INTRODUCTION

For most developing countries, if not to say all, the major part of the population is now living in rural areas. In 1998, almost four fifths of the Vietnamese population lives in rural areas and account for the same proportion in total labor force. More than 90% of the families living below poverty line belong to rural households. Hence, the government has declared rural development a high priority to reduce poverty, enhance equity and promote overall socio-economic development.

The Vietnam Communist Party Congress VIII in 1996 has launched a Resolution focusing on “Development and upgrade the electric network”, which set a target of bringing electricity to 100% of district towns, 80% of communes and 60% of rural households throughout the country by the end of the year 2000. The Resolution gave light to the prospect of having more access to this modern form of energy for the rural poor. However, the process of achieving this policy has faced many problems, which threaten the sustainability of further expansion and improvement of the rural electrification programs in Vietnam.

The most outstanding and controversial issue in this new policy is the tariffs used to charge for this modern form of energy.  Specifically, the concerns are for the constant increases to these tariffs. This is a problem common with the whole electrical energy sector and thus with the rural electrification program as well. The rural poor have complained about the high retail tariffs charged on them in comparison with those imposed on the urban residential customer. It appears to prevent them from using electricity. At the other end of the supply of this form of energy, the utility, namely Electricity of Vietnam (EVN), complains of the lack of capital resulting partly from the inefficient investment on rural network development due to the low tariffs charged. At the same time, the government seeks to obtain both social and economic objectives from their energy policy. That is why they have tried to reconcile the conflict by regulating the electricity tariffs with special priority for rural regions.

 

Literature reviews

Much research therefore has been carried out giving comments and arguments around the matter of electric energy tariffs from different points of view with different scopes. With regard to these tariff-setting theories, the existing literature is too numerous to be listed here. Moreover, the thesis will not focus on this very specific field of electricity. What this thesis will focus on is ways to change the policy of electric energy tariff setting and the policy implication of the applied method in practice in Vietnam in order to promote the rural electrification process. The following are researches found applicable to the main focus of the thesis related to the empirical practice of tariff setting.

National Tariff Study: Early 1996, Hagler Bailly Consulting, Inc. was awarded a contract by Asian Development Bank for a project entitled “Improvement of Financial Management of the Technical Assistance Project”. Part A of this project - National Tariff Study – was conducted based on a survey carried out across the nation. The final report gave a methodology (without focus on implementation) for calculating electricity tariffs for both bulk power users and retail power users, which was to be applied uniformly for the whole sector.

Transmission and Distribution Study. The study was carried out by International Resources Group (IRG), following the National Tariff Study. IRG suggested to separate two stages of distribution and transmission. The wholesale tariff consists of generation and transmission costs while the retail tariff will be reached by adding distribution costs to it. The report has recommended an implementation plan for tariff adjustment. However, an in-depth discussion of the retail tariffs is missing, only the average tariffs are discussed.

Rural Electrification Master Plan Study. The study was carried out in cooperation between EVN and the World Bank. Its report consists of all relating issues of the rural electricity process, giving an overall picture of the current situation. Tariffs for rural communities have also been analyzed but no detail suggestion has been given.

NEU-ISS thesis. A thesis paper written by Mr. Cao Dat Khoa of Class 3 also focused on electricity pricing namely  “Public Pricing Policy - Electricity Pricing in Vietnam during 1988-1997”. The thesis briefly discussed methods of calculation for the Long Run Marginal Cost (LRMC) in the electricity sector, and analyzed effects of the current electricity tariff structure (not based on LRMC) on electricity business (chapter III). In the final part of his thesis – Conclusions - Mr. Khoa gave some recommendations for applying LRMC pricing method to the entire sector, without specifically focusing on any particular stage of electricity supply or on any particular consumer group.

The research questions

The focus of this thesis will then be to answer the following question: "How should electricity be priced in order to provide a better means for further improving and expanding rural electrification in Vietnam?" Before coming to the answer for the question, a number of sub-questions relating to the matter should also be considered.

-         Why is rural electrification urgently needed in a developing economy like Vietnam? What effects will rural electrification bring about? Are they positive or negative with regard to a sustainable development of the whole economy? To what extent does the price/tariff play an important role in rural electrification process?

-         What is the best basis to set the price for such a commodity as electricity? What are the available methods of price setting? What are their advantages and disadvantages?

-         What is the current situation of rural electrification in Vietnam? What role does electricity pricing play in promoting the process? What disadvantages has the existing tariff setting mechanism created in the promotion of this process?

-         How can the existing tariff mechanism be improved or changed? What will be impacts of these changes?

