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Transcript of Power Sector Economics
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Power Sector Economics and
Planning
Dr Hiranmoy Roy
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Intro. to Eco. Theories and their
Importance
Economic Theories:Economic Changes and its
consequences
Societys institution and technology affect
prices
Distribution of Income poor can be helped
without harming economic performance
Business Cycle, Monetary Policy swing in
unemployment and Inflation
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Economic Theories
Pattern of Trade, Impact of Trade Barriers
Govt. policies to pursue Growth in DevelopingCountries, Efficient use of resources, Full
employment, Price stability, Fair dist. ofincome
Classical Theories
Depression of 1930s
Classical theory had the difficulty of explainingDepression.
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Economic Theories
J. M. Keynes began to develop alternative
theories
Birth of Keynesian theories
But it also had trouble as unemployment and
inflation began to rise togetherStagflation
PostKeynesian Development Critique of Keynesthree main developments
after Keynes
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Economic Theories
Monetarism, Supply side Economics, Neo
Classical Economics: Rational Expectation
Theory
Milton Friedman Monetarist Criticized
Keynes
He argued Monetary Policy is the prime
engine in causing fluctuations in eco. Activity
through Agg. Demand
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Economic Theories
Keynes view that monetary policy ineffectiveto bring eco. Stability was criticized byFriedman
In fact, he said the monetary policycontributed to almost all recessions
There are differences between Keynes and
Monetarists in two issues (i) Relationshipbetween money supply and inflation (ii) Roleof Govt. in the economy
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Economic Theories
Monetarist led by Friedman Inflation is
always and everywhere a monetary
phenomenon
Inflation is caused by rapid expansion of
money supply
Keynes and his followers activist role of
Govt. Keynes lay stress on adoption of
discretionary fiscal and monetary policy
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Economic Theories
Keynes believed that expansion of moneysupply does not always cause inflation
This depends on possibility of expansion of
output When eco. Is in depression increase in money
supply is likely to lead in large expansion of
output and prevent price rise Monetarist opposed to the fiscal policy,
budget deficit and pub. debt
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Economic Theories
They argued that reducing taxes and public
expenditure so that role of Govt. in the
economy is reduced
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Economic Theories
Supply Side Economics: In 1970s problem of
stagflation appeared high inflation
accompanied by high unemployment
Keynes proposition of fluctuation in agg. dd.
Responsible for either high unemployment or
high inflation could not explain stagflation
This led some economists to believe that
problem was on the supply side eco. activity
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Economic Theories
Keynesian theories were incapable of solving
Keynesian expansionary fiscal and monetarymeasures taken to raise agg dd. to remove
stagflation or high unemployment , itaccelerated further.
On the other hand if steps were taken to
lower agg dd to lower inflation rate it wouldfurther increased already high unemploymentrate
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Economic Theories
Supply side economists mentioned that it was
supply shocks, by reducing oil prices and
increase in oil prices that caused the problem
of stagflation
Contraction in supply due to supply shocks ,
given the agg dd curve price level and
inflation could rise on the one hand and aggoutput could fall giving rise to unemployment
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Economic Theories
Supply side advocates expansion in moneysupply increase in employment opp.,incentives to work, save and invest more were
required to be promoted
Increase in agg supply given the agg dd curve
will lead to increase in employment on theone hand and reduction in inflation on theother
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Economic Theories
According to them high rate of tax serves asdisincentive to work
New Keynesians thus emphasize both fiscal
and monetary policies to attain eco. Stability To encourage more saving work and
investment , they advocated reducing
prevailing high rates of income tax This will not only cause employment to rise
but also lower rate of inflation
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Economic Theories
Laffer Curve When rate of a tax increases
from zero upward Govt. revenue from it
initially increases, but after a point further
hike in rate of tax brings about decrease inrevenue for the Govt.
So lowering of tax rate not only increase N.I
and employment but also reduce Govt.budget deficit
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Economic Theories
New Classical Macro economics: Rational
Expectation Theory : A New Macro theory put
forward which is opposed to Keynesian Macro
theory
According to this new classical macro
economic theory consumers, workers and
producers behave rationally to promote theirinterests and welfare.
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Economic Theories
On the basis of their rational expectation theymade quick adjustments in their behaviour
Producers and consumers collect every
information to determine their behaviour People make a correct relationship between
eco. Event and Govt. policies on the one hand
and results that follow from that Correct prediction from Govt. policies and
changes in eco. environment
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Economic Theories
E.g., when Govt. makes a deficit budget they willexpect that interest rates will rise.
So to they will attempt to take loans now when
rate of int. is less than paying higher int. rates infuture
A sharp contrast of Keynesian theory andRational expectations theory is that according to
Keynesian theory deficit in Govt. budget willleads to increase in agg dd and will promote pvtinvestment
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Economic Theories
On the other hand according to Rational
expectations theory, budget deficit will cause
rate of interest to rise which will discourage
pvt investment
Thus increase in agg dd as result of budget
deficit is offset by decrease in pvt investment
so that N.I., output and employment remainsunaffected
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Economic Theories
Similarly If RBI increases money supply ,
consumers, workers and producers expect
rationally price level will rise .
On the basis of their rational expectations,
workers will get their wages raised , landlord
raise their rents, bankers and lenders raise
their interest and producers will raise theprofit margins
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Economic Theories
As a result of adjustments by various persons, the
effect of expansion in money supply on these
persons will get cancelled.
So according to rational expectation theoristssince the consumers, workers and producers
themselves make adjustment to save them from
adverse effect s of economic events and policiesthere is no need for the Govt. to intervene in the
eco through proper macro eco policy
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Economic Theories
Thus like Friedman and other monetarists thesupporters of rational expectations theoryopposed to the activists role by the Govt.
However Conservative Govt. (US) of the 1980sgradually become disillusioned with Monetarismand returned to modern version of classical ecomanagementNeo- Classical economics.
Like classical eco it stresses the role of freemarkets in delivering the best possible ecogrowth
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Economic Theories
Following three important theories popular ineconomics
Classical / Neo- classical, Keynesian theory,
Monetarist theory Classical refers to the works done by a group
of economists in the 18thand 19thcenturies.
