Month of June has passed in controversy, oil shortages and black marketing in the wake of a drastic cut in petroleum prices announced by the government. International oil prices plunged due to lack of demand due to Corona. Oil prices became even negative, although for a short while. GoP passed on most of the surplus, it could, to consumers. The political and welfare impact was marred by the subsequent market problems which would annoy any ruling setup.
ARTICLE: Sugar, cement and flour scandals have shaken the confidence of people in markets. Regulations and government controls have not delivered either. In Karachi, people are suffering under the poor performance of KE – an example of privatisation. There are no formal and organized markets as we see WhatsApp sugar price manipulation groups instead of spot markets. Thus neither privatisation nor regulation has delivered; markets, too, have failed. Yet markets and privatisation have helped other regions in bringing about well supplied markets. Market works and should work on its own without bureaucratic or autocratic controls or intervention. Broad oversights and institutions should be enough. We will discuss here the issues involved in bringing about an electricity market instead of a regulated control regime.
There are three major issues faced by the power sector today on which major actions and decisions have to be taken by the government and the regulator. These are: circular debt; power plan (IGCEP-Indicative Generation Capacity Expansion Plan) and market (CTBCM-competitive trading bilateral contracts markets). The IPP report has identified issues with respect to circular debt and negotiations are being held with IPPs to neutralize the excessive payment and higher tariff issue. The problem is that worst has yet to land in this respect when very expensive tariff projects will be commissioned between now and the year 2025.The tragedy is that new projects and PPAs are being signed under the old framework against which there is complaint and negotiations are currently taking place. What would be the result, we do not know. Other aspects of circular debt are Disco restructuring and reforms and full-cost recovery from consumers. Technical people want cost recovery and higher tariff while politically sensitive leadership is opposing rise in tariff, in fact they want the opposite of it. Disco reforms have yet to be initiated in a major way which are stalled due to other related policy issues.
We will focus in this space on electricity market issues, while taking a brief overview of the power plan-IGCEP-Power Plan which is a related issue. Current installed generation capacity is 36,000MW, while demand is only 25,000MW or even less, while it was 26,000MW in 2017-18 and should have been 30,000MW by now. There is clearly a demand slowdown and the future is risky and unknown in the context of coronavirus. Power plan envisages a generation capacity of 75,000MW by 2030 by the addition of 50,000MW of new capacity and retirement of 10,000MW of old plants. Out of 50,000MW, there are committed projects of 25,000MW? and the remaining 25000 gap may be filled by yet undefined solar and wind power capacity.
The main issue or bottleneck in bringing about electricity market is the existing or inline power projects for which PPAs have been signed or are already in operation or are at an advanced stage of construction. These are under Take or Pay arrangements which are an anathema to competitive market. If there is some commitment why are new liabilities being created under old arrangement which has to be changed. Currently, there is 50,000MW capacity that is under Take or Pay. There has been a provision all along for solicited projects in various power policies under which competitive bidding could have taken place. However, easier said than done. Any competition in CPEC projects would have been a farce. Yet, other projects were there in which competitive bidding could have been organized. There have been talks of organizing some sort of competitive bidding, reverse auction or otherwise, which has not happened.
There are three types of projects and PPAs; one which are in early stage of operations and their debt has not been paid off; second, which are in the mid or later stage of debt pay-off; and the third, where debt has been paid off. It is in this last category of power projects where new market design and terms may be feasible. This is a capacity of 7,500MW. And there is 25,000MW of yet not sure solar and wind power capacity that may be brought under new market regime. In richer countries, where this market transformation took place, reportedly paid off the investors and started the same projects on the new slate of competitive market. In our financial situation and circular debt situation, this kind of financial undertaking is not feasible and is rather thinkable. There may be other solutions such as bond or conversion to forward markets which is beyond the scope of a newspaper article. It appears that regulated and market based projects may run side by side.
There are two types of market models; one is cost-based while the other bid-based. CTBCM has adopted the cost-based model, probably due to the bottlenecks created by existing PPAs. The like of cost-based model is already there in a rough form under the existing merit-order system wherein Nepra determines the costs and may continue to do so. For competitive market enthusiasts it is an anathema; to them price should be decided through bids by sellers and the buyers. They reject a system where all the trappings of a regulated system manage to survive.
Electricity market has essentially two components; wholesale market and retail markets. Retail markets often depend on wholesale market. Retail markets require open access to transmission and distribution, while wholesale markets require unrestricted investment activity and competitive generation tariff. A million dollar question is: Is it possible to have retail competition without wholesale market? Theoretically, the answer must be in the negative but practically something can possibly be done to bring about a functioning retail market without a wholesale market. But how?
