power sector economics

8/13/2019 Power Sector Economics

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Power Sector Economics and

Planning

Dr Hiranmoy Roy


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Intro. to Eco. Theories and their

Importance

Economic Theories:Economic Changes and its

consequences

Societys institution and technology affect

prices

Distribution of Income poor can be helped

without harming economic performance

Business Cycle, Monetary Policy swing in

unemployment and Inflation

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Economic Theories

Pattern of Trade, Impact of Trade Barriers

Govt. policies to pursue Growth in DevelopingCountries, Efficient use of resources, Full

employment, Price stability, Fair dist. ofincome

Classical Theories

Depression of 1930s

Classical theory had the difficulty of explainingDepression.

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Economic Theories

J. M. Keynes began to develop alternative

theories

Birth of Keynesian theories

But it also had trouble as unemployment and

inflation began to rise togetherStagflation

PostKeynesian Development Critique of Keynesthree main developments

after Keynes

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Economic Theories

Monetarism, Supply side Economics, Neo

Classical Economics: Rational Expectation

Theory

Milton Friedman Monetarist Criticized

Keynes

He argued Monetary Policy is the prime

engine in causing fluctuations in eco. Activity

through Agg. Demand

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Economic Theories

Keynes view that monetary policy ineffectiveto bring eco. Stability was criticized byFriedman

In fact, he said the monetary policycontributed to almost all recessions

There are differences between Keynes and

Monetarists in two issues (i) Relationshipbetween money supply and inflation (ii) Roleof Govt. in the economy

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Economic Theories

Monetarist led by Friedman Inflation is

always and everywhere a monetary

phenomenon

Inflation is caused by rapid expansion of

money supply

Keynes and his followers activist role of

Govt. Keynes lay stress on adoption of

discretionary fiscal and monetary policy

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Economic Theories

Keynes believed that expansion of moneysupply does not always cause inflation

This depends on possibility of expansion of

output When eco. Is in depression increase in money

supply is likely to lead in large expansion of

output and prevent price rise Monetarist opposed to the fiscal policy,

budget deficit and pub. debt

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Economic Theories

They argued that reducing taxes and public

expenditure so that role of Govt. in the

economy is reduced

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Economic Theories

Supply Side Economics: In 1970s problem of

stagflation appeared high inflation

accompanied by high unemployment

Keynes proposition of fluctuation in agg. dd.

Responsible for either high unemployment or

high inflation could not explain stagflation

This led some economists to believe that

problem was on the supply side eco. activity

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Economic Theories

Keynesian theories were incapable of solving

Keynesian expansionary fiscal and monetarymeasures taken to raise agg dd. to remove

stagflation or high unemployment , itaccelerated further.

On the other hand if steps were taken to

lower agg dd to lower inflation rate it wouldfurther increased already high unemploymentrate

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Economic Theories

Supply side economists mentioned that it was

supply shocks, by reducing oil prices and

increase in oil prices that caused the problem

of stagflation

Contraction in supply due to supply shocks ,

given the agg dd curve price level and

inflation could rise on the one hand and aggoutput could fall giving rise to unemployment

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Economic Theories

Supply side advocates expansion in moneysupply increase in employment opp.,incentives to work, save and invest more were

required to be promoted

Increase in agg supply given the agg dd curve

will lead to increase in employment on theone hand and reduction in inflation on theother

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Economic Theories

According to them high rate of tax serves asdisincentive to work

New Keynesians thus emphasize both fiscal

and monetary policies to attain eco. Stability To encourage more saving work and

investment , they advocated reducing

prevailing high rates of income tax This will not only cause employment to rise

but also lower rate of inflation

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Economic Theories

Laffer Curve When rate of a tax increases

from zero upward Govt. revenue from it

initially increases, but after a point further

hike in rate of tax brings about decrease inrevenue for the Govt.

So lowering of tax rate not only increase N.I

and employment but also reduce Govt.budget deficit

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Economic Theories

New Classical Macro economics: Rational

Expectation Theory : A New Macro theory put

forward which is opposed to Keynesian Macro

theory

According to this new classical macro

economic theory consumers, workers and

producers behave rationally to promote theirinterests and welfare.

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Economic Theories

On the basis of their rational expectation theymade quick adjustments in their behaviour

Producers and consumers collect every

information to determine their behaviour People make a correct relationship between

eco. Event and Govt. policies on the one hand

and results that follow from that Correct prediction from Govt. policies and

changes in eco. environment

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Economic Theories

E.g., when Govt. makes a deficit budget they willexpect that interest rates will rise.

So to they will attempt to take loans now when

rate of int. is less than paying higher int. rates infuture

A sharp contrast of Keynesian theory andRational expectations theory is that according to

Keynesian theory deficit in Govt. budget willleads to increase in agg dd and will promote pvtinvestment

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Economic Theories

On the other hand according to Rational

expectations theory, budget deficit will cause

rate of interest to rise which will discourage

pvt investment

Thus increase in agg dd as result of budget

deficit is offset by decrease in pvt investment

so that N.I., output and employment remainsunaffected

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Economic Theories

Similarly If RBI increases money supply ,

consumers, workers and producers expect

rationally price level will rise .

On the basis of their rational expectations,

workers will get their wages raised , landlord

raise their rents, bankers and lenders raise

their interest and producers will raise theprofit margins

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Economic Theories

As a result of adjustments by various persons, the

effect of expansion in money supply on these

persons will get cancelled.

So according to rational expectation theoristssince the consumers, workers and producers

themselves make adjustment to save them from

adverse effect s of economic events and policiesthere is no need for the Govt. to intervene in the

eco through proper macro eco policy

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Economic Theories

Thus like Friedman and other monetarists thesupporters of rational expectations theoryopposed to the activists role by the Govt.

However Conservative Govt. (US) of the 1980sgradually become disillusioned with Monetarismand returned to modern version of classical ecomanagementNeo- Classical economics.

Like classical eco it stresses the role of freemarkets in delivering the best possible ecogrowth

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Economic Theories

Following three important theories popular ineconomics

Classical / Neo- classical, Keynesian theory,

Monetarist theory Classical refers to the works done by a group

of economists in the 18thand 19thcenturies.

