 2001 - Delhi Electricity Reforms Act, 2000 comes into force  July 2001 – Consultants’ final report  May 2001 - Bidders short listed – Six bidders – Two expressed lack of interest  Nov 2001- RFP issued  Nov 2001 - Policy Directions

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…continued:

Feb 2002– DERC order fixing opening loss levels and initial BST.  April 2002 – Bids received from two bidders. – Considered not acceptable ―in present form‖ by Cabinet. – Core Committee authorised to explore alternatives including negotiation.

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…continued:

Share Acquisition Agreement, May 31, 2002
– Amendments to Policy Directions and Transfer Scheme Rules

Shareholders Agreement and other agreements signed June 27
– Operative from June 30 – Transfer Scheme operationalised June 30 – Management handover
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Reform process once started: There may be no time to waste.

Political will:
– Its relationship with compulsions of situation.

If available, it must be honoured:
– Implications for time frame—delay will damage credibility; – Necessity to go it alone in Delhi to achieve tangible results within a Government’s term.
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The main objective of reform:

Reduce the high commercial losses in distribution:
– In India (most States) all else pales into insignificance, for the time being. – Motivation for other efficiencies—reducing technical losses, DSM—also depends on it.

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Design of package essentially to handle the transitional phase:

During the transitional phase, it is necessary to balance
– Realistic expected efficiency gains; – Possible tariff increases; – Transitional assistance until the benefits of greater efficiency are realised. Therefore the main features of the package should preferably be “frozen” for the transitional phase.
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No Time Gap between Corporatisation & Privatisation in Delhi:
Shell companies registered in advance.  Objective was privatisation, not mere corporatisation.

– New entities would incur losses before privatisation. – Govt. retained option to abort the entire exercise in absence of investor response.

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In Delhi, time assumptions were an input in the valuation:
– Business Valuation method used for second time in India—Kanpur, then Delhi. – Business Valuation, as adopted – • value assets on going concern basis • asset value derived based on future earnings potential assuming reasonable retail tariff increase and efficiency improvements

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... Valuation of Assets

Principles applied: – electricity business becomes self sustaining within five years – Minimise retail tariff shock. – Support from GNCTD for funding initial losses - about Rs. 2600 crores (increased to Rs 3450 crores).

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...Financial Restructuring Plan
Legend Assets Liabilities

DVB
2. All the liabilities of DVB are transferred to Holding Company, entire Equity of Holding Company is issued to GNCTD

1. All the assets and liabilities of DVB are acquired by GNCTD

GoNCT

Holding Co.

3. All the assets are transferred from GNCTD to successor entities. Assets will be assigned a value equal to serviceable liabilities

4. Equity and Debt in the successor entities, equal to the value of serviceable liabilities is issued in favour of the Holding Company

Genco

Transco

D1

D2

D3

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...Financial Restructuring Plan
Support for funding losses in initial years

About Rs 3450 cr to TRANSCO
– at interest rate of 12% – moratorium of four years on interest and principal repayment – Servicing of principal in eighteen equal half yearly installments.

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...Power Purchase/ Bulk Supply Arrangements

TRANSCO to buy and sell power for initial 5 years
– but no bar on additional purchases by DISCOMs direct from generating companies or other sources

After 5 years DISCOMs to buy power directly and pay wheeling charges to TRANSCO
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Setting efficiency improvement targets:
Primary investor concern.  Regulatory (and public) regulatory approval not forthcoming for reasonable, achievable multi-year targets:

– Lack of understanding of nature of problem. – Lack of benchmark experience.
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Multi-year tariff principles proposed by DVB in 2001:
Annual Tariff fixation: general principles for power purchase, O&M, salaries, interest, depreciation.  DERC to fix targets for collection efficiency shortfall.  T&D loss reduction targets:

200102 2% 2002-03 2% 2003-04 2% 2004-05 3% 2005-06 3%
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Negative response (except from investors):

