Fuel Supply Agreement and Issues

7/30/2019 Fuel Supply Agreement and Issues

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Coal India’s fuel supply agreements - a solution to India’s power crisis?

Overview

India’s power sector has been witnessing challenges in recent times, with the

country’s power deficit at around 8.5 percent. The demand for electricity is

continuously growing, driven by high economic growth and increased rural

electrification; however, supply is unable to keep pace with demand primarily

due to a fuel shortage. Currently, more than 50 percent of India’s installed

generation capacity is coal-based. Over the last five years, the demand for coal

has been growing at an average rate of 8–9 percent annually as compared to a

5–6 percent increase in domestic production. This has widened the

demandsupply gap, leading to growing dependence on imported coal. In 2011–

12, the country imported around 100 million tons of coal (including thermal and

coking coal) .

The shortage of coal is not only affecting operational plants but is also raising

concerns around the viability the viability of future power projects. The lack of

coal linkages is making it incrementally difficult for power-generation companies

to raise capital for their proposed thermal plants. Further, as per recent reports,

the Government of India is likely to lower the country’s power capacity addition

target for the Twelfth Five Year Plan from 1,00,000 MW to 75,000 MW as a result

of fuel shortage.

Fuel supply agreement: key terms and challenges associated with

implementation

To ensure fuel security to coal-based power producers, the Indian Government

issued a presidential directive to CIL in April 2012, asking it to sign fuel supplyagreements (FSAs) with power companies. The following are the key

characteristics of FSAs, proposed by the CIL:

• Criteria: FSAs will be signed with power plants that have entered

longterm power purchase agreements (PPAs) with distribution companies,

commissioned between April 2009 and December 2011. In the next round,

CIL will sign FSAs with those plants scheduled to be commissioned by 31

March 2015.



• Duration: The FSAs will be signed for a period of 20 years and will be

reviewed after every five years.

• Commitment and penalties: The FSAs will be signed with 80 percent of

assured contracted quantity (ACQ) of the committed coal supply. In the

event of supply falling short of 80 percent, CIL has to pay a penalty at 0.01percent of the value of the shortfall quantity. Further, this penalty clause

is said to be applicable only after three years of signing the contract; this

means that for the first three years, CIL will not be obliged to supply the

contracted quantity.

• Coal imports: If CIL cannot meet demand through domestic supplies, it

can meet the shortfall through imported coal. If the buyer agrees to

accept the imported coal, CIL will import coal for power companies and

supply it at the unload port on a cost-plus basis, including service charges.

Thus, CIL would not be responsible for the transportation of imported coal

from the port to the project site. Additionally, if a customer does not

accept imported coal, CIL would not be liable to pay any penalties.

• Force majeure clause: The new FSAs - along with existing force majeure

events such as natural calamities, strikes and mine fires - includes

additional force majeure circumstances to cover the risks arising from

third parties. Additional conditions include the global shortage of imported

coal, lack of response to enquiries, the breakdown of equipment, delays by

contractors, power shortages, and obstruction in the transportation of

coal, from pithead to sidings, by agitations/mob-violence/riots.

Power plants covered under the new FSA are expected to be at a disadvantage

over plants that are supplied coal as per existing FSA. Many power-generation

companies have raised concerns over the terms of the new FSA and are not

willing to sign the contract with CIL. As on 18 June 2012, only 27 of all planned

48 thermal power units have entered the long-term fuel supply agreement.

Power producers are opposing the new FSA due to the following reasons:

• In the new FSA, the penalty rate is very low (0.01 percent as against 10–

40 percent in the existing FSA). Therefore, it may be possible that CIL,

instead of meeting demand requirements, prefers to pay penalty.

• In the case of partial supplies from CIL, power producers have to either

operate at a relatively low plant load factor (PLF) or use expensive

imported coal. At current international coal prices, the cost of power

generation from imported coal (assuming a 70:30 mix between domestic

and imported coal) is around 40 percent higher than a plant solely based

on domestic coal.



