CENTRAL ELECTRICITY REGULATORY COMMISSION

Analysis of the Comments Received from Stakeholders on the Proposed Methodology for Calculating Escalation Rates for Use in Tariff Based

Competitive Bidding by the Staff of the Commission Central Electricity Regulatory Commission (CERC) is required under the Guidelines for Determination of Tariff by Bidding Process for Procurement of Power by Distribution Licensees to notify and update, every six months, the escalation rates for various elements of the power procurement cost such as fuel costs, fuel transportation costs, fuel handling costs, power transmission costs, etc. CERC had received representations from several stakeholders, requesting CERC to ensure that the escalation and other rates being computed and notified by the CERC are as realistic as possible. Accordingly, a study with the aim to review the computation methodology of escalation rates for various elements of the power procurement cost was undertaken and a draft proposal for reviewing the computation methodology was prepared by the Commission. (http://www.cercind.gov.in/2010/Whats-New/Note_Public_Comments_Escalation.pdf) The draft proposal along with a Notice was put on the Commission’s website for wider stakeholder consultation on October 2, 2010. Stakeholders were invited to provide their comments by October 22, 2010. Simultaneously, to solicit comments from experts, individual communications were also sent to 11 different experts from IIT Kanpur, IIT Mumbai, IIM Bangalore, IIM Ahmadabad, IGIDR Mumbai, Institute of Economic Growth New Delhi, ISI New Delhi, NCAER, and Indian Econometric Society. Since no substantial comments were received till the closing date of October 22, 2010, the closing date for receipt of comments from stakeholders was extended up to November 8, 2010. The 11 individual experts were also informed of the extension in the closing date for receipt of comments.

At the end of the extended closing date, comments have been received from three stakeholders – Tata Power Trading Company Limited, Gujarat Urja Vikas Nigam Limited, and Prof. Anoop Singh, IIT Kanpur (One of the 11 experts whom individual communications was sent). The copies of the comments from the three stakeholders are placed at Annex 1. The Commission staff analysis of the comments received from stakeholders is elaborated below.

Analysis of Comments Received from Stakeholders 1. Basic Methodology Comment: • Method of mean square error by ISI Kolkata is the appropriate method while calculating

the escalation rates (Tata Trading) Commission staff Observation/(s): None Recommended Action: None 2. Use of Geometric Mean in Place of Arithmetic Mean Comments: • Escalation rate should be the geometric mean of yearly changes (Tata Trading) • The choice of escalation rate for ‘payment’ purposes needs to be simple and realistic.

This means that the investor/generator should be adequately compensated for change in prices. Any method which artificially/statistically reduces the ‘actual escalation’ realized in the recent past (for e.g. choosing geometric mean instead of arithmetic mean) would be inadequately compensating against change in prices/underlying indices. (Prof. Anoop Singh, IIT Kanpur)

Commission staff Observation/(s): The new proposed methodology of minimum mean square error does not use or does not involve geometric mean calculations. Recommended Action: No change is required in the methodology. 3. Combining two or more series in a predetermined proportion into a new single

series Comments: • Escalation rate of a parameter requiring combination of two or more series in a

predetermined proportion, if composed into a single series is more accurate (Tata Trading)

• The rationale for combining hybrid series is justifiable and be implemented (Prof. Anoop Singh, IIT, Kanpur)

• Rate of inflation for indexed energy charge in case of captive fuel sources should be reviewed. It is expected that ‘captive fuel’ in most cases would be coal rather than petroleum products like HSD, In this context, appropriate weights should be included for domestic coal and that HSD be replaced with heavy fuels (and its weight should also be reduced). Role of CPI is also limited in the case of ‘energy charges’ and hence its weight

should also be reduced. Table giving new weights has been provided (Prof. Anoop Singh, IIT Kanpur)

Commission staff Observation/(s):

• The new proposed methodology does exactly what has been mentioned by Tata Trading and Prof. Anoop Singh, i.e. Escalation rate for parameters that require combining of two or more series in pre-determined proportion (hybrid index) is proposed to be determined by combining each data point of two or more series in the pre-determined proportion to arrive at a combined new single series and then to find the mean escalation of this composite new single series.

