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PMO directive on coal FSAs
Reading between the lines; understanding winners across sectors
We interacted with bureaucrats, corporates and industry experts on the recent directive by the
Prime Minister's Office (PMO) assuring fuel security for power projects. The attempt is to put
in place a co-ordinated approach which addresses the viability issues for large number of
capacities under construction.
Reading between the lines suggests: i) Only 35GW of the 70GW projects under construction
based on coal linkages to be eligible for FSAs ii) FSA commitment for 68% of capacity utilization,
entailing protection of debt servicing but equity returns unlikely iii) Coal India's production required to increase by atleast 110-120m tons
over next 3 years (CAGR of 8%), and will translate into a substantial operating leverage iv) Penalty for non-performance is possibly not
severe, as even the current max penalty rate of 40% on say 50m tons shortfall will be an impact of INR20b and thus unlikely to act as
a large deterrent / protection.
The obvious beneficiary is the financial sector, where the risk of NPA threat has been partly mitigated given that the committed fuel
supply will ensure 68% capacity utilization. Thus, the project developers will start working for debt servicing, while equity returns
continue to be a question-mark. For Coal India, the possible upside is from a volume growth, leading to operating leverage. Capital goods
companies, particularly for power generation are likely to witness 'order intake holiday' and elongated execution periods.
Key takeaways from the interactions
Only 60GW capacities to enter into FSAs: Fuel Supply Agreements (FSAs)
will be signed with 25GW of capacity (already commissioned during FY10-
12), plus another 35GW (expected to be commissioned during FY13-15).
FSA commitment for only 68% capacity utilization: FSA commitment will be
for 80% of the requirement, at 85% capacity utilization. Hence, effective
project capacity utilization stands at 68% based on the fuel commitment.
Thus, direct imports by power generators will continue to be an important
part of the fuel procurement.
How can the incremental coal requirement of 200-225m tons be met? We
calculate the incremental fuel commitment for 60GW of capacities to be
commissioned during FY10-15 at ~200-225m tons (at 68% PLF). This can be
met through i) Diverting large part of the incremental coal production to
the power sector at notified rates; and thus ~110-120m tons can be possibly
met through increased production by COAL, SCCL, etc. ii) increased
production from captive mines allocated to states / CPSUs (~20m tons), iii)
diversion of part coal from existing FSAs (~30m tons), and iv) balance 15-
20m tons through imports.
E-auction volumes provide a balancing mechanism. FY12 e-auction volumes
are expected at 47m tons +; and as per the directive from the Coal Ministry,
the e-auction target may be lowered in a progressive manner to 7% of
production from 10% by the end of the Twelfth Plan in case COAL is not
being able to meet the FSA commitments. Hence, e-auction acts as a
balancing mechanism with a cap and floor; and provides a 'carrot and stick'
structure.
Backdrop: Enter the PMO - Emerging like a phoenix
Its initiatives to kick-start economic engine has many beneficiaries
After a long period of hiatus during which the Government was widely criticized
for policy inaction while opposition and coalition politics too were blamed for
stalling key reforms, government seems to have tightened its belt to streamline
the decision making process.
The mechanism of Prime Minister's Office (PMO) as the key authority has entered
the policy-making scene to signal progress in several economic initiatives,
including dealing with contentious economic matters involving several
ministries.
We believe that the PMO assuming a central role assumes great significance in
the current stalemate, but execution still remains the key challenge.
Key potential beneficiaries of PMO intervention
Power Generators | Coal Miners | Financials | Capital Goods | Infrastructure
(Also refer our full report released on 8 February 2012)
PMO directive on Coal FSAs
Our views: Sectoral implications
Private power developers: FSAs protect bankers, but meaningful equity
returns unlikely
We understand that of the 60GW of capacity (commissioned post FY09) being
assured fuel linkages, private sector projects will account for just ~20-25GW. This
compares with possible capacity under construction of ~45GW based on coal
linkages (from private sector). Thus, several projects will not be a part of the list,
and hence an understanding on the same is important to estimate the possible
gains for developers. We believe that the gainers are companies like Indiabulls
Power, Lanco, GMR, Adani Power, Jaiprakash, etc.
