Delhi might soon face power cuts. One of its power distribution companies has threatened to cut electricity to consumers by eight to ten hours every day. But the impending power cuts might have nothing to do with a shortage of electricity and more with a surfeit. How is this possible?

One has to first understand how Delhi's power sector functions. The bulk of Delhi’s power is distributed by three private-sector companies – BSES Yamuna Power, BSES Rajdhani Power and Tata Power Delhi Distribution. The first two are run by the Reliance Anil Ambani Group (ADAG), the third by the Tata Group.

The distribution companies buy a fixed amount of power from government-owned generating stations through long-term power purchase agreements.

Consumer demand for power, however, is not fixed. It varies from hour to hour, day to day and month to month. Think of air-conditioners firing away on hot summer afternoons.

Because distribution companies must meet consumer requirements at all tim­es, they buy power from producers based on their projections of peak consumer demand. This leaves them with surplus power at off-peak times.

Since the surplus power cannot be stored, it must be sold to other distributing companies or large industrial users in the short-term market at whatever available price. The short-term market involves transactions for one year or less. Long-term contracts last 25 years or more.

A simplified example will help illustrate this. Let's assume that the long-term power purchase contract covers not 25 years, but just one week. Let's also say that during a particular week for which the distribution company is looking to sign a long-term contract to buy power, peak demand is expected to be 1,000 MW, which lasts for 24 hours on one weekday, say Wednesday. Assume that on the remaining six days, demand is at a uniform 500 MW.

Now the company can decide to sign a long-term contract for energy units equivalent to 500 MW x 7 days and buy the extra 500 MW it will need throughout Wednesday in the short-term market. Or, if it does not want to depend on the short-term market, it can sign a long-term contract for energy units equivalent to 1,000 MW x 7 days and then sell the extra 500 MW it will have on all days except Wednesdays in the short-term market.

What it chooses to do depends on prices -- the tariff it is charging consumers, the price it is paying in the long-term contract and the price it is paying in the short-term market -- and also on the difference between peak and off-peak demand, which will determine the quantity of extra power it will have to arrange to buy or sell (depending on which of the above routes it takes).

The greater the variation, the more carefully the company will have to plan. In practice, the variations in peak and off-peak demand are not as neat as those in the above example. For instance, demand varies not only throughout the contract period, but also over the course of a day. But the simplified example nevertheless illustrates the parameters that the company has to consider.

Delhi's power distribution companies have claimed their earnings from short-term sales are less than the payments they make under long-term agreements, which is partly responsible for their worsening balance sheets. The other reason for rising losses, they say, is the 50 percent reduction in consumer tariffs by the Aam Aadmi Party’s newly formed government in Delhi.

This is only partly true.

Take the instance of BSES Yamuna. The actual price at which the company sold power in the short-term ­­market is not available in the public domain. But the last available price data for the short-term market as a whole, for the month of November 2013, shows the average price was Rs 3.53 per unit for bilateral sales – sales made through direct contracts between companies – and Rs 2.69 per unit for sales made on power exchanges – where price is determined in ways similar to stock exchanges.

This is indeed lower than the average price of Rs 3.98 per unit fixed by the Delhi electricity regulatory commission (DERC) for BSES Yamuna’s long-term power purchases.

Since the price of long-term purchases is higher than the price of short-term sales, distribution companies should ideally minimise the potential surplus. But data show that BSES Yamuna bought considerably more power than it sold to consumers. The last time it went to DERC for tariff approvals, the company estimated annual consumer demand for 2013-14 at 5,233 million units. The regulator projected a higher demand of 5,545 million units, added 15 percent as potential distribution losses and fixed the total projected requirement by the company at 6,542 million units.

In actuality, however, the company bought a much higher 9,334 million units, and the regulator approved these purchases. This would leave it with 2,792 million units more than what it requires for sale to consumers. In other words, BSES Yamuna’s purchases amount to 40 percent more than the expected demand.

The executives of the private distribution companies maintain that surplus power is inevitable because:
a) Delhi experiences high variation in demand for power.
b) The companies cannot exit long-term power purchase contracts signed well before they took over Delhi’s power distribution in 2007.

Delhi indeed experiences very high variations in demand not just seasonally but over the course of a day. In an article published in the ‘Economic and Political Weekly’, Kannan Kasturi, an independent researcher, says the city’s extreme climate coupled with the primarily domestic and commercial nature of its power consumption leads to a large gap between peak demand and minimum demand.

