THE HARYANA STATE ELECTRICITY BOARD TARIFF AWARD A CRITICAL REVIEW

Transcription

1 INFRASTRUCTURAL DEVELOPMENT AND FINANCING PROJECT REPORT A Report On THE HARYANA STATE ELECTRICITY BOARD TARIFF AWARD A CRITICAL REVIEW Submitted to Prof. G. Raghuram Prof. Rekha Jain Professor Sebastian Morris In Partial Fulfilment of the Requirements of the Course By Amol Manjrekar Dr. Kiran S. Rao Mohit Taneja Naveen. V Pankaj Duhan Section B Group 4 On 24 th August, 2001 Indian Institute Of Management Ahmedabad

2 TABLE OF CONTENTS S. No Topic Page Number 1 INTRODUCTION Background 1.2 HERC 1.3 Tariffs 2 TARIFF APPLICATION OF HVPNL Proposed Transmission And Bulk Supply Tariff Application 2.2 Proposed Retail Tariff Application for Distribution and Retail Supply Business 2.3 Proposed Retail Tariff Rates 3 A CRITIQUE OF THE HERC TARIFF AWARD Criteria for Setting Tariffs 3.2 Tariff Application for Distribution & Retail Supply 3.3 A Review of HVPNL Tariff Proposals 3.4 Transmission & Bulk Supply Tariff 3.5 Critical Analysis of T&BS Tariffs 4 COMPARISON OF TARIFF AWARD BY MERC WITH HERC 36 AWARD 5 COMPARISON OF TARIFF AWARDS OF HERC AND 45 APERC 6 DELINEATION AND EVALUATION OF THE GERC TARIFF 52 AWARDS 7 CONCLUSIONS 66

3 1. INTRODUCTION 1.1 Background Haryana Electricity Reform Act (HERA) Haryana is the second State in India to initiate the process of Reform & Restructuring of the Power sector in India. The Haryana Electricity Reform Act (HERA)-1997 was passed by the Haryana State Legislative Assembly on July 22, According to HERA, the erstwhile Haryana State Electricity Board was unbundled into two corporate bodies namely Haryana Power Generation Company (HPGC) for the Generation of Power and Haryana Vidyut Prasaran Nigam (HVPN) for the Transmission & Distribution of power within the state of Haryana Power Situation in Haryana Draw backs of power sector as perceived by the public of Haryana: High Power Losses 33% T&D Losses in (as shown in Table-1) Supply Interruptions Frequent power blackouts and interruptions in power supply, affecting industrial output Voltage Fluctuation Frequency Problems HSEB had not been determining revenue requirements and fixing tariffs based on realistic and economic costs of electricity. Historically, the tariffs in electricity industry in Haryana were set with reference to tariff levels prevailing in the neighboring states and in accordance with ability to pay principle. Also, these principles were, in general, at variance with economic principles of tariff settings Tariffs distorted by grant of subsidies and cross-subsidies at the expense of efficiency and cost recovery The efficiency of tariffs and financial viability of the licensees is required to deal with these issues The statistics of the Haryana SEB are shown in Table 1, which indicate that: HPGC has made no meaningful capacity addition over the last five years. The state relies for about three-fourths of its energy availability on outside purchases This reliance on outside purchases has led to a relatively high average cost (Rs 2.89 per unit). The average revenue, however, is much lower. This is a result of a very high share of consumption of the agriculture sector (45 per cent). The rate of return, despite subsidies, was negative 8.9 per cent. Without the subsidies, it was negative 22.1 per cent. Amol,Kiran,Mohit,Naveen,Pankaj 1 Section-B, Group-4

4 According to the Ministry of Power, the state, which hardly had any peaking shortages in , experienced shortages of 8.3 per cent in Table-1: HSEB - Key Statistics Total Capacity (MW) as on March 31, Total Generation (Million Units) during ,397 Total Purchase (Million Units) during ,370 Average PLF (%) 49.2 T&D Losses (%) 33.1 Total Revenue (Rs Million) 18,532 Profit Loss with Subsidy (Rs Million) -2,450 Profit Loss without Subsidy (Rs Million) -6,090 Number of Employees 43, Haryana Electricity Regulatory Commission (HERC) The Haryana Electricity Regulatory Commission was set up on The Commission is a three-member body with specialised supporting staff, designated to function as an autonomous authority responsible for regulation of the power sector in the state Need for HERC The HERA envisaged the need for a regulatory body to be set up to initiate the process of power reforms for the following reasons: 1. Removal of Inefficiency: The State owned industry in the past have often been utilised for achieving social and political ends such as creating avenues for employment and giving subsidy to certain categories of consumers unmindful of the detrimental effects on the industry viz. draw down on resources for sustenance and expansion, lack of accountability in performance, poor quality of service and eventual financial sickness of the industry. 2. Regulatory Autonomy: The new regulatory regime is designed to be different from the command and control exercised by the government and envisages that the Government of Haryana would Amol,Kiran,Mohit,Naveen,Pankaj 2 Section-B, Group-4

