Group Project

Salient features of selected MERC tariff orders and disposal of petitions of the MSPGCL (Genco)
Faculty Guide Prof. Sebastian Morris In partial fulfillment of the course Infrastructure Development and Financing Submitted by Section B, Group 3 Group members:
Anandh Sundar Tripuri Aniket Khasgiwale Badrinath Srinivasan Manish Kumar Miheer Desai Rahul Venkatraj

Table of Contents
Introduction .................................................................................................................................................. 3 Objectives and methodology used ............................................................................................................... 4 Overview of Applicable Policies/Laws/Regulations ...................................................................................... 5 About MSPGCL .............................................................................................................................................. 7 Summary of Tariff Orders ............................................................................................................................. 8 Non Routine Orders ...................................................................................................................................... 9 Individual Tariff Order Highlights ................................................................................................................ 10 AREAS OF DISPUTE ...................................................................................................................................... 13 Window dressing / Behavioral orders ........................................................................................................ 15 Performance Parameters ............................................................................................................................ 17 Unique Hydel Power Policy ......................................................................................................................... 18 General MERC Order Analysis- Quality and Consistency ............................................................................ 19 Is MERC playing the game well? ................................................................................................................. 21 Overall Observations................................................................................................................................... 22

Introduction
The objective of the assignment is to bring out the salient features of the tariff orders /disposal of petitions of the MSPGCL (Genco). Power sector tariff regulations are manifold. The Central laws/regulations viz. Electricity Act 2003, Electricity Policy, Tariff Policy; are applied for interstate projects, and are used as guiding principles for designing state policies. The Forum of Regulators ensures some uniformity at the state level in terms of tariff setting etc. This project analyzes the key issues as: (1) Variations over various tariff orders implicit change in principle or in key assumptions in the order of the MERC. (2) Variations between ARR and orders/directions resulting in petitions and the variations in the way the petitions were dealt with. (3) How far were the directions adhered to and what measures were used to improve adherence? (4) The quality of the response of the MERC to the ARR/ Petitions. The project aims at seeing only the MSPGCL tariff orders over a defined time period.

Objectives and methodology used

After the exploratory analysis about MERC tariff philosophy and approach to petition handling, this studys objectives was to diagnose whether: (1) The process could have been faster. (2) Are they true to the spirit of the provisions of the EA 2003? (3) What was the nature of the due diligence with regard to the ARRs /disposal of petitions and were they adequate given the law? (4) What are the regulatory risks imposed by the MERC? Could these have been avoided by upfront laying down the principles etc? (look at the general regulations, the format for submitting the ARR, the explanations etc) (5) Could the disputes and petitions have been avoided /reduced? (6) What improvements are therefore possible?

For this, the methodology used was 1. The tariff orders were downloaded from the MERC site. 2. A checklist of points to be analyzed was prepared. This included points like prudence check on costs, timelines, appeals, dispute resolution techniques, regulatory risks, crosscheck of regulatory accounts with statutory accounts etc. 3. The tariff orders were then evaluated using this checklist. 4. Brainstorm about improving the process, and learn from the central best practices/best practices of other states. 5. The checklist and draft report was then discussed with Prof Morris.

Overview of Applicable Policies/Laws/Regulations

Title Section 61 & 62 of the Electricity Act, 2003 Maharashtra Electricity Regulatory Commission (Terms & Conditions of Tariff) Regulations, 2005 National Tariff Policy/CERC Tariff Regulations Deals with General unbundling of the electricity principles Determining tariffs for the period 2006-2011(originally 2009 but was extended due to data issues etc) Principles and Guidelines for setting tariffs centrally Scope/Applies to Central projects/interstate lines but is a model for state laws Maharashtra power utilities. Principles follow the CERC norms/EA Act 2003 except for cross subsidy etc Central projects/interstate lines but is a model for state laws, and forum of regulations adopt this.

