Correct method of pricing electricity and need to reduce costs

Can electricity prices be reduced?

By Dr Tilak Siyambalapitiya

The answer to the question in the title of this article is in the affirmative. I explained in The Island of January 2023 [https://island.lk/the-correct-method-of-costing-electricity/] the correct method of costing electricity supply. In January, the Public Utilities Commission (PUC) announced the costs submitted by the two distributors Ceylon Electricity Board (CEB) and Lanka Electricity Company (LECO) for 2023, and the proposed prices. PUC’s proposed prices did not match the costs submitted. The government, which traditionally would not allow electricity prices to be increased, went to the extent of appointing new commissioners to PUC, and secured approval overnight to ensure prices were increased to a level that costs would be covered.

The government states that electricity prices will be revised (presumably both upward and downward) once in six months. Similar governments and a sympathetic PUC since 2010 prevented electricity prices being adjusted once in six months, while power plants designed to keep production costs lower, one after the other, were cancelled or delayed. The costing and pricing procedure was in place since 2010, ever since the Electricity Act was approved in 2009.

Previously, on 10th August 2022, Sri Lanka’s electricity prices were increased from Rs 17 to Rs 30 per unit. Different customers pay difference prices, but what we present here is the national average price, including both fixed and variable costs. Most recently on 15th February 2023, prices were further increased to Rs 48 per unit of electricity. On the day electricity prices were announced, Rs 48 worked out to 13.2 USCts per unit of electricity. Any national average price above 10 USCts per unit is seen internationally, as a country of “high electricity prices”. While Sri Lanka was demoted from upper-middle income country to a lower-middle income country, Sri Lanka graduated to the status of high electricity costs and prices. The key to reducing prices is in reducing costs. More on cost reductions later.

Principles of pricing

Electricity is like many commodities but also different to all those commodities. Similarities are that retail customers are more expensive to supply, while it is cheaper to supply bulk customers. Therefore, it is cheaper to supply electricity to the factory down the road, than to supply your house.

How is electricity different to any other commodity? It must be produced exactly at the same time the customer wants it. There cannot be even a one millisecond delay. Electricity cannot be stored in the form of electricity. If one power plant cannot produce electricity owing to lack of water, reduced wind flow or lack of sunshine, another power plant must be ready to operate and immediately takeover. That means there are fixed costs to keep power plants on standby, for which customers have to pay through their regular tariffs. If those power plants are too expensive to operate, such costs too will add to the operating costs.

Here (table 1: ‘Fixed and variable costs 2023’ and ‘Variable costs for Jan to Jun 2023 submitted to PUCSL’) are the calculated costs (not price) of electricity, on the basis of costs CEB submitted to PUC for the period January to June 2023. Fixed costs DO NOT include any profits. However, fuel (coal, naphtha and oil) prices used for electricity production surely include profits (no calculations are presented) to such suppliers, including Lanka Coal Company and Ceylon Petroleum Corporation, and taxes to the government. Prices paid for renewable energy (including minihydros, biomass, wind and solar power plants, all owned by the private sector) and rooftop solar prices include a profit to all such suppliers. Profits to renewable energy suppliers are pre-defined in the pricing formula; only a few of them were ever built under competitive bidding. All others, including that solar unit on your roof, have a pre-defined guaranteed profit.

The total cost was estimated to be Rs 85,683 million in fixed costs and Rs 301,412 million in variable costs, to make it a total of Rs 387,095 million for the first six months of 2023. Watch that 25% figure on the “oil” row. More on that later.

These costs have never been formally approved by PUC, but some other document shows the prices have been approved. PUC has violated its own procedures and has not approved the costs, but prices have been approved.

Be that as it may, how should the costs be translated to prices?

Fixed costs are allocated based on the burden imposed by each customer on the grid. A low-user imposes a lower burden. Hence a low user is required to pay a lower fixed cost, because the assets (generation, transmission, distribution) standing-by to supply him are proportionately smaller.

Then to variable costs. These include payments to renewable power suppliers (250 companies and 40,000 rooftop solar units), oil for both CEB and private power plants and for coal. Variable costs have features of seasonality and changes based on time-of-production. Seasonality is accounted for by revisions once in six months. A separate method is used to account for cost variations according to time of use.