5 withdraw from the power sector giving way to privately managed utilities operating in a competitive and appropriately regulated environment of power sector. This would facilitate insulation of the electricity industry from short term and shortsighted political decisions and rigid bureaucratic controls and ensure that the industry operates on commercial lines. 3. Parity among Stakeholders: The new regulatory regime, designed on the pattern prevalent in the USA and UK, is expected to set in position rules and procedures with due public participation by which the Commission can balance and protect the interests of all the stake holders, who participate in this sector and those who are served by it Functions of HERC The functions of the HERC can be summarized as follows: Aid and advise, in matters concerning electricity generation, transmission, and distribution of electricity supply in the State Issue licenses in accordance with the provisions of the Reform Act and determine the conditions to be included in the licenses Regulate the working of licensees and to promote their working in an efficient, economical and equitable manner Regulate the procurement, distribution, supply and utilization of electricity, the quality of service, the tariff and charges payable keeping in view both the interest of the consumer as well as of the licensee Promote competitiveness and progressively involve the participation of the private sector, while ensuring a fair deal to the customers Require licensees to formulate perspective plans and schemes in coordination with other stakeholders for the promotion of generation, transmission, distribution and supply of electricity Set appropriate code of conduct and standards for the electricity industry in the State 1.3 Tariffs The objectives of designing an appropriate tariff structure are sustainability, efficiency and equity. The responsibility of the Haryana Electricity Regulatory Commission (HERC) is to ensure that the regulated utilities are able to finance its operations, and any required investment, so that it can continue to operate in the future. Consequently, the stakeholders should be able to earn at least the interest and cost of capital. However, it has to be ensured that no group of consumers are burdened with a Amol,Kiran,Mohit,Naveen,Pankaj 3 Section-B, Group-4

6 disproportionately large part of payments to the utility, relative to the costs they impose upon it. Tariff design should also take care of productive efficiency i.e. optimisation of resource mix to produce or make available goods or services of a given quality at the least possible cost. The issues that HERC need to consider while awarding tariffs are: Technical & Non-Technical Losses HERC considers the existing losses (33%) to be significantly higher than the loss that should occur in a well performing transmission and distribution system. Transmission loss has two components - Inter-state transmission losses (incurred in wheeling power from out of state generating sources to the Transmission and Bulk Supply licensee in Haryana) and intra state transmission losses (losses taking place within the state). As an interim measure, the Commission allowed an intra-state transmission loss of 5% of the net power available for use in state. HERC has also recognized a distribution a loss level of 35.77%. It is of the firm view that such a high level of distribution losses is unsustainable and puts unnecessary avoidable burden on the consumers because of inefficiency of the licensee Power Metering A large number of consumers at the low voltage level have defective meters or none at all. The bills are prepared for non-metered consumption based on estimates of consumption using parameters such as horse power rating of the hydraulic pumps, load factor or connected load. These do not reflect the actual consumption of un-metered consumers due to aberrations such as consumers replacing pumps with higher rating; others frequently exceed the connected load or load factor used for calculating bills. HERC has directed that HVPNL should complete the installation of interface metering by June Subsidies & Cross Subsidies The prevailing levels of electricity tariff in Haryana contain a large degree of cross subsidy, with some categories of consumers paying well above the economic cost of supply. It has to be recognised that low and subsidised tariff initiate inefficient high demand for power, which puts pressure on the system capacity and the quality of service. An idea of consumer category wise subsidy involved can be had from the following table (See Table 2): Table 2: Extent of Subsidy in HVPNL Tariffs Percentage of Cost of service paid (HERC Order dated ) Category At the existing tariffs At the new tariffs Amol,Kiran,Mohit,Naveen,Pankaj 4 Section-B, Group-4

7 Domestic Consumers 61% 69% Non-Domestic 91% 98% Agriculture (Metered) 10.5% 13.5% Agriculture (UnMetered) 12.7% 19.2% The paradox often faced is that while efficiency criterion calls for a cost based tariff, the social criteria may at times call for relief to certain consumers e.g. low-income group. However, subsidised tariff should not distort the general tariff structure by imposing burden on another set of consumers. Consequently, subsidised tariff should be financed from government's general budget, because raising funds through a general tax system imposes lower cost on the society than creating a sector specific levies. The Commission is addressing the above issues to improve the financial health of the sector as well as promote efficiency, and economy in the use of resources. The two tasks before the Commission in this respect are: Determine a plan for elimination of cross subsidy in electricity tariff in Haryana. Quantify cross subsidies and the short fall in revenue caused by charging subsidised tariff. HERC would like to study steps to initiate elimination of cross-subsidies in view of the long term effect of the system remaining economically viable and efficient. The social and political objectives for cross subsidies needs to be addressed. The options available to deal with the task number one is same as mentioned in the earlier issue. The second task calls for a through examination by the Commission because of its financial impact on the licensee and the transfer from the state government. The licensees are required to quantify cross subsidies and revenue shortfall caused by the subsidised tariff. The quantification of cross subsidies may be done by comparing the prevailing tariffs with the economic costs of the licensee. Similarly, revenue shortfall caused by subsidised tariff may be estimated by comparing the prevailing tariffs with the cost based ones. While the prevailing tariffs are known, the cost and cost based tariff must be determined by using one of the following: Embedded cost. Marginal cost. Marginal cost plus efficient share of revenue gap. General Method of Price Regulation The Commission shall decide the regulatory framework it will use to regulate the price of Haryana licensees in conformity with the Act [(Section 26(6)], which require that tariff " shall be just and Amol,Kiran,Mohit,Naveen,Pankaj 5 Section-B, Group-4