Section 7 of the Electricity Act 2003 permits any generating company to feely establish, operate and maintain a generating station without obtaining a license under that Act, if it otherwise complies with the technical standards relating to connectivity with the electricity grid. For hydel projects, certain additional approvals exist to ensure optimum riverine utilization and non conflict with other public purposes like irrigation, flood control, navigation etc. Section 61 of the Electricity Act 2003 lays down tariff setting principles, which are adhered to as follows. Principle the principles and methodologies specified by the Central Commission for determination of the tariff applicable to generating companies and transmission licensees Meaning/ Example as applied to generation units The cost accounting norms, efficiency principles and tariff philosophies of CERC should be adhered to at State level where possible. It will promote transparency, consistency and predictability in regulatory approaches across jurisdictions and minimize perceptions of regulatory risks the generation, transmission, distribution and supply of electricity are conducted on commercial principles the factors which would encourage competition, efficiency, economical use of the resources, good performance and optimum investments Open access, increasing normative standards yearly, permitting efficient standard costs (normative costs) only, setting quality of service linked bonus, and approving capex. This would mean arms length transactions between the unbundled arms of erstwhile integrated utilities

Principle safeguarding of consumers' interest and at the same time, recovery of the cost of electricity in a reasonable manner

Meaning/ Example as applied to generation units Allowing cross subsidy for limited purpose of universal service obligation, till the time the appropriate state directly pays subsidy. Also, uncontrollable costs should be recovered speedily to ensure that future consumers are not burdened with past costs. Address the risk sharing mechanism between Utilities and consumers based on controllable and uncontrollable factors.

the principles rewarding efficiency in performance

Enhanced ROE for better PLF, sharing of efficiency gains. Operating parameters in tariffs should be at normative levels only and not at lower of normative and actuals

multiyear tariff principles

Approve business plans for 5years at a go, with minor annual revisions reflecting changed costs/projections, but rarely changed capex. Control period length however, depends on data uncertainties and other practical considerations

that the tariff progressively reflects the cost of supply of electricity and also, reduces cross-subsidies in the manner specified by the Appropriate Commission the promotion of co-generation and generation of electricity from renewable sources of energy The National Electricity Policy and tariff policy

Reducing customer categories(since this leads to cross subsidy), among other things

Mandating higher generation feed in tariffs, and compulsory off take contracts with distribution licensee, for renewable energy National Tariff Policy should be used as the base, with appropriate state level modifications

About MSPGCL
The Maharashtra State Power Generation Company Limited (MSPGCL or MahaGENCO) is a Company is a company incorporated under the Companies Act, 1956 on 6th June, 2005, formed under the Government of Maharashtra General Resolution No. ELA-1003/P.K.8588/Bhag-2/Urja-5 Dated January 24, 2005. This resolution gave effect to the reorganization of Maharashtra State Electricity Board in terms of the Maharashtra Electricity Reforms Transfer Scheme 2004. As per this Order, the Maharashtra State Electricity Board (MSEB) has been restructured into four entities MSPGCL, MSETCL, MSEDCL and MSEB Holding Company. The State Government as a part of this transfer scheme had allocated the generating stations of MSEB to MSPGCL. MSPGCL also maintains & operates the hydro plants owned by the Irrigation Department, Government of Maharashtra as a lessee. The State Government had allocated the generating stations of MSEB to MSPGCL. MSPGCL supplies electricity in bulk to

MSEDCL, hence the role of the MERC to determine tariffs for MERC generating stations. It is said that the sins of the parent are borne by the children. In the case of MSPGCL, it was saddled with legacy old plants, under spending on O&M/capex in previous years and consequential inability to meet the normative standards. When MERC prodded MSPGCL to become more efficient by setting policy parameters close to normative levels, MSPGCL approached the Appellate Tribunal for Electricity to appeal against MERCs order, and was partly successful, including on substantive issues like fixing the levels(realistic versus normative). This had lead to some tension between MERC and MSPGCL as borne out by its critique of MSPGCL accounting, capex gold plating and faulty planning, but overall there is now a healthier relationship.

