DSIJ Mindshare

Tariff Wars In The Power Sector

Over some time now, the government has been taking measures to bring back a spark into the power sector. However, a recent order by the CERC that was aimed at safeguarding the power generators’ interests has brought to the fore irregularities in the bidding process. Shrikant Akolkar throws some light on why this decision has become a bone of contention.


The power sector has seen a lot of policy initiatives in the last one year. The announcement of the coal price pooling policy, debt restructuring of State Electricity Boards, FDI in power trading, etc. are some of these. However, as far as the economic value of the decisions is concerned, there has been no decision more striking than that of raising power tariffs, which also happens to be the most important issue in the power sector. If one studies the entire value chain of power, then power generation is the most important link. If this link fails, the entire value chain would get disrupted.

In fact, this chink in the sector’s armour has been showing through over many years now. Remember last year's massive power outage in the northern region, which plunged nearly half of the country's population in the dark for nearly two days. Besides, the power deficit in the country has also been increasing despite the addition of huge generation capacities. In short, the generation sector has hit its trough, and an urgent revival of the same is a must if the country is looking at a consistent and reliable power supply. Besides, how can we rightfully lay claim to superpower status if the country cannot generate enough electricity to provide to its homes.[PAGE BREAK]

In a previous special report probing what ails the Indian power sector Indian Power Sector: Searching For Light, DSIJ Vol. 28, Issue # 2, dated January 13, 2013 , we had covered the issues related with coal imports and mentioned that power companies which have such power projects are seeking tariff hikes.

In a more recent development, the Central Electricity Regulatory Commission (CERC) has directed the state power utilities to provide compensatory tariffs to Tata Power and Adani Power. This would be over and above the tariff agreed upon under the long term power purchase agreements. The entire power sector cheered this decision. Investors too hailed the ruling, and many analysts raised the targets on the power stocks.

But there are still a few issues that remain unresolved. The first question that comes to the mind is how private companies are allowed to increase tariffs in a public project many years after winning a bid. Shouldn’t that be a sign of something amiss? Besides, will these companies really get what they want? Was this decision necessary? What would the future impact of this decision be?
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The CERC Order

In its order dated April 4, 2013, the apex power regulatory authority CERC allowed Adani Power to recover its higher fuel costs by way of compensatory tariffs from distribution utilities in Gujarat and Haryana. Adani Power successfully made a case before the regulator that it is facing huge losses in its 4620 MW Mundra Power Project. The aforementioned state utilities are procuring 2424 MW of power from this company but had refused to pay it higher tariffs.

In its second such order dated April 15, 2013, CERC also allowed Coastal Gujarat Power, a subsidiary of Tata Power, to recover higher fuel costs in its 4000 MW Mundra Ultra Mega Power Product (UMPP). Five state utilities, viz. Gujarat, Maharashtra, Punjab, Haryana and Rajasthan are procuring 3800 MW of power from this UMPP. These state utilities had also declined to increase the tariffs to the company earlier.

What is common in the two situations is that both the private power companies have been allowed to recover higher fuel costs until the coal supply situation improves. Besides, the companies had won the respective power projects by participating in public bids.

The passing of this order has raised a crucial concern on the legal sanctity of such projects. Ideally, public projects which are won through bids are not expected to be re-negotiated.[PAGE BREAK]

Raising A Red Flag

Despite the fact that the CERC has passed this order, it has come under criticism from within its own ranks. S Jayaraman, a CERC member, raised grave concerns over the orders passed by CERC. The issues he has raised are many, such as incorrect pricing to win bids, ignorance, flawed knowledge of international trade, etc. In a separate order to Adani Power, he says, “The petitioner had quoted non-escalable capacity charges and non-escalable energy charges to win the bid, thereby absorbing all future escalation in capacity charges or energy charges”. He made a similar observation in the case of Tata Power, saying, “Though the petitioner had the option to quote 100 per cent fuel energy charges as escalable, the petitioner had quoted non-escalable fuel energy charges up to 55 per cent to win the bid, thereby absorbing all future escalation in energy charges”.

Jayaraman also brought to notice the fact that Adani Power was originally supposed to supply power from its power project in Chhattisgarh but due to the cancellation of the fuel supply agreements, it opted to supply power from the Mundra project, which is based on imported coal. This messed up its financials.

Besides, he also said that the both the companies entered into fuel supply agreements with their parent companies which had invested in Indonesian coal mines. According to him, at the time of bidding, Adani Power did not consider the international coal prices, which would have made its bid costlier than those of other bidders. Tata Power too did not quote full energy charges, which would have insulated the company from any change in international coal prices.

Jayaraman added, “There was neither any prohibition nor any embargo on the petitioner to purchase coal from Indonesia except that the petitioner may not have found the lowest bidder. In other words, the aggressive and predatory bidding by the petitioner by not factoring in the market price of coal and carrying rupees exchange rates and not quoting the escalable energy charges has helped it in winning the bids”.
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Is This A Force Majeure Event?

