ET Energy World, May 31, 2021
By Shakti Sinha and Sarthak Shukla
In an attempt to address the increasing population of venomous Cobra snakes in Delhi, the then colonial government formulated a scheme that offered a bounty to be paid for every dead cobra brought to the officials. The success of this scheme was short lived as enterprising people ingeniously started breeding and killing cobras to be presented before the administration in lieu of bounties. The scheme had to be scrapped, but it entered the lexicon of economic governance as the Cobra effect, a term coined by the economist Horst Siebert. Such counter-intuitive outcomes are more often than not a result of linear thinking for addressing complex problems.
The Cobra effect phenomenon has resulted in the Indian power sector compounding the problem of poor financial health of the sector.
Power regulators has invented an accounting device, Regulatory Assets, a concept that goes against all accounting norms. In essence regulators accept that the power tariff does not adequately covers the costs of procurement, but the lacking courage to pass on the costs to the consumers and the inability to enforce higher efficiency norms in the industry results in the difference between the costs and sales revenue being classified as regulatory assets. In other words, they recognize the expenditure but do not take such into account while fixing tariffs. The magnitude of this problem has gone beyond control, estimated to be Rs 76, 963 crores as per a report by India Ratings.
Unable to actually deal with the problem head on, regulators often allow a surcharge to be charged from the consumers so that the uncharged amount can be recovered incrementally. However, the surcharge is often less than even the carrying costs of this revenue gap, leading to a cascading effect.
The concept is not just a perversion of accounting norms but is also flawed financially and ethically. It is not an asset since it represents electricity consumed that cannot be monetised. Two, by not allowing capital costs to be recovered, it constrains the health of the sector, and would ultimately impact on the quality of service. In any case, it is hard to segregate such investments from the larger distribution and subject them to seizure by lending entities. These factors inhibit banks from extending credit to distribution companies against these fictional ‘assets.’ There is a strong ethical argument in that it is passing on current consumption charges to tomorrow’s customers, including to the unborn, looking at the level and rate at which regulatory assets are growing.
The regulators and policy makers seem to ignore that complexity of the problem. A linear thinking approach for addressing this problem would suggest either cutting expenditures of the distribution utility or increasing their revenues. However, the problem has complicated linkages, causes and consequences. For instance, in additional to sub-optimal tariffs, the revenue collections are inadequate for multiple and varied reasons across the country. Technical and commercial losses could be disproportionately higher leading to less revenue recovery with respect to cost of supply. In some cases, the expenditures might be disproportionately high owing to inefficient power purchase agreements, higher financial costs, poor infrastructure, low levels of technology adoption, poor capacity of state agencies to recover power bills from consumers, wilfully defaulting consumers, higher levels of pilferage and theft, amongst a host of other factors.
In addition to these factors, there are intertwined social, political, environmental and behavioral externalities acting as catalysts in this process. Cross-subsidising the power tariffs by collecting higher revenues from well-off consumers (industrial, commercial and domestic) to provide subsidised tariff to low-income households and agricultural consumers has its social as well as political significance. It is no wonder that subsidised tariffs have found a concrete place over the years in election manifestos of political parties across the spectrum. Similarly, the race to adopt renewable energy sources because of their environmental benefits is another externality affecting the fiscal prudence of the power sector.
The result of these failures has adversely affected the health of the power sector, which has larger social and economic implications for the countries. While the total installed capacity has risen to 382 GW, while peak load is just 182 GW. The net result is that on the one hand, many generation plants are either non-operational or operate at low levels of capacity, thus affecting the health of the industry and of the lending banks. On the other hand, our per capita consumption is just 1181 kWh, against the world average of 3260 kWh, depriving much of our population of minimum energy needs.
To top it off, there are deeply rooted motives in the regulatory processes and decisions. With a questioned independence, Independent Regulatory Agencies are likely to serve interests of political masters rather than the public. Their appointments are seen as rewards for past actions that favoured the government of the day; domain expertise and capability are clearly at a discount. What we desperately need is to create conditions where regulators work in the public interest instead of being a safety-valve for the government of the day for blame shifting and politics of optics.
Each of the factors mentioned above operate in a system. There are intrinsic structural and systemic factors leading to such operational and behavioural outcomes. These require holistic diagnosis which is decentralised and sensitive to regional realities.
Unfortunately, regulatory assets are seen as a solution instead of adopting an approach that takes into account the complexities of the problem it aims to solve. In absence of a concrete, realistic and carefully-drawn liquidation strategy, which addresses the complicated factors causing the financial stress in the power sector in the first place, these assets would remain liabilities, and grow exponentially.
The recently announced draft National Electricity Policy calls for cost-reflective tariffs without taking the route of regulatory assets. The question is why were no questions raised when commissions were approving such assets? What was the economic logic of allowing them in the first place? Were the policymakers unaware of this unsustainable nature of regulatory assets? What is the roadmap for implementing this now?
It is high time the public called out this game that has greatly harmed society and continues to grow.
This piece was authored by Shakti Sinha, Director, Atal Bihari Vajpayee Institute of Policy Research and International Studies, MS University, Vadodara; and Sarthak Shukla, Assistant Policy Analyst, CUTS International.
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