Green Shoots in Indian Power

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longer willing to fund these losses. Ina nut shell, the situation couldn’t have

been worse. All those visionaries whohad joined the great Indian powersector gold rush were wondering why

they bet a fortune on this troubledindustry. The projections for returnson equity were quickly scaled downand the capital employed itself wasat stake. The penny dropped whencaptains of the Indian industry metIndian Prime Minister to specicallyhighlight the plight of their invest-ments in power sector and requestedfor government intervention.

Today, two years after that meet-ing, green shoots are emerging inthe power sector due to the Indian

government’s FY13 and FY14 policymeasures towards solving two keyissues - fuel risk and poor nancialhealth of state power utilities (SPUs).In the following text we take stock ofthe government’s policy moves overFY13 and FY14 and assess the impactthereof on beleaguered investments inthe Indian power sector.

Concern I - Fuel AvailabilityIndian power producers added

46GW of coal-based generation capac-

ity over FY11-FY13, nearly 2.3x of thecapacity added over FY04-FY10. How-ever, domestic coal output growthcould not keep pace with the capacityaddition. During FY11-FY13, domesticcoal output could only increase by34MT. The total coal required for the46GW added over the same period,assuming 80 per cent plant load fac-tor (PLF) would have been 216mMT.Hence, there was a huge demand-supply mismatch which developerstried to bridge through imported coal,although its use was restricted.

Indian industry rushed to set uppower plants after policy changesushered in by the Electricity Act,2003. By 2007, most large Indian

business houses had either an-

nounced mega plans for seing uppower generation plants or, startedinvesting huge amounts into new proj-ects. Thus, it was easier to count thelarge business groups which did nothave power sector presence instead ofthe other way around.

In 2008, one prominent Indian con-glomerate raised more than INR10 bnthrough an IPO for its power genera-tion venture. By 2009, many other In-dian power sector entities had evincedinterest in approaching the stock

markets for raising equity. Investorinterest reached a feverish pitch whenthe private equity players bestowedunheard of valuations on yet-to-beoperational power companies.

Meanwhile, a few sane voices werehighlighting the risks associated withthis bubble. The market participants,as usual, ignored all these warnings.This was because Indian economy wasgrowing at very handsome rates in2009 and 2010 despite the shadow cast

by Lehman bankruptcy and the global

nancial crisis that followed and, itwas easy and convenient to ignore therisks. The rst warning signs came inMarch 2009 when Government-ownedcoal mining companies stopped sign-ing fuel supply agreements (FSAs).Hope was still alive but signing offuel agreements did not pick upthrough 2009 and the whole of 2010.The new plants that came up in 2011were running short on coal. The fateof gas-based generators was evenworse as domestic gas supplies starteddwindling and imported gas became

Salil Garg maps the tumultuous journey of India’s power sector

and is optimistic of its future growthPower Sector

Green Shoots in

too expensive to be viable. Additionaltrouble started when power distribu-

tion companies started delaying pay-ments to power generators in 2011.All those risks which were consideredtheoretical till a year ago had mani-fested themselves in a very rm andclear manner.

By the start of 2012, the party wasfinally over. Banks were no longerwilling to sanction and distributemoney to power projects. Dues fromstate-owned distribution companies(discoms) were mounting and discomswere themselves laden with losses thatwere funded by banks. Banks were no

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B y the start of2012, the party

was finally over.Banks were nolonger willingto sanction anddistribute moneyto power projects.Dues from state-owned distributioncompanies

(discoms) weremounting anddiscoms werethemselves laden

with losses that were funded bybanks.

36 CFOCONNECT February 2014



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Although Coal India Limited (CIL)had revised its production targets inthe past, it could achieve 97 to 98 percent of them, leading to lower domes-tic coal availability. For FY14, CIL’s

production target has been xed at482mt and over 9MFY14 (April 2013 -December 2013) CIL’s production was319.2mmt, 95.4 per cent of the target.The lower increase in domestic coaloutput and limited use of importedcoal led to a fall in the PLF of all-Indiaaverage coal/lignite-based powerplants to 70 per cent in FY13 from thehighs of 78 per cent.

Measures Initiated

Signing of FSAs ResumedAs of 31 December 2013, CIL suc-cessfully executed 153 Fuel SupplyAgreements (FSAs), of the 173 FSAsfor 78GW coal-based power plantsthat were either commissioned orare likely to be commissioned duringApril 2009 to 31 March 2015. This isa stepping stone towards domesticcoal supply for the newly set upthermal power plants. After comingto a standstill post April 2009 andleading to signicant fuel availability

concerns, signing of FSAs came in afterthe government issued a presidentialdirective to state-owned coal miningcompanies. The resolution of dier-ences over the terms and conditionslisted in FSAs, such as penalty triggerlevel, penalty amount, contractedquantity and quality of coal, gatheredpace subsequent to the issue of thepresidential directive.