Methodology

The basic theory of this study is pricing. Furthermore, the study will focus on tariffs for the rural communities by employing a method for calculating “Long Run Marginal Cost of electricity in rural regions” presented by Professor Peter G. Soldatos published in the magazine named Energy Economics (1991).

Structure

Analysis within the thesis will range from broad issues (such as electricity energy sector as a whole or rural electrification…) to specific matters  (such as rural electrification as a part in the sector or tariff setting for rural areas…). The theory and generally accepted arguments relating to this theory will be discussed first to serve as a basis for the empirical analysis that will come later in the thesis. Therefore, the thesis will consist of four chapters. Chapter I at first gives an overview on electricity in general and theories of its links with economic development then focus on rural electrification in the context of rural development. Chapter II follows by presenting a theoretical framework, which focuses on pricing issues, for further practical analysis in the next chapters. Chapter III then will show the current situation with rural electrification in Vietnam, after giving an overall picture of the whole sector, of which rural networks and rural electricity consumption is going to be an important part. The currently applied theory of price setting will then be shown to have a number of shortcomings in comparison with those presented in chapter II. The need for modifying the current tariff system will give rise to Chapter VI, where a new basis for price setting is presented with relevant policy implications.

CHAPTER 1

ENERGY AND DEVELOPMENT

RURAL ELECTRIFICATION

IN THE RURAL DEVELOPMENT PERSPECTIVE

 

1.1            ENERGY AND DEVELOPMENT

There are many economic indicator to assess the dependence of the economic development on energy. The most popular one among those is GDP elasticity of demand for energy, which is the ratio between the rates of growth of energy consumption and of the GDP. The second best indicator is the energy intensity, which is the ratio between energy consumption and concerning economic indicator (such as GDP, value added or personal consumption).

Among various kinds of energy, electricity appears to play a more important role. The GDP elasticity of electricity consumption for the period 1990-1999 is about 1.76, i.e. to fuel for Vietnam’s development, the electricity consumption must grow at least 70% faster than the economic as a whole. Such a high energy requirement implies a badly need of capital for the sector.

Price elasticity of electricity demand has been estimated approximately at -0.1, the most inelastic among those of other form of energy. However, electricity tariff in Viet Nam has never  reflected its real costs. This criteria thus may give a wrong advice for policy analysis.

1.2            RURAL ELECTRIFICATION AND RURAL DEVELOPMENT

1.2.1    WHY RURAL DEVELOPMENT IS NECESSARY

Various economic development models have given evidences for the contribution of agriculture to the development process. According to those models if the traditional sector developed, it can provide unlimited and cheap labor surplus, marketed surplus for savings and capital accumulation to modern sector development. Improving living standard in rural areas means expanding market for industrial products and releasing the demand constraint in the development process.

1.2.2    DEFINITIONS

1.2.2.1.            APPROACHES TO RURAL ELECTRIFICATION

1.      Supply driven approaches: National electrification programs are centrally planned, basing on an increase in generation capacity and extension of transmission grids. Demand assessments are based upon assessments of community size, linked to the national standard consumption configuration. The nationally set tariff rates for grid – linked power often does not reflect true cost, normally under the required level to assure financial coverage.

2.      Demand – led approaches: Demand – led approaches for rural electrification help in widening and strengthening rural electrification programs with entrepreneurial development. Demand – led approaches meet existing needs and desires, however, it cannot reach all rural areas resulting in a large fraction of the area being excluded from electricity services. These approaches can facilitate the development of various communal schemes with a variety of ownership and management structures.

1.2.2.2.            LEVELS OF ELECTRIFICATION

q       Access to grid: This term refers to the situation where a household is or can be connected to the power service at a "reasonable cost".

q       Connection to grid: This term refers to the fact that a household is supplied with electricity from the grid. Connection is sometimes referred to as penetration.

q       Electrified. There are two definitions for this term. Firstly, in the Rural Electrification Master Plan study, World Bank used this definition with similar meaning to “access to the grid” as defined earlier. Secondly, according to Institute of Energy, the term “electrified” should reflect a reliable supply of electricity to the concerning executive unit. It means that electricity must be adequate and stable to meet any potential demand, not merely sufficient lighting.

In this paper, the terms used by IoE will be applied. In addition, those definitions did not cover areas supplied by Independent Power Providers (IPP).

1.2.3        CHALLENGES IN RURAL ELECTRIFICATION - PRICING ISSUE

Firstly, demand for electricity per capita is very modest in rural areas because of  low population density. Meanwhile, physical factor causes high connection costs to those areas, even beyond rural household's affordability.

