Power stocks have seen a bounce-back from their lows. The gains have been powered by two factors. One, the government instructed Coal India to sign fuel supply agreements (FSA) with projects that had signed long-term power purchase agreements (PPAs) with electricity boards.
This was expected to address the issue of fuel shortage faced by these companies. Two, many state electricity boards began to revise the consumer tariffs. This led to optimism that they would now purchase power at a higher price and would repay their past dues. This was conducive to power generation companies.
Additionally, Budget announcements such as extension of 80IA (10-year tax-holiday) for projects implemented before March 2013, duty cut on coal imports, and access to overseas borrowing were viewed as other positives by the market.
Bullish start to 2012
Stocks such as Lanco Infratech, KSK Energy Ventures, GVK Power, Indiabulls Power and Reliance Power have gained more than 48 per cent in the last four months. But these were the stocks that were hit hard in the correction from the November 2010 peak, losing between 60 per cent and 85 per cent.
Despite the rally, these stocks are still trading well below their 2010 highs. The reasons behind the sector's underperformance include lower domestic fuel availability, changes in regulations abroad making imported coal expensive, subdued merchant power realisations, fixed tariffs with insignificant fuel cost pass-through component and frail financial health of their main clients, state electricity boards (SEBs).
Gains capped
Recent optimism about power stocks, however, may not be entirely justified. Fuel availability continues to be a concern even as CIL is ready to sign FSAs. But according to news reports, Coal India may be required to shell out a penalty of only 0.01 per cent of the value of coal, in case of missed targets. This penalty may be too low to ensure that Coal India ramps up supply.
This compares unfavourably with penalty of 10 to 40 per cent of the contract value in the case of FSAs signed prior to March 2009. This is a clear negative for the expected beneficiaries of FSAs such as NTPC, Adani Power, Lanco Infratech and Sterlite Energy who are locked into fixed tariffs and rely on Coal India supplies.
A Planning Commission report states that the production of Coal India, in the base case scenario, will only support an additional 7,500 MW in the Twelfth Plan. This may lead to scaling down of capacity addition targets by as much as 30,000 MW.
Importing coal
Power generation projects may import as much as 213 million tonnes per annum or 25 per cent of the overall coal requirement by 2016-17. According to a Planning Commission report, blending imported coal with domestic coal (50 per cent supply from Coal India) pushes the cost higher by as much as Rs 0.60-0.7 per unit for power plants.
In this context, introduction of a mineral resource rent tax on coal mined in Australia and a ‘minimum' notified price for coal exported from Indonesia, will further push up the costs. Indonesia is also planning to hike export tax on thermal coal which would further aggravate the situation. This is likely to lead to the costs of imported coal shooting up from the expected price of $30-36/tonne to over $70.
Companies such as Adani Power, Tata Power, Reliance Power and JSW Energy may be affected because they have projects that rely solely on imported coal. The past competitive bids for power purchase agreements are designed in such a way that there is no fuel pass-through component.
Alternatively price revision is indexed to inflation which is far lower than the actual rise in imported coal prices.
Tata Power in fact had to ‘impair' the value of its Mundra Power project due to the spike in coal costs — this project is completely dependent on imported coal. Adani Power has incurred losses in the December quarter due to higher coal costs.
Funding
Weak equity markets and the poor performance from the power sector have closed the route of easy fund-raising for power generating companies. Additionally, lesser cash flows generated internally — given the falling load factors and execution delays — have reduced funds available for ploughing into new projects.
Private generation projects have operated at 68 per cent plant load factor for the year ended March 2012.
While the low load factor may be due to very high capacity addition, this factor has to improve for these projects to recover costs and improve profitability.
Given this backdrop, the sector may remain unattractive in the near-term.
The key triggers for improvement of the sector would be any re-negotiation of power purchase agreements with the SEBs and fuel supply agreements.