Summary of Tariff Orders

Case Number Case No. 48 of 2005 ARR Period FY 200506 FY 200607 Tariff Period FY 200607 First ever tariff order for unbundled entity. Hence focus more on accounting/segregation issues Efficient and reasonable estimates for technical parameters and costs to arrive at tariff. Peaking power pricing for hydel power adopted. Appeal to MERC disposed of in Case 34 of 2006. Case No. 68 of 2006 FY 200708 FY 200809 FY 200910 Case No 71 of 2007 second year of the first Control Period Case 16 of 2008 Truing up FY 200506, FY 2006-07 and FY 2007-08 ATE/CPR Case 115 of 2008 Last year of control period FY 200910 N/A MSPGCL to recover the approved amount of Rs. 762.77 Crore in 12 equal monthly installments from MSEDCL, in order to avoid any tariff shock to the consumers. Much lesser areas of disputes here, as ATE rulings/CPRI norms had resolved many issues N/A This order was to give effect to the ATE judgments and the CPRI norms. The only new principles introduced there were the identification of non tariff income to reduce ARR requirements. June 1,2008 till mar 31 2009 Mostly giving effect to the ATE order for setting tariffs N/A FY 200708extended till May 31,2008 first Control Period for MYT framework shall be the three financial years from April 1, 2007 to March 31, 2010 Mahagenco C won an appeal at the ATE, and MERC had to revise the tariff in Order 71 of 2007 Subject Matter/Highlights Principle(s)/Remarks

26/ 95 of 2008

First 2 years of new Paras Thermal station

FY 200809

Unit No. 3 of Paras Thermal Power Station

Appealed to ATE, and revised in 2011. MERC revised its orders vide Orders 74/75 of 2011.

102 of 2009

Truing up for FY 2008-09, Annual Performa nce Review for FY 2009-10

FY 201011

Much lesser areas of disputes here, as ATE rulings/CPRI norms had resolved many issues

N/A

Non Routine Orders

FIRST TIME PLANT TARIFF The Tariff orders for the Parli Unit were for new plants, which had the special characteristics of unstable control period, need for incremental capex principle and fresh start. Both the projects experienced cost overruns, which the MERC disallowed blaming them on the Mahagenco induced delays. This, naturally, is now under appeal to the ATE. HYDEL LEASE RENTAL ORDER Order from first principles-ROE based Pass through for MSPGCL so very little opposition from the utility per se. Only others opposed it/submitted pleas. Another interesting order is on hydel lease rent needs some background to appreciate. As per Maharashtra law, the dams and hydel power plants are constructed by (and belong to) the Irrigation Dept. Many of these projects are ECB funded by World Bank and others. The Govt. (not unreasonably) wanted to charge the unbundled Mahagenco a fair lease rent to recover the interest & ROE on its dams. Now, the tariff fixation powers for this are not on any electricity regulator as this subject is missing in the Electricity Act 2003. But if the Govt. had arbitrarily fixed a higher amount (100% pass through to customers), this may have been challenged. Hence, Govt. requested MERC to calculate the amount on its behalf, in its administrative capacity. So MERC considered various methods like DCF but finally decided on a ROE model. This order is an excellent example of practicalities in financial management of power sector.

Individual Tariff Orders Highlights

1. Case No. 48 of 2005 a. As envisaged in the tariff policies, two part station-wise generation tariffs. b. Unique hydel tariff policy envisaged, to ensure economic signals without burdening consumers unduly. This was done through differential energy tariff for peak and nonpeak hours, and is elaborated later on. Has been specified, where peak is 20% higher than non peak. c. One-time R&M expenses permitted during future truing up(over and above the approved amount) to compensate inadequate spending in the past d. While income tax expense in petition was sought at 33% on ROE(assuming that it would pay maximum marginal rate on its ROE), the allowed expense was capped at the MAT amount of 10%(prevailing then) e. Norms for new stations as per MERC Tariff Regulations have been applied for existing stations as well. This was the most controversial part of ruling, and successfully appealed by MSPGCL before the ATE. f. While O&M costs taken on normative basis, interest allowed only on actual, that too only on the approved borrowings. g. While rejecting MSPGCLs plea for lower normative PLFs, the MERC said that ageing of units and non-availability of time for Planned Outages cannot be considered as reasonable causes for high SHR or low PLF, and MSPGCL should explore all avenues for improvement in its plant operations, routine maintenance, and capital maintenance to enhance reliability and efficiency of their thermal generating units. Again, the ATE partly reversed this logic. h. The Commission has calculated the variable cost of fuel for FY 2006-07 based on the actual cost of fuel in the month of March 2006, agreeing to adjust changes via vetting of FAC claims. This is analogous to LIFO system of accounting! i. MSPGCL had been importing coal without a proper cost benefit analysis, and so MERC directed MSPGCL to install and maintain the required meters with in next three months for measurement of Coal GCV and then carry out the cost benefit analysis of the usage of imported coal at its generating stations j. Most of the generating units had no weightometers and hence an accurate measurement of coal is not being done. The Commission has therefore not accepted the MSPGCLs projections and approved transit loss as per MERC Tariff Regulations only

