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T Sustainable Power for Maharashtra Electricity Markets and Reforms Blueprint Ishita Ghosh – GreenEarth Social Development Consulting Pvt. Ltd. March 2013 l Version 2 - Draft for Approval © Maharashtra NavNirman Sena Table of Contents IS ELECTRICITY A PUBLIC OR A PRIVATE GOOD? .......................................................................................... 2 WHAT QUALIFIES FOR PUBLIC VS. A PRIVATE GOOD? ................................................................................................. 2 ARE ALL PUBLIC GOODS MEANT FOR SOCIAL WELFARE? .............................................................................................. 4 IS THERE AN EFFICIENCY YARDSTICK FOR THE PRODUCTION OF PUBLIC GOODS? ............................................................... 7 CAN THE GOVERNMENT PROVIDE ELECTRICITY FREE OF COST? ..................................................................................... 8 WHY SHOULD ELECTRICITY BE TREATED AS A MERIT GOOD? ...................................................................................... 10 A BRIEF OVERVIEW OF WHAT ELECTRICITY MARKETS ARE ........................................................................ 17 WHAT ARE THE CHARACTERISTICS / NATURE OF THE ELECTRICITY MARKET? ................................................... 17 ELECTRICITY TARIFFS: THE UNDERLYING PRINCIPLES AND PRACTICE ........................................................ 50 WHAT IS AN ELECTRICITY TARIFF? ....................................................................................................................... 50 RECOMMENDED PRINCIPLES TO BE USED IN DETERMINING AN ALTERNATIVE ELECTRICITY TARIFF STRUCTURE ............................................................................................................................................... 73 CURRENT TARIFF ADJUSTMENT MECHANISM ........................................................................................... 79 LESSONS FOR MAHARASHTRA FROM THE REFORMS IN ELECTRICITY MARKETS BY WORLD ECONOMIES . 82 GOVERNANCE – 1 ................................................................................................................................... 139 MARKET STRUCTURE AND GOVERNANCE ................................................................................................. 139 GOVERNANCE – 2 ................................................................................................................................... 185 REGULATION OF ELECTRICITY/POWER MARKETS ..................................................................................... 185 GOVERNANCE – 3 ................................................................................................................................... 208 ACCESS AND AFFORDABILITY TO ELECTRICITY SERVICES .......................................................................... 208 GOVERNANCE – 4 ................................................................................................................................... 235 IMPLEMENTING ELECTRICITY/POWER MARKET REFORM ........................................................................ 235 GLOSSARY ................................................................................................................................................. 258 A ROAD MAP FOR MAHARASHTRA ......................................................................................................... 272 SHORT AND MEDIUM TERM.............................................................................................................................. 272 LONG TERM.................................................................................................................................................. 279 REFERENCES ............................................................................................................................................ 282 Electricity Markets and Reforms 1 Is Electricity a Public or a Private Good? What qualifies for public vs. a private good? In any economy, there are certain commodities and services that the government pledges to provide to the people because they are considered essential for social and economic welfare. These are made available at a cost or free, depending upon the nature of the good in question. Vis-à-vis this, there are goods that are not essential for welfare. When such goods have to be purchased, it depends on the individual’s willingness and ability to buy such items. Whether the government provides a good or not, all commodities and services have to be bought and sold in markets. When we talk of markets in economics, we essentially are interested in how a commodity is being traded or is being made available to the consumer. This is largely determined by the nature of the good in question – whether, public or private. The following discussion and argument is to determine whether electricity is a public or private good. Paul A. Samuelson is usually credited as the first economist to develop the theory of public goods. In his classic 1954 paper The Pure Theory of Public Expenditure, he defined a public good, or as he called it in the paper a "collective consumption good", as follows: … *goods+ which all enjoy in common in the sense that each individual's consumption of such a good leads to no subtractions from any other individual's consumption of that good...This is the property that has become known as Non-rivalry. In addition a pure public good exhibits a second property called Non-excludability: that is, it is impossible to exclude any individuals from consuming the good. A public good is a good that is non-rivalrous and non-excludable. In plain terms, Exclusive means it is reasonably possible to prevent a class of consumers (e.g. those who have not paid for it) from consuming the good. Rivalrous means consumptions by one consumer prevent simultaneous consumption by other consumers. Private goods satisfy an individual want while public good satisfies a collective want of the society1. This means that for a commodity to be called a “public good”, the consumption of the good by one individual does not reduce availability of the good for consumption by others; and that no one can be effectively excluded from using the good. In the real world, there may be no such thing as an absolutely non-rivaled and non-excludable good; 1 Hal R. Varian, Microeconomic Analysis ISBN 0-393-95735-7; Mas-Colell, Whinston & Green, Microeconomic Theory ISBN 0-19-507340-1; or Gravelle & Rees, Microeconomics ISBN 0-582-40487-8. Electricity Markets and Reforms 2 but economists think that some goods approximate the concept closely enough for the analysis to be economically useful. For example, if one individual visits a doctor there is one less doctor's visit for everyone else, and it is possible to exclude others from visiting the doctor; it is a rivaled and excludable private good. Conversely, breathing air neither significantly reduces the amount of air available to others, nor can people be effectively excluded from using the air. This makes it a public good, but one that is economically trivial, as air is a free good. A less straight-forward example is the exchange of MP3 music files on the internet: the use of these files by any one person does not restrict the use by anyone else and there is little effective control over the exchange of these music files.2 The opposite of a public good is a private good, which does not possess these properties. It is safe to assume that a private good, on the other hand, is clearly excludable and rivalrous and are almost exclusively made for profit. A loaf of bread, for example, is a private good: its owner can exclude others from using it, and once it has been consumed, it cannot be used again. Non-rivalness and non-excludability may cause problems for the production of such goods. Specifically, some economists have argued that they may lead to instances of market failure, where uncoordinated markets driven by parties working in their own self interest are unable to provide these goods in desired quantities. These issues are known as public goods problems, and there is a good deal of debate and literature on how to measure their significance to an economy, and to identify the best remedies. These debates can become important to political arguments about the role of markets in the economy. More technically, public goods problems are related to the broader issue of externalities.3 A good which is rivalrous but non-excludable is sometimes called a common pool resource. Such goods raise similar issues to public goods: the mirror to the “public goods problem” for this case is sometimes called the tragedy of the commons. For example, it is so difficult to enforce restrictions on deep sea fishing that the world's fish stocks can be seen as a non-excludable resource, but one which is finite and diminishing. As per the definition of non-excludability, we know that it is impossible to exclude individuals from consumption. Though, technology now allows radio or TV broadcasts to be encrypted such that persons without a special decoder are excluded from the broadcast; however, an unencrypted broadcast is still non-excludable. Many forms of creative works have characteristics of public goods. For example, a poem can be read by many people without reducing the consumption of that good by others; in this sense, it is non-rivalrous. Similarly, the information in most patents can be used by any party without reducing consumption of that good by others.

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