Is revival on the cards for the Indian power sector? - Quoted in The Mint Asia

For 16 months since January 2012, there hadn’t been a single private equity investment in Indian power utilities that use conventional fuel such as coal and gas to generate electricity, so hope flickered in April on the likelihood that JP Morgan Asset Management may buy a stake in Diligent Power Pvt. Ltd.

 

Diligent Power, a unit of the publishing house, Bhaskar Group, may get $150 million for selling the stake to the US-based money manager, Mint reported on 13 April, citing a person familiar with the development and an investment banker, both of whom requested anonymity.

 

The company is developing coal-based generation capacity of 6,400 megawatts (MW), which includes a 1,200MW project in Chhattisgarh and a 1,320MW plant in Madhya Pradesh. The size of the stake it may sell couldn’t be ascertained.

 

To be sure, one swallow does not a summer make, and $150 million is, after all, a small investment, if indeed it comes to pass. But the promise of a return of investor interest, dovetailed with other positive tidings, have generated optimism that the power sector is set to turn the corner.

Also in April, the Central Electricity Regulatory Commission (CERC), through separate orders, allowed Adani Power Ltd and Tata Power Co. Ltd to charge higher prices for electricity generated by their plants in Mundra, Gujarat, to offset losses incurred on account of an increase in the price of imported coal and scarcity of domestic coal.

 

The orders could pave the way for similar compensation to other power projects in the country, including Reliance Power Ltd’s imported coal-based project in Krishnapatnam, Andhra Pradesh.

“After having gone through a tough time over the last couple of years, the Indian power sector is showing signs of recovering over the next 12 months through policy interventions, debt restructuring initiative, tariff hikes and progress on imported coal issue of Tata and Adani,” said Sambitosh Mohapatra, an executive director at the Indian unit of PricewaterhouseCoopers LLP.

 

“Buoyed by a large financial restructuring package, and the central government coordinating actively with all stakeholders, the financial condition of the state utilities is set to improve, which will have a cascading effect on the entire sector,” Mohapatra said.

 

Tough times may be an understatement to describe the travails experienced by Indian power producers in the past two years.

 

They have endured an economic downturn and high borrowing costs; a funding crunch amid delays in land acquisition and project approvals such as environmental clearances; lack of power purchase agreements; fuel shortages that increased the dependence on imports of coal, and then an increase in the price of foreign coal.

 

Some 9% of India’s installed power generation capacity of 223,344MW is fuelled by gas and 58.3% is based on coal. The country faces a peak-hour power shortage of 8.7%, causing distribution firms to ration supply to industrial and household consumers in several parts of the country.

Key to economic growth

Power plants have been operating below production capacity because of the inability of state-owned Coal India Ltd to meet demand and declining gas production from Reliance Industries Ltd’s D6 block in the Krishna-Godavari basin, the country’s largest reservoir of gas.

 

The importance of the power sector for Asia’s third largest economy, which, in the year ended March, is estimated to have grown 5%—its slowest pace in 10 years—was shown in a report card published in February on the completion of 100 days in office by power minister Jyotiraditya Scindia.

“India’s investment cycle is inextricably linked to the power cycle, as 30% of our capex is determined by the power sector. To get the Indian economic juggernaut rolling, we need to re-energize and refocus the investment in power sector,” the report said. Capex is short for capital expenditure.

 

The power sector is the biggest consumer of coal, absorbing 78% of domestic production. In the year ended 31 March, Coal India missed its production target of 468 million tonnes (mt) by 12 mt, although output increased 5.8% year-on-year. It failed to meet production targets in the preceding two fiscal years as well, although output did increase.

 

Coal demand in India is expected to grow from 649 mt a year now to 730 mt a year in 2016-17, making the country heavily dependent on more expensive, imported coal, given that the projected local availability is only 550 mt per year.

 

The concern on fuel shortages was articulated by the annual Economic Survey presented in February. It said: “The short-run action needed to remove impediments to implementation of projects in infrastructure, especially in the area of energy, includes ensuring fuel supply to power stations, financial restructuring of discoms.” Discoms is short for power distribution companies.

