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Sanctity of contract PDF Print E-mail
Saturday, 27 August 2011 00:00
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When the government was arm-twisting Cairn into accepting ONGC’s demands before it cleared the Cairn-Vedanta sale, many pro-reformers including this newspaper argued that the government must honour its contract. The shoe’s on the other foot now, with leading private sector firms asking the government for help in renegotiating contracts they have signed. The government should not accept these demands. If it does, this will open up demands, from even within the government, that any project, such as a PPP awarded for electricity distribution, that is viewed as unfavourable be cancelled/renegotiated.

At the heart of the issue is the Indonesian coal mines purchased by firms such as Tata Power to fuel their ultra mega power projects (UMPPs). With the Indonesian government dramatically raising the cost of coal exports, these UMPPs are now unviable and want the government to raise prices—the UMPPs were awarded on the basis of the lowest bid made by firms for the power they’d supply over the next 25 years. The power ministry’s stand is that if there is an escalation clause in the agreement, that will be implemented, but nothing beyond this can be offered. Industry, on the other hand, argues that this is a special situation and will affect the project as well as the Indian bankers who have lent to the project. While this sounds reasonable, the problem is that it encourages firms to bid aggressively to win projects and, having won then, press for a renegotiation on precisely these kind of grounds. If a decision is taken to bail out the UMPPs, the danger is the signal this will send to prospective investors. If the UMPPs are instead re-bid by the bankers and another firm comes in, it may still be willing to offer power at the same price as it will buy out the original owner’s equity at a substantial discount. Even if the new bidder wants to sell the power only at a higher price, the old bidder still loses a part of the money he has invested—which is the lesson of capitalism.

What is, of course, true is that the single-part tariff bid that the power ministry introduced some years ago, where the power producer has to take a call on the fuel risk for 15-20 years, was always a bad idea since it is not possible to either anticipate or hedge such risk. Those in the government/Group of Ministers that cleared this have to go back to the drawing board to figure out just how they expected this to work. All future contracts, whether for UMPPs or smaller power projects, should do away with the single-part bid criterion. Needless to say, if power regulators don’t allow, as they are at the moment, even legitimate fuel price hikes to be passed on to consumers, even the two-part tariff bid won’t work.

 

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