Discussion Paper on Terms and Conditions of Tariff

November 12, 2003

Objective of Tariff Norms

• Provide incentive for investors for realizing the “power for all” target

– Tariff norms that reflect opportunity cost for a given business risk

• To reduce cost of generation in addition to reducing fixed cost

– Reduce taxes

– Reduce fuel cost

Fixed Cost Recovery

• Fixed cost recovery should be different for coal and gas plants

– Coal plants at [70% ] availability

– Gas and liquid plants at [75%] availability

Return on Equity

• The current guideline on Return on Equity of 16% may be continued– The ROE method has been in practice and well

understood while ROCE method is complicated to implement

– The ROE is linked to risk of business and not interest on debt

– There is no return during construction (for 3-5 years)– Project finance debt interest rate is about 11% based on

the type of project and risks etc.– Normative Debt: Equity at 70:30 may be continued– FE adjustment for both debt and equity– Interest as a “pass through” may be continued

Interest on Working Capital

• Existing norms may be continued

• The Coal companies are demanding I (one) month L/C and I (one) month cash advance (equivalent to supply of coal) and the cost of L/C and cash advance should be included for the working capital norm

Depreciation

• The existing norm of depreciation may be continued

– Allows repayment of loans, tenors are usually for 10-12 years for power projects

– Provides cash for additional capacity

– Advance against depreciation etc. would lead to micro-management by and burden on the Regulatory Commissions

Operation and Maintenance (O&M)

• The current O&M norm of 2.5% of capital cost is low

• O&M norm should be different for coal (lignite) and gas (liquid) fuel plants

• O&M should escalate on the basis of WPI

• O&M should vary with age

• The suggested base O&M norm as % of capital cost as of COD:

Type 0-5 of COD > 5 of COD

Coal (Lignite) 2.5% 3%

Gas (Liquid Fuels) 5% 5.5%

Other Operating Parameters

• Heat Rate

– Heat Rate for coal Plants of 2500 Kcal/ kWh to be continued

– Heat Rate for gas/ liquid fuel plants 2000 Kcal/ kWh (Combined Cycle) and 2900 kcal/ kWh (Open) Cycle may be continued

• Justified based on existing data• Also need to account for load fluctuations, degradation (esp.

in case of gas based plants), etc.

– The condition “whichever is less” may be removed to incentivise operations to be efficient

Other Operating Parameters

• Specific Fuel Oil Consumption and Auxiliary Energy Consumption

– The existing norms may be continued

– The condition “whichever is less” may be removed to incentivise operations to be efficient

• Incentive for higher availability

– The existing norm may be continued

Additional Points for Reducing Cost of Generation

• Reduction in taxes

– Customs duty on capital goods import: 21.8%

– Customs duty on spares: 50.8

– Sales taxes 12-16%

– Taxes on fuel

– Impact of taxes on capital cost (Base Cost : 100)

Imported Content (60)

Customs Duty

= 60x22%= 13.2

Local Content (40)

Sales tax

=40X16%=6.4

Total increase in cost 20%

Additional Points for Reducing Cost of Generation

• Reduction fuel cost

– Fuel cost forms 40-50% of total cost

– Fuel taxes

• Suggestions

– Export parity pricing for liquid fuels

– Cost of coal to be in line with international prices