concept note by lindash


									                               Performance Benchmarking and Quality of Supply and Service
                        Distribution Reform, Upgrades and Management (DRUM) Training Program

                      Pisupati Karthikeya, Emerging Markets Group, Ltd

This paper deals with the role of Electricity Regulatory Commission (“ERC”), as set out
in the Electricity Act 2003 (“the Act”), the precedents from the workings of ERCs in
various states, the emerging tariff setting methodology as set out in the draft National
Tariff Policy (“NTP”), and the impact it has on the workings of the Utilities.

                                           1. Background

As per the Act, the main function of the ERCs (and also as defined through the working
of the institutions and views of the various experts in the sector) is in setting the tariff for
purchase and sale of electricity including the retail tariffs to be paid by the end

Apart from the tariff setting principles, ERCs other main function are:
   licensing the distribution and retail supply (as per the Act, these functions are
       bundled together and cannot be segregated), transmission and trading functions
   setting various standards of supply and the performance codes to be adhered to/
       maintained by the licensee
   ensuring that the sector works in an efficient fashion such that the value chain
       justly reflects the economic way of reaching the electricity to the consumer
   setting tariff and other parameters to ensure that open access is facilitated in
       transmission and distribution. This includes the identification and elimination of
       cross-subsidies over a period of time

Given the above, most of the focus of the ERCs is on the setting of tariffs (including
elimination of cross-subsidy) and this function consumes large resources from the
Commission as well as Utility. In fact, one of the stringent criticisms from the utility is
the time that is consumed in the annual regulatory process and the critical part it plays
in shaping of the utility’s financial health.

                               2. National Tariff Policy (NTP)

As per the draft NTP that has been circulated, commissions are required to consider
certain methodologies while setting the tariff and introduce performance-based cost of
service regulations, a move away from the extant “Cost +” methodology.

While introducing the above methodology, ERCs would consider introducing multi year
tariff (“MYT”) principles. In MYT, the ERCs and the utilities are encouraged to set in the
initial and final values for certain controllable parameters such as loss levels, Salaries,
R & M, etc. through a discovery and negotiation fashion (including public hearings).

    Space for
 Institution Logo                                                                        Power Finance Corporation Ltd.
                                                                                                (A Govt. of India Undertaking)
                              Performance Benchmarking and Quality of Supply and Service
                       Distribution Reform, Upgrades and Management (DRUM) Training Program

Uncontrollable parameters such as power purchase costs are to be automatically
passed through the tariff, every quarter or a suitable period through Fuel Surcharge
Adjustment (“FSA”).

The ERCs would review the position of the controllable parameters only at the end of
the control period (usually a 5 year period, though some Latin American countries have
a 10 year control period) and not within the control period. Thus, the utilities are given
longer period to work-in the efficiency into the system and not be worried about the
annual tariff exercises.

This is not necessarily the precedent set up by Andhra Pradesh in its Long Term Tariff
Principles (“LTTP”) or in Delhi’s 5 year order passed in conjunction with privatisation.
Under LTTP, the utilities will be required to set the path of reduction/ improvement in
efficiency of the controllable factors for a period and this would be reviewed once in the
beginning and then at the end of the control period.

Uncontrollable parameters would be allowed automatic pass through during the period.
Utilities are expected to file in annual tariff requirement through their Annual Revenue
Requirement process and the tariff would be set (assuming that the ERC works out the
intermediate path for the controllable parameters) annually – a deviation not necessarily
present in the international practice. This could be due to the fact that the initial set of
data in many of the utilities does not inspire confidence with the Commission or the

Similarly in Delhi, the ATC loss reduction path (the bidding parameter) for the
privatization process was set to the final negotiated value (17.5% in 5 years). The
utilities were to file their annual revenue requirements, which would be vetted by the
commission in the normal methodology – except that the ATC loss reduction would be
reviewed only at the end of the control period.

If the ATC loss reduction at the end of the control period exceeds the target, then the
utilities are expected to retain 50% of the incremental benefits and the balance is to be
set off against the tariff hike requirements.

The MYT principles, set out in the international practice, act more as a price cap rather
than a revenue cap. They set out the maximum that can be charged in the “RPI-X”
principles (separately for each and every function) and that drives the tariff calculations.

Cross –Subsidy Elimination
While setting the charges to be paid in the open access regime (the network hire
charges, the losses to be paid, cross-subsidy element and the scheduling charges),
ERCs are mandated to work out the cross-subsidy element and the path that would be
followed by the ERC in eliminating the same i.e. the number of years and the quantum
of reduction either year-by-year or at the end of the period.

    Space for
 Institution Logo                                                                       Power Finance Corporation Ltd.
                                                                                               (A Govt. of India Undertaking)
                              Performance Benchmarking and Quality of Supply and Service
                       Distribution Reform, Upgrades and Management (DRUM) Training Program

Trading Margin
According to the Act, the Central/ State ERCs are given the right to determine the
trading margin i.e. the profit that can be charged by the trader while selling the power to
licensees. This would require ERCs to evaluate the financial working of a trader,
evaluate the reasonable-ness of the margin which can be charged and the ultimate
impact it has on the end retail tariffs to the consumer.

