merc generation tariff order analysis

8/3/2019 MERC Generation Tariff Order Analysis

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Group Project

Salient features of selected MERC tariff ordersand disposal of petitions of the MSPGCL (Genco)

Faculty GuideProf. Sebastian Morris

In partial fulfillment of the courseInfrastructure Development and Financing

Submitted by Section B, Group 3

Group members:

Anandh Sundar TripuriAniket KhasgiwaleBadrinath Srinivasan

Manish KumarMiheer Desai

Rahul Venkatraj


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Table of Contents

Introduction .................................................................................................................................................. 3

Objectives and methodology used ............................................................................................................... 4

Overview of Applicable Policies/Laws/Regulations ...................................................................................... 5

About MSPGCL .............................................................................................................................................. 7

Summary of Tariff Orders ............................................................................................................................. 8

Non Routine Orders ...................................................................................................................................... 9

Individual Tariff Order Highlights ................................................................................................................ 10

AREAS OF DISPUTE ...................................................................................................................................... 13

Window dressing / Behavioral orders ........................................................................................................ 15

Performance Parameters ............................................................................................................................ 17

Unique Hydel Power Policy ......................................................................................................................... 18

General MERC Order Analysis- Quality and Consistency ............................................................................ 19

Is MERC playing the game well? ................................................................................................................. 21

Overall Observations ................................................................................................................................... 22


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Introduction

The objective of the assignment is to bring out the salient features of the tariff orders /disposal of petitions

of the MSPGCL (Genco). Power sector tariff regulations are manifold. The Central laws/regulations viz.Electricity Act 2003, Electricity Policy, Tariff Policy; are applied for interstate projects, and are used as

guiding principles for designing state policies. The Forum of Regulators ensures some uniformity at the

state level in terms of tariff setting etc.

This project analyzes the key issues as:

(1) Variations over various tariff orders implicit change in principle or in key assumptions in theorder of the MERC.

(2) Variations between ARR and orders/directions resulting in petitions and the variations in the waythe petitions were dealt with.

(3) How far were the directions adhered to and what measures were used to improve adherence?(4) The quality of the response of the MERC to the ARR/ Petitions.

The project aims at seeing only the MSPGCL tariff orders over a defined time period.


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Objectives and methodology used

After the exploratory analysis about MERC tariff philosophy and approach to petition handling, this

studys objectives was to diagnose whether:

(1) The process could have been faster.(2) Are they true to the spirit of the provisions of the EA 2003?(3) What was the nature of the due diligence with regard to the ARRs /disposal of petitions and were

they adequate given the law?

(4) What are the regulatory risks imposed by the MERC? Could these have been avoided by upfrontlaying down the principles etc? (look at the general regulations, the format for submitting the

ARR, the explanations etc)

(5) Could the disputes and petitions have been avoided /reduced?(6) What improvements are therefore possible?

For this, the methodology used was

1. The tariff orders were downloaded from the MERC site.2. A checklist of points to be analyzed was prepared. This included points like prudence check on

costs, timelines, appeals, dispute resolution techniques, regulatory risks, crosscheck of regulatory

accounts with statutory accounts etc.

3. The tariff orders were then evaluated using this checklist.4. Brainstorm about improving the process, and learn from the central best practices/best practices

of other states.

5. The checklist and draft report was then discussed with Prof Morris.


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Overview of Applicable Policies/Laws/Regulations

TitleDeals with Scope/Applies to

Section 61 & 62 of the Electricity

Act, 2003

General unbundling of the

electricity principles

Central projects/interstate lines

but is a model for state laws

Maharashtra Electricity

Regulatory Commission (Terms

& Conditions of Tariff)

Regulations, 2005

Determining tariffs for the period

2006-2011(originally 2009 but

was extended due to data issues

etc)

Maharashtra power utilities.

Principles follow the CERC

norms/EA Act 2003 except for

cross subsidy etc

National Tariff Policy/CERC

Tariff Regulations

Principles and Guidelines for

setting tariffs centrally

Central projects/interstate lines

but is a model for state laws, and

forum of regulations adopt this.

Section 7 of the Electricity Act 2003 permits any generating company to feely establish, operate and

maintain a generating station without obtaining a license under that Act, if it otherwise complies with the

technical standards relating to connectivity with the electricity grid. For hydel projects, certain

additional approvals exist to ensure optimum riverine utilization and non conflict with other public

purposes like irrigation, flood control, navigation etc. Section 61 of the Electricity Act 2003 lays down

tariff setting principles, which are adhered to as follows.