Secondly, the demand pattern in rural areas tends to concentrate on peak – period (mainly in the evening as people switch on lights) resulting in even higher costs for the rural  population.

Thirdly, rural electrification program is financially non - viable due to limited rural demand, slow growth of rural market and unproductive use of electricity.

Finally, the electricity tariffs set for the rural poor are usually regulated at low level to meet diverse targets, from economic to social ones. It drives the financial situation of rural electrification projects even worse. To arrive at tariff levels which can reconcile those often conflicting objectives is proven to be very difficult in rural electric system.

1.2.4        SOCIO-ECONOMIC IMPACTS OF RURAL ELECTRIFICATION

Electricity is often considered, along with others, as necessary but it is not necessarily the sufficient condition for the economic development.

1.2.4.1  . Productivity impacts

q       Agricultural activities: The objectives of rural electrification programs, especially at the very beginning of the process, is fueling for irrigation pumping, for modern equipment in primary processing of agricultural products and providing longer lighting for a better serve in the working time.

q       Non – agricultural activities: Empirical evidences shows the large proportion of industrial input is electricity. Electrification program also benefits various activities such as  craft making and small industry. However, rural industries and services are insignificant in terms of contribution to the GDP of the region as well as in terms of electrical load therefore the non – agricultural impacts of rural electrification are negligible in general.

1.2.4.2  . Social impacts

Normally, social impacts are non-quantifiable. A rural electrification project leaves impacts, negative and positive alike in many aspects of a social life such as: improving human well-being of rural population, especially the poor, better health, education services, better population control but negative effects on environment by having compensation and resettlement plan..

CONCLUSION

As acknowledge the importance of the fuel for economic and social engine in the development process, governments in most developing countries tend to pay more attention to the improvement and expansion of power system, especially for the accessibility of the poor in rural areas. Though immeasurable, rural electrification has been proven to benefit an wide range of social and economic subjects, productive and non-productive alike. However, it has been facing obstacles on the way to further expansion and improvement for the sake of a better life for the poor such as: modest rural demand, high cost in expanding power system to those areas, especially remote ones, low internal rate of return which is the discouragement for the investor…. To overcome those hurdle for benefit obtainment and objectives achievement, pricing issue has been considered as an effective tool in rural electrification project as long as it is sound established.

CHAPTER 2

THEORETICAL FRAMEWORK
PRICE AND PRICING ISSUES

2.1.    PRICE AND PRICING

2.1.1.   PRICE VERSUS TARIFF

In the sector relating to the sale of electricity as a commodity, the two terms “price” and “tariff” can be and will be used interchangeably in this study. “Tariff” though is preferable in this case.

2.1.2.   FUNCTIONS OF PRICE

Price is an indispensable concept in economics and business. It has many functions such as informational, allocation, rationing, mobilization and distribution function.

2.1.3.   PRICING

There are various ways of pricing all over economies. However, in the thesis we will only discuss the theories of public commodities pricing, which are popular and applicable in electricity sector:

q       Pricing based on utility of the goods

q       Pricing based on average cost.

q       Pricing based on marginal cost: It is proved that pricing at marginal cost enables the economic entity and the economy to reach Pareto’s optimum level and this is the most popular and overwhelmingly applied method.

2.2.    MARGINAL COST PRICING

2.2.1.   DEFINITIONS

Definitions of cost, marginal cost, long-run and short-run marginal cost are given in this part

2.2.2    MARGINAL COST PRICING

By pricing basing on marginal cost, a maximised social welfare is reached even in the case of different demand overtime for certain goods such as electricity. The LRMC pricing is not a good method where LRMC is lower than LRAC.

2.2.3    MARGINAL COST - BASED ELECTRICITY TARIFF SETTING

2.2.3.1. Characteristics of electricity

 Electricity is a non-storable goods. Therefore, the load (i.e. demand) must be forecasted beforehand for the coming production period to ensure the match between supply and demand. The load is a time variable, it can be very high at certain hours called peak periods and it can fall at other times, namely intermediate and base load periods. There are different types of generating plants:

1.      Peaking unit: used for supplying electricity during peak load periods, typically have short start-up times, low capital but high running costs.

2.      Base load unit: used to serve base load demand, characterised by having long start-up times, low running costs and being able to operate almost continuously throughout the year.

3.      Cycling unit: used to serve intermediate demand, has fairly short start-up times, intermediate running costs.

To generate electricity economically, a mix operation of those units should be applied according to the least cost principle.

Finally, electricity is a social commodity. The government's role in the pricing function is a decisive factor on the imposed price.