Much of these work subsequently beenupdated by modern economists and they aregenerally termed as neo-classical economists
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Economic Theories
We look in to works of classical economists
what they believed and proposed
Beliefs, Theories, AS & AD policies, Virtual
Economy Policies
Neo-Classical Theory: Beliefs
Malthus Population growth depress eco
growth then diminishing returns would cause
further problems for growth
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Economic Theories
They believed Govt. should not intervene tocorrect this as it would only make thingsworse so only way to encourage growth is to
allow free trade and free markets. This approach is known as laissez-faire
approach
This approach places total reliance on marketsand anything that prevent markets clearingproperly should be done away with.
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Economic Theories
Neo-Classical Theories: Revolved mainly aroundthe role of markets in the economy
If markets work freely and nothing prevents their
working then the economy would prosper Role of Govt. is to ensure the free workings of
markets using supplyside policies
The main theory to justify this view is
Free Market Theory, Says Law, Quantity Theoryof Money
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Economic Theories
Free Market Theory
Eco left itself tend to full employmentequilibrium
Unemployment (a surplus of labour) fall inwages increased dd for labor - equilibrestored at full employment
Initially hig h wage results in unemp l( a b indiag) . This causes wage rate to fall andunempl in the eco is voluntary unempl
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Economic Theories
Similarly if there is discrepancy between savingsand investment the equilibrium would change inthe market.
This would require free and flexible market
Increase in inv Increased dd for money Increased Rate of int. Increased Savings equilib is restored
Compared to Keynesian macro theory of incomeand employment classical theory is more relevantto the conditions of prevailing in developingcountries
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Economic Theories
And the theory highlight those factors whichgovern income and employment in thesecountries
While Keynesian theory emphasizes the roleof effective dd in the determination of incomeand employment, classical economistsbelieved that in a free market eco there isalways tendency toward the establishment offull employment and sufficient dd for output
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Economic Theories
Classical theory of employment and output is based on thefollowing two basic notions:
Says Law, Wage Price Flexibility
Says Law: Jean Baptiste Say early nineteenth century
SupplyCreates its Own Demand Assumptions: (i) Any increase in goods and services
(supply) will lead to an increase in expenditure to buy thosegoods and services (dd) (ii) There will not be any shortageof dd full employment if there is any unemployment it
would simply be temporary Greater production leads to more income and which
creates market for goods and deficiency in dd is not aproblem
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Economic Theories
Income which is not spent on con goods will
be saved and will be reinvested. Thus inv
equals saving
Thus leakage caused by saving in income flow
is made up by the inv expenditure
J. M Keynes bitterly criticized the classical
theory of automatic full employment
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Economic Theories
Wage-Price Flexibility: The amount of productiondepends not only on agg dd or exp but also onprices of products.
Inequality in saving and investment may causedeficiency in agg expeven then over productionand unemployment would not arise
This is because they thought deficiency would be
made by changes in price level Due to increase in savings expenditure declines, it
will then affect the prices of the products
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Economic Theories
At lower prices all products will be sold and sothere is no overproduction andunemployment
Thus increased savings will bring down theprices of products and not the amount ofproduction and employment
Now a question arises to what extent thesellers of the product will tolerate the declinein prices
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Economic Theories
However to make their prices profitable they willhave to reduces the prices of factors such aslabourers
With fall in wages all workers will get
employment but if labourer do not work at lowerwages, this is voluntary unemployment accordingto classical economists
According to classical economists involuntary
unemployment is not possible in a free marketeconomy, all those who are willing to work at theexisting wage rate will get employment
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Economic Theories
During great depression of 1929-33 Pigou suggested cut inwage rates in order to remove huge widespreadunemployment prevailed at that time
Keynes criticized Pigous view in his General Theory -Supply may not create its entire dd
Income earned by different factors of production are equalto the value of the output produced this do not meanthat whole income will be spent on goods and services
If inv is not equal to desired savings then agg dd will not be
equal to agg supply, producers will unable to sell wholeoutput and so profit will be less, they will reduceproduction which will give rise to involuntaryunemployment
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Economic Theories
In a capitalist eco agg dd is the sum of con dd andinv dd. But in a free market capitalist eco personswho save is different from those who invest. Invdepends on marginal eff. Of capital
Keynes also explained that equality betweensavings and investment can not be brought aboutby changes in interest rate as savings depends onincome.
But classical economists ignored changes inincome due to their assumption of fullemployment
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Economic Theories
Quantity Theory of Money Neo- Classical theory: Agg Supply (AS) and Agg
dd (AD): The classicals have complete faith inmarkets they believed eco would always settle
automatically the full emp. Equilib. in the longrun
However there may be slightly different reactionin the short run as the eco adjusted to its new
long run equilib. This can be explained with AD and AS analysis
(diagram)
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Economic Theories
Neo-Classical Theory Policies: Classical view eco is self adjusting, there is no need to activelyintervene in the eco
Intervention may simply destabilizing andinflationary.
The key to long term growth is thusensure freemarkets with no imperfections (through supply
side policies) Control the growth of the money supply to
ensure low inflation
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Economic Theories
Supply Side Policies: Supply side policies canbe used to correct market imperfections. Iflevel of agg supply increases then Says law
predicts that dd will also increase This will only be non-inflationary way to get
increase in output (Diagram).
Money Supply Policies: Open marketoperation, Funding, Monetary Base Control,Interest Rate Control
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Economic Theories
Keynesians: Theories The Labor Market,Money Market, The Multiplier, KeynesianInflation Theory
The Labor Market Did not have same faith in
market as classical. Wages would be stickydownwards
Workers are not happy about wage cuts andwould resist, this would mean ages will not fall
enough to clear the market and unemploymentwould linger (Diagram)
Demand deficit unemployment
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Economic Theories
Keynesian Theory Introduction: Much of J.M.Keyneses works took place at the time of GreatDepression of 1930s
Assumptions: (i) Market did not automatically lead to
full employment equilibrium (ii) The Level of output(N.I.) would adjust between leakages and injections Imbalance between leakages and injections (increasein Govt. exp) extra agg dd more employment
more income leakages (tax, savings, and imports). Ifleakages and injectins are equal than equilib restored,this is Multiplier Effect.
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Economic Theories
Money market: Classical economists believedthat savings to be increased to invest more.Keynes argued that savings would mean
people to spend less This would mean a decrease in agg dd This
would make things worse and firms would beeven less inclined to invest as demand for
product decreasing
Inv depends on business expectation
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Economic Theories
The Multiplier:
Keynesian View of Inflation: Keynes rejectedquantity theory of money. Increase in money
supply will lead to inflation Increase in M may lead to decrease in V.
