Sri Lanka’s electricity pricing: slab or low-user?

Feb 18, 2008 (LBO) - The rather unusual step taken by the CEB to actually follow the law and make available for comment its proposed tariff has stirred up significant interest.   This short contribution will not address all the issues pertaining to the tariff revision, but simply seeks to shed some light on one key proposal: shifting from a slab model to a low-user model.  I will not deal with the actual numbers, only the principle.

Anticipating the questions that will be raised, I will state some key positions up front:

• Bipartisan agreement on infrastructure policy is essential because zig-zags on infrastructure policy are extremely harmful.   The Electricity Reform Act of 2002 was based on years of multi-stakeholder consultation that started in around 1998 (the one change from that consensus was the creation of a Public Utility Commission instead of an Electricity Regulatory Commission).   Throwing out the result of years of work just because the JVP unions did not like it was wrong.
• Long-term planning and, most importantly, consistent implementation is essential if Sri Lanka is to have stable and reasonably priced energy supplies.
  
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     Energy is a fundamental input to all production processes and unless it is reliable and competitively priced, all economic activity is negatively affected.
  
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• The current government-owned monolithic organizational structure has failed to achieve the objectives it was created to meet.   It must be changed.
• Given the massive policy failures that have given rise to the present situation marked by excessively high prices and certainty of load shedding every few years it is not reasonable to discontinue subsidies immediately.
  
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Each of these positions are not uncontroversial and are worthy of extensive debate.  But they are long-term issues.  A decision on any one of them will not stanch the losses in the CEB today. The only solutions for the immediate problem are (a) a tariff that will yield adequate revenue to cover costs (the question of whether the costs are reasonable is a different and important one); and (b) well-targeted subsidies to address social concerns.

Efficient subsidies Subsidizing electricity use of homes or businesses through money printing is wrong.  When a government that lacks adequate tax revenues tries to subsidize electricity, it ends up printing money and driving up inflation.   The result is an invisible “tax” on the assetless, generally the poorest in society; this is a reverse-Saradiel action whereby the poor are robbed to pay the rich. Assume no money printing.   Government subsidizes electricity for those who cannot afford to pay, but raises the necessary funds through direct or indirect taxation.   The subsidy would have to be carefully targeted. Safeguards would have to be established to ensure that only those who meet the criteria get the subsidy.   The costs of maintaining the scheme and ensuring that the subsidy does not go to the undeserving will have to be kept low. The best solution would be to give energy vouchers to Samurdhi recipients.

  This is a large group of people (around half the households in the country) who get welfare payments from the government. The government currently makes payments to these households; it can channel energy subsidies in the form of vouchers through the same channels at little extra cost.

  Instead of paying cash, the recipients can pay the CEB in vouchers; or they can pay for kerosene using the same vouchers; or buy solar panels. This is a great solution, but is unlikely to be implemented by the present government.  Primarily because it does not have the money. It’s also problematic because everyone more or less agrees that you cannot have half the country’s households on the dole in the long term.   But there is always someone powerful in government (Former Minister SB Dissanayake when he was in power; and the President now) who objects to rationalizing Samurdhi.

The first part about raising funds through taxation will not work in present day Sri Lanka.  But the criteria for designing the mode of disbursing the subsidy need not be thrown out with the bathwater. Second- and third-best solutions In the non-optimal solutions, money for the subsidy comes from within the CEB itself.   Some people/companies pay above cost; others pay below cost.   This is called a cross subsidy.

   Very bad in economic theory, but very common in political practice. If the subsidy is inefficiently targeted, one would need a lot of money for the cross subsidy.   The people paying above-cost would have to pay a lot more in order to finance the subsidy.

So one would choose the best method of identifying those deserving of cross subsidy; of preventing leakage and keeping administration costs low.  The current slab mechanism is definitely not a good targeting device.   But its administrative costs are low, being simply written into the billing software.

Slab pricing is a bad mechanism for targeting subsidies because it gives the benefit of below-cost prices to every customer.   You can be ultra rich, owning all the electric appliances in the world, running the air conditioners all day, and you will still benefit from the below-cost prices offered for the first x units. In the proposed tariff, the CEB replaces slab pricing with low-user pricing.   What this means is that anyone who exceeds the upper threshold will pay for ALL units consumed at the higher unit rate.   One could have low electricity consumption one month and pay the lower rate; if the consumption increases the next month, the higher rate will kick in for all the units.  The change in the bill will be eye-popping. Unlike with vouchers, there is little chance of the undeserving obtaining the subsidy.   Qualification depends on behaviour.   The only way to game the system is to bribe someone at the CEB (but that applies to slab pricing too).

Cost of administration is extremely low.  As with slab pricing, all that is required a few lines in the billing software.

Low-user tariffs have two principal advantages over slab tariffs.   First, it gives the subsidy to a smaller number of customers through better targeting.

   The equation of low users with people with constrained budgets is generally defensible (a few rich people who maintain second homes may benefit from low-user tariffs, but that would be a miniscule number in Sri Lanka).  Because the overall subsidy is reduced, there is less need to charge above-cost prices (whether this is actually the case, remains to be seen).

Second, it gives very strong signals for energy conservation.   The best way to reduce consumption is through strong price signals, not the dreary ad campaigns unleashed periodically by the CEB.   The shocks people will get when their consumption exceeds the threshold will create powerful incentives to conserve electricity. The real answer The real answer is not low-user pricing.   The real answer is long-term planning and consistent implementation to bring down costs from their present unconscionably high levels.  But while actions are taken to reach the real answer, something has to be done to ensure the CEB remains solvent and inflation brought down.   A least-worst approach to subsidies favors low-user tariffs over slab tariffs. Of course, it would also be good if some knowledgeable entity could look at the revenue and cost data to see if the costs that are sought to be recovered are reasonable before the tariff is approved.