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A quest for a possible option for the subsidy phaseout

Originally posted in The Financial Express on 26 March 2024

Recent electricity tariff hike

The Ministry of Power Energy and Mineral Resources (MoPEMR) has increased electricity prices starting from February 2024, with adjustments planned to continue over the next three years to end the subsidy burden. The decision aligns with the IMF’s conditions linked to a $4.7 billion loan, including the implementation of an automated pricing formula for petroleum and raising electricity and gas prices to reduce subsidies in the power sector by 2026 in six reviews.

The first phase saw an increase in electricity tariff of Tk 0.34 to 0.7 per unit (an 8.5 per cent tariff hike). Previously the tariff was increased by 15 per cent in 2023. Lifeline consumers have experienced a tariff increase of 17.5 per cent while the rate is 21.5 per cent for the consumers of the sixth slab. As the upward tariff revision will have sectoral impacts, sectors such as SME, irrigation, and other commercial sectors are more vulnerable to the price hike. Additionally, distributional considerations are more closely aligned with the adjustments made by the MoPEMR compared to those made by the Bangladesh Energy Regulatory Commisison (BERC). In February 2023 the tariff rate imposed by the BERC in the industry was 1.4 per cent higher than that of SME whereas, the tariff imposed by the MoPEMR in the industry was 2.6 per cent higher than that of SME. In Februaray 2024 BERC tariff rate in industry was 115 per cent higher than that of irrigation and 117 per cent higher in case of MoPEMR.

The authors working at the ‘CPD Power and Energy Study’ of the Centre for Policy Dialogue (CPD) proposes an alternate mechanism to reduce the subsidy burden of the government in the power and energy sector without raising the electricity tariff at the retail level. The authors reviews the functionality of the BERC in tariff revision, fiscal rationalisation of tariff adjustment, and implications of tariff adjustment on economic activities. Based on that, the authors proposes the alternate mechanism for reduction of suibsidy in the power sector.

CHANGED INSTITUTIONAL PROCESS FOLLOWED IN TARIFF REVISION: The Bangladesh Energy Regulatory Commission (BERC) Act 2003 was amended in December 2022 to pass the jurisdiction of raising prices through executive orders to the government. Under the new mechanism, the government has the authority to determine, re-determine, and adjust the power tariff as it seems fit for the reasons. The new amendment by the executive orders is a faulty way to revise and adjust the electricity tariff as it is passing the whole burden onto consumers’ shoulders. The factors mentioned as the reasons for subsidy rationalisation seem vague as these can often depend on the decision of the authority. The rationale for subsidy rationalization, aimed at benefiting consumers, and the demands of agriculture, industry, business, and households, does not provide a clear justification for adjustments in tariffs. Another main weakness of the new mechanism is it doesn’t promote transparency and accountability when it comes to price setting as it excludes public participation in the tariff adjustment process.

FISCAL RATIONALISATION OF TARIFF ADJUSTMENT: The power generation capacity has been increasing without taking into account the rise in demand (Figure-1). Growth in the number of BPDB consumers is much lower compared to the growth in the power generation capacity, leading to a rise in unutilized generation capacity (Table 2). As known very widely, the reason for the unutilised generation capacity is due to the overestimation of power demand.

In FY 2023, BPDB incurred a loss of Tk 117.7 billion and the comprehensive loss has increased more than 3.5 times from the comprehensive loss of FY2021-22. This is mainly due to the increase in operating expenses driven by the diesel/ furnace oil used for the electricity generation in rentals and quick rentals as well as significant cost of electricity purchase and amount of capacity payment for the IPPs. The Finance Ministry has covered BPDB’s loss through subsidy allocations. Over the years, it has been found that there is a positive correlation between subsidy and capacity payment paid to the rentals and quick rentals. Despite increasing electricity prices from January to March last year, the Power Development Board (PDB) reported a loss of Tk 435.4 billion in FY2023, necessitating a subsidy of Tk 395.3 billion. Again, despite increasing the electricity tariff for the fourth time in the last year, the subsidy burden is still persistently hovering on the MoPEMR.

According to BPDB annual report of FY 2023, the average production cost of electricity is Tk.11.3, and the tariff has been increased to Tk 8.95 per unit. In 2020, the average cost of electricity generation was almost half of the current cost of generation. Historically, the power generation fuel mix is dominated by the natural gas. During FY2020, the share of gas in fuel mix was 54 per cent, whereas it is now 45.6 per cent. The generation cost has been doubled due to the blend of expensive imported LNG in the fuel mix.

