The Central Electricity Regulatory Commission, or CERC, in a move that should be questioned, has essentially bailed out the private promoters of two ultra mega power projects, Adani Power and Tata Power, both in Mundra in Gujarat. The CERC has awarded the two plants a "compensatory" rise in power tariffs, above what they bid and contracted for to charge state-owned distribution companies. The CERC's stated reason for this was to compensate the power producers for a sharp rise in the cost of their primary input, imported Indonesian coal. This is despite the fact that the two companies had secured the projects through a fixed tariff-based competitive bidding process without indexation. It is worth noting that this has created considerable wealth for the private sector owners at the expense of state-owned companies and end-users - after the CERC decision, Tata Power's stock showed a big jump and Adani Enterprises' a modest gain.
The issues are obvious. A windfall gain of this kind undermines past - and worse, future - bidding processes. In the future, bidders will quote aggressive tariffs, knowing that if unforeseen developments take place and they cry long enough, they will be rescued. Like with many other big enterprises, profit is privatised while risk is socialised. Clearly, the bidding model used for these projects was flawed - many subsequent auctions saw a shift to "pass-through" provisions for fuel costs. The CERC's argument is that projects cannot be abandoned; and 70 to 80 per cent of the funding of such projects comes from the public (institutions and minority shareholders), who will be left holding the baby in case of abandonment. This is true, but abandonment is not the only option. A third option is to ensure that the promoters, who took the risk, suffer the costs of their poor judgement about input costs and lose their equity in the project. This would be the appropriate decision in terms of economic theory - as well as political practice.
Like their counterparts in many other sectors, Tata and Adani goofed through competitive entrepreneurial adventurism. It should gravely embarrass any major multinational to say that a rise in the price of imported coal could not have been foreseen, as both these companies have insisted in this case. No sensible business organisation assumes stable long-term energy prices in this day and age. True, given the impossibility of easy power-purchase agreements extending into the future, the public will have to share in the cost of increased energy inputs. But if the public has to pay more than what was contracted for, then the promoters shouldn't get the near-free ride the regulators have given them. The CERC direction provides for a one per cent reduction in return on equity as a consequence of the tariff rise allowed. This is far from being enough. At the very least, promoters should be asked to take an appropriate level of write-down in their equity. This will ensure that any future bidders will take the possibility of cost escalation into account - and not just assume that they can escape risk evaluation errors at the time of bidding through frantic persuasion of the government or regulators if conditions turn against them.
The issues are obvious. A windfall gain of this kind undermines past - and worse, future - bidding processes. In the future, bidders will quote aggressive tariffs, knowing that if unforeseen developments take place and they cry long enough, they will be rescued. Like with many other big enterprises, profit is privatised while risk is socialised. Clearly, the bidding model used for these projects was flawed - many subsequent auctions saw a shift to "pass-through" provisions for fuel costs. The CERC's argument is that projects cannot be abandoned; and 70 to 80 per cent of the funding of such projects comes from the public (institutions and minority shareholders), who will be left holding the baby in case of abandonment. This is true, but abandonment is not the only option. A third option is to ensure that the promoters, who took the risk, suffer the costs of their poor judgement about input costs and lose their equity in the project. This would be the appropriate decision in terms of economic theory - as well as political practice.
Like their counterparts in many other sectors, Tata and Adani goofed through competitive entrepreneurial adventurism. It should gravely embarrass any major multinational to say that a rise in the price of imported coal could not have been foreseen, as both these companies have insisted in this case. No sensible business organisation assumes stable long-term energy prices in this day and age. True, given the impossibility of easy power-purchase agreements extending into the future, the public will have to share in the cost of increased energy inputs. But if the public has to pay more than what was contracted for, then the promoters shouldn't get the near-free ride the regulators have given them. The CERC direction provides for a one per cent reduction in return on equity as a consequence of the tariff rise allowed. This is far from being enough. At the very least, promoters should be asked to take an appropriate level of write-down in their equity. This will ensure that any future bidders will take the possibility of cost escalation into account - and not just assume that they can escape risk evaluation errors at the time of bidding through frantic persuasion of the government or regulators if conditions turn against them.