Importantly, the FSA commitment for 80% at 85% utilization effectively translates
into a PLF of 68%. Recovery of capacity charges are linked to ~80-85% plant
availability under most of the PPAs. Thus, while 68% capacity utilization provides
comfort to the bankers, it does not guarantee any meaningful equity returns.
While we await details on the penalty structure for short supplies, historical trends
suggest that the quantums are not severe, and may not act as a deterrent. Under
the new FSAs being signed post March 2009, the penalty is 10% for shortfall below
50% commitment. For prior contracts, penalty is based on a graded scale of 10-
40% for supplies below 90-80% of the commitment. Even assuming 40% penalty
for say ~50m tons of shortfall (~25% of the incremental requirement during FY09
-15), the possible quantum will be just INR20b. This does not act as a sufficient
dis-incentive, nor provides enough protection in our opinion.
Financials: NPA threat addressed partly, as 50% of capacity under
construction kept out
Capacity under construction stands at 110GW+, of which we believe that ~70GW
are based on coal linkages. The current directive provides fuel security to only
35GW of capacity to be commissioned during FY13-15, and several of the projects
left out (~70%+) are from the private sector.
Thus, post the PMO directive, while the financial system is much better off than
the earlier stand; the current directive does not address the problem in totality.
Equipment Vendors / Capital Goods: Order intake holiday, elongating
execution periods
We believe that the business outlook for several players in the power generation
equipment value chain has been significantly impacted. No further Letter of
Assurances for fuel supplies are expected atleast for the next three years. This
coupled with poor business visibility will lead to subdued order intake trends and
elongated periods of project execution.
BHEL will be the most impacted; companies like L&T, BGR, Thermax, etc that have
set-up BTG manufacturing facilities will also be impacted by the challenging
environment.
Coal India: Ramping production is the key
We believe that the key message to COAL is to get its act together and ramp up
coal production. After a long time, a co-ordinated effort involving the Environment,
Railway, Coal and Power Ministries is being worked out to address the constraints.
Coal production growth from open cast mines stood at 7-8% CAGR during FY04-10;
but over the last 2 years, production has been largely stagnant. Production CAGR
of 7-8% from open cast mines during FY13-15 will result in incremental coal
production of ~100-110m tons by FY15 and will be crucial to achieve the targeted
commitments.
We continue to believe that COAL continues to be a non-controversial way to
enhance production in the system and the company has a large operating leverage.
We calculate the gains from 1m tons of incremental production at Rs700m; and
thus possible incremental production of 40m tons pa in FY15 (over the current
estimate of 60m tons) can lead to earnings upside of INR28b (EPS INR4/sh).
Negatives are: possible diversion / stagnation of e-auction volumes (at ~44-45m
tons) and penalty in the event of unable to meet the FSA obligations. As per the
Coal Ministry directive, the target supplies under e-auction may be lowered to
7% of production from 10% currently, in a progressive manner by the end of the
Twelfth Plan in case the company is not being able to meet the commitment. We
calculate the impact of 1m tons e-auction diversion / shortfall at INR1b; and thus
even in the event of shortfall of ~10m tons till FY15, the impact is manageable at
INR1.5/sh of EPS (~3-4% of earnings). Even assuming 40% penalty for say ~50m
tons of shortfall (~25% of the incremental requirement during FY09 -15), the
possible quantum will be INR20b; which is an important but not a large enough
deterrent.
COAL: Management clarifies on several intriguing issues
COAL management clarified their viewpoints on various issues being raised post
the directive from the PMO, while they await further clarity from the Ministry.
The management stated that in the event of coal imports, the attempt will be to
pass on the cost of imported coal to the consumers, plus marketing margins.
