“Electricity Market in India and Learning's from the Developed Markets”Workshop

Day 1 Session IV “Cost of Supply of Power”India Habitat Centre, New Delhi

March 1st and 2nd 2005

Presenter: Mr. (OS- SIIS)National Thermal Power Corporation Limited

Back to the Economics Fundamentals

Electricity Tariff Determination

Presentation Synopsis

Part- A Indian Tariff Practice- industry linked evolutionneed to make it more responsive

Part- B Indian Power Sector Issues- unique and fundamentalprompting Tariff Destinations

Part- C New Tariff Approach- beyond performance benchmarksexpanding the “fairness” scope

Part- D Normative Control- need for a balanced approach to match the economics fundamental

Part- A

Indian Tariff Practice- industry linked evolution

need to make it more responsive

Co m p o n en ts o f Co st o f G en eatio n

R eturn on E quity

Interest on D ebt

D eprecia tion

O & M expenses

Interest on W .C .

Fixed C ost

P rimary Fue l

S e condary Fue l

F u e l C o st

Variable C ost

T o ta l C O G

GenerationGeneration TransmissionTransmission DistributionDistribution

Contemporary Tariff is determined on cost regulated cost plus fee basis over the full value chain of Generation, transmission and distribution…

Steps involved for each stage

• Cost scrutinizing/approval

• Financing plan scrutinizing/approval

• Scrutinizing interests rate

• O&M costs on normative basis

Regulated Cost Plus Basis:

Demand/Supply

Demand Supply

Pri

ce

Fuel Component

Fuel Component

Current tariff structure established in the last 3 years and applicable to Central Generators reflects the country’s tariff direction…

Cost of Supply

Fixed Charges UI Charges Energy Charges• Separates actual generation from keeping station available

• No charge applicable for prolonged outages

• Capacity charge pegged at 80% availability

• 25 paise incentive for energy unit generated above 80% utilization factor

• Generation based on framework of Declared Capacity and Scheduled Generation

• UI Charges applicable in the frequency band of 49 to 50.5 Hz.

• Rs. 5.70 per unit admissible below 49 Hz which reduces to zero in two gradients upto 50.5 Hz.

• Accounts for primary and secondary fuel

• Primary fuel cost is a complete pass through

• Secondary fuel cost is linked to norms

The base inputs like project costs, financing schemes, fuel charges, etc are proposed to be scrutinized on the approach of light regulation

The current tariff approach has gradually developed over the many decades…

Tariff Milestones

1910 1948 1975 1992 1998 2003

ES Act ES Act ES ActCentral Utilities 2 Part tariff

British India- agglomeration of provinces

Indian Union

Isolated Private LicenseesIsolated SEBs

RegionalSystem

Central Utilities Central Utilities, IPPs, CTU, SEBs

Early British Model State Govt Central Govt Regulator

CountryStatus

SectoralMakeup

InstitutionalStructure

The sectoral set up has evolved from monolithic inceptive SEBs and certain private licensees and is transiting to independent Generation, Transmission & Distribution…

State

Joint

Private

SEBs

DVC,

Licensees

Under MOP: NTPC, NEEPCOOther Ministries: NLC, Central

Transmission

State

CTU-Power GridCentral

STUs- SEBs

State STUs- SEBs

Private Licensees

Power Trading: PTC, NVVVNL Financing: PFC, REC

, IPPs

/State GenCos

, Pvt DisComs

/State DisComs

/State TransCos

Generation

Transmission

Transmission

Distribution

Generation

Distribution

Generation

Transmission

Transmission

Distribution

Generation

Distribution

Indian Tariff approach has developed as a response to industry evolution…

Cost of Supply

CapacityCharge

UI Charge Energy Charge

Cost of Supply

CapacityCharge

Energy Charge

Cost of Supply

Bundled Charges

Single Part Tariff Two Part Tariff Availability Based Tariff

1910 1992 2001

• Carry over of early isolated licensees utility centric electricity luxury era

• Practically all costs were pass on without any performance linkage

• First capacity utilization linkage came in 1975 with entry of central utilities @ 55%

• Response to excess capacity charge accruals on performance exceeding industry average

• First systematic effort to lay tariff determination principles

• Fixed charges pegged to 62.8% capacity utilization and incentive beyond 68%

• Regulators response to contemporary sectoral situation to enhance performance and instill grid discipline.

