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India: Utilities: Power - Generation
Equity Research
SEB Health-check 2: Uttar Pradesh: Another bailout on the cards?
UP: 16% of population; 75% of rural houses yet to be electrified
Continuing with our state electricity board (SEB) health-check series, we
analyze the finances of UP state distribution companies, which currently
purchase about 7% of total power generated in India. We believe UP discoms
have high potential to absorb incremental power supply and their financial
health is critical to UP state finances, generators and lenders, in our view.
Accumulated losses of about US$8 bn as of FY10 and counting
We believe accumulated losses are primarily due to: 1) revenue gap, and 2)
collection inefficiencies (AT&C losses of about 40% vs India average of 26%).
As per FY10 ARR, it appears UP is incurring an annual cash loss of US$1.0-1.2
bn, and with tariff hikes looking unlikely till assembly elections in mid-2012,
we believe losses could increase further by about US$2 bn till end-FY12E.
Tariffs not populist; losses appear largely ‘unrecoverable’ by hikes
In absence of audited accounts since FY06 and with the regulator ruling that
consumers cannot be burdened with bad debts, accumulated losses appear
largely ‘unrecoverable’, in our view. Tariff hikes to recover earlier losses seem
unlikely as current tariffs are not populist (UP agri-tariff is among the highest in
India) and potential hikes, if any, should reflect rising fuel costs, in our view.
Another bailout of US$5-6 bn is critical
UP discoms have debt of about US$3 bn as of FY09 drawn primarily to fund
cash losses, and with more debt likely for cash losses in FY10-FY12E, which
appear largely ‘unrecoverable’, we estimate a state bailout of US$5-6 bn (5.6%
of FY12E GSDP; 66% of UP’s own tax revenues), in line with earlier bailouts in
2000 and 2003, is critical to clean up the balance sheets of UP discoms.
R-APDRP and more power supply should help reduce cash losses
Franchise distribution, the R-APDRP scheme, and more sales to industrial
customers leveraging incremental power supply should help improve the
finances of UP discoms, in our view.
Lanco (C-Buy), RPWR (C-Sell), NTPC, NHPC have exposure to UP
UP discoms, since 2003, have not defaulted to generators and the key risks
with deteriorating finances are higher receivables and lower utilization levels,
in our view. We have reflected the risk to utilization levels (80% vs consensus
of 85%) into our FY12E EPS for Lanco (C-Buy), NTPC and NHPC (both Neutral).
Revenue gap + collection inefficiencies = accumulated losses;
another bailout on the cards?
Uttar Pradesh (UP) state power distribution companies (discoms) have accumulated losses
of about US$8 bn (Rs350 bn) as of FY10, which we believe are primarily on account of: 1)
revenue gap (revenue per kwh is less than average cost of supplying to the customer), and
2) high commercial losses.
It appears unlikely that these losses could be recovered through tariff increases, in our
view, due to the following reasons:
1) No ‘true up’ petition (substantiating the need for recovery of losses for earlier years) has
been filed by UP discoms with the regulator and no audited accounts have been provided
since FY06;
2) UP discoms managed to collect on average only 80% of its annual revenue during FY05-
FY09 (see Exhibit 3), or in other words it could not recover about 20% of its revenues/15%
of its annual cost of power purchase. As these losses were due to collection inefficiencies
of the UP discoms, the regulator consistently has not allowed them to pass it through to
end-consumers.
Further, with the tariff petition for FY11 (for the period April 2010 to March 2011) and FY12
just filed, we estimate the revenue gap for FY11 would be similar to that of FY10 (US$1.0-
1.2 bn) despite a 13% hike in tariffs in April 2010. With impending state assembly elections
in 2012, we believe the discoms may not propose any tariff hike for FY11 and FY12.
Considering these losses plus the cost of their funding, we estimate that a state
bailout of US$5.0-6.0 bn (5.6% of FY12E GSDP; 66% of UP own tax revenues), in line
with earlier bailouts in 2000 and 2003, is key to clean up the balance sheets of UP
discoms.
As per the Comptroller and Auditor General’s report, the UP government pursuant to the
Uttar Pradesh Power Sector Reform Transfer Scheme had written off in January 2000,
Rs210 bn (about US$4-4.5 bn) of assets and liabilities primarily relating to assets not in use,
intangible assets, deferred cost, receivables from GoUP on account of sale of power, other
trading receivables, liabilities on account of reserves, grants and Government of UP loan.
Further, the UP government through the Power Policy, 2003, undertook another round of
financial re-structuring. The key highlights of this restructuring were:
The power purchase payables to Central Generating Stations of about Rs60 bn
have been securitized as per the recommendations of the GOI Expert Group and
GoUP deciding to service this liability directly without any corresponding burden
on the sector.
