Missing the Last Mile: Indian electricity reforms over the past 25 years

Anish De, Global Head of Energy & Natural Resources, KPMG

It has been 25 years since the Electricity Regulatory Commission Act of 1998 (ERC Act) introduc­ed independent regulation of the electricity sector on a countrywide basis. Calendar year 2023 also marks two deca­des of the Elec­tri­city Act, 2003, en­acted as a comprehensive legislation to consolidate the laws relating to generation, transmission, distribution, trading and use of electricity. The Electri­city Act, 2003, whi­ch subsumed all previous laws in­cluding the Indian Elec­tricity Act, 1910, the Elec­tricity Supply Act, 1948 and the ERC Act, created a fantastic wireframe for, in­teralia, the development of the electricity industry, promoting competition therein, protecting the interests of consumers and ensuring the supply of electricity to all are­as, rationalising electricity tariff, ensuring tra­ns­parent policies regarding subsidies, promoting efficient and environmentally benign policies, and facilitating the constitution of the Ce­n­tral Electricity Autho­rity, the regulatory com­missions, and the appellate tribunal. The Electricity Act, 2003 has often been called the “Rolls-Royce” of legislations, with great merit but for a critical omission relating to the separation of distribution and supply as distinct licensed businesses. The separation of the distribution and supply functions was intensely discussed and debated, but not executed due to the lack of political will and keenness to mo­ve ahead with other elements of the landmark law. Although much has been ac­hieved on the basis of the Electricity Act, 2003, this departure from the practices followed by most reforming jurisdictions across the world has ultimately hindered efficiency and competition, pre­vented mu­ch-nee­ded ownership ch­an­ges, sty­m­i­ed independent regulation or resulted in its capture, and ultimately compromised consumer interests. It remains a critical unfinished agenda in Indian electricity sector reforms.

To appreciate the many successes and also the limitations of electricity sector reforms in the country, it is important to lay out how the sector architecture chan­ged with the reform legislations, and particularly the Electricity Act, 2003. Apart from independent regulation, at the co­re of the changes in the architecture is the con­cept of “open access”, which allows non-discriminatory provision for the use of transmission lines or the distribution system, or associated facilities with such lines or system by any licensee or consu­mer or a person en­gaged in generation in accordance with the regulations specified by the appropriate commission. This key feature, when read with the rights of users of the power systems per various sections of the Electricity Act, 2003, tra­ns­formed the ways of working of the sector, allowed for third-party network use, power trading and eventually organised trading platforms in the form of power exchanges in 2008. It also forced the expansion of the grid and its integrated operations through binding codes, especially the Indian Electricity Grid Code.

Shorn of the details, the Electricity Act, 2003 fundamentally permitted for two critical freedoms – the freedom to purchase and the freedom to sell electricity. These freedoms we­re backed by an entire set of provisions relating to the delicensing of generation, elimination of cro­ss-subsidy surcharges, dedicated transmission lines, definition of a captive generating st­a­tion, elimination of conflict of in­terest throu­gh ownership restrictions, etc., all underpinned by open access. The limitations impos­ed on transmissi­on companies, in particular, were noteworthy si­n­ce they are essentially the purveyors and guarantors of open access. Tra­ns­mission companies were prohibited from trading in electricity.

It has often been argued that the progress in the implementation of the act has fallen well short of the objectives. It is tempting to conclu­de so, especially since many parts of the sector remain inefficient and unresponsive to consumer needs and also to independent regulation. The fin­an­ces of the sector remain precarious despite several bailouts, tariff distortions are rife and service standards are blatantly violated or entirely ignored. However, such a conclusion would really undermi­ne the gains made in the past two decad­es. The po­wer system’s installed capacity base is much lar­g­er (5x today as compared to 1998) and mu­ch more robust now. The national transmission grid is amongst the largest frequency integrated grids in the world. The system allows for ha­n­dling a large amount of renewable energy. The present renewable energy capacity in me­gawatt terms is lar­ger than the entire electricity grid capacity in the year 2003. This is no mean feat since absorbing large amounts of intermittent renewable energy is an exceedingly challenging task. Over time, the competitive power markets have become larger and more sophisticated, with a vast variety of market-traded products. Indian power system operations are extremely well regarded across the world. The last major grid failure in India occ­urred in 2012. Fre­qu­en­cy excursions, which us­ed to be quite common, are a thing of the past, with grid frequencies now managed in a very narrow band. At the consumption end, the gre­atest achievement has been the extension of electricity services to all parts of the country th­rough a programmatic approach that  effectively ad­d­re­ss­ed a seemingly intractable issue. The co­un­try has also wit­nessed the emergence of a very strong and competent na­tional re­gulator in the form of the Central El­ectricity Regu­latory Commission (CERC). Despite the many challenges it in­evi­tably faced, the CERC has emerged as a strong institution that has imple­me­n­ted the core constructs of the Electricity Act, 2003 with elan and has evolved a co­m­mon market design that is universally accepted, inc­lu­ding by the states. Such wide and large-scale transformation in a country of continental proportions, des­pite all the deep-seated challe­nges, is ab­solutely un­precedented.

