By Dr Tilak Siyambalapitiya Courtesy The Island

At a time the entire society is confused about who does what in determining electricity costs and prices, it would be useful for the learned and intelligent Sri Lankans to examine the correct procedure. What is written here is practiced across the civilized world, in countries where electricity generation is not a monopoly but electricity supply is still a monopoly. That includes India.

Five activities to get electricity to customer

Electricity industry comprises five businesses: electricity production, transmission, bulk supply, distribution, and retail supply. Transmission and distribution are natural monopolies, since there cannot be several companies building their own lines in the same geographic area to facilitate competition. However, electricity production, bulk supply and retail supply can be open for competition. Competition in generation can be at the initial procurement (as in Sri Lanka) or through short-term competitive contracts. They can be day-ahead competitive procurements (eg: India) or real-time competition. In Sri Lanka, electricity generation is open for private investments. If the investment is private, what is procured competitively is a power purchase agreement. If the power plant is to be CEB’s own”, then what is procured is a turnkey contract” to supply, install and commission a power plant. If the power plant is based on renewable energy up to 10 megawatt and private, electricity is purchased on feed-in-tariffs (some are competitively procured, too). For bigger renewable energy power plants, the law previously said it must be procured competitively, but a few months ago, the government changed the law to imply competition is not required.

Procurement is not the theme of this article. Once a power supply system is in place, how does one calculate the costs and then pass it down to customers in the form of tariffs?

Just like any other industry, electricity supply industry costs, too, can be divided into fixed costs and variable costs.

Fixed Costs

Fixed costs relate to the capacity” of electricity production and delivery. A power plant built with a loan requires the loan principal and interest to be paid. The equity investment on the power plant should yield a return on investment. If the power plant is a private investment, its fixed cost are called capacity charges” stated in the power purchase agreement in which the investors commitments to his banks and co-investors are included. Transmission and distribution lines, and various equipment at substations, too, require investments. There will be debt repayments and return on investments, too, required for such investments.

Fixed costs are independent of the amount of electricity produced. Supply of electricity requires a certain level of reliability of service to be assured. Investments on power plants, transmission lines and distribution lines should ensure the required capacity (amount of current), reliability (no power cuts, blackouts) or quality (no brownouts) are available to electricity customers.

Electricity regulators in most countries in the world review fixed costs submitted by electricity suppliers, compare with norms, examine opportunities to be progressively cost efficient” and then approve the fixed costs. Fixed costs so approved include depreciation, interest costs, maintenance costs, spare parts, and staff salaries, and profits. Since electricity industry cost regulation includes a pre-defined profit, a return on investment is also included in the fixed costs. Since fixed costs do not vary rapidly, they are approved, upfront, for three years or five years. This time-interval, for which fixed costs are approved, is called the tariff period”. Sri Lanka, from 2011 to 2020, followed a five-year tariff period, and since 2021, follows a three-year tariff period. Presently, the active tariff period is 2021-2023.

So, fixed costs are totally independent of how much of electricity is produced. Fixed costs are incurred anyway, literally, even if a single unit of electricity is not produced or purchased by customers.

Variable costs

Variable costs are proportional to the energy delivered. Energy is measured in kilowatthour (commonly called units of electricity). Fuel costs are incurred when a thermal power plant, or a biomass power plant, is operated. For renewable energy power plants, such as hydropower, wind and solar energy, there are no fuel costs. Their variable costs, that mean costs that depend on the quantity of energy delivered, if any, are very small.

When a thermal power plant operates, there will be costs on fuel, lubricating oil and other maintenance expenses. These costs are expressed, based on one unit of electricity (a kilowatt hour). If the power plant is private, the price paid per unit of electricity is based on the price of fuel, as stated in the respective agreement. Almost all agreements do not carry any mark-up on production costs. Investor’s profits are built into the fixed costs. For renewable energy power plants that sell electricity to the grid, without any storage, their costs, too, is based on electricity produced to the grid. Since generation costs depend heavily on hydrology and fuel prices, variable costs are required to be submitted for approval, once in 12-months, but represented in two six-monthly intervals, i.e. January-June and July-December.