Much of these work subsequently beenupdated by modern economists and they aregenerally termed as neo-classical economists

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Economic Theories

We look in to works of classical economists

what they believed and proposed

Beliefs, Theories, AS & AD policies, Virtual

Economy Policies

Neo-Classical Theory: Beliefs

Malthus Population growth depress eco

growth then diminishing returns would cause

further problems for growth

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Economic Theories

They believed Govt. should not intervene tocorrect this as it would only make thingsworse so only way to encourage growth is to

allow free trade and free markets. This approach is known as laissez-faire

approach

This approach places total reliance on marketsand anything that prevent markets clearingproperly should be done away with.

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Economic Theories

Neo-Classical Theories: Revolved mainly aroundthe role of markets in the economy

If markets work freely and nothing prevents their

working then the economy would prosper Role of Govt. is to ensure the free workings of

markets using supplyside policies

The main theory to justify this view is

Free Market Theory, Says Law, Quantity Theoryof Money

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Economic Theories

Free Market Theory

Eco left itself tend to full employmentequilibrium

Unemployment (a surplus of labour) fall inwages increased dd for labor - equilibrestored at full employment

Initially hig h wage results in unemp l( a b indiag) . This causes wage rate to fall andunempl in the eco is voluntary unempl

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Economic Theories

Similarly if there is discrepancy between savingsand investment the equilibrium would change inthe market.

This would require free and flexible market

Increase in inv Increased dd for money Increased Rate of int. Increased Savings equilib is restored

Compared to Keynesian macro theory of incomeand employment classical theory is more relevantto the conditions of prevailing in developingcountries

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Economic Theories

And the theory highlight those factors whichgovern income and employment in thesecountries

While Keynesian theory emphasizes the roleof effective dd in the determination of incomeand employment, classical economistsbelieved that in a free market eco there isalways tendency toward the establishment offull employment and sufficient dd for output

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Economic Theories

Classical theory of employment and output is based on thefollowing two basic notions:

Says Law, Wage Price Flexibility

Says Law: Jean Baptiste Say early nineteenth century

SupplyCreates its Own Demand Assumptions: (i) Any increase in goods and services

(supply) will lead to an increase in expenditure to buy thosegoods and services (dd) (ii) There will not be any shortageof dd full employment if there is any unemployment it

would simply be temporary Greater production leads to more income and which

creates market for goods and deficiency in dd is not aproblem

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Economic Theories

Income which is not spent on con goods will

be saved and will be reinvested. Thus inv

equals saving

Thus leakage caused by saving in income flow

is made up by the inv expenditure

J. M Keynes bitterly criticized the classical

theory of automatic full employment

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Economic Theories

Wage-Price Flexibility: The amount of productiondepends not only on agg dd or exp but also onprices of products.

Inequality in saving and investment may causedeficiency in agg expeven then over productionand unemployment would not arise

This is because they thought deficiency would be

made by changes in price level Due to increase in savings expenditure declines, it

will then affect the prices of the products

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Economic Theories

At lower prices all products will be sold and sothere is no overproduction andunemployment

Thus increased savings will bring down theprices of products and not the amount ofproduction and employment

Now a question arises to what extent thesellers of the product will tolerate the declinein prices

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Economic Theories

However to make their prices profitable they willhave to reduces the prices of factors such aslabourers

With fall in wages all workers will get

employment but if labourer do not work at lowerwages, this is voluntary unemployment accordingto classical economists

According to classical economists involuntary

unemployment is not possible in a free marketeconomy, all those who are willing to work at theexisting wage rate will get employment

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Economic Theories

During great depression of 1929-33 Pigou suggested cut inwage rates in order to remove huge widespreadunemployment prevailed at that time

Keynes criticized Pigous view in his General Theory -Supply may not create its entire dd

Income earned by different factors of production are equalto the value of the output produced this do not meanthat whole income will be spent on goods and services

If inv is not equal to desired savings then agg dd will not be

equal to agg supply, producers will unable to sell wholeoutput and so profit will be less, they will reduceproduction which will give rise to involuntaryunemployment

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Economic Theories

In a capitalist eco agg dd is the sum of con dd andinv dd. But in a free market capitalist eco personswho save is different from those who invest. Invdepends on marginal eff. Of capital

Keynes also explained that equality betweensavings and investment can not be brought aboutby changes in interest rate as savings depends onincome.

But classical economists ignored changes inincome due to their assumption of fullemployment

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Economic Theories

Quantity Theory of Money Neo- Classical theory: Agg Supply (AS) and Agg

dd (AD): The classicals have complete faith inmarkets they believed eco would always settle

automatically the full emp. Equilib. in the longrun

However there may be slightly different reactionin the short run as the eco adjusted to its new

long run equilib. This can be explained with AD and AS analysis

(diagram)

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Economic Theories

Neo-Classical Theory Policies: Classical view eco is self adjusting, there is no need to activelyintervene in the eco

Intervention may simply destabilizing andinflationary.

The key to long term growth is thusensure freemarkets with no imperfections (through supply

side policies) Control the growth of the money supply to

ensure low inflation

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Economic Theories

Supply Side Policies: Supply side policies canbe used to correct market imperfections. Iflevel of agg supply increases then Says law

predicts that dd will also increase This will only be non-inflationary way to get

increase in output (Diagram).

Money Supply Policies: Open marketoperation, Funding, Monetary Base Control,Interest Rate Control

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Economic Theories

Keynesians: Theories The Labor Market,Money Market, The Multiplier, KeynesianInflation Theory

The Labor Market Did not have same faith in

market as classical. Wages would be stickydownwards

Workers are not happy about wage cuts andwould resist, this would mean ages will not fall

enough to clear the market and unemploymentwould linger (Diagram)

Demand deficit unemployment

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Economic Theories

Keynesian Theory Introduction: Much of J.M.Keyneses works took place at the time of GreatDepression of 1930s

Assumptions: (i) Market did not automatically lead to

full employment equilibrium (ii) The Level of output(N.I.) would adjust between leakages and injections Imbalance between leakages and injections (increasein Govt. exp) extra agg dd more employment

more income leakages (tax, savings, and imports). Ifleakages and injectins are equal than equilib restored,this is Multiplier Effect.