Last year, the government mandated Coal India to sign fuel supply pacts with power companies and meet at least 80% of the domestic demand for the mineral from the power sector. A total of 143 such pacts have to be signed by the company by 2015, out of which 55 have so far been inked, Mint reported on 8 April.

 

With the ministry of power engaging with the ministry of coal and Coal India to improve fuel supply, the state-owned miner has recently started signing fuel supply agreements with power developers, said Mohapatra of PricewaterhouseCoopers.

 

That, coupled with the regulator’s decision to allow power producers to pass on the cost of imported fuel to customers, will come to the rescue of so-called ultra-mega power projects, capable of generating at least 4,000MW, that had been “looking at large losses due to unrecoverable fuel costs”, he said.

Sourcing fuel

In order to bail out gas-fuelled power projects, the government is also working on a plan to allow them to import the fuel and pass on the incremental cost as higher charges.

 

In addition, the power ministry is also working on a so-called peaking power policy for gas that will encourage power distribution companies to invite bids from generation utilities for meeting power shortages during peak consumption hours.

 

“While some of the competitively bid projects have had challenges and they could have had doubtful economic viability, there has been new hope in light of the compensatory tariffs that the national regulator has agreed to in light of high coal procurement costs from Indonesia,” said Dipesh Dipu, a partner at Jenissi Management Consultants, a Hyderabad-based resources-focused consultancy.

 

“This has been done by the regulator citing national interest in light of the large investments already made in these assets, whose failure could lead to a chain reaction and a systemic risk,” he said.

 

Indonesia introduced policy changes in 2011 aimed at gaining higher revenue from its coal sector, making the mineral more expensive for import by Indian firms that had invested in the South-east Asian country’s coal sector.

 

These steps will help kick-start idling gas- and coal-fuelled power generation capacity. India is targeting a capacity addition of 88,537 MW in 2012-17, of which 72,340MW will be fuelled by coal.

“There has been significant generation capacity addition in the last few years. Once the fuel issues are sorted out, the sector can cater to the needs of the Indian economy, which is expected to bounce back to a higher growth path in the next two years. A policy allowing domestic coal and gas projects to pass through tariff increases in their fuel costs is being debated and if implemented would help independent power producers,” said Debasish Mishra, senior director at Deloitte Touche Tohmatsu India Pvt. Ltd.

 

Indian domestic consumers in 16 states are paying at least Rs.4 per unit for power and in some cases even more, according to data collated by Deloitte for Mint. This has challenged the long-held axiom that raising tariffs is nearly impossible in India because of political compulsions.

 

“All state-owned electricity utilities have (made) substantial increases in consumer tariffs in the last 18 months. This has helped their financial position from deteriorating further. Finally, there seems to be political acceptance that utility tariff increases will have to match with the increase in their input costs,” said Mishra.

Pricing power

According to the analysis by Deloitte, the tariff comparison was made for domestic households consuming 300 units (kilowatt hours, or kWh) on average every month on a minimum load of 4 kilowatts.

 

“People have realized the importance of discoms being financially viable,” said P. Uma Shankar, India’s power secretary. “The debate has now turned towards the quality of service.”

 

Twenty-three states and five Union territories increased electricity tariffs in the last fiscal, ranging from a 2% increase in Karnataka to a 73% jump in Tripura. Also, in a repeat of the last fiscal year, eight states, including Punjab, Gujarat and Bihar, and one Union territory have gone in for another round of increases in the current year.

 

“Tariffs in India have not been reflective of cost structures for some time and they are further distorted by cross-subsidies. Attempts to rationalize the tariffs and make them cost reflective are in the right direction,” said Dipu of Jenissi Management Consultants.

 

“Several states have been looking at the possibilities of aligning tariffs with costs of power procurements even in light of their political challenges, which is a progressive trend. Increasingly, sections of the consumers have also realized that higher tariffs with better quality of supply are in their interest and, hence, the decisions by state-owned utilities to hike tariffs have not been resisted so strongly as may have been expected, given Indian consumers’ price sensitivities,” he said.

