Powering reforms: Bringing power PSUs under competitive bidding will help in tariff reduction

By Raj Pratap Singh

The power sector has to be measured in terms of 5 ‘A’s—awareness, accessibility, availability, affordability and acceptability. Recent policy measures of the government have remarkably improved the first 3 ‘A’s, i.e., awareness, accessibility and availability, especially the “Saubhagya” scheme. However, it has also brought unintended outcomes for the distribution companies as the cost of supply has increased due to increase in LT distribution network length necessitating more conductors, meters, transformers, etc. Most of the newly-added consumers are from rural areas of low-income states like UP and Bihar. They belong to subsidised consumer categories, viz. agriculture, rural-domestic, etc. Thus, the subsidy burden of respective state governments has increased.

There is a limit to which the states can meet subsidy obligations for low-income consumers. The state’s capacity to service power subsidy of its BPL consumers is dependent on its per capita income which varies from state to state. For example, the capacity of Delhi state government to meet its obligations and expenditures from current per capita income of Rs 3.89 lakh and tax-to-GSDP ratio of 10% will be around Rs 38,900 per person, whereas for a state like UP with per capita income of Rs 70,500 and tax to GSDP of 10%, it will be meagre Rs 7,050 per person. Needless to mention that the competing demand for developmental funds from own revenue resources in these low-income states is very high, and the fact that the central government provides no subsidy for this purpose also comes into play. Therefore, making electricity affordable for consumers becomes a priority for the power sector. Lower tariffs will increase the capacity and willingness of the consumers to pay for their electricity consumption, thereby improving the financial health of discoms; it will also make industries more competitive. Limiting focus only to reduction of the cross-subsidy burden of industries, a Zero-Sum game approach, may not be fruitful. In order to make it a win-win situation, the overall cost of supply must come down to make electricity affordable so that it is within capacity and willingness of a large number of consumers, reduces the cross-subsidy burden on industries, and also reduces the subsidy burden of the state governments thereby freeing fiscal space for other developmental expenditure.

The possible policy steps to make electricity affordable are:
Expedite overdue distribution reforms: While generation and transmission sectors have been unbundled, unbundling (segregation of carrier and content business) of distribution has been a non-starter. Privatisation of, and governance reforms in, state-owned distribution companies are likely to unlock huge value and provide efficiency gains through loss reduction for making power affordable. However, this option is the most difficult in our political-economy as it requires wider consultations, ground preparations and strategy for managing the transition to avoid disruptions during an interregnum.

Capping of stranded capacity charges: As of now, we have surplus installed capacity of around 370 GW against a peak demand of 183 GW; therefore, any fresh capacity addition should be limited to projected load demand growth and replacement of retiring power plants. This will reduce the stranded capacity charges the discoms are currently paying to gencos under their long-term power purchase agreements without taking any power from them under availability-based tariff regime.

Say goodbye to cost- plus regime: No new project (except hydro and nuclear) should be allowed on cost-plus route or MoU route under section 62 of the Electricity Act. This section of the Act is reminiscent of Enron episode and era, and had relevance only when India was power-deficit. Now, when the country has sufficient installed capacity, it makes no sense to provide a risk-free 15.5% tax-free (or 22% after-tax) return on equity to the power companies.
Therefore, all new generating projects, including RE should compulsorily be taken up only on tariff-based competitive bidding (TBCB) route and evaluated at procuring state’s periphery, including inter-state transmission charges, to bring in transparency.

Existing power projects of CPSUs like NTPC/PGCIL/NHPC, and state power generating, transmission and distribution companies are the main beneficiary of cost-plus power procurement under Section 62. CERC regulations have been providing a tax-free Return of Equity of 15.5% which is followed by the State Regulatory Commissions’ prescriptions for the state’s PSUs as per statute.

On the other hand, none of the major private power companies could achieve higher ROE than the regulated PSUs. For example, in FY16, FY17, FY18 and FY19 ROE of Tata Power was only 4.82%,-1.06%, 7.73% and 7.45%, and ROE of CESC was 6.08%, 8.45%, 7.19% and 9.73%. Similarly, ROE of all other private power companies was lower as compared to regulated PSUs.

This needs to be reviewed by linking ROE with a formula-based on RBI repo rate and appropriate risk beta weightage. If we use the Capital Asset Pricing Model (CAPM):

Return on equity= Risk-free return+ beta X (market return–risk-free return)
Risk-free return = Average of last five years G-Sec yield = 7.01%
Beta of BSE Power Index=1.004
Avg. annual market return of BSE in last five years (2014 to 2019)=10%
ROE= 7.01+ 1.004*(10-7.2) =9.82%

In the present context, around 5% reduction in ROE from 15.5% to 10% will provide a noticeable reduction in tariff.

Bringing PSUs under the competitive bidding route will create a level playing field between public and private power companies, and help in tariff reduction by increasing competition and efficiency gains.

Restructure normative debt-equity financing to 80:20: At present, the regulatory norm used for tariff computation of projects is 70:30 debt: equity. Debt servicing is limited only to the term of the loan, i.e., up to 12 years, but ROE is allowed in perpetuity even after the plant has fully depreciated. This needs to be limited to the useful life of the unit. Further, if debt: equity is increased to 80:20 as in case of other infrastructure projects, the levelised tariff will be reduced since the cost of equity is higher than debt.

No double-whammy for consumers: National Clean Energy Fund was created as a non-lapsable fund in 2010 for promoting clean technology, and since then around Rs 1 lakh crore has been collected from coal cess. However, most of it has been diverted and used for other purposes like funding to states for their GST losses, etc. Asking gencos to install FGD and pass on the cost to the consumer amounts to a double whammy for the consumers who first paid the coal-cess and now will have to bear the FGD cost also. We should stop using cess as a tax and NCEF should be used to fund the clean energy initiative and FGD installation etc.

Retired IAS, has worked at senior positions, including PMO and World Bank. Chairman, UP Electricity Regulatory Commission. Views are personal