Reforming Electricity Distribution in India: Understanding Delicensing and Retail Competition

Executive Summary

In accordance with the announcement in the FY 2021-22 budget, the Ministry of Power (MoP) has developed draft legislation to delicense electricity distribution to allow multiple distribution companies (discoms) in each supply area. There is general agreement on the need for reforms in the power sector, particularly in distribution. Therefore, the Government’s attention to this sector and its willingness to act are welcome. Given the importance of these proposed structural changes in the power sector, additional objective analysis and evaluation would be useful to deepen and inform the discourse. This note discusses several concerns and challenges with the proposed changes.

First, international experience suggests that, in the electricity sector, most of the economic benefits of competition come from effective wholesale markets and focusing on retail competition alone is likely to have very little effect on the overall price and efficiency in the distribution of electricity. In addition, effective wholesale electricity markets, in turn, require effective fuel markets. Unfortunately, the fuel markets in India are quite distorted. Furthermore, the benefits of retail competition for residential and small consumers are very limited. Instead, it exposes vulnerable groups to potentially exploitative marketing practices of retailers — an issue of special relevance in India with a large percentage of small consumers who are very price-sensitive. A better alternative to starting with full retail competition would be to continue to allow choice of supplier to large consumers but through improved open access provisions, as discussed in detail in this note, and let discoms continue to purchase power for smaller consumers. In addition, the threshold for open access can be progressively lowered to 50 kW or 100 kW of load, in order to allow almost all high-tension (HT) consumers choice of supplier.

Second, distribution is a natural monopoly. Making ownership and responsibility of the distribution network non-exclusive will lead to unnecessary duplication of resources and increase the cost of electricity. The experience in the Mumbai experiment with multiple licensees—endless litigation, planning and regulatory failures, and significantly higher tariffs—should be a sobering reminder of the perils of such an approach.

Third, delicensing of distribution is likely to lead to the neglect of distribution network operation, just when its importance for the sector is growing. The role of the distribution network operator will become more important and challenging in the future due to the increasing contribution from renewable energy; growing presence of distributed energy resources; new behind-the-meter technologies; and increasing use of smart meters. Delicensing distribution and spreading responsibilities for the network will dilute accountability and lead to finger-pointing, if not chaos.

Fourth, there will be very significant challenges in allocating legacy power purchase agreements (PPAs) and aggregate technical and commercial (AT&C) losses. If AT&C losses need to be socialized due to fundamental limitations of apportionment, this would obviate many of the benefits of competition. In addition, while the Government is mindful of the risks of suppliers cherry-picking the most desirable consumers and proposes solutions to this problem, these are unlikely to work. The outcome is likely to be a segregation of consumers, with the higher-paying ones being served by financially viable retailers, while the less economically attractive consumers (the smaller and poorer consumers) being served by a discom that is financially even weaker than today. Some of the cherry picking might occur not just within an area but also through the choice of geographies by the new entrants.

A better alternative to delicensing would be to pursue privatisation of discoms and harness the superior managerial and technical skills of the private sector but with competent and appropriate regulation and oversight. Private discoms would also be less likely to be susceptible to political interference in such a regulatory framework, although not completely immune from it. The Government has been promoting privatisation of distribution starting with union territories. Focusing on those efforts is likely to yield much greater benefits for the power sector. Parallel efforts to delicense distribution are likely to impede the progress on privatisation because delicensing will increase the risk for potential investors and reduce their interest in bidding. In the pursuit of privatisation, it is important that before any decision the central and state Governments consult and negotiate in an open and transparent manner with all stakeholders, particularly the unions, to address their apprehensions. While a consultative approach may seem frustratingly long and slow, it is essential for having a thriving power sector that can propel the Indian economy on a high growth path.