 

With attempts being made to bridge the gap between the cost of electricity procurement and tariff realization, the other states and Union territories that are expected to raise tariffs are Tripura, Tamil Nadu, Kerala, Maharashtra, Jharkhand, Goa, Chandigarh, Chhattisgarh, Uttarakhand, Karnataka, Assam and West Bengal. To be sure, not everyone is convinced that raising tariffs is the solution, given that losses on account of theft, transmission and billing inefficiencies are pegged at around 24.8% of the total.

 

“By increasing tariff indiscriminately, we are passing on the inefficiencies of the power sector to hapless consumers,” said a government official, requesting anonymity.

 

Former power secretary Anil Razdan said, “Fuel pass-through is a realization thing, but at the same time the regulator should take a monthly or bi-monthly review of AT&C (aggregate technical and commercial) losses. Tariff increase should not be the only direction.”

 

Many experts said more needs to be done to make the process of tariff revision fair and participatory.

“Improvement in quality of power supply and paying capacity in urban areas, along with the perception that payers get a fair hearing, has to be contrasted with the still very poor and variable supply of power in rural areas. Moreover, regulatory commissions are based in state capitals, leaving out many voices of protest,” said Ashwini Chitnis of Pune-based Prayas Energy Group, which analyses policy in the Indian power sector.

Fixing power distributors

The health of the power distribution sector holds the key to the success of generation projects in a sector seen as a key bottleneck in efforts to sustain and boost economic growth.

 

With attempts being made to bridge the gap between the cost of electricity procurement and tariff realization, the central government announced a bailout plan in September 2012 for discoms, which included regular tariff revisions as part of the conditions to be met.

 

What’s going to be key in turning around the power sector “will be the viability of the discoms”, power minister Scindia said. “Tariff revision is only one leg of that viability of the discoms.”

Under one of the most important policy initiatives of the government, state governments are to take over half the outstanding loans of state electricity distribution companies, and convert them into bonds, which would then be issued to banks backed by state government guarantees.

 

The remaining 50% debt was to be restructured by banks with a three-year moratorium, or a repayment holiday on principal repayments. Electricity distributors owe Rs.2 trillion to banks and other financial firms.

 

“Some of the worst utilities in the country are taking advantage of the short-term debt restructuring scheme announced by the central government,” said Mishra of Deloitte. “Once implemented, the financial condition of utilities in Uttar Pradesh, Rajasthan, Bihar, Haryana, Tamil Nadu, etc., will have considerable improvement.”

 

To make the financial restructuring plan attractive to the state governments and discoms, the debt will carry an interest rate of less than 9%. Ten states—Bihar, Andhra Pradesh, Haryana, Himachal Pradesh, Jharkhand, Kerala, Meghalaya, Rajasthan, Tamil Nadu and Uttar Pradesh—are already on board.

 

“These developments are positive signs for the power sector in India, leading to renewed investor interest,” said Amol Kotwal, associate director, energy and power systems practice, for South Asia at consulting firm Frost and Sullivan.

 

Many distribution utilities are saddled with losses arising from theft, besides transmission and billing inefficiencies. Some regularly bought expensive power to tide over short-term deficits and didn’t revise rates for years. According to a study conducted by energy consulting company Mercados EMI Asia for the 13th Finance Commission, the losses in 2014-15 are projected at Rs.1.16 trillion. The cumulative losses of the distribution utilities increased from Rs.1.22 trillion in 2009-10 to Rs.1.9 trillion as of March 2011. Their poor financial health is also on account of states not reimbursing them for the subsidy built into the price of power.

 

Apart from introducing a mandatory rating system for 65 state-owned distribution firms for streamlining lending to them, the government is preparing model legislation that may be adopted by the states to enforce discipline in the working of distribution firms. The Bill is being drafted in the backdrop of the financial restructuring plan.

Work in progress

On the policy front, the government has also started the process of providing full autonomy to the Power System Operation Corp. Ltd (Posoco), which is responsible for the reliable, secure and efficient operation of the power grid, to avoid a repeat of incidents such as India’s worst power outage last year.

