Transcript Meghraj Capital Advisors Private Limited Infrastructure Advisory I Mergers & Acquisitions I Syndication I Capital Markets MYT-Features and Status of Implementation Nagpur- 25th.

Meghraj Capital Advisors Private Limited
Infrastructure Advisory I Mergers & Acquisitions I Syndication I Capital Markets
MYT-Features and Status of Implementation
Nagpur- 25th February 2011
Vivek Mishra
Structure
I.
Introduction to MYT
 Conventional Tariff Setting Process and its Limitations
 Concept of MYT
 Rationale and Benefits
II.
Framework and Options
 Legal and Policy Framework
 Current Status – India and International
 Key Elements of MYT Framework Design
 Options for MYT Framework Design
III. MYT Options in Detail
 Cost plus Regulation
 Targeted Incentive Regulation
 Performance based Regulation – Price and Revenue Cap
 Risk and Return Framework of various Options
IV. MYT Options and Regulatory Objectives
2
I. Introduction to Multi Year Tariffs
I. Introduction to Multi Year Tariffs
I. Introduction to Multi Year Tariffs
3
Conventional Process of Tariff Setting
● Till recently, most of the State Electricity Regulatory Commission
in India have followed the annual process of tariff determination
● The mechanism involves:




Establishing of Prudent costs each year by the Regulator
Limited but assured return allowed in cost estimates (Concept Cost Plus Regulation)
Cost variations (above I.
or below
the approvedto
figures)
true-up at the end of
Introduction
Multieligible
YearforTariffs
each year
I. Introduction to Multi Year Tariffs
Limited or no incentive to outperform regulatory awards
4
Key Limitations of Conventional Tariff Setting Process
• Mechanism is not sufficiently stable to provide the certainty required to
undertake long term investments

Principles are not clearly set and tendency to pad up costs

Annual evaluation and determination of “reasonable” costs

Possibility of change in regulatory principles from year to year
• The annual framework does not provide the requisite incentive

Any savings on account of better performance taken away next year

Any cost on account of under-performance is subject to regulatory discretion, bringing
in uncertainty
• Process is very long leading to high cost of regulation
MYT is an answer to make the tariff setting exercise more predictable, and to ensure that
costs are recovered in a more mechanistic manner
5
MYT – The Concept
“ A new system where the tariff setting exercise is done for a
multiple years in one go, is termed as MYT”
• Concept of MYT can mean several things:

Prescribing values/numbers on a multi-year basis for various elements of cost/ARR

Adherence to prescribed benchmarks

Instead of prescribing numbers/values principles governing the input costs and output
prices for the multi year period can be done
6
Key Benefits of MYT
• Predictability

Leads to regulatory certainty

Simplification of regulatory process
• Innovation and Cost Reduction

Encourages utility to find innovative ways to reduce costs and improve efficiency

Accompanied by a transparent and stable system of incentives
• Improvement in Customer service and satisfaction

There is a provision of reward/penalty to encourage achievement of the prescribed
customer service and satisfaction levels
• Risk allocation

Determines the best entity to bear a particular risk
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II. Multi Year Tariffs – Framework and Options
8
Legal and Policy Framework
●
●
•
Section 61(f) of the Electricity Act, 2003 requires
the Appropriate Commission to be guided by the
principles of MYT in tariff determination
The National Tariff Policy notified by the Govt. of
India in 2006 also provides for development of
MYT framework by the States
As of 31st March 2009, 14 states have notified MYT
regulations

Of the above 8 of them have issued one or more
tariff orders

A no. of other SERCs are in process of
development of MYT regulations
•
Internationally, MYT has been implemented in
several countries

