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Utilities
India
Cost-plus or market pricing—distorting signals. Media reports indicate the Ministry
of Power is likely to cap tariffs or cost-plus tariffs for capacities fueled by low cost
captive coal mines—a departure from the extant policy of transitioning to competitivelybid
or market-driven pricing. The move is likely to be prompted by a spike in merchant
tariffs, leading to disparate profitability for merchant capacities, such as those of Jindal
Steel and Power, running on low-cost fuel.
Proposal to cap tariffs on cost-basis – a departure from the National Tariff Policy
As per media reports, the Ministry of Power proposes to cap power tariffs for plants running on
captive or domestic linkage coal, implying a cost-plus tariffs with limited returns for all such lowcost
producers. In our view, if implemented this would be a reversal of the extant policy
framework that looks to shift to market-driven pricing (competitively-bid and/or merchant) that
rewards efficient low-cost producers while penalizing inefficient producers. In our view, the market
driven policy is progressive as it differentiates between power producers based on their cost
efficiency, unlike the traditional cost-plus regime that allowed a reasonable return for all power
producers—irrespective of their cost of generation.
Policy shift could discourage much-needed development of captive blocks
Moving captive coal-based power under the cost-plus regime would (1) deter the extant owners of
captive blocks from developing their blocks and (2) jeopardize the government’s plan to auction
India’s coal reserves—until complete clarity on the tariff structure to be adopted for captive coalbased
power producers emerges. With domestic coal production significantly lagging demand and
Coal India unlikely to significantly ramp up production, captive production has been viewed as a
way of shoring up domestic coal capacity. Recent policy action has largely been directed at
efficient allocation of captive blocks with the Ministry of Coal cancelling some previously-allocated
coal blocks and putting forth a draft proposal for auctioning coal blocks.
Regulators last intervened to counter a tariff spike during the 2009 general elections
CERC had capped merchant tariffs for power traded at Rs8/kwh in September 2008—preceding
the general and state elections. With merchant rates trending up, leading to assembly elections in
five states (Uttar Pradesh, Punjab, Uttaranchal, Manipur and Goa) in CY2012 the spike in
merchant tariffs and probable policy action is not entirely alarming.
Under the Electricity Act 2003, in case of a shortage of electricity supply, CERC is empowered to
fix a minimum and maximum tariff for sale or purchase of electricity between a generating
company and licensee or between licensees, for a period not exceeding one year, to ensure
reasonable prices of electricity.
Lack of clarity on policy complicates investment decisions
With the power sector already reeling from an acute shortage of fuel and poor financial health of
distribution utilities—lack of clarity on pricing of power for captive coal-based capacities could
further dampen the investment environment. Implementation of the proposed policy could be
negative for companies with merchant capacities running on captive coal (JSPL’s 1,000 MW
Tamnar plant) or linkage coal (subject to availability). Exhibit 1 below highlights the sensitivity of
our fair value estimate of JSPL’s power business to merchant prices.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Utilities
India
Cost-plus or market pricing—distorting signals. Media reports indicate the Ministry
of Power is likely to cap tariffs or cost-plus tariffs for capacities fueled by low cost
captive coal mines—a departure from the extant policy of transitioning to competitivelybid
or market-driven pricing. The move is likely to be prompted by a spike in merchant
tariffs, leading to disparate profitability for merchant capacities, such as those of Jindal
Steel and Power, running on low-cost fuel.
Proposal to cap tariffs on cost-basis – a departure from the National Tariff Policy
As per media reports, the Ministry of Power proposes to cap power tariffs for plants running on
captive or domestic linkage coal, implying a cost-plus tariffs with limited returns for all such lowcost
producers. In our view, if implemented this would be a reversal of the extant policy
framework that looks to shift to market-driven pricing (competitively-bid and/or merchant) that
rewards efficient low-cost producers while penalizing inefficient producers. In our view, the market
driven policy is progressive as it differentiates between power producers based on their cost
efficiency, unlike the traditional cost-plus regime that allowed a reasonable return for all power
producers—irrespective of their cost of generation.
Policy shift could discourage much-needed development of captive blocks
Moving captive coal-based power under the cost-plus regime would (1) deter the extant owners of
captive blocks from developing their blocks and (2) jeopardize the government’s plan to auction
India’s coal reserves—until complete clarity on the tariff structure to be adopted for captive coalbased
power producers emerges. With domestic coal production significantly lagging demand and
Coal India unlikely to significantly ramp up production, captive production has been viewed as a
way of shoring up domestic coal capacity. Recent policy action has largely been directed at
efficient allocation of captive blocks with the Ministry of Coal cancelling some previously-allocated
coal blocks and putting forth a draft proposal for auctioning coal blocks.
Regulators last intervened to counter a tariff spike during the 2009 general elections
CERC had capped merchant tariffs for power traded at Rs8/kwh in September 2008—preceding
the general and state elections. With merchant rates trending up, leading to assembly elections in
five states (Uttar Pradesh, Punjab, Uttaranchal, Manipur and Goa) in CY2012 the spike in
merchant tariffs and probable policy action is not entirely alarming.
Under the Electricity Act 2003, in case of a shortage of electricity supply, CERC is empowered to
fix a minimum and maximum tariff for sale or purchase of electricity between a generating
company and licensee or between licensees, for a period not exceeding one year, to ensure
reasonable prices of electricity.
Lack of clarity on policy complicates investment decisions
With the power sector already reeling from an acute shortage of fuel and poor financial health of
distribution utilities—lack of clarity on pricing of power for captive coal-based capacities could
further dampen the investment environment. Implementation of the proposed policy could be
negative for companies with merchant capacities running on captive coal (JSPL’s 1,000 MW
Tamnar plant) or linkage coal (subject to availability). Exhibit 1 below highlights the sensitivity of
our fair value estimate of JSPL’s power business to merchant prices.
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