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(Photo: Bloomberg)
(Photo: Bloomberg)

Opinion | Power purchase agreements as an albatross

Long-term supply contracts need flexibility for public utilities to adapt to unforeseen situations such as a covid collapse in demand

India is now an electricity surplus country with an installed capacity of 369,000 megawatts (MW) against its peak demand of 183,804 MW. Independent power producers in the private sector now account for 47% of overall capacity—48% of thermal and 43% of renewable—while the Centre owns 25% of it and state governments the rest. The utilization trend has been away from coal and natural gas fired plants towards facilities for renewable energy.

Peak demand has plummeted during the country’s current lockdown. This has made India’s excess capacity problem even worse. What has caught distribution utilities in a bind, however, are the power purchase agreements (PPAs) they had signed earlier with suppliers that generate electricity. Larger supplies have been tied up through these deals than there is demand for. By 2017-18, the country had around 334,000 MW of installed capacity, of which 291,000 was under long-term PPAs. Competitive procurement has meant declining tariffs both for conventional and renewable energy. Utilities have been in poor financial health, and many are keen to renegotiate their PPAs.

It is unfair to put pressure on independent producers to reduce prices or alter other contractual conditions. It sends out a wrong signal to investors, who expect all deals to be honoured. Power is a capital-intensive sector with a considerably long gestation period; therefore, continuity and clarity of policy are a prerequisite for investments. This is why the Union ministry of power has consistently persuaded states not to resort to such tactics. An Electricity Contract Enforcement Authority has been proposed to check renegotiation efforts.

Some utilities have been relieved to have PPAs cancelled on account of supplier defaults or non-availability of fuel as a result of coal-block allocations being nixed. But by and large, they have to abide by their past commitments to buy the power they asked for.

Indian states have signed long-term PPAs for about 90-95% of their peak demand. In several states, contracted capacity is 30% in excess of peak demand. Maharashtra, for example, has deals for 37,896 MW of supply, while its peak demand is 22,516 MW. The figures for Tamil Nadu are 26,975 MW and 14,223 MW respectively.

Distribution utilities cannot trade their contracted supplies. They have the option of selling energy bilaterally or through the power exchanges, but participation in these market mechanisms remains minimal in India. While PPAs are long-term contracts, they have no provision to accommodate future contingencies—such as a sudden fall in demand for electricity. This is unfortunate.

Such contracts need to have elements of flexibility to address unforeseen situations. With decreasing costs for renewable energy projects, PPAs of 7-10 years could be long enough to recover cost. Many of today’s PPAs run much longer than that. India should consider the redefinition of contract tenures. A study of 1,000 concession contracts in Latin America found that 30% of them had to be renegotiated (46 % of them were competitively bid). Renegotiation can be a positive instrument of contract management if done in an accountable manner.

Indian PPAs have no space for adaptation to unexpected factors. PPAs with central generating stations neither have an option to exit the contract, nor provisions for a review of terms and conditions. The deals with independent power producers vary significantly, but they have no exit clauses. They have specific termination provisions in case of specified default event. A non-defaulting party can seek termination with a payment, depending on the status of the project—i.e. whether it is under construction or in operation. In case of renewable energy PPAs, there are specific termination clauses. Save for these instances, there are no provision for any renegotiation, except for a mutually agreed extension of the contract beyond its original term.

Despite the absence of provision for it, many successful tariff renegotiations have happened in India. It was done in the case of M/s Lanco Power, Power Management Company of Madhya Pradesh, and PTC India over the PPA’s tariff-setting methodology, and the parties involved agreed to settle the issue. A verdict of the Supreme Court in 2018 concerning Tata Power Ltd, Adani Power Ltd and Essar Power Ltd showed that deals that were an outcome of competitive bidding could be relooked.

Today, the concern is a significant decline in power consumption on account of the covid lockdown. Demand may not return to earlier levels so long as the current crisis lasts. The country needs a plan to mitigate its impact on the power sector. The government could consider setting up an institutional mechanism under the aegis of NITI Aayog, which would have as members the central electricity regulatory commission, the ministries of power, law and finance, the chief economic advisor, state regulators, the department of industrial planning and promotion, as well as independent experts from business to tackle conflicts arising from the high cost of contracted power while the market price of supplies is low.

Something could be worked out that satisfies investors and also benefits the end consumer of electricity. India should also deepen its power market and promote the trading of power supplies.

A.K. Verma worked as joint secretary in the Union ministry of power. These are his personal views

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