GoUP and the sectoral companies have rescheduled the loans to LIC (Rs17 bn) and
REC (Rs14 bn) at an IRR of about 8%.
GoUP has taken over the pension liabilities of UPPCL employees amounting to
Rs14 bn
Significant difference between ‘booked’ and ‘allowed’ revenue gap
As a normal practice, a distribution utility files a ‘true up’ petition based on actual revenue
and costs incurred during the assessment period and provides documentary evidence to
recover the costs (through tariff hikes in the next period) previously not assumed or
disallowed by the regulator.
However, UPPCL and its distribution utilities have not filed any ‘true up’ petition so far and
the difference in revenue gap as claimed by UPPCL and the regulator continues to remain
without any roadmap for its recovery. In the absence of audited accounts/little
documentary evidence provided to the regulator for recovering actual costs booked by it,
we think the revenue gap of UPPCL appears to be largely “unrecoverable” (which is
funded through borrowings).
On analyzing the FY10 tariff petition, the difference in the revenue gap computations
of UPPCL and the regulator is about US$1.2 bn and line items responsible for the
difference are as follows:
Revenue: While units sold as per UPPCL and the regulator are almost similar, the primary
difference in the revenue line is on account of consumer mix. UPPCL has reflected higher
sales to the rural category, but the regulator has disallowed these sales in the absence of
historical data and adequate documentation and accounted them as sales to industrial
units, the realization for which is about Rs5.6/kwh against the realization of Rs2/kwh to rural
and agricultural customers.
Interest expense: The regulator disallowed interest on loans that are attributable for
funding the working capital requirements and allowed only normative working capital
which takes into account 2 months of receivables. Further, UPPCL on its own had not
claimed interest of Rs9 bn on account of working capital borrowings of the individual
discoms.
Power purchase costs: UPPCL has budgeted for about 1,724 MU’s at Rs6.70/kwh for
plugging the power supply deficit through short-term power purchases. The regulator
allowed the power purchases only at Rs5.0/kwh and issued a specific directive to use
power exchanges for procurement of short term power for more transparency.
Others: The regulator disallowed any provision for bad debts citing the write-offs were not
pursuant to any policy on bad debts and lack of details of the consumers whose dues are
written off.
Collection inefficiencies: Regulator assumes 100% realization, while
actual realization falls short by 20%
AT&C losses are the summation of technical and commercial losses. While the UP
regulator allows technical losses (i.e. transmission and distribution losses) to be built into
tariff, it assumes 100% collection efficiency (i.e., does not allow any commercial losses to
be built into the tariffs) and that the consumer will not be burdened with costs arising from
bad debts. Although UP AT&C losses are showing a declining trend since FY05 (primarily
reflecting the decline in technical losses), there is no meaningful reduction in the
commercial losses (refer to Exhibit 11) resulting in cash losses for the UP discoms.
Our interactions with UPPCL officials and the regulator indicate that: 1) shortage of staff at
the field level; 2) obsolete technology used for collecting receivables; 3) lack of awareness
(or intent) among the rural and agricultural households to pay for the power consumed; 4)
billing to non existent consumers; and 5) political considerations limiting legal options for
recovery of dues, are the primary reasons for the commercial losses remaining high.
UP has about US$1.7 bn in receivables as of FY09 and the UPPCL board has recently
introduced a one-time settlement scheme for the rural and household categories. Our
interactions with the board officials indicated that they received about 10%-15% of the
existing outstanding receivables on account of this scheme and expect some portion of the
remaining receivables also to be recovered.
In November 2008, however, the government decided to hand over power distribution
(under a franchise model) in nine cities to private companies. Torrent won bids for Agra
and Kanpur, while there has been no response so far for the other seven: Bareilly,
Gorakhpur, Varanasi, Allahabad, Moradabad, Meerut, and Aligarh.
We think the UP AT&C losses would likely decline gradually on account of the following
measures:
1) Entry of the private sector in managing discoms would help improve transparency and
thus increase the level of accountability; and
2) Implementation of R-APDRP program over the medium term. The scheme shall be taken
up in two parts. Part-A shall include the projects for establishment of baseline data and IT
applications for energy accounting/auditing and IT-based consumer service centre. Part-B
shall include regular distribution strengthening projects.
With limited ability to increase tariffs, change in consumer mix
should help mitigate revenue gap, in our view
Our interaction with UPPCL officials indicated that there is demand for about 3,000-
4,000MW from industrial customers and we believe incremental power supply (particularly
from IPP’s such as Lanco’s Udupi and Reliance Power’s Rosa) could cater to these
customers. With realization from industrial customers at about 134% of the cost of service,
UPPCL expects the revenue realization to improve going forward. However, with more
villages getting connected to the grid and load cuts still prevalent in rural areas, we are
unsure whether the regulator would allow UPPCL to service the industrial customers at the
expense of its low-paying customers such as the rural and agricultural segments
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India: Utilities: Power - Generation
Equity Research
SEB Health-check 2: Uttar Pradesh: Another bailout on the cards?
