Maximising Efficiency: Key highlights of the CERC’s approach paper on tariff regulations

Initiating the consultation for tariff determination for the next control period, the Central Electricity Regula­tory Commission (CERC)  has recently issued an approach paper outlining the terms and conditions of tariff regulations for the upcoming tariff period from April 1, 2024 to March 31, 2029. So far, the CERC has notified four multi-year tariff regulations for the tariff periods 2004-09, 2009-14, 2014-19 and 2019-24.

The latest paper for the period 2024-29 analyses various provisions of previous tariff regulations, taking into account their efficacy in addressing the issues and challenges faced by stakeholders in the past. It also analyses key macroeconomic indicators and other factors, along with the potential issues and challenges that the power sector is expected to encoun­ter, which will have an impact on the tariff and its determination pro­cess under Section 62 of the Electricity Act, 2003.

Another key aspect emphasised in the ap­proach paper is the exploration of innovative and efficient methods to simplify the entire tariff determination pro­ce­ss. This will minimise the regulatory in­terface without compromising on regulatory jurisprudence. The CERC has sought suggestions on enhancing the efficiency of the existing system of hy­brid mechanisms for tariff setting under the cost-plus approach. The current tariff period will come to an end on March 31, 2024.

A look at some of the key ideas presented in the approach paper by the CERC for consultation with stakeholders…

Tariff determination

The paper presents two potential opti­o­ns for simplifying the tariff determination process. The first approach proposes a shift to a normative tariff structure, where the capital cost is approved on an actual basis after a prudence check, while all other annual fixed cost (AFC) components are determined on a normative basis. The other approach suggested in the paper is the further simplification of the existing performance-based hybrid approach, wherein, based on admitted capital cost, the AFC components can be approved based on actuals or norms as specified for the control period. Further, additional capitalisation may be allowed on certain aspects on a normative basis.

Approach 1 – normative tariff: The components of AFC that increase over a period can be categorised as operation and maintenance (O&M) expenses; while AFC components that decrease over a period can account for the remaining AFC components. If the normative re­gime is to be adopted, it is crucial to co­n­sider the impact of the weighted average rate of interest and interest on working capital from time to time. This en­ab­les the AFC components to be fine-tuned to effectively incorporate changes in market dynamics. In addition to the year-on-year variations, which could be station-specific, there can be inherent variations due to varying costs of funds, funding patterns, depreciation rates and other plant-specific peculiarities. There­fore, normative tariffs for these stations appear to be feasible only when asset-specific factors are determined. Imple­menting asset-specific normative tariffs will allow the determined tariffs to be closely aligned with actual costs, thereby minimising the likelihood of significant gains or losses. This approach will also help ac­hi­eve the objective of eliminating the ne­ed for periodic tariff filings. Con­sidering the aberrations observed in the initial five years post the commercial operation date (COD), tariffs during the first five years may be approved on an actual basis and will be subject to subsequent truing up.

For projects that are yet to be completed five years post COD as of April 1, 2024, the capital cost will be approved on an actual basis up to the cut-off date. Fur­ther, any additional capitalisation after the cut-off date can be allowed on a normative basis. The tariff components of the AFC shall be determined and trued up on an actual basis until the financial year in which the cut-off date for such generating stations concludes. The AFC for each station will be determined for the first financial year following the cut-off date, consisting of AFC excluding O&M expenses; and O&M expenses. Thereafter, from the sixth financial year onwards, the aforementioned AFC categories will be determined using the proposed indexation mechanism for existing projects. For generating stations, the current practice of approving energy charges will be continued.

Approach 2 – performance-based hy­brid approach: Approach 2 involves the further simplification of the existing tariff determination process.

In the case of generating stations, the ge­neration tariffs for O&M expenses, depreciation and return on equity are specified on a normative basis. However, certain components outlined in the present regulations necessitate the consideration of actual values. In terms of en­ergy charge, fuel costs and gross calo­ri­fic value need to be considered. For working capital, the total receivables are affected by the fluctuating actual fuel costs. Further, it is necessary to consider both the interest rates on loans and interest rates on working capital.

