Karnataka's power privatisation roadmap

Distribution margin and risk allocation approach will be adopted

The government of Karnataka, which pioneered the unbundling of electricity transmission and distribution entities, has announced its strategy to privatise distribution. The government will adopt the distribution margin and risk allocation approach (DM approach) for privatising the business.

Under it the distribution company will be allowed to earn a distribution margin as compensation for operating this business satisfactorily during the transition period.

The approach has been developed with the objective of privatising the electricity distribution businesses in the entire state and not limiting it to cover urban centres only, as has been widely anticipated. Karnataka currently has four distribution companies based out of Bangalore, Hubli, Gulbarga and Mangalore.

Fifty one per cent of the equity of a distribution company, Escom, will be divested to a bidder who offers the lowest incentive charge.

The incentive charge is one of the main components of the DM approach. It will be a predefined proportion of the collection (paisa per rupee collected), above a specified minimum collection requirement, that the Escom will be allowed to retain.

Said a senior official at the Karnataka energy department: "The incentive charge represents the investor's return above the base return on equity fixed as part of the base revenue."

The incentive charge is designed to maximise the total revenues and efficiency of the electricity system by taking care of the major problems associated with electricity distribution "" technical and commercial losses.

In addition to this component, the DM approach encompasses the base reve nue, which is the amount of revenue that the Escom is allowed to retain to meet its cost of operating the distribution business.

"The base revenue will be set by taking into account the estimated total first year cost of distribution services, plus a reasonable minimum equity rate of return. This return on equity will be below market expectations for similar businesses in order to incentivise the Escom to earn a higher return," the official explained.

The rationale for the DM approach is that "it provides a commercial and regulatory framework for a transition period. During the transition period, since the investor will not be able to bear all the risks which it should normally bear, some of these risks will be allocated to other stakeholders like the government and government-owned companies. Meanwhile, some other risks will be mitigated through a number of measures. Once the transition period ends on satisfaction of the preconditions, these risks will be borne by the investors."

The DM approach is designed to ensure that the Escom has a reasonable chance to earn its revenue requirement, provided it meets its performance obligations and targets.

The government has stated that private entities, to successfully participate in the state's distribution business, will have to meet certain preconditions in the near to medium term. This will be done to make the power distribution business a viable investment opportunity.

"These pre-conditions include availability of credible and verifiable data on non-technical losses, consumption by agriculture, operational freedom to disconnect non-paying customers, control of theft through regulation and actual enforcement, and a track record of timely payment by the state government and its undertakings for both subsidy payment as well as consumption of electricity," the official noted.

Highlighting the buffers being adopted in this privatisation strategy, the official said: "As part of the DM approach, a detailed risk allocation matrix is being prepared to address the risks to be assumed by the Karnataka government, privatised Escoms and consumers during the transition period. The risk allocation will be so designed that the privatised Escom will bear a reasonable share of the risks associated with the distribution function, even during the transition period."

The state government is also looking at ways of mitigating some of the risks by introducing predictable multi-year regulatory principles.

To successfully reform the power sector, its financial health has to be restored step by step. This, the official said, has to be done in two ways: by the state government making a commitment on subsidies and the tariffs being "rationalised over a period of time to cost of service levels".

Accepting that various consumer categories are paying much below the cost of supply, he said that the transition to fully recover the actual cost of supply through adequate tariffs should be gradual.

"The state government will, therefore, continue to subsidise certain categories of consumers, directly or indirectly, though the amount of subsidy will decrease over time," he asserted.