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Economic Theories

Money market: Classical economists believedthat savings to be increased to invest more.Keynes argued that savings would mean

people to spend less This would mean a decrease in agg dd This

would make things worse and firms would beeven less inclined to invest as demand for

product decreasing

Inv depends on business expectation

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Economic Theories

The Multiplier:

Keynesian View of Inflation: Keynes rejectedquantity theory of money. Increase in money

supply will lead to inflation Increase in M may lead to decrease in V.

Alternatively increase in M may lead todecrease in T (transaction)

Keynes termed inflation is more likely to becost push.

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Economic Theories

Keynesian AS & AD: He argued that economy

would settle at any equilibrium level of

income at any time, it is duty of Govt. to use

appropriate policies to ensure that equilibriumis good one for economy

Reflationary policy to boost agg dd As agg dd

increases so does output and employ whichleads to inflation

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Economic Theories

Keynesian Policies: Demand management

Policiesadjusting the level of dd so that eco

arrives at full employment

If there is shortfall of dd (deflationary gap),

Govt. need to reflate the eco. If there is excess

dd Govt. need to deflate the eco

Demand for Money and Keynesian LiquidityTheory of Interest:

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Economic Theories Deflationary Policy: (Ref.)

Monetarists Theory- Introduction: Monetarismis very close to classical school of thought(Friedman 1960s,1970s)

StagflationStagnation and Inflation

Monetarists work revolve round role ofexpectation in determining inflation

Monetarists Belief: Re -evaluated QTM andargued increase in money supply would lead toinflationsubstantial empirical evidence

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Economic Theories

Expectation adjust so quickly that policychange will immediately be taken by people

No short term adjustment Rational

Expectation School Inflation is always andevery where a monetary phenomenon

Monetarists Theory:

QTM: Expectation Augmented Philips Curve

(Diagram)

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Economic Theories

Monetarists AS & AD: Short Run, Long Run(Diagram Ref.)

Monetarists Policies: Limited their view onInflation, policy is on inflation only

They believed if inflation is controlled stabilityand growth of the economy will be maintained.

The key policy is to control money supply tocontrol inflation and do not intervene to reduceunemployment

The only way to change natural rate is throughSupply Side policies

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Economic Theories

Supply Side policies: Non Inflationary

increase in capacity (supply) to reduce

unemployment(Diagram Ref.)

Money Supply Policies: (Ref.)

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Depreciation Accounting

Income is defined as the amount that can be

distributed during the period without impairing

the productive capacity of the firm.

The cash flows generated by an asset over its life,therefore, cannot be considered income until a

provision is made for its replacement.

These cash flows must be reduced by the amountrequired to replace the asset to determine the

earnings generated by that asset.

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This is underlying principle of economic

depreciation

The periodic depreciation expense, therefore,

segregates a portion of cash flows forreinvestment, preserving that sum from

distribution as dividends and taxes.

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Suppose an asset costs $240 and is expected

to generate net cash flows of $100 per year

over its three year life, Over the life of the

asset, income equals $60 ($300-$240) as $240is required to replace the asset

As financial statement report income annually,

it is necessary to determine how much income(how much depreciation) to report each year.

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This requires the allocation of a portion of the

multi-period return to each period.

Depreciation is an application of the matching

concept. It aims to match the cost of buyingthe asset to the revenue or other benefits

generated by its use

it as a measure of the use or wearing out ofthe asset over time

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It reduces the book value of the asset but notits market value

The reduction in the book value of an asset is

permanent, gradual and of continuing nature it is not possible to restore it to its original

cost

It is a continuing process because the value isreduced either with the use of the asset orwith a passage of time.

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It takes place gradually unless there is a quickphysical deterioration or obsolescence

It is not the process of valuation of asset; it is

process of allocation of cost of the asset

The term depreciation is used only for tangiblefixed assets. This term is not used in the case of

wasting and fictitious assets such as depletion ofnatural resources and amortization of goodwill,respectively

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Depreciation has several meanings in

literature. However, all different technical

meanings

However, all the different technical meaningsattached to the word depreciation are

basically variants of the following four

concepts

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Decrease in Value: The value of one asset is insomeway computed at two different dates, andthe value at the later date subtracted from thevalue at the earlier date is known as thedepreciation. This is the generally impliedmeaning of depreciation.

Amortized Cost: This is the accounting concept of

depreciation in which the cost of an asset whichis considered an operating expense isapportioned among the years of its useful life

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Impaired Serviceableness: With the passage oftime equipments and machines are often unableto hold as close tolerances as when they werenew. Similarly, owing to decay or corrosion, thestrength of structures maybe impaired

such impaired functional efficiency is also termedas depreciation

there may be several other common reasons for

Decrease in value besides impairedserviceableness

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This pattern, with the amount of depreciationincreasing every year, is known as annuity orsinking fund depreciation.

Straight Line Depreciation: Given the sameasset and the pattern of constant cash flowsshown in Table 3.1, the revenues (cash flowsof $100) generated by the asset are the same

each year, the income shows each year shouldalso be the same.

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The use of this method results in an increasing

rate of return rather than the actual rate of

return earned over the life of the asset

Formula for Straight Line DepreciationMethod: Depreciation in year i = 1/n (Original

CostSalvage) Where n = Depreciation Life

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Accelerated Depreciation Method: Thematching principle can also justify accelerateddepreciation patterns, with higher

depreciation charges in early years andsmaller amounts in later years.

Benefits (revenues) from an asset may behigher in early years, declining in later years as

efficiency falls (the asset wears out). Thedepreciation should decline with benefits.

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Even if revenues are constant over time, an

asset requires maintenance and repairs over

time, costs that tend to increase as the asset

ages. Accelerated depreciation methods

compensate for the rising trend of

maintenance and repair costs so that totalasset costs are level over the assets life.

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Both the efficiency and maintenance of anasset are difficult to forecast, and, in any caseaccelerated depreciation methods are (like

straight line) arbitrary procedures designed toyield the desired pattern of higherdepreciation amounts in earlier years

Accelerated methods have historically been

used for tax reporting, here they are justifiedby the desire to promote capital investment

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The two most common accelerated methods are theSum-of- Years Digits (SYD) method and the family ofdeclining- balance methods

Exhibit 1

Accelerated Depreciation Method- Sum-Of-YearsDigits

Original Cost = $18000

Salvage Value = $3000

Depreciation life, n = 5 Year Rate(Original Cash Salvage value) Depreciation

Expense (Ref. Table)

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For Sum-of-YearsDigits method Depreciation in Year i = (n-i+1)/SYD X (Original

CostSalvage Value) Where,

SYD=n(n+1)/2. for e.g. n=5 SYD=15.