8 reasonable and be such as to promote economic efficiency in the supply and consumption of electricity". While section 26 (2) (a) of the Act sets section 57 and 57A of the Electricity (Supply) Act, 1948 and its sixth schedule as the baseline for Haryana tariff regulation, the act also allows the Commission to depart from the baseline on valid reasons in determining the licensees revenues and tariff [Section 26(3)]. The Commission has a few options in regulating electricity prices of the licensees: 1. Rate of Return Regulation 2. RPI X Regulation 3. Profit Sharing Regulation 4. Revenue Cap 5. Others include price caps, hybrid mixed -controls and trigger points 1. The Rate of Return is the traditional form of regulation that remained dominant regulatory tool for many years. In this approach at short intervals a company s historic costs are reviewed. The price is set to allow profits that delivers the required rate of return if not so i.e. prices move out of line with the company s cost, the company could ask for new set of prices. This is considered to be relatively risk free, as it allows the company to be financed at a lower required rate of return than under any other approaches. However, in this form the regulation becomes intrusive as costs are assessed on their prudence and investments are assessed as to their used and useful status, further, the company has no reason to seek efficiency savings. 2. The idea behind RPI X (retail price index or consumer price index in the Indian context) is to formalise regulatory lags, so that the companies get some incentive to operate efficiently in the interval between reviews. The company is required to keep the weighted increase in a basket of its price to less than the increase in a specified price index i.e. consumer price index, less X percent, so that the price decline by X percent in a year in real terms. In this form of regulation, X is set to pass the expected growth in productivity back to consumer. However, if the company did not expect the price control to be changed in the future, its price would be independent of its action and it would have enough incentive to reduce its cost. On the flip side most price control last for a few year, so any reduction in cost cannot be passed through in the price control for sometime, thereby allowing company to receive a higher profit in the interim. Then once price is reset, they may not fall to level of firm s cost immediately, hence firms are adequately rewarded for their cost reduction. This kind of price control regime provides the option of setting price based on the cost of an efficient firm as against firm s actual cost under rate of return regulation. Amol,Kiran,Mohit,Naveen,Pankaj 6 Section-B, Group-4

9 3. In the Profit sharing kind of regulation, within a band say A to B, the company keeps what it earns, below A, the company is allowed to achieve a greater return and above B, the company is forced to share some of the profit. However, determining the size of the band, degree of sharing and source of sharing becomes contentious issues (should the excess fund be placed in an account that can then be drawn in bad years or customers immediately pay or receive the amount). 4. Revenue cap method of regulation attempts to establish a fixed revenue profile for the life of the price control instead of setting a price path for the next 3 to 5 years. This removes any incentive to under forecast demand and limits the upside potential to the company to those cost aspects that are actually under the control of the company. However, it requires a correction factor in the formula so that any over recovery of revenue can be corrected within the life of the price control. The Commission is examining all the established methods of regulation in the light of the unique situation prevailing in the electricity sector in the state of Haryana to arrive at an appropriate methodology. Amol,Kiran,Mohit,Naveen,Pankaj 7 Section-B, Group-4

10 2. TARIFF APPLICATION OF HVPNL 2.1 Proposed Electricity Transmission And Bulk Supply Tariff Application The Commission determined the existing Bulk Supply Tariff (BST) in its Joint ARR and Tariff Order dated December 14, 2000, as provided in the following table. Table 3: Proposed Tariffs Tariff Bulk Supply Transmission Wheeling Consolidated Fixed Charge Variable Charge (Rs./unit) In addition, the Commission has authorised HVPNL to apply Fuel Surcharge Adjustment (FSA) to these tariffs in accordance with the FSA formula notified by the Commission in its Tariff Regulations. The design of the BST was significantly constrained due to the lack of adequate implementation capability of interface meters to measure the simultaneous maximum demand of the system. Accordingly, for such time till an improved basis becomes available for implementing the two-part tariff the Commission has used an easily available proxy for levying the fixed charge, i.e., the connected load. As directed by the Commission in its Joint ARR and Tariff order, HVPN expects to complete its interface metering by July 31, These meters once installed would have the capability of recording demand on a 15-minute basis. Accordingly, on the installation of these meters, it would become possible for HVPNL to levy and implement a two-part BST to its two customers, viz., the two distribution zones/companies - UHBVNL/North Zone and DHBVNL/South Zone on the basis of their contribution to system peak. HVPNL recognizes that it should replace the existing connected load based charge with a charge calculated based on system peak demand at the earliest. Accordingly, HVPNL is proposing a phased approach for designing the BST for the financial year , as follows: Calculate the proposed tariffs for the full year with a two part tariff structure a demand charge based on the simultaneous maximum demand of Discoms and a variable charge, which shall be effective for the full financial year Amol,Kiran,Mohit,Naveen,Pankaj 8 Section-B, Group-4

