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Cover Story | May 2018

The Stress Marks!

India's power sector is in a catch-22 situation. A sound analysis of the power sector affirms that the sector is in the ICU where 78,000 MW of projects are under stress; and approximately Rs 1,200 billion worth unviable projects and PPAs are signed for a mere 7,000 MW. <br /> <br /> India's power sector is heading towards a crisis. Currently, about 50,000 MW of projects are stressed either for want of power purchase agreements (PPAs) from the distribution companies (discoms) or for want of coal or gas. The Reserve Bank of India's (RBI) recent circular orders that all stressed loans over Rs 20 billion must be resolved or taken to the National Company Law Tribunal (NCLT) under Bankruptcy and Insolvency Act. So will Rs 2,000 billion heading towards NCLT and, eventually, getting liquidated. <span style="font-weight: bold;">POWER TODAY, </span>analysys this issue in detail. <br /> <br /> Before digging deep into the mess, let us present the numbers in detail. At present, 19,723 MW of power capacity has no PPAs, which means no discom is going to buy that power. That said, because of under recovery discoms face loss of about 11,700 MW. What's more! Due to lack of availability of gas, around 10,581 MW of projects are stuck. And finally, due to changes in law in countries like Indonesia, 9,800 MW of capacity has been termed as useless or stressed. Besides, 23,091 MW of power projects under construction are also stressed for want of PPAs or gas availability. In total, 78,895 MW of power projects are stressed! <br /> <br /> Let us only take the projects with finished capacities. Out of 51,804 MW-barring 9,000 MW owned by the likes of Tatas and Adanis, which will not renege on their loans considering they are deep-pocketed conglomerates-chances are high for as much as 42,800 MW of power projects to go to NCLT. Worth to remind our readers, that RBI notifications says, in six months, if stressed loans are not resolved, they have to take it to the NCLT. And the cut-off date for the same is September 2018. <br /> <br /> <span style="font-weight: bold;">The question arises:</span> who will buy it in the NCLT? In terms of money, 1 MW of power plant construction could cost a company Rs 40 million. Hence the cost of construction of 42,800 MW of power plants is Rs 1,710 billion, which has already been spent. That is the kind of money which will look for buyers in the coming six months. So why would anyone come to NCLT and buy these stressed assets, which do not have PPAs (19,723 MW) in place and adequate gas availability (10,581 MW)? If no takers are found, Rs 1,200 billion will go down the drain because they are financially unviable projects. <br /> <br /> Talking about the exposure, banks comprise 53 per cent of the loans, followed by non-banking financial corporations (NBFCs) at 35 per cent and balance from the state governments. About 43 per cent of loans are extended to the power generation sector, followed by distribution at 37 per cent and transmission at 20 per cent of the total loans.<br /> <br /> But there is hope. Several states are towing along the prime minister's policy of 24x7 power, as this is a year of elections. Separately, PT has analysed the price of power on energy exchange which is increasing. Indian Energy Exchange (IEX), an exchange that sells power on alternate days, has witnessed rates going up by 25 per cent to Rs 4 per unit. And for a slightly shorter term, that is, for merchant power, the rates have gone up by 20 per cent from Rs 3.5 to Rs 4 per unit. This indicates that as power prices rise, more and more stressed plants can become viable. However, irony lies in the fact that in the last five years, only 7,168 MW of PPAs have been signed whereas 51,000 MW of project capacity is unutilised.&nbsp; <br /> <br /> According to <span style="font-weight: bold;">Amish Shah, CFA, Research Analyst, DSP Merrill Lynch (India),</span> 71 GW of private sector coal-based projects will face bankruptcy issues and be bid under the ongoing NCLT proceedings (September 2018) - implying probable resolution from June 2019 onwards. &quot;On an average, we expect more than 75 per cent write-offs in loans for such projects - which could pave the way for consolidation,&quot; he said. <br /> <br /> <span style="font-weight: bold;">Plants without PPAs</span><br /> Despite having PPAs, it is estimated that the average year-to-date plant load factor for these plants will be 60 per cent. Plants such as GVK Goindwal Saheb, Jaypee Bara with full PPA are not fully operational due to low demand/ high costs. However, by demonstrating availability of the plant, fixed cost recovery under two part tariff mechanism will ensure sufficient cash flows to meet liabilities. More importantly, a few plants having a PPA and were earlier stressed due to lack of coal supplies, are now being revived under the Scheme for Harnessing and Allocating Koyala Transparently in India (SHAKTI) scheme. The FSA has been signed and coal supply has commenced.