Sher Singh Bhat
Nepalese electricity sector that heralded in 1911 AD with the commissioning of 500 kW Farping hydropower plant has now grown to 2800 MW capacity and is set to gain a size of above 5000 MW in next two years. The current policy, legal, regulatory, and institutional framework of the sector was structured in 1992 for a relatively smaller sector size of about 500 MW. Whereas the state itself has undergone a major restructuring into federal model and the electricity sector has attained a steep growth in last three decades, new issues of development and management of the sector have become apparent and the current policy, legal, regulatory, and institutional framework of the sector has lost its relevance.
It is already late to review the sector and mutate to a new regime of policy, legal, regulatory, and institutional framework. The three decades of sector governance under the current policy, legal and institutional framework have produced encouraging results with the perspective of capacity addition but have also accumulated a stack of issues that might jeopardize other sectors too.
Accordingly, there is a general realization that to address the emergent issues of sector development and management, there is no option but a major departure from the existing sector policy, legal and institutional framework. Whereas policy framework serves as base for legal, regulatory, and institutional framework, the departure must initiate from policy framework. The following discourse presents the crossroads of emergent issues, worldwide trend, and pathway forward that the sector probably could adopt.
Continue with or Abolish the Licensing Regime of Power Development?
The country has been practicing the licensing regime for power development for the last three decades. During this period, the sector has witnessed several evils and anomalies in the sector and there is a general perception that the licensing regime was the fertile land for the sector evils to spring and stem. Unfortunately, we have been practicing a licensing regime that has no linkage with periodic demand of electricity, sector expansion plan as well as the status of transmission and distribution infrastructure.
Such a licensing regime is a pathway to ugly sector structure that not only promotes monopoly market but results in a development that does not fit to system requirements. Experiencing the sector evils tacit with the licensing regime of power development, several countries including India, that once exercised licensing regime of power development, have now transitioned to a delicensed regime of power development.
To get rid of licensing regime borne evils and to facelift the governance of Nepalese power sector, Nepal should not delay adopting a policy abolishing the licensing regime of power development. Sate machinery, exhibiting strong will power, can contribute to long lasting results by taking this important decision of policy change. In a delicensed regime of power development, a Project Development Agreement (PDA) signed with the government based on a provisional Power Purchase Agreement (PPA) with the buyer after tariff bidding will serve as a license. No need to mention that unlike the license, PDA has perfect linkage with updated demand or market, sector expansion plan, and other support infrastructures like transmission.
Common Policy and Projects Basket for Domestic and Export or Separate?
Except for Upper Karnali and Arun 3 projects that were specifically bid as export-oriented projects, Nepal has been practicing a common policy and project basket for development of projects supplying domestic demand as well as for export. So far generation and survey licenses of combined capacity above 18000 MW have been issued without segregating and classifying projects for domestic supply and export. This is a big mesh as the licensed projects do not have a timeline of development that suits the realistic periodic demand of the country i.e. the market and the transmission availability.
If the power development in common basket remains delinked with the market and transmission availability, NEA will have to sign Power Purchase Agreement (PPA)for all projects on take or pay terms and manage the surplus of domestic market by exploring cross border market. Should NEA face a volume or price risk in the export market, the loss will be reflected in the balance sheet of NEA and to recover this loss of export market, NEA will propose the hike in tariff of domestic consumers.
Thus, domestic consumers are exposed to the risk of export market which is undesirable and might increase to a risk volume beyond the appetite of domestic consumers. The only way to immunize the domestic consumers from volume and price risk of export market is to segregate the domestic basket of project development from export basket that ultimately means separate policy and project basket for supply of domestic demand from export-oriented projects. Export oriented project basket will explore its own financing source and cross border market without signing PPA with NEA and the risk of export market shall not be reflected in the balance sheet of NEA.
It is already late to craft segregated policy and project basket for export and domestic market as domestic consumers are already exposed to such risk with only 2800 MW of power development. If GON resorts to this policy departure, then a few of the already licensed projects may be shifted to export basket.
Bundled or Exclusive Businesses through Value Chain Unbundling?