 

The blackout left nearly 620 million people without electricity. On 31 July, the northern grid collapsed, and on 1 August, in a wider blackout, the northern, eastern and north-eastern grids broke down.

 

Experts said the the sector will also get a boost from the finalization of standard documents for case-I and case-II bids.

 

Bids for power projects are sought in two ways. In case-II bidding, such as for domestic coal-based power projects ranging up to 4,000MW, resources such as land, fuel and water linkages are identified and in some cases also provided to the developer quoting the lowest tariff.

 

In case-I bidding, the quantity and time period for power procurement are identified, but the fuel type, sources and the plant location are not specified.

 

“These documents for competitive generation, along with the alignment of the bidding documents for transmission projects with the new POC (point of connection) transmission regime, would really refocus the attention of the bidding community, both nationally and globally to reinvesting in India,” said Mohapatra of PricewaterhouseCoopers.

 

Turning around the power sector will, of course, be a long-haul project, but all the measures that have been put in place, if executed well, hold out the promise of regenerating one of the growth engines of the $2 trillion economy.

 

“I wouldn’t say that a lot of work has been done, but the wheels have been sort of put in motion now,” said power minister Scindia. “We are moving towards execution and conclusion on a number of issues.”

Link coal mining payout to royalty, not profits: panel - Quoted in the Mint

A parliamentary panel has recommended an overhaul of the compensation mechanism for people displaced and otherwise affected by coal mining operations by linking it to royalty payouts.

If the recommendation is accepted, coal miners will have to pay the displaced people compensation equal to the royalty they pay the government—a move that could have an impact not only on state-owned Coal India Ltd (CIL), but also on steel and power producers that have captive coal mines, and ultimately take its toll on consumers.

 

The compensation mechanism suggested by the panel for the coal sector is on par with that proposed for people affected by mining of other minerals such as bauxite and iron ore.

The parliamentary standing committee on coal and steel has recommended that this change be incorporated in the proposed Mines and Minerals (Development and Regulation) Bill, 2011, that will be taken up by Parliament. In the draft Bill, reviewed by the committee, the compensation has been fixed at 26% of profit after tax.

 

Since coal and non-coal miners typically pass the entire royalty burden to downstream consumers, such a move could raise the basic price of these minerals for end-users.

 

The panel headed by Kalyan Banerjee, a Lok Sabha member belonging to the Trinamool Congress, presented its report in Parliament on Tuesday, suggesting that in case of coal and lignite, the compensation formula be based on the royalty paid by miners during the fiscal year instead of the 26% of net profit that had been suggested earlier.

 

The proceeds would accrue to district-level panels that would be set up in areas where coal and other minerals are mined.

 

In July 2011, a group of ministers, while approving the draft Bill, said coal mining companies, including those that mine the mineral for captive use, should pay 26% of their profit net of taxes, while other mining firms should contribute an amount equal to royalty being paid by them during the fiscal year, for regional development.

 

The panel has also suggested several other key changes to the draft Bill. It said shares allotted by mining firms to affected people should be made transferable. According to the present draft, companies have to allot at least one share at par to each member of the affected families, but on a non-transferable basis. It also wants half the monetary benefits passed on to individual families to be handed to the eldest woman of the household, with the remaining distributed equally among the other members. The panel also suggested that granite be brought under the category of “major: minerals.

“This is a welcome step,” said Chintan J. Mehta, an analyst with Mumbai-based Sunidhi Securities and Finance Ltd. “If they (coal miners) were asked to share profits, it is possible that they would have under-reported the same.”

 

While the notified royalty rates on various grades of coking coal vary between Rs.115 and Rs.250 per tonne, the rates for non-coking coal vary between Rs.65 and Rs.85 per tonne. A royalty of Rs.50 per tonne is payable on lignite at present.

 

A top CIL official said that adopting a royalty structure to compensate displaced people would mean that the company would have to revise its prices upwards by at least 12%.