The signing of FSAs will graduallyincrease coal supply to IPPs to 75 percent of the annual contracted quan-tity (ACQ) by FY17 from 65 per cent,considering that a sudden ramp-upof domestic coal output would not bepossible. Even if the plants were toreceive 65 per cent of ACQ in the rstyear of operations it could lead to aPLF of 52 per cent purely on domesticcoal linkage.

Fuel Pass-Through for ImportedCoal in PPAs

CIL is likely to supply 65 percent of ACQ from domestic sourcesand the 15 per cent of ACQ through

imports to meet the trigger level of80 per cent, below which penaltieswould kick in. CIL expects to supplyimported coal on a cost-plus basis tothe power plant developers willingto import coal through it. However,power plants may also directly im-

port coal themselves. In this case, theFSA obligations on part of CIL to theextent of import component would

be deemed to have been discharged.The Cabinet Commiee on EconomicAairs (CCEA) has approved pass-through of the higher cost of importedcoal in the existing Power PurchaseAgreements (PPAs). Also, the pow-ers sector regulators namely CERC/SERCs have been directed to makethe required modications to enablesuch pass-through of costs to end-

consumers in case PPAs were signedon a competitive bid basis.

Coal Block Auction MechanismThe CCEA has approved the meth-

odology for auctioning coal blocksand providing for up-front and pro-duction-linked payments. The policyprovides for a production-linkedpayment on a rupee per ton basis andan upfront payment of 10 per cent ofthe coal block’s intrinsic value. Theauction mechanism is a key develop-ment as it would lead to a prior evalu-

ation of bidders in terms of technicaland nancial capability and would

bring in greater transparency. For theregulated power sector, a 90 per centdiscount on the intrinsic value would

be provided to rationalise powertaris.Moreover, up-front payments from

developers would bring in a certainlevel of commitment and, production-linked payments would incentivisethem to maximise output. The minis-try of Coal (MoC) expects auctioningof 10 coal blocks under this methodol-ogy to start in March 2014. The level ofparticipation from developers would

judge the eectiveness of the policy being put in place.

Fast Tracking Coal BlockDevelopment

The Government had set up a Cabi-net Commiee on Investments (CCI)to fast track decision making for clear-ance of projects in the infrastructuresector. The CCI had considered MoC’sproposal to fast track approvals forenvironmental and forest clearancesin respect of 12 coal mining projects.During May 2013, Ministry of Envi-ronment and Forest cleared CIL’s 18

coal mining projects with environmentclearance accorded to 14 projects andstage I forest clearance accorded tofour projects.

Concern II - Financial Health ofSPUs

The nancial health of SPUs con-tinued to deteriorate with book lossesreaching INR578bn and cash lossesreaching INR622bn during FY12. Thishas been on account of non-cost reec-tive taris, higher ATC losses, delayedreceipt of subsidy and higher relianceon short-term power purchases. Thepoor nancial health of SPUs beganto impact the entire value chain inFY12 as payments to generators/traders/transmission companies weredelayed. Moreover, the poor nancialhealth resulted in SPUs resorting toload shedding, impacting the valuechain further. Cash losses increased toINR622bn in FY12 from INR435bn inFY11. Around 70 per cent of the losseswere accounted for by ve states withdistribution companies in Tamil Nadu,

The signing ofFSAs will gradually

increase coalsupply to IPPsto 75 per centof the annualcontracted quantity(ACQ) by FY17from 65 per cent,considering that asudden ramp-up

of domestic coaloutput would notbe possible.

February 2014 CFOCONNECT 37



Uar Pradesh and Rajasthan being thetop three cash loss making discoms.

Measures Initiated

Tariff HikesDuring FY13 and FY14, manySERCs approved the petitions ofSPUs to raise taris across consumercategories. Though tari hikes werehigh, they were not sucient to coverrevenue gaps in many SPUs and alsodid not result in the recovery of theregulatory assets created by some ofthe regulators in the past. The regula-tors before FY13, under the politicalinuence of the ruling parties, triedto protect domestic and agricultural

consumers from tari hikes. However,FY13 saw across the board tari hikes,which would not only improve cashows but also lower the level of crosssubsidisation, as industrial consumersare paying higher taris than domesticand agricultural consumers. Discomsin Tamil Nadu and Rajasthan, withhigh cash losses of INR137bn andINR189bn during FY12, respectively,saw an average tari increase of 37per cent and 8 per cent during FY13.

The ability of discoms to regularly

hike taris and recover regulatory as-sets through additional regulatory sur-charge would be the key determinantsto their overall nancial turnaround.Though tari hikes alone cannot be thepanacea for the problems of ailing dis-coms, operational eciencies in termsof lower ATC losses, operating costscontrol also should be a key focus areafor discoms to ensure sustainability of

business operations.

Monthly Variable CostAdjustment Mechanism

Power purchase cost is a majorexpenditure in the annual revenuerequirement of the distribution li-censee and is an uncontrollable costfor discoms, as specied in the taripolicy. Most regulators earlier had notallowed for fuel and power purchasecost adjustment formula. However,Appellate Tribunal of Electricity inOctober 2011 directed SERCs to havea fuel and power purchase cost ad-

justment mechanism in place, withmonthly revision that does not exceed

a quarter.

