Fixed charges: boon or bane for electricity consumers?

With the recent Discos tariff determination by power regulator Nepra, fixed charges have been introduced for domestic consumers, and industrial fixed charges have been increased by almost 300%.

On June 14, 2024, Nepra also determined the National Average Power Purchase Price as 27 rupees per unit and the Average Electricity Selling Tariff as 35.5 rupees per unit, which is nearly 19% higher than last year. Although the consumer-end tariff notification for the next fiscal year for this two-part tariff has yet to be issued, this determination has sparked a debate about the implications of fixed charges.

In academics, two basic definitions of cost segregation for businesses are taught: fixed costs and variable costs. Fixed costs are expenditures that do not change regardless of the level of production, at least in the short term. Whether you produce a lot or a little, the fixed costs remain the same.

Variable costs, on the other hand, are incurred in the act of producing—the more you produce, the higher the variable costs. Every business faces these costs and must plan optimally to allocate resources and minimize the mix of these costs. The power sector faces similar issues. We have created significant fixed costs in the form of capacity charges and are struggling to optimize power dispatch, which generates variable costs in the form of energy costs.

The Pakistan power sector has fixed costs associated with an installed generation capacity of almost 45,000 MW. However, our transmission network can only dispatch around 21,000 MW on a hot summer day due to temperature degradation and up to 26,000 MW under optimal summer conditions.

Although the overall demand on the power system has been decreasing over the past two years due to economic conditions and expensive tariffs, even if customers wanted to use more electricity, they couldn’t due to transmission and distribution bottlenecks.

Load shedding in the country clearly highlights the impact of these bottlenecks. This raises the question of why customers should bear the capacity costs resulting from poor planning that has led to increased fixed costs. For FY 2024-25, the total Power Purchase Price is 3,534 billion PKR, of which 64% is fixed capacity costs (2,266 billion PKR) and 36% is variable energy costs (1,268 billion PKR).

The question here is can a business pass their inefficiency cost to the customers in a competitive environment? Currently, industries are facing similar issues to the power sector, such as idling capacity and underutilization due to tight economic conditions.

While Power Division operating DISCOs as a monopoly, can pass these costs on to consumers, industries operating in a competitive environment cannot do the same. This inability to pass on costs will likely lead to further shutdowns.

There are many ways to reduce the cost of electricity, such as increasing production or demand (which lowers fixed capacity costs per unit) and by reducing transmission and distribution losses. A 1% reduction in T&D losses could save 1,062 GWh (1,062 million units) at current sales projections, translating to 37.7 billion PKR in revenue at the current national average power price of 35.5 PKR per unit. However, the government has opted to pass inefficiency costs onto customers instead of addressing these potential savings.

One more point to highlight is that the sanctioned load of customers, on which fixed charges are implemented, is much higher than the actual demand or supply by the distribution company due to the diversity factor. The diversity factor recognizes that the total load is not simply the sum of its parts because of time interdependence or “diversity.”

Therefore, the sanctioned load of individual customers is much higher than that of an individual Disco. This factor must be considered when implementing fixed charges. Nepra should devise a formula to cross-check the collection from fixed charges against the entire database of sanctioned loads for all customers in Pakistan.

The implications of a 300% increase in fixed charges could be severe for industries. A typical industry is currently operating at only 50% production capacity and is unable to spread its internal fixed costs effectively.

Fixed charges of 2,000 PKR per kW per month would translate to almost 9 PKR per unit on a variable unit consumption basis for industry operating at 50% production capacity. Previous fixed charges for industries ranged from 460 to 500 PKR per kW per month, so the increase should be capped at 400 PKR. This would result in final fixed charges of around 860 to 900 PKR per kW per month.

As mentioned earlier, fixed costs can be rationalized with increased utilization. Therefore, adopting a stepwise approach to increasing fixed charges, starting with an increment of 400 PKR per kW per month for this year, would allow industries to adjust gradually.

This strategy holds the potential for further increases next year as economic conditions are anticipated to improve, enabling industries to ramp up production and offset these charges.

On the other hand, there is an argument that certain users, such as those with captive power or distributed generation, are using grid services like voltage regulation, frequency regulation, reactive power, and backup power without adequately paying for these services. Therefore, they should share the cost of maintaining the grid for these services.

There should be an optimal level for fixed charges that does not force consumers to leave the grid or seek alternatives. The concept of a two-part tariff is not new; it is common worldwide. However, what is urgently needed is competition in the power sector and the immediate implementation of the CTBCM (competitive trading bilateral contracts market), first at the wholesale level and then at the retail level.

With competition, consumers will have the option to choose from different electric suppliers offering various pricing models, such as flat tariffs, peak and off-peak tariffs, or two-part tariffs.

Copyright Business Recorder, 2024