contracting for power purchase (1)

8/6/2019 Contracting for Power Purchase (1)

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Contracting for Power Purchase-Ensuring A Fair Deal For The Private Investor As

Well As The Power Purchaser

Lata Chakravarthy

Abstract

Efforts to privatize power generation in India, appears to have largely failed with very

meager capacity creation by the private investors who were initially attracted by the

liberal tariff policy. The focus has shifted from power generation to distribution reforms,where again results are not dramatic. However, given the large gap in demand supply

situation and the magnitude of funds required to invest in order to bridge the gap (as per

the Blueprint for Indian Power Sector drafted by Ministry Of Power in 2001, 100,000

MW of capacity needs to be added by 2012, which would require an investment ofRs.800,000 crores in the next decade), the nation is still dependent on the private sector

to contribute to capacity addition. A study of the power purchase agreements of some ofthe power projects already set up and running in Southern India where the IndependentPower Projects (IPPs) are concentrated, offers some significant insights into how sound

contracting can result in a win-win situation for the private investor as well as the utility

purchasing power. This extends a ray of hope for the IPPs. Of course, the regulator toohas a crucial role to play in keeping the power purchase cost in check.

[Key words: IPPs, Power Purchase Agreements, Power Generation, Role of Regulator]


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Introduction

A decade after announcing permission of entry of private sector in power generation,Independent Power Producers (IPPs) in India have added less than 10,000 MW of

capacity. The increasing risk of default by the State utilities as perceived by the foreigninvestors, resulted in the exit of almost all of them who were initially attracted by thepotential high returns promised by the sector. The IPPs are a much maligned lot today, asthe Enron episode has left a deep negative bias in the minds of the general public.However, the bias is unjustified, as we do have examples in our own country of IPPssupplying fairly low cost power. Considering the optimistic target of 9,400 MW ofcapacity addition by the private sector during the X Plan period, it is important to identifythe factors which contribute to attracting and retaining private investors in powergeneration. It is however to be recognized that further reductions in the price of IPPpower can be realized only if

i) risk of default by the state utilities is reduced;

ii) market is made more competitive;iii) market is more stable and predictable; andiv) there is access to domestic debt at low rates of interest

We now have a few years of experience with IPPs generating power, particularly in theSouthern States of Andhra Pradesh, Tamil Nadu and Karnataka. Each of these States arein various stages of reform process in the power sector, with Andhra Pradesh pushingforward more aggressively than the other two with some perceptible and some not soperceptible outcomes. The less visible but potential outcome is, there is optimism in theair and there are a few IPP proposals in the pipeline, which are nearing financial closure.

Objective

A study was undertaken to compare the cost of power being purchased from these IPPsand the terms of power purchase contracted by them initially and as amended/renegotiated later. The objective was to identify the various items of fixed and variablecomponents of the two-part tariff, which varied significantly across PPAs and thereforehad varying impact on the cost of power purchased by the utility and is likely to affect thefuture tariff differently. The role played by the State Electricity Regulatory Commissionin reducing the cost/ mitigating the risk of cost escalation in future by amending orrenegotiating the PPA was tracked, with the objective of understanding the externalfactors which having a bearing on managing the transition phase.

Scope of the study

The study covers the following IPPs whose PPAs were available in public domain:1. GVK Power Corporation Ltd., Jegurupadu, (Phase I), Andhra Pradesh2. Spectrum Power Generation Ltd.,3. Kondapalli Power Corporation Ltd.4. Tannirbavi Power Company Ltd.5. Balaji Power Corporation Ltd.


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The focus of the study was more on bringing out best practices rather than on findingfault. More inferences are drawn from the State of Andhra Pradesh, where an enablingenvironment has also contributed to efficient contracting.

Sources of data

Data has been sourced from the Power Purchase Agreements (PPAs) signed by IPPs withthe State utilities, which are available in the public domain, tariff orders and otherinformation available on websites of the state regulatory commissions and operationaldata obtained from the IPPs.

Methodology

The terms of each PPA relating to fixed and variable components of the two-part tariffwere studied to see their effect on per unit cost of sale. The terms varied from contract tocontract, even within the same State, especially in Andhra Pradesh. Out of the fiveprojects studied, two were bid route projects and three were MoU route projects. All thethree projects based in A.P are gas based and the non-A.P projects are liquid fuel projects

which inherently are more expensive. The basis for computing fixed costs and incentives,heat rate assumed for calculating energy costs and penalties imposed by one party on theother were all analyzed. Amendments to PPA and effect thereof on tariff were analyzed.The records of hearings of regulatory commissions were studied to understand the role ofregulators in bringing about price efficiency while upholding the sanctity of contract.

Result of Analysis

Key facts pertaining to the 5 sample projects are tabulated below:

Particulars GVK Spectrum Kondapalli Balaji Tanir

bavi

Projectawardedthrough

MoU route MoU route Bid route MoU route Bid route

CompletedCapital cost

Rs.1025cr.

