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India Utilities
Skimming Through Recent
Sector Developments
Impact on our views: We maintain our Cautious view
of the industry primarily due to concerns on domestic
coal supplies and its resultant impact on plant
profitability. There have been various developments and
news reports on the sector since June 2011, which we
have assimilated in this note and provided our views on.
While there seems to be a growing need within the
government to take steps to improve the domestic coal
outlook, remove the impediments for granting
environment clearances and turn around the SEBs, we
believe these steps (once implemented) may only
change ground realities in the mid to long term. Hence,
for the next 12-18 months, profitability of power plants
will be impacted due to these issues. Further, lack of
debt funding, rising global coal prices and changes in
Indonesian coal pricing regulations could act as
additional negatives. We summarize all the sector
developments in the following pages with our views.
What are companies saying post Q1 results? JSW
Energy management mentioned on their Q1 earnings
call that SEBs have been backing down due to lower
demand caused by the early onset of monsoon. Hence,
PLFs have been lower than expected and their outlook
on F2012 merchant rates has been revised downward
from Rs 4.5-4.75/unit earlier to Rs 4-4.25/unit now.
Further, both JSW Energy and Sterlite Energy’s
managements indicated that they would go slow on new
power projects given increasing challenges.
Change in global coal price outlook: Our global team
has increased forecasts for thermal coal prices – C2011
remains unchanged at US$130/t however, C2012 has
been increased to US$135/t (from US$125/t earlier) and
C2013 to US$140/t (from US$130/t earlier). We believe
a rising coal price environment will not bode well for
profitability of power companies, especially those that
have a reasonable exposure to the imported spot market
(such as JSW Energy)
Some of the key developments/news flow since June 2011, along with our views are below:
Topic What Has Happened Our View
Environment clearance to coal
blocks
During end-June, the MoEF granted Stage I
approval to three coal blocks (Tara, Parsa
East and Kante Basan) and re-categorized
five coal blocks as “go” areas (Meenakshi B,
Meenakshi dipside, Manoharpur,
Manoharpur dipside and Dulanga).
With this, some blocks will now be eligible to
apply for Stage I clearance (once a mining
plan is submitted) while some with Stage I
clearance can apply for final clearance
(Stage II). The common reasons for granting
these approvals were: 1. There has been a
substantial change in the mining plan, thus
reducing the requirement of very dense and
medium dense forest land. 2. The Ministry of
Power and respective state governments
were persistently following up with the MoEF
on these approvals. 3. The ultimate power
projects are based on supercritical
technology, which is low on carbon
emissions. 4. All approvals come with the
usual conditions on monetary compensation,
afforestation and wildlife management.
We believe these clearances seem to have
at least got the ball rolling on pushing
through some of the key approvals that have
been holding back development activities on
various power projects. However, we need
many more such approvals to come through
to make a meaningful impact. Further, we
believe approvals will be granted on the
merits of each case as is evident from the
fact that the Mahan and Morga II coal blocks
were denied environment clearance.
Also, from this stage these blocks may still
take about 12-24 months to get all the final
clearances, acquire land and start coal
production.
See our note “Environmental Clearance for a
Few Coal Blocks” dated June 29, 2011
Change of the environment
minister and proposal to set up an
independent authority
In the recent Cabinet reshuffle, there has
been a change in the environment minister.
Further, the Prime Minister has announced
the intention of establishing an independent
regulator (the National Environment
Appraisal and Monitoring Authority) that will
evolve objective standards of scrutiny and
make recommendations to the ministry for
final approval.
It is still too early to take a view on how the
process of granting environment clearances
will change with the change in minister and
the proposal to set up an independent
authority.
However, any proposals to speed up
environment clearances and
commencement of competitive bidding of
coal blocks could be positives for the sector.
SEB conference The State Power Ministers’ Conference on
distribution sector reforms was held in New
Delhi this month and was attended by the
Minister of Power, Deputy Chairman of the
Planning Commission and various State
Power Ministers. The conference was
organized to take stock of the situation and
discuss measures to be undertaken to turn
around the financial health of SEBs. One of
the key messages from the Minister of Power
was that that while the Centre is always
ready to help States, it is their responsibility
to ensure implementation of reforms.