Depreciation thus varies from year to year (as Ivaries) in reverse counting order of the years;

that is the pattern is 5/15, 4/15, 3/15, 2/15 and1/15 and is depicted as follows (Ref. Exhibit 2)

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Impact of Depreciation Methods on Financial

Statements: The choice of depreciation

method impacts both the income statement

and balance sheet; for capital-intensivecompanies, the impact can be significant. As

depreciation is an allocation of past cash flows

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Depreciable lives and salvage value impactboth depreciation expense and stated asset

values. Sorter lives and lower salvage values

are considered conservative in that they leadto higher depreciation expense

Conservative depreciation practices also

increase asset turnover ratio by decreasingthe denominator of that ratio

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Impact of Inflation on Depreciation: Historicalcost based depreciation expense may be used

to define income as long as the total expense

over the assets life is enough to replace theasset after it has been utilized.

If however the replacement cost of the asset

increases, than depreciation expense basedon the original cost will be insufficient.

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Accelerated depreciation methods partiallycompensate for this inflation effect byshortening the tax recovery period

Depreciating the asset over a shorter lifeserves similar purpose.

A number of studies have been examinedwhether accelerated method compensates fordepreciation and /or reflect economicdepreciation.

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ff ff f ff


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Tariff: Different Types of Tariffs

Tariff ComponentsFixed Charges Variable Charges

Interest on Loan Cost of Fuel

Return on Equity Depreciation

O & M Expenses

Interest on W.C Cost of Secondary Fee

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1. Nominal Tariff:

Cost / Unit: Total Cos (Fixed + Variable Cost)/

Total No. of Units produced

2. Discounted Tariff:

N.T X Discounted Factor , discounted Factor =

(1/1 + discount Rate)

3. Levelised Tariff: (N.T X DF)/ DF

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iff iff f iff


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The regulatory bodies have the primaryresponsibility for efficient tariff setting,especially in ensuing that subsidies areallocated and administered optimally and indistancing the process of tariff setting frompolitical interference

Promotion of competition in the electricity

industry in India is one of the key objectives ofthe Electricity Act, 2003

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T iff Diff T f T iff


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Guidelines are aimed at facilitating competitionin this sector through wider participation in

providing transmission services and tariff

determination through a process of tariff basedbidding

Section 61 & 62 of the Act provide for tariff

regulation and determination of tariff of

generation, transmission, wheeling and retail sale

of electricity by the Appropriate Commission.

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T iff Diff T f T iff


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Protect consumer interests by facilitatingcompetitive conditions in procurement of

transmission services of electricity

Enhance standardization and reduce ambiguityand hence time for materialization of projects

Tariff Policy: New Tariff Policy of Central

Electricity Regulatory Commission (CERC) for2004-09 CERC has emphasized that all future

projects and new investment in generation

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T iff Diff t T f T iff


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transmission and distribution both by publicsector utilities as well as IPPs should be

structured through a tariff-based transparent

competitive bidding process. Detailed regulation based on the existing cost,

plus approach which leads to inefficiencies

and lack of initiative for better performance

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CERC will adopt a normative debt equity ratio of70:30 for all generation and transmissionprojects. The return on equity shall be 14 percent post tax, uniformly applicable to CPSUs and

IPPs Tariff Scenario: The other objective of re-

querying a transparent process is to internalizethe concern of the consumers who earlier used to

be at the periphery of the process. Towards thisend, most ERCs issued tariff consultation papersseeking the comments of stakeholders.

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ERCs have adopted a proactive and innovativestrategy by conducting the hearings at multiplelocations and by holding open-house sessions.This process has made informed decision-making

possible by giving access to data that was earliernot available.

The transparent process has for the first time led

to official recognition of the huge hiddeninefficiencies in the system by way of under-reported transmission and distribution losses

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The other aspect of the change is the attention paid toproductive and allocate efficiency in tariff setting.

While the ERCs chose to continue to use the broadprinciples enunciated in the Electricity (Supply) Act,

1948, which essentially is a cost plus kind of regulation,they allowed revenue requirements only to the extentconsidered reasonable.

As a result, the revenue requirements have been

pruned in the range of 5%15% in the recent tariffawards issued by some of the ERCs

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it would be more appropriate for the ERCs todetermine the broad level of efficiency gains

being desired while leaving the managers to

design strategies to realize them. The ERCs have also instituted measures to

allocate the revenue requirement in an

economically efficient manner by reducingthe extent of cross-subsidies

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The regulators thus have the challenging task ofcreating an environment conducive for rapidrestructuring and privatization. They would alsoneed to communicate to the government the

rationale of continuing the subsidies Distorted tariffs in India remain a concern,

causing as they do an unsustainably high cross-subsidy which does not cover the cost of service

provision. Indeed low tariffs rarely benefit Indiaspoor, most of whom lack access to power,particularly in the rural areas.

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The linkage of tariff to cost to service andelimination of cross subsidies is the important

feature of the Electricity Act, 2003.

The tariff should progressively reflect the costof supply and it also requires the appropriate

commission to reduce and eliminate cross

subsidy within time farme

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Tariff Different Types of Tariffs


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A good tariff design promotes the efficientconsumption.

There are five basic approaches to cost to servicecomputation namely

Embedded Cost of Service

Marginal Cost of Service

Average Cost of Supply

LMRC

PBR

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The embedded cost approaches, allocates thetotal revenue requirement to the various

categories of consumer based on the analysis

of the embedded or historic costs of theutility.

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Marginal Cost of Service: Marginal Costadopts future costs instead of historical costs

for determining the costs in supplying

electricity to various consumer categories Long Run Incremental Costs (LRIC), a marginal

cost approach reflects the cost of expending

the system efficiently to satisfy the loadforecast of very long time horizon

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The concept of the long run incremental costsis embedded in integrated resource planning

and generally over long term duration

Whether return to scale is present, LRIC wouldresult in insufficient revenue and requires

corresponding adjustments to bring it to

future average costs.

