From Degenerate Flat Tariff to Rational Flat Tariff Regime

Flat tariff for farm power is universally written off as inefficient, wasteful, irrational and distortionary, in addition to being inequitable. In the South Asian experience, it has indeed proved to be so. It was the change to flat tariff that encouraged political leaders to indulge in populist whims such as doing away with farm power tariff altogether (as Punjab and Tamil Nadu have) or to peg it at unviably low levels regardless of the true cost of power supply. Such examples have led to the general perception that the flat tariff regime has been responsible for ruining the electricity industry and for causing groundwater depletion in many parts of South Asia.

However, we would like to suggest that flat tariff regime is wrongly maligned; in fact, the flat tariff that South Asia has used in its energy-irrigation nexus so far is a completely degenerate version of what might otherwise be a highly rational, sophisticated and scientific pricing regime. Zero tariff, we submit, is certainly not a rational flat tariff; nor is a flat tariff without proactive rationing and supply management. To most people, the worst thing about flat tariff is that it violates the marginal cost principle that advocates parity between the price charged and marginal cost of supply. Yet, businesses commonly price their products or services in ways that violate the marginal cost principle but make overall business sense. Flat rates are often charged to stimulate use to justify the incremental cost of providing a service. In early days of rural electrification, SEBs used to charge a flat-cum-pro-rata tariff to achieve two ends: SEBs wanted each tube well to use at least the amount of power that would justify its investment in laying cable and poles; the flat component of the tariff encouraged users to achieve this level. India's telephone department still provides the first 250 calls for a flat charge even though all calls are metered; the idea here is to encourage the use of telephone service to a level that justifies the incremental cost of providing the service.

In general, however, flat tariff regime is commonly resorted to when saving on the transaction costs of doing business is an important business objective. Organizations hire employees on piece rate when their work is easy to measure; but flat rate compensation is popular worldwide because it is not easy to measure the marginal value product of an employee on a daily basis. Urban public transport systems offer passes to commuters at an attractive flat rate in part because commuters offer a stable business but equally because it reduces queues at ticket windows, the cost of ticketing and collecting fares daily. Cable operators in India still charge a flat tariff for a bunch of television channels rather than charging for each channel separately because the latter would substantially increase their transaction costs. The Indian Income Tax Department a few years ago offered all businesses in the informal sector to pay a flat income tax of Rs 1400 ($30.44)/year instead of launching a nationwide campaign to bring these millions of small businesses within its tax net because the transaction costs of doing so would have been far greater than the revenue realized. A major reason municipal taxes are levied on a flat rate is the transaction costs of charging citizens based on the value they place on the margin of the municipal services.

Are all these businesses that charge for their products or services on a flat rate destined to make losses? No; often they make money because they charge a flat rate. Many private goods share this one feature with public goods like municipal services and defence: the high transaction costs of charging a differential price to different customers based on their use as well as the value they place on the product or service. So they recover their costs through a flat rate and then remain viable through deft supply management. Canal irrigation is a classic example. For ages we have been hearing about the exhortations to charge irrigators on volumetric basis; however, nowhere in South Asia can we find volumetric water pricing practised in canal irrigation. In our view, transaction costs of collecting volumetric charge for canal irrigation become prohibitively high (Perry, 1996, 2001) because: (i) in a typical South Asian system, the number of customers involved per 1000 ha command is quite large; so the cost of monitoring and measuring water use by each user would be high; (ii) once a gravity flow system is commissioned, it becomes extremely difficult in practice for the system managers to exclude defaulting customers from the command area from availing of irrigation when others are; (iii) the customer propensity to frustrate sellers' effort to collect a charge based on use would depend in some ways on the proportion the charge constitutes to the overall scale of his or her income. On all these counts, one can surmise that volumetric pricing of canal irrigation would be far easier in South African irrigation systems serving white commercial farmers; here, a branch canal serving 5000 ha might have 10-50 customers, and charging them based on actual use would be easier than in an Indian system where the same command area would contain 6000-8000 customers (Shah et al., 2002). The only way of making canal irrigation systems viable in the Indian situation is to raise the flat rate per hectare to a level that ensures overall viability.

