India: Future Of "Compensatory Tariff" In Light Of The Supreme Court Decision In Energy Watchdog v. CERC

Last Updated: 14 September 2017
Article by Sourav Jena

In the judgment delivered on April 11, 2017, on the issue of validity of 'compensatory tariff', the Supreme Court has put an end to the unbalanced use of regulatory power, upheld the sanctity of contracts and significantly restricted the impact of power tariffs in light of consumer interest.

In view of upholding a healthy competition, section 63 of the Electricity Act, 2003, allows regulatory commissions to adopt a tariff for generation through a transparent and competitive bidding process conducted as per the guidelines issued by the central government. The guidelines emphasize a fair and transparent process for bidding and give the bidders an option to pass on the fuel price variation and other related risks by quoting various escalable and non-escalable charges transparently at the time of bidding.

As per CERC, most of the tariffs discovered through bidding were more competitive than "cost-plus" tariffs determined for similar projects1. As per a report of Prayas Energy Group2, the tariffs discovered through bidding were indeed lower than those determined on a cost-plus basis. It also highlights several governance concerns regarding bidding processes in several states including potential danger of post-bidding changes to tariffs. Highlighting the potential fuel risks inherent in some of the fixed price bids, the report presciently questioned the feasibility and viability of these projects.

At the time of commercial operation, many companies started complaining about viability issues on account of increased fuel costs. In 2012, some of these projects such as Tata Power's Mundra UMPP and Adani Power's Mundra project filed cases before the Central Electricity Regulatory Commission (CERC). They sought revision of the quoted tariff on grounds of –

  • Increase in the price of Indonesian coal
  • Shortfall in domestic coal supply and depreciation of the Indian rupee.

Similar cases were also filed before the Maharashtra Commission and a few other state commissions.

PPAs (Power Purchase Agreements) allow revision of tariff only on two pre-conditions i.e. change in law, whereby a legal action of a government body or a court imposes any cost (or results in benefit) and force majeure, which implies an unforeseen event which prevents or unavoidably delays the performance of obligations under the contract.

The companies contended that, change in price of coal by virtue of Indonesian regulation should be treated as either a force majeure event or a change in law event and that, they should be compensated for the hardship imposed on this account and making their projects viable. This claim was supported on the grounds of sectoral and consumer interest.

Decision of CERC

The Commission chose to use its overreaching regulatory powers to grant the projects what it termed as "compensatory tariff". The commission noted as follows:

"In our view, the parties should confer to find out a practicable solution and agree for compensation package to deal with the impact of subsequent event while maintaining the sanctity of the PPA and the tariff agreed therein. In other words, the compensation package agreed should be over and above the tariff agreed in the PPA and should be admissible for a limited period till the event which occasioned such compensation exist and should also be subject to periodic review by the parties to the PPA."3

The Commission, going beyond the boundaries of the contract, imposed the entire burden of fuel price variation on to the consumers, directly or indirectly and allowed compensatory tariff to Tata Power and Adani Power, to the tune of Rs. 2,300 crore and Rs. 3,600 crore respectively till March, 2016.

Following this order, regulatory commissions of several other states such as Maharashtra, Uttar Pradesh and Rajasthan adopted the same approach of modifying competitively set tariffs by granting compensatory tariffs. According to economic times4, the total amount of compensatory tariff granted till date would have amounted to, around Rs. 11,000 crore.

Decision of APTEL

The order of CERC was challenged before the Appellate Tribunal for Electricity (APTEL), which rejected the use of regulatory power to grant relief to the projects. It held that changes in the domestic coal distribution policy and promulgation of the Indonesian regulation couldn't be treated as "change in law" under the PPA5. It stated, the change in the price of imported coal would rather fall under the purview of "force majeure". By holding this, it directed the commission to determine the exact scope of relief to be granted to such projects. Subsequently, CERC through another order lessened the amount of tariff6.

Then appeals were made to Supreme Court by several companies and NGO's on account of this order.

Decision of the Apex Court

Composite scheme – The Adani Mundra project has different contracts with different state distribution companies. The Commission granted relief considering them to be under a composite scheme. The SC held that, "..."composite scheme" does not mean anything more than a scheme for generation and sale of electricity in more than one State."

Regulatory Overreach – The Supreme Court has rejected the use of regulatory powers to alter tariffs or any provisions of the contract, inasmuch as the bidding guidelines and the contract specifically deal with such issues. Since the contract (PPA) and bidding guidelines clearly define the circumstances and the manner in which the quoted tariff can be changed, the commission cannot use its regulatory powers to overrule such provision(s).

