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Monday, Dec 06, 2004

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Anomalies in new Electricity Act

Some provisions of the Electricity Act, 2003 require a relook as they are likely to pose serious problems for the successful performance of the distribution segment and consequently the whole power sector, says G. P. Rao

A NON-STARTER: Many provisions of the new Act leave little room for effective competition.

THE ELECTRICITY Act, 2003 came into effect from June 10, 2003 for regulating the electricity industry in the country, repealing all existing Central legislations dealing with this industry. However, some provisions of the Act require a relook as they are likely to pose serious problems for the successful performance of the distribution segment and consequently the whole power sector.

The provisions of the Act have brought changes in the industry structure. This will affect pricing by allowing non-discriminatory open access and trading. In addition, delicensing of generation capacity (except for hydro generation above a certain capacity) and provision for multiple licensees in the same area of supply are expected to further increase competition and throw up new issues. Generators can sell the excess power available with them to a trader or a distribution company. A generation company can itself take out a trading licence.

But at present 92 per cent of the generation capacity in India is owned by State and Central governments and most of it is contracted through long term power purchase agreements (PPAs) for 15 or 30 years depending on the fuel used. Even in the private sector the capacity is currently contracted through PPAs. These long-term contracts will prevent any near term transition to a competitive market based on power pools. Under these conditions, where a quick transition to competitive power pools is not expected, the regulator will be fixing the generation tariff.

The Act prohibits a transmission utility to engage in trading business as it has been mandated to focus only on the transmission business and provide non-discriminatory open access to its network for any licensee, generating company or consumer subject to availability of transmission capacity.

The Act recognises trading as a licensed activity. But distribution licensees do not require licence to undertake trading in electricity. In the near term, the trading business is expected to focus on matching buyer and seller requirements with the trader having back-to-back contracts. Current contracts of the Power Trading Corporation (PTC) are based on the same mechanism. In the medium term, the trader may enter into contracts with a mix of generation companies and sell in real time to the licensees. So market making and trading exchange, as prevalent in some of the developed countries is expected to evolve only in the long term, as it involves a high degree of trading expertise and development of financial markets.

Open access

The Act mandates the regulator to provide non-discriminatory open-access to all consumers where the power requirement exceeds one megawatt, within five years from the commencement of the Act on payment of a surcharge in addition to the wheeling charges, to meet the current level of cross-subsidy within the supply areas of the distribution licensee. The important point to note here is that by this provision for levy of surcharge, the revenue of the existing licensee by way of cross-subsidy is protected to the extent of supply through open access.

The indicative current level of cross subsidisation based on the embedded `cost to serve' model shows that industrial and non-domestic consumers subsidise domestic and agricultural supply. In Andhra Pradesh, the realisation of cost in the case of agriculture is only 18 per cent and for the domestic category it is 52 per cent. These are subsidised by other categories with the industrial sector bearing 78 per cent more than the cost.

The Act also requires the regulator to announce a cross-subsidy reduction and elimination path. Going by the current level of cross-subsidy and the political environment in the country, complete elimination of cross-subsidy is unlikely in the near future. This being the case, with surcharge being gradually reduced, open access is not going to be an attractive option for consumers in the near term. In effect, open access will be a non-starter as far as the consumer is concerned.

The Act allows for parallel distribution networks in a supply area and takes away the exclusivity of the distribution licensee. In such cases, the regulator is required to fix only a ceiling on tariff for retail sale in order to promote competition. It is important to note here that the existing licensee serves a mix of consumers including the poor and the highly subsidised agricultural farmers through a legacy of charging cross-subsidy from commercial and industrial consumers and using that cross-subsidy amount to subsidise the consumers having no paying capacity such as the life line consumers and agricultural farmers most of whose holdings are small. The second distribution licensee may focus only on a selected area where the consumer mix has a high proportion of lucrative industrial and commercial consumers in urban areas to whom he can supply at much lower tariffs as there will be no issue of cross subsidy burden if they come out of the incumbent licensee to the second licensee.

With cherry picking by the parallel distribution licensee, the cross subsidy available to the incumbent licensee will be reduced and he will be required to supply power to the highly subsidised categories of consumers which he will not be able to perform unless the tariffs for the subsidised categories are substantially increased giving rise to a rate shock or alternatively the State government may choose to pay the increased subsidy. But the State governments are not in a position to do so. Then, the only solution is to increase the tariffs steeply for the hitherto subsidised categories. Is this possible in the short and medium term? A number of Indian private distribution companies have shown interest in becoming "second licensees'' in the urban areas of Maharashtra, Uttar Pradesh, Karnataka and Delhi. The parallel distribution in a supply area will also have to deal with the cost of stranded assets that will be passed on to the consumers of the incumbent licensee. The Act provides for an additional surcharge to compensate for fixed cost liability in case of open access but is silent on additional surcharge for meeting the cost of stranded assets in case of parallel distribution.

