1. 1 Implementation of Multi-Year Tariff framework

2. 2 Contents of the presentation Issues to address in design of multi- year tariff (MYT) frameworks Alternative frameworks of MYT for Uttar Pradesh Selecting the appropriate framework Implementation aspects Issues to address in design of multi- year tariff (MYT) frameworks Alternative frameworks of MYT for Uttar Pradesh Selecting the appropriate framework Implementation aspects

3. 3 What an MYT framework intends to achieve Determine framework for regulating the utilities for a period of time, –Principles of regulation of returns/profits of utilities –Principles of regulating individual cost and revenue elements –Degree of regulation on an ongoing basis Incentivise utilities to become more efficient in operations Mitigate risks that are external to the utilities Make the sector financially liquid Introduce efficient tariff design Determine framework for regulating the utilities for a period of time, –Principles of regulation of returns/profits of utilities –Principles of regulating individual cost and revenue elements –Degree of regulation on an ongoing basis Incentivise utilities to become more efficient in operations Mitigate risks that are external to the utilities Make the sector financially liquid Introduce efficient tariff design MYT is recognised to be a key for private sector participation since it reduces regulatory risks very significantly. However even for public utilities it brings about clarity on regulatory principles and incentivises efficient behaviour

4. 4 Conceptual Inter-play Between Sector Development and Strategy Background Scenario A Incentive payments Scenario B Price Scenario B Incentive payments Scenario B Losses Scenario A Price Cost

5. 5 Licensees face a number of financial risks holding back private investment ÞTariffs are not reflective of costs ÞEfficiency incentives may not have been grafted adequately and explicitly into the existing single-year regulatory framework Existing single-year approach to regulation is not mitigating risk ÞGap between costs and revenues too large to bridge in single year ÞCertainty on revenue and tariff determination principles not assured Efficiency improvement targets are failing to achieve meaningful results These problems can only be remedied gradually - therefore the design of the starting point and the transition phase is crucial. Financial Viability and Economic Efficiency of the Sector is at Risk Background

6. 6 Issues for Evaluation of MYT framework Selection of appropriate framework from the options available –Performance based regulation (Price caps/Revenue Caps) –Reference Utility framework –Target based regulation Risk mitigation framework –Identification of controllable and uncontrollable elements –Mechanisms for addressing risks Determining key elements for regulation –Tariffs –Quality of service –Key cost elements (system losses, collections, investments, procurement, etc) Credibility of the regulatory process/extent of regulatory intervention Selection of appropriate framework from the options available –Performance based regulation (Price caps/Revenue Caps) –Reference Utility framework –Target based regulation Risk mitigation framework –Identification of controllable and uncontrollable elements –Mechanisms for addressing risks Determining key elements for regulation –Tariffs –Quality of service –Key cost elements (system losses, collections, investments, procurement, etc) Credibility of the regulatory process/extent of regulatory intervention Background

7. 7 The framework selected has to address the critical issues in Uttar Pradesh Utility operations are currently inefficient Significant improvements are possible by addressing certain specific elements like system losses, collections, efficiency of investments Institutional capabilities in the Licensees are low. Framework needs to help utilities understand where and how to focus Data availability is poor and needs to be improved for improved utility performance and effective regulation Understanding of regulatory principles is low among Licensees – need to clearly lay out the principles and accord them the necessary certainty Utility operations are currently inefficient Significant improvements are possible by addressing certain specific elements like system losses, collections, efficiency of investments Institutional capabilities in the Licensees are low. Framework needs to help utilities understand where and how to focus Data availability is poor and needs to be improved for improved utility performance and effective regulation Understanding of regulatory principles is low among Licensees – need to clearly lay out the principles and accord them the necessary certainty Selecting appropriate framework

8. 8 The implementation of the framework has to address the provisions of UPERA due to which… It may not be possible to set tariffs for more than one year period; and The licensees have to continue to adhere to an annual filing process It may not be possible to set tariffs for more than one year period; and The licensees have to continue to adhere to an annual filing process Selecting appropriate framework

9. 9 Options on MYT Selecting appropriate framework Option Description Performance based regulation (PBR) Characterised by RPI-X+Y formula Base cost set at beginning of control period (3-7 yrs ordinarily) based on historical cost data Efficiency gains/losses to account of utility Pass through of external costs (Y) allowed Characterised by RPI-X+Y formula Base cost set at beginning of control period (3-7 yrs ordinarily) based on historical cost data Efficiency gains/losses to account of utility Pass through of external costs (Y) allowed Reference Utility regulation Based on forward looking (incremental) cost framework Hypothetical ideal utility modelled based on load and generation configuration for control period (upto 10 years) Tariffs for ideal utility set in advance and subject to only a few pass through elements (primarily fuel) Based on forward looking (incremental) cost framework Hypothetical ideal utility modelled based on load and generation configuration for control period (upto 10 years) Tariffs for ideal utility set in advance and subject to only a few pass through elements (primarily fuel) Target based regulation Specific targets set for important operating elements (e.g. losses, collections, quality of service) for control period All other cost elements subject to normal cost-plus regulation Improvements on targets to account of utility or shared with consumers and vice-versa Specific targets set for important operating elements (e.g. losses, collections, quality of service) for control period All other cost elements subject to normal cost-plus regulation Improvements on targets to account of utility or shared with consumers and vice-versa

10. 10 Evaluation of MYT framework for Uttar Pradesh Selecting appropriate framework Criteria Power of incentives PBR Reference Utility Targeted Incentives Degree of regulatory intervention Data requirement for framework design Measurement requirements for implementation Ease of understanding/ institutional capability reqd. Identified focus on critical issues High Low High Low Medium High Low Medium Low Medium High Medium Med/High High

