Insights
Opinion: Change in law provisions in a power purchase agreement – An eye opener
November 2, 2020Change in law provision in the power purchase agreements (PPAs) between the renewable energy project developers (RPDs) and distribution companies (Discoms), for capacities awarded through competitive bidding process, is important from a bankability perspective. As per this clause, the RPD is to be reimbursed, by the Discoms, with the cost incurred by it due to the occurrence of a specified change in law event. The introduction of Goods and Services Tax (GST) in 2017 and imposition of safeguard duty (SGD) on solar cells in 2018 put the change in law provision under such PPAs to test as the GST / SGD led to the increase in project costs for the RPDs. Such increase was to be compensated by the Discoms as per the PPAs.
The change in law provision requires three things from the concerned Electricity Regulatory Commission (ERC) – (a) declaration of change in law event; (b) date of such change in law event; and (c) provide relief to the RPD i.e. approve the compensation payable. The PPA however does not provide the manner in which the RPD is to be compensated for the cost determined, i.e. whether it has to be a lump sum payment, payment as a compensatory tariff on per unit basis, as an annuity payment, or any other such mechanism which is at the discretion of the ERC. As on date, several orders have been issued, by the respective ERCs, for change in law compensation in petitions filed by the affected RPDs, however, these orders have created an ambiguity with respect to the manner of such compensation leading to a delay in such compensation in many cases. The ambiguity arises as most of such orders, including those issued by the Central Electricity Regulatory Commission (CERC), state that the Discoms may make the payment in lump sum or Discoms may pay the compensation, as per mutual understanding with the RPD, as a component of tariff spread through the term of the PPA.
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The first point of contention, arising from such orders, between the RPDs on one hand and the Discoms / NTPC / SECI on the other hand — SECI / NTPC being the intermediary procurers in some of such power purchase arrangements — is that the compensation for increase in costs due to SGD / GST should be on lump sum basis. This option should not have been provided by the ERCs at all as they are the regulator and are well aware of the financial situation of the Discoms. The option of lump sum payment is economically unfeasible for a Discom. Further, by the virtue of the quantum of such compensation which is payable to various RPDs, the consumers in many of the states would have been subjected to a tariff shock as the ERC would have to allow such compensation as a pass through in retail tariff of the Discoms payable by the consumers.
The second point of contention is that for payment through the term of the PPA, whether such amount is to be arrived at on the basis of the principles adopted for determination of tariff (which includes components of return on equity, interest on work capital etc.) or whether such amount is to be treated as loan and accordingly the yearly amount payable is arrived at by considering an applicable interest rate. This complicated the situation to such an extent that SECI has filed another petition before the CERC praying for approving the payment on an annuity basis as mentioned in the said petition. Accordingly, delaying the compensation payable.
Interestingly, the Ministry of Power has now issued the draft Electricity Rules to provide for the manner in which a change in law situation is to be addressed including the timelines for the same. However, these draft rules also appear to be hurriedly prepared. For example, it contains a provision that the pass through in tariff shall happen within 30 days of the change in law event. The draft rules have clearly not envisaged a situation, like imposition of SGD, where the costs may not be incurred by the RPD for a much longer time period from the change in law event. Thankfully, this is a draft and stakeholders will be submitting comments on the same.
Unfortunately, this entire issue brings forth two drawbacks (a) weak and ambiguous contractual provisions of the PPAs being executed with Discoms leading to the issue of bankability of the PPAs; and (b) absence of a robust regulator. These drawbacks are a major concern from a foreign investor perspective also as they will tend to evaluate other provisions like termination compensation, offtake constraints compensation on these yardsticks. The Government should consider preparing a power purchase agreement which leaves no room for ambiguity and uncertainty. The regulator on the other hand has to consider ground realities also and not lose sight of the fact that it is the consumer who has to ultimately bear the cost of such unnecessary delay.
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This is intended for general information purposes only. The views and opinions expressed in this article are those of the author/authors and does not necessarily reflect the views of the firm.