By retail competition, one means, that there are electricity suppliers who could be independent traders or IPPs or a combination of both which sell electricity to the retail customers in the place of a Disco. Currently, Discos sell electricity, which is a monopoly. In the open access retail market, electricity suppliers use the infrastructure of Discos to distribute electricity to their customers. Suppliers pay a wheeling charge to the Discos who invest in physical infrastructure and maintain it. Discos have no connection with the consumers; suppliers market, sell and collect bills. Thus, there may be many suppliers creating a competitive situation whereby consumes have a choice of selecting their supplier company based on quality of service and price. Thus retail customers, in fact, throw up, the suppliers. Suppliers are thus forced to procure cheaper or competitive electricity. They may buy from a competitive wholesale market and in the absence of which may make bilateral arrangements with IPPs under prices which are essentially dictated by the retail market. This indicates that, indeed, retail market may function without a formal structure of a competitive wholesale markets working under an exchange system or the like.
A practical example is Mumbai where there are three suppliers and retail customers are free to select the supplier. Earlier, there was demarcation of customers which with the passage of time has gone away under a court decision in the framework of 2003 Electricity Law of the market in India. There is no formal wholesale market in India. There are two small market exchanges whose market share does not exceed more than a few percentage points.
In Pakistan, we can also have voluntary electric market exchanges wherein excess electricity may be traded; it may come from captive power plants, normal IPPs under arrangement with CPPA-G wherein a certain portion of PPA electricity may be traded under certain circumstances; new solar and wind projects and independent merchant IPPs may sell their output through such exchanges. A lot of work would, however, be required; establishing wheeling charges and Annual Revenue Requirement – ARR – of Discos. Upper ceiling of consumer tariff may also be enforced in order to prevent market manipulation and undue price increases.
Unfortunately, Privatisation Commission (PC) is moving ahead with privatization in a solo flight without getting itself informed of the proposed CTBCM-Electric Retail Market provisions. It would create many legal complications post-privatisation. Wires-only model and existing Disco models are two very different models having serious and severe business implications. PC would be well advised to get informed on the subject accordingly. Privatisation had been on the agendas of successive governments but did not happen for one reason or the other, mostly due to Unions’ and other insiders’ opposition. Retail market-Wires only model is a part privatisation reducing the existing Disco load and involvement to be significantly reduced reducing the rationale of privatisation itself or reducing the consequences of not privatizing.
Another relevant model is of ‘electricity cooperatives’ wherein users are the owners themselves. There are many cooperative models working efficiently in the US 5% of the electricity in the US is generated by cooperatives having a 13% market share in electricity sales.42% of electric distribution lines are owned by cooperatives; there are 831 distribution cooperatives and 62 generation and transmission cooperatives. Electric Cooperatives’ contributions to the US GDP are 88 billion USD and contribute 22 billion USD in taxes. In a no-owner and liquidating situation, Cooperative option deserves serious consideration.
An electric market should address issues of rural and unserved or underserved areas. In order to promote micro-grids ,cooperatives and self-initiatives, licensing requirements and other restrictions for generation and distribution businesses should not be there and should be eliminated that would promote informal markets.
(The writer is former Member Energy, Planning Commission)
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Electricity Act 2003 - Salient Features
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• De-licensing of power generation
• Open Access to Transmission System
• Open Access to Distribution System
• Key provisions for renewable and cogeneration
• Trading in electricity permitted
• Liberal provisions for captive power generation
• Multiple Distribution Licensees permitted
• Rural generation and distribution freed from licen
• Direct and transparent payment of subsidies
• Expanded role for the Regulatory Commissions
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Whole sale Electricity Prices: Reliability Regions-USA-2018-USD/MWh
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2018 2019 2020
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ERCOT-north hub 41.43 29.92 32.74
CAISO SP15 Zone 47.33 36.91 39.29
ISO NE internal hub 49.96 37.46 40.9
NYISO Hudson Valley Zone 42.39 34.21 35.01
PJM western hub 41.66 32.13 32.78
Mid Continent ISO Illinois hub 35.66 31.14 32.76
SPP ISO South Hub 30.36 30.31 32.14
SERC Index into Southern 30.78 30.65 30.83
FRCC Index, Florida Reliability 30.82 30.51 31.09
North West Index-Mid Columbia 37.77 36.37 37.86
South west index, Palo verde 40.66 33.57 37.8
Italics numbers forecasted, normal actual
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Source: US EIA Annual Energy Outlook-2019
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India Electrical Market Prices-Irs/kWh
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Bilateral Power DSM
Trading Exchanges
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2009-10 5.26 4.96 4.62
2010-11 4.79 3.47 3.91
2011-12 4.18 3.57 4.09
2012-13 4.33 3.67 3.86
2013-14 4.29 2.9 2.05
2014-15 4.28 3.5 2.26
2015-16 4.11 2.72 1.93
2016-17 3.53 2.5 1.76
2017-18 3.59 3.45 2.03
Average Annual PPP India 3.85
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Source: IEX India Annual Report-2018Oil Marketing Companies (OMCs) blame the shortage on Petroleum Division that it did not adequately project and manage the demand and supply through timely interventions. Petroleum Division, however, argues that there was an abrupt increase in demand in the wake of lifting or easing the corona restrictions. The government circles blame the shortages on OMCs that did not maintain the required inventory of 21 days and hoarded (did not release supplies to the market) the petroleum products. OMCs argue that they were suffering a loss of Rs 17.00 per litre due to the inventory bought by them at higher prices. Similar arguments were proffered by the dealers as well. The special assistant to prime minister on petroleum Nadeem Babar has acknowledged that the current pricing system does not work well in large price changes, up or down. Some times OMCs and dealers make a killing when prices increase and suffer when prices decrease. For consumers, it is the other way round. It is a zero-sum game; OMCs’ loss is consumers benefit and vice versa. A need is being felt to bring about changes in the current system; easier said than done, but something has to be done.There has to be a fair and efficient system which promotes supplies and investments and at the same time through reduction of process inefficiencies awards fair market prices to the consumers.
