WAPDA-NWFP dispute: award of the Arbitral Tribunal: decision of Javid Akhtar-II

In terms of the President's Order No 3 of 1991 it was decided that WAPDA should pay this amount (albeit payment would be guaranteed by the Federal Government). As we have seen above the Kazi Committee formula artificially created a Net Hydel Profit by transferring a portion of the costs on the thermal side to the hydel side and declaring it to be a profit.
Since this profit did not exist in reality and was far greater than WAPDA's actual profits, therefore the only way in which WAPDA could pay for it was by raising its existing tariff. However as soon as the tariff was raised, the Kazi Committee formula would automatically result in an immediate increase in the Net Hydel Profit. In order to pay for this additional increase, the tariff would have to be raised once again.
Since this would result in yet another increase in the Net Hydel Profit, this cycle would have to be repeated again and again. Needless to say such a process cannot be sustained in even the short run let alone the long run. Thus the original problem (ie the flawed methodology of the Kazi Committee) got worsened because the Federal Government decided that the Net Hydel Profit would be paid by WAPDA. This problem would obviously not have arisen if the Federal Government had paid the Net Hydel Profit out of its own resources.
28. Once WAPDA was informed that it would have to pay the Net Hydel Profit, the Chairman WAPDA in his letter dated 22.4.1991 estimated that the tariff would have to double within three years simply to pay for the Net Hydel Profit.
This placed the Federal Government in a dilemma in that on the one hand they had to implement the decision of the CCI, on the other hand it was not feasible to raise the tariff to such an extent.
29. As noted above WAPDA has never had the authority to determine and set the customer tariff. Until 1996-97, any proposed increase in tariff had to be approved by the Federal Government, and thereafter by NEPRA. Numerous documents have been placed on record which illustrate this process. Thus any tariff increase was the joint result of a WAPDA proposal (often containing a number of alternatives) and the Federal Government's approval.
30. The immediate consequence should have been that the Federal Government should have reviewed its earlier decisions and taken over liability instead. This was not done, and instead WAPDA was authorised in 1991 to levy a surcharge to collect the hydel profit which was gradually increased upto Rs 6 billion and the matter was left at that and has yet to be resolved.
WAPDA has consistently argued that since the proceeds of the surcharge are meant to raise money to pay the provinces (primarily NWFP) therefore this should not be included while determining the revenue per unit generated. As explained below this contention has been accepted by the Supreme Court in the Gadoon Textile case (at para 41). This has, nonetheless, unfortunately resulted in creating a suspicion in the NWFP that it was deliberately being cheated of its due profits by accounting tricks.
31. The next ingredient in the present problem was created by the imposition of the Additional Surcharge in 1993. This was imposed to cover two specific items. The first arose due to the fact that at the time WAPDA had a very large development programme to cover the ever increasing demand for power. Due to budgetary constraints, it was largely financed by the World Bank and the Asian Development Bank.
Both lenders imposed a condition that WAPDA had to enhance its revenue so as to cover at least 40% of its annual investment programme. This would have the effect of increasing the NHP very considerably but matters were kept pending and the hydel surcharge continued to be paid at Rs 6 billion.
32. The second component of the Additional Surcharge was caused by the fact that there was a huge increase in the thermal power, due to both an increase in the prices of gas and oil as well as the introduction of exceedingly expensive private thermal power in the shape of the Hubco Power Co and the IPPs.
The expansion in thermal production meant that the power generated from hydel stations dropped from being 66% of total power generated in 1986 to 30% by the year 2000 (although it subsequently increased to 35% in 2005 after the induction of Ghazi Barotha).
Thus cheap hydel power was reduced to half its earlier proportion. The gap was made up the IPPs and this resulted in an enormous increase in the average cost. It was proposed that this additional cost should be paid for by the levy of the Additional Surcharge.
If the Additional Surcharge was treated as part of the tariff, then in accordance with the Kazi Committee formula there would be a corresponding increase in the NHP with the additional twist that the NHP now also included a proportion of the costs of private power, including a portion of their profits. These results are surely not justifiable nor constitutional nor reasonable. This situation has continued until now.
33. The final factor contributing to the present problem, arose from the fact that the Federal Government decided to restructure and privatise most of WAPDA. As the computation of the NHP depended on WAPDA being treated as a simple entity, the restructuring of WAPDA would invalidate the Kazi Committee formula and the NWFP feared that the NHP would be seriously reduced.
The situation now was that there were 14 separate companies each with their own accounts, many of which were expected to be privatised. A single set of accounts could no longer be prepared but since the actual calculations were not being done this was not noticed.
Here another opportunity was lost to reconsider the matter and evolve a method of calculating the NHP under the new conditions, as under the Constitution the provinces are always entitled to the hydel profits. Instead the CCI in its decision of 1993, gave a categorical assurance that "the hydel profits payable to them under the constitution would not fall below the level which these would have obtained had there been no privatisation."
