Regulatory Assets of DISCOMS – Explained Pointwise

The Supreme Court recently directed the State Electricity Regulatory Commissions (SERCs) and distribution companies (DISCOMs) to clear the existing regulatory assets within four years and liquidate any new assets within three years. The court also advised capping the regulatory asset at 3% of a DISCOM’s Annual Revenue Requirement (ARR) and instructed regulators to set out transparent roadmaps for recovery, along with conducting intensive audits of DISCOMs that continue without recovering these assets.
In this context, let us understand, what are regulatory assets, their impact & what can be done to recover them sustainably.

What are Regulatory Assets?

• Regulatory assets constitute 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), which is the revenue collected by the DISCOM as consumer tariffs and subsidy payments from the government.
• If the ACS is greater than the ARR, the DISCOM effectively makes a loss on the sale of every unit of electricity. To avoid  suddenly burdening consumers with an immediate tariff increase to recover the gap, SERCs allow the DISCOM to record the gap as a Regulatory Asset. This is essentially a deferred cost that the DISCOM is entitled to recover from consumers in the future, usually with interest.

What are the reasons behind ACS-ARR gap?

1. Non-Cost Reflective Tariffs: Tariffs charged to consumers often do not reflect the actual cost of power supply. Political considerations lead to setting retail tariffs lower than needed, especially for certain consumer categories like agriculture or low-income households.
2. Delayed Subsidy Payments: State governments promise to compensate DISCOMs for supplying electricity to subsidized sectors (e.g. agriculture), but the actual release of subsidies is often delayed. This causes a revenue shortfall that adds to the ACS-ARR gap.
3. Power Purchase Cost Volatility: Sudden increases in fuel costs (coal, gas) or reliance on expensive imported coal raise the cost of purchased power for DISCOMs, while tariffs are not adjusted swiftly enough to reflect these higher costs.
4. Operational Inefficiencies: High levels of Aggregate Technical & Commercial (AT&C) losses—including theft, technical losses in transmission/distribution, and poor billing efficiency—mean less revenue is realized compared to the cost incurred.
5. Regulatory Lags & Deferred Tariff Adjustments: Delays in tariff revisions and “true-up” processes (where actual costs are reconciled into tariffs after the fact) mean costs rise faster than regulated revenue. Revenue gaps are often deferred as “regulatory assets” instead of being recovered promptly.
6. Mismatch in Tariff Structure: Inadequate or distorted tariff structures (e.g., cross-subsidization without proper compensation) often prevent DISCOMs from recovering both fixed and variable costs of supply.

What are the impacts of ACS-ARR gap?

Impact on CONSUMERS:

1. Steeper increase in Tariff: To recover the gap, regulatory bodies eventually allow tariff increases and surcharges—sometimes suddenly rather than gradually, leading to “tariff shocks” for consumers. The deferred costs (recorded as regulatory assets) are eventually recovered from consumers, often with interest added.
2. Decline in Service Quality: With persistent losses, DISCOMs face cash flow crises, limiting their ability to invest in network maintenance, customer service, and grid modernization. Power outages, voltage fluctuations, and poor customer support often result for all consumers, especially in regions with large gaps.
3. Financial Burden & Social Inequity: If state governments fail to compensate DISCOMs through timely subsidies, the revenue gap is ultimately passed on to all users via higher bills. This can disproportionately impact vulnerable consumers if subsidy mechanisms are not well-targeted.

Impact on DISCOMs:

1. Rising Losses and Debt: Persistent ACS-ARR gaps mean that DISCOMs accumulate mounting losses and must borrow to cover ongoing expenses. Many are trapped in a vicious debt cycle: as of recent figures, total accumulated losses for public DISCOMs crossed ₹6.92 lakh crore with debt over ₹7.5 lakh crore.
2. Underinvestment in Infrastructure: Financial distress prevents DISCOMs from investing in modernizing grids and replacing aging, inefficient equipment—resulting in high technical losses and service unreliability.
3. Loss of Financial Stability: Inability to recover costs leads to poor cash flows, limiting the ability to pay for power purchases, maintenance, and modernization. Some states have had to take over DISCOM debts, straining state finances and breaching fiscal targets.

Other impacts:

1. Fiscal Risk to States: States stepping in to bail out DISCOMs risk breaching fiscal limits and diverting resources from other priorities.
2. Difficulty Adopting Renewable Energy: Financing transitions to green energy and open access becomes harder due to cash constraints. This hampers India’s wider decarbonization goals and competitiveness.

How can ACS-ARR gap can be bridged?

1. Tariff Rationalisation: Periodic, transparent tariff setting processes aligned with real cost of supply, while using targeted subsidies to protect vulnerable consumers, are needed to avoid deferred regulatory assets and to ensure timely recovery of costs. This will ensure that the burden is shared transparently rather than hidden in deferred recoveries.
2. DBT for subsidies: Instead of indirect tariff reduction, DBT for electricity subsidies ensures targeted segments (rural/agriculture) receive direct payments, reducing scope for misallocation and making revenue more predictable for DISCOMs. Lessons from DBT of subsidies for LPG demonstrate efficiency gains and reduced fiscal leakage.
3. Timely Payment by State Govts: State governments are also needed to release the subsidies on time so that DISCOMs are not left carrying the financial gap on their books.
4. Automatic Fuel Cost Adjustment Mechanism: Automatic Fuel Cost Adjustment Mechanisms, such as the fuel & power power purchase cost adjustment mechanism, can help tariffs respond quickly to sudden changes in input costs.
5. Annual True-up Exercise: Regular annual true-up exercises, where projected & actual expenses are reconciled, can prevent the build-up of large backlogs.
6. Regulatory Reforms: Regulatory Commissions play a critical role in maintaining discipline. By enforcing limits, ensuring transparency in accounting, and setting clear timelines for recovery, they can ensure regulatory assets remain an exceptional tool rather than a recurring feature.
7. Reducing AT&C Losses: 
   • Deployment of smart and prepaid meters helps boost billing efficiency, minimize theft, and accurately track consumption. RDSS (Revamped Distribution Sector Scheme) pushes for mass installation of smart meters to cut AT&C losses.
   • Investment in grid modernization and better network management reduces technical losses and improves overall reliability.

Conclusion:
The SC’s intervention is therefore a call for coordinated action & greater financial discipline across the sector, so that electricity remains affordable for households & sustainable for utilities.