Generators should respond to market signals

One of the last remaining relics of central planning that persists in Indian economy is in power generation. State-owned generators continue to set up high-cost power plants on considerations other than economic efficiency and viability and leaves the state distribution utility with no option but to purchase the power at whatever tariff. The generator's inefficiencies and resultant higher cost of power purchase is passed on to the consumers and tax payers.

In this context, without the usual fanfare associated with important policy decisions, the Ministry of Power, Government of India recently started implementing one of the most progressive reforms in power sector. As part of the National Tariff Policy, it has mandated that from January 5, 2011, all power purchases by distribution utilities should be only through tariff-based competitive bidding. As I have blogged earlier, the tariffs in competitive bids have been generally much lower than that arrived at through cost-plus tariff based PPAs.

It now emerges that, despite the clear mandate of Para 5.1 of the National Tariff Policy, several state government are trying to get round this decision on competitive tariff-based power purchases. They are taking the plea that this would not apply to them without the state regulator's approval. And given the evident lack of autonomy of most state regulators, it is almost certain that most of them will not notify this provision.

Given their high cost of power generation, the mandatory requirement for competitive bids would have effectively shut the door for state-owned generators. Instead of setting up power plants and then thrusting it on utilities, generators would now have to participate in open-competitive tenders and win the right to sell their power. Their high cost of power means that they are most likely to be priced out in any competitive bidding process and even from the short term markets.

Accepting such reforms would require generators to abandon their current supply-driven investment strategies and adopt capacity addition strategies that are demand-based. Generators would have to calibrate their investment decisions to the market signals and not invest in new plants based on extraneous considerations.