• Applicable only to Central utilities

• Concept and Systems for UI charges established

While the evolution has been logical there are a number of issues in the Indian Power Sector which the tariff approach need to consider in future

Part- B

Indian Power Sector Issues- unique and fundamental

prompting the Tariff Destinations

Indian Power Sector is today faced by a host of issues ….

Key Sectoral Issues• Capacity Crunch• Energy Carbon Conflict• Energy Conservation• Capacity Utilization• Low Energy Efficiency• New Technology Induction• Fuel Prices• Weak R&D legacy• Capacity Mix Rationalization• High T&D losses• Reduction in cost of supply• High Industrial tariff• Village Electrification

These are fundamentally linked to sound and quick sectoral development

Key Constraints

• Rs 9,00,000 crores investment required in generation, transmission, distribution etc.

• Assuming 30:70 ratio 2,70,000 crores of equity and 6,30,000 crore debt needed in next 8-9 years

• In the present climate, CPSUs, State Utilities and private sector put together are not in position to make required investments

"Power for all by 2012"

Current Required by 2012

During 2002-03 peak shortages were 12.2% and energy shortages were 8.8%.These shortages are with 57% households yet to be electrified.

While the capacity increased by 100,000 MW in last 50 years, demand estimates indicate similar increments in about 10 years….

108930 MW

212000 MW

Very Low Per Capita Consumption

130.5

238

559

83.534.815.6

1950 1960 1970 1980 1990 2002

Calender Year

KW

h/ye

ar

Currently about 60% of installed Capacity is owned by State Utilities, whose poor financial health is a major road block to power sector development in India.

Share in Installed Capacity

59%30%

11%

State Central Private

41.17

253.95

165.75

273.06

172.07

0

50

100

150

200

250

300

91-92 2001-01 2001-02 (RE)

Commercial Losses of State Utilities (Rs. Billion)

Excl. subsidy Incl. subsidy

Source: Indian Economic Survey 2001-2002Source: MOP Annual Report

Non-remunerative retail tariffs, high T&D losses, poor metering, billing and collection and low productivity are the key factors for poor financial health of State utilities

Indian Population Trend

0

500

1000

1500

2000

1900 1920 1940 1960 1980 2000 2020 2040 2060

Calender Year

mil

lio

n p

eo

ple Projection

0

20

40

60

80

100

% o

f T

ota

l

Po

pu

lati

on

1950 2050

Timeline

World Urbanization Pattern

DevelopedDeveloping

The demographic challenge of India calls for widespread electrification ...

Country Electrification Status

Total country households 138.27 million

Households electrified 60.18 million (43%)

Households unelectrified 78.09 million (57%)

Fuel prices are a key determinant to cost of supply and need to be contained ...

0

100

200

300

400

500

600

700

800

900

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Plant Life

PA

ISE

/Kw

h

Variable Charges

O&M Expenses

Interest on workingCapital

Return on Equity

Interest on Loans

Depreciation

Cost Breakdown of a Typical Indian Power Station Key Issues

• Coal and Gas industry in India does not have any Regulators- no transparent pricing mechanism• Coal prices are much higher (typ. 12$/ton vs. typ. 6 $/ton in South Africa)• Indian coal is a difficult fuel with low heating value and very high ash• Coal is geographically concentrated in essentially 4 states requiring long transportation for load centered stations• There is no quality control on coal by the coal companies• Contracts are operated on measurements on coal company end- exposing generators to uncontrolled liabilities• There is a supply shortfall emerging for a country with 250 billion tons of reserve

The issues linked with the fuel market create a open ended risk for generators

Longer term Power Vision of the country call for developing and institutionalizing Electricity R&D base in the country ...

