Kejriwal’s resolve to cut tariffs comes at a time when state utilities finally seem to be moving towards rate increases.Even as the Delhi government ups the ante against two of the three Delhi power distribution companies, there seems to be little sympathy, at least among power sector officials, for the Delhi government’s claims about power tariffs.“Delhi is an overindulged city,” said one senior official of the sector to ET Magazine. And certainly the data seems to bear out the view that tariff increases in the past few years in the capital are justified. In last year’s tariff order, for instance, the Delhi Electricity Regulatory Commission (DERC), which sets tariffs for the capital, pointed out that since privatization, the price at which distribution companies (discoms) have been buying power increased by over 300% — in comparison, consumer tariffs have only increased by 65%.Taking a cue from the Delhi government’s intervention of the past few weeks, the Maharashtra government too has moved to cut tariffs in the state (excluding Mumbai). All this comes, ironically, at a time when state utilities across the country finally seemed to be moving toward tariff rate increases even in areas which were too politically sensitive earlier, such as rates for agricultural consumers. To insiders in the sector then, the Arvind Kejriwal government’s actions in Delhi seem populism at its worst.But the Delhi government’s actions have (perhaps unwittingly) highlighted a deeper problem with the sector: even apart from the political sensitivities of higher tariffs, the economics of the sector, for the discoms, simply don’t work as many state power utilities are unwilling to buy expensive power.So if a regulatory commission pushes through a tariff increase and the state government is willing to look the other way, the state power utility may simply refuse, flat out, to buy the more expensive power and will resort to load shedding. Even outside Delhi, many are in deep losses and have been the subject of yet another government bailout. Facing a choice between buying expensive power and imposing additional stress on balance sheets already awash in red ink, they have simply chosen to turn off the lights. The result? For much of last year, coal power plants in the country were running at capacities well below that of a year earlier. Part of this was because of a fall in demand due to weaker growth.The lack of adequate infrastructure to move the power to the end-consumer (such as transmission lines and substations) didn’t help. But during this same period India’s power deficit remained in place — in the north, in December, it was as high as 7%. So despite surpluses, there was still demand for power that was not being met, even as producers had to run their plants below capacity because there weren’t enough takers. Result: many plants aren’t earning enough to meet even the fixed costs of running their plants.Power generators would argue that matters needn’t have come to such a pass if only state utilities, and the governments who own them, had the guts to continue to raise tariffs (over and above recent hikes) and stop pampering consumers. But as Surya P Sethi, a former principal adviser to the Planning Commission, pointed out in a recent article in the Economic and Political Weekly, tariffs in India are already quite high compared with other countries. “...Average bulk power prices [wholesale tariffs] at the nine major US electricity hubs ranged between 2.3 and 4.7 cents/kilowatt-hour (kWh) in 2012 whereas the price of bulk power in India averaged 6.5 cents/kWh in 2012. Now, even if the distribution sector in India was as efficient as that in the US...average retail tariffs in India would need to be 25-30% higher, in the very least, because of higher bulk tariffs — all else being the same.”The conclusion? “Indian consumers with average per capita income of less than 8% of their US counterparts, in purchasing parity terms, must pay up to 30% more for their electricity to ensure viability of the power sector in India!” ET Magazine updated those tariff comparisons to 2013. If anything, the contrasts are even starker.Sethi highlights a basic contradiction within the power sector, which is that policy is heavily tilted towards favouring generating companies vis-a-vis distribution. Public sector power companies like NTPC for instance (which supplies the bulk of power to Delhi) are allowed to charge tariffs based on a costplus model which guarantees them a return on equity of 15.5% (private sector players in the hydro sector too are allowed a guaranteed return). In the December quarter of 2013, NTPC reported profits of `2,861 crore and operating margins of almost 25%. NTPC’s case has always been that such incentives are needed to attract funds to a sector that has faced a shortage of investments.“The central power generators came into existence because of the failure of the States to meet the accelerated power requirements of the country,” says an official with one of the PSU generating companies. Pointing to the fact that per capita consumption of power in India is still well below international averages, the official said: “the need...is to ensure...that continuity in regulation is maintained, investment is encouraged, and capacity addition in the sector is accelerated.”Under the norms as they exist today, utilities such as the Delhi discoms have long-term contracts with suppliers like NTPC under what is effectively a take-or-pay structure. Even if a utility does not need power at any point in the day or over the course of a month, they must still pay the supplier a minimum fixed charge regardless.The Central Electricity Regulatory Commission (CERC), which is in charge of tariff setting for NTPC, and a bunch of other public sector generation companies, have proposed a new set rules to determine how those fixed charges are set. It has tightened efficiency norms