11. 11 Appropriate MYT design in the context of the current proceedings From an MYT perspective the current proceedings need to address the following issues –The Order should incentivise efficient utility operations across a multi-year period. The philosophy of incentivisation/disincentivisation needs to be clearly articulated –The Order should clearly identify the elements for which the utilities can be held responsible. Conversely the utilities should be protected from any risks that are external to their business –The process of regulatory review of utility performance in the coming years needs to be clearly laid out in the Order Key process issues that need to be addressed include, –Mechanism and periodicity of review –Mechanisms/information systems for measurement of performance –Administration of the incentives/disincentives From an MYT perspective the current proceedings need to address the following issues –The Order should incentivise efficient utility operations across a multi-year period. The philosophy of incentivisation/disincentivisation needs to be clearly articulated –The Order should clearly identify the elements for which the utilities can be held responsible. Conversely the utilities should be protected from any risks that are external to their business –The process of regulatory review of utility performance in the coming years needs to be clearly laid out in the Order Key process issues that need to be addressed include, –Mechanism and periodicity of review –Mechanisms/information systems for measurement of performance –Administration of the incentives/disincentives

12. 12 Developing a selection criteria to choose the right elements is critical for MYT Measurability Measurability of the element around which incentivisation will be planned is important for design and correct implementation. MaterialityControllabilityPredictability Risk mitigation mechanisms become necessary around those elements that have the potential to significantly affect the performance of the utility The element will need to be controllable to the utility to enable them to beat regulatory targets The element will need to be predictable because the ability to determine a prudent level of regulatory target is crucial for the incentivisation process

13. 13 Typical cost Profile of Distribution Utilities Bulk Supply Cost –Power purchase cost of units sold by the licensee –Power purchase costs of units bought by the licensee to cover system loss Operating Costs –Network costs Employee expenses R&M expenses A&G & Other expenses –Financing costs Interest cost Reasonable return Bulk Supply Cost –Power purchase cost of units sold by the licensee –Power purchase costs of units bought by the licensee to cover system loss Operating Costs –Network costs Employee expenses R&M expenses A&G & Other expenses –Financing costs Interest cost Reasonable return

14. 14 Identification of the element for incentivisation plan MeasurabilityMaterialityControllabilityPredictability

15. 15 Identification of the elements have to be followed by a suitable incentivisation process Structuring of the incentivisation is a decision which will have to take into account –the adequacy of the reasonable return to absorb adverse variations of cost elements –need for a minimum size of the incentives to induce utilities towards exceeding regulatory targets set at the start of the year –the mechanism in which financial risk / benefits are shared between the utility and the consumer Structuring of the incentivisation is a decision which will have to take into account –the adequacy of the reasonable return to absorb adverse variations of cost elements –need for a minimum size of the incentives to induce utilities towards exceeding regulatory targets set at the start of the year –the mechanism in which financial risk / benefits are shared between the utility and the consumer

16. 16 Open Ended Incentivisation Scheme Superior Performance Adverse Performance Regulatory target levels set at the beginning of the year Benefits Loss In an open-ended design, the entire financial benefit (or loss) arising out of superior (or adverse) performance is retained (or absorbed) by the utility Higher risk and Higher gain

17. 17 Closed Ended Incentivisation Scheme Superior Performance Adverse Performance Regulatory target levels set at the beginning of the year Total Benefit Total Loss In a closed-ended design, the total financial benefit (or loss) arising out of superior (or adverse) performance is shared (or absorbed) by means of a pre-determined formula between the utility and the consumer Extent of benefit retained by the utility Extent of benefit distribute d back to the consumer Lower risk and Lower gain

18. 18 UPERC has already made some moves towards a long term framework Multi-year trajectories have been established for system losses and collection efficiency for UPPCL A comprehensive power purchase true-up process has been put in place Multi-year trajectories have been established for system losses and collection efficiency for UPPCL A comprehensive power purchase true-up process has been put in place

19. 19 UPERC has already made some moves towards a long term framework However the accompanying mechanisms and implementation processes need to be put in place –Measurement mechanisms not identified clearly –Review process (during and after the year) not specified –Incentives/disincentives not defined –Treatment of other cost and revenue elements need to be firmed up –Certain aspects of cost definition need review Cost-to-serve study, a fundamental instrument for regulation is not yet in place However the accompanying mechanisms and implementation processes need to be put in place –Measurement mechanisms not identified clearly –Review process (during and after the year) not specified –Incentives/disincentives not defined –Treatment of other cost and revenue elements need to be firmed up –Certain aspects of cost definition need review Cost-to-serve study, a fundamental instrument for regulation is not yet in place

20. 20 UPERC also needs to establish the future framework of MYT regulation As the utilities gain experience in commercial operation and functioning under regulatory oversight, the framework needs to be advanced to a more powerful and less intrusive framework of regulation The new Act prescribes MYT and the National Electricity Policy and Tariff policy is likely to provide implementation options Multi-year tariff philosophy and a blue-print for future implementation needs to be put in place. Consultation needs to commence soon – if possible the initiation can happen through the forthcoming orders Mechanisms for improved data discovery need to be emphasised upon, and incentivised if feasible As the utilities gain experience in commercial operation and functioning under regulatory oversight, the framework needs to be advanced to a more powerful and less intrusive framework of regulation The new Act prescribes MYT and the National Electricity Policy and Tariff policy is likely to provide implementation options Multi-year tariff philosophy and a blue-print for future implementation needs to be put in place. Consultation needs to commence soon – if possible the initiation can happen through the forthcoming orders Mechanisms for improved data discovery need to be emphasised upon, and incentivised if feasible