Alternatively increase in M may lead todecrease in T (transaction)
Keynes termed inflation is more likely to becost push.
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Economic Theories
Keynesian AS & AD: He argued that economy
would settle at any equilibrium level of
income at any time, it is duty of Govt. to use
appropriate policies to ensure that equilibriumis good one for economy
Reflationary policy to boost agg dd As agg dd
increases so does output and employ whichleads to inflation
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Economic Theories
Keynesian Policies: Demand management
Policiesadjusting the level of dd so that eco
arrives at full employment
If there is shortfall of dd (deflationary gap),
Govt. need to reflate the eco. If there is excess
dd Govt. need to deflate the eco
Demand for Money and Keynesian LiquidityTheory of Interest:
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Economic Theories Deflationary Policy: (Ref.)
Monetarists Theory- Introduction: Monetarismis very close to classical school of thought(Friedman 1960s,1970s)
StagflationStagnation and Inflation
Monetarists work revolve round role ofexpectation in determining inflation
Monetarists Belief: Re -evaluated QTM andargued increase in money supply would lead toinflationsubstantial empirical evidence
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Economic Theories
Expectation adjust so quickly that policychange will immediately be taken by people
No short term adjustment Rational
Expectation School Inflation is always andevery where a monetary phenomenon
Monetarists Theory:
QTM: Expectation Augmented Philips Curve
(Diagram)
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Economic Theories
Monetarists AS & AD: Short Run, Long Run(Diagram Ref.)
Monetarists Policies: Limited their view onInflation, policy is on inflation only
They believed if inflation is controlled stabilityand growth of the economy will be maintained.
The key policy is to control money supply tocontrol inflation and do not intervene to reduceunemployment
The only way to change natural rate is throughSupply Side policies
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Economic Theories
Supply Side policies: Non Inflationary
increase in capacity (supply) to reduce
unemployment(Diagram Ref.)
Money Supply Policies: (Ref.)
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Depreciation Accounting
Income is defined as the amount that can be
distributed during the period without impairing
the productive capacity of the firm.
The cash flows generated by an asset over its life,therefore, cannot be considered income until a
provision is made for its replacement.
These cash flows must be reduced by the amountrequired to replace the asset to determine the
earnings generated by that asset.
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Depreciation Accounting
This is underlying principle of economic
depreciation
The periodic depreciation expense, therefore,
segregates a portion of cash flows forreinvestment, preserving that sum from
distribution as dividends and taxes.
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Depreciation Accounting
Suppose an asset costs $240 and is expected
to generate net cash flows of $100 per year
over its three year life, Over the life of the
asset, income equals $60 ($300-$240) as $240is required to replace the asset
As financial statement report income annually,
it is necessary to determine how much income(how much depreciation) to report each year.
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Depreciation Accounting
This requires the allocation of a portion of the
multi-period return to each period.
Depreciation is an application of the matching
concept. It aims to match the cost of buyingthe asset to the revenue or other benefits
generated by its use
it as a measure of the use or wearing out ofthe asset over time
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Depreciation Accounting
It reduces the book value of the asset but notits market value
The reduction in the book value of an asset is
permanent, gradual and of continuing nature it is not possible to restore it to its original
cost
It is a continuing process because the value isreduced either with the use of the asset orwith a passage of time.
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Depreciation Accounting
It takes place gradually unless there is a quickphysical deterioration or obsolescence
It is not the process of valuation of asset; it is
process of allocation of cost of the asset
The term depreciation is used only for tangiblefixed assets. This term is not used in the case of
wasting and fictitious assets such as depletion ofnatural resources and amortization of goodwill,respectively
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Depreciation Accounting
Depreciation has several meanings in
literature. However, all different technical
meanings
However, all the different technical meaningsattached to the word depreciation are
basically variants of the following four
concepts
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Depreciation Accounting
Decrease in Value: The value of one asset is insomeway computed at two different dates, andthe value at the later date subtracted from thevalue at the earlier date is known as thedepreciation. This is the generally impliedmeaning of depreciation.
Amortized Cost: This is the accounting concept of
depreciation in which the cost of an asset whichis considered an operating expense isapportioned among the years of its useful life
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Depreciation Accounting
Impaired Serviceableness: With the passage oftime equipments and machines are often unableto hold as close tolerances as when they werenew. Similarly, owing to decay or corrosion, thestrength of structures maybe impaired
such impaired functional efficiency is also termedas depreciation
there may be several other common reasons for
Decrease in value besides impairedserviceableness
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Depreciation Accounting
This pattern, with the amount of depreciationincreasing every year, is known as annuity orsinking fund depreciation.
Straight Line Depreciation: Given the sameasset and the pattern of constant cash flowsshown in Table 3.1, the revenues (cash flowsof $100) generated by the asset are the same
each year, the income shows each year shouldalso be the same.
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Depreciation Accounting
The use of this method results in an increasing
rate of return rather than the actual rate of
return earned over the life of the asset
Formula for Straight Line DepreciationMethod: Depreciation in year i = 1/n (Original
CostSalvage) Where n = Depreciation Life
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Depreciation Accounting
Accelerated Depreciation Method: Thematching principle can also justify accelerateddepreciation patterns, with higher
depreciation charges in early years andsmaller amounts in later years.
Benefits (revenues) from an asset may behigher in early years, declining in later years as
efficiency falls (the asset wears out). Thedepreciation should decline with benefits.
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Depreciation Accounting
Even if revenues are constant over time, an
asset requires maintenance and repairs over
time, costs that tend to increase as the asset
ages. Accelerated depreciation methods
compensate for the rising trend of
maintenance and repair costs so that totalasset costs are level over the assets life.
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Depreciation Accounting
Both the efficiency and maintenance of anasset are difficult to forecast, and, in any caseaccelerated depreciation methods are (like
straight line) arbitrary procedures designed toyield the desired pattern of higherdepreciation amounts in earlier years
Accelerated methods have historically been
used for tax reporting, here they are justifiedby the desire to promote capital investment
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Depreciation Accounting
The two most common accelerated methods are theSum-of- Years Digits (SYD) method and the family ofdeclining- balance methods
Exhibit 1
Accelerated Depreciation Method- Sum-Of-YearsDigits
Original Cost = $18000
Salvage Value = $3000
Depreciation life, n = 5 Year Rate(Original Cash Salvage value) Depreciation
Expense (Ref. Table)
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Depreciation Accounting
For Sum-of-YearsDigits method Depreciation in Year i = (n-i+1)/SYD X (Original
CostSalvage Value) Where,
SYD=n(n+1)/2. for e.g. n=5 SYD=15.