• The escalation rate for indexed energy charge in case of captive fuel sources is being notified to account for escalation in the cost of coal from captive mines. Since there is no specific bench mark or index price for coal mined from captive mines, cost components of captive mining and their weights have been considered for computing the escalation rate for cost of captive mined coal. Since WPI for coal will not have any bearing on the escalation rate in the cost of coal mined from captive mines, the same has not been considered.

Recommended Action: No change is required in the proposed methodology.

4. Escalable Portion of the Energy Charge

Comment/(s): Cap the escalable portion of the energy charges at 25% (GUVNL)

Commission staff Observation/(s):

• This comment does not pertain to the methodology of escalation rate determination per se. The comment pertains to the Guidelines for Determination of Tariff by Bidding Process for Procurement of Power by Distribution Licensees, and hence needs to be taken with the Ministry of Power.

Recommended Action: No change is required in the proposed methodology.

5. Choice of indices for determination of escalation rate for imported coal

Comments/(s): • Use mix of long-term and spot prices in case of imported coal (GUVNL) Commission staff Observation/(s): • Reliable long-term imported coal price index is not available. Hence spot price indices are

being used by CERC. For determining the escalation rate for imported coal for payment purposes, CERC uses a composite index comprising of three spot price indices: API 4,

Barlow Jonker/Coalfax and Global coal index. For determining the escalation rate for evaluation purposes, CERC uses the Barlow Jonker/Coal fax spot price index.

• Few contracts for imported coal are now being signed for periods beyond one year. Even for one year contracts, while the quantity is assured, the price is usually linked to the day of dispatch/ delivery and is based on mutually agreed formula using mutually agreed spot price indices.

Recommended Action: No change is required in the proposed methodology. 6. Period of data to be used for determination of fuel price escalation Comments/(s): • Period of data to be used for determination of fuel price escalation, especially imported

coal should be 25 or 30 years (Tata Trading and GUVNL) Commission staff Observation/(s): • Presently, CERC uses data for the past 12 years to determine the escalation rate in fuel

prices, including imported coal (Barlow-Jonker Index/Coalfax spot price index). • An exercise to see the bearing the period has on escalation rates as well as on

corresponding error term and disagreement coefficient (DC) values was undertaken by CERC. The results are in Table 1, below. It is seen that the error term and DC values are least when period of 12 year is used.

• However, the results also show that period has bearing on escalation rates.

Table 1: Sensitivity of Escalation Rate, Average Squared Error and Disagreement Coefficient Values With Respect to Period of Data for Imported Coal Prices (BJ Index)

S.No. Period in Years Escalation Rate (%)

Average Squared Error

Disagreement Coefficient

1 10 (2001 - 2010) 13.35 19.46 0.392 11 (2000 - 2010) 15.56 18.20 0.343 12 (1999 - 2010) 13.99 17.61 0.324 13 (1998 - 2010) 11.35 18.03 0.335 14 (1997 – 2010) 7.63 20.45 0.436 15 (1996 – 2010) 4.97 22.89 0.567 16 (1995 – 2010) 3.81 23.73 0.648 17 (1994 – 2010) 5.05 21.55 0.55

• Prices of imported coal have been volatile since 2006-07 (see Figure 1). If it is thought

that the prices in future will continue to be volatile then shorter period data will, relatively