The introduction of a monthly vari-able cost adjustment mechanism bySERCs allows discoms to recover anyuncontrollable costs, primarily powerand fuel cost, from end-consumerson a monthly/quarterly basis. This

would lead to lower cash-ow mis-matches, as such adjustments earlierwere allowed at the end of the year todiscoms during the true-up exercise.The full impact of this judgment will

be evident once the recovery of fuelcosts is institutionalised.

Financial RestructuringPackage(FRP)

The CCEA approved a FinancialRestructuring Package (FRP) fordiscoms during September 2012. Ac-cording to the nancial package ap-proved by the CCEA, 50 per cent of theshort-term loans will be taken over bystate governments. They would rst beconverted into bonds to be issued by

discoms to the participating lenders, backed by a state guarantee. The stategovernments would then take overthese liabilities over a period of two tove years by issuing special securitiesto lenders in a phased manner. The

The Governmenthad set up a

Cabinet Committeeon Investments(CCI) to fast trackdecision makingfor clearance ofprojects in theinfrastructuresector

THINK TANK

38 CFOCONNECT February 2014



balance 50 per cent of the short-termliabilities would be re-scheduled andserviced by discoms with a morato-rium of three years as they begin toimprove their nancial position.

The proposal also looks at cur-tailing ATC losses by incentivisingstates through grants. Moreover, thepackage comes with preconditionswith respect to the regular ling ofnancial accounts and regular revi-sion in taris. This provides immedi-ate relief to SPUs and may result inan operation level turnaround if theterms of the package are implementedin spirit. As of date, discoms in vestates namely Haryana, Uar Pradesh,Rajasthan and Tamil Nadu and Hi-

machal Pradesh have restructuredtheir liabilities as part of FRP. Therestructuring exercise for discoms inthe states of Bihar, Andhra Pradesh,and Jharkhand are underway. DuringNovember 2013, to enable these three

states to participate under the scheme,the cut-o date for reckoning the eli-gible amount of short-term liabilitiesfor issuance of bonds and restructur-ing of debt by lenders was shifted to 31March 2013 from 31 March 2012. Themonitoring mechanism proposed inthe FRP, through constitution of bothstate level and central level commieesand the composition of the commit-tees, is expected to ensure compliance

with the guidelines listed in the FRP.The commiees are likely to monitorthe progress quarterly till a successfulturnaround of the state discoms.

Positive Trends EmergingPositive trends have begun to

emerge in the power sector in termsof payments being made to powertraders, generators and capital goodssuppliers, thus lowering the debtordays and improving cash ow fromoperations of these entities. H1FY14

also saw the receipt of past over-duepayments from discoms to powertraders, non-prevalence of expen-sive short-term power purchases bydiscoms and higher domestic coaloutput from CIL (9MFY14: 319.2mmt,9MFY13: 308.9mmt), lower deficit(April-November 2013: 4.2 per cent,April-November 2012: 9 per cent). Re-cently, CCEA also approved changesto the mega power policy whichwould allow an additional 15 proj-ects to be classied as mega powerprojects thus providing the benets of

Power purchasecost is a major

expenditure in theannual revenuerequirement ofthe distributionlicensee and isan uncontrollablecost for discoms,as specified in thetariff policy.

The author is Director –

Corporates, India Ratings

& Research

zero import duty. Though most stepsinitiated by the government of Indiahave long-term implications; however,some positive impact is likely in theshort term.

Way ForwardBesides the above policy initiatives,

a large number of other issues needresolution to ensure viability of invest-ments in the power sector:• Universal open access• Clarity on the pricing of natural gas

for the power sector from FY15• Institutionalisation of fuel cost

adjustment and monthly variablecost adjustment charges by allregulators

• Tari nalisation for UMPPs andcase II operating plants under theconsultative process

• A time-bound roadmap for liquida-tion of regulatory assets

• An annual performance reviewand a yearly true-up exercise ofpast expenses and annual revenuerequirement

• Operationalisation of the nationalgrid through connectivity of South-ern region with other regions

• Loan restructuring for large IPPs

• Strengthening of SERCs• Introduction of competition in thedistribution space through pres-ence of parallel operators

• Amendments to the ElectricityAct, with respect to pass-throughof fuel costs, open access, stricterimplementation of renewable pur-chase obligations, enhancement ofgrid security, co-existence of taridetermination and competitive bid-ding regime, thrust to hydro poweramong others

• New standard bidding documentsfor peaking power and medium-term power procurementDespite such measures, consider-

able challenges persist for the exist-ing investments to become viable,to reduce stress on bank lending tothe sector and for aractive returnsto emerge which could infuse fresh

investments.

THINK TANK

February 2014 CFOCONNECT 39

Green Shoots in Indian Power

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