Weigh the costs and benefits of creating monopolies

A widely held view, spanning various network-based sectors such as electricity, water and now natural gas, is that distribution of these services is a natural monopoly. However, this view needs to be examined in the context of the maturity of the existing distribution systems, their coverage and age. The telecom sector is an outstanding example of competitive distribution wherein multiple service providers have rolled out their network infrastructure to provide competition. Of course, the number of competitors varies across distribution circles. The underlying premise in the way that this sector expanded was that the economics of the business was linked to both the size of the system as well as the intensity of customer loads!

The reference to the Indian context is to highlight the fact that distribution infrastructure in Indian cities are either very old and inadequate or non-existent. In the case of gas, with the exception of fairly embryonic systems in a couple of cities, the distribution infrastructure is non-existent. This poses both a challenge and an opportunity - a challenge due to the magnitude of investment that would be required to connect all households to city gas distribution networks and an opportunity to de novo model the system for efficient delivery of service to the consumer.

So, what should be the model of infrastructure development for city gas distribution that should be followed in India? The answer to this question should bear in mind the provisions of the Petroleum and Natural Gas Regulatory Board Act, 2006, which calls for the board to determine whether a distribution network should be developed/categorised as a common carrier or a contract carrier. In deciding on this, the board is expected to be "guided by the objectives of promoting competition among entities, avoiding infructuous investment....".

In an earlier Teri study (2000) pertaining to electricity distribution networks, it was recommended that smaller distribution licensees (inset licensees) be allowed to operate based on clearly identified sub-geographical zones of a city so as to facilitate a closer mimicking of competition and benchmarking performance, with adequate compensation for losses to the main distribution licensee due to the expected impact of cherry picking of areas.

To the credit of the government, this concept was recognised in the Electricity Act ,2003, and is finding increasing application now. Supporting provisions of open access that mimic the separation of the wires business from supply do help. The consumers of these areas are experiencing a qualitative difference in supply and customer service and are happy to pay a cost-reflective price for the same.

For the all-new city gas distribution networks, this question of exclusive distribution rights becomes important. Indian cities are characterised by high population densities and a rather haphazard growth that would pose enormous technical and investment challenges. Should entire cities be earmarked for a single business provider? The experience from the electricity sector reveals that smaller areas within cities can provide viable business units. As such, should cities be broken into smaller zones? Presumably, there would be a larger number of potential bidders if the investment requirements are at lower unit levels. Additionally, should we, right from the outset, separate the business of laying pipelines (either for the city as a whole or for demarcated zones) from that of supplying gas?

It is important for India to set these principles keeping in mind the long-term development of the market while allowing for possibly lower levels of competition at the initial stages. We also need to be aware of the implications of restricting the development of the gas market to a relatively small number of firms on the potential market power that can be acquired by a single company. Quite independent of the number of players involved, is the issue of pricing of city gas. Different distribution entities could have different cost structures that reflect the density and challenge of setting up networks in a specific area. The regulators would need to accept the political challenge of having different prices in different parts of the city. The existence of monopolistic situations reinforces the need for regulatory oversight as a poor substitute for competitive efficiencies. We must weigh the costs and benefits of creating monopolies by regulation.