Amending the Electricity Act 2003- Getting the regulatory incentives right

State Electricity Regulatory Commissions (SERCs) constituted under state level legislation in seven states from 1995 and subsequently under the Electricity Regulatory Commissions Act 1998 (since subsumed into the Electricity Act 2003) have failed, to uniformly tackle the twin problems of high operational cost and distorted retail tariff structures not reflective of the cost of supply.

The average technical and commercial loss in distribution (difference between energy input into the system and energy billed) was 21% (2019-20) and discoms (licensed distribution and retail supply companies or entities) incurred a loss of Rs 867 billion after accounting for a support of Rs 1. 1 trillion from government. Without government support, the loss would be 1 percent of the net state domestic product. Discoms have accumulated overdue, unpaid bills of Rs 1.37 trillion (August 19, 2022). Since 2000, the fourth attempt to reform discom finances is underway which includes legislative changes to improve the regulatory incentives for reform.

Aligning the institutional structure with incentives for reform

The union government proposes to infuse some reform momentum by tweaking the existing legislative provisions of the Electricity Act 2003, through an amendment bill tabled in Parliament on August 8, 2022,

The focus in earlier legislative attempts at reform, was on creating competitive conditions on the demand side of retail supply by, for example, allowing open access (allowing customers to choose their supplier) for large users of electricity. This time around, the primary focus is to open the supply side in distribution to competition in the market.

Ending the monopoly of discoms

The monopoly of discoms over retail supply in their licensed areas will end. Multiplicity of suppliers was possible even previously. The catch was that the incumbent was not obliged to let the newcomers use its network. This made contestation well-nigh impossible because of the implementation challenges (right of way) in laying new networks and the associated time lag. This difficulty is now proposed to be removed by allowing new licensees to use the existing network on payment of a user (wheeling) charge.

However, defining the user charge rationally is not trivial, particularly since the new licensee would be wholly dependent on the incumbent’s network for fulfilling supply commitments. Regulations will be needed to specify non-discriminatory access to network monitoring data for the new licensee, along with sufficiently high deterrent, penal provisions and compensation for loss of business, due to system outages in addition to compensation for customers.

CERC gets licensing powers for multi-state retail supply

In a major change, the Central Electricity Regulatory Commission (CERC) will now license applicants for distribution in more than one state. Hitherto licensing distribution was purely a State Electricity Regulatory Commissions (SERCs) function.

Regulations would be needed to separate the regulatory mandates of the two commissions. Would, the CERC, seek a no-objection- which should not be unreasonably withheld- from the relevant SERCs before issuing a license? Both the existing licensees and SERCs need be heard before the market structure is dramatically altered. If the incumbent discom is privately owned, legal suits could be anticipated if CERC acts unilaterally.

It remains unclear which commission could revoke the license. CERC, the licensor, should typically also have the authority to revoke the license. Would CERC operate on the recommendations of the SERC, any other interested party or Suo-motto?

Existing liabilities from Power Purchase Agreements (PPAs) to be shared

The amendment specifies that liabilities arising from the existing PPAs of the incumbent discom will be shared proportionately between the incumbent and the new player. Regulations must specify how the actual (not average) costs would be allocated between the two discoms if significant variations in their load profiles generate differential costs of supply.

The new licensee is barred from contracting for additional power, so long as the legacy PPAs are sufficient to meet demand- a sensible provision to avoid over contracting of supply, but administratively difficult to implement. Would the bar apply to contracting additional renewable power when the national program is to rapidly increase renewable capacity?

Alternatively, what if the new licensee gets new PPAs at cheaper rates than the cost of terminating the existing PPAs? Would it not be economical to do so? Savvy regulations need to specify sensible carve outs for new power contracts.

Common universal, service obligations

How will the universal service obligation be enforced? Both discoms would strive to shed loss incurring customers and maximise profit giving customers. Would regulations enforce a minimum share of area-specific, below cost-tariff customers?