Also, on e-auction, FY12 volumes are expected at 47m tons +; and as per the
directive from the Coal Ministry, the e-auction target may be lowered in a
progressive manner to 7% of production from 10% by the end of the Twelfth Plan
in case the company is not being able to meet the FSA commitments. Hence, eauction
acts as a balancing mechanism with a cap and floor; and provides a
transparent structure with a carrot and stick.
The management clarified that one of the options for meeting the increased
coal requirement, will be through redistributing from the existing FSAs signed
prior to FY09. These old FSAs had a trigger level of 90%, and the supplies currently
stands at 94-95%. Thus, this provides option for redistribution of coal towards
the new FSAs. However, there is no attempt to revise the old FSAs to lower the
trigger level to 80% in line with the new FSAs; and thus the coal supplies to the
power capacities commissioned prior to March 2009 will not be impacted much.
Company has applied to Ministry of Environment and Forests for clearances on
additional capacity in existing mines. A fast track process is being set up, and this
can possibly lead to enhanced output by 20-25m tons shortly. Environment
clearances for new mining projects are being expedited; and recently Amrapali
mine project has received MoEF clearance (expected capacity 15m tons) while
clearances for several projects are expected to be fast tracked. This will possibly
lead to a meaningful improvement in production volumes in the Twelfth Plan till
FY17. The optimistic production target in the event that environmental clearances
are fast tracked is 615m tons in FY17 (CAGR of 7.2%) as compared to the earlier
target of 556m tons (CAGR of 5%).
Wage negotiations have been signed with most of the unions and the annual
impact on a recurring basis is INR40b. In addition, the company will have to
provide for gratuity / actuarial expenses on the increased levels and this will be
an additional provision of INR25b. COAL has been making provisions for wage
increases at the rate of INR7.5b per quarter and thus the balance incremental
provisions wef 2QFY12 will be made in 4QFY12. We have factored in staff cost of
INR71b in 4QFY12, vs INR56b in 3QFY12.
We maintain Buy on COAL with a price target of INR396/sh and believe that any
declines should be used as a buying opportunity. The stock quotes at a PER of 14x
FY13E and 11.7x FY14E.
Power sector imbroglio could get resolved?
90-day revival plan with monthly milestones
A high-powered meeting led by PMO was held on 18 January 2012 with several Cabinet
Ministers and CEOs of power companies including from Tata group, ADAG, GMR, GVK,
Adani, Vedanta, Jindal, Lanco, etc. The key agenda was to address the logjam in the
power sector.
Complete lack of co-ordination across ministries, persistent delays and logjam had
led the matter to be escalated to the highest level. The initiatives taken now indicate
the seriousness, and urgency on the part of authorities for an important sector.
Domestic coal production is near stagnant for 3 years in a row. Coal India's
production target is now at 440m tons in FY12 v/s 431m tons in FY11 and 430m tons
in FY10). This is due to multiple reasons: 1) Environment/forest clearances, 2)
Evacuation issues, 3) Operational slippages owing to adverse climatic conditions,
etc. We believe that Coal India remains the most non-controversial way to increase
domestic production and thus, this leads to hopes for uptick in production in
FY13/14. Similarly, declining gas supply/production and capacity addition by several
IPPs have led to both existing and new projects being stranded for fuel.
Support for UMPP projects based on imported coal needs more clarity. Our past
discussions with incumbents (Tata Power, Reliance Power) suggested several
hurdles which need to be addressed including "State government willingness (as
power is procured by discoms, which are counterparty to such PPA)". This, in our
view, is unlikely to be resolved in haste, and would go into several deliberations
before any final outcome. We would be watchful of any development on this
front. TPWR could be biggest beneficiary, assuming "support" indicates 100% fuel
cost pass through (v/s 50% currently).
Development of captive coal block, in our view, is an equally pressing issue and
thus, resolving issues on related environment and forest clearance and land
acquisition is critical.