• The addition of new force majeure conditions would allow CIL easy exit

options from the agreement.

Government intervention to resolve the issue between CIL and power

companies

To strike a middle ground between CIL and power companies, the Prime Minister

Office (PMO) has intervened and suggested a revision to CIL’s new FSA to

address the concerns of all stakeholders.

• Commitments: The Government concurs with CIL’s demand and agrees

to lower fuel supply commitment of 65 percent for first three years asagainst 80 percent prescribed earlier. Further, in the fourth year, the

supply has to increase to 72 percent followed by 80 percent in the fifth

year of the agreements.

• Penalties: The Government also proposed an increase in penalty, from

0.01 percent to 20-40 percent, depending on the level of supply shortfall

below the level agreed upon (65 percent).

• Other clauses: The PMO has also asked CIL to remove the three-year

moratorium on penalty, review the force-majeure clauses, and modify

clause terms that allow CIL to review and amend delivery levels every five

years.

The proposed changes are acceptable to some power producers, and the NTPC

has agreed to sign FSA with the revised terms. However, the Ministry of Power is

not willing to accept the 65 percent commitment level and has said that banks

are not accepting the 65 percent trigger level as against the earlier directive of

80 percent supply assurance. The CIL board is yet to take a final decision on the

revised terms of the FSA.

Analysis

The presidential directive to CIL is a small step forward towards the resolution of

the country’s fuel problem. However, this step alone cannot plug the gaps, as

aggregate demand from all proposed FSAs and letter of assurance (LoAs) is likelyto exceed the CIL’s current and near-future coal production. By 2015, CIL is



expected to see a shortfall of around 80 million tonnes, thus limiting CIL’s ability

to meet growing demand. Further, to bridge this gap, the PMO has suggested

that CIL reduces its e-auction quantity and divert e-auction coal to the power

sector. While this measure will likely help increase coal supply to the power

sector, it may be regressive step as it will adversely affect small coal consumers

and CIL’s profitability.

The following measures could help resolve India’s coal shortage:

• Build CIL’s coal import capability: CIL is primarily a producer and has

little experience in importing large quantities of coal. Yet, given the

growing dependence on imported coal, CIL need to build its import

capabilities. Initially, CIL could import coal with the help of the MMTC andSTC and gradually develop the capability and infrastructure (logistics) to

import large volumes of coal.

To increase imported coal acceptability, CIL could consider the price-

pooling of imported coal with domestic coal and supply coal to power

companies at an average price. This could help lower the cost disparity

among power producers. However, for this mechanism to be efficient, the

pooled price should be available to only those power plants that have coal

linkages with CIL and are not based on imported coal.

• Increase power tariffs to make imported coal affordable: There is a

need to increase power tariffs for the end consumer to make imported

coal-based power plants economically viable. Further, the government

should address the issues of power plants that are stuck with low price

PPAs and their fuel cost has increased considerably due to regulatory

changes in coal exporting countries such as Indonesia and Australia. To

protect these developers, the government could allow at least a partial

‘pass-through' of fuel costs for projects awarded under tariff-based

competitive bidding. This would increase end-consumer prices but help in

avoiding stranded capacities and is necessary to retain private players’

interest in the power sector.

• Enhance domestic coal production: To increase productivity from

existing fields, it is important to deploy the latest technology and

professional assistance. Further, there is need to accelerate the process of

land acquisition and environmental clearances, to increase the total area

under exploration. Further, the government could adapt the NELP model

(used for oil and gas blocks bidding) and allow global mining majors to

participate instead of limiting the bidding to only end users (such as steel,

cement and power plants).This route, along with much needed

investment, can be expected to bring global technology and capabilities tothe Indian mining sector.



Thus, to resolve the power crisis, the government should take a holistic approach

- considering the interest of various stakeholders, eliminating roadblocks to

increased domestic coal production and allowing generation companies to pass

high-fuel costs on to end consumers.

Source: www.kpmg.com

http://www.kpmg.com/

http://www.kpmg.com/

Fuel Supply Agreement and Issues

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