Pricing of Inter State Sales of Electricity

Final Project Report Infrastructure Development and Financing

Submitted to Prof. Sebastian Morris Prof. Rekha Jain Prof. G. Raghuram

By Group 1 (Section B) Dwaipayan Sadhu Shailesh Tamagade Shantanu Dey Vinay Madhav Pai Vishnu G On August 24, 2001

Indian Institute of Management, Ahmedabad

Table of Contents

1. NEED FOR INTERSTATE TRANSMISSION ----------------------------- 4

1.1 BRIDGING THE GAP BETWEEN SURPLUS AND DEFICIT STATES ------------------------- 4 1.2 1.3 TRANSMISSION CONSTRAINTS--------------------------------------------------------- 6 INTER REGIONAL TRANSFER CAPACITY ---------------------------------------------- 6

2. DEVELOPMENT OF REGULATIONS -------------------------------- --------- 6

2.1 2.2 2.3 2.4 INDIAN ELECTRICITY ACT 1910------------------------------------------------------- 6 ELECTRICITY SUPPLY ACT 1948 ------------------------------------------------------ 7 POST LIBERALIZATION MEASURES --------------------------------------------------- 7 DRAFT ELECTRICITY BILL 2000 ------------------------------------------------------ 7 Inter State Transmission of Electricity ---------------------------------------- 7

2.4.1

2.4.1.1 Roles of Various Entities-------------------------------------------------------- 7 2.5 DEVELOPMENT OF A POWER MARKET: PROPOSED PLAN ------------------------------ 14

3. POWER TRADING -------------------------------- -------------------------------- ---- 15

3.1 CURRENT ----------------------------------------------------------------------------------- 15 3.2 NEW AGREEMENTS ------------------------------------------------------------------------ 15

4. ISSUES IN INTER STATE TRANSMISSION ------------------------------- 15

4.1 REGULATION OF INTER-STATE TRANSMISSION ----------------------------------------- 15 4.2 ISSUES IN THE PRICING OF CENTRAL POWER SECTOR UTILITIES (CPSU) ------------ 17 4.3 TOWARDS A TARIFF POLICY -------------------------------------------------------------- 18 4.4 TOWARDS A FRAMEWORK FOR TRANSMISSION TARIFFS ------------------------------- 19

5. TARIFF ISSUES -------------------------------- -------------------------------- --------- 20

5.1 CURRENT TARIFF SYSTEM ---------------------------------------------------------------- 20 5.1.1 Bulk Purchase and Sales Order ---------------------------------------------------- 20 5.1.2 K.P Rao Committee Recommendations-------------------------------------------- 21 5.1.3 Current Mechanism of Transmission Pricing------------------------------------- 21 5.1.4 Determination of Norms for inter-State Transmission Tariff - CERC Order - 24

5.1.5 Evaluation of the alternatives suggested ------------------------------------------ 26 5.2 AVAILABILITY BASED TARIFF ------------------------------------------------------------ 26 5.2.1 Problems with the present system -------------------------------------------------- 26 5.2.2 Proposed ABT System --------------------------------------------------------------- 27 5.2.3 Problems with ABT ------------------------------------------------------------------ 32

6. INTERNATIONAL EXPERIENCE-------------------------------- -------------- 33

6.1 US EXPERIENCE --------------------------------------------------------------------------- 33 6.1.1 Open Access -------------------------------------------------------------------------- 34 6.1.2 Transmission Issues------------------------------------------------------------------ 34 6.1.3 Retail Wheeling----------------------------------------------------------------------- 35 6.2 THE UNITED KINGDOM -------------------------------------------------------------------- 36 6.2.1 Electricity Act 1989------------------------------------------------------------------ 36 6.2.2 Transmission-------------------------------------------------------------------------- 37 6.2.3 The England and Wales Power Pool----------------------------------------------- 37 6.2.4 Pricing --------------------------------------------------------------------------- 39

1. Need For Interstate Transmission

1.1 Bridging the Gap Between Surplus and Deficit States Power trading is comparatively a new business concept in India although trading in power has proved successful in many western countries. The main suppliers of bulk power in India are the central sector stations and their capacity has been fully allocated to states. There are no merchant generators. All IPPs have long-term contracts assuming recovery of full fixed cost and return on equity at 68.5% availability. Some IPPs have even guaranteed off-take of power. Thus there is little untied capacity available for open market trading of power and Inter-state exchanges from surplus to deficit systems are taking place in limited quantities. Inter-regional exchanges in 2000-2001 were about 9.87 billion units, which is 2% of the total electrical energy availability in the country. Bulk of inter-regional exports are taking place from Eastern Region which is surplus in power availability. Further trading opportunities exist in terms of exports from Eastern Region but there are transmission constraints in enhancing the supplies. With the strengthening of inter-regional links and increased emphasis on commercialization, the volume of power trading is expected to increase in the future. But power trading to evolve and develop in to a mature and attractive business will take some time. In India there are surplus regions and deficit regions and surplus periods and deficit periods that require to be matched by optimising the generating capacity through transmission of power from surplus areas to deficit areas. For example, regions deficit in peak capacity but surplus in off-peak capacity can transmit power to regions deficit in off-peak capacity. For meeting these requirements, identification of sellers and buyers and for fine-tuning the flow of power on a day-to-day basis, trading can perform a very useful function. If you have a market, trading will be an essential part that must be facilitated in any open economy. Power trading is an attractive business opportunity in India. The factors that create a substantial scope for power trading in the country are:1
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The given mismatches between power surplus and power-deficient markets in the country

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?? ??

Limited growth of IPPs The new generating capacities in the country, which would lead to an increase in power supply

However, to effectively carry out power trading in the country, the following steps must be considered:
?? ?? ??

More investment to be put into interstate reconciliation metering A transparent flow of information for interested participants Establishment of a common interstate network pricing model

Although power trading has proved successful in many western countries, in India it is still at a nascent stage. The capacity of the central sector stations has been fully allocated to the states. There are no merchant generators. All IPPs have long-term contracts, assuming recovery of full fixed cost and return on equity. Some IPPs have even guaranteed offtake of power. Thus there is hardly any untied capacity available for open market trading, and inter-regional exchanges from surplus to deficit systems are taking place in limited quantities. Interregional exchanges in 1999-2000 were about 9 billion units, which is 2 per cent of the total electrical energy available in the country. Further, where trading opportunity exists in terms of exports, for example, from the eastern region, there are transmission bottlenecks. With the strengthening of interregional links, and an increased emphasis on commercialization, the volume of power trading is expected to increase in the future. But for power trading to evolve and de-velop into a mature and attractive business will take some time. With the setting up of mega power projects, strengthening of interregional transmission links, and introduction of availability-based tariff, the volume of power exchanges is going to increase substantially. Introduction of the Electricity Bill, 2000 will provide enabling provisions for establishment of bulk electricity markets to facilitate efficient, competitive and orderly trading and supply of electricity. The draft bill provides for setting up of new generating stations without licence, non-discriminatory access to transmission systems and gradual introduction of "open access" in the distribution system to permit competition among multiple suppliers. Trading of energy has been recognised as a distinct function to encourage market-based operations, leading to the setting up of merchant power stations. The draft bill also provides for a bulk electricity spot market.