11 The interface meters shall be in place only after July 31, 2001, change in tariff has been proposed from 1 st August Thus, a part year revised two-part BST is being proposed for the remaining eight months of the financial year , i.e., with effect from August 1, 2001 till March 31, HVPNL proposes a part year tariff for FY wherein a fixed charge is based on the averaged forecasted system peak for the remaining eight months; and the variable charge per unit will be levied based on the balance revenue requirement after realisation from the tariffs for the first four months and the fixed charge recovery as proposed for these eight months. Table 4: Summary of Existing and Proposed Tariff Particulars Full-Year Proposed Tariff Existing Tariff Part-year Proposed Tariff Full year Proposed Current Part year Proposed Fixed Variable Fixed Variable Fixed Variable Effective Single Part Rs/kW/ Rs./unit Rs/kW/m Rs./unit Rs/kW/ Rs./unit Rs/unit Rs/unit Rs/unit mth th mth Bulk Supply Transmission Wheeling Consolidated Need for Tariff Application One of the main objectives of the reform process being pursued by the Government of Haryana is to transform the power utilities (the successor entities of erstwhile HSEB) into operationally efficient, financially viable and commercially disciplined companies that are not dependent on state subsidies and other external sources of finance. Given the deep-rooted financial problems of the sector and the history of inadequate commercial and operational discipline, it will require significant amounts of time, effort and funding to help these utilities achieve a financial and operational turn around. Substantial capital investment and implementation is required in a time-bound manner for critical activities like system augmentation, rehabilitation and modernization of existing facilities, and loss reduction initiatives through up-gradation of metering infrastructure. Besides the capacity augmentation requirements, even to ensure that the transmission and bulk supply businesses remain cash neutral and their financial viability is maintained it would be necessary to ensure full recovery of the input costs. An analysis of the factors that contribute to the input costs and the recovery mechanism of such costs would reveal that though the input costs have been steadily Amol,Kiran,Mohit,Naveen,Pankaj 9 Section-B, Group-4

12 increasing the recovery mechanism has not kept pace with it. This resulted in significant underrecovery of revenue from the consumers impacting the overall financial condition of the company/ies. HVPNL filed its first BST application with the Commission in June, 2000 and set out the broad objectives of such a tariff to: Improve its liquidity position; Develop a representative tariff structure to discharge its own purchase obligations; and Recover its full reasonable costs. The Commission also in its Joint ARR and tariff order noted that a BST is necessary to: Ensure adequacy of revenue recovery; Send efficient price signals to distribution companies and wheeling customers; Develop cost reflective tariffs; Follow the principle of cost causation in recoveries to be made through tariffs; and Minimize the incidence of FSA. Recognizing this need, the Commission determined two-part T&BS charges and a wheeling charge for the financial year Though the Commission calculated these tariffs on an annualized basis for the financial year , these still need to be realigned for the financial year in view of the following reasons: The aggregate revenue requirement representing the costs to be recovered for the T&BS businesses for the financial year is different from the aggregate revenue requirement for the financial year ; The individual parameters used for the calculation of tariffs such as the connected load as well as the units projected to be sold are different for the two financial years; Due to implementation constraints, the tariff for the financial year was based on easily available proxy (i.e., connected load based fixed charge). This needs to be replaced, either for the full year or part year, with more efficient tariff design, particularly as the interface meters which were limiting the implementation ability of a more efficient tariff structure are expected to be in place by July, Proposed Retail Tariff Application for Distribution and Retail Supply Business Amol,Kiran,Mohit,Naveen,Pankaj 10 Section-B, Group-4

13 2.2.1 Tariff Award for While the broad attempt to rationalize tariffs with cost of service was made, the Commission also recognized that tariff shock is not desirable in the short-term and hence adopted the following approach: The deferred payment liability of government subsidy ascertained at Rs crore was allowed as one time exception to be liquidated by adjustment against the return and electricity duty payable by licensee to the government. The pre-subsidy full year revenue gap was placed at Rs crores for the consolidated distribution business after taking into account the fact that the new tariffs would be applicable only for last quarter of the FY The residual revenue gap after adjusting for Rs crores of government subsidy, and allowed deferred payment of Rs crores comes to Rs 432 crores. The Joint D&RS ARR and Tariff Order envisaged that 60 percent of this residual gap i.e. Rs crores would be allowed to be carried forward as a regulatory asset and the balance has to be made up through the efficiency gain of the licensee. The Commission, through its Joint D&RS ARR and Tariff Order sought improvements in the following areas of tariff design: Reduction of cross subsidy: The Commission had stipulated that if the government wishes to administer tariffs lower than cost of service, it has to provide consumer specific government subsidy or else the tariffs would be raised to appropriate cost recovering levels Rationalization of monthly minimum charges for all categories Discounts (lower tariff per unit) for supply at higher voltage for HT consumers, bulk supply and railway traction Creation of a three-layered telescopic tariff structure for domestic consumers Need For Filing Tariff Application With current tariffs applicable for full FY , the revenue gap before subsidy would be Rs crores (See Table 5). After taking into account government subsidy of Rs crores, revenue gap at current tariffs for full year for FY would be Rs crores. The D&RS licensee has the following options to cover this gap: a) Direct Government Support: The total government subsidy for FY is limited to Rs crores for both the distribution companies Amol,Kiran,Mohit,Naveen,Pankaj 11 Section-B, Group-4

