Power sector perils

In Karnataka, higher than expected tariff claims by an independent power producer, claims now accepted by the State government, raise questions essentially with regard to the viability of the government's whole programme of power sector reform.

THE recent decision by the Government of Karnataka to accept the tariff claims made by an independent power producer (IPP), against the strongly argued advice of its own power transmission utility, will impose a stiff financial burden on the State. This burden may be passed on to the consumers in the form of substantially higher tariffs. The cash-strapped Karnataka Power Transmission Corporation Ltd (KPTCL), whose objections to the claims by Tanir Bavi Power Company Pvt Ltd (TBPC) have been overruled by the government, will now be forced to buy power at a price much higher than it had bargained for. According to KPTCL sources, a conservative estimate of the additional payment that the corporation will have to make during the project's period of seven years owing to the 'excess' claim made by TBPC will be Rs.1,040 crores. According to KPTCL's computations the actual return on equity (ROE) for TBPC would be of an order substantially higher than 16 per cent that was provided for in the power purchase agreement (PPA).

"The Advocate-General has given his legal opinion which upholds TBPC's interpretation of the PPA," V.P. Baligar, chairman and managing director (CMD) of KPTCL told Frontline. The matter, he said, would go before KPTCL's Board for approval soon. While most IPPs are costly, he said, TBPC was like a "mini-Enron" (he was alluding to the Dabhol Power Company) with its cost of power at Rs.4.30 per kWh at 85 per cent plant load factor. TBPC sources, on the other hand, told Frontline that the cost of power was Rs.3.89 a kWh. "We believe we are amongst the cheapest IPPs in Karnataka," a company source said. However, KPTCL sources say that as per the invoices of Tanir Bavi in the last few months, the effective cost for KPTCL at the current level of plant utilisation, ranges from Rs.4.65 to Rs.9.20 a kWh.

TBPC, a joint venture of the GMR Group and the U.S.-based PSEG Group, commissioned a 220 MW barge-mounted naptha based power generation plant in June 2001 in Tanir Bavi village, Dakshina Kannada district. The floating power plant was brought on a submersible ship from the Mipo Shipyard in South Korea, and docked in a specially created pier off the Gurpur river, 7 km inland from the coast. The PPA was originally signed between the then Karnataka Electricity Board (KEB) and Chicago Power Inc on December 15, 1997. The GMR Group, which also runs the 200 MW Basin Bridge power plant in Chennai, came into the picture in June 1998 when it bought the majority equity stake from Chicago Power. The PPA was further amended on May 29, 1999. The project cost at the time of financial closure on September 14, 2000 was Rs.934 crores. With a debt-equity ratio of 70:30, the dollar component of the project cost is Rs.820.25 crores and the rupee component Rs.114.40 crores. The plant became operational on June 8, 2001, producing 170 MW in single cycle mode. From November 21 this year it has been producing its full quota of 220 MW power in combined cycle mode. TBPC presented its first tariff invoice to KPTCL for payment in June and has been presenting monthly invoices since then.

KPTCL, immediately upon receipt of the first invoice, objected to the calculation on which the billing was based. It turned to the relevant clauses in the PPA to support the restriction of its payment to what it deemed was the contractual price. According to KPTCL sources, the billing by TBPC was based on an "audacious interpretation of the tariff-related clauses of the PPA", which would increase the fixed cost component of the tariff by at least Re.1 a kWh, that is, from Rs.1.115 to Rs.2.035. The claims and counter-claims, which also involved both parties seeking legal and financial expertise, remained inconclusive until the State government directive in favour of TBPC. An order dated December 1, 2001, endorsing TBPC's tariff claims based upon its interpretation of the PPA, was signed by K.P. Pandey, Principal Secretary, Department of Energy. To it was appended a 13-page legal opinion given by A.N. Jayaram, the Advocate-General. Pandey had in a written submission to the Chief Minister in September backed TBPC's stand, referring to legal opinions obtained by the company. In October 2001, the company also got an opinion from P. Chidambaram, the lawyer who is a former Union Minister, endorsing their stand.