The current regime of policy, legal, regulatory, and institutional framework allows operation of bundled business of Generation, Transmission and Electricity Service (DCS) i.e. an organization can operate more than one of these businesses. The bundled business model is in practice and consumers are imposed a bundled tariff rate for all value chain elements of the business operation of the organization.
There is a general perception that the bundled operation and tariff does not reflect the actual cost of service for each value chain segment and the functional inefficiency of organization in any value chain element of the bundled operation is camouflaged in the bundled tariff to be borne by consumers. This means consumers unknowingly pay for the inefficiency of a particular value chain element and the bundled structure of operations does not ensure the best sector efficiency. Besides this, the bundled structure of operations promotes monopoly by restraining the establishment of competitive market, the ultimate destination of the sector liberalization process since:
i. Bundled structure of business operation rules out the presence of independent and
impartial transmission operator to provide non-discriminatory transmission open
access to all other business entities.
ii. Bundled structure tends to minimize the number of business entities participating in
the market that negatively impacts the full-scale competition in the market.
Bundled structure of operations was acceptable for the financial sustainability of business when size of the sector and market was relatively very small, but with the size of sector and business today and will gain in two years, financial sustainability is not an issue to replace the bundled structure by exclusive business structure through value chain unbundling. There is no reason to continue with the bundled structure that not only camouflages sector inefficiency but hinders the establishment and operation of the competitive market of electricity. Nepal is at clear policy crossroads as to whether to continue with bundled structure or make a departure from bundled structure to business entities of exclusive business of generation, transmission, and electricity service (DCS) through value chain unbundling.
Electricity Tariff through Competitive Market or State Regulation ?
Like other market products, electricity also has two distinct levels of markets i.e. wholesale level or bulk market and retail market. The current sector framework imposes state regulated tariff at both wholesale and retail level and electricity consumers are forced to pay the state regulated tariff that neither faces competition at wholesale level nor at retail level. The regulated tariff at both market levels is perceived as a product of collusion between the project developers/service providers and the state machinery. This balance sheet based regulated tariff is perceived as an exploitation of consumers as it does not discover the lowest cost of service. Theoretically, a tariff rate discovered through competition at both levels would best protect the interests of consumers but for the reasons mentioned below, at least the wholesale or bulk purchase tariff discovered through competition is a must. Although a tariff rate discovered through competition may be reviewed by the regulator before giving final consent for imposition.
The present regulatory provision and practice of posted tariff rate for projects up to a capacity of 100 MW not only bypasses competition but also undermines the site-specific advantages of relatively larger sized generation projects. To avoid the lengthy process of Power Purchase Agreement (PPA) of small sized projects up to 10 MW capacity exercising a detailed cost plus process of calculating tariff a posted rate tariff may be acceptable but the site-specific advantage of projects above 10 M W cannot be ignored and the tariff rate should be discovered through tariff bidding so that ultimate benefit of site specific advantages goes to consumers.
Implementing tariff competition at retail level is possible only if distribution is limited to wire business and supply business is segregated from distribution. Constitution of Nepal 2072 does not conceive a segregation of distribution and supply business but recognizes both in bundled format as Electricity Service business and segregation of distribution and supply business against the constitution might raise issues related to jurisdiction of levels of state structure. Accordingly, a competitive retail market of electricity may not be applicable for now and hence the wholesale market needs to be mandatorily competitive to discover the bulk purchase tariff rate.
In the best interests of the consumers of electricity, the government should make a policy departure from regulated tariff at both market levels to the discovery of tariff through competition at least at wholesale market level and regulated tariff of electricity service at retail level.
Transmission as Natural Monopoly of State or a Market Product
Non-discriminatory open access in the transmission system can be guaranteed by an independent and impartial transmission system owner and operator (with transmission as exclusive business) and such transmission provider only can take the sector liberalization to its destination by supporting the establishment of competitive market of electricity. Though the prevalent policy and legal framework of the sector does not prohibit commercial transmission lines through private business investment, government has been reluctant to issue open access rules, regulation, and procedures to develop and operate commercial transmission business.