 

“At present, the royalty payout across all our subsidiaries is to the tune of Rs.10,000 crore. If this mechanism is implemented, the additional Rs.10,000 crore burden would be fully passed on,” this official said. He did not want to be identified.

 

CIL is the largest producer of coal in the world, and meets more than three-fourths of the country’s domestic needs.

 

Dipesh Dipu, an energy analyst and a partner at Jenissi Management Consultants, said that a 12% increase in the price of coal would typically mean that power tariffs would go up by around 7% on average.

 

Dipu further said that in case of integrated steel plants with captive coal mines, the royalty-based structure will have a greater impact on downstream prices of finished products. “Since royalty is paid on the actual volume of coal mined, the incremental costs will be passed on,” he said.

 

Steel Authority of India Ltd (SAIL), Tata Steel Ltd and Jindal Steel and Power Ltd are among steel firms that have significant captive coal capacities.

 

A Tata Steel official said that the company could not immediately respond to an email query seeking comment. An email query sent to a Jindal Steel spokesperson remained unanswered. A phone call made and a text message sent to SAIL chairman C.S. Verma remained unanswered.

 

Firms that mine metals such as zinc, aluminium and manganese may have to take a hit as they may not be able to pass on incremental cost increases to downstream consumers.

 

“Major mineral companies like Hindustan Zinc can’t increase their price as it is market-linked. So if royalty increases, they have to take a hit on their profits. The same applies to other major mineral companies like Nalco (National Aluminium Co. Ltd), etc.,” said a Mumbai-based metals analyst, who declined to be identified.

 

Another Mumbai-based analyst concurred. “Most metal prices these days are market determined. Therefore the companies won’t be able to pass on the increased cost,” the second analyst said, also on condition of anonymity. “However, mining business is still profitable with sufficient cushion. I don’t think any mine is going to get closed because of this added burden. They will take a hit on their margins.”

Coal India may import 15 mt in 2013-14 to meet shortfall - Quoted in the Business Line

To meet shortfall in domestic coal supplies, Coal India Ltd may need to import nearly 15 million tonnes in 2013-14. This follows the Government decision on Monday that allowed the miner to fill the gap between domestic supplies and annual contracted quantity to power stations by imports.

The exact volumes to be imported would depend on demand from power stations, which is reviewed every quarter.

 

“Since the Government has also kept the window open for power companies to import by themselves, Coal India would seek their view,” said S. Narsing Rao, Chairman and Managing Director, Coal India.

 

Rao said the company would appoint a Government agency to import on its behalf in the current financial year.

 

“May be from next year, we may look at importing ourselves,” he added.

After 2009, Coal India has 61 new fuel supply agreements (FSA) that account for 24,300 MW, for which it will have to import coal to meet the gap in supply.

 

The miner would need additional 89 million tonnes to feed these power plants. This is excluding nearly 14,500 MW of projects run by NTPC and its joint ventures, which are also in queue to seal supply pacts.

 

Coal India, in the FSA, said it would supply 80 per cent of a power plant’s requirement. Of this, 65 per cent would be from its mines and the balance imported.

 

Industry observers are of the opinion that opting for cost-plus pricing (means landed price of imported coal plus transportation charges and local levies) for coal supply to power utilities is a transparent way of addressing fuel supply issues, instead of pool pricing.

However, the increase in electricity rates in line with higher cost of imported fuel would have to be seen. 

Cross-subsidy

“Question remains whether power tariff increase could be a politically accepted move, especially with the elections slated for 2014,” said Amol Kotwal, Deputy Director, Energy and Power Systems Practice, Frost & Sullivan.

 

The price pooling mechanism, on the other hand, would not only create an element of cross subsidy but also makes the physical allocation of imported coal more challenging than just the weighted average price determination.

 

“The cost plus mechanism is simple, transparent and fair at large since the coal consumers pay for the imported coal that is physically delivered to them,” said Dipesh Dipu, Partner at Hyderabad-based Jenissi Management Consultants.

 

Under price pooling the average of imported and domestic coal price will be charged from the buyer. This would result in higher coal price.