14 Table 5: Annual Revenue Requirement for FY 2002 UHBVN DHBVN Total Rs. Crores Rs. Crores Rs. Crores Revenue Required [a] Expected Revenue [b] at Current Traffic Revenue Gap [c] = [a] Before Tariff [b] Increase Subsidies [d] Gap after Subsidy b) Efficiency improvement: The licensee recognizes that improvement in efficiency is the only sustainable solution to bridging revenue gaps and generating sufficient resources for running the business. The licensee has undertaken a variety of steps to try and bring down both technical and nontechnical losses in the system, which are described in detail in Section 6 of the accompanying ARR application. With these steps, licensee expects to bring down the losses by about 5 percent in FY as against percent determined by Commission in its Joint ARR (See Table-6). Table 6: Projected Losses in FY2001 and FY Transmission (Inter/Intra State) Distribution Technical Losses Distribution Non-Technical Losses Total c) Tariff Increases/Rebalancing: If the options above do not eliminate the gap, the licensee has to file this application requesting an increase/rebalancing of tariffs. However, while filing this RTA, he should be aware that some consumers are paying tariffs, which are more than the cost of service, while certain others are paying much below the cost of service. Accordingly, while requesting for tariff modifications, licensee s major guiding principles have been : Creating publicly acceptable schedule of tariffs Avoiding rate shock for certain category of consumers whose tariff was significantly re-aligned with their cost of service by the Commission through its Joint ARR and Tariff Order Amol,Kiran,Mohit,Naveen,Pankaj 12 Section-B, Group-4

15 Passing on the inflationary costs to all categories of consumers 2.3 Proposed Retail Tariff Rates Current Schedule Of Charges The Commission through its ARR and Tariff Order for FY brought improvements in the following areas of tariff design: The Commission had stipulated that if the government wishes to administer tariffs lower than cost of service, it has to provide consumer specific government subsidy or else the tariffs would be raised to appropriate cost recovering levels Rationalization of monthly minimum charges for all categories Discounts (lower tariff per unit) for supply at higher voltage for HT consumers, bulk supply and railway traction consumers Creation of three tariff slabs with telescopic structure for domestic consumers. The current schedule of charges has the following components: Energy charges in ps/kwh for all categories;.36 Demand charges (for Railway) in Rs/kVA/month; Monthly minimum charges; Overdrawal charges for certain categories; Flat rate tariffs for Agricultural and Irrigation consumers in Rs./BHP/month Proposed Retail Tariff Rates The following modification have been suggested to the existing retail tariff structure and rates (See Table-7): Table - 7: Percent Increase In Tariff For Each Retail Customer Category Category Current Tariff Increase In tariff Proposed Tariff % age Change Paise/kwh Paise/kwh Paise/kwh DOMESTIC Upto 40 units per month % From 41 to 300 units per % month Above 300 units per % month NON DOMESTIC % HT INDUSTRY (above 70 KW) At 11 KV % At 33 KV % At 66/132 KV % At 220 KV % Amol,Kiran,Mohit,Naveen,Pankaj 13 Section-B, Group-4

16 Furnace (at 33 KV and % above) Special Agreement % LT INDUSTRY (up to % KW) AGRICULTURE Metered Agriculture Upto 100' % 101' to 150' % 151' to 200' % Over 200' % Direct Irrigation Tubewells % Augementation Canals % Lift Irrigation % Unmetered Agriculture (Rs./BHP/month) Upto 100' % 101' to 150' % 150' to 200' % Over 200' % RAILWAY TRACTION* At 11 KV % At 33 KV % At 66/132 KV % At 220 KV % Table - 8: Percent Increase In Tariff For Bulk Supply Category Current Tariff Tariff Increase Proposed Tariff %age Change BULK SUPPLY At LT % At 11 KV % At 33 KV % At 66/132 KV % At 220 KV % STREET LIGHTING % SUPPLY OTHER SALES % (PUBLIC WORKS) Note: -No changes have been proposed in the existing MMC rates. HVPNL, to capitalise on the efficiency enhancement measures envisaged in FY to improve commercial performance, has proposed to generally retain the tariff rates for all categories at the existing levels with minor adjustments. It expects the revised tariffs to be applicable from August 1, HVPNL expects that the remaining gap between the revenue requirements for FY 2002 as approved by the Commission and the revenues from the proposed tariffs, if any, will be met through efficiency improvements and through external subsidies made available by the GoH (See Table-9). Amol,Kiran,Mohit,Naveen,Pankaj 14 Section-B, Group-4

