Compensation Denied

Supreme Court disallows tariff relief to Adani Power and Tata Power

In a historic judgment, the Supreme Court (SC) has rejected Adani Power’s and Tata Power’s claim to compensatory tariffs for their respective imported coal-based power plants in Mundra, Gujarat. The apex court has overturned the earlier orders passed in favour of the appellants by the Appellate Tribunal for Electricity (APTEL) and the Central Electricity Regulatory Commission (CERC), which granted relief through compensatory tariffs payable by state discoms to the two companies. The Supreme Court’s decision brings an end to a contentious legal battle that has extended for over five years, impacting two of the largest private power generators in the sector.

The court passed its judgment based on a set of appeals filed by non-governmental organisations and affected state discoms against Adani Power and Tata Power for seeking a higher tariff owing to an unexpected increase in Indonesian coal prices. The ruling is likely to deteriorate the finances of the two companies. The judgment is a crucial one as it will affect the future investment in imported coal-based power plants and set a precedent for other generators seeking relief under the “force majeure” and “change of law” clauses of power purchase agreements (PPAs) from various state electricity regulatory commissions.

Background

Tata Power and Adani Power have been incurring significant losses on account of increased fuel expenditure for their imported coal-based projects – the 4,000 MW Mundra ultra mega power project (UMPP) and the 4,620 MW Mundra thermal power project (TPP) respectively. Both Tata Power and Adani Power had signed definitive coal supply agreements with Indonesian mining companies for their generation projects in Mundra but the project economics was negatively impacted after a change in Indonesian regulations in September 2010. Indonesia aligned the export price of coal with international market prices, a stark deviation from the previous pricing regime followed in the country for a period of 40 years.

As a result, the two companies suffered losses as the cost of power generation from the projects increased significantly while tariffs remained the same. Adani Power supplied 1,000 MW of power from Phase III of the Mundra TPP (Units 5 and 6) to Gujarat Urja Vikas Nigam Limited at a levellised tariff of Rs 2.35 per unit and 1,424 MW of power from Phase IV (Units 7, 8 and 9) to the discoms of Haryana at a levellised tariff of Rs 2.94 per unit. Meanwhile, Tata Power supplied power to the state discoms of Gujarat, Maharashtra, Rajasthan, Punjab and Haryana at a levellised tariff of Rs 2.26 per unit from the Mundra UMPP.

After discussions on tariff revisions with the discoms failed, Tata Power and Adani Power approached the CERC seeking relief under the “force majeure” and “change of law” clauses of the PPAs. The commission noted that the Indonesian regulations affecting the coal price cannot be covered under the aforementioned clauses but asserted, in an order dated April 2013, that the regulations have rendered the projects unviable and, therefore, the two companies should be granted relief through compensatory tariffs. The CERC invoked special regulatory powers for itself under Section 79(1) of the Electricity Act, 2003 to compute the compensatory tariffs. Subsequently, the regulator approved a compensatory tariff of Re 0.85 per kWh under the Gujarat PPA and Re 0.36 per kWh under the Haryana PPA for Adani Power and Re 0.52 per kWh for Tata Power in February 2014 besides a hefty compensatory package to recover past arrears. However, the litigation process continued as the power procuring states approached APTEL. APTEL partly upheld the CERC’s verdict in an interim order passed in July 2014 by allowing the compensatory tariff while doing away with the recovery of past arrears. As a result, the aggrieved discoms moved the Supreme Court, which put a stay on APTEL’s interim order and asked it to pass a final judgment expeditiously. In April 2016, APTEL referred the case back to the CERC and asked it to calculate fresh tariffs under the PPA’s provisions.

Later, in December 2016, the CERC notified a new mechanism to compensate Adani Power and Tata Power. The commission stated that the difference between the price of coal as per the coal sales agreements and the benchmark price as per the Indonesian index should be paid by the procurers.

