Column: Flickering power reforms

Updated: Mar 4 2014, 10:46am hrs
In its widely-cited report, consultancy major KPMG has mentioned that commissioned-but-stranded power capacity of more than 33 GW was awaiting coal and gas linkages and could possibly result in non-performing assets (NPAs) in the banking system. The plant load factor of coal-based power plants has declined consistently over the yearsfrom 77.98% in FY10 to 69.71% in FY13. To a large extent, this is attributable to the fact that domestic output from Coal India, which controls roughly 80% of the coal market, has not kept pace with the requirements of power generators nor has the natural gas output from RILs KG-D6 field reached its desired production levels. The government recognised that solving the fuel problem for projects at an advanced stage of completion, with substantial capital locked up, could provide an immediate solution, bringing such capacities back on stream notwithstanding the sectors other woes. It has taken a number of steps to ensure that the power requirements of the 12th Plan (2012-17) are met. These included nudging Coal India through a Presidential directive, to enter into fuel-supply arrangements with a number of projects, aggregating 78 GW of power, likely to be completed by March 2015; restructuring the loan liabilities of the cash strapped distribution companies and revising the standard bidding documents to insulate developers from fuel-price risks. The recent ruling of the Central Electricity Regulatory Commission (CERC), giving relief to the Tatas' and Adani's UMPP projects, come as a welcome addition to the power ministrys efforts to revive investor-confidence and restart the virtuous cycle of investment.

However, many of these fundamentally path-breaking measures will have to see actual implementation and an impact across the entire value chain, viz. from generation to distribution, before the sector can be deemed to have indeed metamorphosed structurally. In addition to the problem of inadequate fuel, there remain structural weaknesses across the sector for two reasons.

First, anticipating the relentless need for power in a growing economy, a large number of Indian groups ventured into this sector, including many who were historically inexperienced in managing such long-gestation infrastructure projects. Several over-stretched themselves by bidding aggressively, overlooking the risksthe chief one being the price of imported coal, not factored at the time of bidding. Companies, therefore, faced a situation of open-ended losses. The sector's capital intensive nature, however, meant that once a project was more than 80 % complete, it was better to run it and make losses in the hope of an ultimate resolution by an offsetting regulation, rather than leave it idle or abandon it. Doing so, for the last 2 years, has already seriously weakened the balance sheets of most large infrastructure companies in the power space. Reflecting the weakened balance sheets of the sector, financial distress in this space is acute, with over 19% of the advance to power-sector companies being restructured at the end of March 2013, which is nearly four times the number three years ago. However, merely restructuring a companys loan obligations does not imply that it will become financially viable.

However, as expected, the recent rulings by regulatory bodies like the CERC to mitigate the increase in cost of imported coal by a matching increase in tariff of electricity sold by these projects should offer some remedy.

Another problem is the losses of the buyers, the distribution companies (or discoms) amounting to more than R75,000 crore (as of March 2012). In a politically strong move, the government has made it possible for discoms (via state regulators) to submit their tariffs petitions every year and increase the tariff charged to end-consumers, reflecting their own costs of procurement. Several discoms had obtained regulatory permission to pass on higher tariffs to customersover the past two years, as many as 23 states and 5 UTs have actually increased tariffsby well over 10%. All this has happened at a time of slow growth within the manufacturing sector, which has dropped from 9.7% in 2011 to 1.0% in 2013. As a result of all these factors, we have moved from a situation where the newly set up power plants, actually have enough coal, but operate at Plan Load Factors of 67% or so, way below the ideal of 85% of their normative capacity. This meansnotwithstanding the possibility that over a period of 2-3 years, they will put their coal pricing woes behind themthese plants are still unlikely to be particularly profitable.

If the material improvement of balance sheets of power companies will depend on higher economic growth as well as on discoms actually turning economically self sufficient and fuel related issues getting sorted, this could be a time-consuming process, taking anywhere from 24 to 36 months.

Given this background, we need to enquire whether it is likely that the capacity addition required under the ongoing 12th Planof over 75 GW, expected to require investment of over

R12 lakh croreswill take place. Since decisions pertaining to investment in large infrastructure projects are taken years before the event, would the sector-watchers give these reforms a thumbs up right away, or simply wait to see how the tangled web of regulatory change unravels During periods of high growth, wishful thinking can sometimes tempt investors to invest in sectors whose risks remain unknown or unquantifiable. Unfortunately, in the case of the power sector the challenges are known and their financial implications easily quantifiable. The fundamental uncertainties of these projects requires strategic investors with longer-term horizons and deep pockets, such as pension funds. Though there

are a few green shoots of investment, such as the Infrastructure Debt Fund of the IL&FS which successfully raised R1,500 crore in 2013 from insurance and pension funds abroad, the large mass of investors are unlikely to make investments until the impact of the good intentions on fuel-supply, tariff certainty and regulatory approvals is actually visible on the ground.

A common feature of the Indian policy-making establishment is delayed action. It seems likely these reforms will bear fruit only when growth gets back to the 6%-plus level and the balance-sheets of the power companies strengthen. The incoming government will need to address this issue, if it is to achieve a full consummation of the very creditable efforts that have been initiated in the last two years.

Govind Sankaranarayanan

The author is CFO & COO, Corporate Affairs, Tata Capital Financial Services Limited. Views are personal