Tariffs

The tariff setting process is intended to achieve a number of objectives:

• Equitable distribution of water: each person has the right to a minimum level of affordable drinking water (approx. 1 cubic metre per month)
• Improvement of public health: Availability of water and sanitation reduces the likelihood of water borne diseases
• Conservation of treated water: through progressive tariffs and metering of consumption (reduction of unaccounted for water and physical losses)
• Recovery of cost: as a first step: the recovery of operation and maintenance cost and as a second step: full cost recovery including cost of investment;
• Protection of the environment: Reduction of pollution through treatment of sewage

Example: India

Approach to tariff determination (based on the case of the Himachal Pradesh Electricity Regulatory Commission, India)

The Commission while determining the tariff, in the past has kept numerous factors and principles in view, which has already been outlined in the Tariff Regulations. Some of the important measures it has undertaken in the past tariff orders are mentioned below:

• introduction of kWh and time of use tariffs for various categories of consumers
• slab rationalisation across categories of consumers
• cost-to-serve approach in determination of tariff for various consumer categories
• rationalise the Peak Load Exemption Charge (PLEC) and the Peak Load Violation Charge (PLVC)
• introduction of a night time concessional tariff for industrial consumers

The Commission believes that there is further scope for tariff rationalisation across various consumer categories, which will make the industry more competitive, drive growth in the state and attract investments into the sector. The NEP states that consumers below poverty line, who consume below a specified level, say 30 units per month, may receive special support in terms of tariff, which is cross-subsidized. In Himachal Pradesh, such support is currently available to consumers below poverty line consuming 45 units per month. Commission may rationalise the existing slabs for domestic consumers further. The Commission may align the qualification criteria for support in terms of tariff in line with what has been suggested by the National Electricity Policy. The Policy also states that tariffs for such designated group of consumers will be at least 50 % of the average (overall) cost to serve. The Commission will also consider this guideline when determining the tariff for such consumers. It also believes that the future tariff determination exercise will be based on Cost to Serve and under a Multi Year Tariff framework.

Cost to Serve (CoS)

The Classical CoS approach is based on estimating the voltage-wise cost, losses and coincident demand factor, i.e. the extent to which each consumer category contributes to the peak demand. Broadly, there are two approaches to determining the cost of supply: The Embedded Cost Approach and the Marginal Cost Pricing Approach.

• The Embedded Cost Approach seeks to identify and assign the historical, or accounting costs that make up a utility’s revenue requirement.
• Marginal cost approach seeks to determine the incremental (marginal) change in total costs imposed on the system by a change in output (whether measured by kWh, customer, customer group or other relevant cost driver).

While being a forward-looking approach, marginal cost studies are data intensive and are, therefore, contingent upon the accuracy of data. Embedded Cost Model can be easily implemented and understood and data is readily available and verifiable.

   Methodology adopted by the Commission

The Commission adopted the CoS approach for the first time in the tariff order of 2004-05 based broadly on the embedded cost approach. In absence of data on daily load curves of various consumer categories the Commission had slightly deviated from this approach. However, the Commission had then observed that the current analysis would not be affected much, because of absence of essential information required to implement the classical model, since in case of Himachal Pradesh, the state is in surplus during the summer, when most of the country faces peak demand and cost of power purchase is high. Conversely, in Himachal Pradesh the peak occurs in winters when the country does not face any deficit, power purchase price is lower than average and therefore coincident demand would not have any perceptible impact on CoS. The Commission designed and developed a Cost to Serve model on the ‘basic assumption’ that power in Himachal Pradesh electricity network flows through each voltage level to reach Low-Tension (LT) consumer. The Commission also made certain assumptions to arrive at the losses at various voltage levels and network cost at various voltage levels. The CoS for various voltage levels was determined and thereafter COS to various consumer categories falling in those voltage categories was assigned.

Though the Commission had given directions to the HPSEB in 2004-05 to submit relevant data to enable computation of the voltage level cost of supply in a more scientific and robust manner, the HPSEB had not submitted any additional data at the time of filing the tariff petition for 2005-06 and had proposed tariffs in relation to the average cost of supply. Accordingly, the Commission again had to apply its own basis and assumptions to determine the voltage level cost of supply. Considering that there is no additional data to either prove or disprove the assumptions considered by the Commission in the previous tariff order, the Commission has by and large retained the same assumptions, apart from some changes to the loss levels in line with the target loss levels for FY2005-06 in the tariff order issued for 2005-06.

The Commission proposes to continue with the same methodology while designing tariffs for the ensuing year 2006-07 since the Board has again neither filed the present petition on the COS basis and nor has it submitted any additional data to either prove or disprove the assumptions considered by the Commission in the previous tariff orders.

The existing tariff structure in the State indicates that the tariffs are below the cost to serve (determined as per methodology explained above) for some consumer categories and higher than the cost to serve for other categories. The Commission recognises this distortion and has been taking suitable steps from its first Tariff Order to remove this cross subsidisation in a phased manner keeping the interests of both the licensee and the consumers into consideration. In the Tariff Order for FY 2005-06, the Commission moved a step further towards the reduction of cross-subsidy and attempted to align the tariffs with the cost to serve. The Commission finds no reason to deviate from this path in the forthcoming tariff order.

The Commission recognises that the cost to serve for various consumer categories would require extensive, reliable and credible data and information which is a separate detailed exercise on its own. Therefore the Commission would like the utility to take adequate steps in this regard and make the tariff filing for FY 07-08 on the basis of Cost to Serve instead of Average cost to serve.