Regulatory procedure and timetable to approve costs and prices

The Electricity Act 2009 specifies that a tariff methodology” must be established by the regulator, PUCSL. This tariff methodology” is available in the public domain for anyone to study. Electricity transmission and distribution license holders (currently CEB and LECO) must submit their costs, based on a specific format, which are then reviewed and approved by PUCSL. Submissions for transmission and distribution must be once in three years. These formats, too, are available on-line for public to view. This has been done for the window 2021-2023.

The timetable for cost and price review and who submits what, in which format, are all defined in the Electricity (Procedure for Review and Adjustment of Tariffs) Rules No. 03 of 2016”, published in Gazette No. 1978/21, dated 2nd August, 2016. For example, the rules say On or before the last working day of April, the Licensee shall submit to the Commission the following (using the templates approved by the Commission)” and provides a list of documents. It goes on to say On or before the last working day of May of each year the Commission shall prepare the Draft Tariff Estimates using the Tariff Methodology and post the Draft Estimated Tariffs in its Website.” None of these happen on schedule.

The timetable has been largely ignored by CEB/LECO as well as by PUCSL itself who issued the timetable. However, delayed submissions and delayed decisions have been published from time to time, about costs and prices.

Most recent Published costs

Cost estimates for 2023 have not been submitted by CEB+LECO to PUCSL, as it has been widely stated in the media. Apparently, costs have been submitted to the Ministry. Thus, we have to go by the costs approved by PUCSL for the first half and second half of 2022. Sri Lanka’s national average price of electricity, right now, is Rs 30.13 per unit, which is closer to the costs approved by PUCSL and included in electricity prices announced in August 2022. However, it is clear that the costs of the second half of 2022 of Rs 48.45 per unit, published by PUCSL, would not be covered by charging the present price of Rs 30.13 per unit.

We do have to remember that fixed costs” include depreciation, interest payments, staff, spare parts and a fixed return on investment (i.e. profit). If CEB and LECO agree to forego the profits, the fixed costs” will be lower. Depreciation allowed is expected to finance debt repayments related to investments and for equity for ongoing or future investments. If debts are not being repaid, what happens to the cash set aside for depreciation is a question.

Even if depreciation, interest payments and return on equity are taken out of the calculation of pure cashflow requirements, still the following questions require answers:How much of electricity is planned to be produced, in 2023, from diesel and other petroleum fuels? Actual production from these expensive oils, in 2021, was 21%. Seven years ago, the long-term plan stated that only 13% of electricity will be produced from oil in 2021. So, what happened and where did it go wrong? For 2023, the plan of 2015 said only 9% will be produced from oil, but how much does CEB plan to produce from oil and who is responsible for the gap?

At what price is oil bought to produce electricity. A barrel of diesel is now about USD 100 delivered to Colombo, and a barrel has 160 litres. A small calculation yields that a litre of diesel should be Rs 231, since there are no delivery or retail costs to be added to the import costs. Electricity production does not get oil at these actual international prices. Fuel oil should be still cheaper.

However, it is clear that the delay in getting the full quantity of coal for the Norochcholai power plant (2022-23), the absence of Sampur (was due 2021-22) and Norochcholai No 4 generator (due 2024-25) all cancelled by politicians, and numerous renewable energy power plants delayed or cancelled by various people, and the absence of a gas terminal, may require at least 28% of next year’s electricity to be produced, using the killer fuel, oil.

Once the costs are reviewed and approved, they must be converted to a price schedule. The theory of pricing is taught to all electrical engineers, and it is not too complicated to be learned by anyone.PUCSL’s own approved costs for the second half of 2022 are Rs 48.45 per unit, or about 15 US cents per unit. Internationally, 15 US cents is considered a high” cost of electricity. If CEB was private”, the entire Rs 48.45 would have to be paid, even for the past six months. Thus what is important first, is to get the generation costs down, which for the past six months, was an exorbitant Rs 37 or 10 US cents per unit.