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Saturday, April 6, 2013

The Indian power sector should wait before celebrating the CERC order on PPA tariff revision

Two days ago, the order of the CERC made headlines nationally when it agreed to the demand of Adani Power for escalation in tariffs, to compensate for the 'unexpected' increase in imported coal prices after the Indonesian Government passed a law forbidding miners from selling coal below a benchmark price(so that its its revenue based royalty would not reduce due to transfer pricing by coal mining companies selling at lower rates to their parent/group companies). The favourable order can be read here  http://www.cercind.gov.in/2013/orders/SOSJ.pdf and the dissent can be read here http://www.cercind.gov.in/2013/orders/SOALL.pdf Both orders agree that the 'change in law' should only apply to Indian law, and that unexpected price rise does not constitute force majure. However, what they differ on is the regulator's power to intervene in the pricing mechanism of fixed price contracts. For some background, let me reproduce the  main facts below, and my views on it
  1. The power procurers i.e State electricity boards had sought bids for long term power supply. The bids had left room for the bidders to quote escalation based on fuel, foreign currency fluctuation etc. Adani Power, "relying on the Govt of India policy and its coal supply LOAs" in its infinite commercial wisdom, chose to quote a fixed rate, and then won the contract. While the procurers had initially satisfied themselves about the coal linkage, this was entirely the power company's responsibility.
  2. The Adani parent company Adani Enterprises owned 74% of the Indonesian coal company which supplied coal to Adani Power UMPP. Hence, most of the coal price hike went to the parent company. yet, instead of merging the coal company into the power project like how Tata Power did, Adani Power preferred to pocket the coal profits, but pass on the increase to the power purchasers
While the CERC agreed that Adani Power did not have any contractual case for compensation, it interpreted its regulatory power widely under Section 79 to state that since power sector investments were to be encouraged, it could not allow the power project to become sick. It also stated that since the replacement cost of the project(and resultant tariffs) would far exceed even the requested tariff increase, it was in the overall sectoral interest to increase the tariffs. It is with this interpretation that I have the following issues
  1. Suppose the coal prices had fallen instead of rising, and power procurers had sued Adani Power asking for discounts, then it would have cried foul about policy changes/nationalization etc. Why should only the downside be borne by shareholders?
  2. If there was a commercial mistake by Adani Power, let the plant turn bankrupt, and the proceeds be distributed amongst the utilities which can then run the plant themselves using imported coal. 
  3. The bidders who quoted variable price linked escalations related to coal, and who lost for their being realistic, should not be prejudiced. 
  4. Unlike the infamous 2G spectrum allotment which was an opaque process, the results of transparent power procurement by bidding should not be adversely shifted by regulators.
  5. Assuming the parent company guaranteed the power project performance, then encash all possible securities/performance guarantee then only ask consumers to pay more. 
 The ruling has already been appealed, and I hope that the courts will be saner. Also, what persuaded the CERC was the chance of project turning sick. Now, for financially stable companies like Reliance Power, Tata Power etc, especially where parent companies have given guarantees, turning sick would mean even larger monetary losses, or may not be required after considering overall parent resources. Hence, there is a case even before the CERC, to differentiate their case from Adani's.

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