Depreciation thus varies from year to year (as Ivaries) in reverse counting order of the years;
that is the pattern is 5/15, 4/15, 3/15, 2/15 and1/15 and is depicted as follows (Ref. Exhibit 2)
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Depreciation Accounting
Impact of Depreciation Methods on Financial
Statements: The choice of depreciation
method impacts both the income statement
and balance sheet; for capital-intensivecompanies, the impact can be significant. As
depreciation is an allocation of past cash flows
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Depreciation Accounting
Depreciable lives and salvage value impactboth depreciation expense and stated asset
values. Sorter lives and lower salvage values
are considered conservative in that they leadto higher depreciation expense
Conservative depreciation practices also
increase asset turnover ratio by decreasingthe denominator of that ratio
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Depreciation Accounting
Impact of Inflation on Depreciation: Historicalcost based depreciation expense may be used
to define income as long as the total expense
over the assets life is enough to replace theasset after it has been utilized.
If however the replacement cost of the asset
increases, than depreciation expense basedon the original cost will be insufficient.
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Depreciation Accounting
Accelerated depreciation methods partiallycompensate for this inflation effect byshortening the tax recovery period
Depreciating the asset over a shorter lifeserves similar purpose.
A number of studies have been examinedwhether accelerated method compensates fordepreciation and /or reflect economicdepreciation.
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Tariff: Different Types of Tariffs
Tariff ComponentsFixed Charges Variable Charges
Interest on Loan Cost of Fuel
Return on Equity Depreciation
O & M Expenses
Interest on W.C Cost of Secondary Fee
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Tariff: Different Types of Tariffs
1. Nominal Tariff:
Cost / Unit: Total Cos (Fixed + Variable Cost)/
Total No. of Units produced
2. Discounted Tariff:
N.T X Discounted Factor , discounted Factor =
(1/1 + discount Rate)
3. Levelised Tariff: (N.T X DF)/ DF
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iff iff f iff
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Tariff: Different Types of Tariffs
The regulatory bodies have the primaryresponsibility for efficient tariff setting,especially in ensuing that subsidies areallocated and administered optimally and indistancing the process of tariff setting frompolitical interference
Promotion of competition in the electricity
industry in India is one of the key objectives ofthe Electricity Act, 2003
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T iff Diff T f T iff
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Tariff: Different Types of Tariffs
Guidelines are aimed at facilitating competitionin this sector through wider participation in
providing transmission services and tariff
determination through a process of tariff basedbidding
Section 61 & 62 of the Act provide for tariff
regulation and determination of tariff of
generation, transmission, wheeling and retail sale
of electricity by the Appropriate Commission.
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T iff Diff T f T iff
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Tariff: Different Types of Tariffs
Protect consumer interests by facilitatingcompetitive conditions in procurement of
transmission services of electricity
Enhance standardization and reduce ambiguityand hence time for materialization of projects
Tariff Policy: New Tariff Policy of Central
Electricity Regulatory Commission (CERC) for2004-09 CERC has emphasized that all future
projects and new investment in generation
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T iff Diff t T f T iff
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Tariff: Different Types of Tariffs
transmission and distribution both by publicsector utilities as well as IPPs should be
structured through a tariff-based transparent
competitive bidding process. Detailed regulation based on the existing cost,
plus approach which leads to inefficiencies
and lack of initiative for better performance
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CERC will adopt a normative debt equity ratio of70:30 for all generation and transmissionprojects. The return on equity shall be 14 percent post tax, uniformly applicable to CPSUs and
IPPs Tariff Scenario: The other objective of re-
querying a transparent process is to internalizethe concern of the consumers who earlier used to
be at the periphery of the process. Towards thisend, most ERCs issued tariff consultation papersseeking the comments of stakeholders.
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ERCs have adopted a proactive and innovativestrategy by conducting the hearings at multiplelocations and by holding open-house sessions.This process has made informed decision-making
possible by giving access to data that was earliernot available.
The transparent process has for the first time led
to official recognition of the huge hiddeninefficiencies in the system by way of under-reported transmission and distribution losses
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The other aspect of the change is the attention paid toproductive and allocate efficiency in tariff setting.
While the ERCs chose to continue to use the broadprinciples enunciated in the Electricity (Supply) Act,
1948, which essentially is a cost plus kind of regulation,they allowed revenue requirements only to the extentconsidered reasonable.
As a result, the revenue requirements have been
pruned in the range of 5%15% in the recent tariffawards issued by some of the ERCs
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it would be more appropriate for the ERCs todetermine the broad level of efficiency gains
being desired while leaving the managers to
design strategies to realize them. The ERCs have also instituted measures to
allocate the revenue requirement in an
economically efficient manner by reducingthe extent of cross-subsidies
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The regulators thus have the challenging task ofcreating an environment conducive for rapidrestructuring and privatization. They would alsoneed to communicate to the government the
rationale of continuing the subsidies Distorted tariffs in India remain a concern,
causing as they do an unsustainably high cross-subsidy which does not cover the cost of service
provision. Indeed low tariffs rarely benefit Indiaspoor, most of whom lack access to power,particularly in the rural areas.
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The linkage of tariff to cost to service andelimination of cross subsidies is the important
feature of the Electricity Act, 2003.
The tariff should progressively reflect the costof supply and it also requires the appropriate
commission to reduce and eliminate cross
subsidy within time farme
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A good tariff design promotes the efficientconsumption.
There are five basic approaches to cost to servicecomputation namely
Embedded Cost of Service
Marginal Cost of Service
Average Cost of Supply
LMRC
PBR
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The embedded cost approaches, allocates thetotal revenue requirement to the various
categories of consumer based on the analysis
of the embedded or historic costs of theutility.