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Long Run Marginal Cost of Electricity: A classicdefinition of LRMC of generation is defined as

the levelized cost of meeting an increase in

demand over an extended period of time. It is calculated by determining the difference

in the NPV of two optimal generation

development (installation) programs over anextended period (say 30 years)

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Sunk costs are not included in the analysis. Thefirst generation installation is done under thecurrent load forecast and the second under a loadforecast that has a defined increment of load

added. The LRMC is the change in NPV of costs divided

by the change in NPV of load. This is a long runmarginal cost basis as it determines the marginalincrease in costs associated with meeting amarginal increase in demand with all factors ofproduction variable

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Performance Based Ratemaking: The PBRapproach, while recognizing the revenue

requirement of the utility, provides incentives

for improving efficiency and reducing costs. It weakens the link between the utilitys

regulated prices and costs by decreasing the

frequency of rate cases and/or by employingexternal measures of cost.

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The control aspects of regulation are thus soughtto be replaced with a system of incentives and

penalties through institution of industry wide

norms As a result, the PBR creates incentives, which are

similar to those that would exist in a competitive

market place. Such a system would reward

efficient management while inefficient ones

would sooner or later be thrown out

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In frequent tariff reviews also free thegovernment and the regulators to focus onother tasks including improving the quality ofsupply, enforcing tighter customer servicestandards, grievance handling and thesustainable development of the electricsupply industry

These are important tasks, which are vital forthe sustainable implementation of reforms

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In the current context these get neglectedsince the entire attention gets focused ontariff determination which is an annualexercise.

If tariff rationalization is to be delinked fromreform, restructuring and privatization,efficiency improvements and improvements in

the quality if service provided to consumersare necessary

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The reduction of regulatory risk is animportant precondition to privatization. Theadoption of PBR will assist in this process

PBR also provides advance signals whichefficient utilities can use to optimizeoperations

Hence both PBR and the Revenue Cap/Price

Cap approach are more conducive toefficiency enhancements than COS

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Determination of Generation Tariff As per theprovision of section 62 of the Electricity Act,

2003 the appropriate Commission is required

to determine the tariff for sale by thegenerating company to a distribution licensees

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In case of shortage of supply of electricity, fixthe maximum and minimum ceiling of tariff

for sale or purchase of electricity in pursuance

of an agreement, entered into between thegenerating company and the licensee or

between the licensees, for a period not

exceeding more than one year to ensure

reasonable prices of electricity

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Determination of Transmission Tariff (TT): As perthe clause (d) of Section 39 and clause (c) ofsection 40 of the Electricity Act 2003, theappropriate commission is required to determine

tariff for transmission of electricity for atransmission licensee

Two components of TT: (a) transmission chargesderived from the revenue requirements of thetransmission licensees and (b) transmissionlosses.

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Determination of Wheeling Charges Thedistribution company may use their

distribution system for wheeling of electricity

for other licensees or consumers or generatingcompanies or captive power plants

wheeling charges also need to compensate

the distribution company for (a) network costand (b) system losses

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Principle for distribution tariff includes that theappropriate commission should suitably definecontrollable and uncontrollable parameters thataffects the revenue requirement

Availability Based Tariff: ABT has been underdiscussion since 1994 when M/s ECC, an ADBconsultant, first supported it. GOI constituted aNational Task Force in February 1995. It had tenmeetings till end 1998

Jurisdiction was vested in the CERC

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The ABT order dated January 4, 2000 of theCommission departs significantly from the draftnotification as also from the prevailing tariffdesign

What is ABT? It is a performance-based tariff for the supply of

electricity by generators owned and controlled bythe central government

It is also a new system of scheduling anddespatch, which requires both generators andbeneficiaries to commit to day-ahead schedules.

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It is a system of rewards and penalties seekingto enforce day ahead pre-committed

schedules

The order emphasizes prompt payment ofdues. Non- payment of prescribed charges will

be liable for appropriate action under sections

44 and 45 of the ERC Act

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Need of ABT at State Level

There are a good number of reasons why ABT

must be implemented with in a state. The

reasons are listed below: No penalty for state generators/IPPs or

Discoms for deviating from the schedule

Installed capacity of Captive Power Plants(CPPs)are to be tapped.

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To enhance trading and bring grid disciplineamong open access customers

The responsibility of grid discipline should be

shared by SEBs also and not just by theregional electricity boards

Bottlenecks for Intrastate ABT

There is a different set of problems when itcomes to implement ABT at state level. Theseare discussed below

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Upgradation of Metering and Billing systems:There is a need to convert/add 0.5 class accuracymeters to 0.2 class meters at Discom- TranscoInterface. Instrument transformers are needed to

be replaced There is a need for reliable communication

means to connect substation, generating plants,open access customer interface point with SLDCHardware and software is required to consolidatedata and produce bill

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Demand Control: Possible means of DemandControl that can be used by SLDC are

Analyzing the average realization from a

substation area and compare it with systemmarginal price before load shedding Influence

demand by using proper tariff structure

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Demand Forecasting: The problems in this areaare: Discoms doesnt have advanced Demandforecasting tools, Nor does it have historical datato study demand patterns

UI Pass Through: At present the complete powerpurchase cost of Discom is being passed on toconsumer via retail tariff . Hence there is noincentive or penalty for Discom to comply withABT regime Regulator needs to decide themechanism for pass through to consumers

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A specific regulatory formula may need to bebuild by the state regulators to incorporate

this issue.

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Environmental and Societal Benefits of

E T h l i


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Energy Technologies

Energy for the New Millennium: (CurrentPattern of energy production and consumption,Energy Technology and its importance, Primaryenergy consumption)

Energy has begun to play a more crucial role thanever in the development and well being of everynation.

Energy impacts way of living, livelihoods, growthand progress not only at a collective level but alsoat the individual, grass root level.

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E T h l i


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Energy Technologies

At the same time, current patterns of energyproduction and consumption also contribute

to environmental degradation at the local,

regional and global levels. Strategies and interventions are needed that

promote energy as an engine for equitable

economic growth and sustainabledevelopment.

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E T h l i


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Energy Technologies

These challenges presents an opportunity tofind ways of producing and using energy thatare economically, socially and environmentallysustainable and of using this important tool asa means to achieve sustainable development

Today, the transportation, manufacturing,commercial, social, cultural and even the

agricultural sectors consume energy at a largeand ever growing rate

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E T h l i


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Energy Technologies

The twenty first century is the most criticalphase in human history, i.e., the serious

challenge of ensuring reliable and adequate

supply of energy at an ever growing rate, in ascenario of vastly depleting sources of fossil

fuels, a severely polluted environment and

almost totally degraded ecology.

