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Cover Story | February 2014

Outlook Power sector: Consolidation to continue

In the last eight months of FY14, generation growth was faster at 5.3 per cent than the growth in key demand segments, leading to lower energy deficits. However, improvements in power generation will be driven by increased domestic coal availability post the government initiatives in the coal sector and higher availability and acceptability of imported coal. This could be brought about by lower international coal prices, availability of infrastructure to handle coal and acceptance of imported coal cost pass through in power purchase agreements (PPAs). Power generation could also improve on an easing of liquidity situation at the SPU level post financial restructuring package (FRP) implementation as it would lower back-down instructions and increase the ability to buy power.

Tariff hike sustainability: A challenge
Last nine months of FY14 marked the finalisation of FRP for distribution companies (discoms) operating in Tamil Nadu, Uttar Pradesh, Rajasthan, Haryana and Himachal Pradesh. Discoms operating in Jharkhand, Bihar and Andhra Pradesh are finalising the terms. Most of the state electricity regulatory commissions also allowed tariff hikes to discoms. Since FY13, tariffs have been hiked across consumer categories. This was a significant development, as after years, state governments across had realised the inevitability of tariff increases and the fact that tariffs had to be cost reflective. Even the FRP finalised with the discoms envisages regular tariff rationalisation for a financial turnaround in operating performance.

The Delhi government has announced an increase in power subsidy per unit to consumers. Following this, Haryana and Maharashtra have also announced tariff reductions through higher subsidy. However, India Ratings and Research (Ind-Ra), a research firm, believes that tariff reductions for end consumers without subsidy backing or actual reduction in costs could have cash-flow implications for discoms. Though most governments declare high subsidies, the actual materialisation to discoms is lower and untimely leads to stress on cash flows. Also, increases in consumption subsidies usually lead to a diversion of investment resources leading to lower capacity additions by the state government-owned entities in power sector along with inefficient usage of electricity as consumers remain oblivious to the true cost of electricity. On the other hand, a direct reduction in consumer tariffs, without subsidy backup from the state government would lead to a situation prevalent before FY13 when tariffs were not cost reflective and discoms incurred huge losses.

Moreover, given that general elections are scheduled for mid-2014, effecting tariff hikes might be all the more difficult.

Merchant prices: Mixed trends expected
Ind-Ra expects merchant prices to be largely governed through a function of three variables in FY15: connectivity of the southern grid with the national grid, pre-election buying and increase in electricity generation. The southern-grid integration was achieved through the commissioning of the Raichur-Solapur 765kV single-circuit transmission line by the state-owned Power Grid Corporation of India Limited (PGCIL) at a capital cost of Rs 8.2 billion, five months ahead of schedule.

Sector consolidation expected
Consolidation in the power sector expected with interest from foreign strategic operators, or domestic operators with deep pockets. This will attributed to attractive valuations of operating assets, visibility on actions being taken by the government on fuel and SPU financial health and rupee depreciation.

Over 2007-2011, several small to mid-sized operators with limited or no experience entered the power sector. Post successful commissioning of their first projects, some players announced plans to aggressively expand the scale of operations in the sector. Most of these decisions lacked a proper risk analysis and many corporates took large loans (project specific as well as corporate loans) to fund their ambitious expansions. Supported by high asset valuations and a favourable banking system, these companies raised funds successfully.

However, fund flows to the sector gradually slowed considerably as problems with respect to under-construction or operational projects primarily in terms of land acquisition, fuel availability, transmission availability and weak counterparties began to emerge. The valuations fell as foreign currency convertible bonds could not be converted into equity. The weak counterparty profile of state discoms led to delays in receipt of payments from the existing operational projects. Consequently, cash flows turned minuscule compared with debt with corporates having to take the corporate debt restructuring route. These companies are now looking at asset sales for deleveraging.

(With inputs from India Ratings and Research, a Fitch Group Company)
Southern grid connected
The interconnection of the southern power grid with the national grid during January 2014, thereby completing the integration of transmission network in the country, is a significant development. It would lead to the following benefits:

  • The deficit in the southern region could decline as surplus power from east and west could now flow to the southern grid. In FY12 and FY13, the southern region saw a higher power deficit than the northern, western and eastern regions.
  • The short-term power price for the southern grid could come down as the transmission constraint prevalent earlier is now removed. Consequently, power purchase costs from exchanges for discoms operating in Andhra Pradesh, Karnataka, Kerala, Tamil Nadu and  Puducherry could decline. In the past, prices in the southern region remained higher than the all-India average price on exchanges due to transmission constraints.
  • Demand management could be improved, ensuring grid stability as excess power from/to south can now flow seamlessly.
  • The combined play of better power availability and lower power prices would decrease dependence on high-cost-based diesel gen-sets. Consumers (primarily industrial units) have been reeling under acute power shortages and have seen power holidays in the state.
  • Development of a nation-wide electricity market, thus expanding the scope of market for power traders
  • Power generators would now supply their idle capacity, which earlier could not be scheduled due to transmission constraints, to the southern region.

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