,,,Report On

CERC REGULATIONS 2009

UNIVERSITY

OF

PETROLEUM & ENERGY STUDIES

DEHRADUN, UTTARAKHAND

MBA (POWER MANAGEMENT)

December, 2009
University of Petroleum and Energy Studies, India

Submitted to:

Submitted by;

Mrs. Meenu Mishra

Deepmala Pundir

TABLE OF CONTENTS

CERC REGULATIONS-2009

Page 1

Chapter Number
Chapter-1
Chapter-2

Chapter Name
Introduction
CREC Regulations 2009
Conclusion

Page Number
3
7
21

CHAPTER-1
INTRODUCTION

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About CERC:
The conceptualization of independent Regulatory Commission for the
electricity sector dates back to early 1990s, when the National Development
Council (NDC) Committee on Power headed by Shri Sharad Pawar, the then
Chief Minister of Maharashtra recommended in 1994, constitution of
independent professional Tariff Boards at the regional level for regulating the
tariff policies of the public and private utilities. The Committee reiterated that
the Tariff Boards will be able to bring along with them a high degree of
professionalism in the matter of evolving electricity tariffs appropriate to each
region and each State.
The need for constitution of the Regulatory Commission was further reiterated
in the Chief Ministers Conference held in 1996. The Common Minimum
National Action Plan for Power evolved in the Conference inter-alia agreed
that reforms and restructuring of the State Electricity Boards are urgent and
must be carried out in definite time frame; and identified creation of Regulatory
Commissions as a step in
this direction. Thus was enacted the Electricity Regulatory Commissions Act,
1998 paving way for creation of the Regulatory Commissions at the Centre and
in the States. The 1998 Act was enacted with the objective of distancing
Government from the tariff regulation. The Act provided for Electricity
Regulatory Commissions at the Center and in the States for rationalization of
electricity tariff, transparent policies regarding subsidies etc. Under the
provisions of this Act, the Central Government
constituted the Central Electricity Regulatory Commission (CERC) in July,
1998. The ERC Act, 1998 has since been replaced by the Electricity Act, 2003.
The CERC created under the provisions of the ERC Act, 1998 has been
recognized as the Central Electricity Regulatory Commission under the
Electricity Act, 2003. The Commission functions in a quasi-judicial manner. It
has the powers of Civil Courts. It consists of a Chairperson, three full time
Members and the Chairperson of the Central Electricity Authority (CEA) as Exofficio Member. In recognition of the need
for a multi-disciplinary approach while addressing issues related to independent
regulation, the Act prescribes that the Chairperson and Members shall be
persons
having adequate knowledge and experience in engineering, law,economics,
commerce, finance or management. It also prescribes a broad mix of disciplines
to be represented in the Commission.
The Chairperson and Members are appointed by the President of India on the
recommendation of a selection committee constituted by the Central
Government as prescribed under the Act. The Act also provides for the
appointment of a Secretary of the Commission whose powers and duties are
defined by the Commission.
CERC REGULATIONS-2009

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The Electricity Act, 2003 has significantly enlarged the spectrum of