In the near future, with the strengthening of the interregional transmission system between the eastern region and the neighbouring regions by the Power Grid Corporation, it is likely that competition will be generated between the generators in the eastern region to supply power at the minimum cost. A commercially sound trading arrangement for power will not only help achieve optimum utilization of the existing capacities, it will also result, though in the long run, in automatic merit order despatch. 1.2 Transmission Constraints Transmission system were planned and developed for evacuation of central generating stations in a region and not planned for inter-regional power transfers. The planning of transmission system has undergone a change and integration of Regional grids is in progress. Transmission Highways have to be built across the country to facilitate large scale trading of power in future. 1.3 Inter Regional Transfer Capacity The total power transfer capacity of the inter-regional transmission system is about 5500 MW at 220 kV and above level and in HVDC back-to-back systems, which accounts for about 5.5% of the generation capacity in the country. Inter-regional transmission systems that are presently under construction will have the power transfer capacity of 3500 MW.

2. Development of Regulations
Indian Electricity Act, Electricity Supply Act and Indian Electricity Rules provide the basic framework for regulating electricity industry in India. 2.1 Indian Electricity Act 1910 The Indian Electricity Act 1910 was enacted to deal with the supply and use of electricity and was applicable to the whole of India. It also deals with the grant of licenses to persons who wish to engage in the business of transmission and supply of electricity and also to non-licensees who wish to engage in transmission, supply and use of electricity.

2.2 Electricity Supply Act 1948 This Act was enacted right after independence to provide for rationalization of production and supply of electricity and for taking measures conducive to electricity development. It was aimed to ensure a coordinated development of electricity in India on a regional basis. It provides for the necessary legislative powers to link together under one control electrical development of contiguous areas by developing the grid system. 2.3 Post Liberalization Measures In 1991 the power sector was first to open up, by the way of throwing open generation to private players. In 1996 the Central Government along with the state governments went for Common Minimum national Action Plan. The objective of the plan was to initiate steps required to improve the performance of the sector in a time bound manner. Setting up the CERC or Central Electricity Regulatory Commission was a key element of the plan. The Electricity Act 1998 provided for establishment of CERC to regulate the tariff of the central generating companies and sale of electricity to two or more states and to regulate the inter state transmission of electricity undertaken by PGCIL and other organizations, including the tariff. 2.4 Draft Electricity Bill 2000 The proposed legislation provides for enough flexibility in undertaking reforms to make private investment easy, uninterrupted power to the consumer at affordable rates through competition and independent regulation giving enough freedom to the States to decide on the pace and path of reforms taking into account the local specific conditions.2 2.4.1 Inter State Transmission of Electricity 2.4.1.1 Roles of Various Entities

For the purpose of interstate transmission of electricity, the Government proposes to make region- wise demarcation of the country, and, from time to time, make such modifications therein as it may consider necessary for the efficient, economical and integrated transmission and supply of electricity, and in particular to facilitate voluntary

inter-connections and co-ordination of facilities for the inter-state, regional and interregional generation and transmission of electricity. The Government also proposes to set up a centre at the national level, to be known as the National Load Despatch Centre for optimum scheduling and dispatch of electricity among the Regional Load Despatch Centres (RLDC).

Roles of the RLDC The Regional Load Despatch Centre is proposed to be the apex body to ensure integrated operation of the power system in the concerned region. The Regional Load Despatch Centre shall comply with such principles, guidelines and methodologies in respect of wheeling and optimum scheduling and despatch of electricity as the Central Commission may specify in the Grid Code. The Regional Load Despatch Centre shall (a) be responsible for optimum scheduling and despatch of electricity within the region, in accordance with the contracts entered or to be entered with the licensees or the generating companies operating in the region; (b) monitor grid operations; (c) co-ordinate grid planning and expansion; (d) exercise supervision and control over the inter-state transmission system; (e) be responsible for carrying out real time operations for grid control and despatch of electricity within the region through secure and economic operation of the regional grid in accordance with the Grid Standards and the Grid Code; and (f) maintain accounts of power flow in the grid. The Regional Load Despatch Centre may levy and collect fee and charges from the generating companies or licensees engaged in inter-state transmission of electricity as may be specified by the Central Commission. The Regional Load Despatch Centre may give such directions and exercise such supervision and control as may be required for ensuring grid operations and for achieving the maximum economy and efficiency in the operation of the power system in the region under its control. Every licensee, generating company, generating station, sub-station and any other person connected with the
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operation of the power system shall comply with the direction issued by the Regional Load Despatch Centres. All directions issued by the Regional Load Despatch Centres to any Transmission Licensee of state transmission lines or any other licensee of the state or Generating company (other than those connected to inter state transmission system) or sub-station in the State is proposed to be issued through the State Load Despatch Centre and the State Load Despatch Centres shall ensure that such directions are duly complied by the licensee or generating company or sub-station. Every licensee and others involved in the operation of power system shall comply with the decision of the Regional Power Committee. If any dispute arises with reference to the quality of electricity or safe, secure and integrated operation of the regional grid, it shall be referred to the Central Commission.

Roles of Central Transmission Utility (PGCIL) The Ministry of Power has appointed Power Grid Corporation of India Ltd. as the Central transmission Utility and vested it with certain regulatory powers in inter state transmission. The functions of the Central Transmission Utility shall be to ?? ??

Undertake transmission of electricity through inter-state transmission system; Discharge all functions of planning and co-ordination relating to inter-state transmission system with

(i) State Transmission Utilities; (ii) Central Government; (iii) State Governments; (iv) Generating Companies; (v) Regional Power Committees; (vi) Authority; (vii) licensees; (viii) any other person notified by the Central Government in this behalf;
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Ensure development of an efficient, co-ordinated and economical system of interstate transmission lines for smooth flow of electricity from generating stations to the load centers

Now any applicant for setting up interstate transmission system should have to obtain the approval of the CTU. PGCIL thus simultaneously dons the mantle of a regulator and and player, which might endanger the competition. PGCIL could conceivably prevent the entry of private players in t5he transmission sector for example by allotting inhospitable and uneconomic regions for setting up and operating transmission infrastructure.3

Roles of Central Electric Authority The Authority shall perform such functions and duties as the Central Government may prescribe or direct, and in particular ??

Advise the Central Government on the matters relating to the national electricity policy, formulate short-term and perspective plans for development of the electricity system and co- ordinate the activities of the planning agencies for the optimal utilization of resources to subserve the interests of the national economy and to provide reliable and affordable electricity for all consumers

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Specify the acceptable technical standards for construction of electrical plants and electric lines

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Specify the safety requirements for construction, operation and maintenance of electrical plants and electric

?? ??

Specify the Grid Standards for operation and maintenance of transmission lines; Specify the conditions for installation of meters for transmission and supply of electricity

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Promote and assist in the timely completion of schemes and projects for improving and augmenting the electricity system

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Promote measures for advancing the skill of persons engaged in the electricity industry;

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Advise the Central Government on any matter on which its advice is sought or make recommendation to that Government on any matter if, in the opinion of the Authority, the recommendation would help in improving the generation, transmission, trading, distribution and utilization of electricity

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??

Collect and record the data concerning the generation, transmission, trading, distribution and utilization of electricity and carry out studies relating to cost, efficiency, competitiveness and such like matters

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Make public from time to time information secured under this Act, and provide for the publication of reports and investigations

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Promote research in matters affecting the generation, transmission, distribution and supply of electricity

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Carry out, or cause to be carried out, any investigation for the purposes of generating or transmitting or distributing electricity

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Advise any State Government, licensees or the generating companies on such matters which shall enable them to operate and maintain the electricity system under their ownership or control in an improved manner and where necessary, in co-ordination with any other Government, licensee or the generating company owning or having the control of another electricity system; and

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Advise the Appropriate Government and the Appropriate Commission on all technical matters relating to generation, transmission and distribution of electricity

Roles of Central Electricity Regulatory Commission The Electricity Act 1998 provides for creation of Central Electricity Regulatory Commission whose functions are:
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To regulate the tariff of Generating Companies owned or controlled by the Central Government

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To regulate the tariff of Generating Companies other than those owned or controlled by the Central Government specified in clause (a), if such Generating Companies enter into or otherwise have a composite scheme for generation and sale of electricity in more than one State

?? ??

