1 Implementation of Multi-Year Tariff framework. 2 Contents of the presentation Issues to address in design of multi- year tariff (MYT) frameworks Alternative.

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Implementation of Multi-Year Tariff framework

Implementation of Multi-Year Tariff framework

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Contents of the presentationContents of the presentation

Issues to address in design of multi-

year tariff (MYT) frameworks

Alternative frameworks of MYT for

Uttar Pradesh

Selecting the appropriate framework

Implementation aspects

Issues to address in design of multi-

year tariff (MYT) frameworks

Alternative frameworks of MYT for

Uttar Pradesh

Selecting the appropriate framework

Implementation aspects

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What an MYT framework intends to achieveWhat an MYT framework intends to achieve• Determine framework for regulating the utilities for a period of time,

– Principles of regulation of returns/profits of utilities

– Principles of regulating individual cost and revenue elements

– Degree of regulation on an ongoing basis

• Incentivise utilities to become more efficient in operations

• Mitigate risks that are external to the utilities

• Make the sector financially liquid

• Introduce efficient tariff design

• Determine framework for regulating the utilities for a period of time,– Principles of regulation of returns/profits of utilities

– Principles of regulating individual cost and revenue elements

– Degree of regulation on an ongoing basis

• Incentivise utilities to become more efficient in operations

• Mitigate risks that are external to the utilities

• Make the sector financially liquid

• Introduce efficient tariff design

MYT is recognised to be a key for private sector participation since it reduces regulatory risks very significantly. However even for public utilities it brings about clarity on regulatory principles and incentivises efficient behaviour

MYT is recognised to be a key for private sector participation since it reduces regulatory risks very significantly. However even for public utilities it brings about clarity on regulatory principles and incentivises efficient behaviour

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Conceptual Inter-play Between Sector Development and StrategyConceptual Inter-play Between Sector Development and Strategy

Background

Scenario A Incentive payments

Scenario B Price

Scenario B Incentive payments

Scenario B Losses

Scenario A Price

Cost

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• Licensees face a number of financial risks holding back private investment Tariffs are not reflective of costs Efficiency incentives may not have been grafted adequately and explicitly into the

existing single-year regulatory framework

• Existing single-year approach to regulation is not mitigating risk Gap between costs and revenues too large to bridge in single year Certainty on revenue and tariff determination principles not assured

• Efficiency improvement targets are failing to achieve meaningful results

• These problems can only be remedied gradually - therefore the design of the starting point and the transition phase is crucial.

Financial Viability and Economic Efficiency of the Sector is at RiskFinancial Viability and Economic Efficiency of the Sector is at Risk

Background

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Issues for Evaluation of MYT frameworkIssues for Evaluation of MYT framework

• Selection of appropriate framework from the options available– Performance based regulation (Price caps/Revenue Caps)

– Reference Utility framework

– Target based regulation

• Risk mitigation framework– Identification of “controllable” and “uncontrollable” elements

– Mechanisms for addressing risks

• Determining key elements for regulation– Tariffs

– Quality of service

– Key cost elements (system losses, collections, investments, procurement, etc)

• Credibility of the regulatory process/extent of regulatory intervention

• Selection of appropriate framework from the options available– Performance based regulation (Price caps/Revenue Caps)

– Reference Utility framework

– Target based regulation

• Risk mitigation framework– Identification of “controllable” and “uncontrollable” elements

– Mechanisms for addressing risks

• Determining key elements for regulation– Tariffs

– Quality of service

– Key cost elements (system losses, collections, investments, procurement, etc)

• Credibility of the regulatory process/extent of regulatory intervention

Background

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The framework selected has to address the critical issues in Uttar Pradesh The framework selected has to address the critical issues in Uttar Pradesh • Utility operations are currently inefficient

• Significant improvements are possible by addressing certain specific elements like system losses, collections, efficiency of investments

• Institutional capabilities in the Licensees are low. Framework needs to help utilities understand where and how to focus

• Data availability is poor and needs to be improved for improved utility performance and effective regulation

• Understanding of regulatory principles is low among Licensees – need to clearly lay out the principles and accord them the necessary certainty

• Utility operations are currently inefficient

• Significant improvements are possible by addressing certain specific elements like system losses, collections, efficiency of investments

• Institutional capabilities in the Licensees are low. Framework needs to help utilities understand where and how to focus

• Data availability is poor and needs to be improved for improved utility performance and effective regulation

• Understanding of regulatory principles is low among Licensees – need to clearly lay out the principles and accord them the necessary certainty

Selecting appropriate framework

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The implementation of the framework has to address the provisions of UPERA due to which…