responsibility of CERC. Under the ERC Act, 1998 only the tariff fixation
powers were vested in CERC. The new law of 2003 has entrusted on the CERC
several other responsibilities in addition to the tariff fixation powers, for
instance, the powers to grant license for inter-State transmission, inter-State
trading and consequently to amend, suspend and revoke the license, the powers
to regulate the licensees by
setting performance standards and ensuring their compliance, etc.
As entrusted by the Electricity Act, 2003 the Commission has the responsibility
to discharge the following functions:Mandatory Functions
(a) To regulate the tariff of generating companies owned or controlled by the
Central Government;
(b) To regulate the tariff of generating companies other than those owned or
controlled by the Central Government specified in clause (a), if such generating
companies enter into or otherwise have a composite scheme for generation and
sale of electricity in more than one State;
(c) to regulate the inter-State transmission of electricity;
(d) to determine tariff for inter-State transmission of electricity;
(e) to issue licenses to persons to function as transmission licensee and
electricity trader with respect to their inter-State operations;
(f) to adjudicate upon disputes involving generating companies or transmission
licensee in regard to matters connected with clauses (a) to (d) above and to refer
any dispute for arbitration;
(g) to levy fees for the purposes of the Act;
(h) to specify Grid Code having regard to Grid Standards;
(i) To specify and enforce the standards with respect to quality, continuity and
reliability of service by licensees;
(j) To fix the trading margin in the inter-State trading of electricity, if
considered, necessary;
(k) To discharge such other functions as may be assigned under the Act.
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Advisory Functions
(i) Formulation of National Electricity Policy and Tariff Policy;
(ii) Promotion of competition, efficiency and economy in the activities of the
electricity industry;
(iii) Promotion of investment in electricity industry;
(iv) Any other matter referred to the Central Commission by the Central
Government.
The Commission intends to promote competition, efficiency and economy in
bulk power markets, improve the quality of supply, promote investments and
advise Government on the removal of institutional barriers to bridge the
demand supply gap and thus foster the interests of consumers.
In pursuit of these objectives the Commission aims to
Improve the operations and management of the regional transmission systems
through Indian Electricity Grid Code (IEGC), Availability Based Tariff (ABT),
etc.
Formulate an efficient tariff setting mechanism, which ensures speedy and
time bound disposal of tariff petitions, promotes competition, economy and
efficiency in the pricing of bulk power and transmission services and ensures
least cost investments.
Facilitate open access in inter-State transmission
Facilitate inter-State trading.
Promote development of power market.
Improve access to information for all stakeholders.
Facilitate technological and institutional changes required for the development
of competitive markets in bulk power and transmission services.
Advise on the removal of barriers to entry and exit for capital and
management, within the limits of environmental, safety and security concerns
and the existing legislative requirements, as the first step to the creation of
competitive markets.
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CHAPTER-2
CERC REGULATIONS-2009
CentralElectricityRegulatoryCommission
CERCissued
the
Tariff Regulations for generation and transmission projects for the period 2009CERC REGULATIONS-2009

Page 6

14. These regulations have been finalized after detailed consultation with the
stakeholders and would also be the guiding principles for the State Electricity
Regulatory Commissions. The regulations aim at attracting much desired
investment in power infrastructure in the country while ensuring that the
consumers get electricity at reasonable cost. The following are the important
features of the new regulations:
(1) The base rate for allowing return on equity has been raised from 14% to
15.5% keeping in view the need of attracting investment in the current market
conditions.
(2) To incentivize timely completion of projects in the present period of power
shortages, an additional return on equity of 0.5% will be available to those
projects which are commissioned within the given timelines.
(3) In addition to increased rate of return on equity of 15.5%, the
regulations contain several provisions to boost development of hydro power
projects. By modifying the proposal in the draft regulations new hydro power
projects
have
been
appropriately
insulated from hydrological risk during the first ten years of their operations.
The regulations also allow enhanced free power and rehabilitation cost
according to the new Tariff Policy, with the objective of expediting project
implementation.
Tariff
for
hydro
power project has been restructured to incentivize supply of peaking power.
(4) Return on equity will be now pre-tax for which the base rate of 15.5%
would be grossed up by applicable tax rate for the company. This would
incentivize investment promotion as the benefit of tax holiday will be now
available to the project developer. On the other hand, consumers would not have
to bear the burden of income tax on the UI earning, incentive earning and
efficiency gains of the projects. This has been a major grievance of the
beneficiaries.
(5) While doing away with the advance against depreciation in line with Tariff
Policy, depreciation rates have been reworked to take care of repayment of debt
obligations of the new projects. However, once the initial period of 12 years is
over, remaining depreciation would be spread over the balance useful life to
keep
the
tariff
reasonable.
(6) Regulatory philosophy of CERC has been to incentivize efficiency gains and
to periodically pass the improvements to beneficiaries Accordingly, the
availability target for recovery of fixed cost for thermal power plants has been
raised from 80% to 85%. The station heat rate has also been tightened. For the
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new units, operating margin of only 6.5% would be permitted with respect to
the design heat rate. The regulations give maximum permissible design heat rate
to ensure that inefficient machines are not procured. The norm for secondary oil
consumption has been slashed from 2 ml per unit to 1 ml per unit. Further, the
savings in secondary oil consumption are to be shared with the beneficiaries in
ratio
of
50:50%.
(7) The economies of scale available to the developers in operation of
expansion projects are to be shared with the beneficiaries as the permissible
O&M expenditure will be descaled for new expansion units.
(8) To make the tariff fixation more objective and simple, CERC has decided to
set up capital cost benchmarks for thermal power projects and transmission
projects. The provisional tariff has been done away with and the companies will
get
final
tariff
upfront.
(9) Tariff regulations have given due attention to the need of renovation and
modernization. The companies operating thermal power plants will have now
two options. Either they can claim a special allowance on the basis of per MW
per
year
after
completion of normative useful life of the project and will be obligated to
deliver the norms set for availability and operations. Second option is to go for
comprehensive R&M which is to be permitted by Commission on the basis of
detailed cost benefit analysis including the efficiency gains to the beneficiaries.
(10) To incentivize higher availability of power plants, the incentive available to
the generating companies will now be available on the basis of declared
availability instead of plant load factor because the generators can only declare
better availability and actual schedule is not within their control.
(11) The Commission has decided to separately bring out the tariff
regulations for renewable energy based projects. This exercise has already been
started and is likely to be completed within next six months.

