Source: IDEAS AND INSTITUTIONS | ISSUE #46
Analysis
Designing Price Mechanisms for Renewable Energy
How can India’s transition to renewable energy be accelerated? The electricity sector is key to this transition. Changing to renewable sources of energy will require higher electricity consumption, which in turn is generated through renewable sources. However, India’s electricity sector is rife with inefficiencies, and repeated efforts to reform it have failed. The key challenge, therefore, is to increase the share of electricity generated using renewable sources in India’s electricity sector. Akshay Jaitly and Ajay Shah (2021, 2023), and Renuka Sane (2023) have written on this and argued that such an increase can be achieved if power sector reforms allow producers and consumers to follow the price mechanism.
Their simple and powerful insight is that the political economy of India’s power sector prevents the price mechanism from operating, and the absence of the price mechanism is hindering the transition toward renewable sources of energy. Shah and Jaitly point out that while 40 percent of the total installed capacity for power generation is non-fossil fuels, the actual generation of renewables is just 11 percent. Privatization is one part of the necessary reforms in the power sector. The other complementary part, as both Jaitly-Shah and Sane argue, is to let markets fix prices dynamically in the power sector. If done well, the price mechanism should be able to drive the transition toward renewables better than any centrally administered mechanism.
In this essay, I explore designs for price mechanisms in the electricity sector. I also outline some of the available design alternatives and use them to critique recent policy changes that require dynamic electricity pricing in India.
Existing Price Mechanisms in India’s Power Sector
Sane points out that moving to solar power as the main non-fossil fuel source of electricity will require a greater emphasis on using the price mechanism. This is because sunlight is limited during the day, and round-the-clock supply requires storage capacity. The costs of storage, however, are currently high. Unless there is a shift in consumer behavior that incentivizes them to consume less electricity at night, the costs of storage will make solar-powered electricity quite expensive. In addition, allowing firms to charge higher prices for the time of day when supply is dependent on storage will incentivize competition and innovation in storage technology and reduce storage costs gradually. Sane, therefore, advocates for a “surge” pricing mechanism where consumers pay higher costs for electricity at night.
Currently, most users pay for electricity based on the total amount of electricity consumed. There is a tiered structure in electricity pricing, where prices increase for higher amounts of units consumed (see some tariffs for Delhi, Mumbai, and Ahmedabad). This structure does not take into account the variation in electricity consumption during the day, which is of critical importance in the case of solar energy. Shifting to solar-powered electricity will require a shift from this “static” pricing model to a dynamic one that allows for price surges.
Dynamic Models for Pricing Electricity
Globally, jurisdictions are experimenting with different forms of dynamic pricing models. These usually price electricity by using a time-varying element. Different designs of dynamic pricing now exist, each of which incentivizes consumers to change their consumption patterns. These are (for more, read this and this):
- Time-of-Use Tariffs (ToU): In this structure, rates are set for hourly time periods in advance, and consumers are informed about the prices in advance as well, allowing them to vary their usage in response to the prices. Prices and time periods are fixed a year in advance.
- Critical Peak Pricing (CPP): Prices are high for a few peak hours in the day and discounted during the rest of the day. The peak remains the same for all days.
- Variable Peak Pricing (VPP): Here, the peak prices vary from day to day, with advance information being provided to consumers.
- Real-Time Pricing (RTP): Here, prices change at hourly intervals, and consumers are informed shortly before prices change. This is the purest form of dynamic pricing, but also requires a high degree of information communication between producers and consumers.
- Peak Time Rebates (PTR): Consumers are provided rebates for lower than expected consumption during peak hours.
As one can see, each one of these designs varies in the degree of dynamism and price signals it sends to producers. RTP is the best design choice from the perspective of sending signals to consumers and producers. However, it also increases the potential for variance in prices. In addition, because the real-time price can only be communicated to consumers shortly before it is implemented, it requires a higher cognitive burden from consumers to plan their consumption accordingly. On the other hand, a CPP is probably the least dynamic of the different designs and is used primarily to reduce power consumption during peak hours as well as reduce the load on the grid. Of these designs, a ToU is the most widely used dynamic pricing mechanism. However, ToU designs fix prices a year in advance.
How well do each of these mechanisms affect consumer behavior? Two pieces of infrastructure are necessary for dynamic pricing to allow for granular measurement of electricity consumption. Smart meters are one. They allow the transmission of periodic consumption patterns to producers who in turn can make better decisions related to pricing, production, and investment. Smart meters typically record electricity consumption in intervals of one hour or less and communicate this information daily to the utility. A 2014 report for the National Smart Grids Mission found that in the United States, “feedback-induced savings” require that in-home displays or online displays be used as a complement to smart meters. Smart meter penetration in India is low as of now. While close to 220 million meters have been sanctioned, 8 million have been installed (data available here). Therefore, not only does the move to dynamic pricing require smart meters, but behavioral change in consumption also requires effective price communication about varying prices. The costs of such communication are increasingly becoming trivial, but the point remains that such communication is necessary.
Given these design options, which one should policymakers adopt? Any shift to dynamic pricing will require a significant penetration of smart meters and associated communication paraphernalia. This leaves the choice of dynamic pricing mechanisms up for discussion. The shift to solar-powered energy requires not just higher consumption during sunlight hours but also efficient information about pricing for storage equipment manufacturers.
Of the various design options, RTP is the most dynamic, the best communicator of actual prices, and should lead to real-time behavioral choices by consumers for producers to act upon. However, it also makes planning difficult. Thankfully, electricity consumption by itself is fairly predictable. Significant volatility may occur during limited periods of time in a year; for example, an adverse weather occurrence during certain days in a year may lead to a spike in consumption. This in turn reduces the need for an hourly RTP mechanism. As long as producers can forecast consumption with a certain degree of accuracy and consumers can forecast prices with a certain degree of certainty, the price mechanism should work reasonably well. An RTP mechanism that can fix prices a few days or weeks in advance should enable both predictability and certainty.
Recent Changes in Electricity Pricing
With this in mind, let’s look at an amendment the Indian government made to the Electricity (Rights of Consumers) Rules, 2020, in June 2023. Through the amendment, the government mandates the following:
(a) smart meters be read at least once every day and the relevant data be made available to consumers through websites or mobile apps, and
(b) a Time-of-Day (ToD) tariff be introduced for commercial and industrial consumers by April 2024 and for all other consumers (other than agricultural consumers) by April 2025.
It makes two further stipulations. First, peak consumption charges for commercial and industrial consumers should be charged at least 1.20 times the normal tariff and 1.1 times the normal tariff for other consumers. Second, it states that tariffs for “solar hours” (eight hours in a day, to be determined by state electricity regulators) will be at least 20 percent less than normal tariffs.
This amendment essentially requires dynamic pricing in the electricity sector. It creates a minimum level of price variation for peak hour prices (which is different depending on the category of consumer) and mandates state electricity regulators to determine tariffs in such a way that they are provided at a 20 percent discount to normal tariffs during solar hours. Is this amendment creating a better price mechanism? It does create a better price mechanism than the existing situation, which is a static price system, but it falls far short of what is desirable.
First, the amendment mandates dynamic pricing but does not define what design states should adopt. On the one hand, this is a good idea—states should be free to design pricing mechanisms based on their own empirical reality. On the other hand, it introduces the idea of peak pricing and mandates a minimum level of tariff escalation for peak hours. This immediately creates definitional issues. If prices are changing dynamically in response to demand, why is there a need to stipulate a minimum escalation of prices during peak hours?
Second, it seems to presume that a solar hour period (of eight hours) can never be a peak hour because it mandates a 20 percent discount on tariffs during solar hours. This militates against the idea of an efficient price mechanism, where producers change the quantity supplied in response to demand. Some research indicates that peak hour patterns in India are changing and that peak hours are now shifting toward late afternoons rather than early evenings. Consumption patterns change in response to various stimuli, and the new rules do not account for this.
The consequence of these requirements is that the dynamic price mechanism is being distorted even as it is being created. The amendment could instead have simply stipulated the need for states to move to a dynamic pricing model, outlined the different alternatives available to them, and, since these rules are titled “Rights of Consumers,” defined minimum standards for providing information to consumers.
To conclude, moving to a pure price mechanism in the power sector is desirable not just because it is the most efficient system but also because it enables a faster transition to renewables. While other reforms like privatization and greater competition are necessary for the market to work properly, the design of the pricing mechanism is also an important consideration.
I am grateful to Renuka Sane for discussions and inputs.
—By Anirudh Burman
Review
Neerja Chowdhury on How Prime Ministers Decide
In the foreword to a book published in 1963, John F. Kennedy described the American presidency as an institution that is formidable—it represents the “point of ultimate decision” in that system, exposed—it is at the “center of the play of pressure, interest, and idea,” and somewhat mysterious—“the essence of ultimate decision remains impenetrable to the observer—often, indeed, to the decider himself.”
This combination of enormous power, multiplicity of influences, and the essential mystery of the decision often leads to intense debates on why a certain action was taken. As is often the case with events involving decisions, the same facts can be reconciled with multiple explanatory narratives, making the debates endless. In How Prime Ministers Decide, a career-capping work of remarkable expanse and detail, journalist Neerja Chowdhury offers descriptions of seven major decisions by six prime ministers: Indira Gandhi’s decision to call for elections in 1977, Rajiv Gandhi’s decisions to undo the Shah Bano judgment and then to orchestrate the opening of the locks of the Babri Masjid, V. P. Singh’s decision to implement the Mandal Commission’s recommendations on reservations for other backward classes, P. V. Narasimha Rao’s decisions (or lack thereof) that led to a failure in preventing the demolition of the Babri Masjid, Atal Bihari Vajpayee’s decision to conduct nuclear tests, and Manmohan Singh’s decision to enter into the civil nuclear deal with the United States.
Much of the book’s appeal lies in Chowdhury’s selection of the decisions she subjects to her detailed journalistic inquiry. There is no gainsaying that these were historic decisions. They also have an aura of mystery around them, as they have been debated endlessly since they were taken, and Chowdhury’s book contributes to these debates. Most of these decisions involved significant freedom of choice; from the outside, there was no obvious necessity driving them. There was nothing that directly compelled Indira Gandhi to call for elections in 1977, Manmohan Singh to stake his government on the nuclear deal, or Rajiv Gandhi to reverse the Shah Bano judgment. They had a choice.
While we know how these stories end, they are still interesting because we may not know all the important details. And since we are talking about the political choices that have shaped the present, it is useful to know what went into their making. Chowdhury also presents new information and ties together different strands of information in novel ways. For instance, a reader will gain new information on the interactions that the Rashtriya Swayamsevak Sangh informally had with Rajiv Gandhi and Sanjay Gandhi. Chowdhury ties together multiple causal strands that may have led to a moment of decision, provides a detailed account of the hours and days when the decision was implemented, and then delves into the afterlife of the decision.
The chapter on Indira Gandhi is as much about her decision to call the 1977 elections as it is about what she did to bring down the Janata Party government and make a comeback. Even though the Janata Party government had dismissed all the Congress-led state governments in 1977, thereby weakening the party’s material base, Gandhi deftly exploited the internal contradictions and conflicts in the Janata Party government to accelerate its demise. The account demonstrates her political adaptability, and the insight here is that such constraints cannot bind a truly skilled politician—they know how to work with what they have. Of course, there are limits to this political skill, and therefore, it is important to build a system of free and fair electoral contest.
The chapter on Rajiv Gandhi shows how electoral politics can allow a technologically modern outlook to exist alongside concessions to reactionaries, revealing a potentiality of our politics that has cast a long shadow. It is remarkable to read how deeply opposed Gandhi was to the idea of undoing the Shah Bano judgment; despite this, he did a volte-face in response to an outcry by a handful of influential community leaders. Then, to deal with the backlash, he orchestrated the opening of the locks of the Babri Masjid, a decision that started the chain of events that eventually led to its demolition. All along, he was also taking steps to modernize the economy through the introduction of new technology.
The chapter on V. P. Singh shows that even though his decision was one of the most important ones ever taken by a government in India, its main driver may have been the logic of political survival in the short run. Chowdhury shows that even though Singh did hold some beliefs that may have led him on this path, he had also expressed ambivalence about the efficacy of reservations as an instrument of social justice. Perhaps he would not have taken the decision had he not been so cornered. This phenomenon of the enormous power of the modern democratic state being exercised through decisionmaking processes that appear to be driven primarily by shortsighted, narrow, and even petty concerns can be unsettling for some. However, a leader might have a choice of strategies for survival, and the path they take does tell us something about their beliefs. This interplay between events and political becoming is essential to the lives of professional politicians. Singh was shocked by the extent and nature of protests against the decision, especially the self-immolations by students, but the decision’s political irreversibility ensured that Singh’s mark on history would be long-lasting, even though his government lasted less than a year.