Supply restriction is inherent to rational flat rate pricing; by the same token, flat rate pricing and on-demand service are incompatible in most situations. In that sense, consumption-linked pricing and flat rate pricing represent two different business philosophies: in the first, the supplier will strive to 'delight the customer' as it were, by providing on-demand service without quantity or quality restrictions of any kind; in the second, the customer has to adapt to the supplier's constraints in terms of the overall quantum available and the manner in which it is supplied. In the case of buffet meals, restaurants give customers a good deal but save on waiting costs, which are a substantial element in the economics of a restaurant. In the Indian thali system, where one gets a buffet-type meal served on one's table, the downside is that one cannot have a leisurely meal since the restaurant aims to maximize the number of customers served during a fixed working period and in limited space. Thus, there is always a price for the value businesses offer their customers through products and services offered on flat tariff; but that does not mean that the seller or the buyer is any the worse for flat rate pricing.

The reason why flat rate tariff for power supply to WEMs as currently practised in South Asia is degenerate - and power industry is in the red - is because the power utilities have failed to invest more intelligence in managing rationed power supply. Under flat tariff systems until now, most SEBs have tried to maintain farm power supply at 8-15 h/day right through the year. Raising flat tariff to a level that covers the cost of present levels of supply would be so high that it will send state governments tumbling in the face of farmer wrath.15 However, we believe that it is possible for the SEBs to satisfy farmer needs while reducing total power supply to farmers during a year by fine-tuning the scheduling of power supply to irrigation needs of farmers. Ideally, the business objective of a power utility charging flat tariff should be to supply the best quality service it can offer its customers consistent with the flat tariff pegged at a given level. The big opportunity for 'value improvement' in the energy-irrigation nexus - and by 'value improvement' we mean 'the ability to meet or exceed customer expectations while removing unnecessary cost' (Berk and Berk, 1995, p. 11) - arises from the fact that the pattern of power demand of the farming sector differs in significant ways from the demand pattern of domestic and industrial customers. The domestic consumers' idea of good-quality service is power of uniform voltage and frequency supplied 24 h/day, 365 days of the year. But the irrigators' idea of good-quality service from power utilities is power of uniform voltage and frequency when their crops face critical moisture stress. With intelligent management of power supply, we argue that it is possible to satisfy irrigation power demand by ensuring a supply of 18-20 h/day for 40-50 key moisture-stress days in kharif and rabi seasons of the year, with some power available on the rest of the days. Against this, Tamil Nadu supplies power to farmers 14 h/day for 365 days of the year! This is like being in the command area of an irrigation system with all branches and the distribution network operating at full supply level every day of the year.

Groundwater irrigators are always envious of farmers in the command areas of canal irrigation projects. But in some of the best irrigation projects in South Asia, a typical canal irrigator gets surface water for no more than 10-15 times a year. In most irrigation systems, in fact, the irrigator would be happy if he or she got water 6 times a year. In the new Sardar Sarovar project in Gujarat, the policy is to provide farmers a total of 53 cm depth of water in 5-6 installments during a full year. For an irrigation well with a modest output of 25 m3/h, this would mean the ability to pump for 212 h/ha. In terms of water availability, a WEM owner with 3 ha of irrigable land would be at par with a farmer with 3 ha in the Narmada command if he or she got 636 h of power in a year. The WEM owner would be better off if the 636 h of power came when he or she needed water the most. When the Gujarat government commits to year-round supply of 8 h/day of farm power, it in effect offers tube well owners water entitlements 14 times larger than those that the Sardar Sarovar project offers to farmers in its command area.16 Under metered tariff, this may not matter all that much since tube well owners would use power and groundwater only when their value exceeded the marginal cost of pumping; but under flat tariff, they would have a strong incentive to use some of these 'excess water entitlements' for low marginal value uses just because it costs them nothing on the margin to pump groundwater. This is why the present flat tariff in South Asia is degenerate.