17 Table - 9: Additional Revenues Expected for D&RS from Each Category due to Category MU sales to category Proposed Tariff Increase Revenues from current tariffs (Rs. Cr.) Full year expected revenues from proposed tariffs (Rs. Cr.) Part year Increase in revenue (Rs. Cr) Percenta ge Increase in Revenues DOMESTIC Up to 40 units per % month From % units/month Above 300 units/month % NON-DOMESTIC % H.T. INDUSTRY Above 70 kw % Furnace % Special Agreement % L.T. INDUSTRY Up to 70 KW % AGRICULTURE Metered Up to 100' % 101' to 150' % 151' to 200' % Over 200' % Un-metered Up to 100' (BHP % in 000) 101' to 150' (BHP % in 000) 151' to 200' (BHP % in 000) Over 200'(BHP in % 000) Irrigation Direct Irrigation Tube % wells Augmentation Canals % Lift Irrigation % RAILWAY TRACTION % BULK SUPPLY % STREET LIGHTING % SUPPLY PUBLIC WATER % WORKS TOTAL % Amol,Kiran,Mohit,Naveen,Pankaj 15 Section-B, Group-4

18 3. A CRITIQUE OF THE HERC TARIFF AWARD Criteria for Setting Tariffs We feel that any rational tariff setting mechanism should satisfy the following criteria in order to become truly fair to all its stakeholders: 1. The pricing mechanism should bring about an efficient allocation of the resources being used to generate electricity. 2. It should avoid pricing policies, which are diversely related to costs for some sectors or for some specific segments of the market. 3. The prices should be such as to avoid significant shift of benefits between customers on one hand and the employers and investors on the other 4. The prices that the State Electricity Board can charge should be such that there is always a pressure (and may be even incentive) for it to reduce costs. 5. The Government, if necessary, should give subsidy, in a direct manner rather than disguising it in the form of different cost relief. As an example we can see that in case of Haryana, the cost relief to the agriculture sector is disproportionately disguised which leads to electricity being wasted in large quantities. If properly given the subsidy can still provide the same relief while simultaneously avoiding wastage 6. The pricing mechanism should ensure that in situations of scarcity the price controls that are put in place should not lead to a decline in the capacity addition to tide over the scarcity. 7. The prices should be such that they reflect the actual cost to society for production of the item. 8. The pricing mechanism should ensure that the required rate of return is earned on the invested capita i.e. the prices must include a profit element. 9. The prices should in the long-term result in increasing quality, continuity and reliability of the service. 10. The pricing mechanism should enthuse confidence among private investors, which in turn will lead to more participation from the private sector. 11. Due to the natural monopoly nature of some portions of the electricity industry (and hence absence of a market driven solution), proper regulation should build in the necessary efficiency that the market would otherwise have provided. 12. The prices should be such as to smoothen out the variations in the demand seasonally (considering Haryana s seasonal nature of demand) and daily. Amol,Kiran,Mohit,Naveen,Pankaj 16 Section-B, Group-4

19 13. The pricing mechanism should be adjusted to prevent too frequent tariff shocks to the consumers. 3.2 Tariff Application for Distribution & Retail Supply Various elements go into making up the total expenditure of the Distribution and Retail Supply (D&RS) business. These form a part of the total expenditure, which is used to calculate the revenue requirements of the licensee. The various elements are discussed below: Employee Cost Here, HVPNL had given an estimate of Rs million as against which HERC revised the estimate to Rs million. HERC estimated the cost by back calculating the components of the cost for using actual costs for D&RS business from the Profit and Loss Account, and then projecting them for Whereas HVPNL had assumed a growth rate of 10% for both the basic pay and the Dearness Allowance, HERC assumed a growth rate of 2% for the basic pay and 8% for Dearness Allowance. We feel that HERC was correct in assuming the increase in dearness allowance as 8% since it is line with the average inflation rate of around 6%. However, we feel that an increase of only 2% in the basic pay is too unrealistic. An increase of 2% may not be enforceable considering that a significant portion of HVPNL s staff has very low basic salaries. Thus, we propose that the commission for the basic pay component should have considered an increase of 5%. The other allowances have been considered at 10% of basic and DA by the commission, instead of the proposed 15% by HVPNL. We feel that this is correct considering the fact that after pay revision, these had been fixed at 10% by HVPNL and these allowances by their very nature do not change from year to year (it is only the basic and DA on which they are applied that changes). Further, the terminal cost of Rs million as estimated by the commission seems to be based on the correct fundamentals. The commission has allowed capitalization of employee costs to the extent of 9.57% of the total capital expenditure (Rs million). This figure seems to be on the higher side considering that the nature of capital expenditure that takes place in this industry. The commission further agreed to the claim of HVPNL as regards to providing free electricity to all of its employees. We feel that this is not correct and instead of accepting, the commission should have directed HVPNL to phase out the free supply system over a period of three years. The estimated loss per annum considering the free supply scheme for the employees is: (a) No. of employees of HVPNL (as of March 2000): (b) Average consumption per employee per month: 95 units Total consumption by all the employees per annum: a * b = MU Energy charge: Rs per unit (approx.) Amol,Kiran,Mohit,Naveen,Pankaj 17 Section-B, Group-4