Regulatory Norms for Computation of Tariff

The regulatory norms for the computation of tariff for thermal power stations,
hydro power stations, and transmission licensees.
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Thermal Power Stations

For thermal power generating stations (coal, lignite and gas based), the CERC
has been adopting a two-part tariff:
1) Capacity Charges (for recovery of Annual Fixed Costs)
2) Energy Charges (for recovery of Primary Fuel Costs)
1. Components of Capacity Charges/Annual Fixed Charge (AFC)

(a) Return on Equity

The CERC has specified a Pre-Tax RoE of 15.5% for the tariff period 2009-14
as against a Post-Tax RoE of 14% in the previous tariff period. Further, it has
allowed an additional RoE of 0.5% for projects commissioned after April 2009
within specific timelines. The regulator has specified a 33-month of time
schedule for greenfield projects up to 330 MW and 44 months for greenfield
units of 500/600 MW. In ICRAs opinion, the additional RoE will act as an
incentive for a project developer to achieve time-bound milestones, which
appears reasonable. On the other hand, the revised norms will not allow utilities
to recover tax on income such as unscheduled interchange (UI) and incentive
income from beneficiaries.
(b) Interest on Loan Capital
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The CERC has specified a debt-equity ratio of 70:30 as the funding mix for the
capital cost of a project. The interest rate as per actuals on these loan funds will
be recoverable as part of the tariff, which is similar as in the case of the
regulations notified for the earlier tariff period. One of the positives of the new
regulations is the provision that allows retention of 1/3rd of the benefits, if any,
arising out of re-financing of loans; earlier such benefits were required to be
passed on entirely to the beneficiaries.
(c) Depreciation
In the regulations for the earlier tariff periods, the CERC followed the concept
of AAD in case where the normal depreciation rates (notified by the regulator)
were not sufficient to meet the debt repayment obligation of the utility. While in
the new regulations for the tariff period 2009-14 the CERC has removed the
concept of AAD, it has at the same time increased the depreciation rates
applicable for projects. The same depreciation rates will now be applicable both
for tariff purposes and for accounting purposes. As against a deprecation rate of
3.6% for thermal power projects (based on a 25-year project life and 90% of the
capital cost) and 2.57% for hydro power projects (based on a 35-year project
life and 90% of the capital cost), the CERC has increased the depreciation rate
to 5.28% for most components of the project.
While ICRA believes this will result in the lowering of tariff of a project during
the initial years and moderate the impact of the higher RoE on tariff, based on
the funding mix in a debt:equity of 70:30 and the depreciation rate, there will a
slight mismatch in cash flows from depreciation compared to the debt
repayment obligations , in case the projects are not funded with sufficiently
long-tenure debt with a repayment period of 13~14 years. The prevailing
practice in the sector is to fund the project with debt carrying a 10-year
repayment period after the initial moratorium. While the depreciation rate at
5.28% will require a debt repayment period of 13-14 years, the higher return on
equity will partly offset the impact of the abolition of AAD.
(d) Interest on Working Capital
The working capital for a thermal power station will have the following
components:

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Considering the above normative parameters, a utility can recover an interest @