What is the issue at dispute between KPTCL and TBPC?

The KPTCL has objected to the claims of TBPC with regard to the computation of the fixed charge component of the tariff. Typically, a power project has a two-part payment structure. The first is the variable cost that in the main covers all fuel-related reimbursements. The other is the fixed cost which includes the servicing of equity and loans, and payments towards operation and maintenance (O&M). In the case of the Tanir Bavi project, the total fixed charge, according to Section 7.4 of the PPA, comprises a dollar-denominated fixed charge component expressed in dollars and a rupee-denominated other fixed charges component (of Rs.0.145 per kWh). The dollar denominated component provides for a 16 per cent return on foreign equity besides principal and interest repayment of foreign debt. The operational part of the clause, which has been interpreted in different ways by both parties, states: "The fixed charge shall be determined at the time of financial closing and shall be subject to a ceiling of $0.04 per kWh."

According to KPTC, TBPC has interpreted a straightforward sentence in the PPA relating to fixed charges to its advantage. TBPC has taken the ceiling of $0.04 a kWh as an eligible fixed cost due to it, and has billed KPTCL accordingly. In a letter from the company to KPTCL on August 31, 2001, the claim is put forth clearly. "The fixed tariff quoted and accepted is 4 cents/kWh. Out of the 4 cents to be paid per kWh, part of it is paid at the current exchange rate, while the rest is paid at the exchange rate as on the date of financial closing. While the amount paid at the current exchange rate takes care of 16 per cent rate of return on foreign equity plus debt service of foreign loans, the rest takes care of rupee debt, rupee equity plus operation and maintenance charges, etc".

KPTCL sources reject this reading as an "absurd and misleading" one. The cost of servicing the dollar-denominated investment of the fixed charges, according to documents submitted to KPTCL by TBPC itself, is only $0.02054 a kWh. This charge in fact services Rs.820 crores (which constitutes the dollar investment of both debt and equity). Since TBPC assumes that it is eligible for 4 cents a kWh, it accounts for the balance of nearly 2 cents a kWh as the cost of servicing that part of the fixed charges relating to rupee debt and equity and O&M costs. KPTCL sources say that TBPC is double billing them, as they are being charged another Rs.0.145 a kWh under the head of "other fixed costs" to cover O&M costs. This would essentially mean that the balance of $0.0194 would cover the cost related to the rupee investment alone. "How can the cost of servicing Rs.820 crores of the total foreign investment in the project be 2 cents a kWh, and the cost of servicing the balance of the Rs.114 crores rupee investment also be almost 2 cents a kWh?" a highly placed source asked. "That 4 cents a kWh is a ceiling is mentioned several times in the PPA. TBPC has submitted documents on the cost of servicing the dollar-denominated part of the fixed charge, which comes to $0.02054. But it has not provided any supporting documentation of the cost breakdown to claim the additional 2 cents. If it does so, and it is consistent with the PPA, KPTCL could consider paying. In fact, at this rate, on a rupee investment of Rs.114 crores, TBPC recovers approximately Rs.104 crores in the first year itself. This translates into a rate of return of about 700 per cent on the rupee component alone over the seven years. This is an enormous drain on public money, and is especially shocking in the context of the government's keenness to have a transparent reform process which aims to achieve quality power at low cost."

TBPC sources justify their reading of the PPA, and say that their position has now indeed been vindicated. "To begin with, we came to this project through a bid-route," informed TBPC sources said. "Accordingly, the fixed charge component of the tariff was frozen at the bid stage itself at $0.04." Their bid, they claim, was evaluated and approved by the Government of Karnataka in March 1996. The unit cost of power based on a dollar exchange rate of Rs.35 was at that time calculated at Rs.2.62, where the fixed charge was $0.04 and the variable charge $0.035. When asked, the company was however unable to produce proof of any approval by the government of its bid rate. KPTCL sources claim that there is no documentation in support of the claim. Further, they quote a clause in the PPA which states that the PPA is the final expression of the agreement that contractually binds two parties, irrespective of any earlier agreements or understanding.

