The government in Pakistan is all set for another misadventure in the power sector. Not only has it raised the basic tariff substantially for consumers across the board, but it has also extended its fixed charge levy to residential and small commercial (R&SC) consumers. Until now, the fixed charge levy has been restricted to consumers in other categories who have maximum demand indicator (MDI) metering facilities at their connection points with the power grid.
The details of rate increases for various consumer categories are widely reported in print and electronic media and will not be repeated here. Below, we focus on the government’s decision to raise demand charges in the existing consumer categories and extend this charge to R&SC consumers.
This move is ill-conceived for several reasons. Apparently, it’s an effort to stabilise revenue streams by decoupling revenues from electricity consumption, which has been stagnant lately and is declining in some consumer categories. It may provide additional revenues to a cash-starved power sector, but it defies the basic principles of public utility rate design and won’t be fair, efficient, practicable, and equitable.
James Bonbright, in his 1961 landmark treatise, “Principles of Public Utility Rates”, recommends that these rates must:
- be forward-looking and reflecting long-run costs;
- focus on the most cost-sensitive demand;
- simple and informative;
- charge in proportion to usage;
- give consumers a clear signal to adjust their usage; and,
- sensitive to the utility’s temporal and spatial costs in serving consumers.
Electricity tariffs in Pakistan are governed by the NEPRA Act of 1997, NEPRA (Tariff Standards and Procedure) Rules 1998 (“Tariff Rules” for short) and NEPRA Guidelines for Determination of Consumer End Tariff (Methodology and Process), 2015 (“Tariff Guidelines” for short). The process follows a traditional concept called “cost-of-service regulation”, which allows a public utility to recover its prudent capital and operating costs from consumers with a fair return on its investment.
NEPRA requires DISCOs to seek approval for their annual revenue requirement in the format prescribed in Tariff Guidelines, which consists of three components: power purchase costs (capacity and energy from the system upstream); distribution margin (return of and on its rate base and other operating expenses by a DISCO); and prior year adjustment (FYA) to true-up any revenue shortfall/surplus due to actual consumption varying from the forecast.
It was unusual, however, that NEPRA inserted an issue in the above set on its own to extend the fixed charge to R&SC consumers as well
After scrutiny, NEPRA makes a determination on these petitions through a stakeholder consultative process and sends them to the government for approval. The government can either approve and notify it or revert to NEPRA to reconsider some items before notifying it for implementation.
As usual, DISCOs submitted petitions to NEPRA to approve their revenue requirements for the Fiscal Year 2024-25. NEPRA, following due process, framed the set of issues to be discussed in a public hearing and published for public review and intervention. It was unusual, however, that NEPRA inserted an issue in the above set on its own to extend the fixed charge to R&SC consumers as well. It was confirmed later in a public hearing that it was done to modify the existing rate structure (Page 7 of NEPRA’s decision on Federal Government’s Motion). The wisdom of deciding a major change in tariff structure in haste-which would have serious and widespread implications-as a sideline issue can be argued, but let’s not digress from our main issue.
NEPRA approved the petitions after holding a public hearing and sent the revenue requirement for each DISCO along with the Schedules of Tariff to Power Division (PD). The PD sent them back to NEPRA with a request to revise a few items, mainly restricting the fixed charge to Rs1,250/kW-month for existing consumer categories and using 25% of the sanctioned loads of R&SC consumers as the basis for determining fixed charge till MDI meters are provided for these consumers.
Public utilities generally use a two- or three-part tariff structure to recover their approved revenues. In the first part, they recover mostly fixed customer-related costs like metering and billing. In the second part, they recover their capacity and energy costs based on consumers’ volumetric consumption (kWh). Recovering capacity costs in a separate third-party (Rs/kw-month) though isn’t unprecedented, but is not common.
Multiple studies, however, have corroborated that using consumers’ consumption as the basis for recovering both the capacity and energy costs is far superior to using a three-part tariff because both costs are positively correlated, easier for utilities to measure, and simpler for consumers to understand and respond (Synapse Energy, 2016).
The decision to enfold R&SC consumers in the MDI-based tariff list does not make sense and won’t be practicable. In fact, it’s a regressive step and conflicts with NEPRA’s own preference to structure rates as much as feasible on the principles of “marginal cost pricing” (subclause 3(v) of clause 17 of the Tariff Rules).
Most R&SC consumers may not even comprehend the new charge, let alone respond to it. Their demands, when viewed from the system upstream, may not be coincident within their categories or with that of the system. Their recorded maximum demand will allow DISCOs to extract additional money from consumers, but it won’t reduce capacity costs
A utility’s capacity costs are largely driven by the peak demand on its system. A consumer whose maximum demand coincides with that of the utility is more costly to serve than a consumer whose maximum demand doesn’t coincide with it.
Using MDI metering to charge consumers for their maximum demand is a legacy of the past when only electromechanical meters existed, and utilities mainly used them to encourage large consumers to spread out their demand to reduce their peak demand but not to recover capacity costs. The advent of smart meters, especially if deployed as part of the advanced metering infrastructure (AMI), has made it possible for utilities to track consumer demand on their systems precisely and employ measures to level it.
Large consumers have loads they can spread over time to reduce their maximum demand, reduce bills, and help reduce peak demand on the grid. Most R&SC consumers may not even comprehend the new charge, let alone respond to it. Their demands, when viewed from the system upstream, may not be coincident within their categories or with that of the system. Their recorded maximum demand will allow DISCOs to extract additional money from consumers, but it won’t reduce capacity costs. Ironically, the reduction in their volumetric charge, which is promised by the government, may encourage them to consume more during the system peak, thus frustrating the efforts to level the system’s peak demand and promote energy conservation.
The proposal to replace the existing meters of R&SC consumers with MDI-capable meters will not be feasible. It will involve huge costs. Currently, most meters for R&SC consumers hang on the nearest poles/structures. Installing MDI-capable meters on them will be difficult and inconvenient to read and reset. They will also suffer from the same issues that have frustrated efforts to curb theft, allegedly facilitated by the connivance between DISCO staff and consumers.
Using 25% of the sanctioned loads as billing demand for charging R&SC consumers under the new head will also be unfair. Their load factor (ratio of average to maximum demand) is generally 15 to 30%. Though the 25% limit falls in between, it will still be punitive because of the high diversity among the maximum demands of consumers in these categories and their maximum demands’ non-coincident with the system’s peak.
The government should rethink its decision to impose maximum demands on R&SC consumers, which have no significant link to the grid’s capacity costs. Instead of wasting money on MDI-capable meters, it should focus on modernising the power grid with AMI at its core. It will enable DISCOs to closely monitor the patterns of consumer demand and will help them and NEPRA in devising rate structures and regimes that are progressive and reflect the true cost of service to every consumer fairly and equitably.