Markets through the backdoor

Electricity Bill 2001 that will, among other things, allow private players to sell power directly to the consumer, constitutes a short-sighted move.

A DECADE ago, Indian policymakers let themselves be seduced by two mantras - unbundling and regulation - which they believed, would deliver the power sector from the morass it had sunk into. When hindsight exposed the utter inadequacy of these measures in dealing with the problems of the industry, they coined yet another mantra - open access. We are now persuaded to believe that open access is a magic wand that will not only wave away the problems caused by the persistent neglect of distribution-related reforms, but even bring in those much-needed investments which the beleaguered single buyer model had failed to. The new millennium, therefore, rings in the new Electricity Bill which has open access as its centrepiece enabling Independent Power Producers or IPPs (and also Captive Power Plants or CPPs) to sell directly to any consumer, bypassing the utility/regional distribution franchisee. It mandates open access, thus forcing the incumbent utility/franchisee to turn its networks into something akin to public streets, to be used by anyone who wishes to transmit electricity from one point to another, but of course, for a wheeling fee. This move to smuggle in markets through the backdoor is an ill-considered and short-sighted one, prompted more by desperation to do something, or rather anything, to detract attention from the earlier misconceived reform model; it is also likely to hasten the collapse of the State Electricity Boards (SEBs).

The new Electricity Bill, currently under the scrutiny of the Parliamentary Standing Committee on Power, envisages "open access" of transmission and distribution networks in order to facilitate direct sale of power by generators to the final consumers. Section 42 (2) of the Bill dealing with Distribution of Electricity says:

"Where any person whose premises are situated within the area of supply of a distribution licensee, requires a supply of electricity from a generating company or any licensee other than such distribution licensee, such person may, by notice, require the distribution licensee for wheeling such electricity in accordance with regulations made by the State Commission and the duties of the distribution licensee with respect to such supply shall be of a common carrier providing non-discriminatory open access to its distribution system;

"Provided that open access shall be introduced in such phases and subject to such conditions, including the cross-subsidies and other operational constraints, as may be specified by the State Commission and in specifying the extent of open access in successive phases and in determining the charge for wheeling, the State Commission shall have due regard to all relevant factors including such cross-subsidies and other operational constraints;

"Provided further that such open access may be allowed before the cross-subsidies are eliminated, on payment of a surcharge in addition to the charges for wheeling as may be determined by the State Commission."

From the provisions of the Bill, it is evident that all distribution licensees will be obliged to carry electricity sold by IPPs and CPPs directly to the end user. The State Electricity Regulatory Commissions (ERCs) can however decide the timing and contingent conditions governing such direct supply, including levy of surcharge in addition to wheeling charges "with due regard to all the relevant factors including cross-subsidies..." In other words, the Bill does not mandate that the surcharge fully compensate for the loss of cross-subsidy on account of a third-party sale.

OPEN access is being advocated on several grounds, but the most persuasive of them is the introduction of markets, albeit in a limited form.

Although the Bill does not specify any particular category of consumers who could be served through open access, it is a foregone conclusion that high-tension consumers alone can avail of this facility. It would simply not be feasible for the utility to keep track of hundreds or thousands of small-quantity transactions between the generators and small consumers. The emergence of aggregators may alleviate the problem to some extent, but considering the experience in California and elsewhere, it is doubtful whether small consumers will switch to alternate suppliers - especially so in India where low-tension consumers pay lower tariffs than what the IPPs/CPPs might be willing to charge. Therefore, it would be reasonable to assume that only bulk (industrial) consumers will benefit from open access. Hence, what we are talking about is limited markets - that is, markets limited to the industrial consumers - which is indefensible from the point of view of equity.

That brings you to the familiar, yet plausible, conclusion that allowing limited markets (only to high-tension bulk consumers) would wean away industrial consumers who now bear the brunt of cross-subsidies. However, this will happen only if the surcharge plus wheeling charge is lower than the cross-subsidy currently factored into industrial tariffs. Since the Bill does not specify that the surcharge cover the full extent of the cross subsidy element in the tariff, it is not unlikely that the regulator will peg it at a somewhat lower level - just enough to allow an incentive to the industrial consumer to switch to direct supply from IPPs. If the regulator does not do that and fixes the surcharge at a level where the cost of direct purchase is the same as or more than that of the incumbent utility's industrial tariffs, the scheme will remain a non-starter. Therefore, any attempt to introduce third-party sale - in however small a measure - is likely to wean away bulk consumers from the utility, thereby impacting on its revenues.

