Saturday, Feb 04, 2023

Renewable energy has a tariff problem. Here’s how to fix it

Shifting to a two-part tariff for solar and wind will incentivise private investments

In the case of hydropower generation, the fact is that we don’t have any valuation for water as we have for coal or gas and hence, hydro generators do not have any variable cost of generation.

Power generation tariffs in India comprise two parts. The first part is a fixed component – the cost that a generator incurs. This is not linked to the amount of power generated. The second part varies with the quantum of generation. The two-part tariff has been in vogue since 1992. It applies to thermal and hydro generation. It does not apply to renewable generation — solar, wind, and also nuclear. Under the two-part formula, the variable cost is calculated on the basis prescribed by the regulatory commissions. This is based on the cost of fuel — coal or gas or lignite — as the case may be. The fixed cost is also determined by regulatory commissions and it has a graded payment system depending on the extent to which the plant would be in a position to generate. The point here is that when a generator is in a position to generate, it gets to recover the fixed cost (or some part of it), irrespective of whether it actually generates power.

In the case of hydropower generation, the fact is that we don’t have any valuation for water as we have for coal or gas and hence, hydro generators do not have any variable cost of generation. The entire cost of a hydro station is fixed cost and notionally half of this cost is treated as variable cost.

In contrast, solar and wind generation and also nuclear are still governed by a single-part tariff. The single-part tariff applies to nuclear power stations for various reasons including the fact that given the technology, a nuclear generator does not usually increase/decrease the generation at a quick tempo, but maintains a steady stream. In any case, nuclear power accounts for only about two per cent of the entire generation, so let’s leave it aside. On the other hand, solar and wind generation account for about 10 per cent of the generation today and going by the statement delivered during COP26 in Glasgow, we want to ramp it up to 50 per cent by 2030.

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A few issues that need to be considered here. The renewable sector has been given a “must run” status. This means that any generation from renewables needs to be dispatched first. The logic is that if we do not use the sun’s rays or for that matter the wind velocity, it is lost forever. The state load dispatch centres (SLDCs) are under instructions to adhere to this principle. The problem is that “must run” runs counter to the basic economic theory that in order to minimise total cost, dispatch should commence from the source offering the cheapest variable cost and then move upwards. Here lies the problem.

With a single part tariff for renewable generation, the entire cost is variable and at Rs 2.5 per unit for solar generation, it is not the cheapest source. There are several NTPC coal-fired pit head plants whose variable costs are far lower, for example, Simhadri (Rs 1.36), Korba (Rs 1.36), Sipat (Rs 1.43), Vindhyachal (Rs 1.70), and Talcher (Rs 2.00). This list is only indicative and not exhaustive. In fact, Rs 2.5 per unit is only for those solar generators that are of recent origin. For the older solar plants, the tariff could be well above Rs 3 per unit and for wind-based generation, it is even higher, averaging around Rs 4.5 per unit. It is no surprise, therefore, that the SLDCs often flout the principle of “must run”, since the distribution companies would save money by asking the renewable generator to back down while keeping the tap on for a coal-based generation.

The solution to this problem is to apply a two-part tariff for solar and wind generators as we do for hydro plants today. But while in the case of hydro, 50 per cent of the total cost is attributed as a variable cost, what should be the principle for renewable generators?

The overriding principle is that the percentage allocated as variable cost should ensure that renewable generation has the lowest variable cost so that there is no violation of the “must-run” principle. At the same time, the fixed cost component should not be kept so high that it hurts the consumers. A fine balance between the proportion of the fixed and variable costs will have to be maintained. There are other benefits of introducing a two-part tariff for renewable generation. It would ensure a certain minimum return to developers even if they are not generating during certain hours, as in the case of coal and hydro plants.


With a single-part tariff, whenever the renewable generator is asked to back down for maintaining grid balance, it is paid nothing. If we are serious about having a renewable generating capacity of 450-500 GW by 2030, we need to create a proper environment and ensure adequate returns to invite fresh investments into renewable generation. One must remember that while the government may fix targets, implementation has to be done by private players and therefore, market signals are important.

The switch from a single to a two-part tariff structure for renewables has to be made right now as we are at the cusp of ramping up our renewable generation and it takes time for matters to get streamlined as we have seen in the past.

This column first appeared in the print edition on April 4, 2022 under the title ‘Ramping up renewables’. The writer is senior visiting fellow, ICRIER and former, Member (Economic & Commercial), CEA

First published on: 04-04-2022 at 03:50 IST
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