Latin America – Chile, Argentina, Brazil

Europe – UK, Spain

USA

Asia – Pakistan, Vietnam (in process), India
State
MYT Regulations
MYT Orders
Andhra Pradesh
√
√
Assam
√
×
Bihar
√
×
Chhattisgarh
√
×
Delhi
√
√
Gujarat
√
√
Himachal Pradesh
√
√
Jharkhand
√
×
Karnataka
√
√
Kerala
√
×
Madhya Pradesh
√
√
Maharashtra
√
√
Rajasthan
√
√
Tamil Nadu
√
×
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Key Elements of MYT Framework Design
Measurability
Materiality
Measurability of
the element
around which
incentivization
will be planned is
important for
design and
correct
implementation
Risk Mitigation
mechanisms
become necessary
around those
elements that
have the potential
to significantly
impact the
performance of
the utility
Controllability
The element will
need to be
controllable to the
utility to enable
them to beat
regulatory targets
10
Predictability
The element will
need to be
predictable
because the
ability to
determine a
prudent level of
regulatory target
is crucial for the
incentivization
process
Options in MYT Regulatory Framework Design
Conventional
Cost Plus
Regulation
• Prudent costs
established by
Regulator
• Limited but assured
return allowed in
cost estimates
• Cost variations
eligible for true-up
• Limited or no
incentive to
outperform
regulatory awards
Options for MYT Framework
Targeted
Incentive
Hybrid option
• Having elements
of TI and PBR
(few elements on
Multi-year basis)
• Uses the basic
PBR and TI
concepts
• Incentivizes
better metering
and loss
reduction
• Also called
“Benchmark
Regulation”
• Works on the basic
cost plus
framework but
overlays
incentives on cost
plus
• Identifies cost
pass through and
risk mitigation
elements clearly
Performance
Based Regulation
• Regulates by
outcome and not by
cost behaviour
• Utility at liberty to
manage costs and
enhance profits
• Initial rate setting
based on cost of
service
• Two basic variants price cap and revenue
cap
Choice of framework will depend on implementation capabilities of the
sector entities
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III. MYT Framework Design – Options in
Detail
12
Cost Plus Regulation or Rate of Return
• Is the traditional form of US regulation and has been extensively used in India

In India, the approved costs are reviewed every year against the historic costs
• Prices are set to allow the recovery of allowed costs and the required rate of return
• Perceived as relatively less risky, the capital costs of the company is lower than
under other approaches
• Regulation becomes intrusive:

costs are assessed for their prudency

investments are assessed as to their ‘used-and-useful’ status
• Company has the incentive to Gold-Plate Investments and has no compulsion to
achieve efficiency savings
• Profit volatility should be minimized but price and revenue volatility may be high
13
Targeted Incentive based Regulation
• Specific targets set for some important operating elements for the duration of
the control period

Losses

Collection Efficiency

Operating Expenditure

Quality of Service parameters etc
• All other cost elements subject to normal cost-plus regulation
• Improvements over and above the targets to the account of utility or shared
with consumers and vice-versa
• Most of the SERCs in India have adopted the Targeted Incentive approach
14
Performance Based Regulation (PBR)
• Under PBR, rules of the road are better known up front

Reduced risk of prudence disallowance and greater flexibility for utilities, utilities prefer such
regulatory structure

The frequency of rate cases is reduced and there are reduced administrative costs
• Helps in reduction of overall cost of service to the customers and improve system
reliability and quality of service to customers
• In order to achieve public policy goals, the Regulator can set specific goals for
utility management to focus on, such as promoting Demand Side Management, and
supply diversity
• Characterised by RPI-X+Y formula

Base cost set at beginning of control period based on historical cost data

Efficiency gains/losses to account of utility

Pass through of external costs (Y) allowed
• Variants of PBR include “Price Cap” and “Revenue Cap”
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Price-Cap
• Price path established for a set price control period (in the extreme, to the end
of the useful life of the asset, but normally for 3 to 5 years)

Price path is based on forecast of operating and capital costs
• Provides the company with an opportunity, if it outperforms the forecasts, of
earning a rate of return higher than required
• Incentives are, however, linked with a higher required return, owing to the
greater risk faced by the company
• Regulation is, in theory, less intrusive and the more detailed price review only
happens once every 3 to 5 years
• Company has the incentive to game - especially by under estimating demand
• No price volatility but revenue and profits may be volatile
• Has been used in England, Chile, Brazil, Australia
16
Revenue-Cap
•
Rather than setting a price-path, revenue-cap regulation establishes a fixed
revenue profile

Removes incentive to under-forecast demand

Limits the upside potential to the company to those cost aspects actually under the control of the
company
•
Most useful for industries where the fixed costs dominate the cost base
•
Requires a correction factor in the formula so that any under or over-recovery
of revenue can be corrected within the life of the price control
•
Can lead to moderate price and profit volatility
•
Has been used in Spain, Norway, Netherlands, Denmark
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Risk and Return Framework of various Options
Annual CoS Regulation
Targeted Incentive /
Benchmark Regulation
Performance Based
Regulation
Risk Mitigation
High
Moderate to High
Moderate to High
Regulatory Involvement
High
Moderate to High
Low
Incentive
Low
Moderate to High
High
Benefit sharing
To Consumers
Shared
To Utilities
Information Requirement
Moderate
Moderate
High
Measurement Requirement
High
Moderate
Low
Feature
Choice largely depends on the level of data availability, stability in the current regulatory
framework, socio-economic and political considerations etc. An option could also be to gradually
move from Annual CoS Regulation to more advance form of Performance based Regulation
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III. Building blocks of MYT
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Control Period
•
Implies the period for which the principles for determination of allowable revenue
and the applicable norms remain unchanged