20 Total revenue loss due to free power supply: Rs million Total revenue as proportion of total employee cost: 4.3% Repairs and maintenance The commission has rightly set the repairs and maintenance (R&M) costs as 2% of Gross Fixed Assets (GFA) for The commission has noted that the very high rate of transformer burn-outs is a major cause of the very high R&M costs. We feel that commission should also link the approved R&M costs to the age of the equipment, since more of R&M is required, as the equipment gets older. A constant proportion of the GFA may not be the right method to be blindly followed. Maintenance instead of just being considered as a repair function should be viewed as combination of activities that is carried out to retain an item, or restore it to acceptable conditions. The maintenance system should also ensure that all systems are available to further ensure that the returns on investment are maximized. The Commission has rightly advised HVPNL to prepare norms for R&M and submit the same for approval Interests on Loans The commission has approved the following amounts to be considered as interest expense: Table 10: Approved interest expense for FY (Rs. million). Source HERC approval REC HUDA HRDFA Total for capital works IDBI+SIDBI HSEB bonds Private placements Market Committee Loans from banks Total for working capital Total loans Add finance charges Less capitalised interest Interest expensed The commission has rightly instructed HVPNL to consider State Government Loans in the same manner as other loans. The commission has upheld the right of HVPNL to borrow from the State Government. We feel that in the long term HVPNL should borrow only at rates which reflect its true Amol,Kiran,Mohit,Naveen,Pankaj 18 Section-B, Group-4

21 credit rating. The availability of soft loans from the State Government will affect the drive with which HVPNAL will try to reduce its costs and increase efficiency. In the absence of any further details on the rates being presently charged by the various institutions, we cannot say how much these rates really reflect the credit worthiness of HVPNL. We feel that in the initial years HVPNL will not be able to get funding at rates lesser than 3 to 4% above Prime Lending Rate (PLR) of the various financial institutions Depreciation The commission has awarded a depreciation rate of 8.38% (the exact figure proposed by the licensee HVPNL). The licensee is believed to be depreciating land assets, which is against standard practices. The Commission has not pressed the licensees (DHBVNL & UHBVNL) for details of the land being held by them. This should have been used to deduct the appropriate depreciation amount on land assets from the total depreciation amount. Further, the commission has rightly pointed that since this amount of depreciation is being allowed to be recovered through tariff, this should be used for redemption of loan liabilities of the utility to reduce the interest burden ultimately borne by the consumers of Haryana Bad Debts We feel that the commission has acted rightly in its refusal to accept the claim of HVPNL to include 10% of incremental receivable from sale of power as bad debt. HVPNL has not been showing the realization of the dues of the current year separately from the arrears of the previous years. This masks the overall picture of the actual receivables. Also, the licensee has not segregated its sundry debtors into good, doubtful and bad. The commission has rightly observed that HVPNL needs to disconnect those consumers whose dues are classified as doubtful or bad. Also, all avenues for recovery of dues outstanding after adjustment of available security deposits etc. with the licensee should be explored. Allowing for a provision for bad debt as a percentage of the total amount billed will result in the licensee further ignoring the pressing need for improving its collection efficiency. A summary of the total expenditure as filed by the licensee and as finally approved by HERC appears below: Table 11 Approved expenditure for FY (Rs. million). Particulars Original licensee Revised Licensee HERC approval proposal proposal Purchase of energy 30, , , Wages, salaries and related costs 3, , , Amol,Kiran,Mohit,Naveen,Pankaj 19 Section-B, Group-4

22 Other expenditure (R&M) Approved loan interest Bad debts Depreciation Other expenses (A&G) Total Expenditure 35, , , Special Appropriations Contribution to Contingency Reserve Total Special Appropriations Total "expenditure" (including special appropriation) 35, , , Capital Base (Original Cost of Fixed Assets) This element is very essential for calculating the Rate of Return. This forms the base on which the Rate of Return is calculated. The process is to be handled carefully since any deviations at this stage shall get magnified in all subsequent calculations and affect reliability. The values of assets of the utility are required to be accounted for in the process of determination of the tariff under the Performance Based Regulation (PBR) and Rate of Return (RoR) systems of costing. Any under-valuation or over assessment of the assets may lead to perpetual losses or undue enrichment of the utility or its successor in interest. In calculating the Net Capital Base the commission has used the Original Cost minus Depreciation method. This method is the simplest and can easily be based on documented records. Also, it provides an incentive to the licensee to earn incentive on the original investment. However, valuations may be different due to the difference in the economic and the depreciated cost of assets. We feel that the commission has acted rightly in using this method for valuation of assets, since at this stage there is a lack of current information and the legacy that has passed from HSEB to the new licensees can be used to implement this method easily. However, we would like to point out that since this capital base is being used to calculate the return that is to be allowed to the licensees, hence a lot of attention should be paid in its calculation. In this regard, we would like to suggest an alternative option of valuing the assets also on the Reproduction or Replacement Cost basis. This method, though leading to problems like proper fixation of current costs and difficulty in fixing replacement items, will definitely churn out a figure against which a comparison can be made. Amol,Kiran,Mohit,Naveen,Pankaj 20 Section-B, Group-4