For transmission tariff, as per the existing tariff regulations governing the determination of transmission charges, certain components such as O&M expenses, depreciation, return on equity, and wor­king capital requirement and interest are already permitted on a normative basis. The current regulation allows the inclusion of interest on normative loan capital at the actual weighted average rate of Interest. In the existing approach, a significant regulatory overburden arises due to recurring but low-value additional capitalisation claims. To address this issue, the option of normative additional capitalisation has been proposed in the approach paper.

Financial parameters

Capital cost: In the case of hydro generating stations, considering the importance of advancing the local area’s development and for mitigating public resistance and delays, expenses related to the aspects may be allowed as part of the capital cost, subject to certain limits. For projects acquired through National Company Law Tribunal proceedings, the determination of tariff post approval of the resolution plan should consider either the historical cost or the acquisition value, whichever is lower.

Interest during construction (IDC): Pro-rata IDC may be allowed, taking into ac­count the total implementation period. This involves pro-rating the actual IDC incurred until the project’s scheduled COD and period of condoned delay over the total implementation period. The IDC approved in the original investment approval should be considered while allowing actual IDC in the case of delay.

Additional capitalisation: In order to establish a provision that enables additional capitalisation, an amendment may be introduced to Regulation 26. Th­is provision would allow such expenses if they are determined to be benefi­ci­al/es­sential for continued operations, subject to prior approval. For transmission systems, ad­di­tional capitalisation post-cut-off date may be allowed based on factors such as technological obsolescence, change in law, force majeure, or replacement.

Depreciation rate: It may be specified, considering a loan tenure of 15 years, instead of the current practice of 12 years. Further, additional provisions can be specified to allow the generator to ch­arge a lower rate of depreciation in the initial years if mutually agreed upon with the beneficiary.

Interests on loans: To simplify the app­ro­val for interest on loans, the weighted average actual rate of interest of the generating company or transmission licensee may be considered instead of project-specific interest on loans. Further, the cost of hedging associated with foreign loans should be allowed on an actual ba­sis, without allowing any actual for­eign exchange rate variation.

Life of generating stations and transmission systems: The specified useful life of coal-based thermal generating stations and transmission substations may be extended from the current 25 years to 35 years. Considering the continued need for higher repairs, the current dispensation of allowing a special allowance or provision for renovation and modernisation may be continued after 25 years.

Operational parameters

Operational norms: In light of generating stations being granted separate de­gradation impact due to low load operations, the norms may be fixed by considering the optimal loading of generating units.

Emission control systems: Due to the limited commissioning of emission control systems and insufficient data on their actual operational performance and impact on auxiliary consumption, the current tariff norms may be maintained for the next control period.

Blending of coal: By linking the consent of beneficiaries with the percentage blending of imported coal, instead of relying on an increase in ECR, the generating company swiftly responds to an increase in demand. The procurement of such coal should be conducted through a transparent competitive bidding process.

Separate norms for run-of-the-river/ storage-based hydro projects: Conside­ring the anticipated increase in peaking loads, these stations may be incentivised to operate as peaking plants. One way to achieve this is by providing additional incentives for energy supplied during peak periods.

The way ahead

Given that the tariff determination pro­cess has evolved considerably over the past two decades and has achieved a level of standardisation, it is imperative to simplify the tariff determination pro­cess and adopt a more pragmatic ap­pro­ach that does not involve the microan­alysis of each cost component. Past experiences suggest that the approach of dwelling on minute details has only complicated the process without yielding commensurate benefits.

The CERC has clarified that the approa­ch paper does not reflect the views of the commission or its chairperson/membe­rs. The current focus of this approach paper appears to be on efficient and performance-based norms, maximising the utilisation of efficient generating stations, and de-risking the generation and transmission business. It will be interesting to observe how the stakeholders analyse the issues raised in the approach paper as they work towards a smooth transition to a normative tariff regime.