Rational flat tariff, if well managed, can confer two larger benefits. First, it may curtail wasteful use of groundwater. If farm power supply outside main irrigation seasons is restricted to 2-3 h/day, it will encourage farmers to build small on-farm storage tanks for meeting multiple uses of water. Using progressive flat tariff - by charging higher rates per connected horsepower as the pump size increases - will produce additional incentive for farmers to purchase and use smaller-capacity pumps to irrigate less areas, and thereby reduce overdraft in regions where resource depletion is rampant. Above all, restricted but predictable water supply will encourage water-saving irrigation methods more effectively than raising the marginal cost of irrigation. Second, given the quality of power transmission and distribution infrastructure in rural India, restricting the period of time when the farm power system is 'on' may by itself result in significant reduction in technical and commercial losses of power. The parallel with water supply systems is clear here. In a 1999 paper, for example, Briscoe (1999) wrote that throughout the Indian subcontinent, unaccounted-for water as a proportion of supply is so high 'that losses are "controlled" by having water in the distribution system only a couple of hours a day, and by keeping pressures very low. In Madras, for example, it is estimated that if the supply was to increase from current levels (of about 2 hours supply a day at 2 m of pressure) to a reasonable level (say 12 hours a day at 10 m of pressure) leaks would account for about 900 MLD, which is about three times the current supply in the city.' Much the same logic works in farm power, with the additional caveat that the T&D system for farm connections is far more widespread than the urban water supply system.

Five preconditions for successful rationing

We believe that transforming the present degenerate flat power tariff into rational tariff regime will be easier, and more feasible and beneficial in the short run in many parts of South Asia than trying to overcome farmer resistance to metering. We also believe that doing so can significantly cut the losses of power utilities from their agricultural operation. Five points seem important and feasible.

Separating agricultural and non-agricultural power supply

The first precondition for successful rationing is infrastructural changes needed to separate agricultural power supply from non-agricultural power supply to rural settlements. The most common way this is done now is to keep two-phase power on for 24 h so that domestic and (most) non-agricultural uses are not affected and ration three-phase power necessary to run irrigation pump sets. This is working, but only partially. Farmers' response in states like Gujarat is a rampant use of phase-splitting capacitors with which they can run pumps on even two-phase power. There are technological ways to get around this. It is possible to use gadgets that ensure that the 11 kV line shuts off as soon as the load increases beyond a predetermined level. However, many SEBs have begun separating the feeders supplying farm and non-farm rural consumers. The government of Gujarat has now embarked on an ambitious programme called Jyotirgram Yojana to lay parallel power supply lines for agricultural users in 16,000 villages of the state over the next 3 years at an estimated cost of Rs 9 billion ($195.7 million). In Andhra Pradesh, the process of separation of domestic and agricultural feeders is already 70% complete (Raghu, 2004). This would ensure that industrial users in the rural areas who need uninterrupted three-phase power supply as well as domestic users remain unaffected from rationing of power supplies for agricultural consumers. Another infrastructural change needed would be to install meters to monitor power use so that proper power budgeting can be implemented. For this, meters at transformer level, or even feeder levels, might be appropriate. Many states have already installed meters at the feeder level.

Gradual and regular increase in flat power tariff

Flat tariffs have tended to remain 'sticky'; in most states, they have not been changed for more than 10-15 years while the cost of generating and distributing power has soared. We surmise that raising flat tariff at one go to close this gap between revenue and cost per kWh would be too drastic an increase. However, we believe that farmers would be able to cope with a regular 10-15% annual increase in flat tariff far more easily than a 350% increase at one go as has been proposed by the Electricity Regulatory Commission in Gujarat.

Explicit subsidy

If we are to judge the value of a subsidy to a large mass of people by the scale of popular opposition to curtailing it, there is little doubt that, amongst the plethora of subsidies that governments in India provide, power subsidy is one of the most valued. Indeed, a decision by a ruling party to curtail power subsidy is the biggest weapon that opposition parties use to bring down a government. So it is unlikely that political leaders will want to do away with power subsidies completely, no matter what the power industry and international donors would like. However, the problem with the power subsidy in the current degenerate flat tariff is its indeterminacy. Chief ministers keep issuing diktats to the SEBs about the number of hours of power to be supplied per day to farmers; that done, the actual subsidy availed of by the farmers is in effect left to them to usurp. Instead, the governments should tell the power utility the amount of power subsidy it can make available at the start of each year; the power utility should then decide the amount of farm power the flat tariff and the government subsidy can buy.