The implementation of the framework has to address the provisions of UPERA due to which…• It may not be possible to ‘set’ tariffs for more than one

year period; and

• The licensees have to continue to adhere to an annual filing process

• It may not be possible to ‘set’ tariffs for more than one year period; and

• The licensees have to continue to adhere to an annual filing process

Selecting appropriate framework

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Options on MYTOptions on MYTSelecting appropriate framework

OptionOption DescriptionDescription

Performance based regulation (PBR)Performance based regulation (PBR)

• Characterised by RPI-X+Y formula• Base cost set at beginning of control period (3-7 yrs

ordinarily) based on historical cost data• Efficiency gains/losses to account of utility• Pass through of external costs (Y) allowed

• Characterised by RPI-X+Y formula• Base cost set at beginning of control period (3-7 yrs

ordinarily) based on historical cost data• Efficiency gains/losses to account of utility• Pass through of external costs (Y) allowed

Reference Utility regulationReference Utility regulation

• Based on forward looking (incremental) cost framework• Hypothetical “ideal” utility modelled based on load and

generation configuration for control period (upto 10 years)• Tariffs for “ideal” utility set in advance and subject to only a

few pass through elements (primarily fuel)

• Based on forward looking (incremental) cost framework• Hypothetical “ideal” utility modelled based on load and

generation configuration for control period (upto 10 years)• Tariffs for “ideal” utility set in advance and subject to only a

few pass through elements (primarily fuel)

Target based regulationTarget based regulation

• Specific targets set for important operating elements (e.g. losses, collections, quality of service) for control period

• All other cost elements subject to normal cost-plus regulation• Improvements on targets to account of utility or shared with

consumers and vice-versa

• Specific targets set for important operating elements (e.g. losses, collections, quality of service) for control period

• All other cost elements subject to normal cost-plus regulation• Improvements on targets to account of utility or shared with

consumers and vice-versa

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Evaluation of MYT framework for Uttar PradeshEvaluation of MYT framework for Uttar Pradesh

Selecting appropriate framework

CriteriaCriteria

Power of incentivesPower of incentives

PBRPBRReference

UtilityReference

UtilityTargeted

IncentivesTargeted

Incentives

Degree of regulatory interventionDegree of regulatory intervention

Data requirement for framework designData requirement for framework design

Measurement requirements for implementationMeasurement requirements for implementation

Ease of understanding/ institutional capability reqd.Ease of understanding/ institutional capability reqd.

Identified focus on critical issuesIdentified focus on critical issues

HighHigh

LowLow

HighHigh

LowLow

MediumMedium

MediumMedium

HighHigh

LowLow

MediumMedium

LowLow

LowLow

LowLow

MediumMedium

HighHigh

MediumMedium

Med/HighMed/High

HighHigh

HighHigh

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Appropriate MYT design in the context of the current proceedingsAppropriate MYT design in the context of the current proceedings• From an MYT perspective the current proceedings need to address

the following issues– The Order should incentivise efficient utility operations across a multi-year

period. The philosophy of incentivisation/disincentivisation needs to be clearly articulated

– The Order should clearly identify the elements for which the utilities can be held responsible. Conversely the utilities should be protected from any risks that are external to their business

– The process of regulatory review of utility performance in the coming years needs to be clearly laid out in the Order

• Key process issues that need to be addressed include,– Mechanism and periodicity of review

– Mechanisms/information systems for measurement of performance

– Administration of the incentives/disincentives

• From an MYT perspective the current proceedings need to address the following issues– The Order should incentivise efficient utility operations across a multi-year

period. The philosophy of incentivisation/disincentivisation needs to be clearly articulated

– The Order should clearly identify the elements for which the utilities can be held responsible. Conversely the utilities should be protected from any risks that are external to their business

– The process of regulatory review of utility performance in the coming years needs to be clearly laid out in the Order

• Key process issues that need to be addressed include,– Mechanism and periodicity of review

– Mechanisms/information systems for measurement of performance

– Administration of the incentives/disincentives

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Developing a selection criteria to choose the right elements is critical for MYTDeveloping a selection criteria to choose the right elements is critical for MYT

Measurability

Measurability of the element around

which incentivisation will be planned is

important for design and correct

implementation.

