National Tariff Policy

In pursuance with Section 3 of the Electricity Act 2003, the Central Government notified the Tariff Policy on 6th January 2006. According to the Act, the CERC and SERCs are to be guided by the Tariff Policy in framing its regulations. Also, the SERCs are expected to follow the principles and methodologies specified by the CERC for generation and transmission. Forum of Regulators is expected to facilitate consistency across SERC regulations especially in distribution. The Tariff Policy recognizes that it is important to balance the requirement of providing fair and appropriate return on investment to attract investments in the sector and to ensure reasonability of user charges for the consumers. Accordingly, it lays out the following objectives :

  • Ensuring availability of electricity to consumers at reasonable and competitive rates;
  • Ensuring financial viability of the sector and attracting investments;
  • Promoting transparency, consistency and predictability in regulatory approaches across jurisdictions and minimizing perception of regulatory risks;
  • Promoting competition, efficiency in operations and improvement in quality of supply.

The Tariff policy reemphasises the importance of competition and creating conditions for competition in line with the Act and the Electricity policy. Towards this end, it specifies that the distribution licensees would procure power (or capacity) competitively for medium and long-term from generators under the procurement guidelines notified on 19th January 2005 through tariff based bids instead of MoU except from PSU generators. Even PSU generators would have to bid competitively after five years or when the ERC feels that the time is ripe for introducing competition. In case of existing private generators, one time capacity expansion of not more than 50% is also exempted from this requirement. It recognizes that the wires part of the sector would have to be regulated on regulated returns basis being a natural monopoly. Save competitively procured power, it adopts "cost of service" regulation for the sector. As far as return on investment is concerned, it allows CERC to follow either cost of equity approach as in the past or cost of capital approach in case it deems fit. The returns should attract investment in the sector at par with returns in other sector adjusted for risks. The surplus so generated is viewed as important not only for attracting investment but also for growth of the sector. The CERC has to notify the rate of return on equity or capital for generation and transmission keeping in view the prevalent cost of capital and the same would be followed by SERCs. ERCs, according to the policy, have to ensure that the capital costs are reasonable and to this end may evolve benchmarks. The SERCs may follow 'distribution margin' approach in future at an appropriate time and the FOR should evolve within one year a comprehensive approach towards the same. The 'distribution margin' approach should factor in reduction in AT&C losses, cost of supply and quality.

The Tariff Policy specifies debt-equity norm of 70:30. In case equity is more, the excess should be treated as debt but if it is less than the norm, then the actual equity should be considered for tariff fixation. There should be no need for advance against depreciation and the CERC may notify the depreciation rates for generation and transmission, which can be suitably modified for distribution by the FOR. The depreciation would be same for accounting and tariffs. The benefits of fully depreciated assets should be available to consumers. The ERCs should incentivize the debt restructuring wherever it is beneficial to consumers. The foreign exchange risk should not be allowed to pass through and should be hedged by the utility. The operating norms should be 'normative' and should not be lower than normative and actual. The norms should be attainable, but must reflect technological changes, fuel, vintage of asset and operating conditions etc. CERC would notify these norms for generation and transmission and the same would be adopted by SERCs. SERCs may however, fix a relaxed norm in case where operations have been at a lower level but may also draw a transition path towards norms specified by the CERC. Operating norms for the distribution networks would be specified by the respective SERC. The policy, in line with the Act, specifies that from April 1, 2006 all tariffs would be under MYT (multi-year tariff) framework and should feature 3-5 year control period. Once the revenue requirements have been fixed, the ERCs should focus on regulation of outputs and not the input costs. It also discourages creation of regulatory assets implicitly by emphasising on recovery of uncontrollable costs speedily so as not to burden future consumers with past costs. The benefits from CDM (clean development mechanism) should be factored in while fixing the tariff as per the policy but should provide adequate incentive for such development. The policy document underscores the need for State Governments not to impose duties, levies and taxes on selective basis including captive generators so as not to distort competition and also to keep these at reasonable levels so that tariffs remain reasonable.

The policy specifies that the two-part tariff structure should be adopted for all long-term contracts to facilitate merit order dispatch. The ERCs should have time-varying (peak vs. non-peak) fixed charges for better load management. The PPAs should have adequate and bankable payment security mechanisms and in case of persistent default, the generator should be free to sell outside the PPA. In case of coal-based generation, the cost of project may also include reasonable cost of coal beneficiation, coal laundering and dry ash handling and disposal system. The captive generators on the grid should have same terms as other generating stations subject to ABT or should be paid actual variable cost and a reasonable capacity charge, which may be different for peak and non-peak hours. Wheeling charges for such generators should be known in advance as declared by the SERC. On non-conventional sources of energy generation, the tariff policy specifies that the SERCs should fix the percentage of share of power to be procured on a competitive basis (within the same type of source of energy) by the distribution licensees by April 1, 2006. Such procurement may have to be at a differentiated (higher) price. CERC should within three month lay down the guidelines for procurement of such power on non-firm basis.