To regulate the inter-State transmission of electricity To determine inter-State transmission tariff regardless of whether power flows through inter-State lines or intra-State lines

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To regulate the trading margin of an Electricity Trader with respect to his inter state operation

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??

Issue licenses to persons to function as Transmission Licensee and Electricity Trader with respect to their inter-state operations

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To promote competition, efficiency and economy in the activities of the electricity industry

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To associate with the environmental regulatory agencies to develop appropriate polices and procedures for environmental regulation of the power sector

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To frame guidelines in matters relating to electricity tariff for generation and high voltage transmission in accordance with National Electricity Policy

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To arbitrate and adjudicate upon disputes involving Generating Companies or Transmission Companies

Roles of Power Trading Corporation (PTC) The Power Trading Corporation (PTC) has been established with majority equity participation by the PGCIL along with NTPC, Power Finance Corporation (PFC) and other financial Institutions. The PTC would purchase power from the identified private projects and sell it to the SEBs.4 As part of its mega power policy, GOI proposes to set up the Power Trading Corporation (PTC) as sole offtaker of the power generated by mega projects. PTC will buy power from multiple power projects under long term PPAs and sell to multiple offtakers also under long term PPAs.5 PTC may help to optimize costs as creation of parallel structures can be avoided. Second, in order to manage the business a certain set of skills is required to be developed. The third rationale for formation of a single PTC is that of flexibility. For example, if there are three SEBs out of which one of them has a temporary offtake constraint, the PTC has the flexibility of finding an alternative buyer within the constraints of the technical system. In addition, based on global trends PTC may eventually facilitate the move towards merchant trading. It would then serve its true purpose as defined in its name which is power trading.6

Puneet Chitkara et al, The Electricity Report, IIR 2000 www.ptcindia.com 6 www.indiapoweronline.com

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??

Promotion of power trading to optimally utilize the existing power resource in the country

?? ?? ?? ??

Catalyzing development of mega power projects and hydro power projects Promoting exchange of power with neighboring countries Developing a power market To carry on the business of purchase and sale of all forms of electrical Power; conventional & non - conventional and also to supply, import and export or otherwise deal in all forms of electrical energy in all aspects

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To plan, promote and take up necessary developmental work, selection of prospective / established Independent Power Producers/Generating, Transmission/Distribution Companies, utilities and enter into contract / power purchase agreements with them. To act to augment power generation, transmission, distribution, optimum utilisation of electrical power and it's trading

??

To plan, promote, develop and establish an efficient and reliable power trading and distributing system, policies and procedures towards competitive procurement, transfer /wheeling of power from the power producers / generating and transmission companies within India and abroad and supply within India and abroad and comply with the broad guidelines and objectives laid down by the Government of India or any statutory / regulatory authorities created or established from time to time

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To own, acquire, establish, operate and maintain generating stations, transmission systems and power systems for generation, evacuation, distribution and transmission of power for supply to the State Electricity Boards, Vidyut Boards, Power Utilities Generating Companies, Transmission Companies, Distribution Companies, State Government, Licensees, statutory bodies, other organizations and bulk consumers of power

Power Exchanges Through PTC

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During 1999-2000, PTC has traded 28.35 MUs of power from Western Region to Southern Region. In the year 2000-01, PTC has traded 43.75 MUs of energy from the Western to Southern and Northern to Western Region. 2.5 Development of a Power Market: Proposed Plan The Electricity Bill to be introduced shortly, provides for establishment of a bulk electricity spot market to facilitate efficient, competitive and orderly trading and supply of electricity as the electricity industry develops and matures to benefit the consumers from resulting competition and free flow of electricity The following provisions have been proposed in the bill to enable development of competitive power market.
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Setting up of new generating stations without license and they would have freedom to generate and supply electricity in competitive environment

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Non-discriminatory access to the transmission system. Evolution of efficient regional and national grids that would ensure a free and efficient flow of electricity among different regions

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Gradual introduction of 'open access' in the distribution system to permit competition among multiple suppliers

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Trading in the electricity has been recognized as a distinct function to encourage market based operations leading to setting up of merchant power stations. The bill also provides for Bulk Electricity Spot market

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The bill proposes to de-regulate the generation sector and allow prospective generating stations to supply electricity in a free market

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The Bill recognizes the need for progressive reduction in cross subsidization among different classes of consumers.

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Provides for restructuring of SEBs

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3. Power Trading
3.1 Current 42.32 MUs of surplus energy from PSEB was traded to GEB through PTC from 11th November 2000 to 1st December 2000. A detail report on interregional energy exchanges over the years is given in Exhibit 1. 3.2 New Agreements7 Trading of Power from West Bengal Power Development Corporation Limited A Power Purchase Agreement was signed with West Bengal Power Development Corporation (WBPDCL) on 14th Feb 2001 for purchase of up to 200 MW of power. The power flow from WBPDCL to Delhi Vidyut Board and Haryana Vidyut Prasaran Nigam Ltd. has started w.e.f. 12.06.2001 as per the allocations made by CEA/MoP. The average power flow is about 3 MUs per day. Trading of Power from Malana Power Company Limited.

A Power Purchase Agreement has been signed on 18th June 2001 with Malana Power Company Limited (MPCL) for purchase of entire net electrical energy available from 86 MW Malana Hydro Power Project (excluding free power admissible to Himachal Pradesh). This power will be sold to DVB. Power flow is expected to start from first week of July 2001, after commissioning of Malana Power Project.

4. Issues in Inter State Transmission

4.1 Regulation Of Inter-State Transmission The regulation of inter-state transmission, including the transmission tariff of the utilities engaged in inter-state transfers of energy, is a primary role of the Commission under the Act. There are five Regional Grids operating in the South, West, North, East and NorthEast. Each of the regional grids is governed by a Regional Electricity Board which came into being through the resolution of the Government of India in 1964 with the intention of promoting integrated operations of the power systems. While the Regional Electricity Boards are advisory in function Regional Load Despatch Centers (RLDCs) established in

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each region by CEA in the 1970s are in operational control of the regional electricity grids. The REBs were given statutory status in 1991 through an amendment of The Electricity (Supply) Act, 1948. Over the period January, 1994 to January 1, 1996 the RLDCs which were originally part of he Central Electricity Authority (CEA) were transferred to Powergrid Corporation of India. Through further amendments to the ES Act in 1998 the role of the RLDCs was clarified and they were designated as the apex body to ensure integrated operation of the power system in the concerned region. Simultaneously, the Regional Electricity Boards were able to facilitate the RLDC on matters concerning the smooth operation of the integrated grid and economy and efficiency in the operation of the power system through a unanimous decision of the REB. This amendment has further clarified the system of dispute resolution under which, subject to regulations made by the Commission, all disputes relating to directions given by the RLDCs, are referred to the Central Electricity Authority for decision. The fees to be charged by the RLDCs is also to be specified by the CERC. Over time, the procedures to be adopted for planning and operation of the regional grids have been specified by the Central Electricity Authority, decisions of the REBs and operational practices of the RLDCs. While the system has functioned well with diversification of the nature of utilities connected to the system subsequent to restructuring of the State Electricity Boards and the incentives given to the private investment growth in the volume of inter-state energy sales, rapid increases in the demand for energy with significant regional variations there has been a felt need for a unified code laying down the rules, guidelines and standards to be followed by the various agencies and participants in the Indian Electricity Grid System. In pursuance of this objective the Commission set up a special working group under the Chairmanship of Shri D.P. Sinha, Member CERC with the express purpose of discussing with all stakeholders of the regional grids the modalities to be adopted for formulation of an Indian Electricity Grid Code. The working group submitted its report in the first week of February 1999 which was subsequently forwarded to assist them formulating a draft Grid Code.