Another contentious issue has been the Power Purchase Agreements (PPAs)
between states and developers, which have been jeopardized given lower
domestic coal supply, high imported coal prices, regulatory changes in countries
like Indonesia and Australia, etc. This remains to be watched
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
PMO directive on coal FSAs
Reading between the lines; understanding winners across sectors
We interacted with bureaucrats, corporates and industry experts on the recent directive by the
Prime Minister's Office (PMO) assuring fuel security for power projects. The attempt is to put
in place a co-ordinated approach which addresses the viability issues for large number of
capacities under construction.
Reading between the lines suggests: i) Only 35GW of the 70GW projects under construction
based on coal linkages to be eligible for FSAs ii) FSA commitment for 68% of capacity utilization,
entailing protection of debt servicing but equity returns unlikely iii) Coal India's production required to increase by atleast 110-120m tons
over next 3 years (CAGR of 8%), and will translate into a substantial operating leverage iv) Penalty for non-performance is possibly not
severe, as even the current max penalty rate of 40% on say 50m tons shortfall will be an impact of INR20b and thus unlikely to act as
a large deterrent / protection.
The obvious beneficiary is the financial sector, where the risk of NPA threat has been partly mitigated given that the committed fuel
supply will ensure 68% capacity utilization. Thus, the project developers will start working for debt servicing, while equity returns
continue to be a question-mark. For Coal India, the possible upside is from a volume growth, leading to operating leverage. Capital goods
companies, particularly for power generation are likely to witness 'order intake holiday' and elongated execution periods.
Key takeaways from the interactions
Only 60GW capacities to enter into FSAs: Fuel Supply Agreements (FSAs)
will be signed with 25GW of capacity (already commissioned during FY10-
12), plus another 35GW (expected to be commissioned during FY13-15).
FSA commitment for only 68% capacity utilization: FSA commitment will be
for 80% of the requirement, at 85% capacity utilization. Hence, effective
project capacity utilization stands at 68% based on the fuel commitment.
Thus, direct imports by power generators will continue to be an important
part of the fuel procurement.
How can the incremental coal requirement of 200-225m tons be met? We
calculate the incremental fuel commitment for 60GW of capacities to be
commissioned during FY10-15 at ~200-225m tons (at 68% PLF). This can be
met through i) Diverting large part of the incremental coal production to
the power sector at notified rates; and thus ~110-120m tons can be possibly
met through increased production by COAL, SCCL, etc. ii) increased
production from captive mines allocated to states / CPSUs (~20m tons), iii)
diversion of part coal from existing FSAs (~30m tons), and iv) balance 15-
20m tons through imports.
E-auction volumes provide a balancing mechanism. FY12 e-auction volumes
are expected at 47m tons +; and as per the directive from the Coal Ministry,
the e-auction target may be lowered in a progressive manner to 7% of
production from 10% by the end of the Twelfth Plan in case COAL is not
being able to meet the FSA commitments. Hence, e-auction acts as a
balancing mechanism with a cap and floor; and provides a 'carrot and stick'
structure.
Backdrop: Enter the PMO - Emerging like a phoenix
Its initiatives to kick-start economic engine has many beneficiaries
After a long period of hiatus during which the Government was widely criticized
for policy inaction while opposition and coalition politics too were blamed for
stalling key reforms, government seems to have tightened its belt to streamline
the decision making process.
The mechanism of Prime Minister's Office (PMO) as the key authority has entered
the policy-making scene to signal progress in several economic initiatives,
including dealing with contentious economic matters involving several
ministries.
We believe that the PMO assuming a central role assumes great significance in
the current stalemate, but execution still remains the key challenge.
Key potential beneficiaries of PMO intervention
Power Generators | Coal Miners | Financials | Capital Goods | Infrastructure
(Also refer our full report released on 8 February 2012)
PMO directive on Coal FSAs
Our views: Sectoral implications
Private power developers: FSAs protect bankers, but meaningful equity
returns unlikely
We understand that of the 60GW of capacity (commissioned post FY09) being
assured fuel linkages, private sector projects will account for just ~20-25GW. This
compares with possible capacity under construction of ~45GW based on coal
linkages (from private sector). Thus, several projects will not be a part of the list,
and hence an understanding on the same is important to estimate the possible
gains for developers. We believe that the gainers are companies like Indiabulls
Power, Lanco, GMR, Adani Power, Jaiprakash, etc.