Multi Year Tariffs (MYT)

A Multi Year Tariff (MYT) framework is defined as a framework for regulating the licensees over a period of time wherein the principles of regulating the returns/profits of licensees and the trajectory of individual cost and revenue elements of the Utility are determined in advance. It provides clarity on the rules to be applied over a pre-defined future time period in advance. It seeks to eliminate the control aspects of regulation and replace them with a system of incentives and penalties. In this way, all stakeholders are made aware of the outcome of various actions/events for the pre-defined future time period, and are able to plan accordingly.

   Multi Year Tariffs in Himachal Pradesh

In the Tariff Order for FY 2004-05, the Commission directed the Board to submit a proposal for introducing a Multi Year Tariff framework that would allow it to better serve the public interest through economic efficiency, quality and price signals. The Commission believes such a framework is important since there is a need to bring predictability in consumer tariffs and operating efficiency of utility.

The Commission understands that the introduction of Multi Year Tariff would be faced with the following issues:

1. Information Sufficiency - The implementation of an MYT framework usually requires reliable data. In the absence of adequate and reliable data, targets for efficiency improvement would not be accurate and forecasting would be an issue.

2. Capacity Building - The institutional capability - skills, information and resources available with the utility to develop and monitor the application of an MYT regime - of the licensee is another important issue.

In view of the above considerations and necessary prerequisites, the Commission lays out a detailed road map for introduction of the MYT Principles in the state of Himachal Pradesh:

• Commission comes out with a Consultative Paper on Multi Year Principles
• Conduct of stakeholder consultations
• Studies which are necessitated to be conducted by the Licensee for effective setting up of the baseline parameters and development of efficiency trajectories
• Capacity Building in the regulatory Commission
• Design and development of system to be implemented at the Commission
• Utility files for Draft Business Plan based on Approved principles
• Commission comes out with a Tariff Order for transitive period

Example: Zambia

In Zambia, the Water Supply and Sanitation Act No. 28 of 1997 explicitly confers the right to the The National Water Supply and Sanitation Council (NWASCO) to develop guidelines for the setting of tariffs for the provision of water and sanitation services.

In the following sections a tariff structure will be presented that is in line with the National Water Policy of Zambia.

The proposed tariff structure and the metering of water consumption are directly interlinked because the tariffs should progressively increase, the higher the metered consumption of water is. This progressive tariff structure that can only be applied if the customers are metered, is able to meet several of the above mentioned objectives (social aspects, resource conservation, equitable distribu­tion). Therefore NWASCO will seek to encourage the water providers to embark on metering programs as soon and as comprehensive as possible.

Before the tariff structure is introduced in more detail in the following sections consideration is given to the number and type of different consumer groups. Then the block tariff system and the different types of additional fees are discussed.

Consumer Groups

The first consideration with respect to a tariff structure has to be given to the number and type of different consumer groups. The group with the highest number of connections is normally the group of domestic consumers which on its own is usually divided at least into two groups:

• customers with individual house connections and
• customers at public taps/kiosks.

Frequently, more different domestic customer groups do exist. This is mainly due to the absence of metering and the necessity to cluster the customers into groups according to their likely amount of consumption or to their likely level of purchasing power. This is often referred to as areas with low, middle and high income customers. As soon as metering is introduced it is no longer justified to continue with the clustering of domestic customers which is sometimes, especially in mixed areas, rather difficult to do. If customers feel that the clustering is unfair (unjustified, respectively), they are tempted to stop paying their bills.

Other customer groups that can be observed in Zambian towns are:

• Industrial customers
• Commercial customers
• Social customers (churches, hospitals etc.)
• Government customers
• Institutional customers, etc.

After metering is introduced it is advisable to reduce the number of different consumer groups. The above mentioned customer groups can all fall into one single group with a pricing according to consumption. This makes the tariff system simple and less irregularities are likely to prevail.

There is a certain temptation to introduce exceptions for social customers. It is, however, not advisable to look for another pricing system for them because it can in practice become rather cumbersome to decide whether an institution is really social or not. Social considera­tions should be better taken care of by ensuring a subsidized lifeline consumption, which is explained in the following section.

Block Tariffs for Domestic Customers

In order to include cross subsidizing and to achieve water conservation purposes NWASCO proposes a block tariff system with at least three blocks for domestic consumers, such as shown in the following example:

• 1. block of 0 to 6 m3 = 700 Kwacha/m3
• 2. block 6 to 15 m3 = 1000 Kwacha/m3
• 3. block 15 to x m3 = 1500 Kwacha/m3

The cubic meters of the first block of at least 6 cubic meters (but no more than 10 cubic metre) represent the lifeline consumption and are supposed to be billed at a social tariff rate, while the cubic meters in excess of this first block should be billed in accordance with the average cost per cubic metre of water. The remaining third block of the tariff structure is then thought for consumption above the normal needs (such as for watering lawns) and has to generate the revenues for the cross subsidizing of the first block of consumption (lifeline consumption). The quantity of the second block has to be fixed with respect to the local consumption patterns (as influenced by family size and consumption habits) but should not exceed 140 litre per person per day or 25 cubic metre per month for a household of six. A third block is then necessary for higher consumption. A fourth block might also be added. Taking these orientation another example is:

• 1. block of 0 to 10 m3 = 600 Kwacha/m3
• 2. block 10 to 25 m3 = 1000 Kwacha/m3
• 3. block 25 to 50 m3 = 1300 Kwacha/m3
• 4. block 50 to x m3 = 1800 Kwacha/m3

The purpose of this guideline is to show the principles and advantages of tariff blocks while it is not possible to determine the prices and quantities of the blocks that are adequate to a certain locality. Identifying the best tariff structure for a certain provider is best done in form of a tariff study that provides revenue forecasts for different scenarios.