COMMENTARY

Renegotiations in Long-term Infrastructure Contracts

Kumar V Pratap

Private participation in infrastructure development in India has been an important resource, but is at stake with recent developments, especially with regard to renegotiations, as they seek to override the Model Concession Agreements on unjustied grounds. A comment on the implications of opportunistic renegotiations on public-private partnerships.

Views expressed are personal. Kumar V Pratap (k_ [email protected]) is a civil servant with the Planning Commission, New Delhi.

n April 2013, the Central Electricity Regulatory Commission (CERC) granted relief to the Tata Mundra and Adani Mundra imported coal-based power projects by agreeing to reopen signed long-term power purchase agreements. Many road projects, including the recently awarded GMR Groups Kishangarh-Udaipur-Ahmedabad project, are also seeking relief after contract award through renegotiations. The road ministry plans to include renegotiations explicitly in the terms of reference for the proposed road regulator. These developments do not bode well for private participation in infrastructure in India. It is an acknowledged fact that our infrastructure is a cause of concern, apparent from the state of our congested roads, railways, ports, and airports and the poor quality of our power supply. In fact, the World Economic Forum, which ranks India 56th out of 142 countries, identies inadequate supply of infrastructure as the most problematic factor for doing business in the country (World Economic Forum 2011). Since there are competing demands on scal resources and there are numerous concerns with publicly provided infrastructure, private participation in infrastructure has been incentivised and with good results. The private sector contributed about a quarter of the total infrastructure investment of Rs 9 lakh crore over the Tenth Plan period, more than a third of the total infrastructure investment of about Rs 20 lakh crore over the Eleventh Plan period, and is expected to contribute half of the over Rs 50 lakh crore projected to be invested over the Twelfth Plan period. As per the Private Participation in Infrastructure database of the World Bank, India is ranked second among developing countries both by number of projects and associated investments.1
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Among the most important reasons for the country taking rapid strides in private participation in infrastructure is the drawing up of Model Concession Agreements across infrastructure sectors, which dene the risk-reward framework for stakeholders in precise terms. Use of standardised documents is international best practice, which lends transparency to and expedites the project award and implementation process. But, all this is at stake with recent developments, especially with regard to renegotiations, as they seek to override these agreements on unjustied grounds. Issues with Renegotiations Renegotiations would do away with the sanctity of contracts. Everything would be negotiable even after contract award, with the result that the benets of a competitive auction would be lost. Since many infrastructure projects enjoy monopoly in the delivery of services, competitive bidding ensures competition for the market (as distinct from competition in the market) and competes away the monopoly rents available to service providers, thus keeping user charges for infrastructure services low. Once renegotiations are institutionalised and they become routine, competitive bidding would not lead to the selection of the most efcient service provider, but the one who is most adept at renegotiation, which is a perverse outcome. Thus, opportunistic infrastructure players would bid low to get the projects awarded, and then get the contract terms changed through renegotiations. And, these renegotiations are a bilateral process between the selected service provider and the government, untempered by the discipline of competition. Guasch (2004), in his seminal study on renegotiations, analysed over a thousand infrastructure concessions granted over the period 1985-2000 in the Latin America and Caribbean regions, and found that about 30% of the concession contracts were renegotiated and that the average time to renegotiations is 2.2 years from contract award. Signicantly, he also found that concessions in the electricity sector are much less prone to renegotiations (9.7%) mainly because
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the sector is characterised by higher competitiveness and competing suppliers, thus reducing the bargaining power of individual providers. Projects in the transport sector (55%) and water and sewerage sector (74%) are, however, much more prone to renegotiations. Guasch (ibid) feels that while some renegotiations may be desirable when they address the essentially incomplete nature of concession contracts, the prevalent high incidence of renegotiations points towards opportunistic behaviour, including efforts to mitigate cases of aggressive bidding. This is precisely what seems to have happened in the case of the Tata Mundra project. This is a 4,000 mega watt (MW) imported coal-based project with a total project cost of about Rs 20,000 crore. Tata Power bagged the project at a levelised tariff of Rs 2.26 per unit of electricity, after keeping 55% of its fuel charge non-escalable.2 So, it willingly accepted the commercial risk of keeping a major component of its tariffs non-escalable, which was instrumental in Tata Power winning the bid in 2006.3 Subsequently, Tata Power petitioned the CERC that because of change in Indonesian regulations, whereby all existing coal contracts have to benchmark coal prices to international market prices, its Power Purchase Agreement (PPA) with power procurers has become unviable. While correctly ruling that the change in Indonesian regulations does not constitute Force Majeure or Change in Law for the project as dened in the PPA 4 between Coastal Gujarat Power Limited (CGPL, the Special Purpose Vehicle company created for implementing the project) and the state-owned distribution companies in Gujarat, Maharashtra, Rajasthan, Punjab and Haryana, the CERC gave relief to the company, through a majority decision on 15 April 2013 (CERC 2013), after contract award by requiring a committee to be formed, including the power procurers and CGPL, to compensate the project for the unprecedented and unforeseen increase in coal prices. This relief was given under regulatory powers of the CERC under Section 79(1)(b) of the Electricity Act,5
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thus negating the provisions of Section 63 of the Act,6 which provides for the CERC adopting the tariff arrived at through competitive bidding. The international market price of coal will uctuate, and so the exact impact of the Indonesian regulations will vary from time to time and may get neutralised over the 25-year contract period. In addition, the PPA is a legally binding document between CGPL and the power procurers, and should have been honoured. The CERC should also have looked at the claim that the change in Indonesian regulations was unprecedented and unforeseen, as the country has been known to abrogate contracts unilaterally. To take an example in the power sector, Indonesia entered into negotiated contracts for the Dieng, Patuha, and Karaha Bodas geothermal projects around the turn of the century, only to nd the tariffs unaffordable, and brought about new regulations reducing the contracted price of power. The government had to ultimately take over these projects at great cost imposed by international arbitrators (Wells and Ahmed 2007). Thus, the breach of contract by Indonesia is not unprecedented and should not have been unforeseen. There are wider implications of this CERC order. The order transfers fuel price risk from the private sector, which it took on willingly by keeping 55% of the fuel charge non-escalable, to the public sector. When retail tariffs are politically capped, increase in fuel price for power projects would only be