2.2.3.2.       LRMC – based electricity tariff setting

An overview of the most popular methods of LRMC - based electricity tariff setting will be given hereunder:

q Detailed long-term energy models. They are optimization or simulation models in which shadow prices reflect the real cost of fuels. They are usually very complex and cumbersome to work with though there are computer applications to support for them nowadays.

q Screening curves analysis (Appendix 5). For this type of analysis, a system with 3 types of generating stations (peak, cycling and base) as given in the above section, is assumed with the following parameters:

 

Peak	Cycling	Base-load
Running costs	v1            >	v2            >	v3
Annualized capital cost	c1            >	c2            >	c3

The LRMC will be calculated for each rating period (h1, h2 and h3 for peak, intermediate and base load, respectively). A load duration curve (Appendix 5) is established from historical data of the system operation. Assume a sustained increase of 1 kW in peak, or intermediate, or base load demand, the marginal costs for each rating period are calculated respectively as follows:

        MC _intermediate = v₂                     MC _base = v₃    

q Long-run average incremental cost: This is the per kWh cost of generation, transmission and distribution of electricity for the planning period (say T years), all discounted at a specific discount rate i:

where M_t and C_t are annual maintenance and capacity costs and E_t is the amount of energy delivered in year T.

Another economic solution for energy is a two-part tariff, which has both a fixed component (a standing charge) recovering system capital costs and a variable component (a metered running rate) to recover variables costs. The former will be formed basing on capacity LRMC and the latter basing on energy LRMC.

In practice, the total LRMC that will form retail tariff includes LRMC of transmission and distribution (T&D), which may also be divided into capacity and energy LRMC.

q       Transmission and Distribution capacity cost: The usual approach to estimating marginal T&D cost is the LRAIC method.

q       Transmission and distribution energy cost: Since T&D system do not have a direct energy cost (all incurs in generating stage), in the marginal cost analysis, T&D energy cost refers to the added cost of energy due to losses in the T&D system.

CONCLUSION

The common applied method is the long run average incremental marginal cost (LRAIC), which neglected the least cost principle. Though the appearance of the formulas is simple, its application into practice is very complicated. For a small company or agency at provincial level, to hire a consultant company is not economical, and could be a waste of time and money. As well, such a big and complicated analysis may be beyond small company or agency’s capability. On the other hand, the company, which is about to takeover a rural network, as well as the governmental authority need to know what is a suitable retail tariff for that region. The reason of the need for a good applicable tariff calculation includes also an optimal decision and cost recovery. An easier method for electricity calculation therefore will be presented in Chapter 4 of the thesis, which fundamentally simplifies the basic theory given above, for an easy application.

CHAPTER 3

ELECTRICITY OF VIETNAM

RURAL ELECTRIFICATION PROCESS

 

3.1.         ELECTRICITY SECTOR IN VIETNAM: AN OVERVIEW

3.1.1.  ORGANIZATIONAL STRUCTURE OF THE SECTOR

Electricity of Vietnam (EVN) is a state-owned corporation under the Ministry of Industry (MOI). Electricity tariffs are also subject to government control therefore it is a rather complex process for EVN to raise it up to LRMC level.

Though EVN’s organization chart looks hierarchical, such a large institutional apparatus makes managerial procedures more complicated and time-consuming.

3.1.2.      OPERATION OF THE SECTOR

3.1.2.1.      Demand analysis: consumption pattern

Figure 1: Electricity consumption pattern

An increasing importance of residential consumers

Consumers of EVN are divided into sectoral groups, including industry, agriculture, residential, commerce and transportation). Agriculture is the third largest consumer though it only accounts for a modest proportion of the total electricity demand (usually around 13% - 14%). While the majority of the population is living in rural areas, it appears to be a potential market for the service once the rural areas are electrified.

Electricity demand and supply projections up to the year 2020 reveals that the residential consumption will add nearly 1,331 GWh and even 1,507 GWh in periods 2000-2005 and 2005-2010, respectively. It implies a high expectation of the potential of residential consumption in rural areas.

3.1.2.2.      Supply analysis: the growth of the system

The power system in Vietnam is among the fastest growing power systems in the world with high potential capacity for further expansion. However, the existing equipment and small power plants themselves are nearly in ruin. Only approximately 40% of those can be considered well-performed. To finance for continuous growth rate in the period 1998-2010, the required accumulated capital is estimated to be USD 24.849 billion for the base scenario, whereas Vietnam’s GDP in 1996 was only about USD 24 billion. Meanwhile, the system loss factor, especially in transmission and distribution grids, has wasted more than one fifth of the total generated volume over the past decade and only reduced to 16.1% in 1999.

