Forum Meetings

Cost of Supply

  • Determination of cost of supply (CoS) is an integral part of the tariff fixation process as it helps in determining the cost imposed by a particular consumer category on the system and the level of cross subsidy provided to various consumer categories. Section 61(g) of the Electricity Act, 2003 mandates the state electricity regulatory commissions (SERCs) to ensure that electricity tariff for a particular consumer category reflects the cost incurred by the distribution utility to supply electricity to that category and cross subsidies to various consumer categories are reduced or eliminated progressively. The National Tariff Policy (NTP) also mandates the regulators to bring down the cross-subsidy surcharge progressively and ensure that the tariff for a particular consumer category is within ± 20 % of the average cost of supply for that consumer category. While there is an urgent need for determining an efficient and prudent cost of supply of electricity and its recovery from various consumer categories to ensure financial sustainability of the distribution utilities, it must be ensured that any such process does not result in tariff shocks to other consumer categories.

  • Allocating cost of supply to different categories of consumers involves the judicious segregation of total cost incurred by the utility into various consumer categories served.Two widely used approaches for estimation of cost of service are the embedded cost approach and marginal cost approach. In case of the embedded cost approach the historical or accounting costs that make up a utility’s revenue requirement is allocated to different consumer categories. The marginal cost approach is based on the concept that the amount consumers are willing to pay for the last unit of a good or service equals the cost of producing the last unit, i.e., its marginal cost. In a competitive market, this equilibrium is achieved as each firm expands its output until its marginal cost equals the price established by the forces of supply and demand.

  • Both approaches demand a large quantum of reliable data which is not generally available with Indian utilities. Therefore, majority of utilities opt for the simplified approach to estimate voltage wise cost of supply. In this approach, it is enough to determine the voltage-wise cost of supply taking into account the major cost element applicable to all the categories of consumers connected to the same voltage level. Different SERCs, using different factors and assumptions,have carried out the exercise of calculating cost of supply using this approach. SERCs need to move towards setting tariffs based on category wise CoS which helps them measure the extent of cross subsidy levels. Out of 29 states in India, majority are not performing this exercise to assess category wise cost of supply. As the retail supply market is opening up to competition, the primary category which would tend to avail the benefits of competition would be the large industrial/commercial consumers with a demand of 1 MW or above. As these consumers move towards open access, the distribution utilities will suffer heavy financial loss due to cross subsidy erosion. This in turn makes utilities reluctant to supply reliable and continuous supply to rural or agricultural customers, given the heavy distribution losses associated with each unit sold. Further, increasing degree of cross subsidization would result in higher industrial tariffs which in turn feeds into higher product costs. It may also lead to revenue loss to utilities as industries shift to captive power generation.

  • Imposing cross-subsidies also deters competition in retail supply of electricity. Many developing economies like Brazil, Thailand and Philippines have introduced competition in electricity distribution after eliminating cross subsidies. In India, consumption mix of a utility is largely related to its ability to affect a reduction in cross subsidies. Therefore, it is imperative to analyze the impact of DeenDayal Upadhyaya Gram Jyoti Yojana (DDUGJY), SAUBHAGYA and “24X7 Power for All” schemes on cross subsidies and financial health of the utilities.Therefore, in order to measure the true impact of cross subsidy erosion and to take remedial measures, the first step towards addressing the cross-subsidy issue is to determine category wise cost of supply for all states.

  • » Gist of Discussions at the Fourth meeting of the Distribution Utilities Forum held on 10th June, 2019

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