k. A systematic measurement of Gross calorific value of coal by taking periodic samples of coal being fired shall be institutionalized at all the stations l. MSPGCL has not provided any supporting information regarding the details of R&M expenses actually incurred during FY 2005-06 and resultant technical efficiency improvements, hence was told to get its R&M plans approved at the earliest. m. In absence of historical actuals for MSPGCL, Commission is not projecting non-tariff income. This was however determined in later orders. n. R&M expenses are to be determined at an average of actuals as a percentage of GFA for the preceding five (5) years. This is a standard practice by MERC 2. Case 68 of 2006 a. Much more systematic order, largely following the earlier orders b. Conscious of the fact that the unbundling of the erstwhile MSEB should result in overall increase in expenditure on O&M. c. Despite not meeting the desired PLF norms for FY 2006-07-which could have led to lesser recovery for future years- MERC approved the full recovery of fixed charges during FY 2007-08 for all thermal stations. However, in the event of actual availability for the year, computed in accordance with the Commissions Tariff Regulations (after accounting for the unavailability of fuel), being less than 80%, the fixed charges would be proportionately adjusted as per MERC Tariff Regulations, while truing up the revenue requirement in the next year. d. The funding of the schemes has been considered at debt: equity of 80:20 as proposed by MSPGCL in view of shortage of equity capital despite Tariff Regulations providing for normative debt: equity of 70:30. e. For approving the O&M expenses for the Control Period, the Commission has considered the O&M expenses approved in FY 2006-07 as the base expenses. As MSEB under spent due to earlier cash crunch, the method of extrapolation could not have been used to calculate O&M costs. 3. Case 71 of 2007 a. Commission rejects MSPGCLs request for providing incentive for Uran gas thermal station on the basis of reduced availability and PLF, due to shortage of gas. The Commission is of the view that though full fixed cost recovery has been permitted to Uran gas station, despite non achievement of normative availability of 80%, it would not be fair to the consumers to provide incentive at such low PLF levels

b. Though MSPGCL has been putting its efforts and expertise to optimize the performance of scarce hydro resources, MSPGCL is not earning any commensurate returns/incentives over and above the actual cost incurred for such operations. MSPGCL, in its Petition, therefore, proposed a recovery of supervision charges to the extent of 15% of the Operations and Maintenance expenses incurred during the year for such hydro power plants. This was shot down because lease rent payable to GoM already had RoE component, also no provision in the MERC Tariff Regulations under which such expenses may be allowed.

AREAS OF DISPUTE
Cost Item Advance Against Depreciation MSGPCL Stand in respect of some generating stations. intended to meet shortfall in meeting loan repayment obligations of the Generating Company. Hence to be calculated station wise. MERC Stand While tariff is determined on a stationwise basis, AAD is a special provision, which enables the Utility to meet its loan repayment obligations as a whole rather than for each Station(Order 115 of 2008) Disallowance in Project Cost Delay in commissioning of Unit No. 3 of Paras Thermal Power Station was not considered, and cost was disallowed. Operation & Maintenance cost that such an increase in R & M expenses may not fit into the ideology of setting normative O&M expenses since the hydel assets are old and may require more repairs and maintenance in future. Fuel Costs provisions in the National Tariff Policy (NTP), which states that in case the actual performance is much less than the norms, then ARR should Not till actual parameters determined. truing up of actual fuel expenses till such time the reassessed improvement trajectory of parameters is norms for new stations as per MERC Tariff Regulations have been considered for existing stations also Agreed with MERC Appeal No. 86 & 87 of 2007 .given that =expenditure for OLD HYDEL stations not covered under policy Remaining pending The delay was due to Mahagenco so additional cost due to delay is to be disallowed ATE partly agreed with MERC Present Status ATE decides to have this done station wise. Judgment dated 27.4.2011 in appeal no. 191 of 2009

be determined based on relaxed levels. Tariff for Small Hydel Stations entitlement of higher tariff for small hydro projects as the Commissions Order determination of hydel peak and off peak generation and tariff taking into consideration the operational capacity of MSPGCL and system pattern economic signal about pricing of hydel generation only in the case of new projects

available

Agreed with MERC Appeal No. 86 & 87 of 2007

Endorsed MERC approach BUT tailored it to Mahagencos needs Appeal No. 86 & 87 of 2007