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4.2 Issues in the pricing of Central Power Sector Utilities (CPSU)8 Central Power Sector Utilities today consist of a transmission company (PGCIL), several generating companies (NTPC, NHPC, DVC, and BBMB). Other inter-state (and even inter-regional) companies are likely to emerge as some of the IPPs facing demand problems are allowed to sell in more than one state. These and others such entities as they are commercialized would feel the need to sell across state boundaries. The interregional and interstate sales of power which is currently restricted due to illdefined policy, needs to grow as the regulatory and policy uncertainties are overcome. Thus, a meaningful tariff policy would have to include not merely the CPSU's as such, but also all potential participants in the interstate and interregional business. Similarly, tariff policy would have to address the issue of IPP contracts (Power Purchase Agreements) and how best they can be dealt with or recast in a more rational environment of interstate and interregional movement of power. The two objectives of "affordable power" and "development of markets" for power would demand that any tariff policy would have to necessarily cover ? ? Tariffs for transmission ? ? Transmission access rules ? ? Interregional and interstate restrictions (possibly) to protect what would otherwise become stranded assets ? ? Existing IPP contracts ? ? Demand conditions and capacity utilization and hence address the option of time of day pricing The reason for a special focus on transmission rules and transmission pricing is that much of the behaviour of entities and the options available to them in a decentralized situation (and it is already so given the separation of the PGCIL from other generating entities) would be governed a great deal by how transmission is conducted. It needs to be recognized that transmission is not adequately viewed as a profit maximizing business. Indeed if transmission entities are left to maximize their earnings, market failure in generation and distribution are inevitable (through grid congestion, access denial, etc).
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Thus restrictions, including on ownership, and appropriate structuring of transmission entities, besides transmission pricing and access are the keys to commercialization of both generation and distribution. Experience elsewhere and a priori analyses tell us that the success of a decentralized system would depend upon the choices available to price elastic participants whether suppliers or buyers. Thus crucial to the emergence and successful working of a market is the existence of sufficient price elastic demand, i.e. bulk consumers. Today many of these have been repelled from the utility system by the absurd tariff structure of the SEBs, that has made the stand alone cost of power for large buyers lower than the price at which the utility (SEB) supplies! Similarly, the need to bring in as much of the elastic supply as possible would mean that the access (including access prices) to the grid would have to be easy and never above the true marginal social cost of access. Cost of access we define as the additional cost of installing meters, data loggers and monitoring rather than of grid capacity. Today in the rare instance when access is allowed, it is charged at very high rates. In the case of captive generators the current policy has effectively barred their access. It is necessary that such suppliers are brought on the state/regional/central grid, and interstate transmission would have to worry about such players. In other words, open access is crucial to overall efficiency and optimality of the system.

9 4.3 Towards a Tariff Policy

If indeed a market in wholesale power is accepted as a means for ensuring the lowest possible cost of power for consumers, then there is little reason to arrive at the tariff for bulk power. Instead, the focus would have to be on how best to create competition in generation. Nevertheless, such a change is likely to take time, and different state systems are likely to move towards that object of mercerization taking differing times. In order to remove the current distortions it is imperative that a tariff framework for interstate and interregional movement of power is announced quickly that is in keeping with the long term objective, but is not sub-optimal today.
Sector Utilities (CPSUs) (Part I) 9 Prof. Sebastian Morris, Towards a Tariff Policy for Central Power Sector Utilities (CPSUs) (Part I)

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The object of the policy should be to declare a time frame and a maximum barrier to interstate sale of power. This means that an import duty (and an export duty) should be the basis of restricting interstate transfer of power- not grid capacity per se. The base for the duty both import and export can be as follows: ? ? When the power is supplied (contracted and deemed to have been supplied) from a state system with a market in bulk power then the import duty is on the price prevailing at that time. Obviously, measurement of power by the hour at the relevant point on the grid would be necessary. ? ? Where the market is not developed then the contract price for power between the two parties across the state would be basis for levy of import duty. Cost plus has typically led to regulatory capture and generally higher prices and inefficiencies unless accompanied by rather special conditions. Cost plus (rate of return) assumes that some central body (the regulator) knows best and its behaviour is predictable and such as to result in all possible economies including those in the manner of capacity addition can be realised. However incentive regulation is particularly suitable to India today. Essentially it can be very light, reduce regulatory risk considerably, and be very inexpensive and quickly be put in place. And (with safeguards) it brings about large incentives on the part of the regulated to reduce costs. The question of what return is to be given to central power utilities is very important. Prices (whether determined through the market, or through incentive price regulation) would have to be such as to give an expected return on total capital employed that would allow CPSUs (and others) to go the market for both debt and equity. Moreover, there is little doubt that costing has to be on replacement costs basis at the margin, rather than on historical cost as is the case today.

10 4.4 Towards a Framework for Transmission Tariffs

Transmission charges ought to be viewed as consisting of three components

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? ? Connection charges ? ? Line loss charges ? ? Congestion charges The first is an access charge to the network and the second is a charge for actually using the network. The third is not really a use charge but a `rent' that reflects the scarcity value of portions of the network. These should be made nearly symmetric between purchases and sellers of power. Line loss charges are essentially to recover the cost of operations and need to be proportional to the use of the grid. It would have to proportional to the energy drawn or fed to the grid times the notional distance that the current travels. Notional distances can be worked out given the grid geometry and simulations of the current flow patterns. Congestion charges cannot be treated as earnings of the regulated transmission entity. Thus with connection and line loss charges the utility would have to earn the stipulated return if it performs as anticipated. Congestion charges would have to be levied only on those suppliers and buyers who come out as being the cause of the congestion given their contracted schedule of power supplies and purchases.

5. Tariff Issues
5.1 Current Tariff System

5.1.1 Bulk Purchase and Sales Order The Bulk Purchase and Sales Agreements (BPSA) of the NTPC with the State Electricity Boards allowed NTPC easier norms than optimal and created disincentives that resulted in NTPC with usually the lowest unit variable cost, being denied the high Plant Load factor (PLF) it is capable of achieving. Thus off-peak the BPSAs were such as to result in violation of merit order lowering the PLFs of NTPC stations. Similarly they allowed NTPC only a return of 12% on equity when even the average different cost to the prime borrower was higher. At the bulk supply level, electricity that is traded is either generated

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by NTPC, or is surplus from SEBs. Hence NTPC wields a great deal of market power at this level. 5.1.2 K.P Rao Committee Recommendations According to KPRC report the tariff structure for bulk electricity generation consists of 1) a fixed charge and 2) a variable charge. The fixed charge consists of interest payments on debt, return on equity (ROE), depreciations, fixed operations and maintenance (O&M) charges, interest on working capital, and taxes. Fuel cost essentially consists of the variable charges. Calculation of various components of the fixed and variable charges is based on certain normative parameters which have to reevaluated with time. The revised norm for ROE e.g. was from 12% to 16% at 68.49% of the PLF. Furthermore KPRC report recommends that power plants be entitled to incentives at the rate of 1 paisa per kWh above the normative PLF of 68.49 %. Currently NTPC tariffs are being determined in accordance with the KPRC report. 5.1.3 Current Mechanism of Transmission Pricing11 The basic elements of transmission tariff are as below: i. Interest on loan capital ii. Depreciation: Depreciation is calculated as per the norms of laid down by the Central Electricity Regulatory Commission (CERC) from time to time. iii. Operation and Maintenance (O and M) Expenditure: O and M charges are calculated @ 1.5% of the actual expenditure at the time of commissioning of the transmission line in the plain area and @ 2% of the actual expenditure at the time of commissioning of the transmission system in the hilly area. These charges are