IMPLICATIONS OF TARIFF ADJUSTMENT IN ECONOMIC ACTIVITIES: A recent study by the CPD, surveying 1,000 households across Bangladesh’s eight divisions, has unveiled insightful patterns in household power consumption. This study reveals that despite the last revision of electricity prices in March 2023, households’ electricity consumption behaviors remain largely unchanged in the short term, following a predictable seasonal trend: lower consumption during winter and higher in summer. This pattern demonstrates a consistent inelasticity across seasons, indicating short-term stability in household electricity usage habits..

However, the direct implications of a tariff hike present a different narrative. With the increase from the old rate (Tk.1,202 in March, 2023) to the new rate (Tk.1,315 in February, 2024), households are facing an average increase of at least 9.4 per cent in their electricity bills. Notably, the most significant bill increases are observed during the summer months, although these differences are relatively minor.

A crucial observation from the CPD study highlights a conundrum. While households may aim to maintain their electricity expenditure, the actual consumption rates-138 kwh at the old prices versus an anticipated 126kwh at the new prices-suggest an unrealistic decrease in usage by at least 8.6 per cent. This discrepancy is especially poignant given the expected rise in temperatures in 2024, which would naturally lead to increased electricity demand. Bangladesh’s static energy efficiency levels further complicate this scenario, hinting at potentially higher actual expenditures due to concurrent rises in both price and demand.

The ripple effects extend beyond direct consumer impact. The surge in electricity prices plays a significant role in influencing overall inflation, with potential ramifications for monetary policy and the risk of triggering an inflationary spiral if not counterbalanced by thoughtful energy and macroeconomic policies. The hike in electricity tariffs is expected to elevate the cost of electricity-intensive goods-ranging from metals and minerals to everyday items like furniture and paper-further intertwining energy policy with broader economic outcomes.

ALTERNATIVE MECHANISM OF SUBSIDY ADJUSTMENT: In the latest twist of policy and economic calculations, the recent adjustment in electricity tariffs has projected a substantial reduction in government subsidies, amounting to Tk 26.5 billion. This figure hinges on the assumption that electricity generation and consumption patterns remain unchanged. To eliminate subsidies altogether, the average wholesale price of electricity must reach Tk 13.2 per unit-a figure that slightly overshoots the International Monetary Fund’s (IMF) recommendation of Tk 12.1 per unit.

With these numbers in play, the path to fiscal stability appears straightforward: if wholesale prices align with these benchmarks, retail electricity could cost Tk 16.4 per unit. Yet, the absence of a clear, phased plan for price adjustment from the government raises concerns about market stability. A laissez-faire approach to the energy market, although efficient in theory, risks volatility without structured guidance on adjusting to higher costs influenced by demand, fuel prices, and the integration of renewable energy sources.

CPD steps into this debate with an alternative vision that challenges the premise of passing the financial burden directly onto consumers through price hikes. Instead, CPD advocates for a nuanced blend of strategies: timely phasing out of fossil fuel power plants, a policy of “No Electricity, No Payment,” moderate increases in electricity prices, and a full transition to renewable energy sources to meet the ambitious target of 40 per cent renewable energy by 2041.

This proactive approach could nullify the need for subsidies by 2028-29, flipping the fiscal narrative from deficit to surplus for the Bangladesh Power Development Board (BPDB). In contrast to the IMF’s forecasted 12 per cent price increase over five years, CPD’s roadmap suggests a more palatable 6.8 per cent rise to achieve fiscal neutrality. This proposal not only eases the fiscal load on consumers but also aligns with a sustainable energy future. Further analysis by CPD delves into the operational costs and subsidies of power plants, proposing a phased elimination strategy that considers various inflation scenarios. This meticulous planning contrasts with the potential pitfalls of abrupt subsidy removals or unchecked price inflations, offering a more stable transition framework for the energy sector.

Parallel to these fiscal strategies, CPD’s ongoing research underscores the burgeoning role of renewable energy. By adopting a Global Competitiveness Index-inspired methodology to evaluate and phase out underperforming power plants, CPD outlines a phased integration of renewable sources. This strategy not only promises to lighten the government’s fiscal load but also aligns with global trends towards cleaner, more sustainable energy solutions. The transition to renewable energy sources is not just an environmental imperative but an economically sound strategy. The anticipated decrease in the levelized cost of electricity from renewable sources compared to fossil fuels suggests significant subsidy savings and a healthier fiscal posture for BPDB.

– Dr Khondaker Golam Moazzem is Research Director, Centre for Policy Dialogue (CPD), moazzem@cpd.org.bd: Helen Mashiyat Preoty and Mashfiq Ahasan Hridoy are Research Associates, CPD; Faisal Quaiyyum is Programme Associate, CPD. The piece is based on the presentation made in the CPD’s press briefing on March 13, 2024.