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(%) Average Squared Error

Disagreement Coefficient

1 20 (1990- 2009) 2.24 19.25 0.742 15 (1995 - 2009) 3.43 20.60 0.693 12 (1998 - 2009) 9.60 17.70 0.44 Recommended Action: As can be seen from Figure 1, the prices continue to be volatile. After witnessing a downward trend in latter half of 2008 and early 2009, the prices have been rising steadily. Considering this, it is proposed to continue with the present practice of using past 12 year data (Table 1 and 2 indicate that using 12 year data gives efficient estimates of escalation rates as compared to using data of shorter or longer duration) for one more year and see how the volatility plays out. If the volatility continues, it is proposed to continue with short term or 12 year data. If volatility in imported coal price subsides, extending the time period of data beyond 12 years is proposed to be considered. 7. Basis for determination of escalation rate for Normative Transmission Charges Comments/(s): • Using Rupees Per MW Connected Better than Rupees per kWh (Tata Trading) • Not Clear per MW connected on generation side or demand side? (GUVNL) • Not clear if it is existing connected or future connected load? (GUVNL) Commission staff Observation/(s): • Commission is proposing to use Rupees per MW connected as the basis for determining

the escalation rate for normative transmission charges: o Using Rupees per MW connected as the basis allows normalisation of lumpy

nature of the investment in transmission, where lines are put in advance and load growth follows

o All planning and investment is based on connected load o The utilisation of hydro capacity is low but the lines have to be built to cater to

maximum capacity • Rupees per MW connected on the injection or generation side to be used

• It is to be the past connected load and not future connected load Recommended Action: Basis will be Rupees per MW connected. However, considering the data availability issue and to account for transmission charges paid by Short Term Open Access users, the actual steps for arriving at Rupees per MW data that will be used for

Calculation of the escalation rate is proposed to be done as per the methodology shown in Table 3 below. Table 3: Basic Steps for Arriving at Escalation Rate Determination Data

1. Calculations done for 12 Years Data 2. Let Transmission charges for past 12 years be: TC1….. TC 12 3. Let connected load (LTOA) on ISTS system for past 12 years be: C1………C12 4. Assuming 85% capacity utilization, let energy net generated from capacity of C1….C12 be: E1………E12 5. Let STOA transmitted over ISTS for past 12 years be : S1……..S12 6. Let STOA transmitted over ISTS for past 12 years as percentage of net energy generation E1……E12 be: K1 ………….K12; with each K = (S/E) 7. Let Transmission charges to be considered for determination of escalation rate for the past 12 years be: T1…..T12; where each T = {1/(1+K)}* TC; 8. The basic Rupees per MW data that will be used for determining the escalation rate will be M1 ….M12, where each M = T/C (see Table Below)

Year Transmission Charges in Rs.

Mw Connected on ISTS Rupees per MW Connected

1998 T1 C1 M1= T1/C1 1999 T2 C2 M2 = T2/C2 2000 T3 C3 M3 = T3/C3

2001 T4 C4 M4 = T4/C4

2002 T5 C5 M5 = T5/C5

2003 T6 C6 M6 = T6/C6 2004 T7 C7 M7 = T7/C7 2005 T8 C8 M8 = T8/C8

2006 T9 C9 M9 = T9/C9

200c T10 C10 M10 = T10/C10

2008 T11 C11 M11 = T11/C11

2009 T12 C12 M 12 = T12/C12

Based on above steps, the data for MW connected on ISTS have been calculated with data for the period 1997-98 to 2008-09. The same has been shown in the Table 4 on the next page.

Table 4: Actual Calculation as per the Steps in Table 3

Year

Transmission Charges without

ULDC in Rs. Million

Capacity MW in Mid Point on the

Year

Net Capacity assuming

Auxiliary of 8%

Net generation assuming 85% PLF

Million kWh

STOA Million kWh

STOA as % of net

generation (K)

Factor ((1/(1+K))

Transmission Charges without ULDC

adjusted for STOA

Cost per KW

connected

(a) (b) (c )=0.92*(b) (d)=(c*8760*.85)/(10^6) (e) (f) = (e)/(d) (g)= (1/(1+f)) (h)= (a)*(g) (i) =

