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Cover Story | October 2017

TPPs for Sale

<span style="font-weight: bold;">With 20 GW of thermal power generation capacity lying idle and another 20 GW set to join it soon, the government has to do some serious thinking to find a remedy.</span> <p></p> <p> Power sector seems to have seen hectic activity over the last three years - in terms of generation, transmission and distribution of power and efforts to create and bolster demand. However, with every addition of a megawatt in power generating capacity the problems of the sector got accentuated. The result is lack of or curtailed revenues for generators and pressure to pay up bank debt. Due to stress in generation segment about 40 GW of capacity is up for sale now, according to sector analysts. </p> <p>Thermal source of power is the mainstay of India, cornering over 70 per cent of the generation capacity. Of which about 85 per cent is coal fired, while the remaining shared by gas and diesel. About 25 per cent of the coal-based capacities are owned by the Centre, 35 per cent under various state governments, while the remaining 40 per cent is with the private players. </p> <p>Private players have entered the sector in a big way only in the first decade of the new millennium to take advantage of the attractive short term prices ruling on power exchanges, in the wake of acute shortage. However, the prices are subdued in the recent years, with supply surpassing demand growth. With the focus of the government shifting to renewable, the challenges of Thermal power Projects (TPPs) have deepened.</p> <p>Though the government has claimed of surplus power in 2016, the fact of the matter is that about 50 million households or 250 million or one-fifth of the country's population do not have access to electricity even now, according to Central Electricity Authority (CEA) estimates. This is due to structural problem, where the power distribution companies (discoms) are unable to buy sufficient power to ensure 24x7 power supply to all their constituents. As a result, about 25 gigawatts (GW is equivalent to 1,000 megawatts) of coal-fired generating capacity is 'stranded', according to CEA. </p> <p>Though the government said that it was contemplating strategies to resolving the operational and financial stress in the generation sector, it has not come out with any concrete plan to alleviate the pain. As a first step, the government has launched SHAKTI policy, which aims at removing fuel supply bottlenecks. Meanwhile, during the recent cabinet reshuffle, the incumbent Power Minister Piyush Goyal has been shifted to another ministry, and a seasoned and retired bureaucrat RK Singh has been brought in his place.</p> <p> <span style="font-weight: bold;">Consolidation</span><br /> 'Around 20 GW of operating thermal capacity and 19 GW of under-construction capacity do not have a PPA are clearly stressed and available for sale. In addition there are projects with partial PPA's or PPA's at unviable tariff adding to overall stress in the system. In terms of quantum, around Rs.10 lakh crore of overall banking exposure is under stress, with power being one of the major contributors,- <span style="font-weight: bold;">Manish Aggarwal, Partner, Head- Corporate Finance - M&amp;A, Debt Advisory - Infrastructure, Head- Energy and Natural Resources, KPMG </span>in India told Power Today. </p> <p>'Around 50 to 60 GW of capacity is under some stress or other, and thus the banking system debt will be huge,' Aggarwal adds. </p> <p>Non-availability of regular fuel supply arrangements, lack of PPAs, promoters' equity crunch, and regulatory and contractual issues are the bug bears. The latter two essentially impact under-construction projects whereas the rest impact all projects. There are three categories of Independent Power Producers (IPPs) - IPPs with long term PPAs, IPPs with a mix of long term PPAs and short term sale, and IPPs without any long term PPAs, which completely rely on short term sale. 'So, the impact varies on a case-to-case basis. For the first category, the impact of PLF is irrelevant because the PPA gives an option for an IPP to claim an entire fixed capacity charges based on the normative declared availability, and it should not impact from the debt servicing perspective,' says <span style="font-weight: bold;">Girishkumar Kadam, Vice President and Sector Head, Corporate Sector Ratings, ICRA Limited.