Regulated tariffs are here to stay

They are stable and power plants as well as consumers stand to gain from them

With a pan-India thrust on electrification, the nation has become flush with power generation capacity in the last six to eight months. This was further aided by the generation sector delicensing under the Electricity Act, 2003. The spurt in merchant market prices between 2008 and 2011 led power generation players to enter the market. 

India’s supply generation glut was exacerbated due to stunted demand, which brought down prices. Merchant market prices as low as Rs 1.50/Kwh — even lower than the variable cost of fuels — only compromised generation companies and their investors. As a result, power generation companies have left their assets stranded. Discoms have also become hesitant to undertake long-term power generation contracts that span a five to seven-year period. 

This pricing dichotomy raises several questions.

Do merchant prices truly reflect power demand and supply? 

Of the total electricity generation of 997 Gwh (October 2016), over 90 per cent was sold through long-term contracts. Clearly, merchant prices do not represent correct power prices. Power plants have always been set up to meet consumers needs for the long term. Therefore, investors have aligned resources for the long term. An average hydro plant, for example, may have an economic life of 35 years, yet its actual life can cross 50 years. Investment is needed not only at the start of operation but also during the asset's life and financial institutions assess long-term revenue visibility before lending to investors. 

Power transmission is also designed for longevity. Transmission networks planned by the CTU and STU are developed to transmit power for 25 years, if not more, to buyers. Long-term agreements make it possible to finance new coal mines, essential for regular fuel access. For this, PPAs of long duration are the only win-win solution for both generating companies and consumers. This was echoed by the Maharashtra Electricity Regulatory Commission order: “The Commission hereby directs both the parties to enter into an agreement within three months of this order to ensure long-term availability of power to Mumbai consumers.”

Why are power generation firms entering shorter-term contracts?

Historically, power generation has been price-regulated, even after the passage of the Electricity Act in 2003. Tariffs were governed either by the Sixth Schedule of the Electricity (Supply) Act, 1948, or determined by the Regulatory Commission. India’s electricity sector received new impetus under the Electricity Act, 2003; Competitive Bidding Guidelines, 2005; National Tariff Policy, 2006; and other government notifications. However, older plants faced pressure to enter into a PPA, keeping in mind the plant’s “used life”. The PPA period was decided to be shorter (approximately 10 years), as against 25 years (the usual period for a long-term tie-up of new plants). The tariff under such PPAs was determined by the Regulatory Commission.

ENERGY POSITIVE Historically, power generation has been price-regulated, even after the passage of the Electricity Act in 2003. India’s electricity sector received new impetus under this Act

Power plants under regulated tariff 

Across merchant power plants, investors were expected to shoulder the market risk of volatile selling prices. However, not all investors followed this business model. Many preferred the regulated route of tariff determination, favourable with high merchant market prices. The National Thermal Power Corporation, on the other hand, signed PPAs for 5,6205 Mw from May 1, 2005, to January 5, 2011. This, despite market conditions being conducive for merchant power plants. Hence, such investors must be treated differently from merchant market counterparts.

Recovery of investment in short-duration PPAs

Regulated tariff plants also need to recover their investments over their economic life. These require tariff to be determined on a “cost-plus” basis and the investment cost recovered over the economic life to the extent of 90 per cent through appropriate depreciation rates.

Hence, if an “initial” PPA period is less than its economic life, then the remaining period’s tariff should also be based on tariff regulations norms. It would be unfair to leave regulated tariff plants after the initial tariff period “in the lurch”, expecting them to participate in the merchant market. After all, the generating station expects to recover investment using the Regulatory Commission tariff — a legitimate expectation. This approach is the only viable option for a generating station to recover investment.

It is also a myth that investment in old plants is recovered as these plants are fully depreciated.

Moreover, expenditure on overhaul has been approved after assessing its prudence by the Regulatory Commission and has been capitalised. Owing to short duration of the PPA, but using a four to five per cent depreciation rate (representing a life of about 25 to 35 years), there is sizeable investment, which is yet to be recovered. Therefore, even such plants deserve a regulated tariff for a greater period.

Advantage to consumer 

The consumer will also benefit from extending the regulated tariff to the balance period, as regulated tariffs are stable. At present, merchant tariffs are low due to “suppressed” demand. However, discom growth from Make in India’s UDAY scheme can create price fluctuation. While India is trying to move towards more developed international merchant markets, it must avoid compromising the generation business’ health. One of the ways of ensuring this stability is for the PPA period to match the economic life, that is, 25 years for thermal and 35 years for hydro. While case 1 and case 2 competitive bidding for 25 years ensures predictability, another way to get viable tariffs is through the regulated route.

The author is managing director and chief executive of Tata Power