The CCI decision of 1997 reiterated this assurance and the decision of 1998 extended this assurance to the effects of unbundling and restructuring of WAPDA. This was the easy path for Federal Government to take as it did not involve any reconsideration of the profit calculations.
The experience of this Tribunal has shown that the calculation of NHP under the new situation is an impossible task. However this was not realised by the NWFP at the time and it accepted the new assurances.
34. What was the meaning of the new decisions? Did it mean that all expenses incurred and revenues received by the new set of entities were to be reviewed and consolidated on the assumption that restructuring had not taken place? Such an exercise would require a total recasting of the accounts.
For revenues it would mean an assessment of what the revenue would have been instead of what it actually was. For expenses it would mean looking at each and every single expense and deciding whether it would have been incurred had there been no privatisation and what the level would have been.
A plain reading of the CCI decisions leads to such a view and the NWFP has more or less adopted this attitude. WAPDA on the other hand has taken the view that the assurances were restricted to meaning that the NHP would not be reduced below the Rs 6 Billion already being paid. Many of the controversies between WAPDA and the NWFP in the hearings, and which we have found impracticable to resolve, are on this account.
35. Mr Justice Ajmal Mian has discussed these matters at great length in his Award. He has referred to the wide and unbridgeable differences between the parties on practically every major item in the accounts as well as variances in the interpretation of the same set of accounts, ie the books of WAPDA. He has come to the conclusion that the Tribunal would have to post-mortem the very extensive (and already audited) accounts of WAPDA to reach a decision and such a course of action would be neither practicable nor desirable. The best that could be done was to rule on whether some particular items could be included in calculating the NHP according to the Kazi Committee formula.
36. The amounts to be used for the calculation can be divided into two parts. First those relating to revenues and which items are to be included in the calculation. The second group are the items of costs and expenditure and whether they are to be deducted from the revenue to arrive at the profit.
37. The principal items on the revenue side relate to the treatment of the surcharge and the additional surcharge and these have the largest effect on the calculated amount of the NHP. WAPDA has excluded the surcharge and the additional surcharge from its calculations primarily on the grounds that these are passthrough items.
It has argued that these items were not levied when the Kazi Committee wrote its report and hence the only items to be included are the SOP and FAC mentioned in para 6 of the Kazi Report. NWFP has contended that these items are part of revenue as this is what the consumer pays and this is the principle stated in the Kazi Committee. I respectfully disagree with the majority view of the Tribunal that the NWFP's view should be accepted.
38. First of all on the plane of principle it may be reiterated that the CCI (and hence the Kazi Committee) could simply determine the selling rate. The Kazi Committee calculated it on the basis of the SOP and the FAC. In my opinion, it is not correct to speculate that if the surcharge and the additional surcharge had been in existence at the time of the Kazi Committee Report, then they would have been included.
It should be noted that the only thing adopted by the CCI was the Kazi Committee Report as it stood. Therefore without the matter being reconsidered by the CCI again, no one else has the authority to say that because it is possible that the Kazi Committee might have included the surcharge and the additional surcharge in the selling price, these two items should be so included.
The Constitution states that the selling rate shall be fixed by CCI and CCI has declared the selling rate to be that given in the Kazi Committee Report, which in turn has calculated it on the basis of the SOP and the FAC.
39. Turning to the specifics of the two surcharges, in regard to the surcharge it is in reality a hydel surcharge specifically designed to collect amounts for the payment of the NHP. It would clearly be double counting to include it again in the revenue for calculating NHP.
This is an example of the so-called snowballing effect inherent in the Kazi Committee formula which would lead to large increases in tariff merely because of the technical features of the methodology and which therefore would actually prevent a true calculation of the NHP.
Any revenue increasing measures designed to enable WAPDA to pay the NHP (through collections from the consumers) must be excluded from the calculation of the NHP because this is the only way the NHP could be paid while allowing WAPDA to remain solvent.
Surely a methodology which kills the goose that lays the golden eggs must be avoided. In my view, therefore, the surcharge must not be induced in the calculations if the NHP is to be paid by WAPDA. What the rate and amount of the surcharge should be is a different question.
Ideally it should be sufficient to pay the NHP but what the NHP should be is a question so wrought with difficulties, under the present set of decisions, that it has been impossible to arrive at a satisfactory calculation and the Tribunal has had to rely on proxies and approximations.
40. As for the additional surcharge, its purposes are different and these are firstly to fulfil the World Bank conditionality to raise 40% of WAPDA's investment program directly from its revenues. Secondly, it is to provide for the additional costs arising from the increasing costs of gas and furnace oil used as the principal fuels for thermal power stations and thirdly to pay for the then upcoming (and now operational) private power producers, the IPPs.
41. There are two main reasons why the amounts for the conditionalities should be excluded from the calculations. First the amounts are reserved for a specific purpose and can be used only for such purpose. This is a legally recognised principle and to divert them to any other uses is impermissible. Secondly, the payment for capital investments by a utility cannot normally be included in the tariff.
