Independent regulators are good “deal” makers


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Energy development, because of its scale and complexity, only happens when “deals” are struck between governments and developers. Some deals are better than others. From the public policy perspective the “deals” we should be looking for, are those which minimize “rents” and maximize welfare.

In the Indian context, Independent Regulation is best placed to achieve this objective. This is evidenced by the contrasting experience in electric power and gas.

Electric power has been regulated at an arms-length from the government by the Central Electricity Regulatory Commission (CERC) at the center and mirror state level regulators since 1998, and there are at least five indicators of positive change to show for it.

First, during the period 1995 to 2013 the installation of generation capacity outstripped the availability of fuel and today around 30 GW of thermal power assets are stranded, primarily due to non-availability of coal. Not a hall-mark of good planning, but evidence that electricity regulators have done their job rather well, whilst government, which regulates the nationalized coal industry and the gas sector directly, via the Ministry of Coal and the Ministry of Petroleum and Natural Gas, respectively, failed to get coal and gas supply up to scratch.

Second, and more importantly, there is a competitive power market today. Around 10% of the bulk electricity supplied is bought and sold on energy exchanges and not via long term bilateral contracts as was the case earlier. Starting with the introduction of financial incentives to maintain grid discipline, via the Availability Tariff in 2000, the inter-change market has grown with two separate and competing exchanges. Private “merchant power” plants have been established on a pilot basis, which rely solely or partly on sale in the power market, at market prices, rather than on the clunky bilateral contracts of yore.

Third, at the other end of the spectrum, huge, private, mega power plants, each of more than 4 GW capacity, using the latest super-critical boiler technology,  have come up, which supply electricity to more than one state.

Fourth, retail supply is significantly reformed though still financially unstable. Supply quality and access have improved. Mechanisms for customer participation and managing grievances have been institutionalized by the 2003 Electricity Act.

Lastly, the Central Electricity Regulatory Commission has led the commencement of domestic trade in proxy carbon credits by allowing distribution companies to meet their renewable energy (RE) commitments by buying certificates/credits from RE suppliers.

In all these initiatives the CERC has worked in partnership with the Ministry of Power and Private Developers to devise a regulatory framework which progressively relies on market mechanisms to enhance capacity and meet demand, whilst retaining the power to restrain wild, speculation driven fluctuations in electricity prices.    

No one would claim that Indian electricity today is anywhere close to being the gold standard of regulation internationally but we are getting ahead. Compared with the dark days of the private power misadventure in the second half of the 1990s with ENRON, when everything was doom and gloom, electricity has turned the corner, thanks to Independent Regulation.

Take the curious case of the TATA and ADANI Mega Power Plants. Both developers submitted the lowest bids for two separate ultra-mega power plants in Mundra, Gujarat, respectively in 2006 and 2009. Both proposed to use coal imported from their captive coal mines in Indonesia; a smart move at the time because Indonesian coal was cheaper than domestic coal, which was also in short supply. Both parties voluntarily bid a fixed tariff although TATA moderated the fixed element to 55% of the levelised tariff. Fuel accounts for around 60% or more of the cost of coal generation so obviously both parties were pretty sure that they had sewn up the fuel volumes and the price. The units were commissioned from 2009 onwards. As luck would have it by December 2011 the Indonesian government had imposed a minimum export price on coal which was 50% higher, which knocked the economies of imported coal for a six. What had been a commercial coup became a loss leader for the two developers. Both approached the CERC for help to pull them out of the hole they had dug for themselves.

Here is where Independent Regulation made a difference. CERC could have taken the technically “correct” route; thrown up its hands and said a contract is a contract and just as upsides are not shared by the developer, downsides should not burden the consumer. One CERC member did take this approach also pointing out that it was no business of CERC to sort out contractual problems between distribution utilities and generators. He was technically right of course. But the Commission took a more pragmatic, business-like approach. It appointed a committee of experts to examine the issue along with the stakeholders and report to the commission. The report was received in August 2013.

Based on this report, the CERC allowed the enhanced cost of coal to pass through but ring-fenced the possibility of the developer benefiting beyond the pass-through of cost. This was in February 2014. The Haryana supply licensee, one of the consumers, appealed to the Appellate Tribunal of Electricity which partly endorsed the CERC order in August 2014.  Haryana next appealed to the Supreme Court (SC), which stayed the CERC order last week. Both TATA and ADANI shut down their generators last week, though neither entity admits that the shut-down is a response to the SC order.

On the face of it, this saga is illustrative of a regulatory melt down. But consider the facts. Haryana is due for elections within the next two months. It is a Congress ruled State. There is a fair possibility that its opposition to the CERC order is not substantive and commercial in nature but is driven purely by the political compulsion to paint the BJP central government in a bad light, as being captive to crony capitalism. Conversely of course, being a non-BJP State Government, its actions could also be the justified outrage of a consumer at an agreement not being honoured.

This problem of contracts needing to be renegotiated, once they become unviable, has been endemic since the ENRON days and affects infrastructure and energy across the board. Forcing a developer to abandon an unviable contract with punitive sanctions fits technical correctness and possibly could deter speculative bids in future. But it comes at the cost of serious supply disruptions in the short term; significant potential loss for Indian banks financing the project and of course potential bankruptcy for the developer.