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Marginal Cost of Service: Marginal Costadopts future costs instead of historical costs
for determining the costs in supplying
electricity to various consumer categories Long Run Incremental Costs (LRIC), a marginal
cost approach reflects the cost of expending
the system efficiently to satisfy the loadforecast of very long time horizon
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The concept of the long run incremental costsis embedded in integrated resource planning
and generally over long term duration
Whether return to scale is present, LRIC wouldresult in insufficient revenue and requires
corresponding adjustments to bring it to
future average costs.
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Long Run Marginal Cost of Electricity: A classicdefinition of LRMC of generation is defined as
the levelized cost of meeting an increase in
demand over an extended period of time. It is calculated by determining the difference
in the NPV of two optimal generation
development (installation) programs over anextended period (say 30 years)
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Sunk costs are not included in the analysis. Thefirst generation installation is done under thecurrent load forecast and the second under a loadforecast that has a defined increment of load
added. The LRMC is the change in NPV of costs divided
by the change in NPV of load. This is a long runmarginal cost basis as it determines the marginalincrease in costs associated with meeting amarginal increase in demand with all factors ofproduction variable
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Performance Based Ratemaking: The PBRapproach, while recognizing the revenue
requirement of the utility, provides incentives
for improving efficiency and reducing costs. It weakens the link between the utilitys
regulated prices and costs by decreasing the
frequency of rate cases and/or by employingexternal measures of cost.
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The control aspects of regulation are thus soughtto be replaced with a system of incentives and
penalties through institution of industry wide
norms As a result, the PBR creates incentives, which are
similar to those that would exist in a competitive
market place. Such a system would reward
efficient management while inefficient ones
would sooner or later be thrown out
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In frequent tariff reviews also free thegovernment and the regulators to focus onother tasks including improving the quality ofsupply, enforcing tighter customer servicestandards, grievance handling and thesustainable development of the electricsupply industry
These are important tasks, which are vital forthe sustainable implementation of reforms
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In the current context these get neglectedsince the entire attention gets focused ontariff determination which is an annualexercise.
If tariff rationalization is to be delinked fromreform, restructuring and privatization,efficiency improvements and improvements in
the quality if service provided to consumersare necessary
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The reduction of regulatory risk is animportant precondition to privatization. Theadoption of PBR will assist in this process
PBR also provides advance signals whichefficient utilities can use to optimizeoperations
Hence both PBR and the Revenue Cap/Price
Cap approach are more conducive toefficiency enhancements than COS
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Determination of Generation Tariff As per theprovision of section 62 of the Electricity Act,
2003 the appropriate Commission is required
to determine the tariff for sale by thegenerating company to a distribution licensees
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In case of shortage of supply of electricity, fixthe maximum and minimum ceiling of tariff
for sale or purchase of electricity in pursuance
of an agreement, entered into between thegenerating company and the licensee or
between the licensees, for a period not
exceeding more than one year to ensure
reasonable prices of electricity
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Determination of Transmission Tariff (TT): As perthe clause (d) of Section 39 and clause (c) ofsection 40 of the Electricity Act 2003, theappropriate commission is required to determine
tariff for transmission of electricity for atransmission licensee
Two components of TT: (a) transmission chargesderived from the revenue requirements of thetransmission licensees and (b) transmissionlosses.
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Determination of Wheeling Charges Thedistribution company may use their
distribution system for wheeling of electricity
for other licensees or consumers or generatingcompanies or captive power plants
wheeling charges also need to compensate
the distribution company for (a) network costand (b) system losses
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Principle for distribution tariff includes that theappropriate commission should suitably definecontrollable and uncontrollable parameters thataffects the revenue requirement
Availability Based Tariff: ABT has been underdiscussion since 1994 when M/s ECC, an ADBconsultant, first supported it. GOI constituted aNational Task Force in February 1995. It had tenmeetings till end 1998
Jurisdiction was vested in the CERC
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The ABT order dated January 4, 2000 of theCommission departs significantly from the draftnotification as also from the prevailing tariffdesign
What is ABT? It is a performance-based tariff for the supply of
electricity by generators owned and controlled bythe central government
It is also a new system of scheduling anddespatch, which requires both generators andbeneficiaries to commit to day-ahead schedules.
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It is a system of rewards and penalties seekingto enforce day ahead pre-committed
schedules
The order emphasizes prompt payment ofdues. Non- payment of prescribed charges will
be liable for appropriate action under sections
44 and 45 of the ERC Act
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Need of ABT at State Level
There are a good number of reasons why ABT
must be implemented with in a state. The
reasons are listed below: No penalty for state generators/IPPs or
Discoms for deviating from the schedule
Installed capacity of Captive Power Plants(CPPs)are to be tapped.
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To enhance trading and bring grid disciplineamong open access customers
The responsibility of grid discipline should be
shared by SEBs also and not just by theregional electricity boards
Bottlenecks for Intrastate ABT
There is a different set of problems when itcomes to implement ABT at state level. Theseare discussed below
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Upgradation of Metering and Billing systems:There is a need to convert/add 0.5 class accuracymeters to 0.2 class meters at Discom- TranscoInterface. Instrument transformers are needed to
be replaced There is a need for reliable communication
means to connect substation, generating plants,open access customer interface point with SLDCHardware and software is required to consolidatedata and produce bill
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Demand Control: Possible means of DemandControl that can be used by SLDC are
Analyzing the average realization from a
substation area and compare it with systemmarginal price before load shedding Influence
demand by using proper tariff structure
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Demand Forecasting: The problems in this areaare: Discoms doesnt have advanced Demandforecasting tools, Nor does it have historical datato study demand patterns
UI Pass Through: At present the complete powerpurchase cost of Discom is being passed on toconsumer via retail tariff . Hence there is noincentive or penalty for Discom to comply withABT regime Regulator needs to decide themechanism for pass through to consumers
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A specific regulatory formula may need to bebuild by the state regulators to incorporate
this issue.
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Energy Technologies
Energy for the New Millennium: (CurrentPattern of energy production and consumption,Energy Technology and its importance, Primaryenergy consumption)
Energy has begun to play a more crucial role thanever in the development and well being of everynation.
Energy impacts way of living, livelihoods, growthand progress not only at a collective level but alsoat the individual, grass root level.
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Energy Technologies
At the same time, current patterns of energyproduction and consumption also contribute
to environmental degradation at the local,
regional and global levels. Strategies and interventions are needed that
promote energy as an engine for equitable
economic growth and sustainabledevelopment.
