Power - coal risk out weighs merchant risk; Edelweiss

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Impact from lower coal supplies higher than lower merchant sales

In view of Coal India (CIL) recently revising down its volume growth guidance to ~3%, we have analysed the impact of coal supply shortfall on power projects. Our analysis reveals 20% lower coal supply impacts NPV ~33%, which is greater than the ~12% impact of 20% lower merchant sales. Hence, we believe if a power developer is unable to generate power within the bid fuel cost levels, the earnings impact is higher, since the generator in addition to losing on merchant sales will also recover less fixed costs.

Fuel risk on the developer, for Case I bids

The analysis assumes significance as fuel risk is not a pass through in Case I bids. Even if there is an escalation clause for linkage coal and the developer manages to secure coal through e-auction or imports, he is unlikely to recover the cost of these spot market purchases (since escalation pertains only to domestic coal). Hence, earnings from Case 1 bids are at risk if developers do not secure fuel (both quantity and price) within bid levels, especially to the extent of open market purchases.

Port capacities and higher blending could cope with coal shortage 

Our channel checks indicate that most of the current domestic linked coal-based power plants can operate with ~10-15% imported coal blending. If only the existing NTPC capacities (~27 GW that run on linkages) blend at 15% coupled with higher blending by new linkage-based power plants at ~20-30% (including the private sector), the 60 MT domestic coal shortfall in FY12 can be overcome by importing additional ~39 MT (~18 MT imported in FY11) of higher calorific coal, which we believe can be supported by adequate capacity at Indian ports (which can handle incremental ~119 MT of coal cargo). However, scaling up of rail infrastructure is imperative to ensure timely deliveries. The flipside is that if existing linkage-based plants continue at historical average PLF of 77% using only domestic linkage coal, incremental capacities may receive 50% of required linkage coal and the balance will have to be met via imports.

Lenders at risk even if coal supplies at 60% & without escalation clause

Our analysis highlights that power generation projects need to secure more than 60% of their fuel requirement (within cost limits as per tariff bids) to meet their debt obligations. Another option for developers is to bid for projects where complete fuel cost is pass-through / fuel risk is with customers. Failing this, the developer runs the risk of defaulting (as with only 60% fuel supplies and 20% power merchant sales, the project will incur losses, stressing cash flows, risking servicing of loan).

Current valuations focused only on risks to FY11 capacities

Our calculations reveal that in FY11, Navabharat Ventures and Lanco Infratech are the most impacted due to large component of merchant sales, and also JSW Energy, due to its sizeable exposure to spot coal purchases, which is reflected in their respective stocks’ recent correction. Moreover, based on FY13 capacities, even Adani Power is impacted, as ~60% of its coal requirement is based on linkages.