Should power firms be bailed out?
Shantanu Dixit-Prayas Energy Group
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: The last few weeks have seen hectic activity by developers of power projects who have entered into long-term agreements based on the competitive bidding framework, to protect their projects and profits. This is also being associated with the need for modifying the bidding framework for new projects. Like any evolving policy framework, modifying the bidding framework for new projects is understandable if it is based on sound analysis and conducted in a transparent manner involving all stakeholders, not just developers. However, the clamour to amend contracts that are already signed, and to allow costs to be passed through to consumers, needs to be examined critically.

Developments in countries such as Indonesia and Australia leading to the high cost of imported coal, and the failure of the domestic monopoly supplier, Coal India, to supply adequate coal are said to be rendering several contracted projects unviable. Solutions are being sought by amending existing contracts to allow increased fuel costs to be passed through.

The 2005 bidding guidelines, under which these projects were bid out, allowed bidders to fully pass the fuel price risk to consumers. Bidders who chose a 100% pass-through of the fuel price risk would be paid on the basis of an index linked to either the international or domestic coal price. This predefined index is calculated and published by the Central Electricity Regulatory Commission every 6 months.

To secure projects, developers opted for a less than 100% pass-through of fuel price changes to consumers. This was based on a shrewd business approach of back-to-back arrangements to secure fuel at attractive prices. These included fuel purchase agreements with foreign suppliers and/or ownership of coal mines abroad. Such arrangements enabled developers to win contracts, and those who failed in such an approach or found it risky lost in the bidding process. This approach also created possibilities for higher profits than a regulated tariff. The current demand of developers using imported coal to pass through price risks needs to be seen in this context.

Accepting this demand would translate to post-bidding changes in contracts, which do not offer a level playing field for those who failed in the initial bidding. The real impacts of recent changes in Indonesia also need to be evaluated. It is likely that the power project may show negative cash flows (because of less than 100% fuel cost pass-through), but at the group level, cash flow may still be positive, due to the group company’s direct or indirect ownership of the mine. This may reduce the projected equity return, but would still offer some return, all part of any commercial business. Hence, a bailout would send a wrong message of our willingness to accommodate developers who either took excessive risk or failed in business acumen. This would prove counterproductive to the oft-demanded, transparent, competitive and market-based approach to the power sector and the economy.

In the case of domestic coal-based projects, developers who won contracts on the basis of a less than 100% pass-through of fuel costs (despite the bidding framework allowing for full pass-through) need not be bailed out, as they had assumed a business risk. The real problem in the case of domestic coal-based projects is an inadequate supply of coal, and a weak or absent contractual commitment by Coal India. It would be inappropriate to create stranded capacity because of such planning and operational inefficiencies of the coal sector.

Hence, we should focus attention on improving domestic coal availability, instead of bailing out power developers and asking consumers to pay for the planning and operational inefficiencies of the domestic coal sector. In the case of projects based on imported coal, there is no case to heed the demands to modify contracts.

The author is member,

Prayas Energy Group