Letters of credit (L/Cs) are to remain the main security for power purchasers in India if the recommendations of a taskforce on power sector reforms are taken on board.

The NK Singh taskforce has made several recommendations for the sector, but its critics suggest that a cost-plus-margin charging mechanism backed by L/C-based securitisation is a retrograde step away from the free market system they would like to see.

Free market

Over the past few years India has enacted a new electricity bill and some states have begun to open up their power sectors by allowing larger power customers to choose their own suppliers.

The power regulator in Kerala for example told a large company in January that it could bypass the state electricity board (SEB) and buy power from anyone it wished.

Dabhol lessons

Such open competition seems a long way from the cost-plus-margin pricing and guaranteed offtake backed by L/C model that continues to cause trouble for the ill-fated Dabhol Power Company (DPC), its customers and its financiers (DC World News, 28 January 2004).

They have been arguing for years about whether payments are due on L/Cs used to secure payments for offtake from DPC under its power purchasing agreement (PPA) with the Maharashtra State Electicity Board (MSEB).

Pricing formulas

The report nevertheless suggests that several cost-plus-margin formulas are adopted and says that in these, the L/C will be the fundamental level of payment security for all power purchases through long-term PPAs.

The taskforce goes on to say that L/Cs need not be the only level of security. Presumably this leaves the option for the type of state or federal guarantees that were in place in the DPC financial model but which, so the power producers argue, failed to make sure that L/C obligations were met.

The views in this article are those of the author and not necessarily those of ICC or the other partners in DC-PRO.