Key Issues • Both immediate and longer term destinations require technology interventions.• The country’s design and O&M conditions are unique requiring custom solutions• The Indian power sector has had a import legacy and has a weak R&D base• Knowledge institutions which provide country specific studies to narrow down on R&D cases are a must• Coal being the mainstay fuel- switching to alternate coal conversion technologies is necessary beyond a point• Weak petroleum base calls for energy sources all of which require electrical interface- need to manage energy carbon challenge

The long lead time for establishing institutions and knowledge processes require immediate attention on building energy R&D base

Expanding Capacity Base •New Capacity Additions• Village Electrification

Generation Enhancement

Existing Capacity•Increase capacity utilization• Increase Energy Efficiency• Reduce T&D losses• Energy Conservation

• T&D Loss reduction• Increase capacity utilization• Reduce fuel prices• Increase energy efficiency• Energy conservation• Capacity mix rationalization

Cost Reduction

• Advance coal technologies• Hydro & Nuclear option• Renewables Induction

Energy Carbon Conflict

Classification of sectoral issues along with the actualization instruments prompt the need of using Tariff as a MULTIPRONG instrument ….

Actualization Instruments• Enabling through knowledge inputs• Incentivize efficiency and availability• Micro Technology Interventions• Need for Light regulation

• Stringent Benchmarks• Enable cash flows with promoters• Create Policy Instruments• Catalyze advanced technology use• Fuel fairness advocacy• Incentivize candidate technologies• Enable candidate energy sources• Active scrutiny in unconventional cases

Tariff need to be used as a “BROADBASE” instrument and need to grow beyond the approach of control through performance benchmarks

Part- C

New Tariff Approach- beyond performance benchmarks

expanding the “fairness” scope

Cost plus system though inevitable in the absence of an established market, has certain deficiencies…

Discourages Efficiencies

Micro Management

•Financials•Technological•Operating

•Detailed scrutiny of technology•Technology/Equipment vetting•Time consuming process

Not tuned to dynamic structure

•Enhanced participation of private sector players•Faster approvals (tariff etc.)

Any structure modification need to consciously take into account the constraints to include necessary enablers

Generation Regulated on cost plus basis

Transmission Regulated on cost plus basis

Distribution Regulated on cost plus basis

Generation Un-Regulated

Transmission Regulated on cost plus basis

Distribution Regulated price cap

Cost plus system though inevitable in the absence of an established market, has certain deficiencies…

Present System Target System

Target System will take some time to evolve

An interim structure needs to be established which also takes care of specific sectoral issues

The interim structure need to enable capacity buildup & release, incentivize productivity and compensate systemic deficiencies…

Interim Tariff Structure

Regulated on Normative Basis• Determination of normative costs• Normative financing plan• Normative O&M costs• Normative Operating Parameter• Judiciously established enablers

• Institute Technology Development Fund• Time of the day bias in the tariff chain• O&M charges towards maximizing reliability• Incentives for top range efficiency bracket• Enable advanced technologies induction• Catalyze R&M and life extension• Catalyze candidate energy sources • Traditional project cost appraisal on norms• Advanced technology projects on active scrutiny• Chronic Fuel uncertainties to be compensated

Following enablers need to be suitably included in the new tariff framework to provide a proactive instrument:

Necessary institutional arrangements, monitoring and control systems will need to be developed to enable and maintain systemic effectiveness

100%

25%

7%

7%

8%

35%

4%

4%

10%

100%

25%

7%

7%

8%

35%

4%

4%

10%

Fuel O&M-Gen.

Interest Tech Losses Comm. Losses Dep. TotalReturn.O&M-Dist.

The focus areas for normative control need to be balanced on relative importance w.r.t. end cost of supply…

Cost of Supply Breakdown

Capital costs and O&M charges form a very low component of the total supply costs, however, they form the backbone of the electrical system

COUNTRY DOMESTIC INDUSTRIAL

JAPAN 21.3 14.3

ITALY 13.5 8.9

GERMANY 12.4 4.4

ARGENTINA 8.6 6.9

FRANCE 10.2 3.6

BRAZIL 12.8 5.7

U.K. 10.1 4.8

U.S. 8.5 4.8

CHINA 4.5 4.4

INDIA 3.9 8.0

AV. TARIFF

17.8

11.2

8.4

7.75

6.9

9.25

7.45

6.65

4.45

5.70

It need to be considered that domestic tariff in India is lower compared to international tariffs and it is the purchasing power which is low. …

While any attempt towards reduction in cost of supply is reasonable it need to consider the bigger picture

Part- D

Normative Control- need for an enabling system

to match the economics fundamental

• Cost of Debt• Cost of equity• Debt : Equity• Tax on returns• Additional capitalization• R&M capitalization• Capital costs basis• Working capital• O&M expenses• Depreciation• Operating norms• Target Availability• Utilization Incentive• Efficiency Incentive• Development Fund• Technology Compensations• Fuel Compensations

