CHAPTER 5

5. GENERATION TARIFFS

International experience in restructuring of the electric power industry indicates that generation is the first segment of the industry, which is opened to competition. In India also, the liberalisation of the power sector was commenced by introducing private sector competition into generation. The Mega Power Policy of the Central Government has already opened the area of tariff setting for such project to market forces by opting for the competitive bidding route. However progress beyond entry point competition is restrained by the overall deficit in supply and the need to step up investments. Private sector investors and debt providers have so far insisted on transferring market risk to the consumers as a precondition for investment inflow. Generation stations have long term contracts which insulate them from all market risk, defined as the possibility that they may not be able to sell their production. Long term contracts restrain competition. Hence the tariff design has to simulate the beneficial impacts of competition to extract efficiency improvements. This chapter defines the regulated entities, reviews the primary objectives of the Commission while setting thermal and hydro generation tariffs and identifies options for tariff setting. These objectives, strategies and issues are specific to generation tariffs. The more general issues have already been separately discussed in Chapter 4. The reader would be advised to keep these general issues in mind while perusing this chapter.

5.2 Regulated entities in generation

NTPC, NLC, NEEPCO and NHPC are the primary entities in the central public sector, which are under the regulatory jurisdiction of the Commission. There are several other power utilities in the central public sector, which are not incorporated under the Companies Act and hence are not currently, under the jurisdiction of the Commission. Any other generators, which may be established in future, under a composite scheme, for the generation and supply of energy, in more than one state, will also be under the regulatory jurisdiction of the Commission. However there no such projects are under construction though the central government is considering some proposals.

5. 3 Objectives of Tariff Setting

5.3.1 NTPC commands the largest share of generation within the capacity under the regulatory jurisdiction of the Commission. NTPC is a progressive company with strong fundamentals. However, its financial credibility faces threats on account of the accumulating burden of current assets due to bills remaining unpaid by SEBs or their successor entities. The SEBs on the other hand complain that much of the outstandings are on account of over generation by NTPC and other bills under dispute. The Commission is committed to resolving the situation.

5.3.2 The Commission is concerned that the long time gap, since the operational norms were notified in 1990, has resulted in their no longer being challenging. While, over the last ten years, they have been responsible for considerable improvements in efficiency they now need to be revised. Such revision will reduce the burden on SEBs, and their successors, by lowering the tariff for bulk power.

5.3.3 The Commission is concerned about the falling share of hydro power in the generation profile. It intends to ensure a tariff which induces incremental investment in hydro while preserving its status in the merit order, as a must run technology.

5.3.4 Currently generators bear the cost of providing reactive power even though the corrective steps for reducing reactive load are not within their control. Generation of reactive power, at the cost of real power, is an avoidable efficiency loss. The cost of meeting reactive power demand must be transferred to consumers

5.3.5 The Commission would like to implement competition in bulk supply and allow market determination of the price for such supply.

5.4.1 Unbundling of Generation Tariffs

The Commission has already heard the petition and the responses filed in Petition No.2/1999 regarding the Availability Based Tariff (ABT) proposed by the Central Government. This proposal intends to implement a two-part generation tariff which unbundles the availability charge from the energy charge. This availability charge will be payable by all those SEBs, who have either contracted for capacity creation with the generator, or to whom capacity has been allocated under the Gadgil formula. The availability charge will comprise of all fixed costs, which have been prudently incurred by the generator as a consequence of installing capacity. Its recovery will be linked to a target availability. Underachievement will result in under recovery of the fixed costs while over achievement will result in an incentive over and above recovery of fixed costs. The availability target will be set at challenging levels.

5.4.2 Redefinition of operational norms

The Commission would like to introduce a tariff regime, which ensures a continuous improvement, in the efficiency with which energy is supplied. It feels this can best be done by a regime which rewards performance through incentives. Towards this end, it will introduce, either a PBR regime or a regime based on RPI minus X. In determining the operational norms it is considering the use of the operational norms finalised by the CEA in 1997. These are expected to reduce the cost of bulk energy supply.

5.4.3 Incentives for hydropower

The uncertainties of hydropower development have deterred the private sector so far from investing in this energy resource. The public sector projects on the other hand do not, in practice, have a hard budget constraint. This is one reason why public sector entities have found it easier to develop this resource. A cost effective way to compensate developers for the uncertainty of hydro power development will need to be formulated.

5.4.4 Reactive energy charge

Reactive energy supplied by generators at the cost of real power could be charged to the SEBs as a separate charge.

5.4.5 Introduction of competition and power markets

A competitive market for generation requires some surplus capacity in generation and transmission. This does not appear feasible in the short run. However, the possibility of introducing partial competition can be explored on a regional basis.

5.4.5.1 One alternative, is to introduce competition during off peak periods. The appropriate definition of peak and off peak periods will be a precondition Presently, REBs notify peak and off-peak periods. Appreciating the considerable scope for regional variations, the methodology for such identification would need detailed examination. The experience with IPPs so far indicates that incremental investments in generation are dependent on the assured payment of fixed cost linked to availability targets. The problem is that assured payments of fixed costs reduce incentives for progressive cost reductions by generators. In fact, if the full fixed costs and return on the rate base are recoverable on the basis of availability and the energy charge only reflects actual variable costs, the generator has no particular incentive to be despatched. He only has an incentive to be available. The purpose of proposing competition at off peak is to incentivise the progressive reduction of variable costs and to allow actual variable costs to be revealed. The possible outline is given below: