Supreme Court Order on Regulatory Assets of DISCOM 

Syllabus: GS3/ Energy

Context

• The Supreme Court recently directed the State Electricity Regulatory Commissions (SERCs) and distribution companies (DISCOMs) to clear their accumulated regulatory assets within a fixed timeframe.

What are regulatory assets?

• Regulatory assets are the unrecoverable revenue gap due to the difference between the average cost of supply (ACS), the expense incurred by a DISCOM to deliver a unit of electricity to consumers, and the Annual Revenue Requirement (ARR).
  • ARR is the revenue collected by the DISCOM as consumer tariffs and subsidy payments from the government.
• Instead of immediately raising tariffs, regulators allow DISCOMs to carry forward these shortfalls and recover them from consumers at a later date.
• While this prevents sudden tariff hikes, it builds up hidden liabilities that burden both consumers and DISCOMs over time.

What Did the Supreme Court Rule?

• Clearing Old Assets: The Court directed to clear the existing regulatory assets within four years and liquidate any new assets within three years. 
• Capped Limits: The court advised capping the regulatory asset at 3% of a DISCOM’s Annual Revenue Requirement (ARR).
• Recovery Plan: Instructed regulators to set out transparent roadmaps for recovery, along with conducting intensive audits of DISCOMs that continue without recovering these assets.

Reasons for the ACS–ARR Gap

• Suppressed tariffs: Electricity prices are kept below cost for social or electoral reasons.
• Delayed government subsidies: Subsidies promised for farmers or vulnerable households are not released on time.
• Fluctuating input costs: Volatility in coal and fuel prices raises generation costs.
• Technical and commercial losses: Power theft, faulty billing, and transmission inefficiencies widen revenue gaps.
• Inadequate cost-reflective tariff adjustments: Tariffs are not revised regularly in line with rising supply costs.

Effects of regulatory assets

• For Consumers:
  • In the short term, they benefit from stable tariffs.
  • However, deferred recovery leads to steeper tariff hikes in the future, often with added interest.
• For DISCOMs:
  • Accumulated regulatory assets worsen cash-flow problems, making it difficult to pay generators. This forces greater borrowing, increasing financial stress.
  • Lack of liquidity hampers investments in infrastructure, renewable energy, and grid modernization.

How Can the ACS–ARR Gap Be Bridged?

• Cost-reflective tariffs: Regulators must set tariffs that reflect actual supply costs, with targeted subsidies for vulnerable groups.
• Timely release of subsidies: State governments should ensure disbursement without delay.
• Fuel cost pass-through mechanism: Automatic tariff adjustments should be introduced when input costs rise.
• Annual ‘true-up’ exercises: Regulators must reconcile projected and actual costs annually to avoid backlogs.
• Improved efficiency: Investments in smart meters, better billing systems, and stronger enforcement against theft can reduce losses.

What are the global best practices?

• RAB Model (Regulated Asset Base): Utilities are allowed to recover their investment in regulated assets through tariffs, with a regulated rate of return on the asset base, thus ensuring long-term revenue certainty.
• RIIO Model (Revenue = Incentives + Innovation + Outputs): Links utility revenues to asset investment and to clearly defined output parameters, e.g. reliability, customer service, and carbon reduction, creating stronger accountability and performance incentives.

Source: TH