Some of the other key reform measures
discussed were that state governments
would consider converting loans due from
the state governments as state government
equity to ensure capital infusion and
improvement in net worth of SEB, states to
ensure that subsidies are released in
advance and state governments to ensure
automatic pass through in tariff for any
increase in fuel cost.
a. This was an annual conference wherein
of the many policy actions discussed,
most were activities that should have
been done in the normal course of
business.
b. The measures discussed need to be
ultimately implemented by the
respective state governments/SEBs.
c. A week after this conference, the Indian
Express reported that the power
minister of Tamil Nadu had indicated
that the state government was not
considering a hike in electricity tariff.
d. ICRA, a credit rating agency, has
revised Tamil Nadu Electricity Board’s
rating from [ICRA]BB+ to [ICRA]D
which implies that the bank lines are in
default or are expected to be in default
soon.
e. As per an article in the Financial
Express (dated Aug 1), it is believed that
Tamil Nadu, Rajasthan, Madhya
Pradesh and Uttar Pradesh have turned
to the Power Ministry and Planning
Commission, seeking their help to bail
out their discoms. The Centre, which is
believed to be open to the plea, has
however, made it clear that such issues
cannot be addressed in isolation, but
only under a broader policy framework.
See our note “Policy Measures Discussed to
Reinvigorate SEBs” dated July 14, 2011
Indonesian Coal Prices to go up
due to regulations
The Indonesian government proposes to link
the royalties to a benchmark price that is
indexed to Newcastle, Platts and Global
Coal, as well as the domestic price (ICI). This
is proposed to be effective from September
23, 2011. The important point to bear in mind
is that some Indian companies import
low-quality coal from Indonesia that may not
have global benchmark prices; however, we
believe these prices may be determined
based on calorific value.
The Indian Embassy at Jakarta has
confirmed that the new Indonesian
regulations stipulate that spot coal prices
should refer to a benchmark price in the
month in which coal shipments are
conducted and for term sales it should refer
to the three month average benchmark price
that occurred before coal price agreement
was made. The adjustments to the coal
contracts, finalized prior to these regulations,
need to be made within 12 months.
We believe an upward revision in Indonesian
coal prices could have the following impact:
• Indian power companies might invoke
the force majeure clause under the PPA
and ask for an upward revision in power
tariff to pass on the additional fuel cost.
• Renege on PPAs that have already
been signed and hence be liable for
liquidated damages.
• Incur substantial losses, which might
hinder their capability to service debt.
• There should, however, be no impact on
plants where fuel cost is a pass-through.
• Mine-owning companies might face a
decline in coal trading profits if they were
to fulfill the obligation of selling coal to
the power company at original
contracted prices.
Related to the issue of power plants asking
for an upward revision in tariffs to pass-on
the incremental cost, the Andhra Pradesh
government is likely to turn down the
suggestion for a tariff increase for the
Krishnapatnam UMPP (4,000 MW) of
Reliance Power as the provisions under the
PPA do not allow a rate revision due to
changes in policies by foreign governments.
See our note “Impact Due to Price Revision
of Indonesian Coal Contracts” dated June
21, 2011
Power sector exposure limit of
banks
The power ministry had sought a 5 ppt
increase in the single-borrower exposure
limit of banks and other financial institutions
to meet the sector's funding requirements in
the Twelfth Five-Year Plan.
However, the finance ministry is not keen to
let banks raise their exposure and has
instead suggested that the power sector
should tap other sources such as dedicated
finance firms and upcoming debt funds.
While there is a proposal to set up an
infrastructure fund, it is still not in place. Also,
foreign funding institutions are only ready to
fund operational plants as they do not wish to
take on construction risk.
We believe lack of domestic funding could
become an impediment to capacity growth
going forward.
Environment clearance to Adani
Power’s projects
The Environment Ministry granted
conditional clearance to Adani Power’s
Dahej project (2,640 MW).
The Dahej project is still in the pipeline as
coal sourcing needs to be tied up which will
then be succeeded by a PPA and finally by
financial closure. Equipment ordering and
construction activities can only begin
thereafter.
On a separate note, the company’s
Chhindwara project (1,320 MW), which is
also in the pipeline, is facing local protests.
Nonetheless, both these projects are
included in our Bull Case fair value.
Lawsuit filed against Lanco Perdaman Industries, an Australian
company, has filed an A$3.5 bn lawsuit
against Lanco alleging non-compliance with
the coal supply agreement for their upcoming
urea plant in Western Australia.
The coal supply agreement is for about 2.75
mtpa of coal and the supply begins sometime
in 2015-16.