Supreme Court’s judgment

The Supreme Court stressed on the fact that the sourcing of Indonesian coal at a definite price was not a binding factor in the PPAs and that the companies had alternative modes to source coal. As per an excerpt from the judgment, “The doctrine of frustration cannot apply to these cases as the fundamental basis of the PPAs remains unaltered. Nowhere do the PPAs state that coal is to be procured only from Indonesia at a particular price. It is clear that an unexpected rise in the price of coal will not absolve the generating companies from performing their part of the contract for the very good reason that when they submitted their bids, this was a risk they knowingly took.”

The bench took note of the fact that Adani Power voluntarily quoted non-escalable energy charges in a competitive bidding round to secure the contract for setting up the generation project. The energy charges cannot be escalated now on the pretext of being affected by force majeure. “The price of coal is the price of raw material and if prices go up, a contract does not get frustrated merely because it becomes commercially onerous. In any event, the fundamental basis of the PPAs between the parties was not premised on the price of coal imported from Indonesia,” stated the panel of judges in its order.

The Supreme Court also clarified that relief cannot be granted to the companies under the “change in law” clause because as per the PPA, the clause applies to Indian regulations and not international laws. The judgment also shed light on the CERC’s authority to determine compensatory tariffs. As per the order, the commission does not “determine” but only “adopts” the tariff obtained through competitive bidding as per the Electricity Act, 2003. It further clarified that there is no residuary source of power contained in the CERC either in Section 79 of the act or otherwise to fix compensatory tariffs once the tariff is adopted under Section 63 of the act.

At the end, the Supreme Court set aside the earlier orders pertaining to the case passed by APTEL and CERC. Further, the court asked the commission to consider the matter afresh and determine what relief should be granted to those power generators who fall within clause 13 of the PPA, which deals with change in Indian laws.

Impact of the ruling

The judgment drew a strong negative reaction from the stock markets. While Adani Power’s shares declined by 16 per cent to Rs 37.20 following the decision on April 11, 2017, Tata Power’s shares fell by 1.95 per cent to Rs 85.40.

According to India Ratings, the Supreme Court’s order will result in continuous under-recoveries of fuel cost at Coastal Gujarat Power Limited (CGPL), Tata Power’s wholly owned subsidiary operating the Mundra UMPP. This will amount to around Rs 10 billion for coal prices at $60 per million tonne (freight on board). According to another market analyst report, since the plant will not be viable for Tata Power, the company could look at an option of forgoing its equity of Rs 40 billion in the plant, and asking lenders to come forward and take over this project. Lenders, in turn, can then restructure the plant, sign a new PPA, or find a new developer for the project. Meanwhile, Tata Power has said, “The company will continue to pursue all alternative options at CGPL, including sourcing of competitive coal from other relevant geographies and also use low grade and blended coal options to contain the onslaught of under-recovery at the Mundra UMPP.”

For Adani Power, industry experts estimate more severe consequences of the ruling due to its higher debt levels. However, Adani Power is expecting some respite as the order allows for the grant of relief on account of changes in Indian laws. As the company sources only a part of its total coal requirement from Indonesia, it can seek relief for the domestic coal shortfall faced by its Mundra TPP and other plants. In a statement to the exchanges, Adani Power said, “The judgment has granted relief for the cost burden arising due to shortage in the supply of domestic coal under “change of law” provisions. However, the judgment does not grant relief qua the increase in coal cost due to the change in Indonesian regulations. A preliminary analysis reveals that the company will get benefit in respect of its PPA with the Haryana discoms (1,424 MW) as well as for PPAs  with Maharashtra discoms (3,300 MW) and Rajasthan discoms (1,200 MW).”

Net, net, the judgment is credit negative for Adani Power and Tata Power and the two companies would need to explore ways to mitigate losses and hedge risks. Going forward, investors in the sector would need to cautiously invest in imported coal-based power projects while ensuring that the PPAs explicitly mention pass-through of cost escalations due to international regulations.

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