In for a tariff shock

A tribunal's award in favour of the Tanir Bavi Power Company in Karnataka on tariff claims holds an important lesson to the State: read the fine print before entering into power purchase agreements.

in Bangalore

CONSUMERS of electricity in Karnataka must be prepared for a major tariff shock in the near future as a result of the decision by an arbitral tribunal to uphold the tariff claims of the Tanir Bavi Power Co. Pvt Ltd. (TBP) against those of the Karnataka Power Transmission Corporation Ltd. (KPTCL), the State government's power transmission utility. The KPTCL has already applied to the Karnataka Electricity Regulatory Commission (KERC) to approve a substantial tariff increase. If approved, the costs of Tanir Bavi power will contribute in no small measure to that increase. With the award, the KPTCL's power bills to TBP will more than double, from approximately Rs.150 crores to Rs.330 crores annually. If the KERC fails to approve a tariff hike, it could have serious financial implications for the financially stressed power utility, which must then look for financial support elsewhere.

"Now that the award has been given by the arbitrators, its legality appears to be binding," K.N. Shrivastava, Managing Director, KPTCL, told Frontline. "I think we must move forward and not let the present impasse continue. We must now look to ways of bringing down the cost of power in dialogue with the Tanir Bavi company."

This is possibly the closest the KPTCL has come to an admission of defeat in its nearly two-year running battle with TBP over the cost of power that it contracted to buy. It is certainly a far cry from the statement of an earlier managing director who likened the company to a "mini-Enron". The KPTCL had rejected TBP's power tariff claim as unacceptable because it would in effect accord TBP a 65 per cent return on equity year on year, as against the 16 per cent return on foreign equity that the power purchase agreement (PPA) envisages (Frontline, January 4, 2002). By upholding Tanir Bavi's claims, the award will most certainly impact on the power tariff regime in the State and indeed the future of power sector reforms. In a situation where the presence of independent power producers (IPPs) is only likely to increase, the validation of TBP's power tariff claims by the arbitral tribunal will set a rather costly benchmark in power tariff calculations for future projects. It will hopefully alert the KPTCL in attending to the fine print of future PPAs they enter into.

With the KPTCL refusing, in the last two years, to pay for power at the rate claimed by TBP in their tariff invoices, and with the TBP in turn invoking the escrow clause in the PPA and withdrawing from the escrow account what it deemed was the balance payable by the KPTCL, the dispute was finally placed before an arbitral tribunal. This constituted the final step in the dispute resolution mechanism as laid down in the PPA. In its award dated May 19, 2003, the arbitral tribunal, comprising former Chief Justice of India Justice Y.V. Chandrachud and former Supreme Court Judges S. Mohan and Justice G.N. Ray, upheld the substantive part of TBP's submissions. This includes the claim by the company to compute the fixed charges component of its power cost at $0.04 per Kwh, as against KPTCL's reading of $0.0205. It is this differential reading that constitutes the crux of the dispute between the two sides. The award also upholds the company's plea to recover an amount of Rs.191.31 crores from the KPTCL as default payment at the rather high interest rate of 24 per cent a year.

The award has been criticised by several energy experts on more than one ground. The primary criticism, however, is that it falls short of presenting a convincing argument for upholding Tanir Bavi's plea. The submissions and pleas of both parties are reproduced several times in the award document. The final decision in favour of TBP does not offer a reasoning independent of the one offered by TBP's counsel. The oft-repeated argument advanced by the company is upheld, namely, that this particular project was finalised through a bid route and that the fixed charge computation was frozen at $0.04 per Kwh in the PPA. The KPTCL, on the other hand, has consistently pointed to a clause in the PPA that states, unambiguously, that the figure of $0.04 per Kwh is a ceiling and not an actual fixed cost. It argues that the actual fixed charge component of the tariff works out to only $0.02054 per Kwh, a computation that covers 16 per cent return on foreign equity besides principal and interest repayment of the foreign debt.

The KPTCL has also objected to TBP's invocation of the argument that in a project that has come through a bid route the fixed charge must necessarily be a final figure from which no deviation is possible. The KPTCL has argued that it is the PPA which is the final expression of the agreement that contractually binds two parties, irrespective of any earlier understanding or agreement. The basic approach of the Tribunal to the issue is contained in its approval of the Tanir Bavi counsel's proposition: "The Claimant stipulates a definite predetermined price irrespective of its cost or the buyer's ability to acquire electricity in the market at a lower price." Such a proposition would appear to go against the grain of the stated objectives of power reform, which is to provide electricity to consumers at affordable prices for the purposes of social and economic development.

BUT the dispute now appears to be an issue of the past, and it remains to be seen how the KERC responds to the application by the KPTCL for a tariff increase. The average per unit cost of Tanir Bavi power last year was Rs.4.24, according to KPTCL sources. "We have accumulated payments of Rs.450 crores on account of the Tanir Bavi project and Rs.300 crores on account of other reasons," Shrivastava said. "Perhaps the entire hike in tariff cannot be passed on straight away and may have to be staggered over two years, but this may translate into a tariff increase of 10 per cent or so."

Given the complexity of the issues involved, the Tanir Bavi project has not been debated in the public domain with the same involvement as, for example, the Cogentrix project in Karnataka was. The company's heavy-handed manner of dealing with criticism will most certainly act as a deterrent to informed public debate. Its response to an article written in The Hindu on June 16, 2002 by Professor V. Ranganathan, Professor and RBI Chair at the Indian Institute of Management (Bangalore), was to file a defamation suit of Rs.1 crore against the distinguished energy expert. According to the company's plaint, the article caused "grave and irreparable injury and damage to the plaintiff, which runs into crores and crores of rupees". The court case is likely to drag on with no out-of-court settlement in sight.

"The KPTCL is in the process of negotiating down the cost of power with the Tanir Bavi company," says Shrivastava. They hope first to bring down the rate of interest from 24 per cent to 11.5 per cent, which was the State Bank of India's lending rate on the day of default of payment to TBP by the KPTCL. "We are also looking to extend the life of the PPA from seven to 15 years. Today the fixed cost is high because the company will recover its capital cost in seven years. Can a long-term PPA bring in cost reduction?" Shrivastava asks. He believes it will, provided TBP changes its fuel base from naphtha to liquefied gas. TBP, according to him, has offered to consider making the substitution at its 220 MW plant in Mangalore by purchasing liquefied natural gas (LNG) from `mother ships' that carry such gas on the high seas. Smaller ships or barges pick up LNG to operate power plants. "We believe that if we can negotiate for the lowering of fixed cost to Rs.1.40 combined with another reduction of Rs.1.25 owing to the change in fuel from naphtha to gas, we can bring down the unit cost of Tanir Bavi power to Rs.2.65, which will make it very affordable," Shrivastava said. He envisages this happening in the next year or year and a half. "We are confident of rationalising power costs with all power producers. We could not be in a worse situation with a capacity deficit of 1,500 MW."

This is a very optimistic projection in a power scenario riddled with uncertainties. An equally important aspect of the future is the proactive role given to state regulators under the Electricity Act, 2003, in determining the tariffs of generating companies in the future. This will put far greater onus on the KERC in intervening in tariff fixation in a way that will make the process more transparent and involve the public to a greater degree. This will in the future be the only effective mechanism of curbing unfair practices in a market ruled by a few players who seek to delink power prices from costs.