In the old model, power developers divided up their costs into two parts while bidding for power projects. There was the capacity charge which was, essentially, the tariff required to pay for the costs incurred on capital, on O&M, and a profit margin as well. There was then the fuel surcharge which, subject to certain norms, would be passed on to customers—each unit of coal, for instance, is supposed to produce so much of power based on a ‘station heat rate’. So if the capacity charge for a plant was R1.1 per unit and the fuel component R0.65, the total tariff would be R1.75; now if the coal price doubled, the tariff would automatically go up to R2.4 per unit of electricity.
This worked well till the ministry of power decided it wanted more certainty in pricing, and went in for what was essentially a single-part bid encompassing both the capacity and fuel charges. While you could fashion your bid to put in an escalation schedule even in fuel costs, this lowered the attractiveness of the bid. Essentially then, in this model, power producers were encouraged to take a call on long-term fuel costs and to put their money on it. Since few, especially private sector firms, have the financial muscle to be able to take a 20-year call on fuel prices, this seemed like asking for trouble and the best example of how this can backfire are the Tata Power and Reliance Power ultra-mega power projects which are based on imported coal. With a huge hike in imported coal costs from Indonesia, the promoters of both plants will find it cheaper to pay the stipulated penalties in the contract than to generate power. Though it will be prospective when the Cabinet finally passes it, the Inter-Ministerial Group (IMG) has done well to say that bidding for all future projects which are to get coal from either Coal India Ltd or from captive mines will be on the basis of a single variable, the capacity charge. At some point, it will be a good idea to apply this to even imported coal.