Power sector needs a regulatory overhaul
Insufficient regulated tariffs are the dominant reasons for discom cash shortfalls. Fixing this is necessary and urgent
The largest chunk of financial shortfall, ₹5.9 lakh crore out of ₹10 lakh crore, in electricity distribution company (discom) finances is due to systemic failures that create a so-called residual gap, we wrote in an earlier piece on these pages.
This calculation was based on cash received by discoms, which painted a direr picture of discom accounts than government calculations that are based on accrual accounts (where money is booked but may be received later, if at all). This was done as part of our studies looking into discom finances between FY07 and FY21.
The methodologies are different, and therefore, not comparable. An entity’s cash-adjusted gap (or surplus) gives insights that a balance sheet or a traditional profit-and-loss statement (calculated on an accrual basis) misses out.
The Power Finance Corporation (PFC) has also started releasing cash-adjusted gap statements, whose recent annual figures are close to the numbers in our studies.
Last week, PFC released FY22 discom data that shows a measurable improvement in aggregate technical and commercial (AT&C) losses, especially in the collection, where payment of subsidy arrears has helped; anecdotal preliminary data for FY23 accounts indicate a positive trend as well.
But even if there is no extra AT&C loss beyond the allowed targets, discoms will still face a shortfall due to the residual gap, our research shows. Government efforts with smart metres, for example, can help fix many issues, but the residual gap can only be addressed through regulatory mechanisms and cost-reflective tariffs.
Tariffs, by design, are meant to be cost-reflective, but our studies found an interesting phenomenon. When state electricity regulatory commissions set consumer tariffs in advance (ex-ante), they make a range of assumptions on costs and revenues, and set tariffs to cover costs. But the actual operations and finances (ex-post) show costs were almost always higher than planned, and revenues, for the most part, lower.
Couldn’t this just be bad luck? The fact that it is heavily skewed in one direction (costs over revenue) – costs rose ex-post in FY19 by 18% on average, and manifested in almost all discoms – suggests this isn’t random.
There is inherent pressure to keep tariffs low. We then teased apart the causes, and found that failures in performance such as AT&C losses were only about a quarter of the problem.
Other factors dominated, especially power procurement costs from generators. There were also measurable changes in revenue because the consumer mix changed.
These changes are not the fault of discoms, and should ideally be recoverable, in part or in full, through what is called a true-up reconciliation process (used to close the gap between estimated costs and actual costs) in future tariffs. But we found the true-up process is insufficient. In FY19, the ex-post cash-adjusted gap from tariffs and operational revenues grew to ₹1.64/kWh, or 22% of costs, but prior true-ups embedded in FY19 cost structures were just 7 paisa/ kWh.
There is complexity or even opacity in this process.
Worse, even if all the allowable changes were recovered, these may take several years to materialise. This creates a carrying cost for discoms, in the order of tens of thousands of crore annually. We thus need a revamp of the regulatory process to minimise the no-fault gap, which shows up as a residual. This may need not only higher tariffs up front (which is never easy, politically) but also greater transparency and timeliness in allowable costs and recovery mechanisms. This requires discoms (and their owners, the state governments) to work with regulators.
Because they are cash-strapped, discoms resort to a range of coping mechanisms. They are owed lakhs of crores by consumers and state governments.
Discoms, in turn, similarly delay even larger payments to generators and other suppliers. Over the last year, the government has launched a scheme to add liquidity and even pause interest penalties (late payment surcharges) imposed by generators as long as discoms are paying off their dues. These are welcome steps. But the larger issues of the residual gap and cost-reflective tariffs remain.
Proper tariffs aren’t just about discom viability, but are key for India’s entire energy policy philosophy, which relies on social welfare redistribution, where some consumers – especially commercial and industrial – overpay to cross-subsidise under-payers such as some households and agricultural users.
This entire equilibrium is at risk with the ongoing transition towards decarbonisation. Thanks to solutions such as rooftop solar, overpayers are going to be the ones to first cut down their purchases from discoms. This inevitably means we have to raise prices disproportionally on lower-paying consumers. Until storage technologies mature, such users are unlikely to entirely exit discom supply. But our tariff processes mostly do not reflect such issues or considerations.
Discoms are the last link in the chain of electricity supply but bear the most risk. The present system parks a whole chain of inefficiencies and distortions with them, such as ones of fuel supply and generation lock-ins. We must tackle all of these in coordination, otherwise, a fix on one side could simply become a zero-sum game elsewhere.
The good news is that the government’s efforts, technological shifts (renewable and digital solutions), and consumer pressures can all bring about improvements and change. How fast, and how smoothly, are works in progress.
Rahul Tongia, Rajasekhar Devaguptapu, and Nikhil Tyagi are senior fellow, fellow, and research associate, respectively, at the Centre for Social and Economic Progress (CSEP).
The views expressed are personal
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