Rs.972.60cr.

Rs.1112 cr. Rs.429.03 cr. Rs.880 cr.

InstalledCapacity inMW

216.824 208 368.144 106 220

Capital cost perMW

Rs.4.73 cr. Rs.4.68 cr. Rs.3.02 cr. Rs.4.05 cr Rs.4 cr.

Term of PPA 18 years 18 years 15 years 15 years 7 years

Primary Fuel Gas Gas Gas (switchedover fromnaphthaIn Sep 2002).

LSFO Naphtha

CommercialOperation Date

June 1997 April 1998 October 2000 September 2001

July2001


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A comparison of the items constituting the fixed charges as per the tariff clause in thePPAs of the three IPPs in A.P is tabulated below.

Components of tariff

GVK Spectrum Kondapalli

Fixed charge components1.Interest on term loans2. Interest on workingcapital3. Depreciation4. Return on Equity5. Insurance 1% of capitalcost6. O&M expenses of 2%of capital cost7. Foreign exchange

variation on interest, debtrepayment and Return onEquityFull recovery of fixed charges

at 68.5% PLF

Variable Charge components

1. Fuel charges based onStation Heat Rate of 2000kcal/kwh

Other charges

1. Income tax2. Incentive as a % ofreturn on equity (cappedat 85% PLF)= Equity x (PLF-68.5) x0.00525Incentive payment onnotional generation also.

Fixed charge components1.Interest on term loans2. Interest on workingcapital3. Depreciation as per ESAct4. Return on Equity5.Insurance 20% of O&Mexpenses6.O&M expenses of 2.5%of capital cost

7.Foreign exchangevariation on interest, debtrepayment and Return onEquityFull recovery of fixed charges

at 68.5% PLF



Other charges

1. Income tax2. Incentive as a % ofreturn on equity:PLF >68.5% < 80.50% =0.4% increase in ROE forevery 1% increase from68.5%>80.5% < 85.5% =0 .5%for every 1% increase from68.5%

>85.5% = 0.6% for every1% increase from 68.5%

Fixed charge components1. Foreign Debt Service

Charge (FDSC) = $0.01628per unit of energy generatedpayable to the IPP for 12years at>=80% PLF

2. Other Fixed Charges(OFC) = Rs.0.4776 per unit(at >=80% PLF) payable tothe IPP for the entire 15 yearterm of the PPA

3. Forex adjustment=FDSC payment x (CurrentExchange Rate on paymentdate Current ExchangeRate on metering date)

Full recovery of fixed charges at

80% PLF



Other charges

1. Income tax2. Incentive as a % of OtherFixed ChargesUp to 80% nil80 to 85% : 2% for every 1%increase in PLF

85 to 90%: 3% for every 1%increase in PLFAbove 90%: same as for90% i.e., 25% of OFC


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Fixed cost component

While the variable cost component is a function of primary fuel used by the power plant,fixed cost component is a function of PPA structure. Given the fuel, which is gas ornaphtha or diesel or coal and the price trends, the variable cost is fairly predictable and

therefore associated price risk is manageable. As regards, fixed cost, it is varying fromproject to project based on capital cost, foreign exchange component in means of finance,interest rates, exchange rates, tax rates, incentives and disincentives, penalties andrebates, level of working capital and interest rate on working capital, O&M expenses,insurance expenses. The per unit fixed cost differs from project to project on account ofhow the terms in the PPA are drawn up with respect to these payments. It is here thatsound contracting can save millions of rupees for the power purchaser while ensuring theintended return for the investor. In the case of bid route project like Kondapalli, the fixedcost computation is simple with just two items-foreign debt service charge of $.01628and other fixed charges of Rs.0.4776 per kwh. In current exchange rate terms, the totalfixed charge adds up to Rs.1.22 per kwh. In the case of GVK and Spectrum the fixed

charge calculation has too many variables, exposing the utility to higher risk.

The fixed costs for IPPs studied, for the year 2001-02 were as follows:

Name of IPP

Fixed costIn Rs. Per kwh

GVK 1.52

Spectrum 1.61

Kondapalli 1.22

Balaji 1.52

Tannirbavi 1.98

Incentives

The PPA terms relating to incentive payments are different in respect of each IPP. TheGVK project was initially entitled to incentives without a ceiling, but a subsequentamendment to GVKs PPA capped the incentives at 85% PLF. In the case of Spectrum,incentives are payable up to 100% PLF and in the case of Kondapalli, upto 90% PLF..There are obvious advantages in incentive entitlements of Spectrum and Kondapalli ascompared to GVK where it is at a flat rate of .0525% for PLF between 68.5% and 85%.With no cap, and with floor at 68.5%, the incentives are the highest for Spectrum. At

92% PLF which was achieved by the company in year 1999-2000, the Return On Equityincluding incentives was 30.29%. For Kondapalli, with floor at 80% and cap at 90%, thesame PLF achievement will result in an ROE of only 26.67%. For GVK, with the cap at85% PLF, the maximum ROE possible including incentives is only 25%. Which perhaps,explains why the PLF in all these years of generation has hovered around 85%. A capmay not be a good idea to if plant has to achieve higher levels of PLF.


