It is well recognised that the capital cost generally bears a direct functional relationship with the efficiency, i.e. the capital cost goes up as the efficiency increases. Similarly, it is also well recognised that the operating or running or energy cost usually exhibits an inverse relationship with efficiency, i.e. the operating/running or energy cost reduces as the efficiency increases. The total cost curve, which is the sum of capital and running/operating costs (discounted present value of the yearly operating costs over the life of the product), is generally a U-shaped curve. The total cost is lowest not at the highest or lowest efficiency levels but somewhere in between. The lowest total cost occurs corresponding to the efficiency level normally referred to as optimal efficiency level for a specified level of output. Because of the U-shaped nature of the total cost curve, for any other efficiency level, either on lower or higher side of this optimum efficiency level, the total cost is always higher. Consider now the bid evaluation criteria specified in the new guidelines for case 2 projects: winning bidder is the one who has the lowest level-adjusted capacity cost for a given minimum level of efficiency/SHR. Using this single variable criteria, one will no doubt be able to identify the lowest cost bidder, but this lowest cost bidder will be the lowest cost bidder corresponding to the efficiency/SHR level specified in the bid document. If this efficiency/SHR level specified in the bid document does not coincide with the optimal efficiency level, the lowest cost bidder will not be the least cost bidder in the true, overall sense because as seen earlier, the total cost is always higher for efficiency levels on either side of optimal efficiency level.
What are the chances that we shall be able to specify the efficiency level in the bid documents that is the optimal one The answer is, more often than not we shall end up specifying efficiency level that is not congruent with optimal efficiency level since the latter is the outcome of the bidding process, i.e. what the optimum efficiency level is will only be known post bidding when data from all bidders is analysed.
The question is how to identify the least cost bidder then. The simple answer is by comparing the various bidders on the 'total cost' basis. This, however, will entail using two variablescapacity and energy charges for comparing various bids. The moment we think of using energy charge as one of the variables, however, the question of dealing with the risk associated with the movement of coal prices over a long contract period, usually 25 years, assumes significance. The risk, however, can be mitigated/eliminated if the entire energy cost/charge is allowed as pass-through. This is possible if 100% escalation, as per the escalation index provided by the Central Electricity Regulatory Commission, is allowed on the entire first year energy charge quoted by the bidder, and by asking the bidder to quote the same corresponding to the market price of coal. Once this is ensured, the risk of movement of coal price in future years will stand eliminated. In fact, to eliminate the risk of future coal price movements, the bidders could be asked to quote yearly capacity charges and heat rate. The procurer/buyer then can calculate the first year energy charge by taking the calorific value and prevalent market price of this coal (same for all bidders in case 2 situation). For arriving at energy charges for subsequent years, the procurer can use the escalation rate as provided by the central commission.
Hence, it is recommended that the bid evaluation methodology prescribed in the new bidding guidelines for Case 2 projects be revised to incorporate two-variable bidding instead of single-variable bidding.
Pramod Deo & Vijay M Deshpande
Deo is former chairman and Deshpande is an energy economist and former principal advisor (economics), CERC