The hearing on this suit commenced on July
27 and we believe it will take time for it to be
finally concluded. In our view, this issue will
remain an overhang on the stock’s
performance till such time.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Utilities
Skimming Through Recent
Sector Developments
Impact on our views: We maintain our Cautious view
of the industry primarily due to concerns on domestic
coal supplies and its resultant impact on plant
profitability. There have been various developments and
news reports on the sector since June 2011, which we
have assimilated in this note and provided our views on.
While there seems to be a growing need within the
government to take steps to improve the domestic coal
outlook, remove the impediments for granting
environment clearances and turn around the SEBs, we
believe these steps (once implemented) may only
change ground realities in the mid to long term. Hence,
for the next 12-18 months, profitability of power plants
will be impacted due to these issues. Further, lack of
debt funding, rising global coal prices and changes in
Indonesian coal pricing regulations could act as
additional negatives. We summarize all the sector
developments in the following pages with our views.
What are companies saying post Q1 results? JSW
Energy management mentioned on their Q1 earnings
call that SEBs have been backing down due to lower
demand caused by the early onset of monsoon. Hence,
PLFs have been lower than expected and their outlook
on F2012 merchant rates has been revised downward
from Rs 4.5-4.75/unit earlier to Rs 4-4.25/unit now.
Further, both JSW Energy and Sterlite Energy’s
managements indicated that they would go slow on new
power projects given increasing challenges.
Change in global coal price outlook: Our global team
has increased forecasts for thermal coal prices – C2011
remains unchanged at US$130/t however, C2012 has
been increased to US$135/t (from US$125/t earlier) and
C2013 to US$140/t (from US$130/t earlier). We believe
a rising coal price environment will not bode well for
profitability of power companies, especially those that
have a reasonable exposure to the imported spot market
(such as JSW Energy)
Some of the key developments/news flow since June 2011, along with our views are below:
Topic What Has Happened Our View
Environment clearance to coal
blocks
During end-June, the MoEF granted Stage I
approval to three coal blocks (Tara, Parsa
East and Kante Basan) and re-categorized
five coal blocks as “go” areas (Meenakshi B,
Meenakshi dipside, Manoharpur,
Manoharpur dipside and Dulanga).
With this, some blocks will now be eligible to
apply for Stage I clearance (once a mining
plan is submitted) while some with Stage I
clearance can apply for final clearance
(Stage II). The common reasons for granting
these approvals were: 1. There has been a
substantial change in the mining plan, thus
reducing the requirement of very dense and
medium dense forest land. 2. The Ministry of
Power and respective state governments
were persistently following up with the MoEF
on these approvals. 3. The ultimate power
projects are based on supercritical
technology, which is low on carbon
emissions. 4. All approvals come with the
usual conditions on monetary compensation,
afforestation and wildlife management.
We believe these clearances seem to have
at least got the ball rolling on pushing
through some of the key approvals that have
been holding back development activities on
various power projects. However, we need
many more such approvals to come through
to make a meaningful impact. Further, we
believe approvals will be granted on the
merits of each case as is evident from the
fact that the Mahan and Morga II coal blocks
were denied environment clearance.
Also, from this stage these blocks may still
take about 12-24 months to get all the final
clearances, acquire land and start coal
production.
See our note “Environmental Clearance for a
Few Coal Blocks” dated June 29, 2011
Change of the environment
minister and proposal to set up an
independent authority
In the recent Cabinet reshuffle, there has
been a change in the environment minister.
Further, the Prime Minister has announced
the intention of establishing an independent
regulator (the National Environment
Appraisal and Monitoring Authority) that will
evolve objective standards of scrutiny and
make recommendations to the ministry for
final approval.
It is still too early to take a view on how the
process of granting environment clearances
will change with the change in minister and
the proposal to set up an independent
authority.
However, any proposals to speed up
environment clearances and
commencement of competitive bidding of
coal blocks could be positives for the sector.
SEB conference The State Power Ministers’ Conference on
distribution sector reforms was held in New
Delhi this month and was attended by the
Minister of Power, Deputy Chairman of the
Planning Commission and various State
Power Ministers. The conference was
organized to take stock of the situation and
discuss measures to be undertaken to turn
around the financial health of SEBs. One of
the key messages from the Minister of Power
was that that while the Centre is always
ready to help States, it is their responsibility
to ensure implementation of reforms.