Principle Meaning/ Example as applied to generation units

the principles and methodologies

specified by the Central Commission for

determination of the tariff applicable to

generating companies and transmission

licensees

The cost accounting norms, efficiency principles and

tariff philosophies of CERC should be adhered to at

State level where possible. It will promote

transparency, consistency and predictability in

regulatory approaches across jurisdictions and

minimize perceptions of regulatory risks

the generation, transmission, distribution

and supply of electricity are conducted on

commercial principles

This would mean arms length transactions between

the unbundled arms of erstwhile integrated utilities

the factors which would encourage

competition, efficiency, economical use

of the resources, good performance and

optimum investments

Open access, increasing normative standards yearly,

permitting efficient standard costs (normative costs)

only, setting quality of service linked bonus, and

approving capex.


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Principle Meaning/ Example as applied to generation units

safeguarding of consumers' interest and at

the same time, recovery of the cost of

electricity in a reasonable manner

Allowing cross subsidy for limited purpose of

universal service obligation, till the time the

appropriate state directly pays subsidy. Also,

uncontrollable costs should be recovered speedily to

ensure that future consumers are not burdened with

past costs. Address the risk sharing mechanism

between Utilities and consumers based on

controllable and uncontrollable factors.

the principles rewarding efficiency in

performance

Enhanced ROE for better PLF, sharing of efficiency

gains. Operating parameters in tariffs should

be at normative levels only and not at lower of

normative and actuals

multiyear tariff principles Approve business plans for 5years at a go, with

minor annual revisions reflecting changed

costs/projections, but rarely changed capex. Control

period length however, depends on data uncertainties

and other practical considerations

that the tariff progressively reflects the

cost of supply of electricity and also,

reduces cross-subsidies in the manner

specified by the Appropriate Commission

Reducing customer categories(since this leads to

cross subsidy), among other things

the promotion of co-generation and

generation of electricity from renewable

sources of energy

Mandating higher generation feed in tariffs, and

compulsory off take contracts with distribution

licensee, for renewable energy

The National Electricity Policy and

tariff policy

National Tariff Policy should be used as the base,

with appropriate state level modifications


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About MSPGCL

The Maharashtra State Power Generation Company Limited (MSPGCL or MahaGENCO) is a Company

is a company incorporated under the Companies Act, 1956 on 6th June, 2005, formed under the

Government of Maharashtra General Resolution No. ELA-1003/P.K.8588/Bhag-2/Urja-5 Dated January

24, 2005. This resolution gave effect to the reorganization of Maharashtra State Electricity Board in terms

of the Maharashtra Electricity Reforms Transfer Scheme 2004. As per this Order, the Maharashtra State

Electricity Board (MSEB) has been restructured into four entities MSPGCL, MSETCL, MSEDCL and

MSEB Holding Company. The State Government as a part of this transfer scheme had allocated the

generating stations of MSEB to MSPGCL. MSPGCL also maintains & operates the hydro plants owned

by the Irrigation Department, Government of Maharashtra as a lessee. The State Government had

allocated the generating stations of MSEB to MSPGCL. MSPGCL supplies electricity in bulk to

MSEDCL, hence the role of the MERC to determine tariffs for MERC generating stations.

It is said that the sins of the parent are borne by the children. In the case of MSPGCL, it was saddled with

legacy old plants, under spending on O&M/capex in previous years and consequential inability to meet

the normative standards. When MERC prodded MSPGCL to become more efficient by setting policy

parameters close to normative levels, MSPGCL approached the Appellate Tribunal for Electricity to

appeal against MERCs order, and was partly successful, including on substantive issues like fixing the

levels(realistic versus normative). This had lead to some tension between MERC and MSPGCL as borne

out by its critique of MSPGCL accounting, capex gold plating and faulty planning, but overall there is

now a healthier relationship.


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Summary of Tariff Orders

Case

Number

ARR

Period

Tariff

Period

Subject Matter/Highlights Principle(s)/Remarks

Case No.

48 of

2005

FY 2005-

06

FY 2006-

07

FY 2006-

07

First ever tariff order for

unbundled entity. Hence

focus more on

accounting/segregation

issues

Efficient and reasonable estimates

for technical parameters and costs

to arrive at tariff. Peaking power

pricing for hydel power adopted.

Appeal to MERC disposed of in

Case 34 of 2006.

Case No.

