1. Electricity Tariff Models & Way Forward 8th November 2013ChennaiDr Harish K Ahuja President Strategy & Corporate Affairs08/11/20131

2. Structure Power sector Reforms : Fundamentals Tariff models: 3 models Cost of Service model : Basic regulatory economics, Approach , Advantage & Disadvantage Incentive regulations: Approach , Advantage & Disadvantage & limitations Hybrid Model : Approach & example Why competition works better than regulations & privitization Focal issues for taking discoms towards competitive mode. Some conclusions : Create Prosumers08/11/20132 3. 08/11/2013Moser Baer Projects Pvt Ltd3Private and Confidential For Limited Circulation Only 4. Moser Baer Projects Group Structure Moser Baer ProjectsMoser Baer (Projects Private Ltd. (MBPPL) Group Key Investors: Blackstone, IFCI, GEHydroClean Energy (Incl. Solar Farms)Coal MiningThermal: Madhya Pradesh power project: 2,520 MW, Chhattisgarh power project, 1,320 MWThermalSolar: Domestic 223 MW Commissioned International: 63 MW CommissionedHydro: North Eastern India and Nepal 2000 MW, Himachal Pradesh ~500 MWCoal Mining: ChhattisgarhCompany is committed to high quality, low cost and timely delivery of world class projects08/11/20134 5. 08/11/20135 6. Economics of Power reforms 08/11/20136 7. Circle of Power Sector Economics Multi Buyer Multi Supplier Market ForcesGenerationRetail supplyDiscomsTransmission DistributionNatural MonopolyRegulation 08/11/20137 8. Unbundling and Competition CompetitionRegulation RegulationCompetition 08/11/20138 9. Basic Elements of Power Reform To bring Multiple Players especially in competitive segments i.e. Generation and Retail supplyEconomic regulation SET UP Independent REGULATOR to check Monopoly Practices in Distribution/Transmission and avoid Market Power in generationCompetition IN Generation and Retail supply segment By Competitive wholesale Market By Competitive Retail market08/11/20139 10. Different Tariff Models08/11/201310 11. Different components of Retail Tariff Power Purchase Cost - Genco- Deregulated Inter state transmission charge (POC)- PGCIL Intra state transmission charge - Transco Distribution Wheeling - Discom Cross subsidy Surcharge (Area Discom) Additional Surcharge ( Area Discom) Scheduling Charge( SLDC) Retail supply margin Supplier - Deregulated SLDC)08/11/201311 12. Basic Models Of Regulatory tariff 1. Cost of Service or Rate of ReturnRegulations 2. Incentive Regulations Price cap (RPI-X )3. Hybrid Approach08/11/201312 13. BASIC ECONOMICS OF COST PLUS REGULATIONS08/11/201313 14. The competitive firm short run supply curve08/11/201314 15. A competitive firm Long term supply curve08/11/201315 16. 08/11/201316 17. Profit in long term in perfect competitive market Accounting Profit= Economic Profit + opportunity cost of capital(WACC) In Long Run for a firm in perfect competitive market , Economic Profit= 0 So Accounting Profit = Opportunity cost of Capital (WACC)08/11/201317 18. Economic Value Addition EVA = Capital Employed ( ROCE WACC) In Power sector Only WACC is allowed WACC = Equity X ROE + Debt X ROD It is called ROCE approach also EVA in regulatory tariff setting is Zero Regulator in cost plus regulation allows only WACC treating firms are in a perfect competition and economic profit is zero 08/11/201318 19. Cost of Service Regulations Approach The Regulated Firm effectively submit a bill (ARR) for its operating expenses and capital Cost, including an After-Tax Return on its Investment. Equal or Exceed his cost of capital, and the Regulator passes this cost through in the tariff charged after due prudence check EA 2003 & National tariff policy covers cost + regulations to attract investments 08/11/201319 20. Cost + Regulations Advantages Credible approach to attract long term investments in capital starved power sector Reduces the expropriation risk on high cost sunk investments. Attract large quantum of investments in short span of time as investors are assured about recovery of operational & capital investments with reasonable returns (Average Total Cost) Disadvantages Information asymmetry between Regulator & Regulated firm Regulatory capture Transfer of firms & market risk from company to consumers Rent seeking behavior Gold platting of capital exp. Moral Hazard : promote inefficiency Good for only High Cost firmsv 08/11/201320 21. Understanding Incentive Regulations 08/11/201321 22. Incentive Regulations Approach The regulator defines ex ante a set of prices (or a weighted average of prices for different services )that the regulated firm will be allowed to charge consumer for the services . Price adjustments formula is tied to exogenous variables( for example, general inflation and an assumed rate of productivity growth) going forward.The prices are not tied directly to the regulated firm cost or profits. The applicability of tariff is for longer period 4-5 years 08/11/201322 23. RPI-X Advantages Promote Efficiency/motivation by offering upfront incentives for low cost firms. Moderate rent extraction. Tariff certainty for 3-4 years : Offer comfort to investors. Disadvantages Low tariff cap may create indirect penalties for poor quality. Weak in enforcing firms to pass on the savings/efficiency to end consumers. High Tariff cap may offer high rents to investors Social stress : poor may not seek quick remedy. Create Entry barrier for new investors 08/11/201323 24. Incentive regulations Prerequisite for adopting this approach Sound Regulator information system : Excellent information required for firms cost - not to fix price cap too low which may go below ATC. In India where electricity prices have been too low, a credible fixed-price contract that set prices high enough to yield attractive returns can be very effective in attracting investment funds. Setting a cap not too low or too high : Moral hazard vs lazy rat 08/11/201324 25. Best Approach : Hybrid The form of a profit sharing contract : The regulated firm can charge tariff partially responsive to changes in realized costs and partially fixed ex ante (more generally, by offering a menu of cost-contingent regulatory contracts) The basic idea here is to make it profitable for a firm with low cost opportunities to choose a relatively high powered incentive scheme and a firm with high cost opportunities a relatively low powered scheme.08/11/201325 26. Hybrid approach R (revenue) = a ( Fixed component) + (1-b) C (contingent cost) b : Sharing parameter based on responsiveness of Firms efficiency Under a fixed price contract or price cap regulation: a = C* where C* is the regulators assessment of the efficient costs of the highest cost type and b=1 Under pure cost of service regulation where the regulator can observe the firms expenditures but not evaluate their efficiency: a=0 b=0 Under profit sharing contract or sliding scale regulation (Performance Based Regulaion 0