TBPC argues that Clause 7.3 of the PPA has specified a fixed charge of $0.04 as being applicable over the seven-year period. Section 7.3 provides such a table showing fixed and variable charges over a seven-year period. KPTCL argues that the table only provides notional figures, an illustrative example that would be replaced by the actual fixed charge finalised at financial closure. TBPC, while providing proof of payment for the dollar-denominated part of the fixed costs, amounting to $0.02 a kWh, believes that under the terms of the PPA it is not obliged to provide proof of payment for the remaining $0.02. "We magnanimously agreed that a part of the fixed costs could be reimbursed to us in rupees," a company spokesman said. "We have other costs that the balance amount of $0.0196 will be incurred on in India. For example, there is a rupee debt payment, a 16 per cent ROE on rupee equity, interest on working capital, O&M dollar-denominated costs not covered by the Rs.0.145 other fixed charge component, lease rentals on spare engines, and so on." TBPC sources claimed that their cost of power at Rs.3.89 kWh is among the cheapest of IPPs in Karnataka, and that the cost would come down further in the future. "We too have to be efficient and price competitive," a TBPC source said.

In the final analysis, the issue is not one of semantics or interpretations, KPTC sources argue. A 16 per cent rate of return on equity is considered very high and is the bait that draws foreign investment in the power sector in India. When it can attract investment at this generous rate of return, why would a public utility offer anything substantially higher than that? The point was made forcefully by KPTCL in a written submission. "If the contention of the company is accepted, KPTCL would be incurring excess fixed charges of Rs.1,040.80 crores over a period of seven years without any justification," it noted. "The position maintained by the company on charging the ceiling amount of $0.04 per kWh would imply, as per their own figures, collecting at least Rs.2,503 crores in fixed cost on an investment of Rs.934 crores. This would mean a profit of Rs.1,299.20 crores on a dollar-denominated investment of Rs.275 crores. The ROE in such a situation would be greater than 65 per cent year on year".

Under the Karnataka Electricity Reform Act, 1999, all PPAs have to be approved by the Karnataka Electricity Regulatory Commission (KERC) as laid down in Section 17 (Regulation of Generating Companies and Stations). Section 27 (2) states that all contracts entered into by the government prior to the commencement of the Act shall be deemed to have been approved by the KERC. However, KPTCL has provided details of the Tanir Bavi issue to the KERC, according to KPTCL CMD Baligar. The KERC is in the process of reviewing several PPAs through public hearings and is conducting a public hearing on the contract between KPTCL and Jindal Tractabel Power Corporation, a private power generator. If the KERC does take up a review of the Tanir Bavi PPA, there are likely to be questions beyond that of tariff that the public will demand answers for. These could range from the commercial wisdom of opting for barge-mounted projects, to the very basis of accepting the 'bid-route' process which pushes up the cost of power substantially.

Power sector reform has been the centrepiece of the Karnataka government's programme of economic liberalisation. Its three-point agenda for the power sector, namely, reduction in subsidies, increase in tariff, and greater private sector participation, helped it qualify for a recent World Bank loan of $150 million. Its reform zeal led to the bifurcation of the KEB into two autonomous entities in charge of generation, and transmission and distribution respectively. At this early stage of reform, the heavy-handed manner in which the government has intervened in the commercial decisions of its own power transmission utility, has put a question mark over its promise of according operational autonomy to such bodies, it is being pointed out. At the recent KERC hearings on the draft PPA with the Jindal Tractabel Power Corporation, the KPTCL Director (Finance) blamed the government for directing KPTCL to pay a higher price per unit of power. In all these cases, it is the consumer who must eventually bear the cost.