Indian Power Sector: Searching For Light

The power sector, which lights up the country, is itself facing a fuel crisis. The sector has seen some sparks on the policy front this year. Shrikant Akolkar tells you about the outlook of the power sector in the wake of these developments.

There was a time when investors saw a huge wealth creation opportunity in the power sector. A number of companies tapped money from the primary markets over this newly discovered optimism on the power sector. While private sector companies like Reliance Power, Adani Power, JSW Energy, GVK Power, etc. were leading this pack, government PSUs were not far behind, as Power Grid Corporation, NHPC and SJVN also came out with their IPOs. However, the sector dropped out of investors' fancy as it failed to generate any returns on the bourses.

The recent reforms undertaken by the government have raised a buzz around the sector. Has this changed the outlook in any way, or will the power sector continue being plagued by these and other such chronic issues?

The last one year has seen many developments in the sector. Earlier this year, the heads of leading private sector power companies met the Prime Minister and voiced their concerns. For starters, there was a crying need to improve the coal supply. The government, however, seemed to know very little about coal mining as it ordered Coal India (CIL) to improve the coal supply to the sector by signing long-term fuel supply agreements (FSAs). It also asked the mining major to import coal if required. CIL, though, remained reluctant and failed to meet the March 2012 deadline to sign FSAs.

Further, the government issued a presidential directive to CIL, after which it agreed to sign FSAs but set a laughable penalty of 0.01 per cent of the shortfall. The coal major and the power sector seemed to at odds with each other. However, rather than CIL, what was really to blame was the surrounding environment which has been instrumental in stoking this chaos in the sector over a period of many years.[PAGE BREAK]

Poor Projections, Surging Imports

Far from being a coal deficient country, data actually suggests an abundance of coal in India. It is one of the top four countries in terms of coal reserves. The Geological Survey of India (GSI) has pegged these reserves to be 285.86 billion tonnes, of which 114 billion tonnes are proven by 2011. These coal reserves, however, have not seen robust production. As per the Planning Commission’s reports, during 11th Plan period, the demand for coal grew by eight per cent, while coal production grew by 4.6 per cent.

The annual domestic coal demand in FY12 was forecast at 650 million tonnes (MT) while the domestic coal production was expected to be 630 MT, which would have almost matched the demand supply scenario. But the ground reality was different. The actual demand touched 696 MT in FY12 against coal production of 534 MT, leaving a yawning gap of 161 MT. The first setback came from CIL, which did not meet the production targets. CIL's coal volumes in the first four years of 11th Five Year Plan increased by four-six per cent and remained flat in FY12, when it was required the most. In quantitative terms, it was expected to produce 447 MT of coal in FY12, whereas the actual production was 435 MT of coal.

The lower coal production left a void that was to be filled by importing coal. The earlier projections of a roughly 100 MT coal shortfall in FY12 was way below the actual shortfall of 161 MT. According to the Union Minister of State for Coal, Pratik Patil, the country imported about 90 MT of coal in FY12 against 59 MT in FY11. With these figures, it was not clear how the remaining deficit of 71 MT was filled by the power companies.

One of the major reasons for surging coal demand was that a large number of projects were based on coal. However, the poor projections and lower production have made it difficult to predict the future production numbers for coal. After all, when one buys a company’s stocks, it is the future outlook that one looks into and not the past performance.[PAGE BREAK]

Alarming Generation Mix, Failed UMPPs

While it is true that the country does have a large amount of coal reserves, does that mean we should rely overly on coal? Well, the policymakers did seem to have believed so. While coal-based power plants form about 40 per cent of the electricity mix worldwide, for India this number stands at a whopping 57 per cent. This is very high considering the stagnated coal production. It also means that the India will burn coal at a faster rate than the rest of the world, bringing further pressure on CIL.

Surely, this alarming rate of coal-based generation could not have been missed earlier. The 11th Five Year Plan targets have further aggravated this situation. In its mid-term appraisal of the 11th Plan, the Planning Commission revised the capacity addition targets to 62374 MW. This included 81 per cent of thermal power projects (50757 MW), the majority of which were based on coal.

It should also be noted that the much hyped Ultra Mega Power Plants (UMPPs), which were seen as saviours in the face of the country’s power crisis, were a part of these projections. Each UMPP is based on advanced technology and would host a gigantic single location generation capacity of 4000 MW. Unfortunately, the rosy picture painted by the government has not yet come true, as none of the originally planned UMPPs have come fully onstream so far. Tata Power’s Mundra UMPP is the only plant that has commissioned two units (1600 MW).

