EXECUTIVE SUMMARY: Issues in tariff setting

---

1. Tariff design: The existing tariff structures in bulk power are simplistic. In generation, for all practical purposes, there is a single part tariff. In transmission, costs are averaged on a regional basis for tariff determination. Unbundled tariffs have the advantage that they provide discrete price signals for efficient decision making by consumers. They enable a consumer to choose those services, which are beneficial and avoid those which are not. Tariffs can be unbundled in several ways as described below:

(a) Organisational domain: Currently, tariff is determined at the station level for generators. Hence, a station with several units added over time in phases will have an average tariff for all the units. In transmission, tariffs are determined on a regional basis for POWERGRID. A region will comprise of several discrete lines constructed over time, all of which will have the same average tariff. It may not currently be possible to go below the station level in determining generation tariff. However, in the case of transmission, the proposed induction of private transmission lines into the interstate system will require that tariffs be determined separately for such lines. Accordingly, it would be appropriate, to similarly segregate some select lines of POWEPGRID, where the flow characteristic enables separate determination of tariffs.

(b) Nature of service provided: Tariffs can be unbundled on the basis of the services they provide. The capital cost of generation can be allocated to a fixed charge to cover the costs of availability of capacity. The availability of a generator assures a consumer that energy will be available on demand. An energy charge separately meets the fuel and variable cost of supply when a demand is raised. This structure is already in place in IPP contracts. Generation tariffs can also be firm and non firm. Some non-firm contracts already exist, between SEBs and captive power units who have an arrangement to sell surplus power to SEBs. Firm power contracts however are of the type entered into between IPPs and SEBs and the central generators and SEBs. So long as the Commission, and not the market, determines the tariff for generation, a two-part generation tariff is necessary for efficient use of generation capacity. All the five regions suffer from shortages in peak supply. Hence firm supply contracts are unavoidable during peak time. However, generation capacity is surplus during off peak. Hence non-firm supply contracts may be more efficient and optimise the cost of supply during off peak, when generators will be bound only by their short run marginal costs and the SEBs, or their successors, by the avoided cost of alternative supply. For such contracts the Commission would determine only the price cap chargeable by the generator, leaving it to the buyer and seller to negotiate the sale price.

(c) Time of use: Generation tariffs can also be classified on the basis of time of day, day of the week and season of supply. Transmission tariffs can be segregated according to the demands imposed on a line at a point in time. When demand exceeds supply transmission tariffs could reflect the cost of congestion. The Commission is inclined to explore the possibilities of time differentiated tariff. Such tariffs will send the correct price signals for a flattening of the load curve by shifting the energy demand of large industry from peak to off peak. In the case of small industry, commercial and domestic users, inadequate metering restrains time differentiated retail tariffs Despite this handicap, the Commission feels that the cost-push effect of time of use tariff for bulk power could incentivise distributors to take steps towards more effective demand side management.

(d) Incentives for environmental management: The Commission has a mandate to assist in the framing of environmental regulations. Consequently, the Commission is considering an audit of costs incurred by generating stations to meet environmental norms, with the intention of disallowing costs incurred without the consequential environmental benefits. The Commission is conscious that the growing requirements for power in India will need to be supplemented by renewable sources if they are to be met in a sustainable manner. Renewable sources of power have an advantage in that their variable cost is negligible. However, the capital cost of investment is much higher, than comparative costs for fossil fuel based electric power. One reason for the high capital costs is also the low scales of production, particularly in the case of new renewables like wind power and solar power. In the case of hydropower, geological and hydrological uncertainties increase risk perceptions. The Commission could consider recommending a mechanism for cross subsidisation of renewable power through an environmental levy on fossil fuel based generators. This levy can take several forms; for example, a cess on fossil fuel based generation, payable to renewable generation, as an incentive, backed by obligatory purchase of renewable power by bulk suppliers, with the option, for trading of obligations between generating stations.