Against the backdrop of aggressive bidding and continuously plummeting renewable energy tariffs, several state governments have shied away from honouring previously signed power purchase agreements (PPAs). Taking cognisance of these developments, the government is now reportedly working on legislative amendments that would make the obligations under PPAs statutory and binding. Industry experts’ comment on this proposal and its likely impact on the sector. Excerpts…
Will the move to make PPAs legally binding effectively mitigate project risks? What are the checks and balances needed to make this move successful?
PPAs are by definition legally binding documents signed between the power seller and the buyer. In India, these are sanctioned and protected under the Indian Contracts Act. Typically, a PPA defines all of the commercial terms for the sale of electricity between two parties, including details such as when the project will begin commercial operation, the schedule for delivery of electricity, penalties for under-delivery, payment terms and termination. It may even contain engineering and design specifications as part of the document (as appendices) depending on the business model for power procurement. Once executed, the terms and conditions are binding and enforceable in the court of law.
The proposal for making PPAs legally binding was alluded to by the power minister, perhaps in the context of renewable power PPAs being opened for renegotiations by several state-owned distribution utilities. It must be noted that some PPAs do provide for renegotiation of prices/tariffs under prescribed turns of events, but if such provisions are not made in the PPA, the prices cannot be renegotiated even though technological improvements and efficiency gains may have led to tariffs crashing, subsequent to a PPA having been signed, which has been the case for solar power procurement. Considering the chances of PPAs being terminated, power generators may agree to renegotiate tariffs, but such steps must also comply with the terms and conditions of the PPA and the competitive procurement rules and regulations, including Central Vigilance Commission guidelines.
Hence, as such, there may not be much merit in legislating on the legally binding nature of PPAs. The PPAs used by state-owned entities for competitive procurement tend to be picked from the standard bidding documents of central government and central power utilities, which could be amended to make termination clauses a bit more expensive for the parties, and to include a chapter on provisions for tariff renegotiation. These should serve the purpose. Legislating another piece of law may, in fact, create more challenges than the ones it is intending to solve, by creating avenues of conflict between the new law and the contracts law.
A PPA is the foundation for the development of a power project in the country, given the regulatory framework and market dynamics. Most power plants have historically operated under well-defined long-term PPAs. In the past one decade, some developers have also set up power plants through the merchant power route or short-term PPAs and such developments have seen the manifestation of risks that the PPAs seek to address, thus reinforcing the importance of long-term PPAs. However, some states and state power discoms have recently raised questions over the validity of PPAs and sought to unilaterally cancel these, thus endangering some large investments. The central government has made its stance clear on the subject by not only advising discoms and state governments to refrain from such an action but also stating its intention to provide more legal teeth to the existing PPAs by making them legally binding.
In order to understand this phenomenon better, one has to look at the rationale for having PPAs in the first place. India has traditionally been a power-deficit country with a shortage of generating capacity. Power projects require large investments to create generating assets with a long operating life as well as stable and predictable cash flows over their long operating life in order to service the debt. Also, such large investments require assured though reasonable equity returns to attract equity investors and provide them rewards commensurate with the risks. Given this background, the regulations have propagated long-term PPAs, which assure long-term offtake of power, covering all reasonable costs including debt costs within predefined benchmarks and a reasonable return on investments to the equity shareholders. The entire process is regulated through central and state-level regulatory bodies and various benchmarks are modified by the regulators, in line with changes in market conditions and through wide consultation with various stakeholders.
However, discoms are saddled with operating and financial inefficiencies, leading to their inability to transmit the demand fully. This has led to low plant load factors for generators, while the entire fixed cost of a power plant is fully passed on to the discoms under the PPAs, leading to a higher per unit price given the lower electricity purchase for the same fixed costs. Further, discoms have come under pressure to reduce their power purchase costs to remain viable. In order to reduce their power purchase costs, discoms are seeking to cancel PPAs wherein either the variable or the fixed costs are high. Another instance of discoms seeking to cancel PPAs is in renewables, where capital costs have fallen significantly so that even PPAs signed a few years back are a burden on discoms.
Strong support to the existing PPAs is the need of the hour. While the release of central government funds to discoms can work as a carrot as well as a stick, there is a need to strengthen the legal framework supporting PPAs to prevent their one-sided cancellation. Maintaining confidence in the sanctity of PPAs is required not only to safeguard the existing investments but also to send a positive signal for future investments. At the same time, it will be helpful to build the necessary checks and balances in the PPA mechanism so that this framework is not misused. Thus, regulatory oversight over all PPAs should continue and the regulators should make the necessary changes in regulations regarding plant availability, determination of fixed costs, pass-through of variable costs, fixation of returns on equity, etc., so that PPAs reflect the current market dynamics while safeguarding the interests of all stakeholders whether investors, developers, buyers or consumers. The clear goal of PPAs should be to help the development and operation of sufficient generation capacity at reasonable costs while providing suitable returns to investors, besides safeguarding their capital. Thus, strengthening of the legal sanctity of PPAs will make it imperative for the developers and the regulators to keep power generation costs reasonable so that the ultimate consumers benefit as much from the regulation.