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E T h l i


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Energy Technologies

Overview of Energy Technology and itsImportance: There is a resurgent interest in

the renewable energy forms and the role that

this particular form of energy can play, giventhe different considerations relating to energy

access, energy security and environmental

security that are emerging.

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E T h l i


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Energy Technologies

Global Energy Scenario: Global energy demand isprimarily determined by three factors: Economicdevelopment, Population growth andTechnological progress.

However, environmental considerations maychange the rate of growth and pattern of energyuse. Also, in mature economies, there is adelinking between economic growth and energyuse as evidenced by energy-GDP elasticities ofless than unity

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Energy Technologies


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Energy Technologies

An analysis of primary energy shares from1850-1990 reveal a transition away from

traditional renewable energy forms to fossil

fuels. The initial increase in the share of coal till

World War I, followed by emergence of oil,

and natural gas; a peaking in the share of oil inthe 1970s

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Energy Technologies


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Energy Technologies

The current global primary energy consumption is 9.7Gtoe, with developed countries of North America andEurope consuming a little over half this energy.

The consumption in North America has grown at about

1.5% per annum during1990-2003, which is similar tothe world average of 1.6% per annum.

In contrast, the primary energy consumption in theAsia-Pacific region grew at about 3.9% per annum,

indicating the need for energy in this fast growingregion of the world

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Energy Technologies


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Energy Technologies

Oil consumption has a predominant share of 37%in total primary energy consumed globally,

followed by coal with 26% and natural gas with a

share of 24%.

In the Asia Pacific region too, oil plays a major

role.

However, the penetration of natural gas is not as

high as the world average. In this region, coal

continues to be consumed in large quantities

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Energy Technologies


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Energy Technologies

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Clean Development Mechanism


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p

Kyoto Mechanism, CDM and its Characteristics,Small Scale Project Categorization

Section 86(1)(e) of Electricity Act 2003 (the Act)

mandates the Commission to promotecogeneration and generation of electricity from

renewable sources of energy by providing

suitable measures for connectivity with the grid

and sale of electricity to any person

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p

The United Nations Framework Convention onClimate Change (UNFCCC) is the centerpiece of

the global efforts to combat global warming.

It was adopted in June 1992 at the Rio EarthSummit, and its primary objective is the

stabilizationof greenhouse gas concentration in

the atmosphere at a level that would prevent

man- made interference with the climatesystem.

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This was further strengthened at Kyoto in 1997,wherein the nations of the World agreed thatindustrialized countries would reduce aggregateemissions by 5.2% below 1990 level by 2008-

2012 The Kyoto Mechanisms: The Protocol broke new

ground by introducing three innovative marketbased mechanisms: Joint Implementation (JI), theClean Development Mechanism (CDM) andEmissions Trading (ET)

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Of the three flexible mechanisms under the aegis ofthe Kyoto Protocol, the Clean Development Mechanismis the only one involving developing countries

CDM aims to direct private sector investment from

industrialized countries (the Annex- I countriesof theProtocol) with emission reduction commitments toprocure Certified Emission Reduction (CERs) from ecofriendly, development oriented Projects and activities,which reduce GHG emissions, also known as the CDMProjects

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Clean Development Mechanism: CDM is aninvestment proposition by whichindustrialized countries would invest in a GHGmitigation project in a developing country

The organization in the industrialized countrywould get credit towards their emissionreduction targets, while the Project proponent

in the developing country would receive newcapital flows and clean technology

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The CDM has two primary goals: To assistAnnex I countries in reaching their emission

reduction targets.

To promote sustainable developmentobjectives in the host countries (non-Annex I

countries)

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The first goal allows developed countries toachieve their reduction obligations through

projects in developing countries that reduce

emissions through clean energy, energy efficiency

and renewable energy projects

The Main Characteristics of CDM: Participation in

a CDM project activity is voluntary and CDM

investments will be market driven. Public andprivate parties are eligible to participate.

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The Indian Government has formed theDesignated National Authority (DNA), toendorse CDM Projects, which meet thesustainability criteria set by the Indian

Government.

The Executive Board (EB) of UNFCCC has alsoaccredited several agencies to function as

Designated Operational Entity (DOE) forproject validation and verification

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Why CDM in India The commitments given bythe governments of Annex-I countries aretranslated to corporate commitments toreduce GHG emissions in their operations

Opportunities for GHG emission reduction inAnnex I countries are few and the cost ofdoing so is also high as compared to the GHG

emission opportunities in a developingcountry

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As a result, many corporate from thedeveloped countries are forming strategic

alliances with corporate in the developing

countries to meet their emission reductioncommitments.

They finance a potential CDM project and

against that take the credit of GHG emissionreduction

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There are many such projects in India that willcontribute to GHG emission reduction at lowcost and the corporate from Annex I countriesare entering into agreement with Indian

companies to invest in CDM Projects and buycarbon credits

For Indian Industries, this improves the

Internal Rate of Return (IRR) of their Projectsand further improves their bottom line

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TYPE (iii): Other project activities that reduceanthropogenic emissions by sources, and directly

emit less than15/ktCO2 e annually

Glossary of Terms Related to Clean DevelopmentMechanism: According to the Kyoto Protocol, gas

emission reductions generated by Clean

Development Mechanism and Joint

Implementation project activities must beadditional to those that otherwise would occur

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Annex I Countries: These are the 36industrialized countries and economies in

transition listed in Annex 1 of the UNFCCC.

