COVID-19 may power down the energy sector

By Abhishek Tripathi and Mani Gupta, Sarthak Advocates & Solicitors
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The power sector is not excepted from the impact of COVID-19. While power remains an essential supply, lockdowns mean shrinking demand. This will affect every link of the supply chain. Power generation companies may face curtailment, distribution companies (discoms) will lose revenue from premium commercial and industrial users, transmission utilities and the grid will face issues of grid stability. Lenders to the sector will face difficulties of debt recovery. With the lockdown likely to continue in some form for the foreseeable future, the sector has to brace for hard times.

Abhishek Tripathi
Managing Partner
Sarthak Advocates & Solicitors

Coal based generation, which is the foundation of power generation may not be immediately impacted. However, many coal fired power plants depend on Chinese equipment for maintenance. The disruption in the supply chain for maintenance and repair equipment may impact the output of the power plants. However, power purchase agreements invariably provide for minimum availability commitments on the part of the generator, the failure to achieve such commitments usually requiring the generator to pay liquidated damages. It will be interesting to see if the effect of COVID-19 on maintenance and repair is likely to be classed as a force majeure event.

Solar plants under construction face the twin effects of the falling rupee and the disruption of supply due to COVID-19. Such effects are exacerbated because of overwhelming dependence on Chinese equipment. With the government having declared supply chain disruption due to COVID-19 as force majeure, solar power project developers (SPD) that are yet to achieve commercial operation may expect relief in the form of extensions of commercial operation dates.

Mani Gupta
Senior Partner
Sarthak Advocates & Solicitors

However, unless the government intervenes, SPDs that have already started operation may lose the most. SPDs may be the first to receive requests from the discoms for reduced output. If discoms also use force majeure as a ground for reduced output, subject to the contractual terms the SPDs may have only insurance cover to fall back on to enable them to survive. While the scale of the reduction of output is yet to be assessed, discoms may seek relief under section 56 of the Indian Contract Act, 1872, and invoke the doctrine of frustration to declare the power purchase agreements (PPA), as void. The doctrine of frustration allows a contracting party to declare an agreement to be void if the performance of the contract becomes physically impossible. Commercial impossibility is also a ground for invoking the doctrine of frustration. In such a scenario, it will be interesting to see how courts set the boundaries of what constitute grounds for frustration. There may be issues of the constitutionality of such decisions, if they are applied selectively.

Discoms may face a shift in demand from commercial and industrial sectors to domestic consumers. The likely adverse effect of COVID-19 on industrial and commercial consumers will make it harder for discoms to recover debts from them, while also impacting their ability to cross-subsidize domestic consumption from the higher income from industrial and commercial consumers. There may be demands from businesses for longer repayment periods, which will lead to additional stress on the finances of discoms.

Transmission utilities will also face the effects of falling demand. Reduced supply and underutilization of the grid are clearly foreseeable for the immediate future. Defaults by open access customers, particularly under long term contracts, are likely to result in termination of bulk power transmissions contracts. Unless the government or electricity regulators step in, disputes are likely between customers and the transmission utilities on the liability of the customers to pay transmission charges for the outstanding periods of such contracts.

Lenders to the power sector have been struggling for some time to recover debts. While lending institutions have already faced many sectoral and regulatory disruptions, COVID-19 is likely to add another dimension. With the government likely to step in and disallow action under the Insolvency and Bankruptcy Code, 2016, against power developers, lending institutions may be left with little choice but to write off all or part of their exposure to the sector. In the short to medium term, this may have an adverse effect on lending to the sector as a whole, as well as increasing its cost of borrowing.

COVID-19 is a crisis of huge proportions, with little or no global parallel. The world has never been so economically connected as it is now and the adverse impact will be considerable. A coordinated approach by governments and their people will be required to rebuild what may be destroyed, and some sections of the economy may have to shoulder a greater burden than others.

Abhishek Tripathi is the managing partner and Mani Gupta is a senior partner at Sarthak Advocates & Solicitors.

PPA

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