April 27, 2023
You Get What You Pay For: Utility Models Matter for Reliability
By Meera Mahadevan

Summary: Governments around the world are pursuing utility reforms and reorganization in an effort to bring cheaper, more reliable power to their populations. India’s unbundling experience gives a unique opportunity to examine the (surprising) impacts of utility reorganization.

Various electricity reforms have aimed to improve the Indian power system which has long been plagued with supply unreliability, high utility losses, and lower-than-market prices. The sector, therefore, has been stuck in a vicious cycle where low electricity prices result in large financial losses for state-owned utilities, which then result in poor electricity supply. From the viewpoint of firms, particularly the manufacturing sector, poor quality electricity supply imposes long-term productivity losses – even small improvements in reliability have the potential to increase firm productivity by as much as 25%.

Institutional structures can make or break the efficacy of policies aimed at improving electricity provision. Electricity reforms have focused on increasing competitiveness by unbundling historically vertically-integrated electricity supply companies. But, different Indian states have implemented restructuring policies in different ways: when states unbundled generation from transmission and distribution (T&D), some created a single statewide electricity distributor, while others opted to allow multiple firms to distribute and retail electricity. The variation in implementation provides a neat natural experiment to examine how institutional contexts dictate the success or failure of reforms. How important are these seemingly surface-level differences in utility models? Turns out, very.

FIGURE 1: The effect of restructuring on electricity reliability and firm response

Source:You Get What You Pay For: Electricity Quality and Firm Response,” Meera Mahadevan, 2022.

States with a single distributor have higher prices and higher reliability: Looking at how restructuring affected manufacturing firm outcomes, single-distributor states saw an improvement in light density. Surprisingly, the electricity prices in single-distributor states were much higher, meaning that utility revenues are higher and they are therefore able to purchase more electricity from the grid to adequately meet state demand. Conversely, multi-distributor states do not see a big change in average prices but appear to have lower light density, which seems a worse outcome overall even compared to before unbundling. This may be counterintuitive given that a single monopolistic firm may not be perceived as a better option for consumers.

Higher electricity prices are good for manufacturing firms: While electricity pricing remains a politically charged issue in India, with constant clamoring for tariff reductions, it turns out that firms are more than willing to pay higher prices when electricity supply quality improves. In fact, manufacturing firms in India scale up production in response to better reliability, consuming more electricity from the grid and running their factories for more days in the year. 

Institutional setup explains the performance gap 

At first, it may seem surprising that a state with a single state-wide distributor performs better than states with multiple distributors. However, here is where institutional setup matters:

  • Utilities find it hard to raise their prices because they are strictly regulated by state authorities who prefer to keep prices low and encourage parity in prices across the state. So with multiple utilities, if one revises prices upwards and the other keeps prices constant, the regulator is unlikely to approve the price increase. In a single-statewide utility setup, it may be easier to pass price increases and improve supply.
  • Single-entity state utilities usually have greater accountability and visibility, and often have better revenue collection models. They are able to more efficiently cross-subsidize across consumer groups (pricing electricity lower for residential consumers vs industrial consumers) given that they serve the entire gamut of consumers in a state.

This is in contrast to the difficulties faced by states with multiple utilities in coordinating equal price increases and/or designing efficient cross-subsidized price structures. Due to these factors, the market structure of single distributors may then be driving India’s reduction in power outages in recent years. Institutional structures, how electricity pricing is approved, and how cross-subsidization of prices happens all appear to have outsized contributions to electricity outcomes across states. Reform implementation can have unintended effects when the local institutional context is not considered in its design.

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