23 3.2.8 Stores The commission has accepted HVPNL s estimate of Rs million as the cost of stores for This figure is absurdly high when compared with the value of R&M allowed by the commission (Rs million) and even when compared with HVPNL s own estimate of R&M (Rs million). These figures indicate that a lot of non-moving and unserviceable items presently form a part of the stores. The commission should ask HVPNL to submit a list of such items and should remove the same from inclusion in the cost of stores. This will give a more realistic picture Loans The Commission has rightly asked HVPNL to submit instrument-wise details of each loan that it has taken. Also, the commission has raised correctly its objection to the fact that there has been a rising trend in the working capital loans vis-à-vis the loans for the purpose of capital expenditure. This shows that HVPNL has been managing its receivables poorly, due to which it has to rely heavily on working capital loans. Further, a lack of capital expenditure at this stage may spell trouble for HVPNL in the long run. The Net capital base as submitted by HVPNL in its ARR and as approved by HERC appears below: Table 12 Capital base for HVPNL for (Rs. in million). Particulars Licensee proposal HERC approval Fixed assets (excluding 12, , consumers' contributions) Work in progress 1, , Compulsory investment Working capital Average cost of stores 1, , Average cash and bank - (291.09) balance Positive elements of 15, , Capital Base Less Accumulated depreciation 2, , Approved loans 5, , Consumers' security deposits 2, , Negative elements of 10, , Capital Base Net Capital Base 5, , Return On Capital Base The commission has approved HVPNL s claim of a return of Rs million on its capital base. In doing so, the commission has used the Rate of Return Regulation in calculating the return requirement Amol,Kiran,Mohit,Naveen,Pankaj 21 Section-B, Group-4

24 for the licensee. Using this regulation and a 16% return rate, the return allowed on capital base could be upto Rs. 925 million. Since the licensee has asked for a return significantly less than this, the commission had no hesitation in accepting the claim of the licensee. According to this regulation: RR = [RB x RoR] + E D + E O&M + T where i) RR = the total annual revenue requirement of the utility (after taking credit for any subvention from State Government) ii) RB = the rate base (required investment) of the utility = Capital base in case of a licensee and Fixed assets in case of the Board iii) RoR = the allowed rate of return on investment (debt and equity) = Reasonable return in case of a licensee and not less 3% surplus for the Board iv) E D = annual depreciation expense v) E O&M = annual operation & maintenance (O&M) expense vi) T = annual taxes paid by the utility A test year has to be identified and based on past data and measurable changes that are expected to take place in the future, each component of the cost has to be carefully ascertained. The RoR method is the right choice for calculating the revenue requirement because it meets many of the criteria laid out earlier. We feel that the RoR method provides the following advantages: Consumer s interest is protected since each item of the cost is carefully analyzed This system is easily enforceable by the regulatory agency (HERC in this case) Some of the disadvantages of this method are: This method of regulation is very time consuming and the cost for gathering detailed information is significant. Based on RoR being more or less than cost of capital, the licensee may resort to either unnecessary or restrain from necessary investments. We further feel that the RoR method is required in the initial stages of regulation. As time passes, the commission should gradually switch over to a Performance Based Regulation (PBR). This provides for granting incentives to the licensees for better performance of the system. This could also be setup to penalize the licensee for under performance from the set norms. Under this form of regulation, the need for regulation itself is significantly reduced. The base line rates can be set for a longer period using the RoR route. The yearly tariff can then be adjusted based on the performance parameters. Amol,Kiran,Mohit,Naveen,Pankaj 22 Section-B, Group-4

25 The advantages that can result are: No need to undergo the process of estimating costs every year The performance parameters can be chosen by the regulator based on what it considers most important for development and where it feels that the licensee is lacking Some of the disadvantages of this system are: The regulator may not be in a position to test the achievability of the target it sets for the licensee The consumers do not benefit directly, although they do get the benefits of performance improvement in the long run The licensee can ignore improvement in areas which are not specified as performance parameters by the regulatory agency Other Income The other income comes from two sources. These are: Meter Rental and other miscellaneous charges Ancillary and incidental income including surcharges on delayed payments (mainly DPS) The commission has approved a delayed payment surcharge (DPS) income of Rs. 326 million. The licensee had proposed a DPS income of Rs million. The commission has taken a value of 20% of that proposed by the licensee. We feel that this figure is too low and the commission is acting rather conservatively. Given the fact that the erstwhile utility has been corporatised, we feel that there will be significant increase in delayed collections, which would give rise to a larger DPS income. We propose a figure of Rs. 815 million. We feel that the commission has rightly estimated the rest of the components of the Other Income. In light of the above a summary of the aggregate revenue requirement (ARR), which forms the basis for tariff setting, appears below: Table 13 Aggregate revenue requirement of the distribution and retail supply Licensee for F (Rs. in million) Particulars Original Licensee Revised Licensee HERC approval proposal proposal Reasonable return Total expenditure , , Minus Non-tariff income Total Aggregate 34, , , Revenue Requirement Amol,Kiran,Mohit,Naveen,Pankaj 23 Section-B, Group-4