<br /> <br /> With fuel-related issues being addressed, analysts in the domain expect cuts to be minimal for plants that have witnessed cost overruns and debts beyond Rs 50 million per MW. It is estimated that projects that have witnessed 40 per cent cost overrun (from Rs 50 million/MW to Rs 70 million/MW) can sustain debt of Rs 50 million/MW given the existing fixed-cost recovery in the tariffs (assuming no equity return for existing sponsor). Hence, incoming sponsors are expected to quote sustainable debt at Rs 40 million/MW.<br /> <br /> <span style="font-weight: bold;">India needs incremental power supply of approx.</span> <br /> 10 GW every year (assuming 6-8 per cent CAGR in peak demand). NTPC and other state-owned generating companies are able to add 4-5 GW of capacity every year. Hence, the existing excess capacity (stranded projects) of 25 GW will get absorbed over four or five years. Here, SBI Caps builds a scenario analysis around Rattan India Nashik, one of the stranded power plants without PPA. <br /> <br /> <span style="font-weight: bold;">Santosh Hiredesai of SBI Caps Securities</span> says, &quot;Our&nbsp; workings suggest that stranded power plants with no PPA for the next five years could fetch an ask rate (fair value) of Rs 30 million per MW.&quot; And, he goes to say, &quot;An incoming sponsor will need to have deep pockets to fund losses during the initial few years. The upside risks to IRRs for new sponsors emerge from cheaper sources of funding (very high possibility); cheaper sourcing cost (moderate possibility); and flexible debt repayment structure (high possibility).&quot; <br /> <br /> <span style="font-weight: bold;">The offtake </span><br /> Discoms have shied off PPAs (the last one was in 2016 in Uttar Pradesh for 3,800 MW power - only to be cancelled later) and preferred to buy power through short-term contracts or from the open market, given subdued offtake and prices, and significant capacity addition in the past five years. Consequently, many generators have been selling electricity at throwaway prices or have switched off plants leading to defaults on financial covenants. And, with the thrust on renewable energy and procurement of clean energy increasing, incremental procurement of thermal power has tapered.<br /> <br /> The perceived surplus-of generation outpacing demand-is a chimera because on the other side you have load shedding by discoms. The truth is, discoms are not buying enough because of poor financials and not because of low demand.<br /> <br /> Besides, the lack of demand theory does not gel with initiatives such as Saubhagya and 24x7 Power for All, and the fact that at approx. 1,175 kWh, per capita electricity consumption in India is just one-third of the world average. Of late, with hours of supply increasing and coal in shortage, spot prices have surged, with average tariffs touching Rs 4.09 per unit in September 2017. But this over-dependence on the short-term market is a short-sighted approach.<br /> <br /> <span style="font-weight: bold;">Coal supply</span><br /> Absence of fresh coal linkages (none since 2010), restrictions on the use of linkage fuel and cancellation of coal mines without alternative arrangements have socked thermal plants. Another blow-for private sector producers, this time - is the rider that only long-term PPA can holders get linkage. And the response to the past five rounds of coal auctions has been tepid, with the last one (or Tranche V) even getting cancelled. Of the 72 coal blocks auctioned and allotted so far, only a handful have started operations. Many cases have been filed in courts on the auction method, the compensation to be paid to prior allottees and modification of auction rules after bidding.<br /> <br /> But SHAKTI, under which the government is to provide coal linkage to developers, was successful with a total booking of approx. 27.18 million tonne of coal per annum from eight available sources. But this was a limited scheme and needs to be extended. The larger point is, back-of-envelope calculation shows that Coal India Ltd will not be able to meet this requirement tillat least 2020, even if thermal power plants run at 55 per cent PLF.<br /> <br /> <span style="font-weight: bold;">Potential from red to black</span><br /> Here Vivek Sharma, Senior Director-Energy, CRISIL Infrastructure Advisory has three solutions that can put the power sector back on track. Firstly, stricter regulations are necessary to discourage load shedding by discoms and to ensure regular and quality supply to all consumers so as to meet the 24x7 goal. This will help capture actual demand and force discoms into competitive bidding to buy power.<br /> <br /> Secondly, the issue of non-signing of PPAs by discoms can be solved through centralised procurement and allocation of capacity to states - as has been done in renewables. The concern among discoms of long-term fixed cost liability from such PPAs can be overcome by sharing the risks and rewards. For instance, it could be a single-part tariff with discom committing to procure at least 60 per cent of power. Where power is not bought, it could be sold in the open and the difference is then borne by discoms. Similarly, if the price is high on the exchange, the upside could be shared with discoms. <br /> <br /> Besides, says Sharma, &quot;PPAs can be for medium than long term, where both suppliers and discoms have the choice of reviewing tariffs and conditions after three to five years. By then, the market may be more stable in terms price discovery, because of economic recovery, increased per capita power consumption, impact of electric vehicles and infusion of more renewable energy into the grid.