Their responsibilities under the convention arevarious, and include a non-binding

commitment to reducing their GHG emissions

to 1990 levels by the year 2000

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Annex B Countries: These are the 39emissions-capped industrialized countries and

economies in transition listed in Annex B of

Kyoto Protocol 8% decrease (e.g. EU) to a 10% increase

(Iceland) on 1990 levels by the first

commitment period of the Protocol, 2008-2012

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Base Line: A baseline should cover emissionsfrom all gases, sectors and source categories

listed in Annex A (of the Kyoto Protocol) within

the project boundary Baseline Methodology: A methodology is a

tool to determine the baseline for an

individual project activity, reflecting aspectssuch as data availability, sector and region

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Building: Bundling: Refers to combining oraggregating a number (more than one) of small-scale projects and/or project activities into asingle emissions reduction project. Small- scale

CDM project activities may be bundled at thefollowing stages in the project cycle

Carbon Offsets: Offsets are tradable emissionreductions that are used to offset emissions from

various sources, such as emissions related topersonal or business air travel

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Carbon Dioxide Equivalent (CO2 e): Theuniversal unit of measurement used to

indicate the Global Warming Potential (GWP)

of each of the six greenhouse gases listed inAnnex A of the Kyoto Protocol carbon

dioxide (CO2 ), methane (CH4 ), nitrous oxide

(N2 O), hydro fluorocarbons (HFCs), per

fluorocarbons (PFCs), and sulphur

hexafluoride (SF6 )

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CERs (Certified Emission Reductions): Thetechnical term for the output of CDM projects, asdefined by the Kyoto Protocol. One CER is thereduction of 1 tonne of carbon dioxideequivalent.

Certification: Certification is the writtenassurance by the designated operational entitythat, during a specified time period, a projectactivity achieved the reductions in anthropogenic

emissions by sources of Greenhouse Gases (GHG)as verified

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Clean Development Mechanism (CDM): TheCDM was established by Article 12 of theProtocol and refers to climate changemitigation projects undertaken between

Annex 1 countries and non-Annex 1 countries Project investments must contribute to the

sustainable development of the non-Annex 1

host country, and must be independentlycertified

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Project participants are able to choose thestarting date of a crediting period to be after thedate the first emission reductions are generatedby the CDM project activity

A crediting period cant extend beyond theoperational lifetime of the project activity

The project participants may choose betweeneither a fixed crediting period of 10yrs or threerenewable crediting periods of a maximum 7years each (i.e. maximum 21 years)

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Debundling Test: Debundling is defined as the fragmentation of a large project into smaller parts

Designated Operational Entity (DOE): An entitydesignated by the COP (or MOP), based on

recommendation by the Executive Board, as qualifiedto validate proposed CDM project activities as well asverify and certify reductions in anthropogenicemissions by sources of Greenhouse Gases (GHG)

A designated operational entity shall performvalidation or verification and certification on the sameCDM project activity

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The six gases listed in Annex A of the KyotoProtocol are carbon dioxide (CO2 ), methane(CH4 ), and nitrous oxide (N2 O), as well ashydro fluorocarbons (HFCs), per fluorocarbons

(PFCs), and sulphur hexafluoride (SF6 ) Host Country: The country where an emission

reduction project (under Joint Implementation

or the Clean Development Mechanism) isphysically located.

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Kyoto Protocol: Adopted at the ThirdConference of the Parties to the United

Nations Convention on Climate Change held in

Kyoto, Japan in December 1997, the KyotoProtocol commits industrialized country

gratifiers to reduce their greenhouse gas (or

carbon) emissions by an average of 5.2%

compared with 1990 emissions, in the period

2008-2012.

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Leakage: Leakage is defined as the net change ofanthropogenic emissions by sources ofGreenhouse Gases (GHG) which occurs outsidethe project boundary, and which is measurable

and attributable to the CDM project activity. Letter of Approval: A letter issued by the

Designated National Authority (DNA) of the HostCountry to a CDM Project confirming that the

project, as proposed, will assist the Host Countryto achieve its goals of sustainable development.

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Non-Annex I Countries: Countries which arenot listed in Annex I of the UNFCCC (generallydeveloping and least developed countries)

Non-Annex B Countries: Countries which arenot listed in Annex I of the Kyoto Protocol(generally developing and least developedcountries)

Party to the Kyoto Protocol: A country thathas ratified the Kyoto Protocol.

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Project Activity: A project activity is ameasure, operation or an action that aims atreducing Greenhouse Gases (GHG) emission

Project Boundary: The project boundaryencompasses all anthropogenic emissions bysources of Greenhouse Gases (GHG) under thecontrol of the project participants that are

significant and reasonably attributable to theCDM project activity

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Project Design Document (PDD): A projectspecific document required under the CDM

rules which will enable the Operational Entity

to determine whether the project (i) has beenapproved by the parties involved in a project,

(ii) would result in reductions of greenhouse

gas emissions that are additional, (iii) has an

appropriate baseline and monitoring plan.

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Project Idea Note (PIN): A note prepared by aproject proponent regarding a project proposedfor a potential CER buyer, such as the World Bankor SENTER

Registration: Registration is the formalacceptance by the Executive Board of a validatedproject activity as a CDM project activity.Registration is the prerequisite for the

verification, certification and issuance of CERsrelated to that project activity

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Sustainable Development: The original definitionby the Brundtland Commission report (WCED,198) states that development is sustainable whenit meets the needs of the present generation

without compromising the ability of futuregenerations to meet their own needs.

Sustainable development is a requirement ofCDM projects and it is the responsibility of the

host country to confirm whether a CDM projectactivity

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Verification Report: A report prepared by anOperational Entity, or by another independent

third party, pursuant to a Verification, which

reports the findings of the Verificationprocess, including the amount of reductions in

emission of greenhouse gases that have been

found to have been generated.

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Regulatory Framework and Subsidy


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Role of central agencies, Role of FIPB,Subsidies: The growth of the economy, calls

for a matching rate of growth in infrastructure

facilities. The growth rate of demand forpower in developing countries is generally

higher than that of Gross Domestic Product

(GDP). In India the Power Sector, hitherto, had

been funded mainly through budgetary

support and external borrowings.

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Due to growing demands from other sectors,particularly social sector and the severe

borrowing constraints, a new financing

strategy This is reflected in the new policy enunciated

in 1991, allowing private enterprise, a larger

role in the power sector

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State Electricity Boards (SEBs) in India are besetwith problems of high Transmission and

Distribution (T and D) losses, large out standings

to central sector companies, inadequate

investments, and irrational tariff structures

These problems have resulted in power shortages

and poor-quality power supply to customers, and

to the eroding of the financial viability of the SEBs

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The setting up of an independent, autonomous,and accountable regulatory structure at thecentral and state levels was, therefore, becomingextremely essential to address the above issues

Rationalize the Tariff Structure by setting upindependent regulatory bodies

Ensure transparency in generation, transmissionand distribution by unbundling and corporatizingthe SEBs

Provide financial and operational autonomy.

