Global Experience of Retail Competition in Power Supply and Implications for India

In a recent paper ‘Retail Competition in Power Distribution’ in The Energy and Resources Institute (TERI), we explored the evolution and experience of retail competition in the supply of electricity globally and the implications for India of introducing it at this juncture.

The electricity supply industry emerged towards the end of the nineteenth century. Electricity needed a network of wires for supply to consumers. As it could not be stored, generation had to match demand at every moment all the time for stability of the supply network, the grid. Being capital intensive, the industry evolved and spread through local area monopolies. To prevent profiteering and to safeguard consumer interest from private monopoly power, the industry was considered a public utility and made subject to regulation. Public ownership of the industry became the other option for providing reliable supply at reasonable costs.

The transitions between public and private ownerships in the power sector have been influenced by the need to balance a variety of factors and considerations. A networked good with high capital costs which benefits from economies of scale, electricity is an essential commodity and one which could not be stored. The value chain in the sector comprises generation, transmission and distribution. It is an essential requirement for all modern economic activity as well as for all homes. This implies that not only is demand relatively inelastic but costs, availability and reliability of supply are closely linked to productivity and have greater salience in public policy. The debates on regulation are often driven by the tradeoffs between the competing needs to provide reliable access at ‘fair’ costs with the incentive to invest.

A more market-based reforms approach of increasing competition, de-regulation and reducing entry barriers, have been central to the economic reform agenda for the past few decades across the world. This influenced thinking on the power sector as well. The idea behind reforms has been that by making electricity a commodity, market forces and competition would lead to efficiency and productivity gains. Competitive markets would give consumers better supply at lower prices. The UK led the way in the early nineties. The vertically integrated system was unbundled into separate generation companies, a transmission company and regional distribution companies. These were privatised. All generation went into a power pool where prices are discovered in the day-ahead market. Retail competition was introduced by separating carriage, the wires business, from content, the supply business. This led to the emergence of competing Supply Companies. The World Bank became a prominent advocate of power sector reforms in developing countries. These were centred around the creation of independent regulatory bodies; unbundling of vertically integrated state-owned utilities; increased private sector participation and investment; and enhancing competition. As the Bank’s lending became contingent on market-oriented adjustments, including in the power sector, many countries initiated power sector reforms along this ‘textbook’ format.

We discuss in the paper how in the decades that followed, the experience of these reforms has been more mixed than had been initially anticipated. There were stark differences in the extent of adoption of reforms, with many countries having had incomplete adoption, and even policy reversal due to financial or political economy considerations. Why was the implementation more complicated than was initially conceived?

Privatization reforms in Argentina and Brazil were suspended in the aftermath of economic and electricity crises, respectively. The disastrous experience of the 2002 electricity crisis in California was a watershed for retail competition both in the United States, as well as in other countries, including South Korea. In countries where retail competition was introduced their experience has been mixed. Pennsylvania’s PJM market design to introduce retail competition was more successful than the one introduced in California. Interestingly, the average electricity prices in many places with retail competition have been higher, and the volatility in prices greater. In the United Kingdom, where retail competition was introduced the ability to realize the gains from competition in generation and the resultant lower prices, has not been uniform, especially for smaller retail consumers. According to UK’s regulatory agency, Ofgem, even though significant savings were possible by shifting to the lowest tariff, many consumers (especially the poor, elderly, and other vulnerable communities) find it difficult to take advantage and tend to be on more expensive tariffs. One notable feature has been that total electricity demand has been flat since the regulation and retail competition were introduced in the UK.

What are the implications of this experience for India?

The Electricity Act 2003 was enacted after wide stake holder consultation and a broad consensus. It resulted in the unbundling of the State Electricity Boards. A robust competitive market structure in generation has emerged. Private investment in generation has surged and the country has more than adequate generating capacity for the first time. This is after electrifying all households and providing fresh access to over 500 million people.

The consumer is served by Distribution Companies which have the obligation to provide reliable quality supply to all consumers in their licensed area. Consumer tariffs are determined by the State Regulatory Commissions. Consumers over 1 MW have the right to open access and to avail of choice of Supplier. This has not worked on any significant scale.

The aggregate losses of Distribution Companies, which had reached Rs 49,623 crore in 2018-19 (the latest year for which data is available), and are expected to be further straitened by the ongoing pandemic, is the foremost challenge for the power sector.

Our paper spells out the risks from introducing retail competition at this stage.

If retail competition is introduced with multiple suppliers and the wires business being separated the existing Distribution Company would no longer have the universal service obligation. What happens to supply to agriculture and weaker sections? It is not remunerative to supply these categories at current tariffs. The system is sustained by cross subsidy. Cross subsidies have not come down notwithstanding provisions in the Electricity Act and Tariff Policy due to ground realities of political economy. It may be unrealistic to expect significant reduction in cross subsidy only with fresh legislation. A confident political leadership at the state level would need to take a call and support the process of reduction of cross subsidies. Till this happens why should a commercial enterprise seeking to maximise profits serve such consumers and give them reliable and quality supply? Risking existing supply arrangements would neither be desirable nor sustainable.

The Distribution Company has the obligation to assess demand and ensure reliable supply on this basis in the future to all consumers in its license area. It does so by entering into supply contracts with generators. Private investment in generation has been the big success story of the last decade. The renewable energy targets have not only been met fully but are being raised. All this capacity is being created by private investment. This is anchored by the Power Purchase Agreements with the Distribution Companies. This in turn enables financing of generation projects. Quite a few private thermal power projects were started without the anchor of the PPA. These have generally turned out to become stressed/ non -performing assets. Based on this recent market experience, fresh capacity addition in generation would be jeopardised by doing away with the Distribution Company.

India’s ambitious and successful program for expanding renewable energy capacity has made it the only major economy whose efforts have been rated by Climate Action Tracker as being ‘2 degree compatible’. This success based on private investment may not be sustainable with the introduction of retail competition as the anchor of longterm power purchase agreements with Distribution Companies ceases to be available and which has made financing possible.

The disruption and risks which the separation of the wires business from supply would cause are huge. The potential benefits in the best case scenario would be modest going by international experience. It would be best to focus on setting the finances of the Distribution Companies right.

- Ajay Shankar, Distinguished Fellow, TERI

- TCA Avni, Research Associate, TERI