Transit Loss/Auxiliary parameters

reset the operating parameters

Normative

align its Regulations by prescribing achievable norms and not merely ideal norms. engage an appropriate agency(ies) assess and suggest improvements

non-tariff income

should not be considered as part of the revenue

Include for determining the revenue gap/surplus

ATE partly agreed with MERC Appeal Nos. 86 & 87 of 2007

Capex approvals

Accept non DPR schemes after prudence check

Mahagenco to bundle non DPR into DPR else suffer 50% cut till the prudence check done

ATE agreed with Mahagenco. Order 199 of 2010 dated 4 Aug 2011.

Window dressing / Behavioral orders

Regulated utilities will try to game the system/cook the books, while the regulator would want to structure the incentives to avoid gaming of the system. Some Examples of MERC efforts in this line are

Order 68 of 2006

Example(s/Observation The increase in quantum of NonDPR schemes is a worrying trend, as the Commission observes a tendency to split capex schemes so that capital outlay of the scheme is below Rs. 10 Crore, to escape regulatory scrutiny.

Action The Commission will take a review of the schemes being classified under Non-DPR category, and in case it is found that these schemes should have ideally been classified under DPR category, then that capex and the related capital charges will be disallowed till the DPR is submitted and the scheme is approved by the Commission. In Case 115 of 2008, For Non-DPR schemes, the Commission has considered 50% of the proposed stabilization15 by MSPGCL on ad hoc basis, as the Commission is of the view that until it is ascertained that the projected benefits have actually accrued for the benefit of the consumers, it would not be appropriate to allow the entire expenses.

68 of 2006

Seeing lackadaisical approach in fixed asset accounting/submitting capex schemes, MERC had to caution Mahagenco

The Commission would like to reiterate that in-principle approval of the scheme does not absolve the senior management of MSPGCL of their responsibility to prioritize various schemes and undertake cost benefit analysis and financial analysis to validate the commercial prudence of each scheme. MSPGCL should ensure that the projected benefits actually accrue for the benefit of the stakeholders. It would be essential to monitor progress of each scheme as well as track

expenditure and benefits accrued as per the scheme. 68 of 2006 practice of treating Renovation and Modernization as revenue expenditure is not limited to any one department or any one generating station of MSPGCL, but is spread across all departments and all stations 115 of 2008 Gold plating of capex The steep increase in the asset base every year has been suggested by the consumers to be an attempt by the Utilities to increase the returns from the regulated business. The addition to the asset base is clearly not commensurate either with the increase in sales or increase in demand in MW served. Utilities were able to serve the existing consumer base well enough with the existing assets 115 of 2008 Any fallout of poor governance and consequential financial implication/burden should not be passed on to consumers. In this context, the Commission observes that interest paid by MSPGCL on account of delayed payment of income tax, is not an expense properly incurred. The Utility is supposed to pay income tax on time as good governance. For example, any penalty paid by the Utility will not be passed on to the consumers. Accordingly, the Commission has considered the actual income tax, but has disallowed the interest paid by MSPGCL on account of delayed payment of income tax The favourite argument of the Utilities that in the past, there was a backlog on this account and that they want to rake it up is also unconvincing to justify the 100% increase in the asset base in such a short period. As a general rule, the Commission has decided that the total capital expenditure and stabilization16 on non-DPR schemes in any year should not exceed 20% of that for DPR schemes during that year The Commission has not considered the truing up of R&M expenses for FY 2006-07 at this stage. In order to have a clear picture regarding Repairs and maintenance expenditure, MSPGCL should maintain a clear demarcation of capital expenditure and revenue expenditure heads

26 of 2008 and 95/2008

duty of the owner of the plant to ensure thorough inspection and testing that the equipment being procured are of good quality, these are stored at site as required and imparting training to its operating personnel well in advance, and any losses incurred through not performing these elementary duties properly cannot be passed on to the consumers

stabilization period of coal based and lignite fired stations shall be reckoned as 180 days from the date of commissioning. As against this, MSPGCL has requested for consideration of a higher period of stabilization of 427 days. Applied for Parli Unit No. 6/Unit No 3

Performance Parameters
In order 69 of 2006- The Commission has decided that the MYT framework for MSPGCL would incorporate the trajectory of following performance parameters:

The various performance parameters are decided after taking into consideration the performance of units with similar vintage in India.

