Debate grows over new power tariffs
View(s):The debate on the latest round of power tariff increases due to be implemented after the Sinhala (Buddhist) and Tamil (Hindu) New Year, is growing.
Many consumers, activist groups and institutions are complaining about the proposed new rates.Both the Ceylon Electricity Board (CEB) and the Ceylon Petroleum Corporation(CPC) are in dire straits and ridden with debt.In the light of the current debate, the Business Times is publishing an interesting section in the Central Bank report of 2007 that raised issues on the agreements between the CEB and private power producers.
The CB report titled “Conflicts of Public-Private Partnerships in Power Generation” said:
The total electricity generation in Sri Lanka during 2007 amounted to 9,814 GWh, of which 3,873 GWh or approximately 40 per cent was generated by private sector power producers. The private sector power producers in Sri Lanka consist of Independent Power Producers (IPPs) and small-scale hydro power generating establishments. A major share of private sector electricity generation is from IPPs by way of thermal generation which amounts approximately to 90 per cent (3,528 GWh) of total private sector electricity generation. The IPPs in Sri Lanka were first introduced in December 1996 when there was a severe shortage of power as hydro power generation ability was limited due to a prolonged drought. At present, there are 10 IPPs in operation with a combined generation capacity of around 550 MW. They play a major role in the power sector by contributing about 1/3 of total electricity generation.
The most important step in any electricity utility restructuring, including the decision to obtain the service of IPPs, is to understand and articulate the goals of restructuring. Possible goals of introducing IPPs include .
-To attract outside capital to meet rapidly growing electricity needs without imposing large strains on public funds .
-To reduce electricity costs through competitive bidding process and more efficient operations; and .
-To share the risks and returns between the private sector and the public sector.
However, in reviewing the performance of IPPs in Sri Lanka, it is observed that most of the goals listed above have not been fulfilled. Based on the perceived goals of engaging IPPs in a country, the major categories of risks of any private sector participant (IPPs) include
-Currency risk- The risk that IPP operations or the value of investment will be affected by changes in the exchange rate. IPPs may attract foreign equity or borrow internationally for their investment. They may also have cost components in their operations like the maintenance of plant and machinery which are likely to vary with changes in the exchange rate. Hence, if their income is in domestic currency, they could be exposed to currency risks.
-Payment risk- Default by the purchaser of power, if the purchaser is to become financially weak.
-Political risk- The possibility that existing or future governments may change the rules of engagement.
-Management risk- IPPs may face an increased risk of losing their management oversight, if their participation were through minority equity ownership.
-Technology and Performance risk- The technology selected may not perform as originally expected.
The pricing formula based on which the purchase price of power is determined should reflect the extent of risk taken by IPPs and the purchaser, i.e., Ceylon Electricity Board (CEB). However, in Sri Lanka, IPPs’ pricing formula and terms and conditions in Power Purchase Agreements (PPAs) are not compatible with the extent to which IPPs carry aforesaid risks, as explained below.
-The IPPs in Sri Lanka are not exposed to the currency risk as some IPP cost components relating to payments in foreign exchange such as equipment and repair costs, and cost of foreign capital are denominated in foreign currency. In fact, under existing operational arrangements, CEB absorbs the currency risk involved.
-The non-payment for power purchases by the CEB is practically not possible under existing IPP operational arrangements and any delay in payment is penalized by a late payment charge. In addition, there is an implicit government guarantee as the CEB is a state owned enterprise. Moreover, the Treasury provides a guarantee for the repayment of loans raised by the IPPs and all loans including interest payment are included in the capacity charge which is paid by the CEB irrespective of whether CEB purchases power or not from the IPPs.
Any default/ breakdown that may arise from major forces of catastrophically high magnitude events such as natural disasters, civil commotions and riots, acts of terrorism are also covered by an insurance cover for which the premium is paid by the CEB. Therefore, there is no default risk faced by the IPPs.
-As a policy and redress available under the judicial system, any alteration of existing IPP agreements without the consent of all parties involved is impossible.
-The management control of the IPPs in Sri Lanka rests with IPPs either in full or in a majority stake. Therefore, there is no risk of IPPs losing their management oversight.