3.2.         RURAL ELECTRIFICATION IN VIETNAM

3.2.1.      RURAL DEVELOPMENT: AN OVERVIEW

Since the introduction of “doi moi” policy in 1986, rural incomes have increased, poverty incidence has fallen and overall well-being in rural areas has improved, agricultural output and productivity have risen significantly. Though the gap in various aspects between rural and urban areas has been widening; the agricultural sector is constrained by: inadequate access to support services; financial resources; information (market and technical information); vocational training and market. Rural infrastructure is underdeveloped and existing facilities are in poor condition. Rural demand for credit generally far exceeds supply, particularly for the poor. Those challenges constraint further development of rural areas especially if rural economic development is intended to base on household production.

A full rural electrification program therefore will release one of the above constrains in rural areas and the enhancement of rural electricity services (the rural infrastructure) will result in a positive impact on the remaining.

3.2.2.      RURAL ELECTRIFICATION IN VIETNAM

3.2.2.1.      Rural electrification: an overview of the history

Over a decade of 1980s to early 1990s, only a modest proportion of rural population (around 15%) have chance to use electricity. Thanks to some intensive rural electrification program under new governmental policy (the Resolution of Communist Party No 8 in 1996), the rate of electrified population has taken an incredible jump to over 70%.

Figure 2 : Growth rate of rural electrification program

the importance of government’s consideration

3.2.2.2.      Financing rural electrification

According to the estimation of expert from the World Bank, to meet the capital requirement for the said governmental target, about USD 3 billion is required[1].  There are number of sources to fund EVN's needs:

-  Soft loans from WB, ADB, Japan etc... and the Vietnamese government (interest rate varying from 2.6% to 6.8% per annum). However, these sources are limited.

-  EVN's own funds.

Meanwhile, the cash-flow analysis for EVN reveals that EVN is indebting itself very heavily and that the burden of this is being pushed forward due to increasing loans and bad debt services coverage ratio. In other words, the assumption is that the tariff will be raised to 7 US cents only in 2001 and to 8 US cents in 2002 will not clearly be enough for financial sustainability. With the current retail tariff, a simple calculation shows a payback period of about 20 years just to cover initial investment of a rural electrification project.

3.2.2.3.      Management models

The existing management models in rural areas consist of:

1.      Power Departments under the PCs: Regulated low tariffs but cannot be applied nationwide.

2.      Private agent or contractor: Flexible but too high tariffs.

3.      Water and Power Company: high costs resulting in high tariffs though good management skills.

4.      Private company: spontaneous, no legal basis, low technical skills, high tariffs, but high potential to be developed.

5.      Electricity service cooperatives (ESC): can be applied because of reasonable tariffs but low technical and management skills.

6.      Electricity management board (EMB) in the commune: reasonable tariffs but low technical and management skills, is not suitable for further developement.

The current operation of so many different management models at the same time makes it difficult for the government to control and direct the agencies toward the planned target and there should be no unified pricing system at the local level.

3.2.2.4.      Tariffs

Table 1: The average retail tariff in electrified communes – a picture of contrasting colors

by April 2000

 

500 – 700 (VND/kWh)		700 – 900 (VND/kWh)		> 900 (VND/kWh)		Total
	Quan.	%	Quan.	%	Quan.	%	Elec. Com.
Hanoi PC	92	81.4	20	17.7	1	0.9	113
HCM PC	61	100.0	0	0.0	0	0.0	61
Haiphong PC	164	95.9	7	4.1	0	0.0	171
Dongnai PC	120	90.2	0	0.0	13	9.8	133
PC 1	2,075	52.9	1,412	36.0	436	11.1	3,905
PC2	1,108	67.2	388	23.5	152	9.2	1,642
PC3	593	53.0	471	42.1	55	4.9	1,119

Source: EVN – Department of Electricity Development of Rural and Mountainous Areas

The principle of setting electricity tariffs is that the user must incur as much as they caused for the system. However, it seems unfair if the rich (PC Hanoi, Hai Phong, Dong Nai and Ho Chi Minh i.e. the urban population) pays at lower levels in comparioson with the poor (PC1,2 and 3 i.e. the rural population). According to the regulated progressive tariff scheme applied to the urban household, the first  100 kWh costs them only 500 VND/kWh. Meanwhile, the rural resident has to pay at least 500-700 ND/kWh for the same electricity consume. (The average electricity consumption of a rural household is only about 30-45 kWh per month).

3.3.         CALCULATION AND ESTABLISHMENT OF TARIFF SYSTEM

The electricity tariff system in Vietnam consists of two kinds of tariff: bulk supply tariff (BST) and retail tariff.

