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Why CERC’s bailout sets dangerous precedents, dents competition

An effective bailout, amounting to a couple of thousand crores, of power plants owned by the Tatas and Adanis by the Central Electricity Regulatory Commission (CERC) sets many deeply worrying precedents for the power sector. Perhaps the biggest one is that it questions the basic principle underlying electricity reforms since the '90s — the competitive procurement of electricity.

 Till now there were two ways to set 'wholesale' power prices — the price of power paid by a distribution company to a power plant. There was the earlier costplus method which still applies to public sector power producers like NTPC. Under this system, power prices are regulated and capped after allowing for costs and a defined profit margin. The cost-plus method had a number of problems, the most obvious being it gave an incentive to a power producer to pad costs. Also, there was less pressure on the producer to be efficient.

The other method — competitive bidding — was seen as the solution to the problems of the first. A distribution company looking for sources of power to supply customers would ask power producers to bid a tariff at which they were willing to supply power, with the winner being the one offering lowest tariff. The tariff set under this process was more or less sacrosanct, with revisions being allowed only under extreme circumstances.

What the CERC order does is effectively provide a way for producers governed by the competitive regime to switch to being under a cost-plus regime of sorts with all its attendant benefits.

Even with the CERC tightening its cost-plus regime in a new set of regulations issued within days of the order on compensation to the Tatas, and Adanis, the costplus regime remains highly attractive. "You cannot have it better than guaranteed returns," says Surya P Sethi, former principal adviser, power and energy, Planning Commission.

Who Loves Regulation?

At the heart of the problem is the price of coal and its sharp decline in availability in India, and the sharp spikes in its global price in recent years. When the Tatas and Adanis bid for long-term power supply contracts to a range of power utilities, including those in Haryana, Gujarat and Punjab, they were free to bid in such a way that protected them from such sharp volatility in the price of coal and pass on the rise to the distribution companies. Instead they bid in such a way as to take the risk of spikes in the price of coal upon themselves, either completely, or to a major extent.

That was a business decision that went wrong. Both Tata Power and Adani had equity stakes in coal mines in Indonesia from where they imported coal for their plants in Gujarat. All was well till Indonesia introduced regulations in 2011 which effectively set a floor on the export price of coal, hiking the price for Indian customers.

Both the companies went to the CERC for compensation, in the shape of being allowed to charge higher tariffs from discoms to offset the higher cost of coal (which was bought from mines partially owned by them). Both claimed that the sharp spike in the price of coal as well as the sharp decline in the value of rupee were enough to trigger the specific clauses in the power supply contracts which allowed a hike in tariffs set under a competitive bid.

Interestingly, in an initial order issued last April which allowed for such 'compensatory tariffs', the CERC actually disagreed with this view but allowed the compensation anyway, effectively creating another set of conditions under which competitively set tariffs could be revised outside the ambit of a competitive bidding process and the power contract.

"The worst part of the CERC decision is that it establishes, once again, that there is no sanctity of contracts in India," says Sethi. "We have repeatedly lived up to this reputation. We neither look at global experience nor get proper legal, technical and financial advice while drafting the contracts that form the basis for such bids. This suits everyone because it provides room for subsequent discretion in interpreting and renegotiating contracts."

"The decision is most unfortunate and it has set a very negative precedent for competition and governance in the sector," says Ashwini Chitnis, senior research associate with Prayas Energy Group, a non-profit which works in the energy sector. "Further, the commission has not even undertaken the due public process necessary for revising tariff. The decision effectively has ensured that post bidding, a bidder can be totally absolved of all the commercial risk that he willingly took to win the contract."

Source: The Economic Times