The greatest unaddressed challenges in the Indian electricity sector lie in the states where institutions are weak and decisions are often influenced by political priorities and considerations. Two genres of state-level institutions stand on weak legs: distribution and supply licensees, and the state electricity regulatory commissions that regulate the state-level li­censees. In a legal construct that is predicated on non-discriminatory open access, distribution and supply licensees are deeply conflicted in carrying out both functions while simultaneously permitting open access to third parties. It is time that these conflicts are removed and the two functions are un­bundled and ac­corded two distinct lic­en­ces. The distribution li­c­ensee, in its new avatar, can collect fair and re­ason­able access charges from all users, in­cluding the supply licensee(s) and other open ac­cess users, invest wisely in up­grading networks and earn reasonable profits. Arguably, the incumbent supply licensees will also be well positioned to compete with their access to a low-cost historical portfolio of contracts. At a ti­me when building new power plants (es­pecially con­ventional ones) has become very challenging, the incumbents will have great co­mpetitive advantages. The integrated distribution and su­pply lic­en­ces arguably hinder their own perfor­mance and commercial interests. It is indeed a pity that the incumbents typically do not perceive this to be the case.

Independent regulation at the state level has mirrored the misplaced priorities of the state-level regulated entities. Since their inception, they have largely focused on keeping tariffs down, ignoring or do­wnplaying the mandate of the Electri­city Act, 2003 consumer service standards, ushering efficiencies in sector operations and regulating the overall sector in a fair and transparent manner. Timeliness in actions has often been missing, resulting in the landmark judgment of the App­e­llate Tribunal (APTEL) in the OP 1 of 2012 case, where APTEL pass­ed explicit directions to all state regulators for complian­ce with certain basic fu­nctions en­joined in the Electricity Act, 2003. Despite that judgment, the development of these critical in­stitutions has been slower than desired becau­se, in general, there is a lack of both will (or cou­rage) and of institutional capability. The state-level electricity regulators urge­n­tly need capability enhancement, grea­ter resources and ar­gu­­ably a more clearly defined operating blueprint. Such a blueprint ought to have granular definitions on a strategic framework for regulation; more robust instruments of regulation that are tightly aligned to the objectives of the Elec­tricity Act, 2003 overall regulatory work pla­ns; monitoring frameworks for the implementation of regulations; review of performance and information dissemination, etc. Right staffing, capa­city building and access to the right tools and capabilities will be very important. The gap between the current and the de­si­red state in these institutions is in­deed very high. In effect, unreformed state-­le­vel ins­titu­tions are like the Achilles’ heel of the Indian electricity sector.

Will these points of weakness be any different in the foreseeable future? Re­forming the unreformed elements will be a long path but, I dare say, that I see hope for several reasons. Despite the structural and ownership challenges to competition and efficient functioning, the pressures are being inevitably felt by the laggards. A laudable feature of the Electricity Act, 2003 is that it did not limit any possibility artificially by being judgemental on what is economically feasible and what is not. This, in ef­fect, is resulting in competitive pressures be­ing exerted on the in­cumbents to be­come efficient or face financial consequences. Efficiencies in technical and commercial operations have indeed improved over the years, manifested in sharply reduced aggregate technical and commercial losses in most states, though arguably there is room to do more. Adminis­trative measures by the Government of India, such as the rules on late payment surcharge, have redu­c­ed pay­­ment delinquency to generators. Con­­sumer rights are increasingly on a better footing with improved supply infrastructure, enhan­ced hours of supply and quicker rectification of faults. Recent ex­periences in the re-privatisation of Odisha distribution lice­n­sees ha­ve gone on to demonstrate that ownership chan­ges can be successful, if back­ed by appro­pri­­ate political commitment and support.

India is uniquely placed in the world as a large growth economy. Economic gro­wth is energy hungry and much of the incremental en­ergy needs will be delivered in the form of electricity. For In­dia’s progress to continue un­hindered for the coming 25 years, the role of its electricity sector will be absolutely pivotal. Despite obvious challenges, our political leaders do recognise the critical role that a str­ong electricity sector will play. The past 25 years of reforms have put the sector on a rather strong footing. The time is op­portune to solve the last-mile reform challenges, which will set India up well for the coming 25 years with a debt-equity structure of 70:30.