But even assuming that distribution companies need to buy extra power to meet peak demand requirements, is Delhi’s peak demand high enough to warrant the purchase of so much surplus power?

The central electricity authority puts out monthly charts of state-wise demand and supply of electricity. According to those charts, the peak demand in Delhi was highest in the summer month of June. It amounted to 6,035 MW. If this was the demand throughout the month, then the power company would need 4,345 million units of energy.

But in practice, demand does not remain at that level through the day, even in June, peaking in the hot afternoon and then subsiding, so the actual energy requirement for the month came to just 2,782 million units. This indicates that Delhi's distribution companies had surplus power even at the peak of summer.

It is true that the companies cannot exit long-term contracts, but analysts say the private distribution companies initially did not see surplus power as a problem. In fact, in the early years since they took over Delhi’s power distribution, surplus power served them well.

The data presented by Kasturi in the EPW article illustrates this quite clearly. In 2008-09, when the returns on the short-term market were high, Tata Power sold surplus power at Rs 5 per unit. Following a downturn in the short-term markets, in 2010-11, the company could get only Rs 2.96 for every unit of surplus power.

Not only do companies pass on the losses made in short-term transactions to consumers by way of higher tariffs, they also charge transmission losses to the consumer.

In addition, as Kasturi outlines in his article, there is a “complete lack of transparency” in short-term transactions made by the distribution companies. Most of the contracts were made through the trading companies of their parent group.

While buying power on the short-term market, companies often failed to disclose names of suppliers. The contracts were made without any competitive process and often months in advance of power requirements. The sales in the short-term market were equally suspicious, he said.

In the run-up to the Delhi assembly election, the Aam Aadmi Party picked up the issue of the lack of transparency. It circulated a note in which it documented specific instances in which the Anil Ambani-led ADAG group’s BSES Yamuna had bought power from its sister concern Reliance Energy Trading Ltd at higher rates and sold it back to the same company at lower rates. The party alleged the company did so to create “artificial losses.”

Any losses on the balance sheet of a distribution company work to its advantage, say independent experts, because it enables the company to seek higher tariffs from the regulator. Consumer tariffs are based on the distribution company’s cost of power purchase.

Experts say that the regulator should have stepped in to monitor the short-term transactions of distribution companies. But, as Kasturi writes, the regulator “has been content with gently chiding” them.

Although transactions in the short-term market had been working against the interest of consumers since 2009-10, the regulator waited until July 2012 to step in and remind the companies that there was scope for better management of short-term transactions “to significantly promote the interests of the consumers.”

"The poor management of the purchase and sale of power by the distribution utilities is not particularly surprising,” Kasturi concluded, “considering that the cost of power is a pass-through cost as far as the utilities are concerned and in no way affects their profits.” But it did affect the consumers in Delhi. As the additional costs were passed on to them, their electricity bills rose steeply.

The Aam Aadmi Party had made expensive power one of its major election planks. Once it came to power, one of the first decisions it took was to slash power tariffs and ask the CAG to audit the private distribution companies.

This has led to a sharp conflict between the companies and the government, and it might soon lead to power shortages in the city. Last week, citing revenue shortfalls due to tariff reductions, BSES Yamuna said it could no longer afford to pay NTPC, its leading supplier of power. NTPC has threatened to snap supplies if it does not get its dues by February 11. Delhi’s chief minister Arvind Kejriwal has responded to this crisis by threatening to revoke the licence of the company and by reminding everyone about the CAG audit.

In the short term, experts say the CAG audit might bring to light discrepancies in the books of the distribution companies, which could lead to a partial correction in prices, but it might not be enough as a long-term solution.

“There needs to be portfolio optimisation in the future,” says Ravinder, former chairperson of the central electricity authority. This means that companies would have to reduce surplus power by arriving at a better mix of generating stations from which they buy power – reducing reliance on coal-based thermal power plants, which cannot be switched off and drawing more power from hydroelectric and renewable sources.

More significantly, experts say the entire power-pricing regime needs to be fixed, not just one end of it. The price of power is high not just because distribution companies might be inflating their costs, but because coal-based thermal power plants, which account for the bulk of power production, are being allowed to sell power at rates substantially higher than the cost of producing it.

In the long term, to solve the problem of expensive power for Delhi, we might need to solve the problem for the whole of India.