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Friday, April 16, 2021

Texas lessons for power sector

Delicensing of power distribution will create an oligopoly ill-equipped to handle extreme weather and solar events


March 19, 2021 7:01:10 pm
Torrent Power also supplies power to Ahmedabad, Gandhinagar and Surat cities. (Representational image)

Written By Akash Malhotra

There have been reports that the Centre has circulated a draft Electricity Amendment Bill (2021) proposing changes to the Electricity Act, 2003. One of the proposed amendments entails de-licensing of the electricity distribution business to allow for multiple suppliers. Throwing his political weight behind these amendments, Prime Minister Narendra Modi said in a recent webinar: “A consumer should be able to choose his/her supplier as per performance like any other retail commodity.” This line of economic thinking is not new, but is based on the idea that you can treat electricity like onions, or just another retail commodity. This is exactly the premise on which the energy policy of Texas, an American state which suffered catastrophic power outages last month due to a snowstorm of unexpected intensity, is based. The humanitarian crisis that unfolded as millions of Texans ran out of power and water in freezing temperatures showed the world that electric kilowatt-hours are not like onions and pretending that they are is a recipe for disaster.

In terms of product non-differentiation, electricity is the ultimate standard product: Every jolt is exactly like the other. Therefore, we can understand the temptation faced by certain policymakers to experiment with the power sector and prove the virtues of the free-market. If onion crops fail, their price in the retail market rises, and people eventually consume less of it. However, unlike onions, electricity demand is inelastic: It doesn’t respond much to price, but it does respond to weather. In times of extreme heat or cold, demand rises and becomes even more inelastic. And, unlike in an ordinary market, supply must equal demand every minute of every day. If it doesn’t, the entire grid can fail. Texas narrowly escaped a state-wide blackout last month when its power grid was only about 4-and-half minutes away from a total collapse.

In a recent interview, Union Power Minister R K Singh claimed that delicensing the electricity distribution sector will induce competition and empower consumers to switch suppliers. He further stressed that the regulator will fix only ceiling prices. The envisioned system is quite similar to that existing in Texas, where George W Bush, then the governor, approved the top-to-bottom deregulation of the power market in 1999 citing a similar logic. As a consequence of deregulation, electric utilities in Texas are not required to maintain reserve capacity or invest in things like insulation to limit the effects of extreme weather. The theory was that no such regulation was necessary because the magic of the free-market would take care of everything. After all, a surge in demand or a disruption of supply—both of which happened during the snowstorm—will lead to high prices, generating big profits for any power supplier that manages to remain operational under adverse conditions. This creates economic incentives for electricity suppliers to invest in robust systems, precisely to take advantage of extreme price rise induced by adverse events.

This economic theory is deeply flawed as such a system would work “most of the time” like it did in Texas. But people don’t need electricity “most of the time”, they need it “all the time”. Electricity is essential to modern life in a way few other commodities can match. And it’s extremely doubtful whether even the prospect of sky-high profits during a shortage offers private energy suppliers enough incentive to take externalities of huge human and economic costs of a protracted power outage into account.

The monetary losses from the infamous power outage of July 2012 that affected half of the Indian population ran into lakhs of crores of rupees. We understand that when such huge externalities are involved, those goods and services are best provided by the public sector, and this is precisely the reason we don’t talk (or even think) of increasing competition in national defence or fire-fighting services.

Post delicensing, the central and state electricity commissions would have to set ceiling prices at stratospherically high levels and allow for variable-rate electricity contracts in the retail segment, if they want to incentivize private investment in disaster-proofing the distribution infrastructure. However, a system that depends on the incentives offered by extremely high prices in times of crisis isn’t workable, practically or politically. At first, those Texans who didn’t lose power in the snowstorm considered themselves lucky. But then the bills arrived—and some families found themselves being charged thousands of dollars for a few days of electricity. Politicians will argue in times of disaster, as they did in Texas, that no power company should get to earn a windfall because of a natural disaster. But if there is no opportunity of making windfall profits, the private distribution companies will have no incentive to invest in resilience. During normal times, price-sensitive consumers will tend to flock to the distributor with the cheapest and reliable (under normal circumstances) power on offer, leaving little financial incentives for discoms to invest in protection from extreme events. Any company that takes such precautions would put itself at a competitive disadvantage.

It could be argued that weather events like the Texan snowstorm are not likely in most parts of India. However, it is not only snowstorms; heatwaves and high ambient temperatures could also damage electricity transmission infrastructure. With climate change, we are witnessing (and should brace for) more frequent extreme weather events in unlikely geographies. And if not weather, we are constantly living under the risk of a geomagnetic storm in the earth’s ionosphere triggered by a burst of radiation from the sun, formally known as Coronal Mass Ejection (CME), that could damage the transmission lines and fry the power transformers. Averting this catastrophe requires investment in space-based surveillance and forecasting or at least, preparedness to react to alerts issued by space research agencies which starts from building a strategic transformer reserve, followed by other safeguarding measures.

In her Budget 2021-22 speech, Finance Minister Nirmala Sitharaman insisted that there is a need to provide choice to consumers by promoting competition and breaking monopolies existing in the power distribution sector. When policymakers talk about competition and free-markets, they are implicitly referring to Pareto-efficient allocation of economic resources that result from perfect competition — a market structure in which there are a large number of suppliers and consumers competing with one another and where firms can enter or exit the market without cost. This is simply not possible in the electricity sector as there will always be a significant barrier to entry in terms of infrastructure development costs. Delicensing, at best, will create an oligopoly ill-equipped to handle extreme weather and solar events. The recent electricity crisis in Texas gave the world a clear view of the dark (and cold) repercussions of unwarranted free-market fundamentalism; a lesson that should not be ignored.

The writer is an economist and a Fellow at UN Sustainable Development Solutions Network. Views expressed are personal

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