Provides regulatory certainty

Length of the control period determines the incentives available as the surplus available consequent to
superior performance can be retained for the length of the control period

•
Converse is also true as losses too have to be retained for the control period
Several aspects need to be considered while deciding the length of the control
period

Should be sufficiently long so that utilities have the incentive to investment as the probability for costs
recovery is higher. Also the benefits accrue for a longer period

Should not be very long as this would result in inflexible MYT framework

Could lead to excess profits or losses for the utilities
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Control Period contd..
• Commission determines the control period by taking into account:

licensees proposal

data regime in the state

preparedness of the licensees to implement the proposed changes
• Involves periodic reviews by Regulator from time to time, and
• Review at the end of the control period to factor in the “learning” for the next
control period
21
MYT Control Period duration across states in India
States
Control Period
First Year of Control
Period
Andhra Pradesh
First control period = 3 years and subsequent control period = 5
years
FY 2006-07
Assam
Generation = First control period, 5 years from 1st April 2006;
Transmission = First control period, 3 years from 1st April 2006;
Distribution = First control period, 3 years from 1st April 2006
FY 2006-07
Delhi
First control period = 4 years and subsequent control period = 5
years
FY 2007-08
Jharkhand
First control period = 3 years and subsequent control period = 5
years
Not specified
Kerala
First control period = 3 years and subsequent control period = 5
years
FY 2007-08
Madhya Pradesh
First control period = 3 years
FY 2006-07
Maharashtra
First control period = 3 years and subsequent control period = 5
years
FY 2006-07
West Bengal
First control period = 1 year; Second control period = 3 years;
Subsequent control periods = 5 years
FY 2007-08
To start with the control period may be on the shorter side
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22
Controllable Elements
• Sales
• System Losses – Transmission and Distribution
• Power Purchase Cost (except variation in fuel cost & GCV)
• Operating Parameters
• Debt Equity Ratio
• Operating Expenditure

Employee Cost

Administrative and General Expenses

Repair and Maintenance Expenses
• Working Capital Requirement
• Interest Cost and Interest Rate
• Capital Expenditure
• Quality of Supply
• Collection Efficiency
• Bad Debts
There are divergent views on Sales & Transmission losses
some consider these to be uncontrollable
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Un-Controllable Elements
• Price of Fuel – Coal or Oil
• Gross Calorific Value of Coal/Oil
• Terminal benefits of the employees
• Force Majeure Events
• Changes in law, judicial pronouncements and orders of the Central and State
Government or the Commission
• Economy-wide fluctuations like changes in inflation rates, market rates, taxes
and statutory levies etc.
Elements of cost and other parameters which are beyond the
reasonable control of the Utility are considered uncontrollable
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IV. Prerequisites for implementing MYT
25
Implementation Pre-requisites
•
Good baseline data for reasonable estimation of future costs and performance (and
hence efficiency gains)

System losses, power demand, power purchase costs, operating expenditures, un-metered consumption
etc.

•
All the should be estimated through actual measurement or scientific studies
Nevertheless, Regulatory process should not wait for perfect information to be first
available

Process and mechanism can be introduced that improve the data regime in due course

However, reliable and timely information is an imperative, and all steps should be taken to achieve this
• Strong and robust measurement and monitoring mechanisms through the
control period

For approval of incentive/disincentive linked to actual performance

For incorporating the feedback in the subsequent control period
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Key Imperatives for MYT Implementation (Prior to the control period)
Generation Planning (Supply
Side Analysis)
Load Forecasting Study
System and Network Planning
Study
Determination of Power
Purchase Requirement and
Optimization
Preparation of Business
Plans/Account Separation
Plan for Meaningful Consumer
Participation
Study for estimation of unmetered consumption`
Realistic Capex Estimation
and Evaluation Framework
Opex Efficiency Targets
and Verification
Framework
ARR Projections
Dissemination Workshops for
Stakeholders
27
Development of Regulations
(Including incentive and
monitoring framework)
Study on Actual Loss
Estimation
Revenue and Billing
Analysis
Collection Efficiency
Assessment
Tariff Determination and
Rationalization
Monitoring and Verification
Framework
27
Key Imperatives for MYT Implementation (During the control period)
Overall System
Audit
Corrective
Actions –
Implementation
timelines
Regular
monitoring and
generation of
reports
Compliance of
Directions
Data collection
process and
system audit
Establishment of
Robust MIS
System
Assessment of
Performance &
Validation of
Computations
28
Capex Monitoring
Monitoring of
Controllable
parameters
Monitoring of
uncontrollable
parameters
28
Thank You