68 of2006

FY 2007-

08FY 2008-

09

FY 2009-

10

FY 2007-

08-extended

till May

31,2008

first Control Period for MYT

framework shall bethe three financial years from

April 1, 2007 to March 31,

2010

Mahagenco C won an appeal at the

ATE, and MERC had to revise thetariff in Order 71 of 2007

Case No

71 of

2007

second

year of

the first

ControlPeriod

June

1,2008 till

mar 31

2009

Mostly giving effect to the

ATE order for setting tariffs

N/A

Case 16

of 2008

Truing up

FY 2005-

06, FY

2006-07

and FY

2007-08

ATE/CPR

N/A MSPGCL to recover the

approved amount of Rs.

762.77 Crore in 12 equal

monthly installments from

MSEDCL, in order to avoid

any tariff shock to the

consumers.

This order was to give effect to the

ATE judgments and the CPRI

norms. The only new principles

introduced there were the

identification of non tariff income

to reduce ARR requirements.

Case 115

of 2008

Last year

of control

period

FY 2009-

10

Much lesser areas of disputes

here, as ATE rulings/CPRI

norms had resolved many

issues

N/A


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26/ 95 of

2008

First 2

years of

new Paras

Thermal

station

FY 2008-

09

Unit No. 3 of Paras Thermal

Power Station

Appealed to ATE, and revised in

2011. MERC revised its orders

vide Orders 74/75 of 2011.

102 of

2009

Truing up

for FY

2008-09,

Annual

Performa

nce

Review

for FY

2009-10

FY 2010-

11

Much lesser areas of disputes

here, as ATE rulings/CPRI

norms had resolved many

issues

N/A

Non Routine Orders

FIRST TIME PLANT TARIFF

The Tariff orders for the Parli Unit were for new plants, which had the special characteristics of

unstable control period, need for incremental capex principle and fresh start. Both the projects

experienced cost overruns, which the MERC disallowed blaming them on the Mahagenco induced delays.

This, naturally, is now under appeal to the ATE.

HYDEL LEASE RENTAL ORDER

Order from first principles-ROE based Pass through for MSPGCL so very little opposition from the

utility per se. Only others opposed it/submitted pleas. Another interesting order is on hydel lease rent

needs some background to appreciate. As per Maharashtra law, the dams and hydel power plants are

constructed by (and belong to) the Irrigation Dept. Many of these projects are ECB funded by World

Bank and others. The Govt. (not unreasonably) wanted to charge the unbundled Mahagenco a fair lease

rent to recover the interest & ROE on its dams. Now, the tariff fixation powers for this are not on any

electricity regulator as this subject is missing in the Electricity Act 2003. But if the Govt. had arbitrarily

fixed a higher amount (100% pass through to customers), this may have been challenged. Hence, Govt.

requested MERC to calculate the amount on its behalf, in its administrative capacity. So MERC

considered various methods like DCF but finally decided on a ROE model. This order is an excellent

example of practicalities in financial management of power sector.
http://www.mercindia.org.in/pdf/Ord_2008_10_27_CNo_17_of_2007.pdfhttp://www.mercindia.org.in/pdf/Ord_2008_10_27_CNo_17_of_2007.pdf


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Individual Tariff Orders Highlights

1. Case No. 48 of 2005a. As envisaged in the tariff policies, two part station-wise generation tariffs.b.

Unique hydel tariff policy envisaged, to ensure economic signals without burdeningconsumers unduly. This was done through differential energy tariff for peak and non-

peak hours, and is elaborated later on. Has been specified, where peak is 20% higher

than non peak.

c. One-time R&M expenses permitted during future truing up(over and above the approvedamount) to compensate inadequate spending in the past

d. While income tax expense in petition was sought at 33% on ROE(assuming that it wouldpay maximum marginal rate on its ROE), the allowed expense was capped at the MAT

amount of 10%(prevailing then)

e. Norms for new stations as per MERC Tariff Regulations have been applied for existingstations as well. This was the most controversial part of ruling, and successfully appealed

by MSPGCL before the ATE.

f. While O&M costs taken on normative basis, interest allowed only on actual, that too onlyon the approved borrowings.

g. While rejecting MSPGCLs plea for lower normative PLFs, the MERC said that ageingof units and non-availability of time for Planned Outages cannot be considered as

reasonable causes for high SHR or low PLF, and MSPGCL should explore all avenues

for improvement in its plant operations, routine maintenance, and capital maintenance to

enhance reliability and efficiency of their thermal generating units. Again, the ATE partly

reversed this logic.

