Introductory Energy Regulatory Training course for PUCSL

Session 15: Design and implementation of concessions and other licensing instruments

Partha Mukhopadhayay

(Mis?)Allocation• Power

– Tariff Bidding, with optionsfor indexation

• Neglecting renegotiation scenarios

• Over-reliance on market wisdom

• Pipeline and Electricity Transmission Networks– Bid on tariffs

• Oil and Gas– Non-linear revenue shares

• Telecom– Spectrum defined over

large Licensed Service Area (LSA)

• Neglecting character of spectrum

• Avoiding trading• Ports and Airports

– Bidding on highest revenue share

• Neglecting competition• Ignoring renegotiation• Overcharging users

• Highways– BOT (Capital Grant)

Concessions • Neglecting renegotiation

scenarios• Neglecting foregone

revenues

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Electricity

Neglecting renegotiation scenariosOver-reliance on market wisdom

Bidding Mechanism – Case I and Case II

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Bidding Mechanisms

Case I Case II

• Location/technology/fuel – not specified

• Bidder responsible for clearances/ approvals

• Relevant for States with limited fuel source

• Higher risk for developer• Lower risk for state

• Land/ Fuel provided by Procurer

• Procurer obtains clearances/approvals

• Relevant for States with fuel source or having coastal areas

• Higher risk for State• Lower risk for developer

Competitive Bidding Guidelines specifies parameters of bid submission, tariff structure, bid evaluation, payment mechanism and security structure◦ Multi-part tariff structure with separate capacity and energy components of tariff

form the basis of bidding◦ For medium-term procurement of power, a single part tariff or a firm price for each year

along with availability is to be used.

Source: Association of Power Producers, presentation to FOIR June 2011

Market ‘wisdom’ for Case I bids

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Domestic Fuel Based

Imported Fuel Based

Source: Gayatri Gadag, Ashwini Chitnis, Shantanu Dixit Transition from MoU to Competitive Bidding :Prayas Pune March 2011

Consequence and Lessons• Projects are now stalled

since the increase in fuel prices and depreciation of the rupee have made them unviable at the bid tariffs– Recent CERC order

• But…“According to power companies…severe fuel shortages, high coal prices and delay in green clearances are hurting the sector.”

• If market wisdom is to be relied on then it is necessary to ensure that private sector bears consequences of its folly– Looks increasingly unlikely

• If not, minimum/ common mandatory escalation in tariff bids may be needed even at some possible cost of efficiency– Counterbalanced by

reduction in the costs of renegotiation

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Network Infrastructure

Tariff Bids vs. Revenue Bids

Bidding for Transmission

Tariff Bids• Linking revenue to usage

may not be a good idea– Network usage insensitive

to tariffs on sections– Usage inherently difficult to

forecast• Private sector may at best

bring in some forecast efficiency

– Little benefit, but a significant addition to both financing and institutional costs

Revenue Bids• Availability Payments on the

revenue– Only based on capacity, not

on usage– Risk: Regulator determines

capacity, not market• Alternative is LPVR bid

structures• Controllable and

Uncontrollable Risk– Only those risks should be

transferred to the private sector that it is better able to manage

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What is LPVR (Least Present Value of Revenue)?

• The Bid is a discounted PV of gross revenue– The discount rate is specified upfront– Concession ends when discounted revenue

collections equal bid by concessionaire• Revenue monitoring is the key issue

– Makes any required renegotiation transparent – Can be used for both shadow and actual tolls

Key Benefit: Uncertainty in traffic is transformed into uncertainty about duration of the concession– This type of risk (similar to an asset-liability

mismatch) can be handled more easily by lenders

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BOT (LPVR) - Low Costs

• Transaction Costs – Lower than Bill of Materials / EPC and BOT (Capital

Grant) but higher than BOT (Performance Based Payments)

– Low probability of renegotiation• Well-structured mechanism for renegotiation requests

• Low Agency Costs• Low Monitoring costs

– Construction monitoring lower than BoQ/EPC since inputs do not have to be monitored

– Performance Monitoring costs similar to others since payments are conditional on performance

• No foregone options– Well-structured mechanism for competing facilities

Oil and Gas Exploration

Skewed IncentivesNeglecting renegotiation scenarios

Production Sharing Contracts

Pre-tax investment margin (PTIM) is related to cumulative investment by operator relative to net profitIf PTIM is less than 2.5, operator gets 72%, if it is greater than 2.5, operator gets 15%What is the incentive for the operator?Since then, Indian bid structures have been modified to make the relationship more linear

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10%16%

28%

85% 85% 85%90%

84%

72%

15% 15% 15%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Less than 1.5

1.5 - 2.0 2.0 -2.5 2.5 -3.0 3.0- 3.5 More than 3.5

PTIM

Government Share Contractor Share

Port and Airports

Neglecting competitionIgnoring renegotiationOvercharging users

Key Features of Port Bidding• Terminal bids

– Gross Revenue share is the bid parameter

– Tariffs are determined by a regulatory body restricted to major ports, Tariff Authority for Major Ports

• Major ports are those under federal control

• Share of non-major ports rising

• Without a (50%) revenue share, user charges could be cut (in half) and port would still generate enough revenue to operate efficiently– In 2011, actual bid by PSA