Cross subsidy fund

To guard against selective poaching of customers, an associated, new institutional mechanism for sharing the cross subsidy generated is proposed. The “surplus” cross subsidy (the difference between the allowed cost and regulated tariff) collected by any licensee is to be deposited in a cross-subsidy fund managed by a government company nominated by the respective state government.

The SERC would determine how to use the balance in this fund. Some could be given back to the originating licensee. The residual could compensate the second discom or even be transferred to another more needy supply area. Creating managerial uncertainty about cross subsidy, as an assured source for revenue, might result in a focus on efficiency improvement instead.

The problem is leaner margins linked to high efficiency are also likely to reduce the attractiveness of the business for a second licensee. Secondly, if cross subsidy is divertible to another area of supply, are we not creating a new class of cross subsidy? How consistent is that with the dictum that tariff should reflect costs?

Pricing power for discoms- Retail tariff with new minimum and maximum limits

SERCs will now determine minimum and maximum tariffs, giving individual licensees free play in charging tariff within the range. This will encourage efficient licensees to reduce tariff to gain market share. Unique discom tariff plans could emerge resembling the telecom model, encouraging customers to choose the plan most appropriate for them.

Conditional open access in retail supply

Users with a load above 1 MW can now access the interstate transmission system and buy directly from the market or contract with a bulk supplier. Whether SERCs will cooperate by limiting surcharge and wheeling charge to reasonable levels remains critical.

Empowering NLDC – the apex level system operator

In a welcome move, the primacy of the National Load Despatch Centre over Regional (RLDCs) and State level load despatch centres (SLDCs) has been explicitly established. All constituents of the grid are obliged to comply with the directions of the NLDC. This will help in maintaining grid discipline and stability.

Earlier SLDCs, while functionally subordinate to the NLDC-RLDC, marched to the drum beat of State Grid Codes as their rule book, ignoring real time actions necessary for grid stability. NLDC will now also be able to enter PPAs, with the government’s permission, to contract-in ancillary and back up support instead of having to rely on daily nomination basis to secure back up support from generators not likely to be despatched due to higher cost.

Old habits die hard: Government’s continues to micromanage despite positive changes

A welcome change is broadening the functions of the Forum of Regulators to formulate model regulations for SERCs and to monitor utility compliance of corporate governance and performance standards. Empowering this nascent institution is of great relevance for developing esprit-de-corps within regulatory experts.

On the downside, intervention by the Union government (UG) has increased.

  • Multi-state SERCs can be created, merely by consulting states government. Earlier mutual agreements between states were necessary.
  • One instance of micromanagement is that the UG will define criteria for the areas of supply for cross-state licensees. State governments were so authorised earlier because SERCs were nascent in 2003. But now they and CERC are fully functional and well equipped to determine areas of supply.
  • UG will prescribe the payment security mechanism for despatched power. With the CERC mandated to regulate the power exchanges, the grid and the system operator, this task should be entrusted to the CERC instead.
  • UG would approve the purchase of electricity by the NLDC for stabilizing the grid. This is despite the amendment legislation authorising CERC to determine the functions of the NLDC.
  • UG officials, not CERC representatives, would sit on the selection committee for SERCs. Delegating this power to the CERC would empower it further and develop the spirit of cooperative federalism between it and SERCs.  

Nevertheless, using the deterrent power of competition to force improvements in the largely publicly owned distribution and retail supply segment is commendable. The quality of the regulations will determine how well legislative objectives are translated into measurable changes in behaviour and outcomes.

The P word remains taboo, even though privatisation in well-off supply areas, remains the better option for operational improvements versus introducing competition via legislation through multiple licensees.

The 2007 amendment to the Electricity Act 2003, deleting the regulatory objective of eliminating cross subsidy, did a great disservice to the sector. Cross-subsidy harms the economy and retards carbon mitigation. It must be eliminated. Also, income support should be transferred directly to targeted customers by the state government allowing them to choose their level of supply, as in telecom. Discoms must operate on a commercial basis- only then will competition have teeth.

Extracted from the author’s opinion piece in http://www.orfonline.org August 22, 2022 https://www.orfonline.org/expert-speak/electricity-amendment-bill-2022-getting-the-regulatory-incentives-right/

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