In other words, transmission is recognized as a market product in legal terms but practically it is state natural monopoly in the absence of requisite rules, procedures, and mechanism for fixing transmission tariff to operate the business. Absence of requisite rules and procedures for operation of transmission business even after three decades of promulgation of Electricity Act 2049 (1992) indicates strong preference of government machinery to retain transmission as natural monopoly of the state.
Since ownership and operation of transmission system by a public sector entity with transmission as exclusive business could offer most impartial transmission system, idea and policy of acknowledging transmission as natural monopoly of state makes sense and can be given legal strength. Transmission as perfect market product has complications associated with parallel flow of power attributed to geographical monopoly and this reinforces the idea of acknowledging transmission as natural monopoly of state. In case transmission is acknowledged as natural monopoly of state under the policy and legal framework of the sector, state will be responsible for providing transmission system for offtake of power direct from the generating station.
Accordingly, there is a trend in other parts of the world to acknowledge majority of the transmission as natural monopoly of state with small space for developing few typical transmission sections through private commercial investment as market product. For the establishment and operation of competitive market of electricity in the best interest of the consumers, government should decide to take a policy departure from considering transmission as market product to natural monopoly of state in general with space for developing typical commercial lines through transmission tariff bidding.
National Electricity Policy or Level wise Electricity Policy?
The prevailing policy framework is a national electricity policy drafted for unitary state structure in 1992, but the state has been restructured in federal model constitutionally. The constitution neither conceives nor has a mechanism for issuing a national energy policy. Constitutionally, levels of state structure may have their own energy policy encompassing topics of energy sector under their respective jurisdictions.
Energy policy at the federal level does not have compelling enforceability on other sub-national levels though there are misinterpretations that the legal framework of sub-national levels cannot contradict the federal legal framework. This interpretation is true to the extent of federal legal framework corresponding to topics of federal jurisdiction only. But such interpretation in general is against the spirit of constitution as sub-national levels have constitutional mandate to manage the topics of the sector under their jurisdiction independently by issuing their own policy and legal framework and this mandate of sub-national levels cannot be undermined.
But there is a general perception and concern that diverse energy policies at federal and sub-national levels do not streamline efforts of all levels for development and efficient management of power sector in the country which is not in the best interest of the people. Accordingly, a mechanism of consensus of all levels may be devised for national energy policy wherein constitutional jurisdiction and authority of levels is also given due consideration. Federal Ministry of Energy, Water Resources and Irrigation may, in consultation with the sub-national levels, draft an energy policy acceptable to all levels and then get it ratified from all levels to establish it as national energy policy.
Institutional Restructuring for Federal Decentralization
It has already been mentioned that constitution of Nepal 2015 has restructured the state into federal model with 1 federal, 7 provincial and 753 local levels with their respective jurisdictions over subjects or topics of different sectors. It has been almost a decade when the new constitution came into force, but the federal restructuring is limited only up to the political sector where respective legislative bodies of all levels are in place through elections as well as governments of all levels are formed. But policy, legal, regulatory, and institutional restructuring for federal decentralization has remained neglected.
It gives the impression that political parties are interested in accessing the government only and implementation of federal decentralization is not their priority. Country is being governed through a default legal framework of unitary structure of state for last one decade against the spirit of new constitution. The electricity sector is no exception to this situation and policy, legal and institutional restructuring of electricity sector for federal decentralization is also pending till date.
It is understandable that the federal, provincial, and local levels will issue their own respective legal framework encompassing the topics of electricity sector under their jurisdiction, but institutional restructuring is complicated owing to following issues:
i. Who will be responsible for the administration of licenses issued in the past, especially when the topics of licenses fall in the jurisdiction of different levels of state structure? Shall all licenses that have been issued in the past fall under the purview of federal level or under respective levels according to topic of license and jurisdiction of levels?
ii. If an organization is holding multiple licenses that now fall under the jurisdiction of different levels, shall the organization be restructured into multiple organization according to federal decentralization?
iii. What will happen to federal decentralization of public sector organizations? Shall they also get unbundled according to jurisdiction of levels?
In case existing public or private organizations are unbundled on value chain basis as well as restructured for federal decentralization, resulting organizations may be too small to financially sustain.
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