International and ABG Ports for JNPT'S 4th terminal was 51% 47

‘Major’ Ports of India

Source: Tariff Authority for Major Ports

Private Presence in Major PortsPort Private Terminal Operators Public

Haldia Tata L&T KPT

Paradip PPT

Vishakhapatnam JM Baxi DP World Gammon VPT

Chennai DP World PSA Sical CPT

Tuticorin PSA Sical TPT

Kochi DP World KPT

New Mangalore NMPT

Mormugao JSW Steel ABG MoPT

Mumbai Gammon MPT

JNPT DP World APM Terminals PSA ABG JNPT

Kandla Adani ABG KPTMundra DP World

Karachi DP World

Colombo DP World (pre 2007) APM (post 2007)

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Port Policy• Intra Port competition

– Multiple firms in a port• Inter-port competition

– Road and rail connectivity– Coastal monopoly

• Competition oversight– Diversion?

http://www.dnaindia.com/money/report_mundra-port-gains-thanks-to-jnpt-pipavav-and-kandla_1699560

• TAMP does not oversee competition– Only a tariff fixing body– Tariff orders ignored

• http://www.livemint.com/2012/06/07222923/Port-tariff-regulation-faces-t.html

• Are port auctions about allocating scarcity or creating capacity?– Short-term – Medium-term

• Is Tariff bidding a solution?– Proposal to bid out port

terminals after specifying a tariff path

– Does not treat ports as a possibly competitive sector

• Move away from revenue share to concession fee– Invest in connectivity to

spur inter-port competition

– Free tariffs and improve oversight of intra port competition

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Airports: same structure - renegotiated

• January 2006: GMR consortium sole technically qualified bidder as per Sreedharan Committee

– Matches Reliance bid of 45.99% (Original bid of 43.63%)

• February 2009: The Central Government grants approval for levy of Development Fee (DF) @ Rs. 200/- per departing domestic and @ Rs. 1300/- per departing international passenger under section 22 A of the Airports Authority of India Act, 1994, purely on an ad hoc basis, for a period of 36 months w.e.f. 01.03.2009.

– About 5 million international and 10 million domestic passengers embarking at Delhi

• An annual cash flow of over USD 170 million a year over and above the agreement

• April 2011: The Hon'ble Supreme Court in its judgement dated 26.04.2011 held the letter dated 09.02.2009 of the Central Government (vide which the approval of the Government was conveyed for levy of DF by DIAL), as ultra vires the AAI Act, 1994

• November 2011: AERA approves the continuance of the levy as a gap filling revenue source

– “[AERA noted that] neither the OMDA nor the SSA have any provisions pertaining to the levy of DF”

– But …“DIAL have stepped into the shoes of AAI for the purposes of clause (a) of Section 22A. Therefore, the levy and collection of DF is a power statutorily conferred upon DIAL. “

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Implementation Issues in Public Private Partnerships

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Public Capacity• Before venturing into PPP, it is desirable that the

government agency understand – the rationale for PPP projects and the applicability of

different types of PPP models in specific situations– have ability to use risk assessment models to appraise risks

associated with water and sanitation projects– understand options for appropriate risk sharing between

public and private sector parties– be able to use tools to ensure that value for money is

obtained from private parties– determine the necessity and appropriateness of various

mechanisms to enhance viability– understand the structure of concession agreements and how

it can be used to regulate the private party to ensure its performance

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Implementation

• Foundation– Legal Structure– Regulatory arrangements – Policy requirements and sector strategy

• Execution– When in doubt, disclose– Stakeholder Consultation– Selecting a partner– Managing the PPP arrangement

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When in doubt, DISCLOSE

• Legitimacy is likely to be enhanced by consulting customers and other stakeholders during the process of design, and making the objectives of the intervention clear

• If people feel their views have been heard and understood, they are more likely to accept the results, even if they disagree with specific outcomes.

• It is difficult to justify commercial secrecy, unless there is a significant design innovation– The private sector often resists the publication of the draft.

The benefits of publishing contract documents and the final concession agreement often exceed any perceived costs

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Consultations and Policy

• Before beginning consultation, it is useful to consider how perspectives of different stakeholders may differ– Need to elicit and understand the views of groups

that are not often consulted • Policy requirements and sector strategy

– Determining the governance and market structure– Deciding on service standards, tariffs, and the

nature of financial support from the public authority

– Analyzing and allocating risk.

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Selecting a partner: Bid Parameters

• Low probability of renegotiation– Lowest payments from

government • (e.g., a fixed

performance based fee) – Lowest present value of

financial support• discounting

– Lowest present value of gross revenue

• High probability of renegotiation– Highest present value of

future payments to govt.• e.g., a concession fee

– Shortest concession period – Highest revenue share and – Lowest user fee

• Difficult to compare multi-parameter bids

• Single parameter financial bid offers the greatest transparency– Forces the agency to think

through various parameters like performance standards, coverage expansion requirements, etc.

Managing the PPP arrangement

• It is always useful to keep in mind that the private sector’s primary motive is to maximize profit.

• The role of the public sector in a PPP is to harness this motive and structure the relationship, as embodied in the concession agreement in a manner that the private sector is able to maximize profit only when it acts in a manner that meets the public agency’s goals.

• Openness and transparency of a regulatory process is a natural medium for continuing stakeholder consultation and thereby adds to the sustainability of the concession

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Sections of a Concession Agreement

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Concession Agreement

• Definitions • Concession Structure• Disclosure• Scope of Project• Project Site/ Assets• Payment • Concessioning

Authority’s Obligations• Concessionaire’s

Obligations

• Change of Scope • Capacity Augmentation• Force Majeure• Events of Default and

Termination• Substitution Agreement• Hand back of Project

Facilities• Dispute Resolution

Thank You

pmukhopadhyay@gmail.com