h. The Commission has calculated the variable cost of fuel for FY 2006-07 based on theactual cost of fuel in the month of March 2006, agreeing to adjust changes via vetting of

FAC claims. This is analogous to LIFO system of accounting!

i. MSPGCL had been importing coal without a proper cost benefit analysis, and so MERCdirected MSPGCL to install and maintain the required meters with in next three months

for measurement of Coal GCV and then carry out the cost benefit analysis of the usage of

imported coal at its generating stations

j. Most of the generating units had no weightometers and hence an accurate measurementof coal is not being done. The Commission has therefore not accepted the MSPGCLs

projections and approved transit loss as per MERC Tariff Regulations only


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k. A systematic measurement of Gross calorific value of coal by taking periodic samples ofcoal being fired shall be institutionalized at all the stations

l. MSPGCL has not provided any supporting information regarding the details of R&Mexpenses actually incurred during FY 2005-06 and resultant technical efficiency

improvements, hence was told to get its R&M plans approved at the earliest.

m. In absence of historical actuals for MSPGCL, Commission is not projecting non-tariffincome. This was however determined in later orders.

n. R&M expenses are to be determined at an average of actuals as a percentage of GFA forthe preceding five (5) years. This is a standard practice by MERC

2. Case 68 of 2006a. Much more systematic order, largely following the earlier ordersb. Conscious of the fact that the unbundling of the erstwhile MSEB should result in overall

increase in expenditure on O&M.

c. Despite not meeting the desired PLF norms for FY 2006-07-which could have led tolesser recovery for future years- MERC approved the full recovery of fixed charges

during FY 2007-08 for all thermal stations. However, in the event ofactual availability

for the year, computed in accordance with the Commissions Tariff Regulations

(after accounting for the unavailability of fuel), being less than 80%, the fixed

charges would be proportionately adjusted as per MERC Tariff Regulations, while truing

up the revenue requirement in the next year.

d. The funding of the schemes has been considered at debt: equity of 80:20 as proposed byMSPGCL in view of shortage of equity capital despite Tariff Regulations providing for

normative debt: equity of 70:30.

e. For approving the O&M expenses for the Control Period, the Commission hasconsidered the O&M expenses approved in FY 2006-07 as the base expenses. As MSEB

under spent due to earlier cash crunch, the method of extrapolation could not have been

used to calculate O&M costs.

3. Case 71 of 2007a. Commission rejects MSPGCLs request for providing incentive for Uran gas thermal

station on the basis of reduced availability and PLF, due to shortage of gas. The

Commission is of the view that though full fixed cost recovery has been permitted to

Uran gas station, despite non achievement of normative availability of 80%, it would not

be fair to the consumers to provide incentive at such low PLF levels


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b. Though MSPGCL has been putting its efforts and expertise to optimize the performanceof scarce hydro resources, MSPGCL is not earning any commensurate returns/incentives

over and above the actual cost incurred for such operations. MSPGCL, in its Petition,

therefore, proposed a recovery of supervision charges to the extent of 15% of the

Operations and Maintenance expenses incurred during the year for such hydro power

plants. This was shot down because lease rent payable to GoM already had RoE

component, also no provision in the MERC Tariff Regulations under which such

expenses may be allowed.


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AREAS OF DISPUTE

Cost Item MSGPCL Stand MERC Stand Present Status

Advance Against

Depreciation

in respect of some

generating stations.

intended to meet shortfall

in meeting loan repayment

obligations of the

Generating

Company. Hence to be

calculated station wise.

While tariff is

determined on a station-

wise basis, AAD is a

special provision, which

enables the Utility

to meet its loan

repayment obligations as

a whole rather than for

each Station(Order 115

of 2008)

ATE decides to have

this done station wise.

Judgment dated

27.4.2011 in

appeal no. 191 of 2009

Disallowance in

Project Cost

Delay in commissioning of

Unit No. 3 of Paras

Thermal Power Station

was not considered, and

cost was disallowed.