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Puneet Chitkara, Rajiv Shekhar, Prem K. Kalra, Inter-state transmission of electricity: lessons from the

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escalated every year considering 60% weightage to the rise in wholesale price index and 40% weightage to the rise in consumer price index. iv. For the existing transmission system, the equity and loan component of the transmission systems commissioned is notionally divided 50:50 on the book value of the transmission system. The 50% of the book value of the transmission system is deemed as equity for the computation of tariff. 16% return on equity is a component of the fixed charges. v. Interest on Working Capital: working capital consists of O and M expenses for one month, maintenance spares at a normative rate of 1% of the capital cost, receivables equivalent to two monthsaverage billing calculated on normative availability level. vi. Tax on the following income streams: a) The 16% return on equity b) The extra rupee liability on account of foreign exchange variation in computing the return on equity not exceeding 16% in the currency of the subscribed capital c) The amount of grossed up Income Tax liability that is, payable and actually paid by POWERGRID under income streams at (a) and (b) above, relating to Power , Transmission Activity.

In addition to these fixed charges, PGCIL is entitled to incentives if the availability of the transmission system is certified to be above 95%. Incentive is applicable at the rate of one- percent return on equity for each percentage point increase in availability.

Disadvantages:

22

i. This is a traditional cost-plus kind of a tariff determination mechanism. Pure costplus regulatory regimes are best suited to environments with high cost uncertainty. Since Transmission Business in India is a regulated monopoly and is under government control, these uncertainties are reduced considerable, though not eliminated. In such conditions sliding scale mechanisms (combinations of cost plus and price cap mechanisms) should be ideally used. ii. These charges are allocated among the beneficiary states (in a particular region) in proportion of the energy drawn by them from the regional grid. This does not give the users an idea about the extent of resource usage and hence does not provide signals for efficient resource utilization. Moreover, there are certain resources in a region, which are not utilized for transmitting power for some of the states in a region. Such resources, however, are pooled together for the calculation of fixed charges. iii. Calculation of Availability for the transmission system requires the available time of each line and SVC equipment to be weighted by its rated capacity or Surge Impedence Loading (SIL) in case of AC transmission lines. Hence, even if a line requires being partially loaded due to some failure, its availability will still be 100%. Since the availability is system based, some states may have to pay towards incentives, even if specific equipment at the interface with that state is not available. iv. This tariff mechanism neither provides any incentive for optimal capacity expansion in transmission or for capacity expansion in generation. v. This mechanism does not provide incentive for optimal capital structuring. vi. There is no economic basis of load shedding.

23

vii. Total regional losses are calculated at the end of the month and allocated among the beneficiary states in proportion of their energy drawls. Hence there is no incentive mechanism which forces the beneficiary states to choose between setting its own generating station or drawing from the grid. viii. In the case of inter-regional transactions, the transmission charges for inter-regional assets are shared on 50:50 basis by the two contiguous regions. Some states in a particular region may have to pay even if they do not benefit from such transactions. ix. According to the order of CERC on petition no. 86/2000 dated 8th December 2000, the states (in case of wheeling of power through state utility system) should ideally agree on wheeling charges. If the two parties are not able to reach, an agreement the calculation is based contract path method or the verifiable opportunity cost of the wheeling utility, whichever is higher. The contract path, however may not be the actual path of power transmission. Though it is well recognized that tracing of flows may be quite involved, the opportunity cost criteria may be enforced for such transactions. This is because wheeling charges should provide incentives to build new lines and expand capacity when necessary. Wheeling charges should reflect system reliability costs. Power system reliability and security must be preserved

5.1.4 Determination of Norms for inter-State Transmission Tariff12 - CERC Order The provisions for sharing of charges for inter regional transmission of power are contained in Government of India, Ministry of Power's Notification dated 16th

12

http://www.cercind.org/2612/interstate.pdf

24

December, 1997 as amended vide Notification dated 3rd March, 1998. The relevant provisions are extracted below:(i) In case of firm power exchange the monthly transmission charges shall be shared in the following manner: a) One-third by beneficiaries of one region; b) One-third by beneficiaries of other region; c) Remaining one-third as per use i.e. the beneficiaries of the importing region which have received power as per the commitment. (ii) In case of non-firm power exchange the notification stipulates sharing of monthly transmission charges in the ratio of 50:50 between the contiguous regions.

The "firm power exchange" and "non-firm power exchange" are defined as under:??

'Firm Power Exchange' means the uninterruptible transfer of powers in an interstate/inter regional transmission line including the HVDC system, except in case of force- majeure, non payment and outage of transmission lines and / or generations units (in which allocations are made) and is committed by agreement, and / or understanding by selling, buying and transmission utilities for a minimum period of one month, unless a shorter period is specifically agreed to. The firm power exchange could be made between two regions out of unallocated quota / power surrendered by State(s) of one region out of their share in Central Stations or could be the power of State Electricity Boards for bilateral exchange between State (s) of one regions to State(s) of another region.

??

'Non-firm Power Exchange' means any power transfer in an inter-state / interregional transmission lines, (including the HVDC System) which is not covered in the firm power exchange as defined in (vi) above. Such exchange of power between the states or between the regions could be scheduled one day in advance or in real time operation during the course of the day".

Various views had been expressed regarding the sharing of the transmission charges. Some have argued for equal sharing i.e. in the ratio of 50 : 50 by the regions involved in inter-regional exchange of power since, according to them, the assets used are built for

25

transmission of power in either direction. Some others have suggested that only the importing region should pay the entire transmission charges. 5.1.5 Evaluation of the alternatives suggested This issue has to be examined in the light of the concepts underlying the planning and expansion of transmission system. The basic purpose of inter-regional links is to facilitate flow of power from surplus to shortage areas across the regions. In case, the transmission tariff for such transactions are fully loaded on the importing utilities, the total power flow on these lines may get limited and transmission charges per unit for such transactions would become high. This may discourage exchange of power from surplus to shortage areas. A line which is used for import by a utility during a certain period may be used by the same utility for export of power under some other condition. The differentiation between firm and non-firm power transactions would also be contentious. The arrangement of charging one-third of transmission charges as per use may also discourage additional investment in inter-regional lines. Also the fact that inter-regional assets are established for mutual benefit of both the regions by way of rendering timely assistance of power as per requirement, improvement in reliability and quality of supply etc. cannot be overlooked. Further, the establishment of reliable inter-regional links would facilitate formation of national grid. In view of this CERC said that till such time market based conditions drive such inter-regional transactions, the arrangement of sharing of the transmission charges for inter-regional assets on 50:50 basis by the two contiguous regions irrespective of the nature of power flow would be a better option and shall be followed.

5.2 Availability Based Tariff 5.2.1 Problems with the present system In order to understand the need for the emergence of the ABT it is important to understand the present problems in grid operation. Some of the problems are:

26

(a) Low frequency during peak load hours, with frequency going down to 48.0-48.5 Hz for many hours every day. (b).High frequency during off peak hours, with frequency going up to 50.5 to 51 Hz for many hours every day. (c).Rapid and wide changes in frequency 1 Hz change in 5 to 10 minutes, for many hours every day (d). Very frequent grid disturbances, causing tripping of generating stations, interruption of supply to large blocks of consumers, and disintegration of the regional grids.