It upheld the sanctity of contracts while not taking away the regulatory power, especially in a situation where the contract or other legal and policy provisions are silent or inadequate. This clarity will help in improving the quality of regulatory decision-making, as it has demarcated the boundaries for the use of such regulatory power.

Effect of Indonesian laws, thus validity of compensatory tariff – Promulgation of Indonesian regulations would neither qualify under "change in law" or "force majeure". As far as applicability of Force Majeure is concerned, the court cited that, "This clause [Force Majeure Exclusions] makes it clear that changes in the cost of fuel, or the agreement becoming onerous to perform, are not treated as force majeure events under the PPA itself." 7

The judgment further notes that, "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."

It states that the term "law" cannot be construed to mean any law including both Indian and foreign laws, as "The meaning will have to remain the same whether coal is sourced wholly in India, partly in India and partly from outside, or wholly from outside. This being the case, the meaning of the expression "any law" in clause 13 cannot possibly be interpreted in the manner suggested by the respondents."  Hence no tariff increase can be allowed on account of the change in Indonesian regulations. Therefore, no relief is applicable to projects or PPAs based on imported coal (such as Tata Mundra UMPP or Adani Mundra PPA with GUVNL based on imported coal).

The judgment holds that this amendment to the NCDP (New Coal Distribution Policy)8 should be considered as a change in law event. It is to this limited extent that relief has been granted for period after July 2013 for projects that are impacted by such shortfall in the domestic coal supply. However, the exact quantum of the relief will have to be computed by the commission on a case to case basis after taking into account the given project's fuel supply agreements, actual coal supply and cost of alternate coal arrangement.

The Judgment not only protects the public interest in question, but also looks forward, considering a sector plagued with NPAs, as it discourages aggressive bidding by holding bidders and their lenders liable for the risks that are voluntarily assumed to excel in such contracts. In fact, from a competition point of view, it can serve as a landmark judgment as it not only upholds the sanctity of contracts, but also enforces the rule of law and thus creating a level-playing field9.

The commission should indeed take decisions that are in the larger sector's interest, which should, in fact, be broader than the individual companies' interests or issues of viability thereof, by giving a wider interpretation of law. However, such decisions need to be guided by certain principles that would define the circumstances under which such actions are called for and the extent to which the commission can deviate. Coming from the apex court, such clarity has the force of law and hence it will not be limited to power purchase contracts and tariff issues, but will apply to broader sector issues while also setting a good precedence for other sectors to follow. Secondly, the judgment has undoubtedly strengthened competition by enforcing the rule of law and holding bidders and lenders accountable for the risks that had been willingly assumed to win the contracts. Such clear and accountable mechanisms will not only discourage aggressive bidding based on risky fuel arrangements, but will also lead to more realistic tariff discovery for future projects, which would also provide more realistic price signals for the sector at large. To conclude, the judgment indeed puts a bar to the 'bid low today, raise price later' strategy of bidding.

Footnotes

1. An analysis made by CERC, available at http://www.cercind.gov.in/2010/Advice_Gov/timeframe_tariff_based_16-09-2010.pdf

2. Prayas Energy Group, "Transition from MoU to Competitive Bidding: Good Take-Off but Turbulence Ahead", March 2011

3. CERC Order, 2014, available at http://www.cercind.gov.in/2014/orders/SO159.pdf

4. Economic Times, "Tata, Adani can't charge compensatory tariff", 12th April, 2017, available at http://economictimes.indiatimes.com/industry/energy/power/tata-adani-cant-charge-compensatory-tariff-supreme-court/articleshow/58135620.cms

5. APTEL Order dated 7th April, 2016, available at http://aptel.gov.in/judgements/Full%20Bench%20Judgment_07.04.16.pdf

6. CERC Order dated December, 2016, available at http://www.cercind.gov.in/2016/orders/155MP2012.pdf

7. Energy Watchdog v. CERC [2017 SCC Online SC 378]

8. Latest Amendment to New Coal Distribution Policy, available at http://www.coal.nic.in/sites/upload_files/coal/files/curentnotices/260713_0.pdf

9. Ashwini Chitnis and Shantanu Dixit, "Supreme Court's Order on 'Compensatory Tariff' Powers Accountability and Strengthens Competition", 20th April, 2017, available at https://thewire.in/126016/supreme-courts-order-compensatory-tariffs-accountability/

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