The basic premise on which the companies were asking for a tariff hike was the change in regulations in Indonesia. There has been a lot of discussion around whether this event falls within the purview of force majeure. Let’s first understand what this means.

A force majeure event is one that is a result of the elements of nature, as opposed to one caused by human behaviour. According to the Indian Council of Arbitration, requirements of a force majeure event are:

  1. It must proceed from a cause not brought about by the defaulting party's default;
  2. The cause must be inevitable and unforeseeable; and
  3. The cause must make execution of the contract wholly impossible.

Both CERC and Jayaraman have rejected the claim that the change in the Indonesian regulation can be seen as a force majeure event. In fact, in one such case pertaining to Reliance Power’s Krishnapatnam UMPP, the Delhi High Court had declined to term the change in the Indonesian law as a force majeure event on the grounds that, “In a supply contract, particularly where the commodity in question is being imported, parties generally factor in the possibility of sudden fluctuations in international prices”. Besides, as the CERC said in its order, the regulatory changes do not prohibit a power company to buy coal from other sources.

Though on the legal front, CERC has turned down the claims of the generating companies that these developments be termed as force majeure, the events may be viewed as a violation of what is termed as the ‘sanctity of bids’.[PAGE BREAK]

Sanctity Of Bids

This consideration has come into play as the CERC’s order to safeguard the companies from losses eventually amounts to the renegotiation of a public contract. This is a very rare event and can seriously harm competition and send a wrong signal to parties participating in the bid. It is clear that the order in question would allow Adani Power and Tata Power to correct the ‘mistakes’ they had made at the time of bidding. Besides, there would also be players who would have made conservative bids considering fluctuations in coal prices, and all of them would have been let down by the ruling.

This, however, has brought to the fore the burning demand for new bidding documents. In the last one year, many state utilities have raised tariffs, which is a positive for the generating companies. Besides, the quoted tariffs in the recent bids for power projects have also gone up in the range of Rs 3.50-7.00 per unit. It is high time that new bidding documents should themselves contain an automatic pass-through clause, i.e. passing on the increase in costs to the end customers. This will help reduce such instances of messy dealings in the sector.



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Why CERC Did What It Did

The power sector has been going through a lot of issues over a long time. The most important of these is that of coal supply. Coal is required in huge quantities in the country and Coal India (CIL) is unable to assure power companies of adequate supply.

The CERC has conceded that coal imports have now become inevitable. In an agreement, it has commented, “The situation in the domestic coal market at present is not encouraging, as CIL is understood to be itself depending on imported coal to meet up to 20 per cent of its commitment under the FSA”. It has also said that coal prices in other countries are higher than that in Indonesia. “Sourcing of coal from alternative international market does not, at this moment, appear to be a viable option compared to the Indonesian market”.

Besides, a total 88000 MW of power projects worth over Rs 3.5 lakh crore are lined up in the 12th Five Year Plan. If policy initiatives are not taken now, these investments would be at risk and that is not something the country can afford. If the power sector faces hurdles it directly impacts the banking sector, which lends 75 per cent of the total cost of a power project. With this decision, CERC has chipped in to insulate the generating companies.

Last year, the Prime Minister Dr Manmohan Singh had assured that he will address the problems faced by the power companies. After he met the chiefs of power companies, a host of policy initiatives were taken. The CERC’s recent orders are a part of these initiatives. In this scenario, we believe that the renegotiation of the bids may be seen as a one-off event. It can also be reasonably argued that the sanctity of the bid remains untarnished as the CERC has not recommended changing the long-term tariffs.

The compensatory tariffs would be decided by a separate committee on April 30, 2013, which will have representatives of each stakeholder. It is believed that these would not be very high, and therefore, the welfare of the end customers would be maintained. The provision of compensatory tariffs is also temporary in nature and will come to an end when the coal supply situation improves in the future.
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DSIJ’s View

The CERC order is a definite game changer for the power sector. The sector has been performing poorly due to fuel shortage in the country. In such circumstances, overseas coal was the only option left with the power sector. The regulatory changes in Indonesia, however, acted as spoiler for the industry, especially hitting its profitability.

Considering that coal will have to be imported as we cannot run our power capacities only on domestic supplies, the government has also asked Coal India to supply to all the power companies and to meet the shortfall with imports. To ease the situation further, a coal price pooling mechanism is also on the cards, and as per our sources, will be approved soon.

As for Tata Power and Adani Power, our estimates are that a tariff hike of 10 paise would increase their operating profits by Rs 240 crore and Rs 150 crore respectively until the supply crunch eases. A similar pact can also be expected for Reliance Power, which is in the process of building the Krishnapatnam UMPP in Andhra Pradesh. The power utilities will further have an option to go to the Appellate Tribunal, which may take more time. This will remain a drag on the power generators Adani and Reliance, unless a triumph is secured there too.

In any case, if the CERC order materalises, it would serve as a short-term lifeline to the sector. This may also help to bring more private investments into the sector. Renegotiation of bids, however, should not become a new trend in the country.

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