India Power Sector Merchants make merry ::JPMorgan

A trend line of merchant power volumes in India over the past three years is
remarkably flat, despite overall generation increasing by a CAGR of 6% over this
period. Barring a brief spike in ST rates around the previous general elections in
FY10, bilateral contract rates have been range-bound at Rs4.0-4.5/kWh. While the
peak power deficit in India decreased from 14.6% in FY08 to 9% in FY13,
merchant rates have not eased, supported by inflation in the cost of generation –
especially fuel, the absence of growth in volumes on account of the limitations
posed by the weak state of SEB finances, and restrictions on the use of domesticlinkage coal for merchant generation. We believe merchants will continue to
“make merry”, with a busy election calendar lined up over the next year,
encouraging data on SEBs undergoing a fresh round of tariff increases this fiscal,
and integration of the southern grid still ~1.5 years away.

�� -->

 Composition of merchant volumes has changed: Share of UI volume in ST
power has dropped from 45% in 2008 to 21% currently owing to a tightening of
grid transmission frequency and restrictions imposed following widespread
blackouts in India ~Jul-12. The share lost by UI has mainly shifted to
exchanges, and bilateral share has remained fairly stable at ~50%.
 Trends for key merchant IPPs in FY13: As per CERC, the pan-India blended
merchant rate for FY13 was down 1% to Rs4.03, while bilateral rates were up
2.1% to Rs4.32/kWh. We analyzed six IPPs which would account for ~30% of
pan-India ST sale in FY13. JSW Energy, the biggest merchant IPP by volume
(10% of total, up 12.6% YoY in FY13) also had the highest ST realization of
Rs4.6/kWh, up 3% YoY. It was a beneficiary of a higher proportion of bilateral
tie-ups in energy-starved Southern states. Other key merchant sellers witnessed
flat or slightly lower realization in FY13, except Jindal Power (the secondlargest by volume) which faced transmission constraints after the Jul-12
blackout. Adani Power clocked merchant rate of Rs4.1/kWh. For JPVL’s
Karcham Wangtoo (1000MW) merchant realization was lower (~Rs3.5/kWh) as
seasonality in generation renders hydro projects less suited to bilateral contracts
for a large part of the year.
 Could South grid integration drive change? In FY13, the Southern region
peak power deficit was 16.1% vs. 9.0% for pan-India (ex-South 6.2%). South
(including AP, Karnataka, TN, and Kerala among major states) accounted for
~28% of pan-India peak demand (135GW) and ~50% of the peak deficit of
12.2GW, as per CEA. Stagnant merchant volumes may rise after South grid
integration, an event ~1.5 years away, as per PTC. While this is an opportunity
for merchant IPPs to sell more, the health scorecard of southern SEBs may
determine whether the merchant price level can be sustained.
 Investment thesis following more bullish merchant outlook: We expect
bilateral contract prices to remain stable (~Rs4.25-4.40/kWh) in FY14; forward
ST rate curves corroborate our estimate. We have upgraded JSW to N from UW;
we see it as a relatively safe opportunity to buy on dips. We reiterate OW on
JPVL (~53% units sold in ST market in FY13) – 1H has seasonally higher PLF
for hydro. Overall sector reforms are yet to materialize; we maintain our
preference for PGCIL (OW). To benefit from the expected favorable tariff
increase by CERC we would choose Tata Power (OW) over Adani (N), where
balance sheet deterioration and PPA/fuel concerns persist.