bring down their total power purchase cost; and (iv) developing a complex tariff structure made up of several increasing block-tariff (IBTs) rates, fixed costs, surcharges and duties.

Recent developments indicate that policy attention is now turning towards addressing issues of pricing electricity. The central Ministry of Finance through its annual Economic Survey 2015-16 has recently proposed a strategy to make residential price schedules equitable and easier for consumers to comprehend and respond to. The Power Ministry has proposed a draft amendment to simplify tariff categories and rationalize retail prices.<sup>3</sup> At the state level, other regulators, such as Andhra Pradesh’s State Electricity Regulatory Commission (APERC), have undertaken studies to design better residential electricity pricing.<sup>4</sup> Like APERC, Rajasthan’s Electricity Regulatory Commission is also evaluating efficient strategies to better price their residential electricity consumers.

A better understanding of the relationship between socioeconomic and demographic characteristics of households and their willingness to pay for electricity is an important input into the process of designing tariff schedules that can achieve revenue sufficiency for the discoms. Understanding the economic determinants of a household’s monthly electricity consumption, especially for low-income consumers, is also essential for meeting the affordability and equity objectives of the government, regulator and the utility.

This paper uses a structural demand model to propose an alternative tariff structure that can achieve these three objectives. Even though the demand model and welfare analysis outlined in this paper can be used to set prices for any discom in India, the paper uses data from the state of Rajasthan to illustrate the methodology to set tariff levels. The average revenue generated by domestic consumers of a utility in Rajasthan in FY2016-17 was Rs. 6.31 per kWh as against an average revenue requirement of Rs. 7.74 per kWh of energy for the utility. This suggests that domestic consumers of the utility were undercharged by Rs. 1.43 per kWh on average, a shortfall that is cross-subsidized by commercial and industrial consumers of the discom. By achieving cost-neutrality, the proposed alternative tariff design aims to remove the need to cross-subsidize residential users and reduce the higher cost of power currently borne by other consumer categories. However, addressing challenges known to be endemic to India’s power sector, such as low-collection efficiency, high transmission and distribution losses, ineffective dispatch mechanisms, etc., will require policy interventions that are outside the scope of this paper.

Electricity prices in Rajasthan, like much of rest of India, follow an increasing block tariff (IBT) structure, consisting of a marginal price component called an energy charge, and a fixed charge.<sup>5</sup> As shown in Figure 4, the marginal price is the same for all consumption on a block or range of monthly consumption but increases for higher amounts of consumption. Rajasthan’s tariff schedule also has a lower first-block energy charge for households possessing a below poverty line (BPL) card. The utility provides an energy price subsidy of rupees 1.9/kWh and rupees 1.3/kWh for households below and above the poverty line (APL) consuming less than 50 kWhs per month, respectively. An additional fixed charge subsidy of rupees 30 per connection is also provided to households below the poverty 3https://powermin.nic.in/sites/default/files/webform/notices/Seeking_comments_on_revised_provision_at_Para.p <u>df</u>

> 4 th - APERC, Public Notice, October 4 , 2016. http://www.aperc.gov.in/aperc1/assets/uploads/files/6581e <u>pn_tariffcategories_goi_mop_04102016.pdf</u>

> 5 There are several other charges, subsidies, incentives and taxes in the tariff schedule. We describe these charges in further sections of the paper.

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