The delay was due to

Mahagenco so

additional cost due to

delay is to be disallowed

ATE partly agreed

with MERC

Operation &

Maintenance cost

that such an increase in R

& M expenses may not fit

into the ideology of

setting normative O&M

expenses since the hydel

assets are old and may

require more

repairs and maintenance in

future.

norms for new stations

as per MERC Tariff

Regulations have been

considered for existing

stations also

Agreed with MERC

Appeal No. 86 & 87 of

2007 .given that

=expenditure for OLD

HYDEL stations not

covered under policy

Remaining pending

Fuel Costs provisions in the National

Tariff Policy (NTP), which

states that in case the

actual performance is

much less than the

norms, then ARR should

Not till actual

parameters determined.

truing up of actual fuel

expenses

till such time the re-

assessed improvement

trajectory of

parameters is


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be determined based on

relaxed levels.

available

Tariff for Small Hydel

Stations

entitlement of higher tariff

for small hydro projects as

the Commissions

Order

only in the case of new

projects

Agreed with MERC


2007

determination of hydel

peak and off peak

generation and tariff

taking into consideration

the operational

capacity of MSPGCL and

system pattern

economic signal about

pricing of hydel

generation

Endorsed MERC

approach BUT tailored

it to Mahagencos

needs


2007

Transit Loss/Auxiliary

parameters

reset the operating

parameters

Normative align its Regulations

by prescribing

achievable norms and

not merely ideal

norms. engage an

appropriate

agency(ies) assess and

suggest improvements

non-tariff income should not be considered

as part of the revenue

Include for determining

the revenue gap/surplus

ATE partly agreed

with MERC Appeal

Nos. 86 & 87 of 2007

Capex approvals Accept non DPR schemes

after prudence check

Mahagenco to bundle

non DPR into DPR else

suffer 50% cut till the

prudence check done

ATE agreed with

Mahagenco. Order 199

of 2010 dated 4 Aug

2011.


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Window dressing / Behavioral orders

Regulated utilities will try to game the system/cook the books, while the regulator would want to structure

the incentives to avoid gaming of the system. Some Examples of MERC efforts in this line are

Order Example(s/Observation Action

68 of 2006 The increase in quantum of Non-

DPR schemes is a worrying trend,

as the Commission observes a

tendency to split capex schemes so

that capital outlay of the scheme is

below Rs. 10 Crore, to escape

regulatory scrutiny.

The Commission will take a review of the

schemes being classified under Non-DPR

category, and in case it is found that these

schemes should have ideally been classified

under DPR category, then that capex and the

related capital charges will be disallowed till

the DPR is submitted and the scheme is

approved by the Commission. In Case 115

of 2008, For Non-DPR schemes, the

Commission has considered 50% of the

proposed stabilization15 by MSPGCL on ad

hoc basis, as the Commission is of the view

that until it is ascertained that the projected

benefits have actually accrued for the benefit

of the consumers, it would not be appropriate

to allow the entire expenses.

68 of 2006 Seeing lackadaisical approach in

fixed asset accounting/submitting

capex schemes, MERC had to

caution Mahagenco

The Commission would like to reiterate that

in-principle approval of the scheme does not

absolve the senior management of MSPGCL

of their responsibility to prioritize various

schemes and undertake cost benefit analysis

and financial analysis to validate the

commercial prudence of each scheme.

MSPGCL should ensure that the projected

benefits actually accrue for the benefit of the

stakeholders. It would be essential to monitor

progress of each scheme as well as track


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expenditure and benefits accrued as per the

scheme.

68 of 2006 practice of treating Renovation and

Modernization as revenue

expenditure is not

limited to any one department or

any one generating station of

MSPGCL, but is spread

across all departments and all

stations

The Commission has not considered the

truing up of R&M expenses for FY 2006-07

at this stage. In order to have a clear picture

regarding Repairs and maintenance

expenditure, MSPGCL should maintain a

clear demarcation of capital expenditure and

revenue expenditure heads

115 of 2008 Gold plating of capex

The steep increase in the asset base

every year has been suggested by

the consumers to be an attempt by

the Utilities to increase the returns

from the regulated business. The

addition to the asset base is clearly

not commensurate either with the

increase in sales or increase in

demand in MW served. Utilities

were able to serve the existing

consumer base well enough with

the existing assets

The favourite argument of the Utilities that in

the past, there was a backlog on this account

and that they want to rake it up is also

unconvincing to justify the 100% increase in

the asset base in such a short period. As a

general rule, the Commission has decided

that the total capital expenditure and

stabilization16 on non-DPR schemes in any

year should not exceed 20% of that for DPR

schemes during that year

115 of 2008 Any fallout of poor governance

and consequential financial

implication/burden should not be

passed on to consumers.