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Energy Technologies
These challenges presents an opportunity tofind ways of producing and using energy thatare economically, socially and environmentallysustainable and of using this important tool asa means to achieve sustainable development
Today, the transportation, manufacturing,commercial, social, cultural and even the
agricultural sectors consume energy at a largeand ever growing rate
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Energy Technologies
The twenty first century is the most criticalphase in human history, i.e., the serious
challenge of ensuring reliable and adequate
supply of energy at an ever growing rate, in ascenario of vastly depleting sources of fossil
fuels, a severely polluted environment and
almost totally degraded ecology.
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Energy Technologies
Overview of Energy Technology and itsImportance: There is a resurgent interest in
the renewable energy forms and the role that
this particular form of energy can play, giventhe different considerations relating to energy
access, energy security and environmental
security that are emerging.
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Energy Technologies
Global Energy Scenario: Global energy demand isprimarily determined by three factors: Economicdevelopment, Population growth andTechnological progress.
However, environmental considerations maychange the rate of growth and pattern of energyuse. Also, in mature economies, there is adelinking between economic growth and energyuse as evidenced by energy-GDP elasticities ofless than unity
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Energy Technologies
An analysis of primary energy shares from1850-1990 reveal a transition away from
traditional renewable energy forms to fossil
fuels. The initial increase in the share of coal till
World War I, followed by emergence of oil,
and natural gas; a peaking in the share of oil inthe 1970s
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Energy Technologies
The current global primary energy consumption is 9.7Gtoe, with developed countries of North America andEurope consuming a little over half this energy.
The consumption in North America has grown at about
1.5% per annum during1990-2003, which is similar tothe world average of 1.6% per annum.
In contrast, the primary energy consumption in theAsia-Pacific region grew at about 3.9% per annum,
indicating the need for energy in this fast growingregion of the world
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Energy Technologies
Oil consumption has a predominant share of 37%in total primary energy consumed globally,
followed by coal with 26% and natural gas with a
share of 24%.
In the Asia Pacific region too, oil plays a major
role.
However, the penetration of natural gas is not as
high as the world average. In this region, coal
continues to be consumed in large quantities
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Energy Technologies
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p
Kyoto Mechanism, CDM and its Characteristics,Small Scale Project Categorization
Section 86(1)(e) of Electricity Act 2003 (the Act)
mandates the Commission to promotecogeneration and generation of electricity from
renewable sources of energy by providing
suitable measures for connectivity with the grid
and sale of electricity to any person
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p
The United Nations Framework Convention onClimate Change (UNFCCC) is the centerpiece of
the global efforts to combat global warming.
It was adopted in June 1992 at the Rio EarthSummit, and its primary objective is the
stabilizationof greenhouse gas concentration in
the atmosphere at a level that would prevent
man- made interference with the climatesystem.
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This was further strengthened at Kyoto in 1997,wherein the nations of the World agreed thatindustrialized countries would reduce aggregateemissions by 5.2% below 1990 level by 2008-
2012 The Kyoto Mechanisms: The Protocol broke new
ground by introducing three innovative marketbased mechanisms: Joint Implementation (JI), theClean Development Mechanism (CDM) andEmissions Trading (ET)
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Of the three flexible mechanisms under the aegis ofthe Kyoto Protocol, the Clean Development Mechanismis the only one involving developing countries
CDM aims to direct private sector investment from
industrialized countries (the Annex- I countriesof theProtocol) with emission reduction commitments toprocure Certified Emission Reduction (CERs) from ecofriendly, development oriented Projects and activities,which reduce GHG emissions, also known as the CDMProjects
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Clean Development Mechanism: CDM is aninvestment proposition by whichindustrialized countries would invest in a GHGmitigation project in a developing country
The organization in the industrialized countrywould get credit towards their emissionreduction targets, while the Project proponent
in the developing country would receive newcapital flows and clean technology
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The CDM has two primary goals: To assistAnnex I countries in reaching their emission
reduction targets.
To promote sustainable developmentobjectives in the host countries (non-Annex I
countries)
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The first goal allows developed countries toachieve their reduction obligations through
projects in developing countries that reduce
emissions through clean energy, energy efficiency
and renewable energy projects
The Main Characteristics of CDM: Participation in
a CDM project activity is voluntary and CDM
investments will be market driven. Public andprivate parties are eligible to participate.
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The Indian Government has formed theDesignated National Authority (DNA), toendorse CDM Projects, which meet thesustainability criteria set by the Indian
Government.
The Executive Board (EB) of UNFCCC has alsoaccredited several agencies to function as
Designated Operational Entity (DOE) forproject validation and verification
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Why CDM in India The commitments given bythe governments of Annex-I countries aretranslated to corporate commitments toreduce GHG emissions in their operations
Opportunities for GHG emission reduction inAnnex I countries are few and the cost ofdoing so is also high as compared to the GHG
emission opportunities in a developingcountry
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As a result, many corporate from thedeveloped countries are forming strategic
alliances with corporate in the developing
countries to meet their emission reductioncommitments.
They finance a potential CDM project and
against that take the credit of GHG emissionreduction
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There are many such projects in India that willcontribute to GHG emission reduction at lowcost and the corporate from Annex I countriesare entering into agreement with Indian
companies to invest in CDM Projects and buycarbon credits
For Indian Industries, this improves the
Internal Rate of Return (IRR) of their Projectsand further improves their bottom line
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TYPE (iii): Other project activities that reduceanthropogenic emissions by sources, and directly
emit less than15/ktCO2 e annually
Glossary of Terms Related to Clean DevelopmentMechanism: According to the Kyoto Protocol, gas
emission reductions generated by Clean
Development Mechanism and Joint
Implementation project activities must beadditional to those that otherwise would occur
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Annex I Countries: These are the 36industrialized countries and economies in
transition listed in Annex 1 of the UNFCCC.