(h*1000)/©

1997-1998 13519 24447 22491 167466 0 0.00 1.00 13519 553.00

1998-1999 16283 25004 23004 171285 0 0.00 1.00 16283 651.22

1999-2000 18881 26535 24412 181773 0 0.00 1.00 18881 711.56

2000-2001 22486 27770 25548 190230 0 0.00 1.00 22486 809.74

2001-2002 22227 28352 26083 194217 0 0.00 1.00 22227 783.97

2002-2003 24835 29339 26992 200982 0 0.00 1.00 24835 846.47

2003-2004 27701 31462 28945 215521 0 0.00 1.00 27701 880.48

2004-2005 25461 35554 32709 243553 17000 0.07 0.93 23800 669.40

2005-2006 30047 39026 35903 267337 23000 0.09 0.92 27667 708.94

2006-2007 36439 42522 39120 291289 24000 0.08 0.92 33665 791.71

2007-2008 43682 46741 43002 320191 30000 0.09 0.91 39940 854.50

2008-2009 52100 48666 44773 333378 31000 0.09 0.91 47667 979.47

Table 5 below depicts the escalation rates as determined for normative transmission charges under the proposed method of minimum mean square error with and without accounting for short term open access charges. It is seen that the average error squared and disagreement coefficient values are higher when accounting for short term charges is made, i.e. when short term charges are excluded from total transmission charges. However, since logically it is more correct to link the connected load (long term open access load) to transmission charges that the long term open access consumers have to pay, the basis that will be used for determining the escalation rate for normative transmission charges will be the Rupees per MW (or KW) connected as calculated in the last column of Table 3 or Table 4 above

Table 5: Normative Transmission Charge: Escalation Rates and Corresponding Average Squared Error and Disagreement Coefficient Values

Description Rupees per MW without adjusting for Short Term Open access Charges

Rupees per MW with adjustment for Short term open Access Charges

Escalation Rate (%) 5.90 5.13Average Squared Error 93.3 107.66Disagreement coefficient 0.71 1.30

8. Escalable portion of the normative transmission charge

Comments/(s):

• Only O&M portion of the transmission charges be subjected to escalation (Tata Trading)

Commission staff Observation/(s):

• Unlike capacity and energy charge components, Competitive Bidding Guidelines do not provide flexibility to the bidder to stipulate what portion of the total transmission charge the bidder would like to be considered as escalable. As per the Guidelines, the entire portion of the transmission charges, and not just the O&M portion, gets escalated at the escalation rate notified by CERC. To allow only the O&M portion of the total transmission as escalable would therefore have to be considered in the wider context of the amendment to the existing Competitive Bidding Guidelines, which is a policy matter to be decided by the Ministry of Power.

• The allocation of total transmission charges among different users of inter-state transmission system (ISTS) would no doubt have to be made on the actual usage basis. However, since the bidding under Case 1 can any part of the country, for determining the escalation rate in normative transmission charges, the reference point would have to be the country as a whole and not just an individual transmission line or individual user of the ISTS. By considering the reference point as the country as a whole, what is being attempted is in fact somewhat akin to developing a “transmission charge index for India”. It is therefore the total transmission charges at the country

level which would have to be considered for determining the escalation rate in normative transmission charges. For the country as a whole, the aggregate ARR of the inter-state transmission licensees would be a reflection of the total transmission charges. Given the rising power demand and the resultant need for increasing power generation and evacuation capacity, the aggregate ARR and hence the aggregate transmission charges will show an increasing trend for substantial period in future; even though for individual transmission lines, depending on the vintage, the ARR may show a rising or decreasing trend.

Recommended Action: No change is required in the proposed methodology.