3.3.1.  Bulk supply tariff (BST)

The procedure for setting the Bulk Supply Tariff is as follows:

Step 1: Calculation of Total Forecast Profit of the Power Sector.

Step 2: Allocation of the net profit to the PCs

Step 3: Calculation of the Ability to Pay for each PC

Step 4: Calculation of Bulk Power Price (VND/kWh) for each PC.

Bulk Power Price=Ability to Pay/Total bulk power (kWh) purchased from EVN

The procedure has been designed to take into account the ability to pay of each PC, but in fact, there are some problems in this formula:

§         It does not reflect the costs of generation and transmission to the individual PCs.

§         It encourages increases in the number of staff and the associated costs in each PC.

§         It undermines the ability of EVN and the PCs to operate as independent and financially self - sufficient entities capable of attracting the large amounts of capital needed for system upgrades and expansion.

3.3.2.   Retail tariff: a regulation from the government

This tariff is quite low and applied to urban residential, industrial, agricultural and commercial consumers.... no rural residential.

3.3.3.  Retail tariff: a free setting

This type of retail tariff, which is avaiable in rural areas, vary in large range depending on the expected margins of wholesalers thus it is quite high. The highest retail tariff recorded has reached the level of over 3000 VND/kWh.

3.3.4.  Unique tariff and cross-subsidization

Cross subsidization exists in the current tariff scheme causing negative effects as follows:

§         It works against consumers making least-cost choices, undermines investor‘s efforts to provide alternative energy forms.

§         It provides the widespread recourse to unnecessary subsidies frequently proves to be fiscally unsustainable. When coupled with price restrictions, subsidies eventually limit utilities’ investment programs.

§         Subsidies discourage efficient energy use.

Therefore, a regionally discriminated tariff scheme will not only increase overall welfare but also help to avoid counterproductive effects.

CONCLUSION

A sound tariff scheme takes an important role in improving and expanding rural electrification process because it encourages local supplier to joint the business by expanding rural network to rural household and attracts rural users to the modern energy as well.

If EVN has to take over the entire network, it will become a huge burden not only on the organizational structure but also on financial sustainability of EVN. Meanwhile the curren retail tariff in rural areas must be reduced to assure social equality. Cross-subsidization has been seen as a short – term support rather than a long – term strategy while rural electrification is now seen quite an urgent need for fueling rural development in the perspective of trying to catch-up the neighboring countries.

CHAPTER 4

PRICING FOR THE RURAL ELECTRIFICATION

REGIONAL TARIFF SETTING

1.1.         IMPACTS OF ELECTRICITY TARIFF CHANGES

4.1.1.   IMPACTS ON RURAL ELECTRIFICATION AND RURAL DEVELOPMENT

q       Equality: Suppose that the retail tariff will be increased to cover real LRMC, the rural population will be further suffered.

q       Willingness to pay and affordability: An increase in tariff level may exclude the rural poor from using this modern energy.

q       Competitiveness: An increase in electricity tariffs could damage the competitiveness position of Vietnamese industry.

q       Budget saving: National budget will eventually be suffered if EVN suffers losses because EVN is a state-owned enterprise.

q       Financial viability: An increase in the retail tariff for low-rate-of-return rural electrification projects will undoubtedly ease the financial burden for EVN providing that it either takes control over the major rural distribution networks or increase its BST accordingly.

4.1.2.   ELECTRICITY DEMAND AND WILLINGNESS TO PAY IN RURAL AREAS

Table 2: Forecasted willingness to pay for electricity consumption in rural area

	Level 1	Level 2	Level 3
Willingness to pay (VND/month)	25,000	50,000	75,000
Accepted household (%)	50 %	30 %	15 %
Ave. elec. Consumption (kWh/month)	15 – 45 kWh
Willingness to pay (VND/kWh)	800 – 1666 VND

Source: Author’s summary. EVN/World Bank (1998) Report No. 2

One important conclusion from the above table is that the present tariff does not seem to present an ability-to-pay problem for the average rural households, despite the fact that the average tariff (approximately 5-6 USc/kWh or equivalent to 700-840VND/kWh) is quite high compared to other developing countries. Therefore, a reasonable increase in regulated retail tariff is feasible.

4.1.3.   LRMC – BASED TARIFF: RECENT CALCULATIONS

-         The LRMC estimated in 1993 was about US 7.0 cents/kWh.

-         The ADB’s Tariff Study calculated the total LRMC of 8.9 cents/kWh.

-         The World Bank estimated the retail level LRMC of US 8.1 cents/kWh.

-         The Rural Electrification Master Plan Study worked out the average LRMC of 11.9 USc/kWh for the whole system including investment on rural electrification programs up to the year 2005.