However, Mahagenco went on appeal to the ATE, which ordered MERC to appoint an expert to suggest realistic performance norms. The ATE expert (CPRI) suggested the norms, which were first amended during the truing up of the tariffs till FY 2007-08.

Unique Hydel Power Policy

MERC is quite proud (rightly so) of its hydel power pricing policy. The main features of this are a. Hydel power has low O&M costs. The effective energy charge in the case of MSPGCLs hydro generating stations work out to be very minimal as the Annual Fixed Charge is far lesser than the other-wise applicable energy charges (variable cost of the least-cost, available alternative source of power). Therefore, economic value of power is not priced in. b. As the pricing of hydro generation fails to send any economic signal and, guided by Section 61 of the Electricity Act, 2003, which calls for economic use of resources, the Commission has decided to adopt a one part (energy based) differential peaking tariff (for peak and non peak hours) for hydel generation). The tariff for non-peak hours is based on the highest variable cost of the thermal generating stations, as Ideally, the peaking tariff should be the least cost available alternative source of power if such hydel generation is not available in those hours. c. The rationale for having differential peak and non-peak tariff is that hydro power should be used only during peak hours, and during non-peak hours it has to be used only in case of exigencies like grid stability requirements, etc. d. 5% of excess recovery of peak generation to be shared between Genco & Distribution company, rest to passed on to users as rebate. But if peak generation < target (except for uncontrollable factors), then the revenue loss would not be trued up, but borne by Genco & Distribution company in ratio of 50:50. Hence, economic price signals are sent but users do not suffer. e. The rationale for having differential peak and non-peak tariff is that hydro power should be used only during peak hours, and during non-peak hours it has to be used only in case of exigencies like grid stability requirements, etc.

General MERC Order Analysis- Quality and Consistency

We notice that MERC does issue speaking orders discussing the utility stand, opposite views and its own analysis. While the reasons/rationale for the order is quite clear, at times it is perverse to the regulated entity due to interpretation adopted. For example, AAD station wise, coal costs, O&M expenses were all calculated adversely to Mahagenco, without considering the plain text of regulations as applied to Mahagenco. That led to an appeal. There are very few errors of fact or law in the order. In the ATE orders we examined, there were no strictures passed against MERC/loss on this ground. Instead, the main disagreements happened in policy issues-essentially whether the norms of MERC were too strict. When ATE sided with Mahagenco (largely), this induced cascading effect on ROE, working capital, interest etc. Some ATE order extracts are below, with our comments in italics. 1. The MERC Regulations did not specify any norms relating to admissibility of A&G expenses and had approved the expenses based on the principle of reasonable year-on-year increase. The ATE critiqued the MERC order stating that it did not explain the reasonableness of selecting escalation rate of which is not even sufficient to mitigate the inflation rate. Essentially, it was not a speaking order. Also, the escalation factor had not been determined in advance by the regulations but was arbitrary 2. Again for A&G norms, there being no laid down norms, any expenditure incurred on generation and purchase of energy was to be permitted for pass-through in tariff as per Sixth Schedule of Electricity Supply Act, 1948. This finding by ATE indicates that where there are no norms, any determination of norms post facto is likely to be struck down as arbitrary OR determined in favour of the utility 3. For A&G expenses, Mahagenco came up with an interesting ratio of gross A&G expenses per MW generated. Its argument was that the gross A&G expenses averaged over the capacity in MW gives A&G expenses per MW to be 0.347 which is still less than what is allowed in the case of TPC and REL. Given the technical complexity, geographic dispersion, employee strength etc for Mahagenco compared to other utilities, ATE found a strong basis in that argument, and directed MERC to recomputed expenses. 4. The SHR(Station Heat Ratio) targets set by MERC was not being achieved, therefore leading to lower tariffs due to under absorption of fixed costs/no efficiency gains. Observing that this practice did not benefit either the utility or the consumer (since wrong price signals), MERC mandates a scientifically determined ratio.