Importantly, the FSA commitment for 80% at 85% utilization effectively translates
into a PLF of 68%. Recovery of capacity charges are linked to ~80-85% plant
availability under most of the PPAs. Thus, while 68% capacity utilization provides
comfort to the bankers, it does not guarantee any meaningful equity returns.
While we await details on the penalty structure for short supplies, historical trends
suggest that the quantums are not severe, and may not act as a deterrent. Under
the new FSAs being signed post March 2009, the penalty is 10% for shortfall below
50% commitment. For prior contracts, penalty is based on a graded scale of 10-
40% for supplies below 90-80% of the commitment. Even assuming 40% penalty
for say ~50m tons of shortfall (~25% of the incremental requirement during FY09
-15), the possible quantum will be just INR20b. This does not act as a sufficient
dis-incentive, nor provides enough protection in our opinion.
Financials: NPA threat addressed partly, as 50% of capacity under
construction kept out
Capacity under construction stands at 110GW+, of which we believe that ~70GW
are based on coal linkages. The current directive provides fuel security to only
35GW of capacity to be commissioned during FY13-15, and several of the projects
left out (~70%+) are from the private sector.
Thus, post the PMO directive, while the financial system is much better off than
the earlier stand; the current directive does not address the problem in totality.
Equipment Vendors / Capital Goods: Order intake holiday, elongating
execution periods
We believe that the business outlook for several players in the power generation
equipment value chain has been significantly impacted. No further Letter of
Assurances for fuel supplies are expected atleast for the next three years. This
coupled with poor business visibility will lead to subdued order intake trends and
elongated periods of project execution.
BHEL will be the most impacted; companies like L&T, BGR, Thermax, etc that have
set-up BTG manufacturing facilities will also be impacted by the challenging
environment.
Coal India: Ramping production is the key
We believe that the key message to COAL is to get its act together and ramp up
coal production. After a long time, a co-ordinated effort involving the Environment,
Railway, Coal and Power Ministries is being worked out to address the constraints.
Coal production growth from open cast mines stood at 7-8% CAGR during FY04-10;
but over the last 2 years, production has been largely stagnant. Production CAGR
of 7-8% from open cast mines during FY13-15 will result in incremental coal
production of ~100-110m tons by FY15 and will be crucial to achieve the targeted
commitments.
We continue to believe that COAL continues to be a non-controversial way to
enhance production in the system and the company has a large operating leverage.
We calculate the gains from 1m tons of incremental production at Rs700m; and
thus possible incremental production of 40m tons pa in FY15 (over the current
estimate of 60m tons) can lead to earnings upside of INR28b (EPS INR4/sh).
Negatives are: possible diversion / stagnation of e-auction volumes (at ~44-45m
tons) and penalty in the event of unable to meet the FSA obligations. As per the
Coal Ministry directive, the target supplies under e-auction may be lowered to
7% of production from 10% currently, in a progressive manner by the end of the
Twelfth Plan in case the company is not being able to meet the commitment. We
calculate the impact of 1m tons e-auction diversion / shortfall at INR1b; and thus
even in the event of shortfall of ~10m tons till FY15, the impact is manageable at
INR1.5/sh of EPS (~3-4% of earnings). Even assuming 40% penalty for say ~50m
tons of shortfall (~25% of the incremental requirement during FY09 -15), the
possible quantum will be INR20b; which is an important but not a large enough
deterrent.
COAL: Management clarifies on several intriguing issues
COAL management clarified their viewpoints on various issues being raised post
the directive from the PMO, while they await further clarity from the Ministry.
The management stated that in the event of coal imports, the attempt will be to
pass on the cost of imported coal to the consumers, plus marketing margins.