Their responsibilities under the convention arevarious, and include a non-binding
commitment to reducing their GHG emissions
to 1990 levels by the year 2000
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Annex B Countries: These are the 39emissions-capped industrialized countries and
economies in transition listed in Annex B of
Kyoto Protocol 8% decrease (e.g. EU) to a 10% increase
(Iceland) on 1990 levels by the first
commitment period of the Protocol, 2008-2012
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Base Line: A baseline should cover emissionsfrom all gases, sectors and source categories
listed in Annex A (of the Kyoto Protocol) within
the project boundary Baseline Methodology: A methodology is a
tool to determine the baseline for an
individual project activity, reflecting aspectssuch as data availability, sector and region
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Building: Bundling: Refers to combining oraggregating a number (more than one) of small-scale projects and/or project activities into asingle emissions reduction project. Small- scale
CDM project activities may be bundled at thefollowing stages in the project cycle
Carbon Offsets: Offsets are tradable emissionreductions that are used to offset emissions from
various sources, such as emissions related topersonal or business air travel
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Carbon Dioxide Equivalent (CO2 e): Theuniversal unit of measurement used to
indicate the Global Warming Potential (GWP)
of each of the six greenhouse gases listed inAnnex A of the Kyoto Protocol carbon
dioxide (CO2 ), methane (CH4 ), nitrous oxide
(N2 O), hydro fluorocarbons (HFCs), per
fluorocarbons (PFCs), and sulphur
hexafluoride (SF6 )
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CERs (Certified Emission Reductions): Thetechnical term for the output of CDM projects, asdefined by the Kyoto Protocol. One CER is thereduction of 1 tonne of carbon dioxideequivalent.
Certification: Certification is the writtenassurance by the designated operational entitythat, during a specified time period, a projectactivity achieved the reductions in anthropogenic
emissions by sources of Greenhouse Gases (GHG)as verified
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Clean Development Mechanism (CDM): TheCDM was established by Article 12 of theProtocol and refers to climate changemitigation projects undertaken between
Annex 1 countries and non-Annex 1 countries Project investments must contribute to the
sustainable development of the non-Annex 1
host country, and must be independentlycertified
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Project participants are able to choose thestarting date of a crediting period to be after thedate the first emission reductions are generatedby the CDM project activity
A crediting period cant extend beyond theoperational lifetime of the project activity
The project participants may choose betweeneither a fixed crediting period of 10yrs or threerenewable crediting periods of a maximum 7years each (i.e. maximum 21 years)
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Debundling Test: Debundling is defined as the fragmentation of a large project into smaller parts
Designated Operational Entity (DOE): An entitydesignated by the COP (or MOP), based on
recommendation by the Executive Board, as qualifiedto validate proposed CDM project activities as well asverify and certify reductions in anthropogenicemissions by sources of Greenhouse Gases (GHG)
A designated operational entity shall performvalidation or verification and certification on the sameCDM project activity
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The six gases listed in Annex A of the KyotoProtocol are carbon dioxide (CO2 ), methane(CH4 ), and nitrous oxide (N2 O), as well ashydro fluorocarbons (HFCs), per fluorocarbons
(PFCs), and sulphur hexafluoride (SF6 ) Host Country: The country where an emission
reduction project (under Joint Implementation
or the Clean Development Mechanism) isphysically located.
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Kyoto Protocol: Adopted at the ThirdConference of the Parties to the United
Nations Convention on Climate Change held in
Kyoto, Japan in December 1997, the KyotoProtocol commits industrialized country
gratifiers to reduce their greenhouse gas (or
carbon) emissions by an average of 5.2%
compared with 1990 emissions, in the period
2008-2012.
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Leakage: Leakage is defined as the net change ofanthropogenic emissions by sources ofGreenhouse Gases (GHG) which occurs outsidethe project boundary, and which is measurable
and attributable to the CDM project activity. Letter of Approval: A letter issued by the
Designated National Authority (DNA) of the HostCountry to a CDM Project confirming that the
project, as proposed, will assist the Host Countryto achieve its goals of sustainable development.
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Non-Annex I Countries: Countries which arenot listed in Annex I of the UNFCCC (generallydeveloping and least developed countries)
Non-Annex B Countries: Countries which arenot listed in Annex I of the Kyoto Protocol(generally developing and least developedcountries)
Party to the Kyoto Protocol: A country thathas ratified the Kyoto Protocol.
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Project Activity: A project activity is ameasure, operation or an action that aims atreducing Greenhouse Gases (GHG) emission
Project Boundary: The project boundaryencompasses all anthropogenic emissions bysources of Greenhouse Gases (GHG) under thecontrol of the project participants that are
significant and reasonably attributable to theCDM project activity
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Project Design Document (PDD): A projectspecific document required under the CDM
rules which will enable the Operational Entity
to determine whether the project (i) has beenapproved by the parties involved in a project,
(ii) would result in reductions of greenhouse
gas emissions that are additional, (iii) has an
appropriate baseline and monitoring plan.
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Project Idea Note (PIN): A note prepared by aproject proponent regarding a project proposedfor a potential CER buyer, such as the World Bankor SENTER
Registration: Registration is the formalacceptance by the Executive Board of a validatedproject activity as a CDM project activity.Registration is the prerequisite for the
verification, certification and issuance of CERsrelated to that project activity
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Sustainable Development: The original definitionby the Brundtland Commission report (WCED,198) states that development is sustainable whenit meets the needs of the present generation
without compromising the ability of futuregenerations to meet their own needs.
Sustainable development is a requirement ofCDM projects and it is the responsibility of the
host country to confirm whether a CDM projectactivity
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Verification Report: A report prepared by anOperational Entity, or by another independent
third party, pursuant to a Verification, which
reports the findings of the Verificationprocess, including the amount of reductions in
emission of greenhouse gases that have been
found to have been generated.
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Role of central agencies, Role of FIPB,Subsidies: The growth of the economy, calls
for a matching rate of growth in infrastructure
facilities. The growth rate of demand forpower in developing countries is generally
higher than that of Gross Domestic Product
(GDP). In India the Power Sector, hitherto, had
been funded mainly through budgetary
support and external borrowings.
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Due to growing demands from other sectors,particularly social sector and the severe
borrowing constraints, a new financing
strategy This is reflected in the new policy enunciated
in 1991, allowing private enterprise, a larger
role in the power sector
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State Electricity Boards (SEBs) in India are besetwith problems of high Transmission and
Distribution (T and D) losses, large out standings
to central sector companies, inadequate
investments, and irrational tariff structures
These problems have resulted in power shortages
and poor-quality power supply to customers, and
to the eroding of the financial viability of the SEBs
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The setting up of an independent, autonomous,and accountable regulatory structure at thecentral and state levels was, therefore, becomingextremely essential to address the above issues
Rationalize the Tariff Structure by setting upindependent regulatory bodies
Ensure transparency in generation, transmissionand distribution by unbundling and corporatizingthe SEBs
Provide financial and operational autonomy.
