MultiYear Tariffs

1
Multi-Year Tariffs

• in the Power Sector
• in India so far
• (August 2003)

2
Why a multi-year framework (MYT or MYTP) for
power tariffs?

• The two general reasons
• Incentivise efficiency improvement
• Obviate regulatory uncertainty.
• In India (not uniquely) the issue arose
  specifically in the context of efforts to
  privatise distribution
• Creation of investor confidence in context of
  regulatory uncertainty the driving concern.
• Then existing legal framework incompatible with
  MYT, hence MYTP.

3
Role of the Government

• MYT(P) can be mandated either by Regulator or by
  Government.
• Privatisation is necessarily a Government, not a
  regulatory, decision
• The first multi-year framework was improvised (in
  Delhi) in a situation where the overriding
  concern was investor uncertainty about efficiency
  improvement expectations.
• The power to give policy directions proved
  crucial in the face of Regulators reluctance.

4
Legal ContextBefore the Electricity Act, 2003
5
The Indian Electricity Act, 1910

• Defined the responsibilities of licensees and
  consumers
• Gave State Government some powers to regulate
• Did not mandate any periodic tariff fixation
  procedure.

6
Electricity (Supply) Act, 1948

• SEBs were to set tariffs with reference to annual
  revenues (section 59).
• SEB to be guided by any Policy Directions that
  the State Government might issue
• CEA to decide in any dispute as to whether a
  particular question was a question of policy.

7
Electricity (Supply) Act, 1948

• Licensee tariffs to be set according to Sixth
  Schedule (section 57)
• Cost plus
• Tariff to be adjusted annually limiting profits
  to reasonable return defined by the statute
• Up to 5 of excess profit at disposal of
  undertaking balance divided between consumers
  and a Tariffs Dividends Control Reserve).

8
Electricity Regulatory Commissions Act, 1998

• SERC to be guided by the following principles
  (section 29)
• Principles laid down in E(S)Act 1948
• Progressively reflect costs at adequate
  improving efficiency levels
• Factors (as SERC considers appropriate)
  encouraging efficiency
• Interests of consumers requirement to pay in a
  reasonable manner based on average cost of
  supply
• Commercial principles
• National power plans.

9
Electricity Regulatory Commissions Act, 1998
(continued)

• SERC to be guided by any Policy Directions given
  to it by State Government (Section 39).
• State Governments decision final as to whether
  any particular direction qualified as a policy
  direction in the public interest.

10
State Reform Acts typically required SERC to be
guided, but not bound, by E(S) Act tariff
principles.

• Delhi Electricity Reforms Act, 2000 (section 28)
• DERC to be guided by
• Sixth Schedule
• Factors encouraging efficiency, economy etc.
• Consumer interests.
• When the Commission departs fromthe Sixth
  Scheduleit shall record the reasons therefor in
  writing.
• Licensee to submit an Annual Revenue Requirement
• Annual exercise laid down.

11
Policy Directions under State Reform Acts

• All provide for policy directions.
• Most provide for some external authority (High
  Court, CERC) to determine whether a State
  Government direction qualifies as a policy
  direction in public interest.
• But DERA followed ERC Act
• Governments decision final.

12
The Case of Delhi
13
Reform Milestones

• Feb 99 - GNCTD Strategy Paper.
• Nov., 99 -SBI Caps engaged as Consultant.
• Dec., 99 -Regulator Appointed.
• Oct., 2000 Delhi Electricity Reforms
  Ordinance.

14
Reform Milestones

• Oct 2000 Tripartite agreement between staff, DVB
  and Government, on same day as Ordinance.
• Jan 2001 Investors Conference.
• Feb 2001 RFQ issued
• Bought by 31 parties.
• Feb 2001 DVB applies for MYTP along with its
  ARR.
• May 2001 DERC rejects MYTP.

15
continued

• Mar 2001 - Delhi Electricity Reforms Act, 2000
  comes into force
• July 2001 Consultants final report
• May 2001 - Bidders short listed
• Six bidders
• Two expressed lack of interest
• Nov 2001- RFP issued
• Nov 2001 - Policy Directions

16
continued

• Feb 2002 DERC order fixing opening loss levels
  and initial BST.
• April 2002 Bids received from two bidders.
• Considered not acceptable in present form by
  Cabinet.
• Core Committee authorised to explore alternatives
  including negotiation.