Short Term Prime Lending Rate (PLR) of State Bank of India. ICRA expects no
significant impact arising out of the new regulations on the recoverability of
Interest on Working Capital.
(e) Operations & Maintenance Costs
The CERC has specified O&M costs for thermal power stations on the
normative parameters (Rs. lakh/MW), depending on the class of the machine
installed by the power station. The normative O&M expenses allowed are:

For thermal power stations with multiple units of the above sizes, the CERC has
introduced the concept of reduction factor, which will apply to units
commissioned after April 2009. The normative O&M expenses for the new
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units will be determined by multiplying these factors with the normative O&M
expenses detailed above.
Reduction Factor in O&M costs for Thermal Power Projects with Multiple
Units

The regulator has allowed a significant increase in O&M expenses for the tariff
period 2009-14, permitting an escalation rate of 5.72%, as against the 4%
earlier. While the increase in O&M expense over the previous tariff period is a
positive for utilities, there has also been a significant rise in actual O&M
expenses, especially manpower expenses following the implementation of the
Sixth Pay Commission.
On the negative side, the bigger power plants with multiple units will see a
reduction in their normative O&M expenses. However,the bigger power
projects would be able to offset the negative impact of the reduction in
normative O&M expenses on the strength of their superior scale economies.

Separate Compensation Allowance for Coal based Thermal Power Projects

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In addition to the Normative O&M costs, the regulator has also allowed a
separate compensation allowance for meeting the expenses on new capital
assets, which will be based on year of completion of the project.
(f) Cost of Secondary Fuel Oil & Limestone
While conventionally, the cost of Secondary Fuel Oil (SFO) is included in
energy charges, in the regulations for the period 2009-14, the CERC has
included the cost as part of AFC. Projects will be able to recover the cost of
SFO on the basis of normative consumption norms (discussed later) specified
by the regulator and the Plant Availability Factor during the year.
(g) Special Allowance In Lieu of R&M
The CERC in its previous regulations followed the policy of additional
capitalization arising out of any major renovation and modernization (R&M)
expenditure, whereby such capital expenditure was added to the previously
approved gross block of the plant to determine the future tariffs. In its new
regulations for the period 2009-14, the CERC has given an option to a coal
based thermal power plants to avail of a special allowance as a part of AFC for
meeting R&M expenses beyond the useful life of the power project. However in
case the utility opts for this allowance as a part of AFC, there will be no
increase in capital costs on account of capital expenditure incurred on R&M of
power plant during the subsequent periods and no relaxed operational norms
will be allowed for such projects. The allowance is available to the coal/lignite
based thermal power project @ Rs 5 lakh/MW/Year from 2009-10 and is
escalated @ 5.72% p.a.

2. Energy Charges (for recovery of primary fuel costs)

Energy charges for thermal power stations are linked to the normative
operational parameters as specified by the regulator. The normative parameters
include the following:

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Incentives linked to Plant Availability rather than Plant Load Factor

While in its earlier regulations, the CERC had linked the incentives for a
generating station to the plant load factor (PLF), under the new regulations for
2009-14, it has linked the payment of incentive to the plant availability factor
(PAF). This is a positive for plants that are compelled to operate at lower PLFs
compared to their Availability for extraneous reasons. The incentives will be
recoverable as a part of the AFC and will be computed on monthly basis. The
AFC inclusive of the incentive payable will be calculated as follows:
AFC (including incentive) = AFC x (Actual Plant Availability Factor/Normative
Plant Availability Factor)
For the new power plants that are in operation for less than 10 years and
generally witness higher availability, only 50% of the benefits arising out of the
higher PAF will be allowed.

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Hydro Power Stations

For hydro power generating stations, much of the costs are fixed in nature. The
revisions in the norms for capacity charges are as follows:
Components of Capacity Charges/Annual Fixed Costs

Points a,b,c for hydro power stations will be similar to those discussed in the
case of thermal power stations

(d) Interest on Working Capital Working capital for a hydro power station will
have the following components:

