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● Recent coal pricing regulation introduced in Indonesia threatens to
impact viability of power projects based on Indonesian coal.
Developers of impacted projects have requested the government
to allow them to revise tariffs to absorb likely increase in coal cost.
● Reliance Power’s 3.96 GW Krishnapatnam UMPP project was
expecting to source coal from its coal mines in Indonesia at
US$35/ton, but with new regulation, coal cost is likely to increase
to US$65/ton, implying losses at contracted tariff of Rs2.33/kWh.
● As per a team of officials represented by CEA, Ministry of Power
and APPGCL, who recently visited the Krishnapatnam project, the
work on the project has been stalled (as cited in recent news
reports). However, the company denies any stoppage of work.
● In our view, if tariff negotiations fail, Reliance Power could opt to
surrender the project to minimise its losses. This would imply a
loss of Rs4.5 bn (Rs1.6/share) in terms of capex incurred and
bank guarantees submitted. Besides, this would most likely be
litigated by project beneficiaries. If successful, Reliance Power
can instead trade Indonesian coal – a potential upside. We
maintain our UNDERPERFORM rating.
Background of the case
Krishnapatnam UMPP is a 3.96 GW imported coal-based project
awarded to Reliance Power through a competitive bidding (Case II
bidding) process at a levelised tariff of Rs2.33/kWh. To meet the coal
requirements of this project, Reliance Power has acquired three coal
mines in Indonesia. Reliance Power’s bidding is based on the
expectation to procure coal from Indonesia at about US$35/ton at its
project site (landed cost).
However, in September 2010, the Indonesian government introduced
a new regulation, Benchmark Price Regulation, which requires all
Indonesian coal producers to export coal at or above a benchmark
price for each grade of coal (benchmark price of coal is determined
based on certain indices).
Besides, this regulation is expected to be implemented with a
retrospective effect, requiring even existing coal supply contracts to be
modified by September 2011. The new regulation implies that all the
tax and royalty payments made to the Indonesian government shall be
based on benchmark prices (or actual selling price, whichever is
higher). This would result in the landed coal cost for Krishnapatnam
project to increase to US$65/ton (as per company’s estimate).
Power developers’ lobby has requested for tariff revision
Such a sharp increase in coal cost would result in projects based on
Indonesian coal becoming unviable. The Association of Power
Producers has recently made a presentation to the Indian government
requesting it to allow power producers revise power tariffs upwards in
order to absorb the likely increase in fuel costs. Developers argue that
these costs should be allowed to be passed on under the ‘change in
law clause’ in their power supply contracts.
Recent media reports suggest work on project is stalled
As per a team of officials represented by the CEA, Ministry of Power
and APPGCL, who recently visited the Krishnapatnam UMPP project,
the work on the project has been stalled (as cited in recent news
reports).
However, our conversation with the company suggests that the work
on the project is continuing as per schedule and it continues to
maintain that the first unit would be commissioned by its scheduled
time (September 2013). The company has also issued a press release
today highlighting that this project has received approval from the
United Nation Framework for Carbon Credits. As per the press release,
the project is expected to generate 12.3 mn carbon credits during the
initial ten years, with an expected value of Rs11 bn.
Risk of litigation cannot be ruled out
In our view, if Reliance Power is disallowed to revise Krishnapatnam’s
tariff upwards, then it could opt to surrender the project as this allows
the company to minimise its losses. This could result in a loss of
Rs1.5 bn already incurred towards the project over and above Rs3 bn
submitted as bank guarantees (equivalent to Rs1.6/share). However,
this could result in litigation from either/all of the 11
customers/beneficiaries of the project. Besides, the company has
already ordered the equipment order for the project to Shanghai
Electric. While the equipment could be used for other projects of
Reliance Power; its delivery timelines, contractual terms and
compatibility with differing coal characteristics could be an issue.
Coal trading opportunity could be a potential upside
However, on the positive front, surrendering the project would allow
the company to sell coal produced from its Indonesian mines to be
sold on commercial basis. The company expects to commence coal
production by FY14 and ramp it up to peak production of 25 mmtpa by
FY16. But, in our view, the visibility on implementation of the coal
evacuation infrastructure at these mines is low and is key to capture
this potential upside. We maintain our UNDERPERFORM rating.
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