17
continued

• Share Acquisition Agreement, May 31, 2002
• Amendments to Policy Directions and Transfer
  Scheme Rules
• Shareholders Agreement and other agreements
  signed June 27
• Operative from June 30
• Transfer Scheme operationalised June 30
• Management handover

18
Reform process once startedThere may be no time
to waste.

• Political will
• Its relationship with compulsions of situation.
• If available, it must be honoured
• Implications for time framedelay will damage
  credibility
• Necessity to go it alone in Delhi to achieve
  tangible results within a Governments term.

19
The main objective of reform

• Reduce the high commercial losses in
  distribution
• In India (most States) all else pales into
  insignificance, for the time being.
• Motivation for other efficienciesreducing
  technical losses, DSMalso depends on it.

20
Design of package essentially to handle the
transitional phase

• During the transitional phase, it is necessary to
  balance
• Realistic expected efficiency gains
• Possible tariff increases
• Transitional assistance until the benefits of
  greater efficiency are realised.
• Therefore the main features of the package should
  preferably be frozen for the transitional
  phase.

21
No Time Gap between Corporatisation
Privatisation in Delhi

• Shell companies registered in advance.
• Objective was privatisation, not mere
  corporatisation.
• New entities would incur losses before
  privatisation.
• Govt. retained option to abort the entire
  exercise in absence of investor response.

22
In Delhi, time assumptions were an input in the
valuation

• Business Valuation method used for second time in
  IndiaKanpur, then Delhi.
• Business Valuation, as adopted
• value assets on going concern basis
• asset value derived based on future earnings
  potential assuming reasonable retail tariff
  increase and efficiency improvements

23
... Valuation of Assets

• Principles applied
• electricity business becomes self sustaining
  within five years
• Minimise retail tariff shock.
• Support from GNCTD for funding initial losses -
  about Rs. 2600 crores (increased to Rs 3450
  crores).

24
...Financial Restructuring Plan
25
...Financial Restructuring Plan

• Support for funding losses in initial years
• About Rs 3450 cr to TRANSCO
• at interest rate of 12
• moratorium of four years on interest and
  principal repayment
• Servicing of principal in eighteen equal half
  yearly installments.

26
...Power Purchase/ Bulk Supply Arrangements

• TRANSCO to buy and sell power for initial 5 years
  
• but no bar on additional purchases by DISCOMs
  direct from generating companies or other sources
• After 5 years DISCOMs to buy power directly and
  pay wheeling charges to TRANSCO

27
Setting efficiency improvement targets

• Primary investor concern.
• Regulatory (and public) regulatory approval not
  forthcoming for reasonable, achievable multi-year
  targets
• Lack of understanding of nature of problem.
• Lack of benchmark experience.

28
Multi-year tariff principles proposed by DVB in
2001

• Annual Tariff fixation general principles for
  power purchase, OM, salaries, interest,
  depreciation.
• DERC to fix targets for collection efficiency
  shortfall.
• TD loss reduction targets

29
Negative response (except from investors)

• No general appreciation of the necessity for MYTP
  in the context of developing Orissa experience.
• DVB accused of bad faith in making proposals on
  behalf of future, as yet non-existent, discoms.
• Targets considered too low.
• Collection inefficiency pass-through thought to
  be contrary to accounting principles.

30
DERCs views

• multi-year tariff approach linking to some
  indices would be suitable for a mature and stable
  environment so that the investing companies can
  undertake efficiency improvements and reap
  benefits from them. The efficiency benchmarks
  have to be robustneither the utility nor the
  consumer should suffer or benefit unduly in
  future. In conclusionalthough multi-year tariff
  setting principles is an issue that merits
  consideration, it is not the mature stagefor the
  purpose of this tariff order.