Penalties and Incentives
As per the license conditions and also service standards set up by ERCs, there could
be penalties/ incentives for non-achievement/ achievement of standards. For example,
the ERC could set up a rule that for every customer interruption for more than say x
period, the customer should be compensated with Rs X by the service provider.

Points for Consideration
It is clear from the above that the Regulatory process has large implications on the
various activities of the utility, as summarized below:

    Function        Parameters              Remarks
    Tariffs         Revenue                 That which the utility is allowed to bill, charge and
                    Allowance/              collect.
                    Dis-allowance           Any costs incurred outside the approval of ERC
                    of costs                would be not allowed.
                                            IMPACT – profitability and financial viability of the
                    Cost to Serve           Detail of serving customers at various voltage
                    details                 levels including the losses that are incurred
                                            IMPACT – profitability and revenue generation
                    Directives on           For eg. ERC may direct utility to submit detailed
                    certain                 voltage-wise loss levels, asset classification by
                    operations              voltage level etc
                                            IMPACT – elimination of cross-subsidization
                                            (losses, revenue) between categories
                    Capex allowed Affects the efficiency measures (loss reduction or
                                  improvement measures) and hence on the future
                                  of the company
                                  IMPACT – profitability and cash flows

                    Directives              Affects various activities of the utility from the loss
                                            reduction, load forecast, collection drives etc
                                            IMPACT – financial viability of the company

    Space for
 Institution Logo                                                                       Power Finance Corporation Ltd.
                                                                                               (A Govt. of India Undertaking)
                              Performance Benchmarking and Quality of Supply and Service
                       Distribution Reform, Upgrades and Management (DRUM) Training Program

                    MYT                   Controllable parameters – initial and final targets or
                                          Targets for all areas for the utility – ability to fix
                                          tariffs and recover costs
                                          IMPACT – revenue generation, cost allowability and
                                          hence profitability
    Subsidy         Cross                 Timely compensation by State Governments and
                    subsidy and           also payment for policy decisions taken by State
                    Total subsidy         governments (like write off of all outstanding dues of
                    calculation           agriculture consumers) or allowing captive
                                          generation (loss of cross-subsidy from paying
                                          IMPACT – revenue generation, cash flows and
    Collections     Assumption            Usually tariff orders consider collections @ 100% of
                    in tariff order       current billing and generally do not provide for
                                          outstanding or methods of financing the same
                                          (though some commissions allow the interest on the
                                          amounts borrowed for the working capital
                                          IMPACT – profitability and cash flows (near term
    Service         Penalties for         Maintenance of certain minimum standards of
    Standards       failing to            service, failure of which results in compensating the
                    meet                  consumers
                    standards             IMPACT – financial viability and profitability of

Thus, the company needs to understand the strategic and near term impact of the
Regulator’s orders/ tariff approval process. Once these dimensions are understood, the
company would be in apposition to develop its key performance indicators (“KPI”) to
ensure that the adherence to business guidelines set out by the Regulator is practiced
and the company can a tleast end up at the same line as set out by regulator.

This is best explained by the following example.

Utilities in Andhra Pradesh (APTranco and Discoms) usually set their yearly KPI targets
using the tariff order (and its directives) as the basis. Thus the tariff order is analyzed
into its components that affects its profitability, financial viability and liquidity.

These are then converted into monthly targets for each section office, consolidated at
the divisions, further aggregated at circle levels and finally into zone and then at the
company level.

    Space for
 Institution Logo                                                                       Power Finance Corporation Ltd.
                                                                                               (A Govt. of India Undertaking)
                                           Performance Benchmarking and Quality of Supply and Service
                                    Distribution Reform, Upgrades and Management (DRUM) Training Program

The following diagram shows the drill down approach:

                                    Improve Return on Investments / Capital Base

                        Improve                                              Improve
                       Revenue                                              Efficiency
                      ARR Targets                                          ARR Targets

    Improve Revenue                 Improve
      per Customer               Customer Base                      Improve                          Improve
PMRS > Revenue/Customers    PMRS > Growth in Customers           Metered Sales                    Working Capital
                                                             PMRS > % Metered Sales             Non PMRS measure

                                                                Reduce Losses                    Power Purchase
                                                            PMRS > Reduction in Loss           PMRS > Actual/Target

                                                                                                Non PMRS measure

          Move Customers                              Move Customers                                    Control supply to
           to higher slabs                       to remunerative categories                        unremunerative categories
PMRS> Increase in Specific consumption       PMRS> Increase in Revenue/Customer                PMRS> Increase in Revenue/Customer

             Use benchmarks                               Use Load-Factor analysis                           Monitor 9 hour
             and exceptionals                                 and inspections                              supply to agriculture
        PMRS> Malpractice/Pilferage                      PMRS> Malpractice/Pilferage                       11Kv Feeder reports
      RNF/Door-Locked/Low consumption                                                                         Non PMRS measure

          Ensure uninterrupted supply
            to metered customers*
             Non PMRS measure

