Is consumer's willingness to pay a key factor?

Understanding electricity demand, its pricing and willingness to pay (WTP) by consumers for electricity services has always been tricky and a matter of debate, both in India as well as globally. Most electricity distribution companies (discoms) in India today continue to be in the 'red' due to poor governance and/or because tariffs are not cost- reflective, resulting in a gap of nearly Rs 0.60 per unit between the average cost of supply and revenue realized (after adjusting subsidy provided by the state government). However, it is also true that when adjusted for capacity to pay, Indians reportedly pay one of the highest prices for electricity in the world. The authors explore this contradictory phenomenon.

One of the leading organisations working on energy, TERI has recently concluded a research study on consumers' willingness to pay for electricity in India. The study, which is a meta-analysis and an aggregation of distributed research on WTP and electricity pricing, was done against the backdrop of the Central Government' flagship 'UDAY’ programme and the structural changes that may be required to build viability in the electricity distribution sector.

There have been some interesting findings from the study, three of which are of particular interest and are being shared here.

Our study found that for rural household consumers, the defining factor for a high (or low) rate of WTP was the share of disposable income assigned to electricity as a valued service in the overall household income.

While most consumers expressed a significantly higher WTP for basic lighting services compared to their current expenditures on kerosene or other coping fuels, their willingness was found to drop for higher levels of service (beyond basic lighting) as affordability became an issue, as well as due to expectation of receiving electricity services at a nominal price from government run discoms.

The study reinforces that the expectation of the State being a low price/nearly free provider needs to be changed by making electricity pricing more independent beyond political economy considerations, and by helping consumers understand the real cost of electricity supply.

Interestingly, our discussions with some electricity sector regulators revealed that consumer's willingness to pay is not considered whilst setting tariffs; instead pricing is done on a cost-to-serve basis using data provided by discoms or via studies commissioned by regulators.

Even though consumers are invited to limited number of public hearings, which are held by regulators whilst setting tariffs, a deeper understanding of the demand and pricing from a consumer's perspective is not given adequate priority.

A second interesting point that emerged was that increases in tariff may not necessarily be the only way to improve the viability of discoms. While there is no denying the fact that tariffs should be cost-reflective, there are also other ways that may be more effective 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 three times more per unit revenue than it currently earns from the same un-metered connections.

This is primarily due to the fact that an average flat rate tariff of Rs 180 a month recovers only approximately Rs 1.20 per kWh (normalised for 5 hours of supply for a max load of 150 units) at the lowest slab.

However, when metered, the same connections would recover around Rs 3.60 per kWh on average, due to the exact measurement of units consumed for the same slab.

The third interesting observation was that at the all India level, while agricultural consumers account for 23% of the total kWh sales, their contribution to revenue is just 9%.

On the other hand, industrial consumers consume 30% of total electricity units and generate 42% of the total revenue.

Although the above figures may rightly indicate that we need to prioritize agricultural subsidy reforms and minimize subsidy levels for agricultural consumers, however, a pan-India blanket approach may not yield the desired results.

The reforms need to be more state-specific with some states like Punjab, Haryana, Maharashtra, Karnataka etc., being required to prioritize agricultural subsidy reforms, especially tariff rationalization, whereas states like Bihar, Tamil Nadu and Uttar Pradesh needing to initiate reforms primarily in the domestic sector (metering at the household, transformers and feeders, improvement in reliability and availability of supply, etc.) to improve their discom's viability.

Rationalization of tariffs and improved efficiency 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.

Equally important is to take a fresh look at how business is currently done in each segment of the power sector.

Further, the tariff structure for different types and classes of consumers also needs to be simplified and consolidated to improve revenue generation and transparency, and reduce transaction costs to make the electricity distribution sector viable and vibrant.

One would be amazed to know that there are as many as 44 to 61 tariff slabs in states and despite that targeted subsidy delivery is not facilitated!

Lastly, instead of just 'financial window dressing', the UDAY programme should also include extensive and intensive capacity building measures on change management in the discoms, moving them from purely administration to a mode of 'enterprisation' in decision making and management.

While one of the intended objectives of UDAY is to improve the operational efficiency of discoms in a time bound manner, and for this it has identified specific areas for improvement, the scheme does not explicitly include modules on 'change management' or capacity building measures to improve governance.

The electricity distribution franchisee system that was introduced by the previous regime to ensure revenue sustainability and improvement in efficiency at the last mile distribution segment, failed to meet its objective inspite of initial success in many states, because employees of several state discoms were sceptical and felt that it was a backdoor route towards privatisation.

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

The article was published in May issue of Policy Pulse Magazine (Print version).