Power – How to price it right

In a series of blog posts related to the World Economic Forum’s Global Energy Architecture Performance Index Report 2013 report launching on Tuesday 11th December 2012, Dr. Ishwar Hegde, Chief Economist at Suzlon Energy takes a look at the case of the world’s fifth largest electricity consumer: India.

India’s electricity sector is displaying a rather unusual dualism in its transition towards a new energy architecture. On the one hand, there has been stellar growth in the power sector since electricity reforms were launched in 2003. With 208 GW of current installed capacity, India has managed to double its capacity over the last ten years, and there are reasonable chances that this feat will be repeated in the current decade. But on the other hand, the nation continues to face problems of persistent peak power shortage of over 11%, insufficient access to electricity and frequent power outages. Almost 300 million people live without access to electricity.

These issues contribute to India’s lower-tier rank on the World Economic Forum’s Global Energy Architecture Performance Index 2013 (EAPI), where it comes 62^nd out of the 105 countries assessed. The EAPI measures a country’s ability to provide energy access to all, to supply adequate energy as a stimulant of growth and development and the environmental impact of energy production. India struggles for success on each of these three fronts. The root causes for this may be various, but the primary problem is one of a distorted pricing structure

Electricity tariffs are regulated in India due to their politically sensitive nature. Prices are fixed by pooling all sources together, based on a cost plus fixed return basis.  Tariffs are distorted mainly due to two factors. First, cross subsidization: the fact that most states would like to provide power to farmers and rural households at either zero or nominal costs, and consequently overcharge large scale industrial users. State Electricity Boards (SEBs) in general are not allowed to pass on full costs and as a consequence, have been running huge losses.  Accumulated losses of SEBs stand at US$ 44 billion between Financial Year (FY) 2008 and  FY 2012. Crisil, a rating agency, has estimated that tariffs need to be hiked by an average of 50 percent for SEBs to just break even.

Secondly, electricity tariffs in India are heavily influenced by cheap coal.  Electricity based on conventional coal fired plants cost a little more than US$  0.2 /kilowatt hour compared to a minimum of US $ 0.7-0.8 /kilowatt hour from non-hydro renewable sources. The country is sitting on large resources of coal. The Indian government has largely allocated these resources for free as a captive source for power generators, in order to keep the cost of power low. Coal technology is outdated, and does not factor in fully the cost of emissions, making coal-based pricing ineffectual.

Tariffs today do not adequately incentivize investment in the right direction that can take India towards a new energy architecture.

About 25 GW electricity capacities have not come into operation as planned during the last Five Year Plan (2007-2012). The main issue was a shortage of coal due to a lack of adequate investment on the part of the state monopoly, Coal India, and also mining in the allocated mines did not take place due to a lack of clearances. Imported coal is expensive, given the low tariff. Therefore the country continues to reel under a shortage of power, hampering its growth potential.

Perhaps most damagingly, new, clean energy technologies are not able to have as much of an impact as would have been hoped for under a transparent, market determined pricing regime. Wind, solar or any renewable source has to compete with cheap, carbon emitting coal-based power. Growth therefore remains limited compared to potential, and can therefore come about only with government support.

In the long run, this will result in a lower than optimal deployment of renewable energy. While non-hydro renewables currently have a share of 10% in terms of installed capacity, this needs considerable scaling up to meet India’s energy demands in a sustainable fashion. The sustainable growth of renewable industry is only possible with free and fair pricing.

Considerable progress has been made thus far in the power sector, of course. India has not become the fifth largest consumer of electricity by accident. It’s policymakers have enabled this rapid rise by instituting an adroit mix of policies, support mechanisms and regulatory structures.

And yet, in spite of this entirely deserved achievement, there remains the metaphorical elephant in the room that must be addressed sooner or later.  Without an efficient price discovery mechanism, India’s electricity sector will continue to limp, not leap.

Author: Ishwar Hegde is Chief Economist at Suzlon Energy. 

Image: Workers fix power lines on utility poles on the outskirts of Agartala REUTERS/Jayanta Dey