5. The MERC regulations did not stipulate anything about recovery of incentive. While MERC had directed quarterly basis in the order, the utility wanted it monthly, and put forth the logical argument of synchrony with billing cycle. Hence, that argument was upheld by ATE. 6. MERC disallowed the normative fuel cost as per the recommendations of CPRI for the years 2005-06 to 2007-08 and restricted the fuel cost to the actuals, from the year 2008-09 onwards the norms as recommended by the CPRI have been followed. For 2008-09 to 2010-11 also the actual fuel cost should have been allowed or else the norms as recommended by the CPRI should have been used. Any other approach seems cherry picking of approaches in our view 7. Coal costs is a major cost component but MERC had not provided detailed cost sheet workings to Mahagenco, due to which inconsistent figures were there and appeals were preferred. Hence ATE ordered MERC to provide detailed workings of coal cost to Mahagenco. This is another example of needing transparency and two way information sharing between regulator and regulated enterprise. After studying the ATE orders in respect of Mahagenco/MERC, we infer that the main reasons for appeal were transparency (coal costs, reasons for exclusions, post facto regulations) and extraneous policy issues by MERC (disallowing AAD station wise, SHR factors).

Barring the issue of coal costs, MERC has largely issued speaking orders, which have either been upheld/overruled by ATE without the need/request to adduce additional evidence. This speaks volumes for the quality of the regulatory orders. Maybe this is because MERC inducts retired utility officers to act as its Regulatory Experts. These people having decades of experience on the other side, can help the commission detect issues in implementation/genuine problems, and thereof build processes to ensure fair and speaking orders.

There appears scope for improvement procedurally.

Is MERC playing the game well?

Earlier, we modeled the tariff fixation process as a game where barring the regulator, every other player looks to its own parochial interests. This is not a stinging indictment of the process, but a mere recognition that in any political scenario (this IS one given the somewhat vague performance accounting norms & policy issues at stake), there are bound to be winners and losers. We note that Mahagenco being a state owned utility is constrained from subverting regulatory officials with corrupt practices. Therefore, one would expect a more stringent approach with Mahagenco than other utilities, which was partly borne out in the lower (per MW generated) O&M expenses allowed by MERC, which was afterwards felt as unfair by the ATE. One needs to know the game well to play it. MERC was fully acquainted with the situation of Mahagenco, having advised the Maharashtra Govt. on unbundling. Yet, it did not factor in those relaxed standards, leading to sustained under recovery of costs which was not trued up later. On the halter of efficiency, Mahagencos path dependency (reliance on poorly maintained systems, utility of last resort, state owned incumbent) was ignored. This is possible in a price cap situation but not for a normative cost plus situation where path dependency counts.

MERC also, in our opinion, gets too hyper technical at times, forgetting the wider policy issues at play. For example, stricter unachievable norms imposed without a technical study violates principles of natural justice. Still, all is not lost. It has hopefully learnt from its earlier mistakes.

Overall Observations
1. Path Dependency:- Following the hallowed legal doctrine of res juditica, the MERC prefers to follow the reasoning laid down in its earlier orders. While this ensures regulatory consistency, it also results in a tariff shock if the earlier orders are revised with retrospective effect because of an ATE verdict favouring the utility. 2. Maharashtra Govt. /erstwhile MSEB cash crunch:- This lead to deferring O&M/Capex expenses and thus giving the impression of MSEB being the lowest cost power producer, while this was because of deferring of vital expenses. The MERC recognized this, and allowed one-time additional O&M (to make up for earlier year deficits) and relaxed norms. Mahagenco was entitled to 70:30 debt equity ratio for incremental capex, but has applied for 80:20 or even 100% debtstating that GoM (Government of Maharashtra) would not infuse additional equity funds for new projects. This is astounding to say the least. 3. Game Theory:-While reading the petitions/submissions/MERC reasoning, we got the feeling that this situation is amenable to a game theory analysis, because this is a recurring situation where all participants play well defined roles. a. The regulated utility wants to overstate its estimated costs, so that it can get more efficiency gains when it achieves lower actual. Also, even if tariff is adjusted downwards, it still gets interest free use of the surplus till the adjustment order which takes atleast a year. This incentive applies for overstating capex by capitalizing O&M expenses, and also gold plating to ensure higher rate of return. b. End Customers seek the lowest estimated costs so that they can pay lower tariffs. While this will not help as the deficits are recoverable with interest in future truing up periods, they can still manage their cash flows better. That is why both individual consumer associations and industrial consumers like Tata Motors vehemently challenge each cost items rationale, amount and spending efficiency. c. Distribution companies see the generation cost as a 100% pass through to their customers, and so have rarely contested/attended the tariff hearings/technical validation sessions. This is although they are the direct generation customers, and in a sense most affected by the generation companys actions. d. Other generation companies oppose capex/plant location decisions at times for competitive reasons, because though generation capacity addition is de-licensed, the MERC still has the tariff setting authority and therefore carries out prudence checks.

