Utilities- India - Merchant malaise.: Kotak Securities

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Utilities  
India 
Merchant malaise. Merchant tariffs continue to maintain their downward trajectory in
October averaging Rs4/kwh in bilateral trades. Growth in energy requirement has
lagged availability, thus further narrowing the demand-supply gap—currently energy
deficit stands at 6.5%. Although the forward curves show an improved realization in
the short-term markets from January, our estimate of Rs4.5/kwh in FY2012E may carry
downside risks.


Short-term tariffs continue to remain weak across segment
An extended monsoon season carried with it the sluggishness in short-term rates with bilateral
tariffs averaging Rs4/kwh in October 2010, 18% lower than Rs4.9/kwh in 2QFY11. Exchange rates
and UI charges, which contribute 19.2% and 39.5% of the short-term market, had average rates
of Rs2.76/kwh and Rs2.27/kwh (NEW Grid) and Rs3.25/kwh (SR Grid), respectively. We note that
the forward curve in October and November does suggest improved realizations in the coming
months, though highlight that the curve has been revised downwards over the past one month
(see Exhibit 2). Meanwhile, forward curve for October and November also indicates a relatively
stable short-term rate (bilateral) in 4QFY11E.

Growth in energy requirement lags availability, narrowing the demand-supply gap
Energy deficit in November came down to 6.5% continuing its declining trend seen over the past
few months. As highlighted previously, the decline in energy deficit is as much attributable to
increased availability (+5.1% yoy) as it is to a sluggish demand growth (+2.2% yoy). Sluggish
demand can be attributed to extended monsoon that (1) curtailed industrial production—IIP has
come down to 10.8%, (2) lowered demand from agricultural segment as dependence on pumpwater decreased, and (3) most importantly, increased load shedding by the state electricity boards,
which continue to be faced with an increased subsidy burden. Exhibit 3 highlights the demand of
power from various consumer segments.

Near-term earnings risk remains high
We currently factor average merchant rates of Rs4.5/kwh for FY2012E, which may be at risk given
the sharp deterioration in merchant tariffs, and maintain a cautious stance on the sustenance of
the current premium that merchant tariffs enjoy. Private utilities such as Jindal Steel and Power,
JSW Energy, Lanco and Adani (in that order) have a higher exposure to merchant sale as a
proportion of their overall project portfolio. Exhibit 4 highlights the share of merchant sale in
overall portfolio for each of these companies.

Short-term market contributed 8.9% of total generation; expect exchanges to gain prominence
Short-term markets contributed ~8.9% of the total generation in October 2010, having transacted
6,246 MU out of total electricity generation of 70,558 MU during the period. Out of the total
electricity traded in the short-term market, ~41% (2,574 MU) was through bilateral trades, 19.2%
(1,202 MU) was traded through power exchanges, while the balance sale was through the
unscheduled interchange (UI) mechanism (refer Exhibit 1). We expect the sales mix in the shortterm market to shift in favor of power exchange, as longer duration contracts gain prominence
and dependence on the UI mechanism reduces on account of high penal charges and better load
management