Then there is the tricky problem of deciding the quantum of losses to be assigned to such transactions. Will they be the average of technical and commercial losses obtaining in the particular utility allowing open access? If the loss level is high, it might not be profitable for the third parties to pay surcharge, wheeling charge, and also for power lost in open access. Therefore, it may have to be pegged at a level which gives an incentive for such transactions to take place - in which case, the remaining losses will have to be borne by the existing utility which is already reeling under the impact of revenue losses.

The argument that has been advanced in defence of third-party sale is that it will force the utility to stem its commercial losses, rationalise tariffs and gradually align tariffs with cost of supply. This is an unrealistic proposition since it assumes an ability to effect either a dramatic loss reduction or a steep increase in the tariffs of the subsidised categories, or both. The shock treatment sought to be administered through open access is more likely to kill the patient than effect any dramatic cure.

All that the cornered utility can now do is to raise steeply the tariffs charged to its remaining industrial consumers - which in turn could force more and more of them out of the utility's custom straight into the hands of waiting IPPs and CPPs, triggering a price spiral which would hasten the demise of the utility.

BUT it may not come to that. In the Indian context, power from IPPs and CPPs is but a very small proportion of the total energy being fed into the grid. Therefore, increasing the demand for direct purchases bypassing the utility could exert an upward pressure on prices charged by IPPs and CPPs so much so that such power would no longer be attractive enough for more industrial consumers to make the switch. In such a situation, the wise ones would be those who opted for long-term bilateral contracts with direct suppliers. Others might want to revert to the utility or at least have a fallback option. Whether the utility will be in a position to provide that, is a moot question. In such a situation, the only certainty would be chaos.

Economic theory tells us that higher prices resulting from demand-supply mismatch attract new investments to enhance capacity. But the important question to ask is whether IPPs will be willing to set up more capacity without the security, convenience and comfort of an assured take-or-pay contract from a dedicated single buyer. Merchant plants are virtually unknown in the developing world except in one case - Honduras.

That brings us to the conclusion that ushering in retail markets without opening up wholesale markets is not only invidious, but is likely to result in chaos. It will short-circuit any potential gains that may accrue from moving to a market-based electric supply industry. Partial retail markets are not only inequitous but also politically infeasible in a country with acute income disparities.

The other arguments for allowing third-party sale - namely, reliability in supply and quality - are hardly valid in a situation where utilities have little control over either overdrawals by existing consumers or network congestion. And finally, the current wheeling tariffs are based more on whimsy than on any reasoned calculation of costs involved in providing open access. It might not be a bad idea to allow time to utilities possessing distribution networks, to assess their own worth, capacity and potential before quoting a price.

The single buyer model has come in for considerable criticism as being the root cause of all evils that plague the electric supply industry. But the current move towards providing open access does not purport to touch the single buyer model. Besides, it is abundantly clear from the provisions of Section 13 that distribution will continue to be a monopoly. Hence, the model of reform conceived by the New Electricity Bill is worse than that of a vertically integrated monopoly or a fully deregulated competitive market. The least that the policymakers can do before ushering in third-party sale is to unravel existing IPP contracts which saddle the utility with expensive marginal power.

The Bill seeks to put electrical connectivity on par with telephone connectivity, by advocating a two-part tariff - a fixed charge and a variable charge - even at the consumer level. This means that like telephone rentals, the electricity consumer will have to pay fixed minimum demand charge whether or not she actually gets/consumes electricity.

The one salutary provision in the Bill is in Section 61 (a) which stipulates that the principles and methodologies specified by the Central Electricity Regulatory Commission for determination of tariff applicable to generating companies and transmission licensees will guide the State commissions. Does it mean that the blatantly inequitous availability-based tariff order, which the CERC slapped on the public sector thermal generator National Thermal Power Corporation (NTPC), will now be applied to IPPs as well? Or does it merely seek quietly to tip the existing balance of power in favour of the Centre?

And finally, the Bill explicitly states that tariffs should progressively reduce and eliminate cross-subsidies. As energy expert T.L. Sankar points out, the only way it can be achieved would be to dedicate low-cost hydel power to agricultural consumers exclusively and permanently. But the Bill does not concern itself with such practical problems. One can only hope that the Parliamentary Standing Committee will.