1.3.4 Till the establishment of central generating stations under the central government power companies from the early 1980's, the industry was dominated by vertically integrated SEBs and private Licensees. SEBs could purchase electric power from any person under the provisions of section 43 of the E (S) Act on terms as agreed between the contracting parties. However no defining principles were available for tariff setting and tariffs for individual stations were decided on the basis of mutual consent between the generator and the consuming SEBs. The absence of mandatory norms for tariff setting are said to have led to delays in settlement of commercial terms and required extensive negotiation de novo for every station. This was perceived to be inefficient. Consequently the central government constituted a committee under the chairmanship of Shri K.P.Rao Member (E&C) CEA to recommend alternative methods for the determination of generation tariffs of central stations.

1.4.1 The recommendations of the K.P. Rao Committee can be regarded as a landmark in the history of tariff regulation in India. Annexure II reviews the recommendations in detail. While the entire set of recommendations, which were very wide ranging and proposed a substantial change in the methodology of tariff setting, were not implemented by the government, four recommendations, which were implemented, significantly altered the tariff setting methodology.
Firstly, the concept of "deemed generation" was introduced which compensated generators, in the event of a station being available but forced to back down due to system constraint.
Secondly, the concept of two-part tariff, comprising fixed and variable charges respectively was accepted, though it was only implemented in part.
Thirdly, efficiency enhancing changes were effected in the existing incentive structure. Till 1991, the single part tariff was calculated such that full recovery of fixed costs was assured at a PLF of 62.8%. Generation below thss target level penalised the generator on the recovery of fixed cost, since the tariff got proportionately reduced. Conversely, generation above 62.8% resulted in significant excess revenue. The formula adopted post 1991 limited both the incentive and disincentive for recovery of fixed costs. The incentive beyond 68.5% PLF was lower than before while even with nil generation 50% of the fixed cost was recoverable.
Fourthly, for the first time operational norms were determined for station heat rate, auxiliary power consumption, specific oil consumption. More importantly, the norms were challenging relative to average performance levels at the time and hence laid the basis for performance based ratemaking.

1.4.2 Act No 50 of 1991 introduced Section 43A of the E (S) Act, which specifies that in the case of government owned generating companies the tariff would be decided by the state or central governments whichever owned the company. Tariff was determined on the basis of operational norms and PLF as determined by the CEA while the rates for depreciation and reasonable return were to be notified by the central government. It was under these provisions that some of the recommendations of the K. P. Rao Committee were notified by the central government and came to be used in tariff determination of central stations.

1.5.1 The Amendment Act No 50 of 1991 had also changed the definition of "generating company" to include privately owned generating companies. Accordingly a fresh set of norms were notified by the central government on March 30, 1992 to determine tariffs for both thermal and hydro generating stations to be set up by the Independent Power Producers (IPPs) in the private sector. These have been subsequently modified from time to time. Five primary changes were introduced in the determinants of tariff.
Firstly, the recovery of fixed costs was linked to deemed PLF (defined as PLF plus Deemed Generation) thereby making a departure from the past wherein the recovery of fixed costs was linked initially to the PLF achieved and then the deemed PLF. While deemed PLF is arithmetically the same as Availability, the latter has to be declared ex ante and requires the utility to commit to a certain level of preparedness for generation, while the former is a ex-post concept. The adoption of availability as a performance target for the recovery of fixed charges was therefore a natural culmination of the process of rationalisation begun by the K.P.Rao committee.
Secondly, the incentive structure was further revised. In the case thermal generation the deemed PLF for full recovery of fixed charges was fixed at 68.5%. For hydropower the target availability was 90% (subsequently reduced to 85% in 1998). An incentive in the form of a increase in ROE of upto 0.7% points for every 1% point increase in deemed PLF (Availability in the case of hydro) was determined along with penalty calculated as a prorata reduction in the recovery of fixed cost for deemed PLF / Availability below the target level.
Thirdly, along with the increase in the rate applicable for the central generators from 10% to 12%, the Return on Equity for IPPs was fixed a 16% per annum.
Fourthly, against the notional debt equity ratio of 50:50 for central generators, the debt equity ratio for IPPs was revised and the minimum level of equity fixed at 20%. The minimum stake of the promoter to be held as equity was fixed at 11% of the total capital. A cap was imposed on financing from the Indian Financial Institutions at 40% of total outlay (which has subsequently been relaxed).
Fifthly, upto 100% foreign equity was permitted with foreign exchange risk protection.

1.5.2 With effect from November 1, 1998 (and later for licensees as well), the central government revised the return on equity for central government generators also from 12% to 16% without making any change in the notional debt equity ratio of 50:50 applicable for such stations.