</span></p> <p>'More importantly PLF decline will have adverse and direct impact on the IPPs which do not have any long term PPAs, because their operations remain exposed to both - volatility in tariff as well as volume. Definitely for IPPs and for the capacities, where the long term PPAs are not tied-up, the impact is quite severe and more adverse,' Kadam points out. </p> <p> <span style="font-weight: bold;">Challenges</span><br /> Usually, the operation-ready plants get to sign long term power purchase agreements (PPAs) with discoms. In the wake of falling prices following introduction of auction system a couple of years' back, power prices of solar and wind have started sliding. Besides, power is available in spot market at much lower prices than is offered by the new TPPs. Solar prices have dropped below Rs.2.5/kWh, while TPPs are able to offer power at Rs.3.50. Taking cue from the trend, discoms have stopped signing new PPAs and started relying on spot market for meeting their needs, leaving the operation-ready projects in the lurch.</p> <p> 'Today thermal power sector, in terms of its overall capacity, is actually in surplus. That is, what is required is the demand. In fact, almost about 25GW to 28GW of thermal capacity in private domain is without any long term PPAs,' says Kadam. Recently, the outgoing minister Goyal said that the government was looking at `3 per unit as the benchmark price for power from all energy sources like thermal, solar and wind in the medium term.</p> <p>'Depressed demand growth, lack of adequate PPAs to tie-up the capacity, along with mounting debt, have forced players to a situation where they no longer can hold on to these assets,' Aggarwal added.</p> <p> <span style="font-weight: bold;">PLF</span><br /> Overall demand growth has been sluggish in the Indian market over the last two years, bringing down overall PLF below 60 per cent. The PLF of private sector was at 54.61 per cent in July 2017, compared to 53.72 per cent in August 2016, according to the latest CEA data. The total installed capacity of coal-based capacity was at 193 GW at the end of August 2017. However, overall PLF of thermal alone was higher at 66 per cent in August 2017 with PSUs recording higher PLF.</p> <p>Increased capacity addition from renewable sources and lack of demand from Discoms are major contributors to that. 'With improvement in financial health of Discoms we expect some improvement from the current levels of PLF. However, it's unlikely to achieve the levels that we have seen in past,' says Aggarwal of KPMG. The overall PLF was at 83.9 per cent in FY2010. Most of the incremental demand is likely to be met from increased supply from renewable sources. In a report, India Ratings said that it expects the PLFs of coal-based power plants to decline further in FY18 and rise thereafter, though they would continue to remain sub-65 per cent until FY22.</p> <p> <span style="font-weight: bold;">Overall Demand</span><br /> The Central Electricity Authority and NITI Aayog have put the power demand growth at 5-5.5 per cent CAGR in the next five-year plan. The problem is that demand in the country is measured by the amount of electricity that the discoms buy and not by the actual demand from the customers. Load-shedding has been the means used by the discoms to avoid losses as the cost of supply is more than the realisation in most cases. As such one can expect demand to rise only when discom health improves and they buy more power. Thus, hopes are pinned on UDAY for discom revival. </p> <p> 'Under UDAY framework, at least in terms of debt refinancing and takeout financing, it is satisfactory. And in overall discipline in tariff petition filing and tariff order issuing by and large there is progress in most of the states. Overall trend at least in terms of filing is satisfactory. But the quantum of tariff hike is moderate - 4-5 per cent for the last 2-3 years,' says Kadam. Coal availability is no longer an issue for the power sector over the last two years. However, 24x7 quality power supply remains a dream.</p> <p> The proposed scheme to come up with centralized PPA's for certain capacity will help in tiding over immediate challenges. However given the quantum of stressed capacity more such structural initiatives are required, says Aggarwal.</p> <p> Electricity use is estimated to grow 6.2 per cent a year over the 5 years ending March 2022. Consumption over the previous six years expanded 5.3 percent, missing a 7.6 per cent forecast, CEA said in its latest power survey report. The lower-than-expected growth rate led the agency to temper its outlook.</p> <p> Kadam of ICRA feels that the uptick in demand will take place only when we see revival in manufacturing activity. 