PPAs have been around for a long time and have mostly been signed by state governments and state electricity boards (SEBs). By and large, the buyer, which is the SEB, has honoured the PPAs. The problem arises for generators or suppliers. And there again, it is not so much central public sector companies like NTPC or state-owned generating companies, but private players. The problem has cropped up in the past 20-30 years with increasing participation by the private sector. There have been several instances of PPAs being violated. It has happened particularly in the case of ultra mega power projects (UMPPs). In the case of UMPPs, there is a usage of imported coal. For instance, Reliance Infrastructure, even before it entered into any PPA, stopped the project in Andhra Pradesh for the reason that it was concerned about the pricing of imported coal. Reliance had been importing coal from Indonesia. The Indonesian government, at that time, had suddenly come out with a rule stating that any coal exports from Indonesia should be at the ruling market prices.
The government further defined a minimum price, which was not viable. This was because the PPAs that had been entered into were not only for 25 years but were also at very competitive prices. So, Reliance Infrastructure did the right thing by not entering into a PPA. On the other hand, there were instances of companies like Adani and Tata in Mundra. They entered into PPAs with the state governments and others, and it hit both these companies really hard. This was because the price was completely uneconomical on account of the rise in coal prices. Moreover, the state governments were not willing to consider the high costs. Even the Central Electricity Regulatory Commission (CERC) and the government were unable to help these companies. This was primarily because the projects involved imported coal, which the government had no control over.
Therefore, when you look at a PPA, there always has to be some way out when conditions change dramatically. For instance, when the Indonesian government suddenly put a new floor on the price of coal exported to India, it was a completely unanticipated move. How could a generator in India anticipate that the Indonesian government would do something of this sort? Similarly, other unforeseen occurrences could take place. There is another thing in PPAs that I find difficult to understand. Entities sign a PPA for a period of 25 years at a fixed price, but prices can escalate. To my mind, this does not make economic sense. Why would you want such a long period? Nobody can forecast what is going to happen over 25 years. Banks usually demand this duration because they want to be reasonably confident that the buyer will buy the power. However, banks, I believe, do not need more than 12 years. So if you must have a time period, make it 12 years, not 25. Also, there is a need to provide for some eventualities, like dislocation in the supplier country, in the case of imported coal. Similarly, in the case of domestic supplies, PPAs are not signed for reasonable time frames. For instance, how can you enter into a long-term contract for hydro, knowing that generation depends on the availability of water, which, in turn, is out of one’s control. Provisions need to be made for circumstances that are beyond one’s control. In the case of renewable energy, for instance, one cannot enter into a long-term PPA because the quantum of sun and wind energy cannot be accurately forecasted. Domestic coal is another problem. The problem is that coal is now very unpopular and, therefore, the suppliers try to enter into PPAs where there are minimum possible emissions. This requires monitoring the quality of coal bought, the process of washing it, etc. But here again, if the plant load factor is low, the costs are extremely high and the PPAs do not provide for this.
Another important thing is that a PPA is a contract. A contract is a legally valid document and one can always try to enforce it in court. However, it is not a desirable option. As far as the government is concerned, it has already interfered far too much in the power sector. State governments have kept consumer tariffs very low and have encouraged free and below-cost supply of power to agriculture and other sub-industries. They expect the generators to be able to make up for that loss by charging higher prices from other customers. However, these customers may not accept the higher prices and thus, may not buy power. So, the generators are left with power that they are not able to sell, and power that they have sold to government entities, or agricultural consumers, below cost. Thus, the PPA does not provide enough protection to the generators. In sum, I do not think the government should interfere and lay down conditions for PPAs. Also, I do not think PPAs should be for long periods. In my view, the shorter the period, the better. Even 12 years is too long. I would like to see PPAs for three to four years. Banks demand long durations because they want to be sure of their returns.
However, that is unfair to the suppliers. What we need is shorter-term PPAs. We also need a very strong trading market. So if for any reason beyond one’s control, the customer does not take the power, one can trade it. Trading itself has been regulated a great deal by the state governments, which do not allow open access in many cases by imposing several conditions. This needs to be corrected. Another aspect that needs attention is plant health. As per estimates, 60,000 MW of power generation in the country is from plants that are older than 25 years, most of which are owned by the state governments. These are grossly inefficient, both in terms of emissions and perhaps cost. Such plants should be shut down.
So, the government needs to take some basic decisions. And it needs to stop interfering in contracts. The banks also need to agree to reasonable time periods for PPAs.
The issue in the past has been that signed PPAs could not be effectively enforced and government entities always found ways of getting out of their obligations. Hence, even after the proposed government measures, including making renewable purchase obligations (RPOs) mandatory, there continues be an issue regarding enforceability. In this regard, the key fault lies first with the regulatory commissions, which remain mute spectators when discoms and state governments renege on signed obligations. For instance, it is a common practice that discoms do not pay bills on time and they do not typically pay interest (whether fully or partially) on delayed payments. Instead, they always manage to persuade IPPs to voluntarily give up their claims. However, there is really no instance where the regulatory commissions have stepped in to prevent such unilateral moves by the discoms. We really do not need a law to say that a signed contract will be legally binding, as signed contracts are already legally binding.
The second issue lies with the slow process of the judicial system, wherein, till the very end, the parties cannot anticipate how a case will get settled. Of late, there has been a worrisome trend of the Supreme Court turning down orders of the regulatory commissions in some prominent cases. The last point that needs to be noted is that typically, the system of penalties does not work so effectively on government and government-owned entities.
Enforcing signed PPAs (and RPOs) is the key issue and this requires a change in the regulatory/judicial mindset. It is not clear how the changes proposed by the government will address the enforcement issues. But this step is still welcome, as it highlights that at least something is being done to address the issue. As is said, something is better than nothing.