UP: 16% of population; 75% of rural houses yet to be electrified
Continuing with our state electricity board (SEB) health-check series, we
analyze the finances of UP state distribution companies, which currently
purchase about 7% of total power generated in India. We believe UP discoms
have high potential to absorb incremental power supply and their financial
health is critical to UP state finances, generators and lenders, in our view.
Accumulated losses of about US$8 bn as of FY10 and counting
We believe accumulated losses are primarily due to: 1) revenue gap, and 2)
collection inefficiencies (AT&C losses of about 40% vs India average of 26%).
As per FY10 ARR, it appears UP is incurring an annual cash loss of US$1.0-1.2
bn, and with tariff hikes looking unlikely till assembly elections in mid-2012,
we believe losses could increase further by about US$2 bn till end-FY12E.
Tariffs not populist; losses appear largely ‘unrecoverable’ by hikes
In absence of audited accounts since FY06 and with the regulator ruling that
consumers cannot be burdened with bad debts, accumulated losses appear
largely ‘unrecoverable’, in our view. Tariff hikes to recover earlier losses seem
unlikely as current tariffs are not populist (UP agri-tariff is among the highest in
India) and potential hikes, if any, should reflect rising fuel costs, in our view.
Another bailout of US$5-6 bn is critical
UP discoms have debt of about US$3 bn as of FY09 drawn primarily to fund
cash losses, and with more debt likely for cash losses in FY10-FY12E, which
appear largely ‘unrecoverable’, we estimate a state bailout of US$5-6 bn (5.6%
of FY12E GSDP; 66% of UP’s own tax revenues), in line with earlier bailouts in
2000 and 2003, is critical to clean up the balance sheets of UP discoms.
R-APDRP and more power supply should help reduce cash losses
Franchise distribution, the R-APDRP scheme, and more sales to industrial
customers leveraging incremental power supply should help improve the
finances of UP discoms, in our view.
Lanco (C-Buy), RPWR (C-Sell), NTPC, NHPC have exposure to UP
UP discoms, since 2003, have not defaulted to generators and the key risks
with deteriorating finances are higher receivables and lower utilization levels,
in our view. We have reflected the risk to utilization levels (80% vs consensus
of 85%) into our FY12E EPS for Lanco (C-Buy), NTPC and NHPC (both Neutral).
Revenue gap + collection inefficiencies = accumulated losses;
another bailout on the cards?
Uttar Pradesh (UP) state power distribution companies (discoms) have accumulated losses
of about US$8 bn (Rs350 bn) as of FY10, which we believe are primarily on account of: 1)
revenue gap (revenue per kwh is less than average cost of supplying to the customer), and
2) high commercial losses.
It appears unlikely that these losses could be recovered through tariff increases, in our
view, due to the following reasons:
1) No ‘true up’ petition (substantiating the need for recovery of losses for earlier years) has
been filed by UP discoms with the regulator and no audited accounts have been provided
since FY06;
2) UP discoms managed to collect on average only 80% of its annual revenue during FY05-
FY09 (see Exhibit 3), or in other words it could not recover about 20% of its revenues/15%
of its annual cost of power purchase. As these losses were due to collection inefficiencies
of the UP discoms, the regulator consistently has not allowed them to pass it through to
end-consumers.
Further, with the tariff petition for FY11 (for the period April 2010 to March 2011) and FY12
just filed, we estimate the revenue gap for FY11 would be similar to that of FY10 (US$1.0-
1.2 bn) despite a 13% hike in tariffs in April 2010. With impending state assembly elections
in 2012, we believe the discoms may not propose any tariff hike for FY11 and FY12.
Considering these losses plus the cost of their funding, we estimate that a state
bailout of US$5.0-6.0 bn (5.6% of FY12E GSDP; 66% of UP own tax revenues), in line
with earlier bailouts in 2000 and 2003, is key to clean up the balance sheets of UP
discoms.
As per the Comptroller and Auditor General’s report, the UP government pursuant to the
Uttar Pradesh Power Sector Reform Transfer Scheme had written off in January 2000,
Rs210 bn (about US$4-4.5 bn) of assets and liabilities primarily relating to assets not in use,
intangible assets, deferred cost, receivables from GoUP on account of sale of power, other
trading receivables, liabilities on account of reserves, grants and Government of UP loan.
Further, the UP government through the Power Policy, 2003, undertook another round of
financial re-structuring. The key highlights of this restructuring were:
The power purchase payables to Central Generating Stations of about Rs60 bn
have been securitized as per the recommendations of the GOI Expert Group and
GoUP deciding to service this liability directly without any corresponding burden
on the sector.
