The electricity crisis in California at the turn of the century, characterized by high prices and rolling blackouts, a result of un-restrained deregulation, offers valuable lessons for policymaking in the electricity sector. As India embarks on an ambitious programme to restructure and reform the power sector in its quest to expand generation capacity and improve quality of supply, it is imperative that these lessons are borne in mind. However, recent trends in our power sector reforms disturbingly incline to the beaten path that California at any rate would be loath to remember.
Photograph: Ramesh Pathania / Mint
The Electricity Act, 2003, set the stage for several radical reforms in the sector, including open access and power trading. The Act allowed for non-discriminatory access for licensees to existing transmission and distribution networks on payment of fixed access fees. This was intended to encourage competition and choice, and to pave the way for more efficient transfer of power from surplus to deficit areas. It was hoped that power trading would lead to optimal utilization of installed capacity, expand generation capacity and thereby lower prices. Reforms were expected to usher in a revolution in electricity similar to that in telecommunications, where competition dramatically lowered prices and expanded service reach and quality.
However, the inability of generation to keep pace with galloping demand means that severe peak power shortages will remain a constant feature for the foreseeable future. Therefore, any market design and restructuring that fails to account for this reality is destined to fail.
The government is now contemplating the idea of making it mandatory for generators to sell some share of their total capacities through open access. Such a mandate opens up the possibility of cherry-picking, as generators sell directly to large industrial consumers, thereby robbing state distribution utilities of their cross-subsidy sources. Similar problems bedevil the existing frameworks on generation, trading and state regulatory practices.
In its efforts to expand generation capacity and increase volumes in power trading, the government had liberalized the policy on merchant power plants, removed restrictions on their sales, and provided them access to critical fuel linkages. However, individual state governments’ policies on such plants, which are dictated by specific short-term demand requirements, have distorted the incentives for these generators. High peak power prices help these merchant plants make handsome profits by committing a share, often small, of generation to the state, even at very low prices, and trading the rest.
It was hoped that the emergence of an active power trading market with an enabling open access framework would go a long way towards ensuring more efficient allocation and utilization of electricity. However, in the context of peak shortages, and limited depth and breadth of the trading exchanges, traded prices have risen sharply, thereby placing a huge burden on state utilities. The incentives have become so skewed that some state utilities with surplus are selling their low-cost power allocations from the Central pool at huge profits to power-deficit states and private traders. The margins available are so large that some private traders in turn intermediate this to deficit states at even higher prices.
The policies of individual state regulatory commissions have exacerbated the market distortions. The profit opportunities presented by the absence of uniform policy standards in cross-subsidy surcharges for open access to transmission, margins on traded power, exports of surplus power by states, and as mentioned earlier, on merchant power plants, have been effectively exploited by private and even state licensees at huge cost to state utilities and consumers. There is, therefore, an urgent need for some level of harmonization of regulatory policies across states so as to efficiently allocate the scarce power.
A free market pre-supposes competition and choice at both sell and buy sides, market depth and breadth, and an enabling regulatory framework. In an ideal world, scarce resources can be most efficiently allocated by a free market based on price signals, and trading allows for the movement of power from surplus to deficit areas, thereby benefiting consumers everywhere.
But we live in a far from utopian world of demand-supply imbalances, where governments find it politically suicidal to increase tariffs while eminently lacking in resources to reimburse the massive costs incurred. Over and above, transmission capacity is limited, regulatory architecture inadequate, traders are few, volume of traded power is meagre, conflicts of interest between generators and traders rife, demand inelastic, and the supply-demand imbalance un-bridgeable.
It is not possible to have a sustainable and efficient electricity market with a liberalized upstream supply side and tightly regulated downstream distribution side. A market design where wholesale prices are uncapped while retail prices are frozen by regulation, especially with a demand-supply imbalance, is bound to generate distortions that signal a far from rosy future.
The deregulation process in electricity appears to have overlooked many of these prerequisites and realities. We have a liberalized free-market framework superimposed on an uncompetitive and inadequately regulated market—a recipe for incentive distortions with adverse consequences. After five years of deregulation, peak power prices have almost tripled, capacity addition has been meagre, and shortages remain a concern.
None of this is an argument against reforms and deregulation, which are vital to achieving our objectives. Deregulation in infrastructure, at the best of times, is a complex and challenging task, and electricity is no different. Experience from across the world and India itself shows that such restructuring has to be done carefully, in a phased and sequenced manner, and only after putting in place adequate regulatory frameworks to police the numerous anticipated market failures.
Gulzar Natarajan is a civil servant. These are his personal views. Comments are welcome at email@example.com