and raised the bar above which power generation companies like NTPC must perform if they are to be allowed higher returns by the regulator. “But the CERC could go further,” says Ravinder, a former chairperson of the central electricity authority, an advisory and policy body under the power ministry.Under current norms, depreciation costs charged by power generators to discoms are set off against the interest those generators have to pay to banks. After those loans have been paid off, those charges should then be used to reduce the generators’ equity, effectively reducing the level of the tariff over the life of the project. “These are correct and rational financial accounting norms followed by infrastructure projects the world over,” adds Ravinder. But this doesn’t happen and depreciation costs end up being an additional return to the power generator even over and above the guaranteed 15.5% return already enjoyed by the power plant. “Instead benefits of reduced tariffs, after assets have been fully depreciated, should be passed on to the end-consumer,” he says.But fixed costs are still a relatively small component of the total tariff that customers pay — as much as 70-80% of costs built into a consumer tariff are effectively costs of fuel, usually coal but also gas. The crisis in India’s coal sector is a critical reason for higher costs in power generation these last few years. Is there room for reduction in tariffs on this count?Seemingly not. Even the DERC, in its tariff orders, repeatedly refers to fuel costs as “uncontrollable”. The whole tone is one where such costs are inevitable, and have to be passed onto the end-consumer.But even on the coal front there may be room for efficiency. NTPC has been locked in battles with Coal India over what it claims are cases where the coal it finally received was inferior than what it paid for. But this problem applies to imports as well, given that imported coal is now a significant component of overall coal supply.An official with a regulatory body in the sector points out that import tenders should specify the quality of coal in terms of when it is actually ‘fired’ — in other words the amount of heat it releases when it’s in the boilers of the power plant. Instead tenders specify the quality the coal should be when it lands in Indian ports, which is usually much higher. Effectively then Indian companies are overpaying for imported coal, in relation to quality. “We feel that just this technical change in tenders can improve efficiency levels by as much as 25% and bring down costs of fuel,” says the official.This was pointed out even by the Association of Power Producers, a lobby group, to the CERC in comments on the draft norms: “It is an established fact that there is a considerable GCV [an indicator of coal quality] difference between received coal and fired coal,” it said. Tariff norms, by requiring fuel costs to be a pass through, and by terming them “uncontrollable”, have also played their part in reducing the incentive on power generators to be efficient. If such costs are to be recovered from consumers, why bother monitoring them, especially in a regime with guaranteed returns?But it’s hardly as if the problem only lies with generating stations. “Many state utilities are not doing a proper estimation of the amount of power demand they expect,” says the regulatory official. He points out that Punjab is now looking at a situation of surplus power for nine months of the year — this is pretty much the problem that is faced by the Delhi discoms, which are effectively stuck with more power sourced through long-term contracts than they know what to do with. They have to sell off those surpluses at a substantial loss. Getting out of such contracts has proved an uphill struggle, especially as the suppliers have found few other takers.And regulators have a role too. “In all cases of tariff setting, it is essential that the regulator allows maximum transparency and adequate opportunity to the public to participate in the decision making process,” says Ashwini Chitnis, senior research associate with Prayas, a non profit focused on the energy sector. “In a number of states what has also happened is that tariff increases were not allowed for many years, and then were sharply hiked in a short time period to compensate. This naturally results in tariff shocks and equally sharp public reaction.”If incentives in the power sector are tilted towards setting up a generation plant, recent trends have merely made that tilt more pronounced. Over the next couple of weeks the CERC will rule on whether or not to allow companies like Adani and Tata Power to charge compensatory tariffs to their customers, to account for higher fuel costs.Unlike say, NTPC, such companies won contracts to supply power on the basis of competitive bidding and on the basis of the tariffs they quoted. Those companies now want CERC to allow them to revise tariffs upwards. If this happens, it could create a serious problem wherein companies would be incentivized to bid very low tariffs to win a power supply contract, in the secure knowledge that they can later hike those tariffs, making the whole point of an auction meaningless.The Delhi government’s battle with BSES may seem to be a specific problem limited to one city, but it raises issues that the power sector will increasingly face in years to come."In the story it was stated that depreciation costs charged by generators are set off against interest those generators have to pay to banks. This is incorrect. Depreciation costs charged by generators are set off against principal, not interest. The error is regretted."(In the story it was stated that depreciation costs charged by generators are set off against interest those generators have to pay to banks. This is incorrect. Depreciation costs charged by generators are set off against principal, not interest. The error is regretted.)