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Foreign debt component

Very high foreign currency debt component in total debt in almost all cases, is leading toburgeoning and cascading debt servicing costs for the utility. The PPA has, in all casespassed on the foreign exchange variation risk to the utility, which is not the party best

capable of handling the risk.

Depreciation Vs Repayment of debt

The PPAs of MoU projects provide for recovery of capital by way of reimbursement ofdepreciation. These projects have assumed almost the entire amount of project investmentas depreciable fixed assets (land, for example is an item of project cost which is notdepreciated) and depreciation is charged on 90% of fixed assets. This amounts to returnof not only debt capital but also a significant portion of equity. The promoters enjoy notonly return on capital but also return of capital. In the case of Spectrum and GVK, theoriginal PPA provided forboth depreciation as well as repayment of debt which amounts

to repaying the debt twice over. The amended PPA has done away with repayment ofdebt and has retained depreciation. The cost of GVKs project for example, is Rs.816 cr.all of which is taken as depreciable fixed assets. The project cost is financed with 239 cr.of equity and 577 crores of debt. Depreciation of 90% of Rs.816 cr. results in recovery ofRs.734.4 crores which is Rs.157 crores more than the debt of Rs.577 cr.This results inrecovery of 65% of equity capital invested in the project, over and above the fixed returnon equity of 16%. The PPAs of bid route projects however, allow only debt repayment.

Total cost of power

The actual cost of power purchase incurred by the State utility in the States of A.P.,Karnataka and Tamil Nadu are given below;

Cost of power purchased in Rupees/kwh

Year GVK Spectrum Kondapalli Balaji Tanir Bavi

1997-98 2.20

1998-99 2.22 2.19

1999-00 2.18 2.06

2000-01 2.16 2.09 4.00

2001-02 2.14 2.11 3.50 4.10 4.59

2002-03 2.37 2.25

The cost of power purchased from Kondapalli project was higher in the initial years onaccount of higher fuel cost as the plant was running on Naphtha. After switching over tonatural gas obtained through pipe line from GAILs newly developed gas fields in KGBasin during the year 2001-02, the power cost has come down to the same level of theother two gas based projects. The power cost of Tanir Bavi project is high not onlybecause of naphtha but also due to high fixed cost.


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Renegotiation of PPA

The PPAs of GVK and Spectrum have been amended and renegotiated to ensure greatertransparency and control over the final cost of power. The State Electricity Regulatory

Commission of Andhra Pradesh has played a key role in this process. Some of thesignificant amendments are:1. Ceiling on capital cost The completed capital cost of GVKs project was

Rs.1025 cr, as against original approved cost of Rs.816 cr. The PPA was amendedto fix the ceiling on capital cost at Rs.816 cr. This reduction of Rs.206 cr incapital cost has resulted in levelized tariff being lower by 6.3 paise

2. Shifting of fuel risk from utility to IPPs3. Cap on incentive and reduction in rate of incentive- For GVK, the incentive was

capped at 85% PLF and rate of incentive was reduced from 6% to 5.25%. Thishas resulted in reducing maximum ROE including incentives to 25% from 32.5%,a 7.5% decrease. Applied to an equity of Rs.243.23 crores and assuming the IPP

operates at 90% PLF, the saving is Rs.6.27 cr p.a.4. Reduction in O&M charges was effected for GVK It was originally 2.5% ofcapital cost with forex fluctuation and amendment reduced it to 2% without forexfluctuation. Excluding forex fluctuation, this saving is Rs.40.80 cr.

5. Disallowance of duration For GVK, it was earlier allowed at 1.5% after 5 years.6. Disallowance of third party sale the PPAs of both GVK and Spectrum earlier

allowed third party sale above 71% PLF.7. Reduction of term of PPA-This was effected for GVK to bring down the term of

PPA from 30 years to 18 years.8. Deletion of repayment of debt from fixed charge calculation (as depreciation was

also included, it was double counting) PPAs of both GVK and Spectrum wereamended to this effect.

9. Rebate entitlement Spectrum PPA was amended to allow a rebate of 2.5% ofbilled amount if payment was made by the utility within 5 days of presenting thebill and a rebate of 1% if payment was made after 5 days but before due date ofpayment. Earlier, the PPA provided for only 1% rebate.

10. Liquidated damages for delay in commissioning Spectrum PPA was amended toprovide for the same.

The Regulatory Commission played a proactive role by using the rates quoted by thenewer IPPs which entered the market through international competitive bidding, asthe bench mark rates to renegotiate the terms under the existing contracts.


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contracting for power purchase (1)

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