'Energy demand growth has been quite moderate and it requires an uptick. And that is a function of how fast the pick-up in the industrial demand happens, and a factor of overall capital expenditure recovery and overall macro environmental factors. And how the uptake capacity of the distribution utilities will pan out going forward will also impact this,' says Kadam. Industrial demand constitutes about 30-35 per cent of the overall power demand. </p> <p> <span style="font-weight: bold;">Renewables</span><br /> Recently, Piyush Goyal said that 3/kWh will become the new benchmark price for power from all energy sources like thermal, solar and wind in the medium term. His comment was based on the falling tariffs of solar and wind generators, which were arrived at through competitive bidding. </p> <p> 'According to new benchmark price again viability has to be seen on a case-to-case basis. For wind, post reverse auction bid of February 2017, where the price of Rs.3.46 was discovered, the rules of the game for the wind sector have changed,' says Kadam. The wind fit-in tariff design is no longer preferred by utilities for new PPAs. </p> <p> For solar also, tariffs have fallen quite sharply to Rs.2.42 is the winning bid in Tamil Nadu recently. Over the last three months, however, PV module prices rose marginally by 6-7 cents, upsetting those who have bid lower in anticipation of below 30 cents (100 cents makes a US dollar) per watt. 'Now the prices are at 35-36 cents per watt. Certainly the projects that have been recently bid out and where the tariff is below the Rs.3/unit, they are going to be adversely impacted,' says Kadam, while agreeing that the fundamental competitiveness of wind and solar has improved against conventional sources. </p> <p> Aggarwal of KPMG does not foresee renewables as a competition to conventional projects. The way he looks at base scenario is that of cooperation rather than competition. 'But at the same time, we need to understand that renewable cannot replace conventional as a bulwark of energy system. The change will happen, but it will take time. Conventional would command a definite premium because of their on demand nature of generation.' </p> <p>India's massive power grid system needs re-balancing to deal with the fluctuating/erratic nature of power generated from renewable energy flowing into the system and keep supply in sync with demand. Increased share of renewables would require enhanced investments in transmission or peaker plants.</p> <p>Even the <span style="font-weight: bold;">Chief Economic Adviser, Arvind Subramanian </span>also said recently that overemphasis on renewable energy would create a 'double whammy' for the government by reducing the viability of TPPs and raising bad loans of state-owned banks. While renewable energy needs to be tapped, in the short-to-medium run, the nation ought to focus on traditional sources of energy like coal, he added.</p> <p> <span style="font-weight: bold;">Buyer's Choice</span><br /> Large investors and conglomerates who had earlier stayed away from bidding due to scepticism are considering acquisitions of operating capacity as an attractive, low risk strategy to enter the market. 'Having said this, it will be a very selective asset play and to my mind large part of capacity will still not find a solution,' says Aggarwal. <span style="font-weight: bold;">Sajjan Jindal, Chairman and MD of JSW Energy</span> said at the company's AGM recently that the company was 'future ready for consolidation'. 'As and when any opportunity comes our way where we can capitalise at the right place and the right value and where I can supply power at the new normal of Rs.2.5/unit,' Jindal added, specifying his parameters for selection of target company/plant.</p> <p>JSW Energy is considering inorganic growth as one of the ways of achieving its target of achieving 10,000 MW generation capacity from the present 4,531 MW of capacity.</p> <p>The public sector NLC India Ltd plans to acquire 3,000 MW of stressed power generation capacity, driven by its strategy of using the revenue generated from running ready-to-operate private sector projects to finance capital expenditure. With Rs.12,000 crore of fund for acquisitions, NLC has zeroed in on GMR Group's 1,370 MW coal power project in Chhattisgarh and Hyderabad-based Ind-Barath Power Infra Ltd's 700MW plant in Odisha. </p> <p>Kadam said that the buyer should analyse parameters like capital cost; availability of PPA; if PPA is tied-up, whether it is cost reflective, and if fuel linkage is tied-up, before arriving at a 'buy' decision. They also should watch out for cost overruns, which are at 35-45 per cent for many projects, he advised. </p> <p>Strategic investors derive value by bringing in much valued technical and implementation capability. Strategists are more interested in a portfolio which gives them necessary scale and possible operational optimisation that can help them drive returns, says Aggarwal. There is limited interest for under-construction assets. Acquiring projects that are already in operation is a less risky way to enter the market than constructing a long gestation period asset. </p> <p>However, short term mergers and acquisitions will be driven by financial investors, who look for projects with all the necessary linkages in place and which can be quickly turned around.</p> <p> <span style="font-weight: bold;">Bank Debt</span><br /> While the total stressed assets of the banks are over Rs.10 lakh crore, the total loans to the power sector stands at Rs.5.24 lakh crore. After iron and steel sector, power is the largest contributor to stress for banks.