Some of the other key reform measures
discussed were that state governments
would consider converting loans due from
the state governments as state government
equity to ensure capital infusion and
improvement in net worth of SEB, states to
ensure that subsidies are released in
advance and state governments to ensure
automatic pass through in tariff for any
increase in fuel cost.
a. This was an annual conference wherein
of the many policy actions discussed,
most were activities that should have
been done in the normal course of
business.
b. The measures discussed need to be
ultimately implemented by the
respective state governments/SEBs.
c. A week after this conference, the Indian
Express reported that the power
minister of Tamil Nadu had indicated
that the state government was not
considering a hike in electricity tariff.
d. ICRA, a credit rating agency, has
revised Tamil Nadu Electricity Board’s
rating from [ICRA]BB+ to [ICRA]D
which implies that the bank lines are in
default or are expected to be in default
soon.
e. As per an article in the Financial
Express (dated Aug 1), it is believed that
Tamil Nadu, Rajasthan, Madhya
Pradesh and Uttar Pradesh have turned
to the Power Ministry and Planning
Commission, seeking their help to bail
out their discoms. The Centre, which is
believed to be open to the plea, has
however, made it clear that such issues
cannot be addressed in isolation, but
only under a broader policy framework.
See our note “Policy Measures Discussed to
Reinvigorate SEBs” dated July 14, 2011
Indonesian Coal Prices to go up
due to regulations
The Indonesian government proposes to link
the royalties to a benchmark price that is
indexed to Newcastle, Platts and Global
Coal, as well as the domestic price (ICI). This
is proposed to be effective from September
23, 2011. The important point to bear in mind
is that some Indian companies import
low-quality coal from Indonesia that may not
have global benchmark prices; however, we
believe these prices may be determined
based on calorific value.
The Indian Embassy at Jakarta has
confirmed that the new Indonesian
regulations stipulate that spot coal prices
should refer to a benchmark price in the
month in which coal shipments are
conducted and for term sales it should refer
to the three month average benchmark price
that occurred before coal price agreement
was made. The adjustments to the coal
contracts, finalized prior to these regulations,
need to be made within 12 months.
We believe an upward revision in Indonesian
coal prices could have the following impact:
• Indian power companies might invoke
the force majeure clause under the PPA
and ask for an upward revision in power
tariff to pass on the additional fuel cost.
• Renege on PPAs that have already
been signed and hence be liable for
liquidated damages.
• Incur substantial losses, which might
hinder their capability to service debt.
• There should, however, be no impact on
plants where fuel cost is a pass-through.
• Mine-owning companies might face a
decline in coal trading profits if they were
to fulfill the obligation of selling coal to
the power company at original
contracted prices.
Related to the issue of power plants asking
for an upward revision in tariffs to pass-on
the incremental cost, the Andhra Pradesh
government is likely to turn down the
suggestion for a tariff increase for the
Krishnapatnam UMPP (4,000 MW) of
Reliance Power as the provisions under the
PPA do not allow a rate revision due to
changes in policies by foreign governments.
See our note “Impact Due to Price Revision
of Indonesian Coal Contracts” dated June
21, 2011
Power sector exposure limit of
banks
The power ministry had sought a 5 ppt
increase in the single-borrower exposure
limit of banks and other financial institutions
to meet the sector's funding requirements in
the Twelfth Five-Year Plan.
However, the finance ministry is not keen to
let banks raise their exposure and has
instead suggested that the power sector
should tap other sources such as dedicated
finance firms and upcoming debt funds.
While there is a proposal to set up an
infrastructure fund, it is still not in place. Also,
foreign funding institutions are only ready to
fund operational plants as they do not wish to
take on construction risk.
We believe lack of domestic funding could
become an impediment to capacity growth
going forward.
Environment clearance to Adani
Power’s projects
The Environment Ministry granted
conditional clearance to Adani Power’s
Dahej project (2,640 MW).
The Dahej project is still in the pipeline as
coal sourcing needs to be tied up which will
then be succeeded by a PPA and finally by
financial closure. Equipment ordering and
construction activities can only begin
thereafter.
On a separate note, the company’s
Chhindwara project (1,320 MW), which is
also in the pipeline, is facing local protests.
Nonetheless, both these projects are
included in our Bull Case fair value.
Lawsuit filed against Lanco Perdaman Industries, an Australian
company, has filed an A$3.5 bn lawsuit
against Lanco alleging non-compliance with
the coal supply agreement for their upcoming
urea plant in Western Australia.
The coal supply agreement is for about 2.75
mtpa of coal and the supply begins sometime
in 2015-16.
The hearing on this suit commenced on July
27 and we believe it will take time for it to be
finally concluded. In our view, this issue will
remain an overhang on the stock’s
performance till such time.
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