<b>Vinayak Chatterjee:</b> Compensatory tariff - Untangling the knot

The treatment of increased costs of imported coal in Adani and Tata Group's power projects could prove to be useful case material for using private capital as a bedrock for infrastructure development

With the power sector under severe stress for quite some time, one of the more eagerly awaited developments has been the treatment of increased costs of imported coal for two of the largest marquee investments in power generation - the 4,620-Mw power project being developed by the Adani Group and the 4,000-Mw Ultra-Mega Power Project being developed by the Tata Group, both at Mundra.

Interestingly, both these projects were selected through a transparent tariff-based competitive bidding process. Thus, this post-win "compensatory tariff dispensation" is being keenly analysed by the power market since it may well set the stage for a slew of other projects to seek similar treatment. It also provides signals to the approach that may be followed on the slippery slope of "sanctity" of past and future bid processes vis-à-vis stakeholder interests post-bid.

While these two projects have often been talked about in the same breath, there are some basic differences between the two.

The Adani Power Project consists of two purchase commitments - one contracted for with Gujarat and based on domestic coal, and the second contracted for with Haryana, based on domestic and imported coal. In both cases, the fuel was to be procured by the developer. The source was identified as domestic in the case of Gujarat while it was identified as a mix of domestic and imported coal in the case of Haryana. While the power purchase agreements (PPAs) for both the Gujarat and Haryana bid processes provided flexibility to bidders to de-risk their proposal with appropriate indexation, the bidder chose not to take advantage of the provision and provided a fixed tariff without indexation (for fuel, inflation et al). After the PPAs, the developer chose to contract with its own trading arm for the supply of imported coal. With changes in the law in Indonesia adversely affecting the price of imported coal, the bidder sought compensation for change in the "landed energy price" in the fixed energy charge to the "actual landed energy price" now applicable in the market.

In the case of the Tata Power project, it was clearly based on imported coal, sourced from an entity in Indonesia in which it had a stake. Having bid 57 per cent indexation at a free-on-board (FOB) level, it took a nuanced view and sought compensation for change in the FOB price of coal for only the 43 per cent "non-indexed" portion.

With both projects incurring substantive losses, both sets of promoters petitioned the Central Electricity Regulatory Commission (CERC) on the issue. Cutting through the thicket of ideological debates on the appropriateness, or otherwise, of tinkering post-facto with bid parameters, CERC took the bold step of accepting the fundamental premise of the two developers that their case for compensation had prima facie merit and chose not to be bound by the purity of bid processes. To take matters forward, CERC constituted an independent committee under Deepak Parekh to recommend "compensatory tariff", with clearly defined guiding principles under which the compensation had to be determined. These guiding principles were:

• the compensation is to be variable in nature and be applicable only till the premise on which compensation sought existed;
   
• given that the sourcing for coal was from entities controlled partly or wholly by the sponsors, adjustment for any increased profits of mining subsidiaries of these groups on account of the changed circumstances should be factored in;
   
• assess possibility of using cheaper coal (with lower gross calorific value) to minimise compensation within the technical and operational constraints of the equipment.
   
• assess the possibility of providing some relief through sale to the merchant market and sharing such increased revenues to reduce the compensatory tariff.

The committee had the following members:

• Principal Secretary (Energy) of all procuring state governments
• Arundhati Bhattacharya, Managing Director, SBI Capital Markets
• Dr Devi Singh, Director, IIM - Lucknow
  (SBI Capital Markets were financial analysts to the committee)

It has to be admitted that the committee had the daunting task of balancing conflicting stakeholder interests with the clear realisation that its recommendations were bound to face criticism from one quarter or the other.

In summary, the committee outlined the compensation structure shown in the table.

 

Some of the key implications and learnings are discussed below:

1. The committee recommended that the developers be paid the actual fuel cost they incurred. For Adani, this would include ocean freight, port charges, and insurance, whereas in the case of Tatas, it would be compensated for the change in FOB price for the "non-indexed" portion of coal. It appears that the recommendation is based on a conceptually differential approach to the two projects.
    
2. On the issue of adjustment of potential increased profits of mining subsidiaries, the committee has recommended that the share of the mining profits be adjusted from the compensation. With Adani having since gone for a contract with independent fuel suppliers, this provision now does not apply to its project and hence it is not liable to suffer any consequential reduction in compensatory tariff on this account. In the case of Tatas since it holds a 30 per cent stake in the mining company, 30 per cent profit of the mining company would be adjusted.
    
3. On the issue of cheaper coal options, the committee has taken a view that despite having lower efficiency it could be beneficial. But, it has to be kept in mind that cheaper (lower calorific value) coal will also be required to be imported in larger volumes to get the same energy levels. This higher volume with concomitant increases in freight, insurance, etc may somewhat negate the benefit in one of the cases.
    
4. On the issue of relief due to third party (merchant) sales, the committee has recommended that the state utilities relinquish their rights over the energy generated above the normative availability of 80 per cent for third-party sale, and an equal sharing of revenue (over and above fuel cost) from the sale of such energy. In a reading of the compensatory award principles, the linkage between this added ability to generate more profits and its corresponding ability to reduce future compensatory tariff is not clearly visible.

Now, CERC and the procuring states have to converge on these recommendations.

Overall, the entire exercise provides practical and useful case material for India going forward using private capital as a bedrock for infrastructure development, providing confidence to developers and investors and dealing with the attendant issues of bid sanctity, public-private partnership renegotiation, and life-cycle viability of infra assets and, most importantly, balancing conflicting demands.

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The author is the Chairman of Feedback Infra. vinayak.chatterjee@feedbackinfra.com; Twitter: @Infra_VinayakCh