</p> <p>Typical debt-equity ratios are 70-30, 75-25 or 80-20, depending upon the project profile and stipulations set by the lenders. Largely 75-25 and 70-30 are in use for thermal. And 80-20 may be there for RE projects. </p> <p>Commenting on the impact of power sector problems on banks, <span style="font-weight: bold;">Chief Economic Adviser, Subramanian </span>said, 'All this can have a detrimental effect on the health of the banking sector, especially the public sector banks, in the country, which in turn can adversely impact the health of the Indian economy, already afflicted by the Twin Balance Sheet challenge,' he said at a lecture. The financial impact for the government arises from having to recapitalise the public sector banks that have lent to power companies and to the reduced profitability of the coal industry.</p> <p> <span style="font-weight: bold;">Looking ahead</span><br /> The Central Electricity Authority has already read a swan song for the coal based power projects when it said that there is no requirement for new coal plants in 2017-22 in a report. However, it estimates 50 GW of thermal capacity that is in the works as of now will get commissioned during 2017-22. In these circumstances consolidation may not be a panacea for the ailing power generators.</p> <p>'Consolidation may help benefit on account of optimisation in financing and/or operating structure, but it's not going to yield result unless and until the core issue is sorted out. The reason for bulk of stress is structural and much beyond the control of consolidating parties to manage,' Aggarwal feels. </p> <p>Doscoms turnaround is the key to bolster demand. Most of the experts are pinning their hopes on positive results from UDAY and increase in demand from discoms in a few years. Wish it would come true.</p> <p>Analysts predict that thermal will remain the mainstay of the Indian power sector for at least two decades. So, evolving a right mix of all available sources of energy, particularly thermal and renewable, is the need of the hour.</p> <p>Aging power plants are a drag on resources - feedstock- as well as per unit cost-wise. Discoms have already turned cautious about cost of power. This is the time to phase them out or bring in super critical technologies wherever possible. About 25 GW of capacity is estimated to have crossed 25 years of age.</p> <p>If nearly 40 GW of generation capacity is ready and lying idle there is something wrong on the part of our planning. It is nothing short of squandering precious resources of a developing economy like India. A power generation project cannot be built in anticipation of signing a PPAs at a later date. That is bad project planning. The government has to do a serious thinking on this and resolve the riddle at the earliest.</p> <p> <span style="font-weight: bold;">Power Project Dynamics</span><br /> Assuming a capital cost of Rs.7 crore per MW and based on the normative benchmark, if one were to assume a levelised fixed cost for Thermal Power Plant (TPP) it will be at Rs.1.6 to 1.7/kWh or unit. And assuming that fuel cost is a pass through, the Debt Service Coverage Ratio (DSCR) is just above 1 (one), that is the benchmark. The fixed cost of Rs.1.60 in the first year will see a normative decline over the years during the PPA period, assuming a debt-equity ratio of 70:30 and debt of 20 year maturity. </p> <p>The fuel cost, depends on whether the source of coal is domestic or imported. If it is imported coal linkage based, then the cost of coal is roughly about Rs.2.20-2.30/unit based on the prevailing rupee/USD and prevailing international coal prices (in mid-September 2017). For a domestic coal-based power plant, based on the distance between the mine and the power plant, it would work out to as low as Rs.1/unit to 2.00 per unit. So, let's have a median number at Rs.1.5/unit. The fixed and fuel cost together make it Rs3.10/unit on an average for a domestic coal linkage based project. For Imported coal based project, it will be Rs.3.80/unit. From the viability perspective, the tariff required is in the range of Rs.3.50 and Rs.3.80/unit on an average. On the contrary, bilateral short term power traded tariffs remained close to Rs.3.50. That is also because of the reverse auction adopted since April 2016 onwards. At the same time, the spot tariffs on the energy exchange remained anywhere between Rs.2.5 and Rs.3/unit. Having said that there is some uptick in the tariff in the last one or two months, that again is temporary and not likely to sustain. Even if one were to assume a spot tariff of Rs.3 and bilateral tariff of Rs.3.50, it is still below what is required from a TPP viability perspective. So, there is a gap. </p> <p> <span style="font-weight: bold;">-Girishkumar Kadam, Vice President and Sector Head, Corporate Sector Ratings, ICRA Limited.</span></p> <p><br /> <span style="font-weight: bold;">- BS Srinivasalu Reddy</span></p>
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