No general appreciation of the necessity for MYTP in the context of developing Orissa experience.  DVB accused of bad faith in making proposals on behalf of future, as yet nonexistent, discoms.  Targets considered too low.  Collection inefficiency ―pass-through‖ thought to be contrary to accounting principles.
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DERC’s views:
―…multi-year tariff approach linking to some indices would be suitable for a mature and stable environment so that the investing companies can undertake efficiency improvements and reap benefits from them. The efficiency benchmarks have to be robust…neither the utility nor the consumer should suffer or benefit unduly in future. In conclusion…although multi-year tariff setting principles is an issue that merits consideration, it is not the mature stage…for the purpose of this tariff order.‖
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Delhi Solution: Legitimise targets through bidding procedure.
Criteria of Selection of Investor  Minimum target of Aggregate Technical & Commercial Loss to be achieved by investors each year for next five years specified.  Bids invited on ―Aggregate Technical & Commercial Loss‖ with shares being sold at par value.  AT&C Loss concept addresses not only the problem of data reliability but also that of collection inefficiency.
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Policy Directions to DERC:
To mitigate uncertainty and ensure successful privatisation, GNCTD issued policy directions under Section 12 of DERA, binding Regulator to the outcome of the bidding process.  It was (then) felt that it would suffice to mitigate risk only in respect of loss reduction targets.

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The Policy Directions:

require that tariffs for 2001-07 take into account: – Selection process of bidders – Technical & Commercial Loss to be on the basis of the bid of the selected bidder – DISCOMS earn 16% Return on Equity (Assuming loss reduction, ARR approval) – Incentives on over-achievement: 50% retained, 50% to rebate on tariff

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Loss level reduction targets accepted:
2002-3 2003-4 2004-5 2005-6 2006-7 C/E 0.75% 1.75% 4.00% 5.65% 5.10%

S/W

0.55% 1.55% 3.70% 6.00% 5.60%

N/NW 1.50% 2.25% 4.50% 5.50% 4.25%

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Reform package tariff projections:

Years 1 to 3: retail tariff increase up to 10% per annum.
– Year 1 for 6 months only.

Years 4 & 5: retail tariff increases of 5%, 3%.  Bulk (Transco) Tariff to rise more sharply, with phasing out of Government assistance, efficiency improvements.

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First post-reform tariff order:

5.18 % increase overall.  Government decision to further subsidize to avoid tariff increase for consumers up to 400 kwh per month.  Discom issues:
– – – – Depreciation rate; Deferred tax liability; Base for next year (BRYPL) And more.
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First post-reform tariff order:
(Continued)

Order effective July 4, 03.  Holding Company collections assigned to Transco ARR.  Transco and Genco issues.  Overall, effect on investor interest to be watched:
– Was the presumption that advance fixation of loss reduction targets suffices to allay investor apprehensions on regulatory uncertainty justified?
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Some other States:

Shortly after DERC rejection of MYTPs, UPERC introduced 5-year MYTPs for Kanpur:
– T&D loss reduction 2% per annum; – Collection efficiency improvement targets; – Concept of ―effective loss‖=AT&C loss.

Orissa Electricity Regulatory Commission has announced its intention to fix MYTPs.
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Some other States:

Karnataka package (still in the making) tries an alternative approach: envisages prior fixation of a ―Distribution Margin‖ comprising
– Base revenue set in advance for each year of transition period; – Incentive charge (being amount collected above a Minimum Revenue Requirement) to be fixed by bidding.
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…Karnataka continued

Investor to be protected from
– Regulatory risk on tariff; – Collection risk in certain cases (unmetered consumers; Govt); – Partial protection from risk of commercial losses because of lack of law enforcement support.

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…Karnataka continued

Risks transferred to the investor:
– Collection risk in respect of metered consumers; – Theft risk above announced starting level; – Inaccurate metering; – Operating expenditure management risk; – Technical losses risk.
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…Karnataka continued

Karnataka package involves prior fixation of annual figures:
– Therefore control period likely to be only three years.

The starting point was perceived unreliability of AT&C loss figures:
– Perhaps a genuine problem, but could not a simpler alternative have been found? Revenue per unit input?

Too early to judge: package still not final.
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APERC approach to Long-Term Tariff Principles may offer an alternative:
―Control Period‖  Annual targets to be fixed in advance for ―controllable items‖:

– Network costs – Financing costs – System losses

Licensee to normally enjoy benefits or losses of variation from annual targets.
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APERC (Continued)

―Uncontrollable‖ items pass-through:
– Force Majeure; – Change of law; – Judicial decisions; – Government policies; – Economy-wide influences.

Mid-term review.
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Electricity Act, 2003

Section 61: Commission to be guided by
– Commercial principles; – Factors encouraging competition, efficiency, etc.; – Principles rewarding efficiency; – Multi-year tariff principles; – Progressively reflect cost of supply, eliminate cross-subsidy.
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…continued
No specific provision necessitating annual filing.  But how far do the provisions on open access and multiple distribution licenses change the context?

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Thank you

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