The gasoline price has increased from Rs 74.52 per litre to Rs 100.10. The price increase is as sharp as the decrease was last month. International oil prices have increased and thus the price had to be increased. Petroleum Levy has been maintained in the new price at Rs 30.0 per litre. Last month, international prices were low and thus higher PLD of Rs 30.0 was acceptable by the market. The government had the option of reducing PLD, say, to Rs 20.0 and thus the price increase could have been reduced to Rs 90.00 and the increase could have been of only Rs 15.00 instead of Rs 25.00. However, it may be noted that oil prices are still much lower than elsewhere in the region. Also international spot prices have increased by 50%,while local price increase has been limited to 34% only.
Additionally, there is confusion because transparency is lacking. In earlier days, a complete break-up used to be made known. Experts and other people somehow find out the complete price break-up. The government would do well if it reverts to the earlier system. Also, 40% of Petrol is consumed by low income group of motorcyclers which forms a highly price sensitive market segment, although there are additional options to reduce prices in this segment, other than pricing reforms (these are of blending a low RON -87 fuel out of Naphtha and marketed through a separate low-overhead petrol pump system). Another issue is of reducing diesel prices with respect to the Gasoline as is the situation in most countries.
Towards an automated formula
It may be noted that basic oil price(imported or Ex-Refinery)is already linked to international prices (there is a 7.5% customs duty levied on HSD which requires some rationalization). It is related to Platts Oil-Gram but final price is dependent on PSO actuals, which may be a double-edged sword; besides, it is a time consuming process. A better approach could be interlinking with an appropriate index such as Platts Oil-Gram. Import expenses such as Ocean Transport, insurance, L/C costs, etc., can be based on estimated averages of the past months on the line of OGRA LNG calculations.
OMCs have been demanding a 15-day pricing cycles as opposed to the current monthly pricing cycle to reduce the price risk exposure. This can be reduced, in our view, to even one-week, a la – Malaysian pricing system, which is similar to Pakistan’s. The difference is that the Pakistani system is based on a time-consuming calculation of actuals, while in most other places, there is an automatic formula. The regulator can announce a six-month charge of the three items; IFEM, OMC and Dealers Margin which adds up to under Rs.10.00 currently. EX-Refinery price can be announced by Ogra on a weekly basis. Taxation changes may be kept on a monthly cycle. Under such a system, an automatic price calculation system can be established without waiting for Ogra/ECC deliberations and approvals.
Elimination of IFEM?
A lot of criticism has been leveled on IFEM such as transparency and transport inefficiencies. Many demand that it should be eliminated. The main advantage or merit is uniform petroleum pricing throughout the country. For pure economists, location advantage should be reflected in costs and prices to boost optimal resource allocation. However, there are other issues of regional inequalities and poverty which argue in the opposite direction. To be acceptable, it can be considered a location tax; after all it is only Rs.3.19 for Gasoline and Rs.1.46 for HSD. Under a deregulated system, however, such costs are subsumed in marketing costs and are not charged separately. Nevertheless, it is an implicit or explicit cost. In India, there is no IFEM; in India, there is a wide difference in regional prices. However, the difference is not only due to varying transport costs. In India, GST is charged by provinces and the rates are different in every province/state. In Malaysia, there is regional transport cost element.
Towards deregulation or price ceiling?
Deregulation means no control on price. Sellers compete for the market share and in the process minimize prices and maximize quality. However, it requires a real competition and institutional system controls that restrict price conspiracy and collusion and other anti-competitive practices. Markets have not worked efficiently in Pakistan. One would be scared to leave prices of such an essential item free and subject to manipulation. However, an alternative would be to announce price ceilings under which efficient companies may be able to acquire market share under a competitive price-quality supply system.
A competition boosting option could be to allow independent dealers. There are three dealer systems; COCO (company owned-Company Operated), CODO(Company owned-dealer operated and DODO (Dealers owned and Dealers Operated).In most countries, DODO is allowed as well. Filling stations under DODO are independent and are not tied to a particular OMC, which often results in lower prices as competition is boosted, while in the other two systems, OMCs have a large handle on prices. And OMCs are not many, while dealers are in thousands. In Pakistan, no more than 10 OMCs operate effectively, although the number of registered ones may exceed the 40 mark. The market share of these smaller OMCs may increase through competition. In Germany, market share of independent DODO pumps is 15% and in Australia 30%.
(The writer is former Member Energy, Planning Commission)
Updated 15th July 2020 on Business Recorder