 

In addition, the cost-plus mechanism also provides incentive for keeping a close watch on imported coal bills at power project levels, while price pooling could lead to greater consumption of imported coal since the costs could be spread across projects, said Dipu.

Public Private Partnership in Coal Mining in India - My Forum Contribution in Powerline magazine

What should be the structure of the proposed PPP framework with Coal India Limited to enhance domestic coal production? What checks and balances should be imposed to ensure a fair and transparent framework?

The public private partnership (PPP) in coal mining sector in India given the statutory and regulatory environment may well be a misnomer. The PPP structures with CIL as the key partner with ownership of coal mining assets and also owner of coal produced from these mines would leave PPP restricted to contract mining, which by definition would not be PPP. That said, however, contract mining would in itself be useful for enhancing capacities. It has been observed that in the past CIL and its subsidiaries have resorted to various kinds of contracts – from overburden removal to coal extraction – to enhance coal production, productivity and efficiency. So, the new PPP regime is likely to increase the scale and is unlikely to make any significant departures in terms of roles and responsibilities that haven’t been done yet.

The most likely structure that CIL would adopt would be outright contracts with the contract mining company having no ownerships in the project, no stake in the deposits and no rights over coal produced. This is similar to small scale coal production done in countries like Malaysia and Philippines, and contracts awarded by CIL itself as well as several electricity utilities that have been awarded captive coal blocks. The key factor here is the market depth. In the past there have been some participation of global contract miners but mostly the participation has been restricted to local players, typically in view of scope of work that have included activities such as land acquisition, rehabilitation and resettlement of project affected people, and mine development, operations and maintenance. Some of these are not typically included in the scope of work for contractors in global context and hence, obviously have led to global contract miners considering these projects too risky. The proposed PPP framework needs to take into account the shallow market depth and the risk perceptions of global contract miners to be able to enhance participation and hence to truly competitive.

The qualification parameters have played crucial role in success of contract mining tenders. With limited number of players with any significant coal mining experience, the qualification parameters have tended to be more inclined to keep stiff financial criteria and loose technical criteria. This also underscores the belief that a financially strong player can pull off a mining project. This is however not true. Coal mining projects are capital intensive and are challenging to manage in scope, time schedule, quality, risks and costs, and therefore have proven to be difficult even for deep pocketed participants in the contract mining tenders, causing substantial delays. The proposed PPP structure may need to correct this anomaly and focus significantly on qualification of players with proven capabilities in managing mining projects. It may be a good idea to keep the fields open for relatively smaller contractor miners for whom the time is ripe to scale up. From Indian experience in other infrastructure sectors including roads and power projects, the relatively smaller players of today may be well placed to grow and add value through their better comprehension of Indian mining risks and rewards pay-offs.

The other prudent measure required in the PPP framework is that of risk sharing between mine owners and the contract miners. The risks are asymmetric in several cases of contract mining and hence, many haven’t progressed as expected. Unreasonable risk aversion on part of the mine-owners may lead to the project becoming unviable sometimes right from start and sometimes in future, even though these may be well participated tenders. There are geo-technical risks that are not within reasonable control of the contract miners and the same should be recognized so and appropriately addressed in the contracts. The same may be true for several issues pertaining to land acquisitions and rehabilitation and resettlement. In several cases, these issues have been overlooked and risks have been totally pushed on to contract miners leading to untenable positions. Land acquisition in India has become unpredictable and there are cases of failures from public, private and PPP domains. The framework for PPP in coal mining needs to address the risks just as they are.

A transparent and fair process of evaluation is a must. The PPP proponents need to prepare well and make the projects marketable. At the same time, they need to establish an economic range for the project to operate. This will help the mine-owner assess if the bids are too expensive or too aggressive, neither of which are sustainable propositions. In place of a deep focus on lowest tender, the mine-owner needs to establish a set of evaluation parameters that gives due weightage to economic costs of operating a project along with the capabilities of the bidders. This would go well for a long term contract and the mine-owners wouldn’t have to face requests for “compensatory fees” nor would have to renegotiate fees due to “supernormal” profits being made by contract miners at the expenses of mine-owners.