4.2.    REGIONAL TARIFF SETTING: SIMPLIFIED MODEL

4.2.1.   RELEVANT OF UTILIZING THE MODEL

-  This simplified model of LRMC calculation will be applied for different regions, reducing negative effects of cross-subsidization.

-  This simple calculation can be easily utilized by any institution or even individual who may concern.

-  The consumers may find it more acceptable to pay high tariffs if they know how tariffs are calculated than if they are just presented as a fact.

4.2.2.   ASSUMPTIONS

1-       The “least cost” combination of the power plants is achieved and the system is not substantially sub-optimal.

2-       There is no residual value of the equipment or other fixed assets. In other words, after the period of useful life span, the equipment is assumed to entirely wear-out.

3-       The inflation rate will not change through the whole planning period.

4.2.3.   SUMMARY

The advantage of this methodology is that it can be applied for a consumer group of any size, from a single consumption unit to a commune or the whole country.

Electricity cost is distinguished into: running costs, generating capacity costs, transmission capacity costs, distribution capacity costs and others

4.2.4.   EMPIRICAL PRACTICE

q       Region of practice: The chosen area is specified as profile No 7 in the survey of the World Bank on Rural Electrification Master Plan Study in cooperation with EVN – Demand forecast issues.

Table 3: Description of sample region - Profile 7

Criteria

Unit	Quantity/Description
Income per household per year	Million VND	7
Population density	Capita/km2	38
Average population per commune	Capita	7000
Terrain		Hilly-mountainous
Region classification		NM, NCC,SCC,CH
Electricity consumption	KWh/-HH/year	180-560
Connection rate 1998-2010	%	30-75
Connection rate 2010-2020	%	90

Note:  HH means “household”

Source: EVN/ World Bank (1998) – Report No 2 –  Table 5.1 page 16 & Table 5.2 page 20

q       Data: The data will also be taken from the same survey carried out by World Bank.

q       Outcome: Data will be categorized and applied into the model. The following are the results:

Table 4: Result of empirical application LRMC for a given commune

	System load rating periods
	Peak	Intermediate	Base
1.  Marginal plant (typical)	Gas turbine	Coal thermal	Hydro
6.  Adjusted running cost (USD/kWh)	0.032	0.025	0.00
13. Adjusted generating capacity cost (USD/kWh)	0.090
21. Adjusted transmission capacity cost (USD/kWh)	0.034	0.047	0.024
27. Adjusted distribution capacity cost (USD/kWh)	0.027	0.038	0.020
28. Electricity LRMC (USD/kWh)	0.183	0.110	0.044

The calculated average electricity LRMC in this rural commune is 9 USc/kWh (equivalent to about 1260 VND/kWh[2]). This is a reasonable result in comparison with others such as system average tariff of 8.9 USc/kWh calculated by Hagler Bailley and rural average tariff of 11.9 USc/kWh in the calculations of World Bank.

q       Policy implication

Ø      The table of results tells us that the large portion of total LRMC is categorized under generation and transmission costs rather than distribution costs. It implies that the PCs (or EVN) will be suffered most since the BST for rural are at low level ranging from 360 VND/kWh to 759 VND/kWh.

Ø      Suppose a full rise in the retail tariff up to the LRMC of 9 USc/kWh (i.e. 1260 VND/kWH), the total payment per year that each household will have to make for their electricity utilization ranges from VND 226,800 to VND 705,600 accounting for 3,3% to 10% of the yearly income. It implies that increasing regulated retail tariff level is acceptable, even up to its LRMC.

Ø      Suppose three scenarios of partly raising retail tariff up to 6, 7 or 8 USc/kWh, consequently. Given the current regulated retail tariff of 700 VND/kWh.

Table 5: Retail tariff setting scenarios

	UNIT	SCENARIO 1	SCENARIO 2	SCENARIO 3
Retail tariff	USD/kWh	0.06	0.07	0.08
VND equivalent	VND/kWh	840	980	1120
Loss per kWh	USD	0.03	0.02	0.01
Loss per household	USD	10.8	7.2	3.6
Number of HHs in the sample commune		1000	1000	1000
Loss per commune	USD
- (1) Connection rate of 30%		3,240	2,160	1,080
- (1) Connection rate of 70%		7,560	5,040	2,520
Number of electrified commune		7,100	7,100	7,100
Rough estimated compensation	Mill. USD
- Connection rate of 30%		23.004	15.336	7.668
- Connection rate of 70%		53.676	35.784	17.892

Note:   (1) Refer to Table 3: Description of sample region - Profile 7

The best solution is a full support of the governmental budget in the early stage of rural electrification program to encourage the growth of connection rate in rural areas. The retail tariff then will be increases gradually over time up to a certain level within the constraint of ability to pay.