reected in the increased losses of the state power distribution companies.7 This also sets a very bad precedent for all long-term infrastructure contracts in the country. Outcomes of Renegotiations What is more worrisome is that the outcomes of renegotiation frequently turn out to be in favour of the private sector and against the government. Thus, Guasch (2004) nds that renegotiations lead to increases in tariffs (in 62% of the cases), delays and decreases in investment obligations (69%), increases in the number of cost components with an automatic pass-through to tariffs (59%), and decreases in the annual fee paid by the operator to the government (31%). It is likely that the same pattern would be repeated in India, as we are more than willing to accommodate the concerns of the private sector, but do not show the same urgency when it comes to protecting the public interest. The outcomes of renegotiation would be looked at unfavourably by agencies like the Central Vigilance Commission, the Comptroller and Auditor General of India (CAG), and the Central Bureau of Investigation, leading to difculties for the private sector, regulators, and the government, and ultimately for the future of private participation in infrastructure in the country. Let us look at a few Indian examples of renegotiations to illustrate this point. The infamous Dabhol Power Project was renegotiated in 1996, increasing the size

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of the project more than threefold to 2,184 MW and ultimately adding to the liabilities of the government when the project failed. The government eventually paid Rs 8,485 crore8 to the owners of the Dabhol Project in 2005, when a smaller project would have cost much less. The fast track GVK Jegurupadu electricity generation project in Andhra Pradesh was renegotiated twice prior to commercial operations. The renegotiations largely favoured GVK Industries Limited by providing for a central government counter-guarantee and a better plant load factor incentive formula. As pointed out by the CAG in its report Delhi International Airport Limited (DIAL), there was no provision for the Development Fee in the Operation, Management and Development Agreement that DIAL signed with the government. But, it was able to arm-twist the government into agreeing to levy a development fee in 2009 at the cost of passengers, the nancial implication being Rs 3,415 crore (CAG 2012). The outcomes of all these cases turned out to be against the government and in favour of the private sector. But, when it comes to protecting the public interest, there is no similar urgency. The Delhi-Noida Toll Bridge project needs to be renegotiated to protect the public interest, but there is no urgency shown by either the Noida Authority or the Uttar Pradesh government to renegotiate it, though it is widely acknowledged that the project is a case of bad contracting by the government. One of the clauses in the contract is that the Noida Authority guarantees 20% return on the total project cost annually and any shortfall is added to the project cost to be serviced in the following year. Projections show that while the project can provide a rate of return of about 10%, there would still be signicant shortfall in the guaranteed returns. So, a project costing Rs 408 crore in 2001, when it was commissioned, would become a huge liability of over Rs 80,000 crore at the end of the original concession period in 2031 (Pratap et al 2012). Therefore, it is in the public interest to either renegotiate the project abrogating the guaranteed returns clause or cancel it after