These wide frequency fluctuations tend to cause serious damages both at the generation and load ends Experts consider these fluctuations unacceptable all over the world. In India though the problems have been identified, no progress has been made in bringing them under control. One important reason for this has been the absence of direct incentives or penalties for the individual utilities responsible for the problems. There has also been a general reluctance among all concerned to introduce financial incentives or disincentives. Resolution of these problems requires: a).Maximisation of generation during peak load hours and load curtailment equal to the deficit in generation. b) Backing down of generation to match the system load reduction during off peak hours, keeping the merit order of generation in view." These problems and their remedies have to be seen in the light of the present system of tariff. The present bulk tariff system does recognise the total cost as consisting of two elements, namely capacity cost and energy cost. In the present system, both the fixed cost and the variable cost of a generating station, are charged to the beneficiaries in proportion to the actual energy drawn by them during that period. 5.2.2 Proposed ABT System In the proposed ABT system, the fixed charge for a period is to be pro-rated among the beneficiaries in the ratio of their entitlement for power from that station. The logic is that,

27

the station was created for catering to these beneficiaries. Hence its fixed cost has to be borne by them according to their share in the capacity so created. As regards energy charges, they are proposed to be charged only to the extent of the scheduled drawal by the beneficiary It is argued that Central generating stations (CGS) were set up to supply power to specific SEB Hence they must be responsible for the proportionate overheads (fixed charges), s. of the CGS to the extent that they have agreed to buy the CGS capacity and it is s available. Any running (variable) costs would be paid in relation to energy drawn which can even be traded. This argument entrenches the tie between generator viz. CGS and buyer by ensuring part payment of the fixed charge for the portion of the capacity that is allocated to the customer. Even if he does not need the supply, he has to bear the fixed charges. He can however, sell the capacity entitlement to others, and may pass on to the next buyer such part of the fixed charges that the new buyer is able to pay, depending on the needs of other suppliers and customers. In these circumstances, the regulator has to determine the tariff for each generating station separately, since the fixed charges will vary with each. The regulator has to get into the details of all costs claimed by the generator. By bifurcating the method of charging Capacity Charges (fixed) and Energy Charges (variable), the incentive for trading in power is enhanced. The beneficiaries have a claim on the capacity, which they can trade either within or outside the region. By isolating the variable charge, a beneficiary can again trade such power depending upon its needs, market demand and the economics of power in the home state. All this goes to develop the market for power . Apart from the two charges, a third charge contemplated in the ABT scheme is for the unscheduled interchange of power (UI charges). The UI charges are payable/receivable depending upon who has deviated from the schedule and also subject to the grid conditions at that point of time. This is the element, which is expected to bring about discipline in the system. This is stated to be effective because, UI charges will be payable/recoverable if:

28

a)a generator generates more than the schedule, thereby increasing the frequency b)a generator generates less than the schedule, thereby decreasing the frequency c)a beneficiary overdraws power, thereby decreasing the frequency

d)a beneficiary underdraws power, thereby increasing the frequency. These four are clearly identifiable instances of grid indiscipline. The corresponding UI charges will accrue to the benefit of the party who is adversely affected on account of the indiscipline, by any of the acts referred to above. This system of UI charges is absent in the present tariff mechanism. Presently there is over generation/under drawal during off peak time, and under generation/over drawal at peak time. Consequently, grid disturbances and violent frequency fluctuations take place in the system.

Average Frequency of time block 50.5 Hz and above Below 50.5 Hz and up to 50.48 Hz elow 49.04 Hz and up to 49.02 Hz Below 49.02 Hz

UI Rate (Paise per kwh) 0.0 5.6

414.40 420.00

Between 50.5 Hz and 49.02 Hz linear in 0.02 Hz step

The ABT enables despatch of power in relation to a schedule which can be given by every beneficiary based on the availability of allocated shares of CGS stations and other power that might be available.
??

Each day of 24 hours starting from 00.00 hours be divided into 96 time blocks of 15 minutes each.

29

??

Each generating station is to make advance declaration of its capacity for generation in terms of MWh delivery ex-bus for each time block of the next day. In addition, the total ex-bus MWh which can actually be delivered during the day will also be declared in case of hydro stations. These shall constitute the basis of generation scheduling.

??

Based on the above declaration, the regional load despatch centre shall communicate to the various beneficiaries their respective shares of the available capability.

??

After the beneficiaries give their requisition for power based on the generation schedules, the RLDC shall prepare the generation schedules and drawal schedules for each time block after taking into account technical limitations and transmission constraints.

The basic idea behind scheduling is to match the supply and demand on a daily basis at least one day in advance. It enables penal tariffs to be charged when power is drawn beyond the schedules. This feature of ABT can help to bring about a great deal of grid discipline combined with self-discipline on the part of all utilities. This is lacking at present. Another distinctive feature of the new system is the method of determining how much of the fixed charges are payable to the generating stations. The generating station cannot be paid all its permissible fixed cost, irrespective of the extent of the capacity utilisation, known as the Plant Load Factor (PLF). As per recommendations of the K.P. Rao Committee which was adopted in modified form by the Government for its tariff notifications (till May 15, 1999), a thermal generation station was entitled to reimbursement of full fixed cost (100%) in case it achieved a PLF of 68.49%. Sometimes, the actual generation might not be to this extent, due to factors beyond the control of the generator. Then a "deemed" generation was also taken into account while determining the capacity utilised, namely, the PLF. As against this system, the proposed ABT system will entitle the generating station to reimbursement of fixed cost based on the availability or declared capacity of the

30

generating station. The ABT proposal has measures to check and penalise excess/under declaration of availability. In order to incentivise generation, there must be rewards for increased generation. The present system has an incentive mechanism, which earns for the generator incentives at the rate of one paisa for every kWh generated beyond the prescribed PLF. For example, in thermal generation, for every kWh generated beyond 68.49% PLF, there is an incentive of one paise per kWh per percentage increase in PLF over and above the normal variable charges. As against this system, the proposed ABT contemplates incentives reckoned as a percentage return on the equity invested in the project. These incentive rates are also staggered, so that at certain higher levels of availability, the rate of incentive is lower than at the earlier level. This is intended to prevent excessive strain on the generating equipment. For example, under the draft notification, for a thermal station, incentive is payable @ 0.4% on equity for each percentage increase of availability between 70% and 85%, but the incentive rate is reduced to 0.3% for each percentage availability on availability beyond 85%. For coal based and gas/naptha based thermal stations of NTPC and NEEPCO the annual capacity charges are payable as follows: Availability Capacity charge 0-30% 30-70% 70% 70-85% Prorata fixed charge excluding ROE, between 0 and 30 %. Annual fixed charges (excluding ROE) plus pro-rata ROE between 30 and 70 %. 70% Full annual fixed charges including ROE 70-85% Full annual fixed charges + 0.4% return on equity for each 1 % increase in Availability beyond 70 %. 85-100% Full annual fixed charges + incentive up to 85% at 0.4% + incentive at 0.3% for each 1% increase in availability beyond 85 %.

100%

31

TARGET AVAILABILITY FOR VARIOUS TYPES OF PLANTS (IN Percentages)13 1st April 2000 to THERMAL COAL/GAS 80 1st April 2001 onwards 85 82 To be notified by the Commission LIGNITE 77 HYDRO 85

31.3.2001

The initial roll-out plan was as follows: Southern Region 1-4-2000 Eastern Region - 1-6-2000 Northern Region - 1-8-2000 Western Region - 1-10-2000 However the ABT roll-out ran into trouble with various SEBs approaching the courts demanding restraining the order. The ABT system was followed in the Eastern Region for a period of about three weeks during May, 2001. It led to considerably better grid discipline in a region where grid indiscipline was rampant due to opposite reason i.e. over-generation, under-drawal, high frequency and overall surplus.