Materiality Controllability Predictability

Risk mitigation mechanisms

become necessary around those

elements that have the potential to

significantly affect the performance of

the utility

The element will need to be

controllable to the utility to enable them

to beat regulatory targets

The element will need to be

predictable because the ability to

determine a prudent level of regulatory target is crucial for the incentivisation

process

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Typical cost Profile of Distribution UtilitiesTypical cost Profile of Distribution Utilities• Bulk Supply Cost

– Power purchase cost of units sold by the licensee

– Power purchase costs of units bought by the licensee to cover system loss

• Operating Costs– Network costs

• Employee expenses• R&M expenses• A&G & Other expenses

– Financing costs• Interest cost

• Reasonable return

• Bulk Supply Cost– Power purchase cost of units

sold by the licensee– Power purchase costs of units

bought by the licensee to cover system loss

• Operating Costs– Network costs

• Employee expenses• R&M expenses• A&G & Other expenses

– Financing costs• Interest cost

• Reasonable return

Network Cost14%

Loss19%

Power Purchase Cost63%

Financing Cost4%

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Identification of the element for incentivisation planIdentification of the element for incentivisation plan

Measurability Materiality Controllability Predictability

Element

Unit Cost of Power

High High Low Medium

System Loss Medium High High High

Network costs High Medium High Medium

Interest cost on LT loans

High Low Low Medium

Level of Receivables

High High High High

Quality of Service

Low High High Medium

Customer Mix Medium High Low Medium

Quantity of Sale of Power

Medium High Low Medium

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Identification of the elements have to be followed by a suitable incentivisation process

Identification of the elements have to be followed by a suitable incentivisation process

Structuring of the incentivisation is a decision which will have to take into account

– the adequacy of the reasonable return to absorb adverse variations of cost elements

– need for a minimum size of the incentives to induce utilities towards exceeding regulatory targets set at the start of the year

– the mechanism in which financial risk / benefits are shared between the utility and the consumer

Structuring of the incentivisation is a decision which will have to take into account

– the adequacy of the reasonable return to absorb adverse variations of cost elements

– need for a minimum size of the incentives to induce utilities towards exceeding regulatory targets set at the start of the year

– the mechanism in which financial risk / benefits are shared between the utility and the consumer

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Open Ended Incentivisation SchemeOpen Ended Incentivisation Scheme

Superior Performance

Adverse Performance

Regulatorytarget levels

set at the beginning of the

year

Benefits

Loss

In an open-ended design, the entire financial benefit (or loss) arising out ofsuperior (or adverse) performance is retained (or absorbed) by the utility

Higher riskand

Higher gain

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Closed Ended Incentivisation SchemeClosed Ended Incentivisation Scheme

Superior Performance

Adverse Performance

Regulatorytarget levels

set at the beginning of the

year

Total Benefit

Total Loss

In a closed-ended design, the total financial benefit (or loss) arising out ofsuperior (or adverse) performance is shared (or absorbed) by means of a pre-determined formula between the utility and the consumer

Extent of benefit

retained by the utility

Extent of benefit

distributed back to

the consumerLower risk

andLower gain

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UPERC has already made some moves towards a long term frameworkUPERC has already made some moves towards a long term framework• Multi-year trajectories have been established for system losses and

collection efficiency for UPPCL

• A comprehensive power purchase true-up process has been put in place

• Multi-year trajectories have been established for system losses and collection efficiency for UPPCL

• A comprehensive power purchase true-up process has been put in place

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UPERC has already made some moves towards a long term frameworkUPERC has already made some moves towards a long term framework• However the accompanying mechanisms and implementation

processes need to be put in place– Measurement mechanisms not identified clearly

– Review process (during and after the year) not specified

– Incentives/disincentives not defined

– Treatment of other cost and revenue elements need to be firmed up

– Certain aspects of cost definition need review

• Cost-to-serve study, a fundamental instrument for regulation is not yet in place

• However the accompanying mechanisms and implementation processes need to be put in place– Measurement mechanisms not identified clearly

– Review process (during and after the year) not specified

– Incentives/disincentives not defined

– Treatment of other cost and revenue elements need to be firmed up

– Certain aspects of cost definition need review

• Cost-to-serve study, a fundamental instrument for regulation is not yet in place

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UPERC also needs to establish the future framework of MYT regulationUPERC also needs to establish the future framework of MYT regulation• As the utilities gain experience in commercial operation and

functioning under regulatory oversight, the framework needs to be advanced to a more powerful and less intrusive framework of regulation

• The new Act prescribes MYT and the National Electricity Policy and Tariff policy is likely to provide implementation options

• Multi-year tariff philosophy and a blue-print for future implementation needs to be put in place. Consultation needs to commence soon – if possible the initiation can happen through the forthcoming orders

• Mechanisms for improved data discovery need to be emphasised upon, and incentivised if feasible

• As the utilities gain experience in commercial operation and functioning under regulatory oversight, the framework needs to be advanced to a more powerful and less intrusive framework of regulation

• The new Act prescribes MYT and the National Electricity Policy and Tariff policy is likely to provide implementation options

• Multi-year tariff philosophy and a blue-print for future implementation needs to be put in place. Consultation needs to commence soon – if possible the initiation can happen through the forthcoming orders

• Mechanisms for improved data discovery need to be emphasised upon, and incentivised if feasible