ANNEX 1

Copies of the Comments As Received from Various Stakeholders

8th Nov. 2010

Secretary Central Electricity Regulatory Commission 3 rd & 4 th Floor, Chanderlok Building, 36, Janpath, New Delhi- 110001

Sub: Comments on “Proposed Modification in the Methodology for Calculating Escalation Indices for Use in Tariff Based Competitive Bidding”

Dear Sir, This is with reference to the “Proposed Modification in the Methodology for Calculating Escalation Indices for Use in Tariff Based Competitive Bidding”. I have gone through the document and herein record some of my comments on the same. I hope that comments provided would help the regulatory process initiated by the CERC. Thanking You. Sincerely Yours (Dr. Anoop Singh) Associate Professor Chair, Energy Conclave 2010 Department of Industrial and Management Engineering, Indian Institute of Technology Kanpur Kanpur - 208 016 (India) E-mail: anoops@iitk.ac.in

Comments on “Proposed Modification in the Methodology for Calculating

Escalation Indices for Use in Tariff Based Competitive Bidding”

Dr. Anoop Singh Associate Professor

Department of Industrial and Management Engineering, Indian Institute of Technology Kanpur

Kanpur - 208 016 (India) E-mail: anoops@iitk.ac.in

1. The objective of escalation rates is to compensate the

generators/transmission companies for compensating against increase in various cost components. The choice of any escalation methodology depends on the way the escalation rates would be applied. The process of ‘deriving’ the escalation rate should be symmetric to the way it is to be applied. The geometric mean is always less than the arithmetic mean.

2. In case of a change in the way escalation rates are computed, the potential suppliers / investors would use the similar methodology and bid rates so as to ensure that they get similar rates of return as in the case of a previous escalation methodology. Theoretically speaking, a bidder would raise for the base rate for the escalable component in case the applicable escalation rate would be lower to compensate for the loss associated with change in escalation rate. The bidder would essentially reverse engineer the bids to be quoted based on the escalation rate applicable. Hence, it is important that the methodology/basis for deriving the escalation rates be specified so that bidders can take informed decisions accordingly.

3. We can note the following from Clause 5.6 (iv) of the Guidelines for competitive Bidding

“The index to be adopted for escalation of the escalable component shall be specified in the RFP. For the purpose of bid evaluation, median escalation rate of the relevant fuel index in the international market for the last 30 years for coal and 15 years for gas / LNG (as per CERC’s notification in (vi) below) shall be used for escalating the energy charge quoted by the bidder.”

The escalation rate for the purpose of bid evaluation would have

less impact on the bids as the investors would make appropriate adjustment in the bid values. However, the choice of escalation rate for

‘payment’ purposes needs to be simple and realistic. This means that the investor/generator should be adequately compensated for change in prices. Any method which artificially/statistically reduces the ‘actual escalation’ realized in the recent past (for e.g. choosing geometric mean instead of arithmetic mean) would be inadequately compensating against change in prices/underlying indices.

4. The rationale for combining hybrid series is justifiable and be

implemented. However, the following may be noted in terms of choice of indices.

Rate of inflation for indexed energy charge in case of captive fuel sources should be reviewed. It is expected that ‘captive fuel’ in most cases would be coal rather than petroleum products like HSD, In this context, appropriate weightage should be included for domestic coal and that HSD be replaced with heavy fuels (and its weight should also be reduced). Role of CPI is also limited in the case of ‘energy charges’ and hence its weight should also be reduced. A suggested in this regard is tabulated below.

Existing Proposed (a

scenario) CPI 20 10 WPI 10 10 WPI for coal 0 25 WPI for HSD oil 25 15 (for Heavy

Oil) WPI for matches explosives and other chemicals

10 10

WPI for tyres 10 10 WPI for heavy machinery and parts 25 20

5. A change in the basis for escalation rate for transmission charges should consider the applicable basis for charging for transmission services. In case transmission charges are applied on per MWh basis, provision of escalation rate in per MW of connected load would require additional inputs. This would be especially be applicable in case transmission pricing for intra-state transmission network, which continues to be per MWh basis and where there is a need to apply escalation rate as well.