5.2.3 Problems with ABT It is argued that all situations cannot be affected as desired by financial incentives, particularly when the disincentives are not being passed on14. In certain situations (and adherence to grid rules is a primary example) only credible denial (disconnection) can
13 14

R. Ramanathan.CERC Report Sebastian Morris, Towards a Tariff Policy for Central Power Sector Utilities (CPSUs) (Part I)

32

ensure grid discipline. The ABT presumes that the frequency would vary significantly from the norm of 50 hertz. As the grid frequency reaches 50 hertz its potential to regulate would decline. There is only one way to overcome grid indiscipline - disconnect overdrawing (and oversupplying entities). There are other measures through that would help. Foremost would be removal of the PLF based incentives for SEB staff, which makes the SEBs reluctant to backdown when the load goes down (off peak), to result in high frequency during such hours. The allowed rate of return as it exists has a major difficulty in that makes it completely unsuitable to a situation wherein the bulk of the external funds have to be raised in markets rather than from government or multilateral and parastatal financial institutions. The return today is on the equity base. This gives rise to perverse incentives to not look for the cheapest sources of debt and capital in general, to designate more of the funds as equity than is necessary since the equity rate (for IPPs) is far higher than the market cost of debt plus the risk premium due to the equity given the risk character of electricity generation as a business. The role of verification and certification of grid indiscipline, which leads to the imposition of unscheduled interchange charge, rests with the RLDC, a unit of the CTU, which itself is a commercially interested party. Though the central commission has noted in the ABT order that regarding the claim for payment of UI charges by transmission utility, specific instances of dereliction on the part of the transmission utility can always be brought up no rational commercial organization could be expected to adversely , affect its own profits by pointing out its own dereliction Moreover, given the entire . data on system operation is available only at the RLDC, it may be difficult for anyone outside the RLDC to know the exact nature of power system failure. Under the transmission incentive mechanism suggested above, load point indices at the bus level are recorded even by the state utilities and hence there is no monopoly of information.

6. International Experience
6.1 US Experience

33

America's electricity market is massive. Its total assets are worth approximately $500 billion and it has net revenues of over $200 billion annually. 6.1.1 Open Access The PURPA, the EP Act of 1992, and the latest FERC orders seeking to open up the electricity marketplace to competition all build on the open access philosophy of deregulation. Complete open access within the electric market would require all vertically integrated utilities to open their transmission and distribution facilities to rivals so they could "wheel" their power across those lines to customers. Currently, under the PURPA, the EP Act, and FERC No. 888, only "wholesale wheeling" has been required; independent producers have been given only the ability to sell their power to other generating utilities, who then make that power available for resale to customers along their lines. "Retail wheeling" would allow these independent generators to sell their power directly to any sort of final customer along the transmission/distribution lines.

Open access to existing networks is a somewhat controversial deregulation strategy because its application and continuation does require a small degree of transitional regulation and raises legal concerns about ownership and control of transmission networks. Open access has proven itself vastly superior, however, to the current regulatory arrangement. A retail-wheeling regime would reduce the scope of regulatory oversight significantly. Regulators who are currently charged with monitoring utility expenditures and second-guessing a range of utility investment decisions through prudence reviews would confine their focus to expenditures associated with the absorption and retransmission of power, and the maintenance of transmission capacity by the host utility in its capacity as transactor on behalf of retail buyers within its service territory. 6.1.2 Transmission Issues The Energy Policy Act (EPACT) created a new type of wholesale electricity generator, Exempt Wholesale Generators (EWGs), and provided these EWGs with a system to assure transmission of their wholesale power to its purchaser. Some lacunae in the EP

34

Act were remedie through Orders 888 and 889 of the FERC. Under Order 888, the Open Access Rule, transmission line owners are required to offer both point-to-point and network transmission services under comparable terms and conditions that they provide for themselves. The Rule provides a single tariff providing minimum conditions for both network and point-to-point services and the non-price terms and conditions for providing these services and ancillary services. This Rule also allows for full recovery of so-called stranded costs with those costs being paid by wholesale customers wishing to leave their current supply arrangements. Order 889, the Open Access Same-time Information System (OASIS) rule, establishes standards of conduct to ensure a level playing field. The Rule requires utilities to separate their wholesale power marketing and transmission operation functions, but does not require corporate unbundling or divestiture of assets. Utilities are still allowed to own transmission, distribution and generation facilities but must maintain separate books and records. FERC described four primary characteristics and eight functions as being essential for Commission approval of an RTO (Regional Transmission Organization). The required characteristics are independence from market participants, service region of sufficient size and responsibility for operational control and maintaining short-term reliability of the grid. The RTO is expected to: administer its own transmission tariff; ensure the development and operation of market mechanisms to manage congestion; address parallel flow issues both within and outside its region; serve as supplier of last resort for all ancillary services; administer an Open Access Same-Time Information System; monitor markets to identify design flaws and market power and propose appropriate remedial actions; it must provide for interregional coordination; and an RTO must plan necessary transmission additions and upgrades. 6.1.3 Retail Wheeling Encouraging competition in the electric supply system is already occurring as some states allow retail wheeling. Since this remains under state regulatory control FERC hopes that its Orders will pave the way for states to permit retail wheeling.

35

However, mandatory retail wheeling subverts the market order by discouraging alternatives to the heavily regulated monopoly system. Compulsory access to the grid would lessen the incentives for third parties to form alternative networks or various userowned arrangements. The market experiments necessary to discover more efficient institutional arrangements for the grid will proceed far slower and more haltingly under a regime of mandatory retail wheeling. Retail competition would lead to increased exports from low price states and increased interstate transmission. Utilities in low price states would have to be relieved of their obligation to serve customers in their franchise areas. Transmission interfaces will become crucial under retail competition and interstate shipments will be subject to regional regulation. The underlying market forces are expected to shape the evolution of prices and interstate trade. The price elasticity of demand depends on the amount of time allowed for adjustment, which consumer groups are included, and so on. Estimates of the price elasticity of demand for electricity in the literature fall between 0.5 and 1.0 in absolute value. There will be winners and losers with retail electric competition. The main losers in low price states will be residential customers. Large industrial customers might be able to bargain for lower rates, but export demand would put upward pressure on all prices in the exporting states. In the face of proposals to mandate retail competition at the national level, policymakers in low price states should realize the benefits of maintaining regulated low prices and the obligation to serve for at least the immediate future. After prices in the relevant electricity market have fallen and restructuring

schemes have settled, low price states can move to retail competition in a less costly fashion.