These UMPPs, however, have often made headlines for negative reasons. While Tata’s Mundra UMPP has asked for a tariff hike, Reliance Power’s Krishnapatnam has seen financial troubles. The Sasan UMPP also made it to the CAG report that rocked the country in the second half of the year. All of these projects have fallen behind schedule, and do not assure sustainable cash flows.

Two of these planned UMPPs (Mundra and Krishnapatnam) are based on imported coal. The world dynamics, however, have changed and that has hit these plants. The other mega projects of Adani Power, JSW Energy, Lanco Infra, GMR Infra, GVK Power are also badly affected by fuel-related issues.[PAGE BREAK]

Gas Woes

Is only coal to blame for the current problem? To large extent, yes, but other methods of thermal power generation have not been helping to ease the pressure on coal-based generation either. Gas-based power plants in the country were expected to benefit after Reliance Industries found gas in the Krishna-Godavari (KG-D6) basin. What happened to these gas-based power plants is another story altogether in the power sector. The output of the KG-D6 basin has been consistently depleting. The gas output from these fields has fallen from as much as about 55 million standard cubic meters per day (mmscmd) in August 2010 to 22.77 mmscmd in December 2012. The technical issues are yet to be fixed, and the gas output may slow down further going ahead.

The situation of the gas-based power plants, mainly located in Andhra Pradesh, is so bad that they are being run only when gas is available. The overall industrial environment in the state is badly affected. The central government has now asked the power companies to cancel all plans to set up gas-based projects till 2015-16. This indicates that gas-based generation is yet to see the trough.

As per one of the documents on the International Energy Agency (IEA) website, gas prices are set to rise in the future, which will further lower the margins of the gas-based plants. Among the companies that will be impacted by this are GMR Infra, Torrent Power, Tata Power and GVK Power.[PAGE BREAK]

Coal Imports

With regard to coal imports, it must be noted that the prices of the coal in the international markets are expected to rise. The major driving force for coal prices are India and China. IEA expects that over the next 25 years, the coal demand in the country will double and India will become the second largest coal consuming country. Based on this assumption, the coal exporting countries have raised the prices of coal. Indonesia increased the coal prices to the level of the international market prices last year, which affected many Indian companies’ profits. Further, the country has proposed to ban the export of lower grade coal and doubling the export tax in future. These proposals would turn many private sector power plants based on Indonesian coal unprofitable. Australia has also raised the carbon tax, which has impacted the Indian companies.

Pre-empting this fuel uncertainty, Indian private companies have already started investing in these countries. Billions of dollars have been put in by companies like Tata Power, Adani Enterprises, GMR Infrastructure and GVK Power and Infrastructure. These investments, however, have not proven to be beneficial as the regulatory changes in these countries have hit the profits of these companies.

Mozambique in Africa is one such country which has been attracting a lot of attention. Reports suggest that there is a lot of coal and gas available in the country, but there is some problem with its infrastructure. Indian companies like GAIL, Videocon and Coal India have made some investments in this country, but they can only think of mining coal after building road and ports in the country. Besides, from the way Indonesia has played with coal prices, one cannot guarantee stable coal prices in Mozambique. It is well known that as governments change, so do their policies.

Elsewhere in the world, US and Russia also have vast coal resources but logistical issues make it costlier to import from them.

The currency exchange rate is another angle to this story. The rupee has been weak for the last two years and though coal prices have declined in the last few months, the rupee’s slide has capped the benefits. Besides, China, which is the largest coal importer, will drive the prices up as its economy is showing signs of recovery.[PAGE BREAK]

Higher Tariffs: Need Of The Hour

India is a country where power tariffs are a political issue. Electricity is provided free to farmers. Power generators are required to take permissions from the respective regulatory bodies and state governments to raise tariffs. Petitions to raise tariffs could get a nod, but may take some time to get approved. The dynamics may further change by the time a company gets approval.

The country endorses a range of rules and regulations for power companies. There is a winding maze of regulatory bodies such as the CERC, CEA, the Power Ministry, Coal Ministry, Environment Ministry, state-level electricity regulatory bodies, etc. that control the electricity regulations and must be negotiated. The issues around this are so overwhelming and numerous than even the President has stepped in to address the situation, making it the rarest of such incidents of presidential directives in the country.

