Merchant power: All plug and no play?
Munira Dongre 02 September 2010

The recent rise in merchant power bid rates has created enthusiasm in the Street, but rates may soften in the next four years. Here’s a current account of various broker views

An ICICI Securities report dated 30 August 2010 says it expects merchant power rates to soften in the next four years. Key reasons — 67 gigawatts (GW) capacity addition, which would result in power deficit dropping to low single digits; inability of the state electricity boards (SEBs) to sustain high merchant prices considering that their losses are likely to rise to Rs713 billion by FY14E from Rs411 billion in FY10, and the fact that even privatised distribution areas such as Mumbai and Delhi have under-recovery of more than Rs50 billion as of FY10, which raises flags about the sustainability of high merchant prices.

ICICI pegs its expectations over the next four years at 67GW, which it still considers ambitious but considering private participation, it expects execution to improve. Plans are drawn up for 97GW and projects worth ~100GW have already met initial requirements. This will hike the overall supply to 1.1 trillion kilowatt hour (kWhr) from the current 0.74 trillion kWhr.

ICICI expects demand for electricity will match the pace of Gross Domestic Product (GDP) and not more (around 8%) — this is because while on the one hand availability will drive demand, it will be balanced against increased energy efficiency and rising energy tariffs at the consumer level, and lower AT&C (Aggregate Technical & Commercial) losses, which will free up billable supply. With supply rising at a 10% compounded annual growth rate (CAGR) till FY14E, ICICI expects the power deficit to come down drastically to just about 5% by FY14. AT&C losses would come down to 25% by FY14E, says the report. ICICI is assuming new thermal capacity to operate at 75% PLF (plant load factor) on the conservative side, but adds that if the PLF were higher, say 80%, there would be no deficit at all!

The reducing power deficit will lower merchant rates to Rs Rs3.5/ kWhr in FY14 from Rs5/ kWhr in FY11, says I-Sec. “We believe deficit and merchant rates share a non-linear correlation; a marginal drop in deficit could lead to a significant fall in merchant power prices and vice versa. Owing to rising overall cost, merchant rates should stabilise at ~Rs3.5/kWhr and grow at a pace of 2% per annum to reflect the increase in cost,” says the report.

ICICI believes that SEB losses will rise to Rs713 billion in FY14 if power prices (consumer tariff) continue to rise at around 5% p.a. “To stem losses at current levels, FY10 level prices need to rise at least 7.3% y-o-y. This should act as a deterrent for expensive power purchase by SEBs,” it says in its report. However, because demand growth is probably going to increasingly come from the bottom of the pyramid (the lower income group) price sensitivity is going to increase. So SEBs would find it hard to afford power at these rates and thereby, exhibit some restraint.

I-Sec asks the question if the consumer is really paying for high merchant prices. It points to metros like Delhi and Mumbai where despite privatisation of DISCOMs (distribution companies) and higher consumer affordability, under-recovery was at Rs54 billion mainly because of higher merchant prices, lack of political will, and marginal consumer protests.

“Over time, a part of the burden would be passed on to the consumers,” says I-Sec, which could have an impact on demand.

The report also touches on the fact that India’s dependence on imported coal is set to rise, which would lead to higher costs. Our country will need to import 201 million tonnes of coal by FY15, of which 147 million tonnes will be for the power sector.

It also points out that while Coal India (CIL) has hiked prices only four times in the past decade, the last hike was much quicker than the previous one. Also, with its IPO (initial public offering) round the corner, external influence on CIL may lead to faster price hikes.

Here are some Street views on Adani Power and JSW Energy (with inputs from research reports of various brokerages):

Adani Power (APL)

Adani Power is a part of the Adani Group. It has 5.61GW of projects under construction and 990MW commissioned capacity — most, 4.6GW, is located in the Mundra SEZ (owned by the Adani group), Gujarat, and 2GW is in Tiroda, Maharashtra. Additionally, it has a development pipeline of 5.94GW at Kawai (Rajasthan), 1.32GW, Tiroda-II, 1.32GW,
Chhindwara (Madhya Pradesh), 1.32GW, Dahej (Gujarat), 1.98GW and Bhadreshwar (West Bengal), 3.3GW)

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A great part of APL’s value comes from cheap landed coal available from Adani Enterprises Ltd. AEL is committed to supplying coal with an average GCV (Gross Calorific Value) of 5,200Kcal/kg for 15 years at $36/tonne (Cost, Insurance and Freight Mundra). However, it has been seen in the past that this coal was of lower GVC which put pressure on the cost (since it had to blend South African coal, which translated into an average landed coal cost of $70/tonne). In Q1 the cost did come down with an improvement in GVC.

Q1 numbers were above expectations despite lower PLF largely because of very high merchant realisations of Rs6.75/ kWhr (not many brokers had estimated this to be higher than Rs4.5/ kWhr). However, a part of this can be attributed to seasonality (summer) — even so, a lot of brokers have upped their estimates of merchant power realisation by between Rs0.24-0.75/ kWhr.

