Supreme Court’s Verdict Denying Compensatory Tariff to Power Projects opens a pandora box!

[yt_dropcap type=”square” font=”” size=”14″ color=”#000″ background=”#fff” ] A [/yt_dropcap]dani power limited has set up a power plant at Mundra with a total capacity of 4620MW. It has a power purchase agreement (PPA) with GUVNL (Gujarat Urja Vikas Nigam Limited) and two other Haryana utilities ( UHBVNL and DHBVNL) to provide power at levelised tariff of INR 2.3495 per unit ( INR 1 per unit capacity charge and INR 1.3495 non-escalable energy charges). Similarly Tata power has bagged Mundra UMPP (4000MW) based on imported coal from Indonesia at a very competitive tariff of INR 2.26 per unit. Mundra UMPP has to supply power to 5 states.

In the year 2010, Indonesia promulgated “Regulation of Ministry of Energy and Mineral resources No 17 of 2010” which link the coal prices in Indonesia to international benchmark prices for any sale ( domestic or export). Due to the change in law, the coal prices have invariably increased for Tata Power and Adani power for their power projects in Mundra and adversely affect their revenues. The companies have reported huge under recovery for these projects and knocked the door of Central Electricity Regulatory Commission (CERC) for a price revision under compensatory tariff. They have sought this revision under “force majeure” conditions. CERC after several rounds of discussions and hearing; saw merit in their appeal and approved compensatory tariff under a formula. This ruling was upheld in Appellate Electricity Tribunal (AET) also. The aggravated parties (Distribution companies and several other CSOs and NGOs) took the matter to SC.

In a historical judgment in April 2017, SC (Supreme Court) set aside the order of CERC /AET to allow Adani power and Tata Power to charge compensatory tariff against the increased imported coal cost from Indonesia. While this is a great relief for the consumers and state distribution companies who are parties to the agreement, it raises several other concerns starting from the financial ramifications for the affected generators to business viability of the sector as a whole. Although Adani Power and Tata Power, the parties that were affected badly by the SC would find ways and means to lower down the risk or work out to avoid the adverse consequences, questions are raised against SC intervention on an issue that can be dealt with by the sector regulator under its jurisdiction.

My Assessments

The SC verdict on denying compensatory tariff raises several other concerns which require immediate attention such as its long term consequence on contractual arrangements between parties and flexibility in distribution of risks over a long term period, project promoters’ acceptance of force majeure conditions and its definitions under certain conditions, impact on competitive bidding for other renewable energy project particularly on solar, and its overall impact on competition and market development for the energy sector in India. Any interventions from the Supreme Court on the quasi-judicial bodies like CERC may undermine its authority on the sector.

The Supreme Court Judgment and its repercussions on the stakeholders

The SC took a stand on the “Force Majeure” clause in the contract and declared it null and void for any changes in law and regulation outside the host country of the contract; in this case Indonesia. While bidding companies were well aware that they were bidding under a fixed price contract for a long term and would have to absorb any risks arising in the future, they should not have been come forward for a re-negotiation for a price adjustment for the increase fuel cost whatever the reasons. But in India, it is often a common practice that the project promoters first bid unreasonably to win the contract at first stage and then come back to renegotiate at the later stage citing taking advantage of weak regulations and badly designed contracts.

The recent SC judgment affects every stakeholder in the power sector value chain. For Adani Power and Tata power, it is hard to believe that they did not have any alternative plans for these kinds of eventualities. While the last option is to forego their equity and sell the assets to the investors for further restructuring, they may also go for other coal sourcing options to run the plants.

For distribution companies having PPA with Adani power and Tata power, this comes as a big relief. While they have saved themselves from any additional burden in terms of fuel price pass through, this might trigger another set of troubles for the power sector. Distribution utilities may refrain from signing fresh PPAs and may stick to price discovered without any flexibility in the contracts. This will make project promoters to be very cautious while bidding aggressively for the projects.

While any adverse judgement against the project promoters dents their revenue and overall profitability prospective, there is a fear of power assets going bad. In this situation, servicing debt would be under severe pressure and it directly impacts the funding agencies. Generally 70 to 80% of the project cost is debt financed and any default will result in huge NPA for the banks. As a consequence, they will refrain from any further loans to the sector as is clearly evident for many projects in the power sector now. While the flow of fresh investments dry down owing to bad assets, the whole sector may become unviable.

As far as CERC is concerned, they need to have a balanced approach. A balanced approach would require understanding of the complete scenario and the intention of taking such steps as deemed necessary to run the sector. They have seen merits in this case and due to perceived threat of generators defaulting on PPA contract and overall repercussions to the entire sector. The question still remains whether CERC has taken this stand due to fear perceptions for the generator getting out of the contract as a defaulter or simply favour the generators because of any hidden interest

Consumers are the least consulted but most affected party. They have little voices in any regulatory hearings due to lack of knowledge and interest. They completely depend on the government to represent their case through the utilities. However, organizations like Prayas and CUTS are representing the consumer voices and put forth the consumer’s perspective in several forums. In general, public perception is positive for reverse auction bidding procedure where discovered tariff is on a downward trend owing to intense competition. If such renegotiations occur mid-way or any regulator interventions favoring the project developers, it dents their confidence. The tax payers in such cases make the government responsible which might affect the political economy of the ruling parties in terms of disgruntled consumers not opting to vote them in elections

No doubt, SC ruling in this case affects the economy at large and have long term repercussions for the entire sector. Questions are raised in its intervention on the quasi-judicial bodies like regulators and AET. But SC is the last resort for any justice and its views and opinions are important. The economic consideration arising out of shutting down the power units citing financial concerns and the resultant job losses should have been taken into consideration while pronouncing judgements and a balanced approach could have been worked out for this case by the SC. When assets get stressed, power companies stand to lose credit rating and combined with less equity and higher interest, cost of capital, the chance of defaulting increases.

SC does not always consider the entirety of the case or the business and it restricts itself to the contract provisions under which it has to pass judgements. So in this case while passing judgments, it clearly defines that “force majeure” cannot be evoked for any changes in law in any foreign countries ( in this case Indonesia) and the contract clearly defines that any risk arising in future will have to be borne by the developer. So, even if the case merits for a compensatory tariff on other various grounds, the contracts do not have such a provision and going by the book, it should be disallowed.

The Way Forward

The argument is not that who is right and who is wrong. In this case, there is a clear indication on risk assessment by the bidder and risk distribution which is not set through the bidding contract. Can it be reallocated through regulatory or judiciary interventions? Consequently, the consumer interest cannot be overlooked. SC in its judgement has not commented on the power of regulator under section 79 to fill in the gaps if any; in the bidding process but it has only highlighted that any foreign change in laws and regulations cannot be accepted as force majeure for Indian contracts.

The SC in its judgment clearly highlighted the followings which lays down clear indications for any bids in future in terms of creating informed bidding procedures with specific guidelines for procurement of input materials. The bidders need to be well aware of pricing risks in competitive bidding for long term contracts with imported components if any and SC is in for creating better risk allocation and built in mitigation measures in long term contractual projects.

This is a clear case of responsibilities and priorities set. While government should be allowed to decide on how to allocate resources and projects and what is best for country, regulatory and other institutes should perform their duty strictly on guidelines and procedures set. While government should decide on how to utilize an idle asset and recovery of dues so that NPAs could decline, the institutions should rather function independently to take decisions under its judicial provisions and mandate.