Ø      In addition, the model with clear formulas gives some suggestions for the way to reduce LRMC by making change on technical parameters such as losses:

Table 6: Impacts of rural network improvement

Changes in distribution loss

Reduce of distribution loss (%)	- 7	- 5	1	3
Calculated LRMC	9.6	9.4	8.95	8.8

A reduction by 3% in distribution loss will result in corresponding fall in LRMC from 9 USc/kWh to 8.8 USc/kWh.

CONCLUSION

The rural electrification process in Vietnam is facing conflicting benefits of different involving subjects. The government wants EVN to take over rural network and keep retail tariff under control at rather low level. EVN is now too cumbersome to have more institutions covering all rural areas. Moreover, additional investment on non-profit rural electrification projects will further push its financial position come from bad to worse.  It wants to increase regulated tariff level, including in rural regions, to ease the burden. The rural households in their turn want to have better management of the rural network lower retail tariff.

A methodology of calculating LRMC therefore was presented in chapter 4 as a basis for further study on detail rural tariff – setting policy. The whole process of the calculation, step by step, and the outcome has recommended some valuable ideas, which even go to the opposite direction to what was expected. Instead of reducing the free-setting retail tariffs, which are claimed to be high, to low regulated level, the result suggested that the tariffs for the rural population should also be raised gradually to the corresponding LRMC level along with tariffs for other consumer groups. Reasonable increases over time will not exclude rural residential out of accessibility to this modern energy but strengthen financial capability of ENV and the government in case of a rural electrification project. That means those projects will be more viable, speeding up the electrification process. On the other hand, the tariff adjustment will of course eliminate partly disadvantages of cross-subsidization available in the electricity sector.

The different retail tariffs basing on the presented LRMC calculation methodology are applicable in various regions all over the country for the two reasons. First, this tariff system does actually exist in electrified communes. The problems of the current spontaneous system are that (i) the customers do not know whether they are charged at reasonable price; and (ii) the high tariff actually benefit the local electricity authority rather than encourage or aim at future rural network expansion or improvement. Therefore, it should be modified for the sake of the economic development in rural regions as well as in the whole economy. Second, many management models down to the commune level are available with all the advantages and disadvantages for comparison. It is also a convenient basis for realizing tariff system of various levels.

Nevertheless, detail of a tariff-setting mechanism has not been discussed in the study. Policy recommendations target to the retail and bulk supply tariffs on average. For example, a lifeline tariff[3] is useful for low-income households. This encourages low-income household to use electricity. However, the lifeline tariff should be restricted to very low consumption levels to prevent the utility or local electricity agency being overburdened. The current residential tariff block is suggested to be refined by reducing the upper limit of the first tier to 30kWh per month instead of the current 100kWh per month. This will prevent unnecessary subsidization to a too large part of people while the adjusted upper limit is proved to be enough for the basic needs. Therefore, a further study on the establishment of the tariff system basing on this LRMC calculation is expected to be carried out for a comprehensive and effective pricing policy. The tariff system should enable a transparent and practical mechanism of  revising tariff level over time according to changes in relating economic indicators such as inflation rate.

As the increasing gaps between rural and urban areas are certain to slow down the economic growth and to hamper a sustainable development. Therefore, the need of expanding and improving rural electrification has ranked among top priorities. In order to speed up the progress,  a number of policies should go in line with pricing policy as follows:

q       It would be more rational to prioritize full electrification including upgrading of the existing and often deficient LV rural networks, before pushing ahead with an electrification which may not reach many consumers anyway. Therefore, priorities should be defined clearly for each regions or communes. The capital in this case will be used intensively and efficiently for the improvement of the electrified communes rather than for expanding the national grid to remote areas. Instead,  IPPs using renewable energy will be planned to be developed in those areas.

q       There should be an isolated fund for governmental investment on RE with separate financial management so as to reduce financial burden on EVN. 

q       Decentralization, especially at low managerial levels such as communes, is necessary to prevent disadvantages of a full monopoly in the sector. In addition, it also lessens the complication in managerial structure of EVN. However, the  involvement of private parties will work providing that:

Ø         Legislation to allow the generation and sale of electricity by private parties is established officially.

Ø         Standard level of service (which may be less than full availability in some cases) is clearly defined.

Ø         Standard contract conditions and warranty requirements are clearly defined

Ø         Technical and managerial training will be provided by the engineers of EVN and PCs.