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Apr 13, 2013, 04.03 PM IST | Source: CNBC-TV18

Unravelling truth behind renegotiation of contracts

In a recent time, there has been many examples of private companies in infrastructure sector wanting to renegotiate their contracts with public bodies on the ground that projects are becoming unviable due to unforeseen developments.

In a recent time, there has been many examples of private companies in infrastructure sector wanting to renegotiate their contracts with public bodies on the ground that projects are becoming unviable due to unforeseen developments.

However, it remains to be seen whether such demand for renegotiations of contracts arise from genuine unanticipated developments or because the bidder bids predatory prices to edge out competition.

This phenomenon was seen in two recent cases.

Adani Power agreed to supply power to the Gujarat electricity company Gujarat Urja Vikas Nigam Limited (GUVNL) for 25 years at a levelised tariff of Rs 2.34 per kilowatt-hour (kWh) and to Haryana electricity companies at Rs 2.94 per kWh. The company did not opt for any escalability clause while bidding.

Three years after winning the contract the company entered into long-term coal purchase agreements in Indonesia with its own group company at USD 36 per tonne, much lower than prevailing prices. However, Indonesia changed rules last year asking companies to change long-term contracts to prevailing market prices. This resulted in coal prices doubling for Adani.

The company has therefore asked the electricity regulator to allow a price escalation.  The Central Electricity Regulatory Commission (CERC) in its recent order asked the two electricity companies and Adani to arrive at a way to compensate the company for a limited period till the higher prices last.

In another instance, GMR Infrastructure walked away from a road widening project awarded by the National Highways Authority of India (NHAI) on grounds of delayed clearances by various government bodies. The NHAI has now asked GMR to return to the project by offering some sweeteners. It has allowed GMR to backload the payments it has to make to NHAI to a date after the toll collections start. In exchange the company will be charged 10 percent cost of capital. So GMR instead of paying Rs 320 billion to NHAI will pay Rs 590 billion. In the meanwhile NHAI will provide a guarantee to lenders upto 90 percent of the project cost in case GMR defaults. The restructured contract is yet to get cabinet approval.

Such demand for renegotiations of contracts raises some fundamental questions

1. Bidders who are edged out could take the government bodies to court saying the incentives were not extended to them and they were unfairly edged out.
2. The sanctity of the contract is violated and many more project developers can demand similar renegotiations.
3. There is a moral hazard in that private bidders know their losses will be wiped out by subsequent government larges while their profits don't have to be shared.
4. How does one distinguish between projects that are unviable because of a genuine unforeseen development and projects that are unviable because the bidders bid at predatory prices merely to edge out competition.

CNBC-TV18 spoke with three eminent personalities who have in-depth knowledge of such contracts namely Amit Kapur, Senior Advocate Jyoti Sagar Associates, SL Rao India’s first CERC Chairman and KK Mohanty, CEO, Gammon Infra.

Below is the verbatim transcript of the discussion.

Q: What is the more common problem, projects becoming unviable because prices have gone out of whack suddenly, or because companies purposely quote lower, confident that having won, they can either suck out their equity or just walk away.

Rao: It's a mix of all this. Let’s start at the beginning. In any kind of infrastructure contract, particularly in the case of power, you are trying for what is called a levelised tariff, you're trying to get a single tariff over a period of 30 years. Now within that you are allowing certain kinds of escalations on account of foreign exchange evaluations or whatever else. However, we have to remember that 30 years is a very long period in a complex world and in that complex world in those 30 years so many things can change particularly when you are talking about a Rs 20,000 crore rupee project, building 4000 megawatts of a power plant or building 100 kilometers of road going to all kinds of forest lands and so on.

I am not going onto all the other issues- land clearance being delayed, environment clearance being delayed all the other things that are causing big delays in infrastructure but I am talking about your requirement of a single tariff. Now within that you make assumptions and those assumptions are extremely difficult. Even the best economist in the world will not be able to tell you what things are going to be like in the next 30 years particularly in specific items like this. So, I think that is where it starts. Second, you also have as you said quite rightly very aggressive bidding. We have seen this particularly in the case of road projects, power projects also particularly in some Ultra Mega Power Projects (UMPP) projects.

Thirdly, whoever is looking at the bids has no concept of a floor price, saying below that price the project is unviable. The best example of this is the Secunderabad Metro where Maytas had quoted a price where they did not want viability gap funding. They  in fact willing to pay, but what happened at the end? The project just collapsed. Now Larsen and toubro (L&T) are doing it and they are also having problems because of forecasts. These are the 3 things that I wanted to point out.

Q: You have looked at the entire variety. Just at the outset, is it always possible to distinguish against wilful default or wilful predatory pricing and cases where things have been in a sense genuinely miscalculated?

Kapur: I would concur with Rao for the reason that the most predictable reality of infrastructure projects is that in a 30 year cycle, unpredictable happen.

So unless your contract structure provide to deal with handling unpredictable situations which are not controllable, for which no one can be blamed; you have already started with an incomplete contract. Now that's where the problem begins. Second aspect just to add to what he said was also the structure of the concessions. Largely when the government started with the idea of getting investments post 91, they were very risk averse. And the approach was to try and pass on as much as away from the government.

So from a public-private partnership (PPP), which was a concept, the idea was that the public will be the good, but private will be the person who takes the entire risk of the operations, so that was one problem. So we have contracts and concession arrangements and legal frameworks that do not address the uncertain realities which are not blameworthy on any party, that's one issue.

Second issue is that people were excited with the prospects of bidding and they made assumption which were not actually robust and that happens all the time, you look at the national telecom policy 94, in 99 the telecom policy was rewritten from highest royalty you went to revenue share. But what was the outcome? The outcome was that teledensity went up tremendously from Rs 32 a minute, you came down few paisa.

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