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In order to get a overview the following pointsaid in learning the Regulatory framework of
the India Power Sector:
Common Minimum National Action Plan forPower: The Chief Ministers met on 16th
October and 3rd December, 1996 to discuss
and deliberate upon the issues pertaining to
the power sector
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Recognized that the gap between demand andsupply of power is widening Acknowledged
that the financial position of State Electricity
Boards is fast deteriorating Power sector cant be sustained without
improvement of operational performance of
State Electricity Boards
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Agreed that reforms and restructuring of StateElectricity Boards are urgent and must be carriedout in a definite time frame
Identified creation of Regulatory Commissions asa step in this direction
Requirements of the future expansion andimprovement of power sector cannot be fullyachieved through public resources alone and it isessential to encourage private sectorparticipation in generation, transmission anddistribution
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A national consensus evolved for improvingthe performance of the power sector in a timebound manner and the following was adopted
National Energy Policy: The Governmentwould soon finalize a National Energy Policy
State Electricity Regulatory Commission: EachState/Union Territory shall set up an
independent State Electricity RegulatoryCommission (SERC)
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To set up SERCs, Central Government will amendIndian Electricity Act, 1910 and Electricity (Supply) Act,1948
To start with such SERCs will undertake only tarifffixation
Licensing, planning and other related functions couldalso be delegated to SERCs as and when each StateGovernment notifies it
Appeals against orders of SERCs will be to respectiveHigh Courts unless any State Government specificallyprefers such appeals being made to the CentralElectricity Regulatory Commission
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Central Electricity Regulatory Commission: Union Government will set up a Central Electricity
Regulatory Commission (CERC) CERC will set thebulk tariffs for all Central generating andtransmission utilities
Licensing, planning and other related functionscould also be delegated to CERC as and when theCentral Government notifies it
All issues concerning inter-State flow andexchange of power shall also be decided by theCERC
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Rationalization of Retail Tariffs: Determination ofretail tariffs, including wheeling charges etc., willbe decided by SERCs which will ensure aminimum overall 3% rate of return to each utility
with immediate effect. SERCs are mandatory
If any deviations from tariffs recommended by itare made by a State/UT Government, it will haveto provide for the financial implications of suchdeviations explicitly in the State budget
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Private Sector Participation in Distribution: StateGovernments agree to a gradual programme of privatesector participation in distribution of electricity
Role of Central Agencies: The Central Governmentwould make a comprehensive review of the role ofCentral Electricity Authority (CEA). Techno- economicapproval of competitively bid power projects will besimplified and CEA shall not be concerned with capitalcost, tariff and other commercial aspects of the
project. Powers regarding approval of projects
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State Governments will have powers to accordapproval for power projects
The role of FIPB will be minimized by putting
as many projects on the automatic clearanceroute as feasible
Ministry of Environment & Forests have,
proposed the following delegation to theStates for environment clearance
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All cogeneration plants and captive powerplants up to 250 MW
Coal based plants up to 500 MW using
fluidized bed technology subject to sensitiveareas restrictions
Power stations up to 250 MW on conventional
technology Gas/Naphtha based station up to 500 MW
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Autonomy to the State Electricity Boards: Stateswill allow maximum possible autonomy to the
State Electricity Boards. The State Electricity
Boards will be restructured and corporatized and
run on commercial basis
Improvements in the Management Practices of
State Electricity Boards: State Electricity Boards
will professionalize their technical inventorymanpower and project management practices
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Cogeneration/Captive Power Plants: StateGovernments will encourage co-generation/captive power plants
Advance Action and High Priority for HydroProjects: A national policy on hydro powerdevelopment will be evolved by the CentralGovernment which, inter-alia, would includedevelopment of mega hydro projects, both in thepublic sector and the private sector, at locations
with substantial hydro potential, along withconcomitant
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Electricity tariffs for farmers in India amountto less than 10 percent of the cost of supply
That means a power subsidy for theagricultural sector of an estimated US$6
billion a yearequivalent to about 25 percentof Indiasfiscal deficit, twice the annual publicspending on health or rural development, and
two and a half times the yearly expenditureon irrigation
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At the same time, the quality of supply tofarmers has worsened over the years
Operational inefficiencies and high
distribution losses due to pilferage havecontributed to the financial insolvency of
power utilities across India
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A study covering two statesAndhra Pradeshand Haryanaassessed the impact of cutting
subsidies as part of broad reforms of
governance and regulation aimed at reducing
losses, controlling theft, strengthening
metering and collection, and moving to
independent tariff setting, competition, and
privatization
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The Costs of Unreliable Quality and SupplyAlthough farmers pay a small fraction of the
cost of power, they endure the frustration and
economic costs of supply that is both
unreliable (not available at predictable times)
and of poor quality (with fluctuating voltage)
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Both problems mean that water often cannotbe pumped during critical periods in the plant
growth cycle, leading to lower crop yields and
incomes for farmers Electricity is available to agriculture mostly
during off-peak hourssometimes for as little
as three and a half hours a day
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The Costs of Theft The electricity subsidiestake the form of a flat rate paid by farmers per
unit of horsepower per pump; farmersactual
power use is not metered or recorded. These
flat-rate subsidies help to camouflage theft
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The Costs of Poor Targeting Large farmers aremore vocal in arguing for retaining thesubsidized flat rate because it represents amanageable share of their gross income
Moreover, paying a flat tariff for every pumpenables them to irrigate a large area at a lowper unit cost. But for small farmers who can
afford electricity for irrigation, the cost perhectare is significantly higher
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Reality Check on Reform To gain a betterunderstanding of the potential impact onfarmers of different reform packages, thestudy simulated several policy reform
scenarios Business as usualwith tariff increases but
deteriorating quality Gradual reformwith
steeper tariff increases and someimprovement in quality
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Accelerated reformwith the same tariffincreases but more aggressive improvements
in quality
Implications: Small and marginal farmers inHaryana have shown a high willingness to pay
for improved reliability of power supply
because the poor quality of supply has
affected them so severely
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By contrast, medium-size and large farmers(about 60 percent of those owning electric
pumps) are less willing to pay in the short run
because of their expensive backup
arrangements, which reduce their
vulnerability to supply fluctuations. So it is the
smaller and poorer farmers who end up