New electricity tariff structure leaves room for considerable improvement

Originally appeared on the Daily Mirror, Timesonline.lk

By the Resident Fellow of Advocata Institute

The recent revision of electricity tariffs is a step towards reducing the fiscal burden caused by the supply of electricity below its cost of production. While the new tariff structure is an improvement on the previous one, anomalies remain.

 In determining tariffs, there are three characteristics of electricity that must be noted:

I. Electricity is a commodity that is interchangeable, both in its generation and use. One megawatt hour (MWh) of electricity produced from coal or hydropower contains the same amount of energy. Different categories of users consume the same product.

II. It must be produced and used simultaneously. Electricity storage is still prohibitively expensive. Supply must meet demand exactly in the power grid.

III. The cost of supplying electricity fluctuates throughout the day, depending on the power generation mix, cost of fuels used, transmission costs and energy losses.

As electricity is a commodity, there should be no difference in the prices charged to different users. The tariff should also reflect the varying cost of supply, depending on the time of day and should as far as possible, balance the generation of electricity with its use. For sustainability, the tariff needs to be on a cost-recovery basis.

The new tariff addresses some of the shortcomings of the existing structure but there is still considerable room for improvement.

1. The proposed structure reduces the discrimination between different types of bulk supply customers.

For users below 42kVA, the different rates that were charged to hotels, government and general-purpose bulk supply, have been amalgamated into a single general-purpose tariff but a lower rate remains applicable to ‘industrial’ customers. However, it is positive that the differential between the general-purpose bulk supply and customers categorised as ‘industrial’ has decreased.

For larger bulk customers, it is welcome that the distinction between categories has been done away with and a single tariff, close to cost recovery and reflecting time of use, has been applied.

The Public Utilities Commission of Sri Lanka (PUCSL) consultation document states that the average cost of generation is Rs.32.87 but the tariff charged to low-use industrial users (Rs.20) and low-use general-purpose customers (Rs.25 for those below 180kWh) is both below cost.

The only justification for a discriminatory tariff is for a lifeline tariff for the poor. While the domestic users below 90kWh do receive a subsidised tariff, the domestic consumers, who exceed this, pay the highest tariff (Rs.50 for usage between 90-180kWh, Rs.75 above 180kWh), which is almost double that of all bulk users. Thus, high-use domestic consumers are subsidising industrial and commercial users.

Moreover, instead of increasing the rate for each block of use, the moment domestic customers exceed 60 units, the tariff increases from an average of Rs.9 to Rs.16. A customer, who consumes 59 units, will pay Rs.9 but one who consumes 61 units will pay Rs.16 per unit. This is unfair and can promote corruption in meter reading. In general, such cross subsidies are undesirable, as they can lead to inefficient resource allocation or have unintended consequences.

For example, the higher domestic tariff may serve as a disincentive for remote work. Remote or flexible work arrangements can reduce transport costs, congestion, energy use and for some, enable a better work/life balance. The government should be facilitating flexible work but the higher rates applicable to some domestic consumers may be a disincentive.

The PUCSL has an unusual definition of industry. It includes, ‘agriculture’, ‘forestry and fishing’, ‘mining and quarrying’, ‘manufacturing’, ‘electricity, gas, steam and air conditioning supply’, ‘water supply, sewerage and waste management. As a matter of principle, the producer should not make judgment on how the product is used or attempt to encourage or discourage particular activities through prices. If the government does wish to encourage particular industries, it is more efficient to do this through a transparent system of grants, rather than distorting prices.

Economic activity is increasingly complex and a value chain can involve many different sectors. For example, the tea industry involves agriculture, processing in factories, transport, warehousing, blending, financing, marketing and exports. Moreover, products are now more knowledge intensive, so a greater part of the value addition arises in non-production-oriented components of the value chain. With differential tariffs, parts of the same value chain may pay different prices for use of the same commodity.

Religious and charitable bodies continue to enjoy preferential treatment under the domestic tariff category but there is a small decrease in the discount offered to these bodies. High-use customers in this category should also be subject to a time of use (TOU)-based tariff. Advocata reiterates that there should be no price discrimination between users; at most there should be two categories, households and businesses.

2. It is welcome to note that the new tariff structure extends the TOU tariff to the agriculture subsector but this should be extended to smaller bulk users and made compulsory for the high-use domestic category. For customers using solar power on a net metering basis, the export and import tariffs should be based on TOU. A TOU-based tariff reflects the changing cost of generation across the day. Generation during peak hours relies more heavily on thermal power, which is more costly. Tariffs charged to customers should reflect this, so that the consumers are incentivised to shift demand to off-peak hours.

3. The new tariff maintains a lower rate for low-use domestic customers and it is welcome that the new structure applies marginal tariffs based on different slabs of usage. The previous system was inherently unfair to the consumer; the new tariff removes this anomaly.

4. The decision to charge for street lighting, which should be paid for by the local authorities, is welcome. Previously, as the Ceylon Electricity Board (CEB) did not charge for street lighting, the local authorities, which have control over when the lights are switched on and off, had no particular incentive to switch off street lights during day time. A lower rate for street lighting is justified because the major part of the use falls into off-peak hours.

5. It is regrettable that the PUCSL permitted the CEB to compel selected clients to pay for electricity in US dollars. This is a step towards forced dollarisation of payments and is precluded under Section 4 of Monetary Law Act No. 58 of 1949. The proposal is meant to address the current shortage of US dollars for importation of fuel for the energy sector. However, this would only divert resources from other alternative users and may not be the most efficient way of allocating the scarce foreign exchange in the country. It would be preferable to allow US dollars to flow into the banking sector (by removing any restrictions and requirements such as forced conversions and surrendering requirements) and for those funds to be allocated based on price (exchange rate).

The increase in the electricity tariff is unavoidable but will impose an additional burden on consumers. Therefore, it is imperative that this must be accompanied by increased transparency and efficiency

within the utility.

Consumers may expect to pay for higher world prices but cannot be expected to pay higher costs, due to inefficiency, waste or corruption. State enterprises need to be open and transparent in their affairs, particularly in procurement and where possible should operate in competitive markets.

As a first step, the CEB should provide a detailed breakdown on the components of its tariff:

• Energy costs: (Own generation costs and that paid to the private generation companies). This must be broken down into the fuel cost and the costs of operating the power stations, such as the manpower and maintenance costs as well as the capital cost of the stations.

• Network costs: This reflects the cost of transporting electricity through the power grid.

• Overhead: This is to recover the costs of central administration, billing and meter reading, data management, retail market systems as well as market development initiatives.

The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.