6.2 The United Kingdom 6.2.1 Electricity Act 1989

36

The Electricity Act of 1989 created an Office of Electricity Regulation (OFFER), which has primary responsibility for electricity regulation. The 1989 act also created the position of Director General of Electricity Supply, providing a single individual with responsibility for electricity regulatory activity. In the United Kingdom, generation was deemed an area where regulation was needed least of all and where a competitive market could develop most successfully. The only formal restrictions placed on the newly-created private sector power companies was that National Power and PowerGen sell their electricity to a national wholesale pool. No specific price regulation was initially intended for generation, as the pool was intended to produce market-based pricing. However, although OFFER's mandate was not to set pool prices, it had considerable influence over National Power and PowerGen through its authority to refer cases involving monopolistic behavior to the Monopoly and Mergers Commission (MMC). 6.2.2 Transmission In contrast to generation, the UK's transmission system was considered a natural monopoly. With the breakup of the CEGB, all transmission assets fell under the ownership of the National Grid Company (NGC). The twelve RECs assumed ownership of the NGC, although safeguards were put in place to restrict the RECs' influence over managing the grid. In addition to providing electricity transportation services throughout England and Wales, the NGC also supported the mechanism from which electricity supply and demand were balanced: the England and Wales Electricity Pool ("the pool"). The pool requires that electric power generators whose capacity exceeds 100 megawatts submit their generation units to dispatch by the NGC. The UK adopted a form of price cap regulation for transmission services known as RPI-X. RPI-X essentially imposed periodic price reviews and price caps based on changes in the overall rate of inflation (as measured by the retail price index (RPI)) less expected future productivity gains (the X). 6.2.3 The England and Wales Power Pool In order to balance electricity supply and demand, the UK government instituted a power pool to act as a clearinghouse between suppliers of electricity (generators) and wholesale

37

consumers of electricity (primarily the regional electricity distribution companies). The pool is open to all generators and consumers wishing to participate. Those electric power generators whose capacity exceeds 100 megawatts are required to submit their generation units to dispatch by the National Grid Company (NGC). The NGC manages and operates the pool with an independent facility that attempts to balance supply and demand with an auction, which roughly operates in the following manner. In the power pool every day is broken up into forty-eight half-hour segments. The system manager forecasts demand for each half-hour segment. Twenty-four hours in advance, generators submit bids for the various levels of power they are willing to supply at various prices and for various periods, for each half-hour period of the following day. The system manager then ranks these bids from least to most expensive. The system manager also calculates the minimum amount of generating capacity needed to meet demand projections. A merit order dispatch schedule is created whereby the cheapest generation units are selected first and supply is capped when enough generation units are selected into the system to cause generation capacity to be sufficient to supply one unit of energy over and above the forecasted demand. The pool purchase price for all suppliers becomes the highest price bid by the last generation facility needed to accommodate the last unit of demand. This balancing activity is an attempt to arrive at the electricity generation industry's marginal cost, or the system marginal price (SMP). The price actually paid to generators also includes a financial incentive for maintaining some additional (peak load) generation capacity in the event that demand exceeds consumption forecasts. This capacity payment equals the value of lost load (VOLL) times the loss of load probability (LOLP). The VOLL attempts to measure the system cost of not producing enough electricity to meet peak load or in other words extent to which generators are prepared to invest in additional capacity in excess of the actual maximum on the system. The LOLP simply measures the probability that supply will be insufficient to meet demand at a particular point in time. The LOLP changes over the course of the year and the course of the day. The closer demand is to scheduled supply, the higher the LOLP and therefore the higher the capacity payment. The price paid to electricity suppliers is the pool input price (PIP), which equals

38

SMP + (VOLL * LOLP). The price paid by purchasers is the pool output price (POP), which equals the PIP plus an uplift charge, calculated to cover certain ancillary functions, such as reserve plant availability, forecasting errors, transmission constraints, and marginal plant adjustments. Thus, as a means of controlling price volatility, a hedging market has developed. This market (called the contract for differences market [CfD]) allows for bilateral contracts to be negotiated between generators and consumers. In the CfD market, generators and electricity purchasers can hedge pool prices by committing to a contract with an agreed-upon price, (the strike price). The strike price, for instance, may be set at an average of expected daily pool prices. If the strike price turns out to be higher than the daily average pool price, then the generator pays the purchaser the difference. Conversely, if the strike price turns out lower than the daily average pool price, the electricity purchaser reimburses the generator for the difference. 6.2.4 Pricing RPI-X is supposed to provide utilities with a stronger incentive to reduce costs than rateof-return regulation because the utilities themselves realize all the value of the cost reductions made beyond the benchmark. The other advantage of RPI-X regulation is that it is also designed to reduce regulatory costs and provide a disincentive for the regulated to engage in costly activities designed to influence the regulator (an activity called regulatory capture). The visibility of a single national regulator may also provide for more accessible public scrutiny of regulatory decisions. However, RPI-X regulation has some clear shortcomings, both theoretical and practical. One problem is calculation of the appropriate initial level of prices. In the United Kingdom, this proved particularly difficult because the government was also attempting to maximize the value of these companies for a successful initial public offering. Lower future electricity prices would have meant lower immediate gains to the treasury during the public auction of electricity industry assets.

39

A second problem involves estimating future productivity gains. In order to achieve the desired allocation of the future benefits achieved through realizing greater industry efficiency gains, the regulator would still need detailed knowledge of the industry and future market developments in order to come up with a suitable initial price and projected future productivity gains. In addition, X would represent not expected future productivity gains, but rather some theoretical cutoff rate for electric utilities to have an incentive to surpass in order to retain all of the cost reductions benefits that accrue beyond X. Thus far, in terms of economic efficiency, RPI-X has been a clear success. In the United Kingdom, the RPI-X regulatory approach has induced cost reductions well beyond expectations. Electricity companies have been able to greatly reduce operating costs in large part through substantial work force reductions. As intended, the electricity industry has benefited financially because these cost reductions have made substantial contributions to the bottom line results. However, substantial controversy has surrounded the new form of electricity regulation. In particular, some dissatisfaction has arisen over whether the efficiency gains (the economic rents) have been equitably distributed between the industry's stakeholders, i.e., investors, labor, and consumers. As a result of this controversy, several of the basic tenets of RPI-X pricing have become suspect.

Exhibit 1 DETAILS OF INTER-REGIONAL ENERGY EXCHANGES (All figures in MU) REGION 1996-97 1997-98 1998-99 FROM TO 1999-00 2000-01

40

Western Eastern Northern Southern

579.1 4.7 Nil

1154.2 5.1 Nil 1159.3 377.3 520.9 1.1 899.3 536.6 536.6 Nil 1200 820.2 454.4 2474.6

1060.1 14.9 184.1 1259.1 376.4 1499.8 Nil 1876.2 522.7 522.7 88.3 1461.6 1682.8 395.4 3628.1

700.2 29.4 70.8 800.4 599.6 1067.1 Nil 1666.7 518.1 518.1 394.4 2772.9 2492.1 397.2 6056.6

984.7 16.8 83.8 1085.3 573.5 323.9 Nil 897.4 658.5 658.5 455.4 2471.4 3812.6 493.6 7233

Sub-Total 583.8 Northern Southern Western Eastern Nil 164.1 Nil

Sub-Total 879.3 Western Southern Sub-Total 578.9 Northern Western Eastern Southern Nil Nil 301 578.9

N.Eastern 383.3 Sub-Total 684.3 N. Eastern TOTAL

Eastern

28.2

23.2

11

Nil

Nil

2754.5

5093

7297.1

9041.4

9874.2

Source: Central Electricity Authority

41

Bibliography

?? ?? ?? ?? ?? ?? ??

www.powermin.nic.in www.indiainfoline.com www.indiapoweronline.com www.rediff.com Chitkara, Puneet, et al, The Electricty Sector, IIR 2000 Chitkara, Puneet, et al, Morris, Prof. Sebastian, Towards a Tariff Policy for Central Power Sector Utilities (CPSUs) (Part I)

?? ?? ?? ?? ??

www.cea.com www.ptcindia.com www.cerc.com http://pier.saic.com/PDF/SDGE05.pdf Ramanathan K., Bathani Gaurav, Transition to a Liberalized Environment: Issues in Regulation, 1999

?? ??

www.economictimes.com/080100/08indu14.htm Vaney, Arther, Coordination and Pricing on An Open Transmission Network

?? ??

www.eia.doe.gov www.indiapoweronline.com/Scripts/GNT006C1.ASP

42