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Considering the above normative parameters, a utility can recover an interest @

prevailing Short Term Prime Lending Rate (PLR) of State Bank of India. It is
expected that no significant impact arising out of new regulations on the
recoverability of Interest on Working Capital.
(e) Operations & Maintenance Costs
Since various factors such as location, topography, and project layout determine
the nature of a particular hydro power station, the O&M costs for two hydro
plants can vary and hence no normative parameters for O&M expenses have
been defined by the CERC. As a result, the actual O&M expenses (excluding
abnormal expenses) for the period 2003-04 to 2007-08 will form the basis for
O&M expenses for the tariff period 2009-14. For practical purposes, the
normalized O&M expenses for the period 2003-04 to 2007-08 will be escalated
at 5.17% p.a. to arrive at the 2007-08 price levels and the average of these
expenses at the 2007-08 price levels will be escalated at 5.72% p.a. to arrive at
the O&M expenses for the year 2009-10. To account for the increase in
employee cost on account of pay revision, O&M expenses for 2009-10 will be
increased by 50% (positive), which will form the base for the next years in the
tariff period. For new plants commissioned after 2009 April, 2% of the project
cost (excluding R&R expenses) will form the base O&M expense, which will
be escalated @ 5.72% p.a. The new norms provide for better coverage of O&M
expenses, as the regulations for the period 2004-09 allowed an O&M cost of
1.5% of the capital cost escalated @ 4% p.a.
Recovery of Annual Fixed Costs Shift from Capacity Index based Fixed
Charge Recovery to Availability Based Fixed Charge Recovery
The CERC norms for the period 2001-04 and 2004-09 followed the concept of
Capacity Index (CI1) for recovery of AFC, whereby irrespective of actual water
availability, a plant would have been in a position to declare a high capacity
index and hence becomes eligible for recovery of AFC as well as incentives. As
a result, these plants were protected against hydrological risks. The CI on which
the AFC could be recovered varied from 85% to 90%, depending on the type of
the hydro project. However there were certain drawbacks in recovering AFC
based on CI, as during years of low water availability, the beneficiaries of the
project had to pay AFC despite power not being available from the project. On
the other hand, in years of excess water availability, the generating company
became eligible for secondary energy charges (which was the lowest variable
cost of a thermal power station in its grid). Hence the benefits in a scenario of
adequate water availability were accruing to the generator, even as it was
insulated against any hydrological risks. Given this backdrop, the CERC has
divided the recovery of AFC into two components:
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CI = Declared Capacity (DC) (MW) / Maximum Available Capacity (MAC) (MW) x 100

where DC is the power that is expected to be generated next day based on

availability of water & machine; and MAC is the maximum power that a station
can generate with all units running, under the prevailing water levels and flows
over the peaking hours next day.

Capacity Charge (Rs. lakh) = AFC x 0.5 x (Actual Plant Availability Factor/Normative
Plant Availability Factor)

Energy Charge (Rs/Kwh) = AFC x 0.5/Design Energy (adjusted for Auxiliary

consumption and free power sale)

Total Energy Charge (Rs. Lakh) = Energy Charge (Rs/Kwh) x Actual Generation

The regulator has capped the energy charges at Re. 0.80 paisa per KWh. (for all
the hydro projects)
Following the division of AFC into Capacity Charge and Energy Charge, the
benefits and losses arising out of variation in water availability will be shared as
follows:

Till the tariff period 2004-09, the energy generated over and above the design
energy was sold to beneficiaries at the lowest variable cost of generation of a
thermal plant in their grid. However, according to the formula for energy charge
under the new regulations, a hydro power plant that has been in operation for
many years and has largely paid off its debt thereby resulting in lower AFC and
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hence a lower energy charge thereby loosing on the power generated over the
design energy. On the other hand, a new power plant will benefit from its higher
AFC by virtue of debt repayments and hence benefitting from a higher energy
charge (although capped at Re. 0.80).
Effort to Incentivize Peaking Load Generation
The CERC has emphasized the need for hydro power plants to meet the peaking
load requirements, and has stated the norms of operation for hydro power plants
by specifying the Normative Annual Plant Availability Factors (NAPAF). These
NAPAF are based on actual hydrological data for the period 2003-04 to 200708 for the existing stations.
Parameter for recovery of AFC