GoUP and the sectoral companies have rescheduled the loans to LIC (Rs17 bn) and
REC (Rs14 bn) at an IRR of about 8%.
GoUP has taken over the pension liabilities of UPPCL employees amounting to
Rs14 bn
Significant difference between ‘booked’ and ‘allowed’ revenue gap
As a normal practice, a distribution utility files a ‘true up’ petition based on actual revenue
and costs incurred during the assessment period and provides documentary evidence to
recover the costs (through tariff hikes in the next period) previously not assumed or
disallowed by the regulator.
However, UPPCL and its distribution utilities have not filed any ‘true up’ petition so far and
the difference in revenue gap as claimed by UPPCL and the regulator continues to remain
without any roadmap for its recovery. In the absence of audited accounts/little
documentary evidence provided to the regulator for recovering actual costs booked by it,
we think the revenue gap of UPPCL appears to be largely “unrecoverable” (which is
funded through borrowings).
On analyzing the FY10 tariff petition, the difference in the revenue gap computations
of UPPCL and the regulator is about US$1.2 bn and line items responsible for the
difference are as follows:
Revenue: While units sold as per UPPCL and the regulator are almost similar, the primary
difference in the revenue line is on account of consumer mix. UPPCL has reflected higher
sales to the rural category, but the regulator has disallowed these sales in the absence of
historical data and adequate documentation and accounted them as sales to industrial
units, the realization for which is about Rs5.6/kwh against the realization of Rs2/kwh to rural
and agricultural customers.
Interest expense: The regulator disallowed interest on loans that are attributable for
funding the working capital requirements and allowed only normative working capital
which takes into account 2 months of receivables. Further, UPPCL on its own had not
claimed interest of Rs9 bn on account of working capital borrowings of the individual
discoms.
Power purchase costs: UPPCL has budgeted for about 1,724 MU’s at Rs6.70/kwh for
plugging the power supply deficit through short-term power purchases. The regulator
allowed the power purchases only at Rs5.0/kwh and issued a specific directive to use
power exchanges for procurement of short term power for more transparency.
Others: The regulator disallowed any provision for bad debts citing the write-offs were not
pursuant to any policy on bad debts and lack of details of the consumers whose dues are
written off.
Collection inefficiencies: Regulator assumes 100% realization, while
actual realization falls short by 20%
AT&C losses are the summation of technical and commercial losses. While the UP
regulator allows technical losses (i.e. transmission and distribution losses) to be built into
tariff, it assumes 100% collection efficiency (i.e., does not allow any commercial losses to
be built into the tariffs) and that the consumer will not be burdened with costs arising from
bad debts. Although UP AT&C losses are showing a declining trend since FY05 (primarily
reflecting the decline in technical losses), there is no meaningful reduction in the
commercial losses (refer to Exhibit 11) resulting in cash losses for the UP discoms.
Our interactions with UPPCL officials and the regulator indicate that: 1) shortage of staff at
the field level; 2) obsolete technology used for collecting receivables; 3) lack of awareness
(or intent) among the rural and agricultural households to pay for the power consumed; 4)
billing to non existent consumers; and 5) political considerations limiting legal options for
recovery of dues, are the primary reasons for the commercial losses remaining high.
UP has about US$1.7 bn in receivables as of FY09 and the UPPCL board has recently
introduced a one-time settlement scheme for the rural and household categories. Our
interactions with the board officials indicated that they received about 10%-15% of the
existing outstanding receivables on account of this scheme and expect some portion of the
remaining receivables also to be recovered.
In November 2008, however, the government decided to hand over power distribution
(under a franchise model) in nine cities to private companies. Torrent won bids for Agra
and Kanpur, while there has been no response so far for the other seven: Bareilly,
Gorakhpur, Varanasi, Allahabad, Moradabad, Meerut, and Aligarh.
We think the UP AT&C losses would likely decline gradually on account of the following
measures:
1) Entry of the private sector in managing discoms would help improve transparency and
thus increase the level of accountability; and
2) Implementation of R-APDRP program over the medium term. The scheme shall be taken
up in two parts. Part-A shall include the projects for establishment of baseline data and IT
applications for energy accounting/auditing and IT-based consumer service centre. Part-B
shall include regular distribution strengthening projects.
With limited ability to increase tariffs, change in consumer mix
should help mitigate revenue gap, in our view
Our interaction with UPPCL officials indicated that there is demand for about 3,000-
4,000MW from industrial customers and we believe incremental power supply (particularly
from IPP’s such as Lanco’s Udupi and Reliance Power’s Rosa) could cater to these
customers. With realization from industrial customers at about 134% of the cost of service,
UPPCL expects the revenue realization to improve going forward. However, with more
villages getting connected to the grid and load cuts still prevalent in rural areas, we are
unsure whether the regulator would allow UPPCL to service the industrial customers at the
expense of its low-paying customers such as the rural and agricultural segments
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