Similarly, the Act has liberalised the setting up of captive power plants and has broadened the definition of these by including group captives and cooperatives. These units are exempted from payment of cross-subsidy surcharge. On one hand, the Act, in the case of open access, provides protection to the incumbent licensee against loss of revenue arising out of the exit of a consumer contributing to the cross-subsidy by levying surcharge equivalent to the current level of cross-subsidy and additional surcharge to compensate for the fixed cost obligation of the distribution licensee. On the other hand, it does not extend a similar protection to the incumbent licensee when open access is provided for captive generators. In the name of association of captive generation, industrial and commercial consumers can go out of the fold of the distribution licensee to escape the payment of cross-subsidy. This is contradictory and there is discrimination in the principle of protecting the distribution licensee who is required to discharge universal service obligation. And similarly, where there is a second licensee, consumers taking supply of power from the incumbent licensee pay for the cross-subsidy, while those consumers who take supply of power from the second licensee in the same area of supply, do not pay for the cross-subsidy. Is it correct to make laws that provide for different tariffs for similar consumers in the same distribution area?

One can understand the price differential if there is competition. But in this case there can be no competition as the rules of the game are different for two licensees in the same area of supply. There is no level playing field and this will hinder competition. Where is the need for multiple licensees in the same area of supply if competition is not going to be there? In fact, this amounts to conferring windfall gains on the second licensee. This is an anomalous situation, which will pose a serious threat to the power sector as a whole.

A.P. example

In this context the course adopted by the Andhra Pradesh Electricity Regulatory Commission (APERC) is relevant. The A. P. Electricity Reform Act, 1998 provided for discretion to the Commission to allow or disallow captive generation and also issue second licences in the same area of supply. The Commission decided on regulating open access and group captive generation after considering the implications.

The APERC passed orders restricting captive generation and prohibiting third party sales and directed that generators should directly supply power to the transmission and bulk supply licensee through a power purchase agreement. At the same time, the Commission fixed attractive rates for the developers of non-conventional energy for supply to the licensee and introduced realistic transmission and wheeling charges for supply to third parties.

The non-conventional energy developers found it more profitable to supply to the licensee directly. With the introduction of incentives based on load factor by the Commission, the industrial consumers found it cheaper to take supply from the licensee than from other developers or from their own captive units. This has helped the licensees to improve their financial position with increased sales to the industrial consumers. This was a win-win situation. As a result, the high tension consumption of the licensees went up by 56 per cent and during the current year it is projected to go up to 71 per cent with a corresponding increase in revenues.

The Commission has issued directions on efficiency improvements in distribution and as a result of compliance by the licensees, the average cost of service decreased from Rs. 3.24 to Rs. 2.82 per unit, the revenue realisation per unit increased from Rs. 2.09 to Rs. 2.35. The cost coverage has improved from 64 per cent in 2000-01 to 77 per cent in 2003-04 and is expected to be 84 per cent by the end of the current year. This was achieved with a single tariff hike in 2000-01. T&D losses have reduced from 39 per cent in FY 2000 to 25 per cent in FY 04, that is, a 14 per cent reduction in four years. It is further expected to go down to 23.6 per cent for FY05. Transformer failures have gone down from 29 per cent to 12.7 per cent. The percentage of metered sales went up from 38 per cent to 48 per cent.

These achievements have been possible in a stable regulatory regime with good efforts from the licensees in increasing their level of performance.

It is therefore clear that although the objective of the new Electricity Act is to bring in competition across business segments, many provisions of the Act leave little room for it. Open access to consumers will be a non-starter because of the surcharge and additional surcharge levied on them. Provisions relating to captive generation and multiple licensees in the same area of supply instead of contributing to the development of the power sector may reverse the entire reform process that has taken place over the last five years creating problems in servicing life-line domestic consumers and agricultural consumers.

Most of the provisions of the Act, in effect, address the requirements of commercial and industrial consumers. Providing a level-playing field for the incumbent distribution licensee is an area that needs to be addressed.

The proper course will be to leave the introduction of free captives and multiple licensees to the discretion of the appropriate Commissions rather than mandating the same by statute.. The Commissions are the best suited to decide, taking into account the interest of all stakeholders.

(The author is former Chairman, Andhra Pradesh Electricity Regulatory Commission).

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