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In order to get a overview the following pointsaid in learning the Regulatory framework of

the India Power Sector:

Common Minimum National Action Plan forPower: The Chief Ministers met on 16th

October and 3rd December, 1996 to discuss

and deliberate upon the issues pertaining to

the power sector

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Recognized that the gap between demand andsupply of power is widening Acknowledged

that the financial position of State Electricity

Boards is fast deteriorating Power sector cant be sustained without

improvement of operational performance of

State Electricity Boards

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Agreed that reforms and restructuring of StateElectricity Boards are urgent and must be carriedout in a definite time frame

Identified creation of Regulatory Commissions asa step in this direction

Requirements of the future expansion andimprovement of power sector cannot be fullyachieved through public resources alone and it isessential to encourage private sectorparticipation in generation, transmission anddistribution

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A national consensus evolved for improvingthe performance of the power sector in a timebound manner and the following was adopted

National Energy Policy: The Governmentwould soon finalize a National Energy Policy

State Electricity Regulatory Commission: EachState/Union Territory shall set up an

independent State Electricity RegulatoryCommission (SERC)

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To set up SERCs, Central Government will amendIndian Electricity Act, 1910 and Electricity (Supply) Act,1948

To start with such SERCs will undertake only tarifffixation

Licensing, planning and other related functions couldalso be delegated to SERCs as and when each StateGovernment notifies it

Appeals against orders of SERCs will be to respectiveHigh Courts unless any State Government specificallyprefers such appeals being made to the CentralElectricity Regulatory Commission

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Central Electricity Regulatory Commission: Union Government will set up a Central Electricity

Regulatory Commission (CERC) CERC will set thebulk tariffs for all Central generating andtransmission utilities

Licensing, planning and other related functionscould also be delegated to CERC as and when theCentral Government notifies it

All issues concerning inter-State flow andexchange of power shall also be decided by theCERC

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Rationalization of Retail Tariffs: Determination ofretail tariffs, including wheeling charges etc., willbe decided by SERCs which will ensure aminimum overall 3% rate of return to each utility

with immediate effect. SERCs are mandatory

If any deviations from tariffs recommended by itare made by a State/UT Government, it will haveto provide for the financial implications of suchdeviations explicitly in the State budget

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Private Sector Participation in Distribution: StateGovernments agree to a gradual programme of privatesector participation in distribution of electricity

Role of Central Agencies: The Central Governmentwould make a comprehensive review of the role ofCentral Electricity Authority (CEA). Techno- economicapproval of competitively bid power projects will besimplified and CEA shall not be concerned with capitalcost, tariff and other commercial aspects of the

project. Powers regarding approval of projects

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State Governments will have powers to accordapproval for power projects

The role of FIPB will be minimized by putting

as many projects on the automatic clearanceroute as feasible

Ministry of Environment & Forests have,

proposed the following delegation to theStates for environment clearance

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All cogeneration plants and captive powerplants up to 250 MW

Coal based plants up to 500 MW using

fluidized bed technology subject to sensitiveareas restrictions

Power stations up to 250 MW on conventional

technology Gas/Naphtha based station up to 500 MW

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Autonomy to the State Electricity Boards: Stateswill allow maximum possible autonomy to the

State Electricity Boards. The State Electricity

Boards will be restructured and corporatized and

run on commercial basis

Improvements in the Management Practices of

State Electricity Boards: State Electricity Boards

will professionalize their technical inventorymanpower and project management practices

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Cogeneration/Captive Power Plants: StateGovernments will encourage co-generation/captive power plants

Advance Action and High Priority for HydroProjects: A national policy on hydro powerdevelopment will be evolved by the CentralGovernment which, inter-alia, would includedevelopment of mega hydro projects, both in thepublic sector and the private sector, at locations

with substantial hydro potential, along withconcomitant

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Electricity tariffs for farmers in India amountto less than 10 percent of the cost of supply

That means a power subsidy for theagricultural sector of an estimated US$6

billion a yearequivalent to about 25 percentof Indiasfiscal deficit, twice the annual publicspending on health or rural development, and

two and a half times the yearly expenditureon irrigation

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At the same time, the quality of supply tofarmers has worsened over the years

Operational inefficiencies and high

distribution losses due to pilferage havecontributed to the financial insolvency of

power utilities across India

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A study covering two statesAndhra Pradeshand Haryanaassessed the impact of cutting

subsidies as part of broad reforms of

governance and regulation aimed at reducing

losses, controlling theft, strengthening

metering and collection, and moving to

independent tariff setting, competition, and

privatization

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The Costs of Unreliable Quality and SupplyAlthough farmers pay a small fraction of the

cost of power, they endure the frustration and

economic costs of supply that is both

unreliable (not available at predictable times)

and of poor quality (with fluctuating voltage)

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Both problems mean that water often cannotbe pumped during critical periods in the plant

growth cycle, leading to lower crop yields and

incomes for farmers Electricity is available to agriculture mostly

during off-peak hourssometimes for as little

as three and a half hours a day

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The Costs of Theft The electricity subsidiestake the form of a flat rate paid by farmers per

unit of horsepower per pump; farmersactual

power use is not metered or recorded. These

flat-rate subsidies help to camouflage theft

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The Costs of Poor Targeting Large farmers aremore vocal in arguing for retaining thesubsidized flat rate because it represents amanageable share of their gross income

Moreover, paying a flat tariff for every pumpenables them to irrigate a large area at a lowper unit cost. But for small farmers who can

afford electricity for irrigation, the cost perhectare is significantly higher

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Reality Check on Reform To gain a betterunderstanding of the potential impact onfarmers of different reform packages, thestudy simulated several policy reform

scenarios Business as usualwith tariff increases but

deteriorating quality Gradual reformwith

steeper tariff increases and someimprovement in quality

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Accelerated reformwith the same tariffincreases but more aggressive improvements

in quality

Implications: Small and marginal farmers inHaryana have shown a high willingness to pay

for improved reliability of power supply

because the poor quality of supply has

affected them so severely

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By contrast, medium-size and large farmers(about 60 percent of those owning electric

pumps) are less willing to pay in the short run

because of their expensive backup

arrangements, which reduce their

vulnerability to supply fluctuations. So it is the

smaller and poorer farmers who end up

power sector economics

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