The Jungle and Zoo Analogy: Reconciling Open Market Competition and Regulated Tariff Determination

In the ever-evolving landscape of infrastructure investments, India finds itself navigating a complex confluence of regulatory frameworks. These frameworks, particularly in power transmission and gas pipeline sectors, juxtapose open market competition and regulated tariff determination, often creating a mismatch in objectives and outcomes. To illustrate this dilemma, consider the analogy of zoo/circus animals and forest animals: two distinct species, each suited to its own environment but struggling to thrive when forced to adapt to the other.

The Analogy: Zoo vs. Forest Animals

In this analogy:

• Zoo/Circus Animals represent entities operating in regulated markets. Their performance is dictated by strict rules: they must stay fit, perform predefined tasks, and are rewarded with predictable compensation in the form of regulated returns (e.g., 14-15.5% RoE in CERC’s framework). These players are conditioned to stability, not risk.

• Forest Animals represent players in open, competitive markets. Their survival depends on agility, opportunity, and the ability to adapt quickly. Rewards are unpredictable but can be substantial when the hunt is successful.

When regulators attempt to blend these two species into a single market, the result is often suboptimal. Regulated entities struggle to compete in a kill-or-be-killed environment, while competitive players exploit regulatory loopholes to ensure survival—or thrive at the expense of the system's integrity.

Open Competition in Regulated Markets: A Flawed Design

India’s regulatory frameworks, particularly in the power transmission and natural gas sectors, illustrate this inherent flaw. Tariff-Based Competitive Bidding (TBCB) in power transmission and bidding-based tariffs for gas pipelines under the Petroleum and Natural Gas Regulatory Board (PNGRB) attempt to introduce open competition within regulated markets. However, the following issues emerge:

1. Exploiting Loopholes in the Regulatory Design

• In TBCB/PNGRB bids, bidders can manipulate tariff structures by quoting near-zero rates initially and inflating future tariffs to benefit from discounting factors for NPV (e.g., 10.41% in Transmission & 12% in PNGRB bids) and cross leverage it with margins from production or marketing of respective parent companies, that may accrue because of the asset monopoly. While levelized tariffs appear competitive during evaluation, the long-term costs often burden users or defeat the purpose of unbundling.     

• Similarly, capacity creation having become a factor of bid evaluation, it is prone to get distorted disproportionately for winning the bid, while the actual utilization remains low.  

• The concept of floor ceiling prices and capacities are not fully adopted by both the Regulators.

2. Conflict Between Stability and Opportunity

The regulatory environment rewards regulated players like existing or nominated infrastructure creators like Power grid corporation or 42 nominated parties under PNGRB Sec 42. The tariffs envisaged for them are as per respective regulation, subject to their meeting the normative targets.  However, when both price/tariff and capacity are becoming bidding parameters under open competition, the entities are forced to look for alternative avenue of revenue source or manipulate to win the bids, in addition to the normative performances. Their only risk is to lose their BGs for non-execution. The animal spirits can’t be tamed so easily !      

If percentage returns notified by Regulators are fair, calling bids with Quality based selection (QBS) criteria can expand infrastructure rapidly.

We are caught with predicaments of what we want to Regulate and trying to tame the open market competition for benefit of customer.            

Better would be to have conviction of fair return which can attract investment and expand the infrastructure first rapidly with regulated tariffs.

3. Lack of a Unified Policy Direction

While PNGRB and CERC operate in similar infrastructure domains, their approaches diverge significantly:

·        PNGRB: Adopted a post-tax IRR model for 12% post tax retrun (ie around 16% pretax), & applies on total investment (debt + equity) without differentiation. However, it’s adoption of  DCF method is not investor friendly, as the investors have to wait for long time. Major customers (industries) come much later after pipelines are laid.       

·        CERC: Distinguishes between debt and equity, offering 14-15.5% RoCE on equity, while treating interest on debt as a pass-through cost. However, its adoption of ROCE method is quite investor friendly and provides stable return with existing well established market.    

 Recognising Debt in Regulated Returns

Debt financing plays a pivotal role in infrastructure development, especially in capital-intensive sectors like transmission lines and pipelines. Yet, regulated tariffs not recognizing debt for return under recognises the entrepreneurial effort involved in managing the total project execution and commissioning.

Imagine a project is executed with 100% debt hypothetically offered by an international agency , will they get only interest on debt as return for their entrepreneurship?   

Undervalued Entrepreneurial Risk:

The execution of large-scale projects involves navigating land acquisition, regulatory clearances, and efficient Project/ Cost management. It does not varie how the way the finances are raised and spent.            

Entrepreneurs leveraging  debt, indeed is towards financial risk reduction in open market competition. If the sector is properly regulated on both customer and entity interest aspects, there is no big financial risk to distinguish between debt & equity.  

The approach of PNGRB seems right to the extent that whether debt or equity, entire amount need to be given fair return, to incentivize faster project execution, commissioning, safe operations and meeting the normative targets..

Ministry of Finance & Ministry of Industries & Commerce may come out with a open policy on what is the fair return for this kind of tariff determination, and methodology to be adopted for incentivizing domestic and international investments in these infrastructures.

Toward a Stable and Fair Regulatory Framework

India’s infrastructure sectors need a cohesive and forward-looking regulatory policy that addresses the following:

1. Unified Recognition of Capital Investment

• Emulate PNGRB’s approach by recognizing total investment (debt + equity) for the specified regulated returns.  

• Gap Funder/ Unified pricings are the way to leverage both DCF/ROCE method advantages, rather than only one method.

2. Introduce QBS for open competition

• Selections be made for bidding basis extensive QBS criterial along with floor and ceiling prices/tariffs and capacities.

• Define normative level performances and allow the cost savings be retained in addition to Regulated tariffs for directly authorized infrastructures. 

• If competition is really good for multiple infrastructure projects bid by agencies under QBS, allocate the projects basis evaluated capabilities for concurrent expansion of infrastructure.

 3. Evaluate Effectiveness of Regulated Returns

• Periodically review regulated return rates (e.g., 14-15.5% RoCE under CERC, around 16% under PNGRB) to assess their effectiveness in attracting private investment.            

• Introduce mechanisms to revise returns progressively, attracting  investment commensurate with infrastructure needs.

4. Balance Competition and Regulation

• Clearly delineate markets for regulated players (zoo animals) and competitive players (forest animals), avoiding hybrid frameworks to combine disparate objectives.     

• For competitive segments, establish floor tariffs or capacity caps to prevent over exploitation of regulatory gaps along with QBS.

Conclusion: The Need for Policy Clarity

Regulating infrastructure investments in a mixed market requires clear, stable, and unified policy direction. India must reconcile the objectives of open competition and regulated tariffs by:

• Recognizing the entrepreneurial effort in all forms of capital deployment.

• Designing frameworks that close loopholes while incentivizing private participation.

• Periodically reassessing the effectiveness of regulatory mechanisms in achieving national infrastructure goals.

The jungle and zoo analogy underscores the risks of imposing conflicting objectives within the same market. By addressing these systemic issues, India can create an investment-friendly ecosystem that balances fair returns with public affordability and drives long-term infrastructure growth.