e. The State Government desires to cross subsidize its vote bank (farmers/individuals) at the cost of industrial users. Therefore, the direction to the MERC includes the aspect of perpetuating cross subsidy. f. The regulator(MERC) itself must play a fine balancing act between ensuring the economic health of the generation company, and ensuring that the company has every incentive to maximize its efficiency and operate at minimal costs. While mechanisms like efficiency sharing gains (hydel, PLF>80% etc) do it, the main approach adopted is to estimate normative costs. 4. Cost Accounting matters:- Instead of merely extrapolating incurred costs and calculating ROE, the MERC checks the prudence of those costs (aka performance audit), and then checks whether cost changes were controllable or uncontrollable. Controllable cost changes are mainly (2/3rd) kept with the utility but uncontrollable cost changes are passed on to customers. 5. Regulations fill data void:-The MERC regulations contain certain default technical parameters depending on equipment used in plant. If the utility does not maintain reliable records, then these parameters are used. This was done for O&M costs, auxiliary factors etc for the period where Mahagenco did not maintain adequate records. This is akin to composition scheme/best judgement assessment under the IT Act 1961!. 6. Developmental role-MERC had passed strictures on Mahagenco(detailed below) asking it to segregate plant wise accounts, improve coal handling/purchase systems, streamline O&M management, instill proper capex planning scheme etc. These internal functions of Mahagenco had to be pushed for by the regulator. 7. Petition Scrutiny does benefit MSPGCL at times-MSPGCL had at times sought lower interest rate than the prevailing market rates, and MERC suo moto granted the higher rates. Similarly for D/E ratio, MSPGCL even petitioned for 100% D/E ratio due to cash crunch from Govt. equity, but MERC allowed at 80%, thus ensuring in higher tariffs. D/E ratio, interest rate where MERC had adversely 8. Gentle balancing act:- While the over arching objective of MERC seems to protect the interest of consumers in the State of Maharashtra(its reasons for prohibiting Load Management charge, high hydel lease fees, restricting interstate sales etc), it also keeps the interest of the generator in mind while deciding ROE, efficiency sharing gains etc. 9. Use of incentives:- MSPGCL can keep 2/3rd of its efficiency gains/losses, while passing on 1/3rd to the distribution entity. Interesting, fuel costs being seen as a mix of controllable (consumption) and non controllable (procurement price), its pass through is allowed via Fuel Adjustment

Charge mechanism, which encourages prudent short term power purchase practices. Other uncontrollable costs are passed through in full. 10. Hydel Power incentive structure:- Unlike thermal plants where the utility owns the plant, hydel projects are built by the State irrigation department, and then handed over to Mahagenco, in return for lease rent which encompasses ROE to GoM. Mahagenco is allowed by MERC merely to recover actual O&M expenses, on no profit no loss basis. Since it does not own the plant, there is no ROE/return given. Mahagencos request for an operating fee was shot down as no place in MERC regulations for this. The request does seem fair though, considering that virtually no efficiency gains/incentives exist for Mahagenco under the present tariff regulations. 11. Truing Up:- Actual expenses and the actual revenue will be trued up at the end of the year based on audited financial results and subject to a prudence check. Provisional truing up of certain elements of ARR is considered in cases where the impact is very high, or there is a change in the principles/methodology, or due to revision in capital expenditure/capitalization figures