13 August 2003SAFIR Workshop - R. Sridharan1 MULTI YEAR TARIFFS (MYT), DISTRIBUTION MARGIN (DM) AND PRIVATIZATION IN KARNATAKA

13 August 2003 SAFIR Workshop - R. Sridharan2 Some preliminaries Means and Ends Part of a large jigsaw Need to look at the whole picture

13 August 2003 SAFIR Workshop - R. Sridharan3 Distribution Margin A method of providing a predictable, performance based payment for electricity distribution services to an ESCOM during a transition period 2 components, Base Revenue and Incentive Charge Base Revenue = Cost of operating the distribution business PLUS a reasonable minimum equity rate of return (below market expectations)

13 August 2003 SAFIR Workshop - R. Sridharan4 Distribution Margin Incentive Charge – Predefined proportion of collection above the Minimum Collection Requirement (MCR) that the licensee can retain Bidding for the equity of Discoms on the basis of Incentive Charge MCR – if not achieved, the discom pays penalty

13 August 2003 SAFIR Workshop - R. Sridharan5 Distribution Margin Specific Service Standards to be established for the Transition period Progressive, gradual transition to international standards Cap on returns or sharing mechanism for the equity return of discoms Power purchase by discoms at BST set by KERC – deficit in cash flows to be filled by Govt

13 August 2003 SAFIR Workshop - R. Sridharan6 Risk Allocation Still under preparation Expected that discom would bear a reasonable share of the risks Most risks to be allocated either entirely to the discom or shared between the discoms/Govt.

13 August 2003 SAFIR Workshop - R. Sridharan7 MYT - A Wide Spectrum A “ just and reasonable ” return Specific rates of return on capital Specific numbers, benchmarks General principles Related to output prices or input costs

13 August 2003 SAFIR Workshop - R. Sridharan8 MYT in Karnataka Legal clarity felt necessary Amendments propose Transition Period contract between private investor and Government –To override all other provisions of law –To be based on successful bid or resulting from negotiations –Not to be amenable to any amendment or modification once private investor is in –With right to investors to obtain specific performance or full compensation

13 August 2003 SAFIR Workshop - R. Sridharan9 Transition Contract contents DM mechanism Mechanism for allocation of wholesale supplies and compensation to licensees for shortages Mechanism for allocation of supplies by licensees to consumer classes Incentives for efficient capital expenditure Compensation for loss caused by open access

13 August 2003 SAFIR Workshop - R. Sridharan10 Transition Contract contents Principles and procedures for determination of tariffs to move towards average costs while meeting service quality standards Specific values for different elements of tariff and tariff formula Targets fro gradual elimination of cross subsidies May include profit sharing mechanism

13 August 2003 SAFIR Workshop - R. Sridharan11 Transition Contract To be incorporated into licence Oversight of implementation of contract with ERC, but all decisions only with the Govt Govt entitled, in its discretion, to consult the ERC on all or any aspects of the contract Transition Period not to exceed five years

13 August 2003 SAFIR Workshop - R. Sridharan12 Three Different Problems Regulatory Uncertainty – about norms to be used and their levels Incentive effects of norms Risk sharing between investors, consumers and government

13 August 2003SAFIR Workshop - R. Sridharan13 The Information Problem Attempted Solutions

13 August 2003 SAFIR Workshop - R. Sridharan14 Delhi MYT Scheme Uses AT&C Loss Input Energy and Cash Collection are the only reliable figures Uses intermediate data as well May result in anomalous results

13 August 2003 SAFIR Workshop - R. Sridharan15 Delhi MYT Scheme

13 August 2003 SAFIR Workshop - R. Sridharan16 Karachi MYT Scheme Apparently simple Tariff changes on account of Fuel price, Purchased power and O and M Clawback for excess return Norms not specifically mentioned Has it facilitated privatization?

13 August 2003 SAFIR Workshop - R. Sridharan17 UP – Reference Utility Model Enormously data intensive Data from utility records used Numerous assumptions A virtual utility?

13 August 2003 SAFIR Workshop - R. Sridharan18 Retail Tariffs No MYT scheme can ignore absolute levels of retail tariffs Impact of Power Purchase Costs Sharply increasing cost of new power

13 August 2003 SAFIR Workshop - R. Sridharan19 The Information Problem – a view “ On price setting, what has become absolutely clear is that it is not a science, but an art and is dependent on a number of factors not envisaged at the time of the design of the basic price control system. It has been demonstrated above that the hoped for degree of stability has not been obtainable, and the late amendment of the distribution price control proposals was such as to create a real crisis of regulatory legitimacy. This is not to say RPI-X formula does not have advantages, but rather that they lie in efficiency incentives rather than in the promise of stability; no formula can be immune from public and political pressure where the providers of basic services are seem to be making excessive profits.

13 August 2003 SAFIR Workshop - R. Sridharan20 The Information Problem – a view ( contd) The circumstances of the amendment of the proposals illustrate vividly two problems concerning regulatory procedures. First, statutory consultation on licence amendments has not been treated as offering any serious possibility of affecting outcomes, and secondly even wide statutory powers to gain information are not sufficient in themselves to prevent regulators from being seriously misled; what is additionally needed is some forum for competitive debate and analysis of information offered, and here OFTEL procedures offer important lessons ”. (Tony Prosser. (1997) Law and the Regulators. Oxford. Clarendon Press. Page 179, emphasis added).

13 August 2003 SAFIR Workshop - R. Sridharan21 Incentive Effects of MYT Levels at which norms are fixed is crucial The Delhi sharing scheme – will reported AT&C loss be lower than the minimum? Hygiene and Motivation factors Comparative strength of incentives

13 August 2003 SAFIR Workshop - R. Sridharan22 Risk Sharing in Privatization Government behavior – will risk sharing bring desirable changes? How “ imminent ” is the collapse of the system? Will norms emerge out of competitive bidding? What role should regulators play?

13 August 2003 SAFIR Workshop - R. Sridharan23 Process – a view “ This ” (how decisions taken at the time of privatization determined the parameters within which regulators had to work) “ is also true as regards the chief regulatory controls on the privatized enterprises. The licenses contained lengthy conditions determining the environment in which the enterprises were to operate. These conditions were not set by the regulator, but by the minister after private negotiations with the enterprise; for example, in setting the licence conditions for British Telecom, the Post Office Users National Council, which had previously represented consumer interests, was not allowed to participate.

13 August 2003 SAFIR Workshop - R. Sridharan24 Process – a view These conditions were of absolutely fundamental importance in determining the operation of the enterprises; in particular the conditions limiting price increases have proved the most controversial issue in the whole of utility privatization. As will be demonstrated in later chapters, there is ample evidence to suggest that conditions were set too generously in an attempt to assist the privatization process, and much of the work of regulators has been to tighten the controls and avoid the prospect of unduly large profits being made by the companies ” ( Tony Prosser. (1997) Law and the Regulators. Oxford. Clarendon Press. Pages 47-48).

13 August 2003 SAFIR Workshop - R. Sridharan25 The way ahead From Regulatory Uncertainty To Regulatory Certainty Via a Regulatory Holiday Leading to Regulatory angst?