There are well recognised principles which are used world-wide for the determination of consumer tariffs. These are clearly stated in the WAPDA Act in Section 25(2) and in more detail in the NEPRA Act. Principally the items included in a tariff are to "provide for meeting the operating costs, interest charges and depreciation of assets, the redemption at due times of loans other than those covered by depreciation, the payment of any taxes and a reasonable return on investment."
Indeed the Kazi Committee used a version of these principles in its calculations. Where it caused problems for the future was by including thermal generation costs in the NHP calculations. This will be discussed below. So normally capital costs are not part of a tariff and are not what a consumer should pay.
They have been included in the tariff under force of circumstances, on the requirement of the World Bank and to pay for the loans so badly needed for the development of the Power System. Including them in the calculations for NHP would be placing another burden on the consumers and is not warranted. The entire record and history of tariff making is to the contrary.
Furthermore it would not solve the problem because they would have to be enhanced again and again to pay for the additional NHP generated by each increase in the surcharge.
42. As stated earlier the Kazi Committee included the thermal costs in the NHP calculations by taking the average overall generation cost (including hydel & thermal) per unit as the hydel cost. This was done to provide some additional hydel profit over and above the normally used commercial criteria of determining a sale price based on operating costs, the amortisation of transfer capital costs and a reasonable return on equity.
There was a cost for this in that it made it impossible for WAPDA to pay the profits from its normal operations (or else it would be bankrupted) but then since the NHP was thought at the time to be part of the grants by the Federal Government to the Provinces through the NFC awards it was natural to assume that Federal Government would pay for it.
It bears repeating that had this been done the problems we face today would be much less. In 1986 it may have been not unreasonable to average the generation costs because at that time hydel generation was predominant and two thirds of the electricity generated was hydel and the costs of oil and gas were low.
However, by 1995 the situation had radically changed. Thermal became the dominant mode of generation, now being two thirds of the total. The cost of fuel rapidly increased and the average cost largely reflected thermal costs. The induction of IPPs aggravated the situation to disaster levels.
To still use the Kazi Committee formula could only result in absurdities. By the year 2000 the situation was that if calculation of NHP were made as desired by NWFP and the NHP were included as a part of the cost of hydel generation the hydel cost would exceed the thermal cost of generation! On this more later.
43. The additional surcharge was meant to cover the costs incurred by WAPDA in buying electricity from the IPPs. Since the pricing mechanism guaranteed the IPPs a minimum return on their investment, therefore the additional surcharge covered the IPPs' costs as well as their profits. If the additional surcharge is included in the tariff, then for reasons explained earlier, in effect, the IPPs' costs and profits would be included in the NHP.
Can it be seriously argued that the Provinces are entitled to enhance their Net Hydel Profits by the amount of the IPPs' costs and profits? The absurdity of such a procedure would be self-evident. If the NHP were taken as a first charge on WAPDA's revenue, we would actually be paying out private costs and profits as NHP.
Can this be supported under the Constitution or any law? On this account alone the Kazi Committee formula can no longer be considered a valid method for calculating hydel profits. The only rational conclusion is that those portions of the additional surcharge which relate to provisions for capital investments by WAPDA and those portions of this surcharge which provide for the payment of privately produced power must be excluded from the calculations.
44. It is important to note that the Supreme Court has reached the same conclusion in the Gadoon Textile case (at para 41) wherein it was held that:
"It may be mentioned that the surcharge was kept in a separate account as the intention was to generate Rupees Two Billion out of the liability of Rupees 6.1 Billion towards the payment of net profits under clause (2) of Article 161 of the Constitution to NWFP as per the aforesaid P.O. No 3 of 1991 on account of hydro-electric stations situated in the said Province.
The above item of net profits is admittedly part of operation expenses and, therefore, could have been part of tariff. Whereas the additional surcharge was kept in a separate account as it was intended to be used for discharging certain liabilities of WAPDA and also facilitating the fulfilment of covenant 4.02 of the project agreement dated February 1990, with the World Bank, namely, to generate not less than 40% of the annual average of WAPDA's capital expenditure (at page 115 of the WAPDA's documents file marked part-I filed in Civil Appeals Nos. 72 to 80 of 1996).
The above item could also be included as a part of admissible expenses for determining tariff provided the same did not go beyond the figure of reasonable return on the investment as a whole. It may be pointed out that keeping surcharge or additional surcharge in a separate account for a specific purpose is not a foreign element.
It is not uncommon to have separate accounts for surcharge and additional surcharge for specific purpose as pointed out in the case of C.I.T. v. Ernakulam (ibid)." [Emphasis added]
Therefore it can be seen that even the Supreme Court has held that the surcharge and the additional surcharge were part of operating expenses. From this the logical conclusion is that all amounts raised by the two surcharges had to be either excluded or alternatively they could be deducted from revenues while calculating Net Profits.