31
Delhi Solution Legitimise targets through
bidding procedure.

• Criteria of Selection of Investor
• Minimum target of Aggregate Technical
  Commercial Loss to be achieved by investors each
  year for next five years specified.
• Bids invited on Aggregate Technical Commercial
  Loss with shares being sold at par value.
• ATC Loss concept addresses not only the problem
  of data reliability but also that of collection
  inefficiency.

32
Policy Directions to DERC

• To mitigate uncertainty and ensure successful
  privatisation, GNCTD issued policy directions
  under Section 12 of DERA, binding Regulator to
  the outcome of the bidding process.
• It was (then) felt that it would suffice to
  mitigate risk only in respect of loss reduction
  targets.

33
The Policy Directions

• require that tariffs for 2001-07 take into
  account
• Selection process of bidders
• Technical Commercial Loss to be on the basis of
  the bid of the selected bidder
• DISCOMS earn 16 Return on Equity (Assuming loss
  reduction, ARR approval)
• Incentives on over-achievement 50 retained, 50
  to rebate on tariff

34
Loss level reduction targets accepted
35
Reform package tariff projections

• Years 1 to 3 retail tariff increase up to 10
  per annum.
• Year 1 for 6 months only.
• Years 4 5 retail tariff increases of 5, 3.
• Bulk (Transco) Tariff to rise more sharply, with
  phasing out of Government assistance, efficiency
  improvements.

36
First post-reform tariff order

• 5.18 increase overall.
• Government decision to further subsidize to avoid
  tariff increase for consumers up to 400 kwh per
  month.
• Discom issues
• Depreciation rate
• Deferred tax liability
• Base for next year (BRYPL)
• And more.

37
First post-reform tariff order(Continued)

• Order effective July 4, 03.
• Holding Company collections assigned to Transco
  ARR.
• Transco and Genco issues.
• Overall, effect on investor interest to be
  watched
• Was the presumption that advance fixation of loss
  reduction targets suffices to allay investor
  apprehensions on regulatory uncertainty justified?

38
Some other States

• Shortly after DERC rejection of MYTPs, UPERC
  introduced 5-year MYTPs for Kanpur
• TD loss reduction 2 per annum
• Collection efficiency improvement targets
• Concept of effective lossATC loss.
• Orissa Electricity Regulatory Commission has
  announced its intention to fix MYTPs.

39
Some other States

• Karnataka package (still in the making) tries an
  alternative approach
• envisages prior fixation of a Distribution
  Margin comprising
• Base revenue set in advance for each year of
  transition period
• Incentive charge (being amount collected above a
  Minimum Revenue Requirement) to be fixed by
  bidding.

40
Karnataka continued

• Investor to be protected from
• Regulatory risk on tariff
• Collection risk in certain cases (unmetered
  consumers Govt)
• Partial protection from risk of commercial losses
  because of lack of law enforcement support.

41
Karnataka continued

• Risks transferred to the investor
• Collection risk in respect of metered consumers
• Theft risk above announced starting level
• Inaccurate metering
• Operating expenditure management risk
• Technical losses risk.

42
Karnataka continued

• Karnataka package involves prior fixation of
  annual figures
• Therefore control period likely to be only three
  years.
• The starting point was perceived unreliability of
  ATC loss figures
• Perhaps a genuine problem, but could not a
  simpler alternative have been found? Revenue per
  unit input?
• Too early to judge package still not final.

43
APERC approach to Long-Term Tariff Principles may
offer an alternative

• Control Period
• Annual targets to be fixed in advance for
  controllable items
• Network costs
• Financing costs
• System losses
• Licensee to normally enjoy benefits or losses of
  variation from annual targets.

44
APERC (Continued)

• Uncontrollable items pass-through
• Force Majeure
• Change of law
• Judicial decisions
• Government policies
• Economy-wide influences.
• Mid-term review.

45
Electricity Act, 2003

• Section 61 Commission to be guided by
• Commercial principles
• Factors encouraging competition, efficiency,
  etc.
• Principles rewarding efficiency
• Multi-year tariff principles
• Progressively reflect cost of supply, eliminate
  cross-subsidy.

46
continued

• No specific provision necessitating annual
  filing.
• But how far do the provisions on open access and
  multiple distribution licenses change the context?

47
Thank you