The way it is broken up across the organisatoion is shown below:

                                                                               Overall Revenue/ Profitability Targets for Discom driven by
                                                       ARR Targets
                                                                               ARR Targets

        Targets for
                      Circle 1                Circle 2                  Circle 3
                                                                                               ……                     Circle 10

                                                   Circle Targets
        Targets for Circles
        drilled down

                  Div 1                    Div 2                      Div 3
                                                                                          ……                        Div n

                             Sub-Div 1               Sub- Div 2                    Sub-Div 3
                                                                                                     ……                     Sub -Div n

                  Sec 1                   Sec 2                      Sec 3
                                                                                          ……                      Sec n

    Space for
 Institution Logo                                                                                                       Power Finance Corporation Ltd.
                                                                                                                                  (A Govt. of India Undertaking)
                                           Performance Benchmarking and Quality of Supply and Service
                                    Distribution Reform, Upgrades and Management (DRUM) Training Program

The main KPIs at the company level are

      1.   Energy Utilization/ Energy drawal
      2.   Metered Sales
      3.   Demand Raised (adjusted for actual input)
      4.   Revenue collections
      5.   Losses
      6.   Distribution Transformer Failures

This is then broken down into individual circle/ division and section, as seen below:
S.No Parameter                                  Ananthapur          Kurnool            nagar           Nalgonda            Medak
                                               Target  Actual    Target  Actual    Target  Actual    Target  Actual    Target  Actual
       Power           MU                        1434    1496        870     940     1470    1599      1841    1993      2058    2195
       Purchase        Rs. Crores                  318     330       193     201       326     348       408    433        456     476

                       Metered Sales              584     547       406     452       438     357       655     641       1033        1098
       Sales (MU)
  2                    Agl Sales                  564     627       289     285       685     839       807     917        684         716
                       Total Sales               1148    1174       695     737      1123    1196      1462    1558       1717        1814

                       %                        19.98    21.53    20.11    21.61    23.64    25.17    20.60    21.80     16.56       17.39

                       Adjusted Demand
       Demand (Rs      (Target) vs Actual
       Crores)         Demand (Actual)                                                                                      432
                                                  222     191       208     183       202     169       362     317                    410

       Collections (Rs. Demand Raised
       Crores)          (Target) vs
                        Collections (Actual)      191     160       183     173       169     143       317     255         410        394

                       Total as on March
       Arrears (Rs     2003                                57                25                93               147                    118
       Crores)         Total as on Dec
                       2003                                87                37               136               222                    167

       Expenditure     Operating Exp excl.
       (Rs Crores)     Power Purchase              66      71        52      60        57      69        69      83         56          65
       Apr-Dec         Total                      384     401       245     261       382     416       477     516        511         541

Source: All figures/ tables in this paper - KPMG presentation and Dhiya Internal

The data is captured from the section and division offices and are consolidated at the
circle offices. The circle office reviews and monitors the performance of individual
section and ensures that action is taken to adhere to the targets set. The circle data is
then consolidated at the company level, which is monitored and reviewed by the Head
office monthly. This has helped AP state to achieve an internal efficiency of ~ Rs 1860
crores in 5 year period or save ~4.4% of annual average tariff increase for its

    Space for
 Institution Logo                                                                                        Power Finance Corporation Ltd.
                                                                                                                (A Govt. of India Undertaking)
                                     Performance Benchmarking and Quality of Supply and Service
                              Distribution Reform, Upgrades and Management (DRUM) Training Program

The above shows how the regulatory process drives in the near term. Similarly, the
regulatory process also impacts the long term business planning of the companies.
         Business Planning - Process overview

        Industry                    Regulatory                                           company
        Structure                                                                         analysis

                        Business Plan
       GoK Policies
                                   Performance Review

        Uncertainties                Develop                 Business
           Risks                    Objectives             Case/ Forecast

The trading separation from Transmission utility, vesting of PPAs with discoms, open
access etc are some of the statutory and regulatory policies that affect the business
plan of the companies. If one were to take the vesting of the PPAs with the distribution
companies have changed the risk profile of these companies from low to high, since
    Discoms are responsible for the entire supply risk – to its consumers and buyers
    It has to ensure that the PPA payment term of individual generator is honoured in
       time to avoid the escrow imposition or other penalties
    In the past Transco had been able to manage the short term liquidity crisis by
       borrowing on the strength of a larger balance sheet, which may not be available
       to individual discoms
    Since some of the PPAs are shared, all discoms should act in a concerted
       manner to avoid the penalty on one and all
    The load forecasting and management responsibility falls squarely on the
       discoms (in the past managed by Transco)

Similarly, introduction of MYT principles also would require the Discoms to manage their
business (and also ensure that data availability is adequate for decision support) in a
manner that the profitability or viability is not affected.

                                                   3. Conclusions

Thus the KPIs are to be closely linked to the Regulatory process to ensure that the
business is properly de-risked and its viability or profitability is not affected.

    Space for
 Institution Logo                                                                              Power Finance Corporation Ltd.
                                                                                                      (A Govt. of India Undertaking)

To top