Also, on e-auction, FY12 volumes are expected at 47m tons +; and as per the
directive from the Coal Ministry, the e-auction target may be lowered in a
progressive manner to 7% of production from 10% by the end of the Twelfth Plan
in case the company is not being able to meet the FSA commitments. Hence, eauction
acts as a balancing mechanism with a cap and floor; and provides a
transparent structure with a carrot and stick.
The management clarified that one of the options for meeting the increased
coal requirement, will be through redistributing from the existing FSAs signed
prior to FY09. These old FSAs had a trigger level of 90%, and the supplies currently
stands at 94-95%. Thus, this provides option for redistribution of coal towards
the new FSAs. However, there is no attempt to revise the old FSAs to lower the
trigger level to 80% in line with the new FSAs; and thus the coal supplies to the
power capacities commissioned prior to March 2009 will not be impacted much.
Company has applied to Ministry of Environment and Forests for clearances on
additional capacity in existing mines. A fast track process is being set up, and this
can possibly lead to enhanced output by 20-25m tons shortly. Environment
clearances for new mining projects are being expedited; and recently Amrapali
mine project has received MoEF clearance (expected capacity 15m tons) while
clearances for several projects are expected to be fast tracked. This will possibly
lead to a meaningful improvement in production volumes in the Twelfth Plan till
FY17. The optimistic production target in the event that environmental clearances
are fast tracked is 615m tons in FY17 (CAGR of 7.2%) as compared to the earlier
target of 556m tons (CAGR of 5%).
Wage negotiations have been signed with most of the unions and the annual
impact on a recurring basis is INR40b. In addition, the company will have to
provide for gratuity / actuarial expenses on the increased levels and this will be
an additional provision of INR25b. COAL has been making provisions for wage
increases at the rate of INR7.5b per quarter and thus the balance incremental
provisions wef 2QFY12 will be made in 4QFY12. We have factored in staff cost of
INR71b in 4QFY12, vs INR56b in 3QFY12.
We maintain Buy on COAL with a price target of INR396/sh and believe that any
declines should be used as a buying opportunity. The stock quotes at a PER of 14x
FY13E and 11.7x FY14E.
Power sector imbroglio could get resolved?
90-day revival plan with monthly milestones
A high-powered meeting led by PMO was held on 18 January 2012 with several Cabinet
Ministers and CEOs of power companies including from Tata group, ADAG, GMR, GVK,
Adani, Vedanta, Jindal, Lanco, etc. The key agenda was to address the logjam in the
power sector.
Complete lack of co-ordination across ministries, persistent delays and logjam had
led the matter to be escalated to the highest level. The initiatives taken now indicate
the seriousness, and urgency on the part of authorities for an important sector.
Domestic coal production is near stagnant for 3 years in a row. Coal India's
production target is now at 440m tons in FY12 v/s 431m tons in FY11 and 430m tons
in FY10). This is due to multiple reasons: 1) Environment/forest clearances, 2)
Evacuation issues, 3) Operational slippages owing to adverse climatic conditions,
etc. We believe that Coal India remains the most non-controversial way to increase
domestic production and thus, this leads to hopes for uptick in production in
FY13/14. Similarly, declining gas supply/production and capacity addition by several
IPPs have led to both existing and new projects being stranded for fuel.
Support for UMPP projects based on imported coal needs more clarity. Our past
discussions with incumbents (Tata Power, Reliance Power) suggested several
hurdles which need to be addressed including "State government willingness (as
power is procured by discoms, which are counterparty to such PPA)". This, in our
view, is unlikely to be resolved in haste, and would go into several deliberations
before any final outcome. We would be watchful of any development on this
front. TPWR could be biggest beneficiary, assuming "support" indicates 100% fuel
cost pass through (v/s 50% currently).
Development of captive coal block, in our view, is an equally pressing issue and
thus, resolving issues on related environment and forest clearance and land
acquisition is critical.
Another contentious issue has been the Power Purchase Agreements (PPAs)
between states and developers, which have been jeopardized given lower
domestic coal supply, high imported coal prices, regulatory changes in countries
like Indonesia and Australia, etc. This remains to be watched
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