Independent Regulation, with its attendant appellate arrangements is not immune to this problem. Unviable contracts can surface anywhere. Also even regulators are learning from experience. In electric power the scope for price competition was imagined to be on a much larger scale than seems possible now given the constraints of thinly traded international energy (gas and coal) markets; India’s shackled “nationalized” coal industry and financially fragile retail electricity supply sector.

But competition is a sequentially evolved form of regulation. Even in the case of Rate of Return regulation, as is the norm for NTPC and other State Owned generators, we are still be better-off doing it through an Independent Regulator, than within the cozy confines of a Government Ministry. Why is CERC able to take tough, business-like decision?

First, the process adopted is transparent. All CERC proceedings are public. Stakeholders have equal and open access to all the documents. There can be no allegations of behind the door negotiations. Second, all stakeholders get to hear each other and participate. Third, whilst the CERC members are all retired babus, the institution has developed a reputation for impartial and unbiased decision making. The personal reputations and professional credentials of the members and technical staff are above reproach.

Compare the happenings in power with the twisted tale of Reliance’s Krishna Godavari Basin D6 concession. The paucity of documents available in the public domain; the decisions on gas pricing shrouded in the process secrecy, which is habitual to a government ministry; the sporadic and inspired information leaks; veiled insinuations of “deals” between government and Reliance Industries have all created such a “trust deficit” that finding a way out is a mine-field for any government. Once the credibility of a government process gets seriously eroded there is rarely an option but to replace it with another process.

The credibility of the process adopted by the Ministry of Petroleum and Gas to implement the New Exploration Policy 1999 has become seriously flawed. A “cost of service” type of price regulation mixed with “benchmark price competition” is sought to be retro-fitted onto the Production Sharing Contracts in the absence of explicit market prices and marketing freedom for developers. Even the committee (2012) chaired by no less an eminence that Prof. C. Rangachary (ex-Governor of RBI) has failed to evoke a satisfactory settlement. Yet another Committee under Dr. V. Kelkar is likely to meet a similar fate.

Of course it does not help that the matter concerns Reliance Industries. Like all big corporations, it is on the hate list of assorted activists, who fear its financial muscle and are awed by its’ organizational punch. Reliance is an upstart in the “cultivated” world of Indian business, which remained mothballed till Dhirubhai’s disruptive innovation stood it on its head in the 1980s; widening its equity base to retail investors and sharing its prosperity widely, it created its own brand of public-private partnership based on a mix of the Japanese “Keiretsu” and Korean “Chaebols, which were Asian innovations in business, till that style of deal making was washed away by the 1997 East Asian crisis and next got discredited as “crony capitalism”.

China continues to use such business relationships well. Its’ Party dominated politics provides a steady stream of relationships which can be built upon. But If authoritarian China, is like a large river, flowing placidly but forcefully through the plains, democratic India is like a mountain stream; turbulent, capricious and frothy at the mouth. Our fractured and complicated political architecture is a business persons’ nightmare, with its twists and turns. In our hyper charged political environment, government partnership with business instantly attracts the charge of crony capitalism and a working relationship can be easily mis-construed as a public partnership for private gain.

These perils of democracy ae unlikely to abate. But putting an Independent Regulator between the government and large business helps in holding unsavory deals at bay, whilst promoting “deals” in public interest. The experience of the CERC substantiates this. Had the Ministry of Power taken the very same business friendly decision, as CERC did, in the Mundra Mega Power case, especially in the stormy days preceding the 2014 general elections, allegations of crony capitalism would have flown thick and fast.

Putting an Independent Regulator in Oil and Gas, fully empowered to license production and determine prices, can have similar advantages in “deal making”. The consuming public recognizes that business is all about deal making. What it abhors, is the secrecy and lack of access to information, associated with oil and gas deals.

Had an Independent Regulator been in place Mani Shanker Aiyar (2009) and Jaipal Reddy (2012) need not have been shifted to other portfolios. The brunt of the negotiations would have been between the regulator, the public and the developer. Shining a light on the decision process often automatically dilutes entrenched, but indefensible positions and facilitates consensus.

We need an integrated Energy Regulator covering power, coal, oil and gas. Fortunately, the Appellate Authority for Electricity already has a mandate to include petroleum. The CERC should be similarly mandated to regulate oil and gas. This avatar of the Commission should report directly to a new Ministry of Economic Affairs. Its task must be to achieve growth targets, including by being the administrative ministry for all environmental and economic regulators (excluding the RBI) and by harmonizing their functioning via policy. The now defunct Ministry of Planning could well be retrofitted for this task by shifting the Economic Division of the Ministry of Finance to it. It could be headed by a junior, technocratic Minister, reporting directly to the Prime Minister.

Our under developed governance systems require segregation of functions between Ministers- who make policy and propose legislation and Regulators- who implement policy, fairly and effectively. This distinction is similar to the separation between Legislators- who make the law and Judges-who implement it. For one thing, the two disciplines are very different and require different skills. Secondly, allocating functions narrowly has the advantage of pin-pointing the origin of problems and for finding workable solutions. Mixing up policy and implementation is neither fair to the consumer nor to business. Separation of powers and functions is the key to effective solutions.





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