Electricity Pricing: Is Willingness To Pay a Key Factor?

Indians reportedly pay one of the highest prices for electricity in the world, when adjusted for capacity to pay. Yet, most electricity distribution companies (discoms) in India continue to be in the red due to poor governance, and tariffs not being cost-reflective. Presently, there is a gap of nearly INR 0.60 per kWh (kilowatt-hour) between the average cost of supply and the revenue realized (after adjusting subsidies) for most of the discoms in India.

Understanding electricity demand, pricing and consumers' 'Willingness to Pay' (WTP) for electricity services has long been tricky and debated, both in India as well as globally. TERI recently concluded a study on WTP and electricity pricing which was done against the backdrop of the Government of India's flagship, `UDAY' programme. The study calls attention to structural changes that would help improve the viability of the sector.

WTP as a function of income and expectation

One of the interesting findings is that the share of disposable income assigned to electricity in the overall household income of rural household consumers, is the key factor that determines the WTP. While most consumers expressed a relatively higher WTP for basic lighting services as compared to their current expenditures on kerosene or other fuels, their relative increase in the willingness has been found to drop for services beyond lighting.

This may be because of two reasons - low consumer affordability and their expectation from government-run discoms to provide services at nominal prices. What we need is this expectation to be altered. This can be achieved by making electricity pricing independent of political interference and sensitising consumers about the real cost of electricity supply.

Going beyond pricing to address revenue variance

Discussions with sector regulators revealed that consumers' WTP is not considered while setting tariffs. Instead, pricing is done on a cost-to-serve basis.

However, tariff increase may not be the only way to reduce the revenue-cost gap. For example, in the case of a particular discom in Uttar Pradesh, metering domestic connections would itself contribute to nearly 3 times more per kWh revenue than the same un-metered connections.

The third observation holds that agricultural consumers that account for around 23% of the total kWh sales nationally contribute a paltry 9% to the revenue. On the other hand, industrial consumers consume 30% of total unit sales and generate around 42% of the total revenue. One would also be amazed to know that there are as many as 44 to 61 tariff slabs in states; despite which the targeted subsidy delivery is not facilitated.

There is a clear need to prioritize and minimize subsidy levels for agricultural consumers and move away from a 'one-size fits all' approach. Reforms need to be more state-specific. While states such as Punjab, Haryana, Maharashtra and Karnataka require to prioritize action tariff rationalization for agricultural subsidies, others such as Bihar, Tamil Nadu and Uttar Pradesh must initiate domestic sector reforms (like metering at the household, transformers and feeders, improvement in reliability and availability of supply). Rationalization of tariffs across the entire electricity value chain (including that for fuels and the supply chain for production and transmission of electricity), and not just at the retail level is paramount.

Further, tariff structures for all consumer classes need to be consolidated for easing metering, billing and collection process to ramp up revenue generation and transparency.

Relooking operation & management models

Besides these, improved efficiency at both the retail level and across the electricity value chain is required. Despite initial success in many states, the electricity distribution franchisee system that was introduced in the late 2000s to ensure revenue sustainability and last mile distribution efficiency, failed to meet its objective in many states. This was due to scepticism about the model leaning towards privatisation. It is hence, important to take a fresh look at how business is currently done in each segment of the sector.

Lastly, besides focusing on turning around operational efficiency of discoms, the UDAY programme should also involve intensive capacity-building measures. Modules on 'change management' are of paramount importance for success.

Fundamentally, unless people, systems and procedures are altered for good, no reform will be effective or sustainable.

For more details on the study findings: Click here