In this context, the Commission observes

that interest paid by MSPGCL on account of

delayed payment of income tax, is not an

expense properly incurred. The Utility is

supposed to pay income tax on time as good

governance. For example, any penalty paid

by the Utility will not be passed on to the

consumers. Accordingly, the Commission

has considered the actual income tax, but has

disallowed the interest paid by MSPGCL on

account of delayed payment of income tax


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26 of 2008 and

95/2008

duty of the owner of the plant to

ensure

thorough inspection and testing that

the equipment being procured are of

good quality,

these are stored at site as required

and imparting training to its

operating personnel

well in advance, and any losses

incurred through not performing

these elementary

duties properly cannot be passed on

to the consumers

stabilization period of coal based and lignite

fired stations shall be reckoned as 180

days from the date of commissioning. As

against this, MSPGCL has requested for

consideration of a higher period of

stabilization of 427 days. Applied for Parli

Unit No. 6/Unit No 3

Performance Parameters

In order 69 of 2006- The Commission has decided that the MYT framework for MSPGCL would

incorporate the trajectory of following performance parameters:

The various performance parameters are decided after taking into consideration the performance of units

with similar vintage in India.

However, Mahagenco went on appeal to the ATE, which ordered MERC to appoint an expert to suggest

realistic performance norms. The ATE expert (CPRI) suggested the norms, which were first amended

during the truing up of the tariffs till FY 2007-08.


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Unique Hydel Power Policy

MERC is quite proud (rightly so) of its hydel power pricing policy. The main features of this are

a. Hydel power has low O&M costs. The effective energy charge in the case of MSPGCLs hydrogenerating stations work out to be very minimal as the Annual Fixed Charge is far lesser than the

other-wise applicable energy charges (variable cost of the least-cost, available alternative source

of power). Therefore, economic value of power is not priced in.

b. As the pricing of hydro generation fails to send any economic signal and, guided by Section 61 ofthe Electricity Act, 2003, which calls for economic use of resources, the Commission has decided

to adopt a one part (energy based) differential peaking tariff (for peak and non peak hours) for

hydel generation). The tariff for non-peak hours is based on the highest variable cost of the

thermal generating stations, as Ideally, the peaking tariff should be the least cost available

alternative source of power if such hydel generation is not available in those hours.

c. The rationale for having differential peak and non-peak tariff is that hydro power should be usedonly during peak hours, and during non-peak hours it has to be used only in case of exigencies

like grid stability requirements, etc.

d. 5% of excess recovery of peak generation to be shared between Genco & Distribution company,rest to passed on to users as rebate. But if peak generation < target (except for uncontrollable

factors), then the revenue loss would not be trued up, but borne by Genco & Distribution

company in ratio of 50:50. Hence, economic price signals are sent but users do not suffer.

e. The rationale for having differential peak and non-peak tariff is that hydro power should be usedonly during peak hours, and during non-peak hours it has to be used only in case of exigencies

like grid stability requirements, etc.


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General MERC Order Analysis- Quality and Consistency

We notice that MERC does issue speaking orders discussing the utility stand, opposite views and its own

analysis. While the reasons/rationale for the order is quite clear, at times it is perverse to the regulated

entity due to interpretation adopted. For example, AAD station wise, coal costs, O&M expenses were all

calculated adversely to Mahagenco, without considering the plain text of regulations as applied to

Mahagenco. That led to an appeal.

There are very few errors of fact or law in the order. In the ATE orders we examined, there were no

strictures passed against MERC/loss on this ground. Instead, the main disagreements happened in policy

issues-essentially whether the norms of MERC were too strict. When ATE sided with Mahagenco

(largely), this induced cascading effect on ROE, working capital, interest etc.

Some ATE order extracts are below, with our comments in italics.

1. The MERC Regulations did not specify any norms relating to admissibility of A&G expenses andhad approved the expenses based on the principle of reasonable year-on-year increase. The ATE

critiqued the MERC order stating that it did not explain the reasonableness of selecting escalation

rate of which is not even sufficient to mitigate the inflation rate. Essentially, it was not a speaking

order. Also, the escalation factor had not been determined in advance by the regulations but was

arbitrary

2. Again for A&G norms, there being no laid down norms, any expenditure incurred on generationand purchase of energy was to be permitted for pass-through in tariff as per Sixth Schedule of

Electricity Supply Act, 1948. This finding by ATE indicates that where there are no norms, any

determination of norms post facto is likely to be struck down as arbitrary OR determined in

favour of the utility

3. For A&G expenses, Mahagenco came up with an interesting ratio of gross A&G expenses perMW generated. Its argument was that the gross A&G expenses averaged over the capacity in

MW gives A&G expenses per MW to be 0.347 which is still less than what is allowed in the case

of TPC and REL. Given the technical complexity, geographic dispersion, employee strength etc

for Mahagenco compared to other utilities, ATE found a strong basis in that argument, and

directed MERC to recomputed expenses.