-The technology and performance risk fully rests with IPPs. This is because, IPPs have the unquestionable right to choose the type of technology and modus operandi in order to minimize the risk.
Therefore, the existing PPAs transfer all possible risks to the public sector, while IPPs enjoy a guaranteed profit plus healthy margins through overestimated cost components. There are several deficiencies in the existing PPAs which generate excessive profits over and above the guaranteed return to the IPPs at a cost to the general public.
Major deficiencies are summarised below.
-IPP operations in Sri Lanka are contracted to reflect the relationship between IPPs and CEB in the form of a producer-customer which is a wrong concept.
Preferably, the contracts should have been designed to reflect CEB’s role as a partner in the project. A major share of the project cost (70 per cent) is serviced by the CEB by way of guaranteed capacity charges backed by a government guarantee. Therefore, CEB should have retained the ownership equivalent to at least up to 70 per cent of the asset value. Accordingly, the maximum asset value to be owned by the IPPs should be limited to 30 per cent or to their equity contribution to the total commercial value of the asset. However, the existing PPAs give away 100 per cent ownership of the asset to the IPPs.
-The power plants could be constructed on the basis of “turn-key” projects, where the IPPs will receive the plants ready to operate, or on the basis of “greenfield” projects, where the construction work is undertaken by a third party with relevant expertise in power plant construction. However, in Sri Lanka, the civil construction work of the project is also undertaken by the IPPs without any competitive or tender based bidding process, resulting in a substantially overestimation of costs generating huge profits to IPPs even before the project commence commercial operations.
-All financing costs are paid by the CEB at rates which are well above the normal market rates. Interest payments have also been overestimated by adding SWAP margins on top of commercial interest rates.
-Insurance premiums are quoted through a noncompetitive basis at very much above the market rates. In an event of a claim, the benefit goes to IPPs whereas the premium is paid by the CEB.
-Working Capital mainly for buffer fuel, which is added to the initial project cost and recovered by the IPPs after the commencement of commercial operations, are never returned to the CEB.
-Fuel transport rates are well above the market rates. Sometimes they are three times the rate paid by the Ceylon Petroleum Corporation (CPC) to the private sector operators.
The IPPs enjoy above benefits despite their equity contribution being only 30 per cent of the capital cost, while the general public eventually pay for the losses incurred by the CEB due to deficiencies in PPAs. On a broader scale, if these overstated costs are reassessed at 2007 market prices for the total 550 MW thermal power plants operated by IPPs, a substantial amount could be saved in many different forms.
It has been estimated that the annual cost of the above unfavourable conditions would be around Rs. 3 billion.
In addition, by giving away the 70 per cent ownership of the asset value, CEB would not only lose its share of annual profits, but also the asset value at the end of the contract period. The loss of profit to the CEB for the total 550 MW thermal power plants operated by IPPs is estimated at approximately Rs. 3 billion per annum for 70 per cent of project cost serviced by the CEB. Therefore, if the unfavourable terms and conditions are addressed, CEB could save approximately Rs. 6 billion per annum.
Further, the loss of 70 per cent of asset value at the end of project life, at current market prices for a 100 MW thermal power plant operated by IPPs is estimated at Rs. 7 billion.
If the 70 per cent of asset value is adjusted for the total capacity of power plants operated by IPPs, the CEB could save a substantially high amount through retained assets at the end of project period.
These disadvantageous contracts and arrangements of IPPs reflect serious faults in existing PPAs which have significantly contributed to the losses of CEB and high electricity prices. Unless these deficiencies are rectified, the contracting of cheaper sources of energy, including coal power, may not bring about desired cost reductions in electricity generation in Sri Lanka.
Public -Private Partnerships in power generation can bring desirable benefits only if such partnerships are based on an open competitive bidding process based on PPAs with a proper risk/ return sharing basis. While the original contracts would have been entered into between the IPPs and CEB having taken into account the urgency of the specific situation in the country at that time, it is now necessary to re-visit the contracts and revise the conditions so as to provide equal benefits to both the supplier and the buyer.
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