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    Electricity pricing

    June turned out to be a busy month for the energy sector.
    The Indian government took two decisions that could turn out to be watersheds. The impact of those decisions will percolate through to Nepal in a significant way as well.

    First, the Indian government effectively doubled the producer price of its domestically produced natural gas from US $4.2 per million British Thermal Units (mmbtu) to US $8.4/mmbtu. With taxes, pipeline transportation and marketing costs, delivered natural gas cost will now exceed US $10/mmbtu.
    The new price takes effect on April 1, 2014.

    16965Some reactions to the decision suggest that it was artificially designed to favor Reliance, the country’s largest private sector gas producer. Opposition to the government’s decision has, however, appeared muted in comparison to the usual decibel level of Indian politics. Unless there is a judicial reversal, the decision is now set in stone for the next five years.

    More than the doubling of gas prices, it was the rationale of price determination that represents the bigger shift in thinking. Natural gas prices will now be based on a formula linked to the price of internationally traded liquefied natural gas (LNG) and the average of three major gas trading hubs (US, UK and Japan). The price of $8.4/mmbtu is an estimate of the price that would result if the formula were to be applied at the time the decision was announced.

    With the gas pricing formula, India signaled its intent to move towards “opportunity pricing.” The argument was that you cannot attract investments by pricing energy simply at cost plus some return. Investors will want to price their energy supply at the equivalent price of the substitute fuel. In the case of domestically produced natural gas, internationally traded LNG was the substitute.

    Almost two decades after India began to experiment with reforms in energy markets, the country has come to realize that perhaps the only way to make energy available to all is to first make sure that it is priced right.

    The Indian government’s second important decision last month allowed power producers to pass the cost of imported coal to end-users. Imported coal is typically one-third to one-half more expensive than equivalent domestic coal.

    Most of these plants were under long-term fixed price power purchase agreements with distribution utilities that made no allowances for higher fuel costs. With increasing domestic coal shortages, many of them had to supplement domestic coal with imported coal but were unable to pass on the higher cost of imported coal. The policy change allows these plants to fully recover the higher imported coal cost through the generation tariff.

    Both of the decisions will clearly push India’s electricity prices up.
    “It is better to have power and pay a few paise more than not have power at all,” India’s Finance Minister P Chidambaram said when announcing the decision on the pass-through of imported coal costs.

    The minister was casual in his assessment of impact, referring to it colloquially as ‘a few paise’. But the full impact on India’s electricity prices is likely to be far more significant. Prices could almost double at certain times of the year, particularly when electricity demand begins to peak.

    The question in everybody’s mind was how distribution utilities would pay for the more expensive power. Already many of the Indian distribution utilities are broke, with accumulated losses in excess of US $50 billion.
    The Indian government has indicated that it is considering all options, including potential subsidies to minimize the impact of higher electricity prices. But the reality of the government’s fiscal position may not allow it to do anything at all. In the end, most likely, power prices will creep up slowly and consumers will simply adjust to an era of higher electricity prices.

    The changing dynamics of Indian gas, coal and electricity markets offers many relevant lessons for Nepal.
    First, there will be the direct impact. As power prices rise across the border, imports of electricity from India will become more expensive. Electricity imports, which are already at around InRs 5.5 per unit could increase to as much as InRs 8 per unit. There is also the possibility that these imports could be linked to an international fuel index and be payable in foreign currency.

    But the bigger point for us should be to learn from the lessons and underlying trends in India’s energy sector development.
    Like India’s natural gas sector, Nepal’s hydro sector suffers from a lack of investment. Despite years of reform and having opened the sector to private participation, investors have yet to translate the apparent opportunity into real activity.

    The reason may be as simple as it was for natural gas in India.
    At the current generation tariff, hydro simply doesn’t yield enough returns. Once the cost of political uncertainty, corruption, foreign exchange volatility, hydrology and terrain risks are factored in, it turns out to be more profitable to sell generators and inverters than to produce hydro-electricity for sale to the grid.
    One way to solve Nepal’s current electricity crisis is to do what the Indians did with their natural gas—double the rates. Allow electricity to be priced closer to the cost of the substitute fuel.

    But that still leaves the question of affordability. How do you make such high electricity rates affordable in a country where the distribution utility is essentially broke? A subsidy is clearly not the answer—governments cannot afford that anyway.
    The answer may be to create price reliability and different markets for electricity: one where electricity is expensive but reliable and another where it is cheap but with low reliability.

    This may be the most important lesson from two decades of reforms in India. Electricity for economic growth must be priced differently than power for meeting the objectives of energy for all. While structural and regulatory reforms, such as unbundling of vertically integrated utilities, are important, they don’t necessarily translate into meaningful growth in electricity supply unless it leads to the creation of different market segments that cater individually to those with different abilities to pay.

    A family seeking to replace a kerosene lamp doesn’t have the same ability to pay for electricity as a business running a large diesel generator. So who should get electricity? Our approach must be to expand the supply of electricity by first tapping into consumer segments that have the ability to pay for reliable electricity supply.
    The two recent decisions by the Indian government, along with the other changes in the sector, is part evidence that India is rapidly moving towards a bifurcated market for electricity. Certain segments will have access to reliable but expensive power. Others will pay far less for power but will receive no reliability in return.

    A similar bifurcation in power markets is already underway in Nepal as well. Certain industries, for instance, are able to build special feeder lines that connect directly into high voltage lines. They pay a higher rate for electricity and are free of the load shedding problem.
    Such feeder lines are makeshift solutions. But to address our energy shortages, we must be able to institutionalize the idea represented by these feeder lines—different markets for different needs.

    bishal_thapa@hotmail.com

    Source : Republica