4. The SHR(Station Heat Ratio) targets set by MERC was not being achieved, therefore leading tolower tariffs due to under absorption of fixed costs/no efficiency gains. Observing that this

practice did not benefit either the utility or the consumer (since wrong price signals), MERC

mandates a scientifically determined ratio.


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5. The MERC regulations did not stipulate anything about recovery of incentive. While MERC haddirected quarterly basis in the order, the utility wanted it monthly, and put forth the logical

argument of synchrony with billing cycle. Hence, that argument was upheld by ATE.

6. MERC disallowed the normative fuel cost as per the recommendations of CPRI for the years2005-06 to 2007-08 and restricted the fuel cost to the actuals, from the year 2008-09 onwards the

norms as recommended by the CPRI have been followed. For 2008-09 to 2010-11 also the actual

fuel cost should have been allowed or else the norms as recommended by the CPRI should have

been used. Any other approach seems cherry picking of approaches in our view

7. Coal costs is a major cost component but MERC had not provided detailed cost sheet workings toMahagenco, due to which inconsistent figures were there and appeals were preferred. Hence ATE

ordered MERC to provide detailed workings of coal cost to Mahagenco. This is another example

of needing transparency and two way information sharing between regulator and regulated

enterprise.

After studying the ATE orders in respect of Mahagenco/MERC, we infer that the main reasons for appeal

were transparency (coal costs, reasons for exclusions, post facto regulations) and extraneous policy issues

by MERC (disallowing AAD station wise, SHR factors).

Barring the issue of coal costs,MERC has largely issued speaking orders, which have either been

upheld/overruledby ATE without the need/request to adduce additional evidence. This speaks volumes

for the quality of the regulatory orders. Maybe this is because MERC inducts retired utility officers to act

as its Regulatory Experts. These people having decades of experience on the other side, can help the

commission detect issues in implementation/genuine problems, and thereof build processes to ensure fair

and speaking orders.

There appears scope for improvement procedurally.


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Is MERC playing the game well?

Earlier, we modeled the tariff fixation process as a game where barring the regulator, every other player

looks to its own parochial interests. This is not a stinging indictment of the process, but a mere

recognition that in any political scenario (this IS one given the somewhat vague performance accounting

norms & policy issues at stake), there are bound to be winners and losers. We note that Mahagenco being

a state owned utility is constrained from subverting regulatory officials with corrupt practices. Therefore,

one would expect a more stringent approach with Mahagenco than other utilities, which was partly borne

out in the lower (per MW generated) O&M expenses allowed by MERC, which was afterwards felt as

unfair by the ATE.

One needs to know the game well to play it. MERC was fully acquainted with the situation of

Mahagenco, having advised the Maharashtra Govt. on unbundling. Yet, it did not factor in those relaxed

standards, leading to sustained under recovery of costs which was not trued up later. On the halter of

efficiency, Mahagencos path dependency (reliance on poorly maintained systems, utility of last resort,

state owned incumbent) was ignored. This is possible in a price cap situation but not for a normative cost

plus situation where path dependency counts.

MERC also, in our opinion, gets too hyper technical at times, forgetting the wider policy issues at play.

For example, stricter unachievable norms imposed without a technical study violates principles of

natural justice. Still, all is not lost. It has hopefully learnt from its earlier mistakes.


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Overall Observations

1. Path Dependency:- Following the hallowed legal doctrine of res juditica, the MERC prefers tofollow the reasoning laid down in its earlier orders. While this ensures regulatory consistency, it

also results in a tariff shock if the earlier orders are revised with retrospective effect because of an

ATE verdict favouring the utility.

2. Maharashtra Govt. /erstwhile MSEB cash crunch:- This lead to deferring O&M/Capexexpenses and thus giving the impression of MSEB being the lowest cost power producer, while

this was because of deferring of vital expenses. The MERC recognized this, and allowed one-time

additional O&M (to make up for earlier year deficits) and relaxed norms. Mahagenco was entitled

to 70:30 debt equity ratio for incremental capex, but has applied for 80:20 or even 100% debt-

stating that GoM (Government of Maharashtra) would not infuse additional equity funds for new

projects. This is astounding to say the least.

