Recently, the Supreme Court has ordered DISCOMs and State Electricity Regulatory Commissions (SERCs) regulators to clear regulatory assets within fixed timelines, capping their creation to ensure financial discipline in the power sector

Key Directives of the Supreme Court

• Asset Clearance: All accumulated regulatory assets must be cleared within four years.

• Cap: Any newly created regulatory assets must be liquidated within three years.
• Financial Discipline: A cap on regulatory assets is advised at 3% of a DISCOM’s Annual Revenue Requirement (ARR) to promote transparency and fiscal responsibility.
• Significance: The Supreme Court’s judgment is a critical step toward addressing the systemic issue of unrecovered costs that has long plagued India’s electricity sector

Regulatory Assets

• Definition: Regulatory assets represent the unrecovered gap between the Average Cost of Supply (ACS) and the Annual Revenue Requirement (ARR) of a DISCOM.
• Average Cost of Supply (ACS): The actual cost incurred by a DISCOM to supply a unit of electricity.
• Annual Revenue Requirement (ARR): The total revenue collected from consumer tariffs and state government subsidies.
  • Mechanism: When the ACS exceeds the ARR, DISCOMs experience a loss on each unit sold. To prevent sudden and steep tariff hikes for consumers, regulators often permit this revenue shortfall to be recorded as a deferred cost, known as a regulatory asset. This asset is intended to be recovered in the future, typically with added interest.
• For example: if the ACS is Rs. 7.20 per unit and the ARR is Rs. 7.00, the shortfall is Rs. 0.20 per unit.
  • If 10 billion units are supplied, the total revenue gap is Rs. 2,000 crore. This gap is recorded as a regulatory asset instead of being recovered through an immediate tariff increase.

Causes of the ACS-ARR Gap

• Non-Cost Tariffs: Tariffs are often kept artificially low due to political pressure, failing to reflect the actual cost of supply.
• Delayed Payments: State governments frequently delay or fail to release timely subsidy payments to DISCOMs, which are meant to cover the cost of providing electricity to agricultural and low-income consumers.
• Price Volatility: Sudden increases in the price of fuels like coal or gas directly raise power purchase costs, widening the gap between ACS and ARR.
• Operational Inefficiencies: High transmission and distribution losses further exacerbate the financial stress on DISCOMs.

Impact of Regulatory Assets 

• Consumers: While regulatory assets initially shield consumers from tariff shocks, the deferred recovery eventually leads to steep hikes, including the addition of interest charges.
  • For example, Delhi DISCOMs would need to recover Rs. 16,580 crore annually over four years, adding around Rs. 5.5 per unit to electricity costs.
    
• DISCOMs: Prolonged reliance on regulatory assets leads to cash flow crises, making it challenging to pay power generators and causing DISCOMs to borrow, increasing their debt burden. 
  • This financial strain hampers investments in grid modernization, renewable integration, and consumer services, perpetuating inefficiency.

Measures to Bridge the Gap

• Cost-Reflective Tariffs: Tariffs should be aligned with actual supply costs. However, this must be balanced with targeted subsidies to protect vulnerable consumers.
• Timely Subsidy Release: State governments must ensure punctual disbursement of subsidy payments to DISCOMs.
• Automatic Fuel Adjustment: Implementing mechanisms like the Fuel and Power Purchase Cost Adjustment (FPPCA) can allow tariffs to quickly adapt to market changes in fuel prices.
• Annual True-up Exercises: Regular reconciliation of projected and actual costs can prevent the accumulation of large backlogs.
• Regulatory Discipline: SERCs must enforce transparent accounting practices, cap regulatory assets, and set strict timelines for their recovery.

Global Best Practices

• Regulated Asset Base (RAB) Model (UK): This model allows utilities to recover their investments through tariffs with assured returns, providing long-term revenue certainty.
• RIIO Framework (Revenue = Incentives + Innovation + Outputs) (UK): This framework links a utility’s revenue to its performance targets, such as reliability, service quality, and carbon reduction, thereby incentivizing efficiency.
• Digital Infrastructure: The use of smart grids and platforms like the India Energy Stack can enhance transparency in asset management and support efficiency-based recovery models.

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