The policy document recognizes that the national grid in the country is under development, that the development of state networks has not been uniform and that there is a need to develop the network at all levels by attracting investments. The CERC should develop a national tariff framework, in consultation with the CEA, for transmission tariffs, which are sensitive to quantum, direction and distance of flows. This could be based on zonal postage stamp pricing or MW-mile basis or some other variant based on the principle of system users sharing their respective share of utilization of the network. It should not inhibit development of the network but should also not encourage non-optimal investments. In line with the Electricity Policy, the Tariff policy also states that the network expansion would not be based on prior agreement with the beneficiaries and the CTU/STUs can undertake investments in line with the National Plan and in consultation with stakeholders. CERC within one year would specify the norms of capital and operating costs for transmission lines at various voltage levels based on baseline studies commissioned by CERC. Investment by others (other than CTU/STU) in transmission would be on competitive bid basis for which the Central Government would come out with the guidelines. The tariffs of the projects to be done by the CTU/STU would also be based on competitive basis after five years or whenever ERCs are satisfied that this can be done. Once CERC specifies transmission tariff framework, the SERCs would also use it for intra-state transmission network within two years. Metering on the network should be compatible with the tariff and ABT framework including TOD metering. The policy specifies that the transactions on the network should be charged based on average loss after considering the distance and directional sensitivity as applicable at the relevant voltage level. CERC should evolve such a methodology for inter-state transmission which can be used by FOR to evolve a similar approach for intra-state transmission. The loss compensation should be reasonable and should be established by the ERCs in consultation with the CEA. In order to assess the need for network expansion and investments, necessary studies may be carried out by ERCs and such capex may be allowed to prevent overloading of lines. There is also a need for ERCs to create financial incentives and disincentives for CTU/STUs based on their key performance indicators (KPIs). These should include network construction, system availability and loss reduction. The CTU/STUs/RLDCs/SLDCs should also make available information on available transmission capacity and load flow studies to intending users.

The Tariff Policy underscores the need for the distribution segment of the sector to become solvent and efficient for the realization of full potential of the development of the sector. The ERCs therefore need to strike a balance between commercial viability of the distribution licensees and consumer interests. Loss making utilities need to be transformed into profitable ones and efficiency in operations need to be encourages by sharing the efficiency gains between consumers and licensees through MYT framework specified in the Act. This would also minimize regulatory risks and attract investments. The SERCs should introduce mechanism of sharing gains and losses within overall MYT framework which could be asymmetric for the first control period with more gains accruing to the utility than the losses vis-à-vis consumers. The MYT framework in the first control period should have flexibility to accommodate changes in the baseline estimates consequent to 100% metering. In the first control period, the uncovered gap between required tariffs and current tariffs need to be covered either by tariff increases or financial restructuring and transition financing. The licensee would have the flexibility to charge less than the regulated tariffs and file for an area separately when the area has a competing licensee. The SERC should initiate tariff determination, suomoto, in case the filing has not been made by the licensee. Any revenue gap due to filing would be on account of the licensee.

While determining the revenue requirements and costs, all power purchase costs would be considered legitimate unless it has been purchased at an unreasonable cost or merit order has been violated. Reduction in AT&C losses should not be achieved by denying revenues for power purchase for 24 hours supply, and reasonable O&M costs and capex. Actual retail sales should be grossed up based on normative T&D losses for allowing power purchase costs subject to justifiable purchase mix and fuel surcharge. The MYT trajectory should be attainable and should create political will for theft reduction by allowing full cost recovery. To deter theft and create social pressures, SERCs may impose area/locality specific surcharge based on AT&C losses. SERCs may also encourage area-based incentives and disincentives for the local staff. The baseline independent assessment for various parameters of each circle should be undertaken by SERCS and be completed by March 2007. Metering should also be completed by the same time and then it should be possible to segregate technical losses, which should be treated differently from commercial losses in the MYT trajectory. In line with Section 65 of the Act, the SERCs should fix the tariffs without considering subsidies from the State Government and it should lower only if the Government pays for it. SERCs should allow working capital related to past recoveries. Similarly past losses and profits due to uncontrollable factors should be allowed. During the transition, controllable factors should be to the account of utility and consumers as specified in the MYT framework. The practice of creation of regulatory asset should not be freely resorted to and should be done only as an exception under 'force majeure' conditions as specified in the regulations. In such cases also, the recovery should be time bound and till such time carrying cost should be allowed to the utility. SERCs should also ensure that such regulatory assets do not depress return on equity to very low levels. On Distribution Tariff and Cost of Service The Tariff Policy recommends that the State Government should targeted direct subsidies, than cross-subsidies, for the purpose as spelt out in section 65 of the Act. Only consumers belonging to BPL category may be given special support to the extent of 50% for 30 units a month in line with the National Electricity Policy. This provision may be re-examined after 5 years. The SERCs should notify the roadmap within six months the target latest by 2010-11 for bringing tariffs to within +/- 20% of average cost of supply. For agricultural tariffs, the tariffs should also factor in the sustainable exploitation of ground water resources and should be different in different parts of the state depending upon sustainability of ground water use. The policy also recognizes the need to provide higher subsidies to poor farmers in adverse ground water table condition, which is somewhat contradictory! For every category, the document stresses on the need for recovery of reasonable user charges. Subsidized rates should be permitted only up to a pre-identified level beyond which cost of service should be recovered. The document also stresses on metering for all consumers.

The Tariff Policy document specifies that the cross-subsidy surcharge would be the difference between- (i) the tariff applicable to the relevant category of consumer, and (ii) the cost of the licensee to supply to that category of consumer. The cost of the supply may be computed as- (a) the weighted average of the cost of power purchase of the most expensive 5% at the margin, excluding liquid fuel based generation, in the merit order (including system losses), and (b) the distribution charges determined by the SERC on the principles laid down for intra-state transmission charges. SERCs should bring down the cross-subsidy to +/- 20% in a linear manner by 2010-11. The additional surcharge as per section 42(4) would be leviable only in case it is demonstrated that the power purchase commitments of the licensee would get stranded and/or there is a fixed obligation on any such contract. Wheeling charges for the open access consumers would be based on principles of intra-state transmission and would take into account losses at the relevant voltage levels. The standby arrangements would be provided by the licensee at temporary connection charges to be determined by the SERC. The Tariff Policy also notes that the ERCs need to monitor trading transactions to ensure that traders do not indulge in profiteering in situation of shortages. ERCs may fix margins for achieving this objective.