The capital markets seem to have returned to a growth trajectory with the Sensex touching a high of 16,000. The primary market is also seeing a flurry of activity with the power sector being the centre of action. Adani Power?s public issue has just closed with an overwhelming response from investors. An issue of the size of Rs 30 billion, which is large by all means, was subscribed almost 22 times, setting the pace for a rejuvenation of the IPO primary market post the lull of activity that we have seen for the last year or so. This is being followed up by another public issue of the public sector major NHPC.
Given the deficit scenario of power in India, with a peak deficit of 12% and normative deficit of 9-10%, investor interest in power sector IPOs is understandable. Within this gamut of power producers, analy-sing the value drivers and risks for hydropower players is particularly interesting given their renewable, economical, non-polluting and environmentally benign nature.
Hydropower plants encur no fuel costs, thus having an advantage over fuel-based power plants, which have to live with issues concerning price fluctuations. They also have a long life, extending to over 50 years. It is relevant to note that of the overall power generation capacity of the country, which is about 1,49,000 mw, about 25% is contributed by the hydropower sector. The government has taken specific policy initiatives aiming to attract private funds by encouraging joint ventures with private developers and the use of independent power producer model, besides promoting power trading and speeding up the availability of statutory clearances.
The large hydro-electric developments include a reservoir where excess of water in one season is stored for producing electricity during lower water flow season. Such stations have the inherent ability for instantaneous starting, stopping, load variations, and hence are the best choice for meeting the peak demand.
Tariffs charged are typically governed by the relevant power purchase agreements (PPA)/applicable merchant tariffs. For a PPA-based offtake of power, tariffs are determined in accordance with Central Electricity Regulation Commission (CERC) regulations. These regulations provide for a specified return on equity of 15.5%, subject to a specified level of plant availability. This may get enhanced by charges for excess energy (energy generated in addition to the design energy), incentives for higher than normative plant availability and possible eligibility for certified emission reductions. This could lead to an equity return, which is relatively higher than the specified CERC return of 15.5%. In the current context where the merchant tariffs prevailing in the market are significantly higher than CERC equivalent tariffs, a project?s economics gets a further boost depending on the level of merchant power sales it is able to realise.
Some of these large projects, particularly in the private sector, are structured by entering into an implementation agreement with respective state governments. A certain percentage of power produced is payable as royalty to the state government and the assets of the project after a certain period are transferred to the state government.
Further, the impacts of dams include displacement of local population and the impact on ecosystem. There are inherent risks, in terms of a delay in implementation and escalation in costs, due to rehabilitation, environmental and political issues and due to the need for obtaining various clearances. The economic and social costs associated with the rehabilitation and resettlement of the population affected by the submergence of land can be significant.
Considering the environmental impact and rehabilitation issues related to large hydroelectric projects, other viable alternatives are being considered such as run-of-the-river projects, which harness hydroelectric potential without building dams and reservoirs. Projects up to 25-mw capacity are generally identified as small hydro projects (SHP). These are especially suited for remote areas as decentralised sources of power. Small and mini hydel projects have the potential to provide energy in remote and hilly areas where extension of an electrical transmission grid system is uneconomical. They have little impact on ecology. The government has identified over 4,000 prospective sites, with a total potential of over 15,000 mw, to set up small hydel plants (up to 25 mw).
Of late, small hydropower stations are gaining momentum?they need smaller investments, have short gestation period, grid isolated power solution and have lesser conflict with social issues. Government has also taken initiatives to involve private developers by formulating a long-term policy for encouraging the development of small hydro schemes. Ministry of new & renewable energy sources and various state governments offer attractive plans and incentives for faster development of SHP up to 25 mw.
Most states have promulgated model PPAs (with pre-specified power tariffs) for small hydro projects, which helps in expedited implementation. One key value driver, in the current context of deficit power scenario and prevailing high merchant tariff rates, is the possibility of selling the power produced on a merchant basis within the constraints of the power purchase agreement.
Most small hydro sites are ungauged, hence there is a lack of basic hydrological data. Cost of the system is highly site specific and there is a lot of variation in the estimate. Further, production of power from mini hydro is directly dependent on the occurrence of rains in a particular year. Sometimes production of power realised in a particular year is better than production achieved historically and may not be sustainable.
Substantial activity in capital markets and a positive policy environment seem to augur well for this sector. At the same time, one has to keep the issues highlighted above in consideration while analysing and evaluating such projects.
?The writer is associate director, Ernst & Young transaction advisory services. These are his personal views