Tariff Determination
As aforementioned, the State Electricity Regulatory Commissions (SERCs) set consumer tariffs in a “cost-reflective” way which aims to ensure and balance the economic viability of the utilities and consumer interests. Based on a variety of factors such as consumer category, the load factor, and subsidies which are decided by the state government (outside the tariff mechanism), the actual prices which are borne by end consumers can differ^v. Three parameters can be used to define tariff determination:

1. Aggregate revenue requirement (ARR) represents the total amount of revenue that a power distribution utility (also known as a DISCOM or distribution company) needs to collect from electricity consumers to cover its operational and capital costs, as well as earn a reasonable rate of return on its investments^vi.

1.1. The components of ARR may vary but they typically encompass a variety of elements from across the electricity value chain, i.e., generation, distribution and transmission networks such as power procurement charges, distribution cost and losses, inter and intra state transmission charges and losses, state load dispatch center (SLDC) charges, Interest on Consumer Security Deposit (CSD) and supply margin.

1.2. The key role of ARR is to ensure that the DISCOM can recover all its legitimate costs while maintaining a healthy and profitable financial model.

1.3. ARR forms the basis for calculating the electricity retail tariffs that the utility can charge its consumers. Regulatory authorities use the ARR to assess whether the proposed tariff is justified and reasonable, ensuring that the utility can recover all its legitimate costs while providing a reasonable return to its investors.

1.4. Cross-Subsidization: ARR can also involve cross-subsidization, where different consumer categories pay different tariff rates to ensure affordability for certain groups while covering costs for others. However, while allowing cross-subsidization charges, SERC follows the National Tariff Policy.

1.5. It is important to note that ARR can be influenced by factors such as the cost of fuel, inflation, changes in power purchase agreements, and regulatory/appellate authorities’ decisions. The accuracy of ARR estimation is crucial for maintaining the financial health of DISCOMs and ensuring a sustainable electricity supply system.

2. Average Cost of Supply (ACoS) is the average cost incurred by a utility or a DISCOM to supply electricity to its consumers. It is a metric that calculates the average cost incurred by the utility to supply electricity per unit (typically per kilowatt-hour or kWh) over a specific period. It is the cost per unit of electricity supplied^vii.

2.1. ACoS is calculated by dividing the total cost of supply (including various cost components like power procurement, transmission and distribution losses, operation and maintenance costs, depreciation, and more) by the total units of electricity supplied during the same period. The formula is:

ACoS = Total Cost of Supply / Total Units of Electricity Supplied

2.2. ACoS is primarily used as a reference point for setting electricity tariffs. Regulatory authorities use the ACoS to determine tariff rates that cover the average cost of supplying electricity while allowing the utility to meet its financial obligations and provide a reasonable return to its investors.

2.3. Consumer Categories: ACoS can be calculated separately for different consumer categories (e.g., residential, commercial, industrial) to determine different tariff rates for each category based on their respective ACoS. For example, as per the National tariff Policy which is the overarching policy guidance for SERCs to determine tariff states that the consumer categories must be within the +/-20% of ACoS and cross-subsidising consumers should not exceed 120% of ACoS^viii.

While the two may seem similar at the outset, it differs quite structurally in the purpose it serves:

• ACoS calculates the average cost of supplying electricity per unit and is used as a reference point for tariff setting.

• ARR represents the total revenue requirement of the utility, considering all its financial obligations, and serves as the foundation for setting            electricity tariffs, ensuring that the utility can cover its costs and maintain financial viability.

It is to note that ACoS is not the actual tariff which consumers pay. Due to the presence of cross-subsidization as we have discussed, different consumer categories pay different tariff slabs. The impact of subsidies on the tariff for each consumer category can be seen from the Average Billing Ratio (ABR) to ACoS ratio which brings us to discuss ABR^ix.

3. Average Billing Rate (ABR) is the actual billing rate applicable for each category of consumers. It indicates how much revenue the utility expects to collect for every million units of electricity consumed by a consumer category. It provides insights into the billing structure and revenue expectations for different categories of consumers and improves the billing and collection efficiency for DISCOMs.

3.1. The ABR values are derived from the category-wise revenues available to the DISCOMs. The ABR comprises fixed and energy charges, which are reflected in the electricity bills of the consumers, as per their contracted demand.

3.2. Formula for ABR calculation is:

ABR (for a particular consumer category) = Revenue expected from the respective category in INR (given in the tariff order)/Approved sales in Million Units (given in the tariff order)

3.3. Revenue Expected from the Respective Category in INR: This represents the total revenue that the regulatory authority expects to collect from a specific consumer category based on the tariff rates specified in the tariff order. The revenue expectation is typically calculated for a specific period, such as a year.

3.4. Approved Sales in MU (Million Units): This refers to the total electricity consumption or sales in million units (MU) that the regulatory authority has approved for the same consumer category, as specified in the tariff order. It represents the amount of electricity the regulator expects this category of consumers to consume.

3.5. ABR is not a charge that consumers directly pay to the utility. Instead, it is a metric used by regulators in the process of determining electricity tariffs to establish pricing structures that align with revenue requirements and consumer behavior. Consumers pay their electricity bills based on the tariff rates established through this regulatory process and their load factor (utilization of the contracted load in a specified period)

3.6. The ABR values are derived from the category-wise revenues available to the DISCOMs. The ABR comprises of different types of ‘charges’ (Fixed & Variable) used to recover the costs of tariff components in different ways, which are reflected in the electricity bills of the consumers as per their contracted demand as follows:

3.6.1. Energy charge (Rs per kWh) – This is a variable cost incurred by the customer, which is dependent on the level of electricity consumed. It primarily includes fuel cost i.e., cost of electricity purchased from other utilities, cost of power lost in transmission and distribution, and state levies such as surcharge, taxes^x.

3.6.2. Demand charge (Rs per kW or kVA) – This is a fixed cost incurred by the customer depending on the level of the maximum recorded capacity within each month. It includes fixed charges in power purchase cost and substantial portion of interest, depreciation and employee expenses; these allocated to different consumer categories on the basis of share in total coincident demand (consumer’s demand at the time of System Peak Demand).

3.6.3. Minimum charges (Rs per month or Rs per installation per month) – This is a minimum cost payable by the customer recurring each month regardless of their actual electricity consumption level or capacity usage. That is, if the customer consumes no electricity for an entire month, they still have to pay this charge.

Depending on the State of origin, the final tariff can be a combination of these charge components. Most of the states generally have a two-part tariff which combines energy charge with either a fixed charge, or a demand charge. The tariff will also vary between different customer categories (category slab), such as residential, commercial, industrial, agricultural etc^xi.

In summary, setting of tariffs is not a straightforward process. It involves complexities in in the determination as well as the components involved for which regulators strive to ensure that the process is executed in a transparent, thorough and timely manner. Tariff setting is instrumental, as it determines the net gain or loss of revenue from consumers, which in turn determines the overall financial health of distribution utilities. Tariff setting can be an iterative and lengthy process, spanning over several years, making it difficult to reflect the true costs and gains achieved for a particular financial year. Although the cost per unit of electricity supplied is reflective in the ACoS, the actual levied costs vary for different consumer categories, some of which must bear the burden of others through cross subsidies. As individual state regulators are empowered to recover the costs of power produced and supplied, they must be cognizant of the different categories of consumers and ensure timely revision of tariffs, and that the consequential revenue collected is reflective of the real cost of power produced which underlines the tariff reform discussions in recent times.