JPM estimates that a Rs 0.5 decrease in tariff leads to a 10% decrease in EPS and a 10% increase in coal costs leads to a 14% decrease in EPS.

Some brokers have already factored in even the pipeline projects into their estimates — so sure are they of Adani's execution abilities. This is because except fuel linkages, APL has tied up most loose ends for Tiroda III and Kawai — such as debt and awarding EPC contracts. So they are assuming that there is good visibility on volume growth beyond the 6,600MW under construction.

APL expects the first 660MW unit of its Mundra Phase III (2x660MW) project to come on stream by January 2011. Brokers are factoring in a 3-6 month delay to be on the safe side (since for most of its projects so far, a 1 to 3 month delay has been seen). A lot of its projects are coming on stream in 2012 (Mundra Phase 4 and Tiroda Phase 1). I-Sec has a more conservative approach on execution — “The Street is placing a lot of faith on the group’s execution capacity. In our view, the group’s credentials are noteworthy, but delays beyond the control of the management can affect valuations and consensus estimates.” I-Sec is one of the few brokers with a ‘sell’ recommendation on this stock but its revenue and profit estimates are quite aggressive.

Other negatives for APL are its 1,000MW power purchase agreement (PPA) with Gujarat Urja Vikas Nigam at Rs2.35/kWhr for 25 years (so far, it does not look like it can wriggle out of that one) and the fact that it might have to pay 16% customs duty on power sale from the Mundra SEZ.

It also had some problems with Chinese visa issues (it has around 300 Chinese workers on its payroll).

A far-off positive for the company is Adani Enterprises’ purchase of the Galilee-basin coal tenement from Linc Energy for $2.7 billion which could secure long-term coal linkages for APL.

JSW Energy

JSW was initially started as a captive power SBU (strategic business unit) to supply power to JSW Steel with only one 260MW plant at Vijayanagar in Karnataka. It then set up another 600MW plant at the same location. JSW now has 11.4GW of power generation capacity on its plate, stake in three mines, and has forayed into the power equipment industry and transmission projects.

Its two projects in Vijayanagar (260MW and 600MW) are operational and its Barmer 1 (1,080 MW) in Rajasthan has started but is facing teething problems. Other projects in the pipeline are Ratnagiri 1 (1,200MW) in Maharashtra, Barmer 2 (270MW),  Kutehar (240MW) in Himachal Pradesh, Chhattisgarh (1,320MW), West Bengal (1,600MW), Ratnagiri 2 (3,200MW), and Jharkhand (1,620MW).

JSW Energy is acquiring South African Coal Mining Holdings, which controls the Umlabu and Ilanga mines, with total resources of 61 million tonnes, for $21 million. Ilanga is at its life end, but Umlabu produces ~1.2mntpa.

It is likely to spend another $29 million to enhance production from both mines. It has a joint venture with Rajasthan State Mines and Minerals called Barmer Lignite Mining Company, which will operate lignite mines at Kapurdi & Jalipa in Rajasthan. While mine development has already begun for Jalipa, Kapuradi is still in the approval stage. The mines are expected to be operational by FY12 and will meet the lignite requirement for the Barmer power plant. It has an 11% JV with Mahanadi Coal for thermal coal in Utkal A block in Orissa, which is
likely to have annual production of ~15 million tonnes. This could be used for the Chhattisgarh power plant. It also has a 10% JV with Toshiba JSW which will sell turbines and boilers for the power sector in India. Almost 1/5th of this project is complete. JSW Energy has a 74% JV with the Maharashtra State Electricity Transmission Company and its Jaigad-New Koyna-Karad line in Maharashtra is expected to be commissioned by November 2010.

Negative arguments for the company include its high exposure to international coal prices right now, high dependence on merchant power in case of a fall in merchant tariffs, and project delays at Barmer because of difficult working conditions and environmental issues at the Ratnagiri plant (see Moneylife article on environment clearances:

Positive argument include higher merchant capacity (1,154MW by end-FY11) which means it can cash in the most on the current higher merchant power rates, dependence on imported coal to reduce once captive coal from Rajasthan comes in, and diversification into power trading. JSW Power Trading Company is one of the top 5 power trading companies in India, with market share of ~9% during FY10.

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In its latest quarter, higher fuel costs led to a decline in margins, and there was a 7% drop in realisations. However, the quarter also saw higher net generation and PLF.

Adani Power has risen from Rs100 at the end of last year, to around Rs133 currently. JSW Energy is trading at around Rs130 and has been in a narrow range of Rs115 and Rs135 since June.

yashvanth rao j
1 decade ago
I differ to a large extent from the views presented in the report. India cant 67 GW in the next four years unless otherwise in a best effort business scenario. Even if 67 or say 75 GW get added to our capacity, the peak demand of the country will 60% higher after five years from the current levels. So point of expecting 5% power deficit by FY 14 is completely questionable.
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