Based on CEB submission of costs and PUC’s approval of prices, Table 2 shows the summary costs and prices for the first half of 2023.

These are the calculations, based on allocating the cost of supply to different customer categories. The fixed costs are lower to low-user customers, but the variable cost is higher to low user customers, because such a customer is a peak-time customer, when energy costs are the highest.

In general, the pricing (not the costing) announced imply high user customers receive a subsidy for fixed costs but they are surcharged on variable costs. If Sri Lanka wants to stop discrimination across customers based on consumption, all households can be charged Rs 1379 as monthly fixed costs, and Rs 43.24 per unit of electricity as variable costs.

Subsidies

Subsidies are fine to be provided to any type of customer, provided someone transparently pays them to the electricity suppliers. Electricity law provide for subsidies to be given to deserving customers or customer groups. The national energy policy 2019 states that subsidies by way of life-line electricity tariffs will be limited only to “low-user household customers using less than 30kWh per month.” This implies others must pay what it costs. The Electricity Act says subsidies can be provided but PUC must secure them from the government.

What next?

Costs, therefore, prices have gone up now because of mismanagement of three specific factors: One: cancellation or delaying of lower-cost power plants through government intervention, causing the “energy mix” to unwantedly tilt toward excessive use of oil. Two: uncontrolled addition of staff, making CEB over-staffed by as much as 50%. Three: Keeping electricity prices constant over 2014-2022 across various governments, while cheaper power plants were purposely delayed. If PUC firmly define action to build lower cost power plants with a monthly monitoring system and for reducing distribution costs, some customers, at least, may grudgingly agree to these high prices.

See Table 3. Variable costs can be reduced from Rs 41 to Rs 18 per unit, by eliminating the use of oil. Adding fixed costs of Rs 12, the price to customer will be Rs 30. That’s the price that prevailed before 15th February 2023. If focused action is taken now, to simply implement the long-term generation plan without resorting to shortcuts that take us nowhere, this target can be achieved by 2026. Certainly, it cannot be achieved overnight through political slogans or by going in processions, but through focused actions in building lower-cost power plants, honest procurement and a firm resolve not to use oil to produce electricity.

But what can be done overnight? Variable costs can be dropped from Rs 41 to Rs 30 (see table 3), by honest pricing of oil and coal given to electricity production. That means, at international prices plus 25% to cover all costs and taxes. Adding fixed costs of Rs 12 per unit, the total will be Rs 42 per unit, overnight. That is Rs 6 (15%) less than the prices now. If we add the benefit of the improved status of the Rupee, the variable costs will further decline from Rs 30 to Rs 27, and the price reduction has to be Rs 9 (19%).

So, in summary, what is required is to agitate for the reduction of costs by:

Step 1: correctly pricing coal and oil at international price levels: reduces electricity prices from Rs 48 to Rs 39 (19%) by 1st July.

Step 2: ensure the long-term plan is strictly adhered to, at least from now on, through honest procurements: further reduces electricity prices from Rs 39 to Rs 28 (28%)

Step 3: continue to streamline staff and other fixed costs; the estimated savings are Rs 2 per unit of electricity sold.

So, yes, the electricity prices can be reduced by 19% immediately (on 1st of July according to the procedure) and gradually by a further 28% by 2026. In effect, from the present Rs 48 to Rs 39 immediately, and over 4 years, to Rs 26, to achieve a total reduction of 46%.

That’s almost half the present price customers pay, isn’t it ?

It can be done, but it will never be done. All lower cost electricity production projects, be it gas, coal, wind, solar, hydropower will be meddled with (in the name of facilitating government-to-government deals, promoting FDIs, sustainability) finally ending up with more diesel, and you customers will be asked to pay, to make diesel power plants to be profitable.

That’s what you are paying for now. Your electricity bill should have been Rs 28 but you are now paying Rs 48 per unit.

Future?

The evening peak demand of 2022 that was forecast in 2020 to hit 3000 megawatt reached 2800 by February last year, and then dropped to 2300 megawatt as the crisis ruined the industry and commerce, and remains there until now. Once the economy recovers, the peak demand will surely accelerate toward 3500 megawatt at night, and Sri Lanka has nothing but more and more diesel power plants to meet such demand.

In other words, the economic recovery will not be a reality, when the money required for recovery, is drawn to buy diesel to produce electricity.