Column: Brace for more power shocks

Updated: Nov 8 2013, 11:11am hrs
The Ministry of Power has recently notified guidelines for procurement of electricity from thermal power plants set up on design, build, finance, operate and transfer (DBFOT) basis. These guidelines are expected to be an improvement over the now repealed competitive bidding guidelines for procurement of power under case 2 procurement mechanism that the central government had notified in January 2005. In this column, we examine the efficacy of newly notified guidelines.

One major difference between the new DBFOT guidelines and the case 2 guidelines is with in respect of ownership pattern. While the new guidelines provide for setting up of a power plant on DBFOT basis, the now repealed case 2 guidelines provided for setting up of plants on build, own and operate (BOO) basis. Though a major change, no rationale or arguments in support of preferring to procure electricity from plants set up on DBFOT basis as against plants set up on BOO basis have been provided. As pointed out by the CERC in its statutory advice to the central government in its letter dated October, 26, 2012, DBFOT model is more suited for natural monopoly businesses like roads, transport, transmission, distribution of electricity, etc, and not for de-licensed businesses like generation.

The new guidelines, by allowing pass-through of fuel charges to discoms, and in turn, to their consumers, purport to address the issue of uncertainty associated with fuel cost. This, unlike the old bidding guidelines, no doubt will help the project developers in completely eliminating the fuel cost risk. But, how does this look from the point of view of the supply utilities or their consumers In her book on Making Competition Work in Electricity, Sally Hunt points out that, the major difference between regulation or the MoU route and the competitive route for tariff determination is who bears the various risks. While under the traditional cost-plus-return route, consumers bear most of the risks like demand risk, price risk or technology risk, under the competitive route, the project developers must bear most of these risks. Under case 2 guidelines, while the demand and technology risks were largely borne by the consumers, the price risk was largely the project developers. By allowing pass-through of fuel costs, under the new guidelines, even the price risk would have to be largely borne by the consumers. Thus, the new guidelines have made power procurement much more akin to the MoU route of power procurement as compared to the case 2 guidelines. Further, while the repealed guidelines, providing the choice of quoting escalable and non-escalable components and the use of multiple variables taken together to arrive at least cost bidder, gave the project developer an opportunity to bring in innovative financial engineering to offer competitive tariff, the new guidelines offer no such opportunity.

Another very important issue from the consumer perspective is the procedure to be adopted by those procuring power, i.e., utilities, for effecting any deviation from the new guidelines. The old guidelines provided that the appropriate regulatory commissions could approve any such deviation. The new guidelines, however, shift this authority to the central government. This is a retrograde step from the consumer's point of view because, unlike regulatory commissions, the central government lacks the mechanism of consultative processes such as court hearings or public hearings to seek broader participation, including that of consumers, to discuss the deviations sought by the procurer in a transparent, fair and equitable manner.

The new guidelines may also lead to relatively higher tariffs. Under the old guidelines, the project developer had the opportunity to factor in the advantage of having ownership of the plant and land rights, by the way of lease or otherwise, to quote reduced tariffs. A back of the envelop calculation shows that such opportunity would have translated into reduction of the levelised tariff by 3-4 paise per unit if the project developer had assumed the salvage value of plant and land lease rights as 50% of the original project cost. However, no such opportunity exists under the new guidelines as the plant and land ownership does not rest with the project developer under the new framework. This apart, the fact that under the DBFOT framework the borrower of the funds,i.e., the bidder, does not have ownership rights or title is likely to increase the cost of borrowing for the project developer, which again will result in the consumer paying relatively higher tariff than he would have paid under the case 2 guidelines which have now been repealed.

One of the issues with the case 2 guidelines was that the generation plant by default had to be located in the state whose discom was seeking power procurement under the bidding mechanism. This was due to the fact that many state governments were following the policy of mandatorily taking a share of the generation from plants set up in their geographical boundaries. This was particularly disadvantageous to states which were away from coal fields, but wanted to procure power under case 2 mechanism. The issue remains unresolved even in the new DBFOT framework.

Depending upon the choice of fuel source, the new guidelines prescribe five different bid evaluation criteria. The impression gained from reading of these guidelines is that bidding and its evaluation will be carried out separately for each choice of fuel. This will lead to reduction in the number of bidders participating in each bid and this will result in reduced competition.

When the choice of fuel source is coal linkage to an existing mine, the new guidelines prescribe that bid evaluation be done by using single variable criterion, namely the capacity cost. However, as has been argued in our column Case 2 bidding norms inadequate (Financial Express, September 12, 2013,, this bid evaluation criteria will only help to identify a least cost bidder for the specified level of heat rate, who may or may not be the overall least cost bidder.

When the choice of fuel source is a captive mine, the DBFOT guidelines prescribe that bids be evaluated by using two variables, namely the capacity and energy cost. However, when the choice of fuel source is a captive mine, the only possible visualisation of the bidding process is that the procurer is seeking bids from various bidders who have captive mines possibly situated in different parts of the country to put up a plant at the location specified by the procurer. If this be so, then apart from capacity and energy costs, the bid evaluation will also need to consider coal transportation cost as this will be different for different bidders.

When the choice of fuel source is coal linkage to a captive mine allotted by or on behalf of the discom, the new guidelines prescribe that bid evaluation be done using a single variable criterion, namely, the capacity cost. Implicit in this formulation is the assumption that the efficiency with which mining of coal will be done by different bidders will be the same. It is a matter of conjecture if this assumption could be taken to be true in all situations.

Also, since fuel cost is a pass-through, the bidders will have to compete essentially by manipulating the return-on-equity (ROE) from the project. The bidders, in order to win the bid, will have to undercut ROE, with the bidder willing to undercut ROE the most emerging as the likely winner. This may ultimately result in not getting enough investment in power generation.

The new guidelines, though appropriate for mitigating the fuel cost risk faced by project developers, have many areas where improvements are required, especially when viewed from consumers view point. The failure of the now repealed case 2 bidding guidelines was mainly because Coal India Limited, the monopoly producer and supplier of coal, was unable to meet the demand for coal from contracted power plants. Otherwise, the old guidelines did result in attracting large investments in the power generation, and that too at rates that were decidedly lower than the ones discovered under the MoU route.

Pramod Deo & Vijay M DeshPande

Deo is former chairman and Deshpande is an energy economist

and former principal advisor (economics), CERC