Report of Indian Institute of Public Administration ... - Ministry of Power

Karnataka
distribution business until such time as the electricity industry has achieved a stable
and sustainable financial condition. During the transition period, which will extend to
five years, the investors will only bear the risk of managing the operating cost and
capex of the distribution business, but will also share with Government of Karnataka
some of the risks by subjecting their returns on investments to penalties for nonachievement
of specified performance targets. They will also gain incentives for
efficiency improvements such as subsidy reduction, which would benefit the State
Government directly.
The major risks from which the consultants proposed protection to the privatised
distribution business included tariff risks (regulator not moving tariffs to the full cost
recovery levels), collection risks (arising from lack of support of the law enforcement
bodies, particularly in the rural areas), and commercial losses (especially theft
remaining high due again to lack of support from law enforcement authorities).
The consultants felt that by transferring the risks to the Government of Karnataka
during the transition period, it will be pressurised to manage the risks in such a way as
would lead the industry to financial stability. The strategy proposed by the consultants
for achieving the above was what is termed as “distribution margin” (DM), which is
explained below.
DISTRIBUTION MARGIN
Under this concept, the privatised distribution business would have the reasonable
assurance that it would be able to earn its revenue requirement provided it meets its
performance obligations and targets. The DM is compensation to the company for
operating the distribution satisfactorily. The DM will have two components, namely:
(i) Base revenue and (ii) Incentive charges.
The base revenue is the amount the company will be allowed to retain to meet its cost
of operating the business. It will be set taking into account the estimated total first
year cost of distribution services, plus a reasonable minimum equity rate of return. On
the other hand, the incentive charge will be a pre-defined proportion of the collection
above a minimum collection requirement, which the company may be allowed to
retain. The incentive charge will represent the investors’ return above the base return
on the equity fixed as part of the base revenue.
Bidding for the DISCOMs was to be on the basis of the lowest incentive charges to be
offered by the bidders. Further, the DISCOMs were to collect a minimum gross
revenue, what was called the ‘minimum collection requirement’ or MCR, which
3.23