Fuel

Generators

TransmissionAgencies

DistributionAgencies

The norms for tariff determination need to comply to basics of economics along the full electricity value chain. …

Target Availability

•CERC has now specified 80% target availability for recovery of fixed charges against 68.5% specified in 30th March, 1992 and 70% recommended by NTF.•Fixing benchmark based on performance of one utility is discriminatory and also gives message that improvement in performance will be penalized.•Benchmark should be fixed based on overall industry performance.•National Average PLF of 2002-03 has been 72% and target availability may be fixed considering the same.

Incentive/DisincentiveIncentive/Disincentive

•Under availability based tariff, incentive should be linked to the availability of the station and not on PLF. Incentives and disincentives need to be comparable within a reasonable range of operation say, above 60 percent so that year to year variations can be compensated.

•To have a uniform rate of incentive and disincentive it may be provided as 0.4% of equity for every 1% increase in availability

Rate of Return: Suggested Approach

Tariff setting needs to move from a cost-plus approach to a normative performance based approach.•Cost-Plus approach requires detailed analysis of the different loans, their repayment schedules and other terms & conditions.•It does not provide incentive to utility to lower cost of borrowings as even higher rates are passed through in tariff.•However, for new technologies detail scrutiny need to continue with an active proactive approach Adoption of a Return on Total Investment would incentivize utilities to adopt more efficient means of financing so as to reduce its cost. •The return may be calculated each year with normative cost of equity, debt and the debt-equity ratio.

Rate of Return: ROCE- Cost of Debt

The rate of return on capital employed could be determined considering the prescribed return on equity and interest rate based on prevailing PLR or any other accepted basis. Normative debt:equity of 70:30 could be considered for this purpose.

Rate of Return: ROCE- Cost of Equity

• Return has to be comparable with return available in other sectors, to attract investment in the sector. Rate of return should be commensurate to the risk associated with the sector.

•Considering the present requirement of resources for the growth of the power sector in the country, it would be appropriate to continue existing rate of return of 16%.

Basis of Capital Cost: Normative or Actual• Under the new Electricity Act, 2003, since TEC has been dispensed with, Central Commission in consultation with the Authority may fix benchmark capital cost which could be adopted for the purpose of tariff. Utilities can make investment decisions considering this benchmark capital cost. There should be a provision of automatic approval in the case of capital cost being lower than the benchmark capital cost.

Depreciation

• Accelerated recovery of depreciation will also help power utilities in mobilizing resources from the existing capacities for capacity addition and R&M of the existing facilities.

•Alternatively, since generating companies will have to provide depreciation in accounts as per Companies Act, rates of depreciation for tariff may be prescribed as per Companies Act along with Advance Against Depreciation to facilitate repayment of loans.

ABT for all Generating Companies

• Presently, ABT is implemented for central sector generators. RLDC is involved in the scheduling of only 25% central sector generation in the Region.•To ensure merit order dispatch, ABT will have to be progressively extended to cover all generating stations.•Even for IPPs selected on the basis of competitive bidding, committed off-take should not be granted.•ABT should also be extended to state generating companies as and when SEBs are unbundled.

O&M Expenses (Normative/Actual? & escalation)

• At present, operating norms are based on actual or norm whichever is lower. •Actual operating parameters for the purpose of recovery of fuel charges will not provide any incentive to the utility for improving their performance.•Operating parameters should be fixed on normative basis for promoting efficient operation. •As operating norms will be uniformly applicable to all utilities in the country, norms fixed should be achievable by all utilities and form a reasonable benchmark for utilities whose performance is below this level to improve.•It is necessary that norms are fixed considering the operating performance of all utilities in various categories i.e. fuel, unit size, age etc.

•Inadequate O&M expenditure has led to deterioration in operating performance of many stations in the country.

•With the ageing of the stations, the O&M requirement also increases due to:

-higher requirement of maintenance

-higher price of spares than spares supplied with main equipment

-higher duty for imported spares against project duty for spares purchased with main equipment

Thanks Everybody

The presenter would like to have views on the issues brought out, kindly use: mkvrao@ntpc.co.in