Reforms jolt: Do we need competition in the power sector?

Discom privatisation, not competition among existing discoms, is perhaps the right approach at present

As of August 2009, Bihar had sought 16 extensions and Jharkhand, 19. Other states seeking extensions include Punjab (14), Tamil Nadu (12), Meghalaya (14), Kerala and Himachal Pradesh (10 each).
As of August 2009, Bihar had sought 16 extensions and Jharkhand, 19. Other states seeking extensions include Punjab (14), Tamil Nadu (12), Meghalaya (14), Kerala and Himachal Pradesh (10 each).

By Somit Dasgupta

Restructuring of the electricity sector in India was initiated through the Electricity Act 2003 (Act), though a few states had already passed their own reforms act—for instance, Odisha (1995), Haryana (1997), Andhra Pradesh (1998), Uttar Pradesh, Karnataka and Rajasthan (1999), Delhi and Madhya Pradesh (2000) and Gujarat (2003). We also had the Electricity Regulatory Commissions Act, 1998 that paved the way for the setting up of the Central Electricity Regulatory Commission. The two main features of all these reform acts were unbundling the monolithic state electricity boards (SEBs) into separate entities of generation, transmission and distribution and setting up of the state electricity regulatory commissions so as to relieve the government from the task of tariff determination. This entire process was, no doubt, time consuming as some states were not eager to unbundle and sought repeated extensions from the Centre. As of August 2009, Bihar had sought 16 extensions and Jharkhand, 19. Other states seeking extensions include Punjab (14), Tamil Nadu (12), Meghalaya (14), Kerala and Himachal Pradesh (10 each).

The enactment of these reform acts had little effect on the functioning of the sector—especially the distribution sector—and the financial health of the discoms continued to go downhill. The policymakers’ attention thereafter turned to markets and competition as if the lack of these features held back the turnaround of the sector. Many models for initiating competition have been discussed over the past decade or so. While the Act already makes certain provisions in this regard (though inadequate as it does not recognise that the wires business is a natural monopoly), some other models are being contemplated through amendments in the Act. One such idea of competition was to have more than one retailer in one geographic area and have only a single wire company whose services will be used by all retailers. The latest model that we are now contemplating is delicensing distribution, meaning several discoms will operate in a single area. The nuts and bolts of such a model will only become known over time.

What we seem to have overlooked is that there are a few prerequisites for competition and markets to work. According to Hunt and Shuttleworth (1996), “countries where the electrical system is not yet on a sound and commercial footing may reasonably choose first to get the tariff in order, persuade people to pay their bill and get the accounting system in place, before introducing further complications of spot markets and open access.” It would also be pertinent to hear what Paul Joskow (an authority on power sector deregulation) has to say on restructuring. According to him, an incomplete market structure is bound to fail, and one example is that of the restructuring that was done in California (1998). In California, the generation sector was deregulated whereas retail tariffs were kept fixed. When the generation prices went through the roof because of enhanced demand on account of a combination of factors, the distribution companies went bust because they could not recover the enhanced prices from the consumers (2000).

In the case of India, it is not just the problem of consumers not paying their bills that is leading to abnormally high commercial losses. We have a system of cross-subsidies that, at times, are so huge that they make the industrial sector non-competitive. We have a large section of consumers who are not metered and are billed on a normative basis. We want to promote open-access, but have a high open-access surcharge which defeats the entire purpose of having open-access. We have a very complex tariff schedule, running into dozens of categories. We try to promote renewable generation through a system of renewable purchase obligation (RPOs), but that is rarely enforced by regulatory commissions. There is also a talk of introducing a hydro purchase obligation (HPOs) to promote hydro projects under construction. In addition, we also have a complex system of calculation of inter-state transmission tariff wherein renewable generation is exempt from paying transmission tariff. The ultimate consumer gains nothing from this since the transmission tariff gets loaded on the non-renewable generation. These are only an illustrative set of examples to show how complex the sector has become from a governance point of view, and how introducing competition and markets at this stage is premature.

Why are the policymakers in India so fixated with competition? Is the consumer in this country really bothered as to who his retailer or discom is, as long as it delivers reliable power supply? As far as retail prices are concerned, there cannot be much difference between retailers since 90% of the power is through long-term power purchase agreements (PPAs), which means all retailers face the same power-purchase cost. Considering the fact that power purchase cost constitutes about 80% of the cost of supply, where is the scope for competition? Moreover, in countries like the UK, where retail competition was introduced, the small consumers saw no benefits since they hardly changed their supplier due to high transaction costs. In fact, in the UK, it is the regulated business, i.e., the wires business that actually saw a fall in costs, not the competitive portion, i.e., retail supply. Finally, the irony is that the UK, which had started with vertical utilities, underwent deregulation, right from generation to retail, but has now gone back to the structure of vertical utilities, where 70% of the power generated is being supplied by the vertical utilties. Despite seeing all this, we are still burning midnight oil, trying to introduce competition.

Our policymakers (and also our regulators) need to be clear-headed with regard to what is likely to work under the Indian conditions. We only need to privatise our discoms and do a little hand-holding during the transition period. During this transition period, some financial assistance needs to be extended to the discoms so that they are able to reduce their commercial losses and stand on their feet within 3-5 years or so. The bottom line is that we should prescribe the right medicine for improving the functioning of the power sector—which is privatisation. Trying to introduce competition and markets at this stage is, perhaps, just the wrong medicine.

The author is Senior visiting fellow, ICRIER, and former member (Economic & Commercial), CEA

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