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paying off the current liabilities, including the guaranteed returns, of over Rs 3,000 crore. Conclusions What should be our approach to renegotiation? To limit demand for renegotiations, we need to write better contracts with unambiguous delineation of risks and rewards across stakeholders and include all foreseeable eventualities in the contract document. Once written, these contracts need to be strictly enforced because the sanctity of bids needs to be upheld through, say, high performance bonds. As a further deterrent, the government needs to specify that it would not entertain any demand for renegotiations for the rst ve years of a contract. After this period, the private sector would need to deposit a fee, which should be related to the total project cost, for the regulators to consider any request for renegotiation. This fee would be refunded in case the renegotiation request is approved by the regulator. In evaluating these requests, regulators should be able to distinguish between renegotiation demands based on incomplete contracts and those based on opportunistic behaviour, and only the former kind needs to be considered. Opportunistic renegotiation demands based on aggressive bidding are bad in principle and practice, produce perverse incentives and outcomes, and therefore should not be entertained.
Notes
1 2 3 Private Participation in Infrastructure Database , World Bank and PPIAF, viewed on 5 May 2013 (http://ppi.worldbank.org). Only the escalable fuel charge component of the tariff can be escalated as per the escalation indices of CERC. It was a closely contested bid with the levelised tariff difference between L1 (Tata Power) and L4 (Essar Power) being Rs 0.54 per unit of electricity. As per Tata Powers petition, the 4 5

additional cost on account of increase in Indonesian coal prices translates into a difference of Rs 0.67 per unit of electricity, which implies that the bidders L2 to L4 have reason to feel aggrieved from the CERC order dated 15 April 2013. The PPA between CGPL and the distribution companies was signed in 2007. Section 79(1)(b) of the Electricity Act, which has been used by CGPL to obtain relief from the CERC, deals with the following function of the CERC: [T]o regulate the tariff of generating companies other than those owned or controlled by the Central Government specied in clause (a), if such generating companies enter into or otherwise have a composite scheme for generation and sale of electricity in more than one State. Section 63 of the Electricity Act states that the Appropriate Commission shall adopt the tariff if such tariff has been determined through transparent process of bidding in accordance with the guidelines issued by the Central Government. As per the petition, the additional nancial implication due to increase in Indonesian coal price works out to Rs 1,873 crore per annum and Rs 47,500 crore over the 25-year PPA period. This adverse nancial implication is now sought to be transferred to the account of the state-owned power procurers. Lok Sabha Unstarred Question No 536 answered on 24 November 2006.

References
CAG (2012): Report of the Comptroller and Auditor General of India for the Year Ended March 2012 on Implementation of Public Private Partnership: Indira Gandhi International Airport, Delhi, Report No 5 of 2012-13, Ministry of Civil Aviation, Government of India, New Delhi, viewed on 18 February 2013, http://saiindia. gov.in/english/home/Our_Products/Audit_ Report/Government_Wise/union_audit/recent_reports/union_performance/2012_2013/ Commercial/Report_No_5/5.pdf CERC (2013): Order in Petition No 159/MP/2012, 15 April, viewed on 20 April 2013, http://www. cercind.gov.in/2013/orders/159_mp_2012.pdf Guasch, Luis J (2004): Granting and Renegotiating Infrastructure Concessions: Doing It Right (Washington DC: The World Bank). Pratap, Kumar V, Pramod Agrawal and Syedain Abbasi (2012): Flawed Delhi-Noida Toll Bridge Project Should Be Renegotiated to End Contractors Undue Gain, Economic Times, 27 September, http://articles.economictimes.indiatimes.com/2012-09-27/news/34127573_1_concession-period-development-rights-ntbcl Wells, Louis T and Raq Ahmed (2007): Making Foreign Investment Safe: Property Rights and National Sovereignty (New York: Oxford University Press). World Economic Forum (2011): The Global Competitiveness Report 2011-12, World Economic Forum, Geneva, http://www3.weforum.org/ docs/WEF_GCR_Report_2011-12.pdf

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