)
Two regulatory rulings in the past fortnight have led to investors in the power sector rejoicing like never before. First came the verdict on Adani Power. On April 2, the country's power regulator directed Gujarat and Haryana to compensate the private producer for higher prices of Indonesian coal. A week later, a similar relief was extended to another private power generator, Tata Power.
The Central Electricity Regulatory Commission's (CERC) orders are being hailed as "landmark" as they could open the doors to more such claims from other private power producers. The rulings are also being inferred to have dispelled all apprehensions over the rigidity of long-term contracts and the viability of stranded investments, besides, unequivocally establishing that consumer interests are best served by protecting investor interests
However, a closer look at the two cases shows optimists may have read too much between the lines. In fact, far from benefiting, the companies may have done well without the "favourable" orders which have broken the rigidity of tariffs by adding a "variable" compensation component linked to global prices.
It was this realisation of somewhat minor gains that led the market to offer a muted response after the second ruling. Tata Power's share saw marginal gains of 2.2 per cent before closing at Rs 96.15 on BSE after the CERC order. The lacklustre response was due to the limited impact of the compensation on current valuations, say analysts. But why should cheers be subdued if the CERC's twin rulings are really landmark judgements, as they are made out to be? Here is why.
The core of CERC's judgements is the change in Indonesian law, effected in 2011, that mandated miners to export minerals at a rate indexed to the prevailing global prices. Indonesia's intent was part of a bigger drive called "resource nationalism" under which nations have started insisting on market prices for their minerals. This tying up of price with global indices has ensured that prices increase with rise in global rates and, unlike what investors would prefer, decrease with a decline in global rates. The latter is precisely the case with thermal coal. Global thermal coal prices have witnessed a continuous and unbelievably sharp decline, of as much as 55 per cent, from $190 per tonne in 2007 (when most of these large-sized projects were bid out) to as low as $85 per tonne currently. To spoil the investors' party, the prices are seen heading further southwards this year.
The key question is: will the companies have to forego margins at lower rates whenever global prices fall to the level of production cost in their overseas subsidiaries owing to the "variability" infused by CERC in tariff compensation? The possibility cannot be entirely ruled out given the massive volatility exhibited by coal prices in recent years. The regulator was not only aware of this possibility, it also wanted to ensure that benefits of lower prices in the future were passed on to consumers. The commission, while hearing the Tata Power case, asked the company's lawyer whether the "petitioner would have approached (CERC for relief) under change-in-law clause of the PPA if the prices of imported coal came down?" While agreeing that the "law would operate both ways", the Tata Power counsel said "if the price comes down, the pass through also comes down."
Tata Power's 4,000 Megawatt (Mw) Mundra Ultra Mega Power Project (UMPP), bagged in 2007, has a coal requirement of 11 million tonne per annum. The cost of production in Indonesia at that time varied between $20 and $25 per tonne against the market price of around $40 per tonne for the grade of coal to be used in Mundra (5,300 KCal).
The company decided to source coal from Indonesia through two separate agreements with IndoCoal Resources (Cayman). As per the Fuel Supply Agreement (FSA), 55 per cent of the quantity was to be supplied at a price of $32 per tonne and the rest of it at $34 per tonne. Tata Power says market prices of coal jumped from $50 per tonne in 2006 to $120 per tonne in 2011.
Overall, there has been a 153 per cent escalation between the time of bid submission (Dec 2006) and filing of petition in CERC (June 2012), largely due to rise in demand from India and China. The steep rise was made worse for the company by the Indonesian regulation. Tata Power says it has been incurring annual losses of Rs 1,873 crore, extrapolated to a total loss of Rs 47,500 crore over 25 years, making the quoted tariff of power at Rs 2.26 per unit unviable.
The company had put the additional cost on account of increase in price of Indonesian coal at 67 paisa per unit in July 2012. The commission denied application of force majeure and Change-in-law clauses of the PPA in the case as it could have paved the way for a tariff hike. It opined that the company needs to be compensated. A committee, therefore, was asked to be set up to look into the exact quantum of the compensation and its mechanism.
However, the CERC order may have also complicated the matter. While the commission has allowed the compensatory tariff to be variable, it has also asked for withdrawing or lessening the compensation as soon as the hardships felt by the company are removed. Two key questions remain - what would be the form in which the compensation is administered? If it is built into the tariff, would it not amount to modifying the PPA and breaking the sanctity of a competitively-bid tariff? Secondly, what would be the appropriate time to eject the compensatory tariff? Would it be the time when cost of coal comes down to the level at which the company did its maths before submitting the bids or would the companies continue passing on the benefits to consumers as long as prices continue to drive down?
In addition, the committee is expected to lift the veil of uncertainty over how the compensation mechanism would deal with the issue of discounting benefits accrued to the Indonesian subsidiaries of the parent companies. This was a major argument forwarded by both the state utilities and CERC's dissenting member S Jayaraman to argue against any relief for the companies. The expert committee would have to settle these doubts. There are more reasons why it might be too early to rejoice. At least one state, Haryana, has already said it is going to challenge the CERC order, indicating the possibility of a prolonged legal battle.