&quot;<br /> <br /> Third solution is: along with centralised procurement, the government should consider the SHAKTI scheme (second round) for constructed plants without fuel linkage so that they too can actively participate, given the comfort of fuel source. <br /> This centralised scheme could be extended to imported coal stations as well as hydro stations. <br /> <br /> &quot;These steps,&quot; mentions Sharma &quot;can help minimise NPAs and haircut levels for banks, and also provide a signal to new investors who have not put money into the conventional power sector for more than three years.&quot;<br /> <br /> <span style="font-weight: bold;">Cost-saving math</span><br /> A report by Bank of America Merrill Lynch-Electric Utilities India-suggests state electricity boards has the potential to generate profits of $7 billion versus loss of $9 billion if inefficiencies across the value chain are curtailed. <br /> <br /> To begin with, power theft, inefficiency in billing or collection of power bills comprises a whopping $7.5 billion of annual losses. Besides, the report notes that of the 29 states in India, five states alone account for 45 per cent of total power theft. Addressing the issue of power theft within these states alone could generate significant savings. <br /> <br /> Next in line is the coal mining costs. Domestic coal in India is primarily sourced from Coal India and Singareni Collieries, which have an average cash production cost of Rs 1,050/tonne. However, report checks suggest that, if mined efficiently, cash costs could be curtailed to Rs 450-550/tonne, as has been demonstrated by certain private sector miners. This implies potential savings of $4 billion. That said, a concerned Amish Shah mentions that India has the fourth highest coal reserves in the world but on account of inefficiencies in coal production, it imports $3 billion of coal for the power sector. However, the report notes that adjusted for the calorific value of coal (imported coal has high calorific value), domestic coal is 40 per cent cheaper than that of imported coal. Augmenting domestic coal production can hence help save $1.4 billion of costs.<br /> <br /> Apart from coal import, there is a potential of curtailing coal haulage distance through rail from an average of 510 km currently to 416 km (19 per cent savings) by rationalising coal logistics - coal supply to power project from the nearest coal mine. As per BoAML analysis, if implemented, shorter haulage of coal should help save $1 billion.<br /> <br /> Augmenting the rail network and providing last mile rail connectivity between power plants and coal mines should help reduce coal transport through road. Ironically, the cost of coal transport through road is 58 per cent more expensive when compared to that of rail. While road transport cannot be completely done away with for very remote power plants or coal mines, this has the potential to generate $0.6 billion of savings. <br /> <br /> A large share of the borrowings within the power sector value chain (especially among the power distributors) is to fund the operating losses rather than the capex. Implementing some of the above cost curtailment measures has the potential to significantly cut the need for borrowings to fund the operating losses and thus do away with the interest burden from such loans. Experts estimate that $1.8 billion of borrowing expenses within the power distribution sector originates from loans takento plug the operating losses and could be curtailed.<br /> <br /> Lastly, most of the power entities (mostly government-owned) are heavily staffed, which among other factors, result in O&amp;M or administrative costs accounting for 54 per cent of the total costs within the sector. For instance, Powergrid (efficient entity) accounts for 50 per cent of power transmission in India and has $2 billion of O&amp;M or&nbsp; other costs, while the state government-owned transmission utilities account for the balance 50 per cent transmission but have a huge $17 billion of O&amp;M or other costs. One may argue that it is too simplistic to compare these entities on the basis of share of power transmitted versus their O&amp;M or other costs, but directionally it does point to excessive costs at the state-owned power transmission entities. <br /> <br /> On a cloncluding note, the former power minister tried hard for three years to make the gas-based plants work. They didn't. Now the ministry itself has given up hope. Why should these projects not be taken to the NCLT. It's possible the banks will recover something from some stressed asset funds who are prepared to wait it out. Why should these zombie assets be sitting in the books of banks.<br /> <br /> <span style="font-weight: bold;">- RAHUL KAMAT</span><br />
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