For complete recovery of Capacity Charges (as discussed above), a plant has to
achieve at least a PAF equal to the NAPAF. In case the actual PAF is higher than
the NAPAF, the generating company will be eligible for incentives, which
hitherto were linked to the Actual Capacity Index (under the earlier regulations).
PAF = Declared Capacity/Installed Capacity (Adjusted for Auxiliary Consumption)

where Declared Capacity is the ex-bus power that the station can deliver for at
least three hours as certified by the load dispatch centre after the day is over .As
a result, for achieving a high PAF, the generator will have to operate closer to
installed capacity for at least three hours and earn incentives instead of
operating at a steady load for longer periods.
On the negative side, the linking of recovery of AFC to NAPAF will negatively
impact such hydro power plants whose design energy during the lean season is
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not sufficient to generate three hours of peaking energy, thereby resulting in

lower PAF and under-recovery of AFC.
Transmission Licensees
As in the case of hydro power stations, much of the costs of transmission
companies are also fixed in nature. The components of AFC for transmission
companies also include the five components discussed under AFC for hydro
Power Projects.
Components of Capacity Charges/Annual Fixed Costs

Except for normative O&M costs, the other components of AFC are similar for
transmission companies and hydro power stations (these have been discussed
earlier in this report).
(e) Operation & Maintenance Costs
Normative O&M expenses for a transmission license under the 2004-09
regulations were allowed on the basis of the length of the transmission line in
circuit kilometers (CKm) and the number of substation-wise. These normative
O&M expenses were constant across voltages levels of the transmission lines
and substations. However, under the new regulations, the CERC has not only
defined O&M expenses on the basis of the voltage levels (higher O&M
expenses for higher voltages), but also allowed a considerable increase in these
O&M expenses over the previous regulatory period.

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Operational Norms for Recovery of AFC

the operating norms remain largely remain similar to what were prevailing in
the earlier regulatory period, except for a marginal reduction in the operating
norms for HVDC bi-pole links, which will have a marginally positive impact on
the profitability of transmission license by way of higher incentive income in
case of higher than normative availability.

Other Key Highlights

Billing and Payment
The regulator has maintained the rebates of 2% for timely payment and billings
supported by letter of credit (LC) and 1% for payment within one month. Late
payment surcharge for payment beyond 60 days has also been retained at
1.25%.
Sharing of CDM Benefits
The regulator has clarified the mechanism for sharing of benefits arising of the
adoption of Clean Development Mechanism (CDM). The CDM benefits for the
first year after Commercial Operation can be retained by the project developer.
During the second year, the developer would have to share 10% of the CDM
benefits with the beneficiaries; the figure will progressively increase by 10%
every year till it reaches 50%.
Recovery of Hedging Costs and Foreign Exchange Rate Variation
The CERC has retained the policy of recovery of hedging cost and foreign
exchange rate variation from the beneficiaries.

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CONCLUSION
The new tariff norms for power utilities announced by the Central Electricity
Regulatory Commission (CERC) for the period FY2009-14 will have an overall
positive impact on the profitability of the power sector. While some of the
measures such as a higher return on equity (RoE) will attract more investments
into the sector, the tightened norms for operations should lead to an overall
increase in efficiency in the system. The abolition of Advance Against
Depreciation (AAD) is however a credit negative for projects funded through a
shorter debt repayment tenure (post-commissioning).
While the regulations have provided for higher RoE, for thermal power
projects, the regulations have tightened the operational norms such as reduction
in heat rate for existing bigger units, linking of allowable heat rate to design
heat rate, tightening of working capital norms, reduction in Secondary Fuel Oil
(SFO) consumption norms, tightening of normative Operation & Maintenance
(O&M) Norms for plants with multiple units and reduction in auxiliary
consumption for bigger units. On the positive side, the regulations have
provided for a higher normative O&M expenses in view of significant increase
in employee expenses.
For Hydro Power projects, the regulations have suggested a partial sharing of
Hydrological risks by the project developer (though projects will be protected
during initial ten years of operation against hydrological risks). Further the
regulations have attempted to incentivize the project developers to meet peak
load requirements by linking the recovery of Annual Fixed Charges (AFC) and
incentive income with their ability to operate near to their installed capacities
for at least three hours a day. While these will pose operational challenges for
hydro power projects, on the positive side, the regulations have provided for a
significant increase in O&M expenses apart from a higher RoE.
The regulations are positive for transmission projects, as apart from higher RoE,
the normative O&M expenses for these projects are linked to the voltage levels,
as against the previous practice of similar normative O&M expenses across the
voltage levels.

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