Recently, the tariffs have been rising but they are not enough to cover the past losses of the distribution companies. There are also the losses at the level of transmission and distribution. The total accumulated losses of the State Electricity Boards (SEB) over the past few years are to the tune of about Rs 1.9 lakh crore. This has made the SEBs financially unviable entities. Efforts are now being made to modernise the transmission and distribution network by means of privatisation, but these efforts remain limited to certain cities like Bhiwandi in Maharashtra. Besides, the capital requirement remains huge and efforts by private companies to cover the capex requirement by raising tariffs meet with huge public agitation.

Power trading is another option where power companies can sell power at the market price, but there too, the prices fluctuate a lot. The better part of the year sees the prices hovering between Rs 2-3 per unit, and it is only in summer that the companies see better realisations. Power trading operations, however, remain limited as India is yet to mature for businesses like power trading.[PAGE BREAK]

Having spoken of all these negatives, there are a few positives as well. Recently, some 20 odd states have revised their power tariffs, which should be seen as a sign of improvement on that front. The huge accumulated losses that have been impacting the entire value chain of the power sector have also been addressed by the government as part of its reforms drive.

Debt Restructuring Of SEBs

The government has recently cleared a debt restructuring scheme for the SEBs. Under the scheme, half of the SEB debt will be taken over by the respective states, while the remaining half will be restructured by the lenders with a moratorium on the principal and softer repayment terms. The government has also asked the SEBs to reduce the T&D losses going ahead. Another condition that the government has imposed is to reduce the exposure to short-term power (traded power) and it has also asked to make a provision for automatic pass through of higher fuel costs.

This is indeed a very positive move by the government, but SEBs need to act immediately on these counts. Considering the political interest, tariff revision is bound to meet high resistance from the interested parties. If SEBs fail to revise the tariffs upward, then the debt restructuring will prove to be a bailout package and will not work in right direction.

Coal India Agrees To FSA, Price Pooling Key Trigger

Another positive in the sector is that CIL has also agreed to sign FSAs with a trigger level of 80 per cent of the Annual Contracted Quantity (ACQ), with 65 per cent of domestic coal and 15 per cent of imported coal. It has also agreed to higher penalties, indicating that it is very serious about this business.

However, this has stirred another debate over price pooling, as coal imports would require the power companies to bear the cost of imported coal. Such a move has been opposed by companies consuming domestic coal (like NTPC), stating that they should not have to pay for higher prices as they have abundant domestic coal availability. Private companies have said that they will only turn profitable if price pooling guarantees lower than imported coal prices.

Price pooling is a key to the profitability of power companies, as the fuel cost will be shared by the power generating companies. Though some negative impact may need to be suffered by the domestic coal consuming companies, it will prove to be beneficial mainly to the private sector players. Overall, if price pooling is accepted, we will see more capacity becoming operational over the next few years. The decision on the same is pending, and may come in soon.[PAGE BREAK]

12th Plan Capacity Addition Target

Ignoring the experience of the 11th Plan, the government has gone ahead and set a very steep target of capacity addition for the 12th Plan. The government envisages adding a total 88527 MW of capacity by 2016-17, including a huge 82 per cent based on coal and gas. Based on earlier experience, we expect the capacity addition to remain below the target.

One can also imagine the tremendous pressure that the domestic coal production will face. CIL will have to increase the coal production nearly at the rate of eight to 10 per cent per year. For FY13, it has set a target of an eight per cent rise in coal production to 468 MT. It is also improving on its mining equipment, which may be a step in the right direction. The projections are very robust, but like all the earlier plans, this one too is likely to be missed.

The higher thermal capacities added in the 11th Plan created a mess for the entire sector. Now with a further higher target, it is very difficult to predict where the sector will go.

Financing Woes

The industry has been facing some financial difficulties recently. The work at Reliance Power’s Krishnapatnam UMPP was stopped due to financial troubles. Recently, Lanco Infrastructure is asked to sell some of its assets to improve its cash flows. These are the early signs distress in the sector. The banking sector has also come under considerable pressure due to lending to the power sector. We expect further tightening of lending norms by lenders to the power sector.[PAGE BREAK]

What Should Investors Do?

We believe that the sector may see some positivity due to the reforms brought in by the government. Price pooling will be a major positive for the sector, and hence, one should watch out for that. On the other hand, downside risks can arise if any major project is cancelled due to financial or fuel-related issues.

The success story of the sector currently seems speculative in nature. Hence, we remain selectively positive on very few of the companies and hold that only risk takers should buy stocks in the sector.