3. Game Theory:-While reading the petitions/submissions/MERC reasoning, we got the feelingthat this situation is amenable to a game theory analysis, because this is a recurring situation

where all participants play well defined roles.

a. The regulated utility wants to overstate its estimated costs, so that it can get moreefficiency gains when it achieves lower actual. Also, even if tariff is adjusted

downwards, it still gets interest free use of the surplus till the adjustment order which

takes atleast a year. This incentive applies for overstating capex by capitalizing O&M

expenses, and also gold plating to ensure higher rate of return.

b. End Customers seek the lowest estimated costs so that they can pay lower tariffs. Whilethis will not help as the deficits are recoverable with interest in future truing up periods,

they can still manage their cash flows better. That is why both individual consumer

associations and industrial consumers like Tata Motors vehemently challenge each cost

items rationale, amount and spending efficiency.

c. Distribution companies see the generation cost as a 100% pass through to theircustomers, and so have rarely contested/attended the tariff hearings/technical validation

sessions. This is although they are the direct generation customers, and in a sense most

affected by the generation companys actions.

d. Other generation companies oppose capex/plant location decisions at times forcompetitive reasons, because though generation capacity addition is de-licensed, the

MERC still has the tariff setting authority and therefore carries out prudence checks.


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e. The State Government desires to cross subsidize its vote bank (farmers/individuals) atthe cost of industrial users. Therefore, the direction to the MERC includes the aspect of

perpetuating cross subsidy.

f. The regulator(MERC) itself must play a fine balancing act between ensuring theeconomic health of the generation company, and ensuring that the company has every

incentive to maximize its efficiency and operate at minimal costs. While mechanisms like

efficiency sharing gains (hydel, PLF>80% etc) do it, the main approach adopted is to

estimate normative costs.

4. Cost Accounting matters:- Instead of merely extrapolating incurred costs and calculating ROE,the MERC checks the prudence of those costs (aka performance audit), and then checks

whether cost changes were controllable or uncontrollable. Controllable cost changes are mainly

(2/3rd

) kept with the utility but uncontrollable cost changes are passed on to customers.

5. Regulations fill data void:-The MERC regulations contain certain default technical parametersdepending on equipment used in plant. If the utility does not maintain reliable records, then these

parameters are used. This was done for O&M costs, auxiliary factors etc for the period where

Mahagenco did not maintain adequate records. This is akin to composition scheme/best

judgement assessment under the IT Act 1961!.

6. Developmental role-MERC had passed strictures on Mahagenco(detailed below) asking it tosegregate plant wise accounts, improve coal handling/purchase systems, streamline O&M

management, instill proper capex planning scheme etc. These internal functions of Mahagenco

had to be pushed for by the regulator.

7. Petition Scrutiny does benefit MSPGCL at times-MSPGCL had at times sought lower interestrate than the prevailing market rates, and MERC suo moto granted the higher rates. Similarly for

D/E ratio, MSPGCL even petitioned for 100% D/E ratio due to cash crunch from Govt. equity,

but MERC allowed at 80%, thus ensuring in higher tariffs. D/E ratio, interest rate where MERC

had adversely

8. Gentle balancing act:- While the over arching objective of MERC seems to protect the interestof consumers in the State of Maharashtra(its reasons for prohibiting Load Management charge,

high hydel lease fees, restricting interstate sales etc), it also keeps the interest of the generator in

mind while deciding ROE, efficiency sharing gains etc.

9. Use of incentives:- MSPGCL can keep 2/3rd of its efficiency gains/losses, while passing on 1/3rdto the distribution entity. Interesting, fuel costs being seen as a mix of controllable (consumption)

and non controllable (procurement price), its pass through is allowed via Fuel Adjustment


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Charge mechanism, which encourages prudent short term power purchase practices. Other

uncontrollable costs are passed through in full.

10.Hydel Power incentive structure:- Unlike thermal plants where the utility owns the plant, hydelprojects are built by the State irrigation department, and then handed over to Mahagenco, in

return for lease rent which encompasses ROE to GoM. Mahagenco is allowed by MERC merely

to recover actual O&M expenses, on no profit no loss basis. Since it does not own the plant, there

is no ROE/return given. Mahagencos request for an operating fee was shot down as no place in

MERC regulations for this. The request does seem fair though, considering that virtually no

efficiency gains/incentives exist for Mahagenco under the present tariff regulations.

11. Truing Up:- Actual expenses and the actual revenue will be trued up at the end of the year basedon audited financial results and subject to a prudence check. Provisional truing up of certain

elements of ARR is considered in cases where the impact is very high, or there is a change in the

principles/methodology, or due to revision in capital expenditure/capitalization figures

merc generation tariff order analysis

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