The chapter on Rao’s decisions regarding the Babri Masjid is insightful because it shows that at each point, he had justifications for his decision. At the same time, those justifications do not quite add up to let him off the hook because of the outcome they led to: the illegal demolition of the structure. At the apex level of politics, completely formal justifications can only go so far because there is a residual responsibility that cannot be denied: the responsibility to act creatively to preserve order. Still, it is not easy to pin the blame entirely on Rao. Others in power, especially the state government, were equally accountable for the incident; it was directly responsible for protecting the structure and had given a written undertaking to the court that it would do so. Of course, those who mobilized the kar seva that day are also equally responsible. Chowdhury shows that a day earlier, many people were openly rehearsing how they would bring down the structure. It is, however, also possible that the leaders of the mobilization could not control some of the factions.
While the chapter on Vajpayee’s decision on nuclear tests is quite a straightforward recording of the events, it is remarkable in how it records the long-term continuity that enabled the tests and their political and strategic afterlife. Chowdhury shows how, starting with Nehru, the nuclear program was kept alive even by those prime ministers who were otherwise making efforts towards nonproliferation. This meant that the capability was there when the political appetite for conducting the tests was found. Chowdhury also emphasizes how keeping L. K. Advani in the dark until the very last moment may have widened the rift between him and Vajpayee. She also draws a line between the tests and India’s enhanced stature vis-à-vis the United States in the later years.
Manmohan Singh’s position was very different from the others because he had not achieved premiership by the dint of his leadership of the party. He had been anointed, and yet he took a politically risky decision, one that many in his own party did not agree with and one that alienated the leftist parties that had propped up the government. Political power is not just electorally achieved—it can also be constructed by taking the right steps within the party organization and the government. Even though he was a surprise choice for premiership, Singh had made himself appear indispensable, so much so that he could use the threat of resignation to bring his party around. That someone with no popular base could do this shows that even in democracies, there continue to be other sources of legitimacy and power.
In the narratives presented in this book, one can see the working of informal norms in the polity. From enlisting legislators from the opposition to represent the country, to the back-channel communications between the government and opposition, to the exercise of restraint in discussing the personal lives of leaders, there are many episodes that seem to be from a bygone era. While nostalgia is usually misleading, especially when it is built on selective memory, to the extent such norms really existed and have been undone, it is worth reflecting on what has changed, why, and what could be done to restore some of the norms. This is important because the informal norms in a polity underpin the working of formal institutions, and the proper meaning of representation can only be realized if subtle informal norms blunt some of the sharper edges of formal decisionmaking.
When we read memoirs, autobiographies, authorized biographies, and other accounts based on the versions presented by prime ministers or those close to them, the sense we get is that the dramatis personae are making the world through their decisions. Emphasis is given to specific events, the responses they evoke from various actors who were party to the decision, and the efforts they undertook on their own initiative. There is a thick air of decisionism in such descriptions. On the other hand, when social scientists and historians write about these decisions, they tend to focus more on broader socioeconomic causes. Journalists, if they are so willing, are uniquely placed to find a middle path. They are neither insiders trying to elevate their own role in history nor entirely prone (or trained) to finding explanations in larger forces.
Chowdhury’s book is an example of such a middle path. The decisions studied are described in terms of an interplay between larger forces, which were typically represented by a small number of party functionaries, elected representatives, and civil servants, and individual choices by leaders, who often justified them by citing, sincerely or opportunistically, some larger forces, as can be seen in each of these episodes. It would be as wrong to say that the leaders had no choice as it would be to suggest that they had infinite choice. Instead, this book tries to describe how premiers decided from their perspective.
A key merit of this book is that it takes politics seriously on its own terms. By bringing external standards to a political decision, one can easily evaluate it without understanding it. While such evaluative discussion is essential to the exercise of political liberty, it is also important to understand that those taking decisions have their own reasons for doing so. In other words, politics has its own demands to make. The book does not take what Raymond Guess critiqued as an “ethics-first” approach to political decisions, in which one first develops an ideal theory of ethics and applies it to political decisions, evaluating them against the theory. At the same time, as Leo Strauss wrote, all political action has a directedness toward some “knowledge of the good.” So, when one describes a political action, one is simultaneously addressing the values that direct it. A careful description of the motivations and reasoning of those who took decisions can reveal the contestation of values involved in the decisionmaking process and why some of the values prevailed.
The veracity of the different facts that are woven together in the narrative depends on the sources, and in a work where much of the action happens behind closed doors with only a few people involved, there is no alternative to source-based reporting. The extent to which one believes an account depends on how seriously one takes the sources. New sources may revise or rebut old ones. Such is the nature of historical writing—it is always a draft to be revised.
—By Suyash Rai