Moral Problems of a Price Dispute

The Central Electricity Regulatory Commission (CERC) recently approved a ‘compensatory package’ to Tata Power’s and Adani Power’s Ultra Mega Power Plants (UMPPs) in Gujarat. The CERC allowed the price of electricity per unit to be raised over and above the rate specified in the agreement saying that the present cost structure was untenable. This reversal from a signed agreement would have serious consequences if it were a transaction in the private sector.

These disputes between corporates and the government are symptomatic of a deep malaise within the Indian system which nobody seems to want to address directly. These examples are also used by many to criticize the ‘modernization’ programme of the Indian state. Let’s see what the problem is with the bailing out of these companies.

Sanctity of Contract

In the modern democratic state, much of life is dictated by way of contract. When you order a pizza from Dominos at Rs. 300, you expect to get it delivered to your house at Rs. 300. You cannot underpay the pizza guy by insisting that the cost price was only Rs. 100, and neither can the pizza guy ask you to pay over and above the agreed amount insisting that the cost of electricity used to bake the pizza has risen. Both these considerations must have been taken into account while fleshing out the agreement to buy the pizza.

It is such a simple concept that we’d probably never order from Dominos again if they tried to make us pay over the agreed price of the pizza. Unfortunately, these widely respected essential concepts of the running of a society seem to go out the window when it comes to dealing with certain parties.

The power tariffs agreed to by Tata Power and Adani Power in Gujarat were less than Rs. 3 per unit — ranging from Rs. 2.35 to Rs. 2.94. However, a crucial feature of these contracts was that they did not include important clauses regarding cost escalation. Keep in mind that these contracts were to supply electricity for 25 years and the exclusion of cost escalation clauses in this context looks absolutely ridiculous.

The companies were banking on a coal supply agreement from Indonesian mines. They owned these mines and therefore hoped to keep their costs of raw material low. The coal was thus being exported to the parent Indian power companies at a price much lower than the international market prices. To combat this, the Indonesian government brought about a regulation to ensure that Indonesian coal was exported at a price closer to the prevailing international prices — a very reasonable measure. The power companies pleaded that this was a force majeure and that they should therefore be allowed to increase the price. Not very surprisingly, they were.

This brings us to the important questions. How can any reasonable businessman enter into a 25 year contract without having cost escalation clauses? This in a country with high inflation rates for the past few years. The significance of this lackadaisical approach becomes more serious when you realise that the combined cost of the two projects would be upwards of Rs. 500,000,000,000 (fifty thousand crores or five hundred billion), including their capital and operating expenditures. Would it not be expected that the parties to such a deal tried to think of everything to include in the agreement to protect this huge investment? Then why did the highly paid executives from Tata Power and Adani Power miss this? We’ll see precisely this right now.

Opportunity Cost and a slippery slope

Imagine you’re a businessman. You have to bid for a contract to supply electricity for a period of 25 years. You know that there are problems with coal supply in India, and in any case there is no way to guarantee that your costs would not increase for 25 years. So you bid for the project by citing your price of electricity after considering various uncertainties that you can think of, and various others that might arise during the course of the 25 years. So you perhaps cite prices starting at Rs. 3.20 per unit and a cost revision mechanism every few years. Or maybe a fuel price linked production price. Either way, some other businessman bids for the project at a price you consider impossible and gets the contract as the contract is given to the lowest bidder.

Cut to a few years later. You are still a reasonably successful businessman, but you have lost the opportunity to get into the really big league by having your own UMPP. You however laud yourself on your decision when you see the winning company making huge losses on the power project. But wait, what is that? The CERC has allowed for a price rise? This makes you look like a chump. You could have bid for 1 paise per unit if you had an inkling that the prices could be raised. And herein lies the slippery slope.

This is exactly the moral problem with the power price dispute. Companies are being rewarded for making erroneous and incompetent decisions. The executive who refused to bid too low has probably lost his job. While the executive who took a ridiculous decision to bid high without any provision for price adjustment looks like a rockstar. Should we as a society encourage such a low standard of decision making at the top tier? Especially regarding investment of tens of thousands of crores of public money, seeing that it is banks and other financial institutions that normally back such projects.

Conclusion

Does the price of electricity have to increase? Considering the increase in input costs, I have to say yes. However, should the bad decision makers be rewarded for their hara-kiri? I don’t think so. The companies contend that they would go bankrupt if they continue to sell electricity at agreed prices. So what? If I order a Rs. 300 pineapple pizza with watermelon toppings, do I have a moral right to ask Domino’s to send me a new one? You made a mistake and you suffer the consequences — even if it means having to eat those watermelon toppings.

We must ensure that we do not develop a society where incompetence is lauded while those with good judgement lose out. The solution already exists in our system. A company unable to pay its debts is wound up and assets are sold to a new buyer. Another corporation could have bought the power plants and run them at newly negotiated rates. People should face the consequences of their actions and decisions. Wouldn’t you say that this system is a fair one?

Featured image taken under CC license for reuse from Robert Edwards.

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