Use of off-peak power

In estimating losses from farm power supply, protagonists of power sector reform, including international agencies, systematically overestimate the real opportunity cost of power supplied to the farmers. For instance, the cost of supplying power to the domestic sector - including generation, transmission and distribution - is often taken as the opportunity cost of power to agriculture, which is clearly wrong, since a large part of the high transaction costs of distributing power to the domestic sector is saved in power supply to agriculture under flat tariff. Moreover, a large part of the power supplied to the farm sector is off-peak load power. In fact, but for the agriculture sector, power utilities would be hard-pressed to dispose of this power.17 More than half of the power supply to farm sector is in the night, and this proportion can increase further. But in computing the amount of power the prevailing flat tariff and prespecified subsidy can buy, the power utilities must use the lower opportunity cost of the off-peak supply.

Intelligent supply management

There is tremendous scope for cutting costs and improving service here. The existing rostering policy in many states of maintaining power supply to the farm sector at a constant rate during prespecified hours is irrational and the prime reason for wasteful use of power and water.18 Ideally, power supply to the farm sector should be so scheduled as to reflect the pumping behaviour of a modal group of farmers in a given region when they would be subject to metered power tariff at full cost. However, it is difficult to simulate this behaviour because farmers everywhere are subject to flat tariff under which they would have a propensity to use power whenever it is available, regardless of its marginal product. In many states, there is a small number of new tube wells whose owners pay for power on a metered basis; however, they are charged so low a rate that they behave pretty much like flat tariff-paying farmers. Another method is to compare electricity use before and after flat tariff to gauge the extent of over-utilization of power and water attributable to flat tariff.19 However, our surmise is that the pumping behaviour of diesel pump owners, who are subject to full marginal costs of energy, comparable to what electric tube well owners would pay under unsubsidized metered tariff regime, would be a good indicator of the temporal pattern of power use by electric tube wells under metered tariff. Several studies have shown that annual hours of operation of diesel tube wells is often half or less than half compared to flat tariff-paying electric tube wells (Mukherji and Shah, 2002) (Fig. 11.3).20 Batra and Singh (2003) interviewed approximately 188 farmers in Punjab, Haryana and central Uttar Pradesh to explore if pumping behaviour of diesel and electric WEM owners differed significantly. They did not find significant differences in Punjab and Haryana21 but their results for central Uttar Pradesh suggested that diesel WEMs are pumped

□ Hours of power supplied/day

□ Average daily hours of operation by electric tube wells paying flat tariff ■ Average hours of daily operation by diesel pumps

□ Hours of power supplied/day

□ Average daily hours of operation by electric tube wells paying flat tariff ■ Average hours of daily operation by diesel pumps

Fig. 11.3. Minimizing waste of power and water through supply management. The numbers shown in this schematic diagram are indicative and not based on actual field data.

when irrigation is needed and electric WEMs are operated whenever electricity is available. Very likely, a good deal of the excess water pumped by farmers owning both electric and diesel pumps is wasted in the sense that its marginal value product falls short of the scarcity value of water and power together.

Figures 11.4 and 11.5 present the central premise of our case: a large part of the excess of pumping by electric tube wells over diesel tube wells is indicative of the waste of water and power that is encouraged by the zero marginal cost of pumping under the present degenerate flat tariff regime. Figure 11.4 presents results of a survey of 2234 tube well irrigators across India and Bangladesh in late 2002, which shows that electric tube well owners subjected to flat tariff everywhere invariably operate their pumps for much longer hours compared to diesel pump owners who face a steep marginal energy cost of pumping (Mukherji and Shah, 2002). It might be argued that diesel pumps on average might be bigger in capacity compared with electric pumps; so we also compared pumping hours weighted by horsepower ratings; and Fig. 11.5 shows that horsepower-hours pumped by flat tariff-paying electric WEMs too are significantly higher than for diesel WEMs everywhere. The survey showed the difference in annual pumpage to be of the order of 40-150%; some of this excess pumping no doubt results in additional output; however, a good deal of it very likely does not, and is a social waste that needs to be eliminated.

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