The role of project financing has expanded for the transmission segment with the government’s thrust on tariff-based competitive bidding of projects. Each year, an increasing number of projects are being awarded to private players. Given the massive opportunity, the investor/financier community is upbeat about the segment. There is a growing realisation that transmission stands differentiated within the power sector in terms of the risk-reward matrix. Funds are thus pouring in through both lending books and structured bond trade.
As the appetite for financing transmission projects grows, developers and financiers are collectively exploring various structures to efficiently fund projects while minimising the existing burden on the banking system. In a first, Sterlite Power Grid Ventures Limited successfully closed a Rs 9.25 billion issuance of AAA (SO)-rated non-convertible debentures in January 2016. Opening up of the public debt or the bond market for the transmission segment is a welcome development for developers as it not only creates a new avenue for money supply but also reduces the cost of borrowing.
Power Line moderated a panel discussion on the opportunities and challenges in financing transmission projects at the recent Sterlite Grid Investors’ Meet. This article presents a summary of the discussions…
Changing investor mindset
In recent times, there has been a gradual shift in the mindset of the investor community. Industry stakeholders have been communicating with a wide variety of investors and financiers including insurance companies, pension funds, provident funds, bank treasuries, mutual funds and foreign institutional investors to explain how the transmission segment needs to be analysed, addressed and understood differently from generation and distribution. While the generation segment suffers from the challenge of inadequate fuel supply and power purchase agreements, the distribution segment is reeling under high financial losses and debt.
“In the case of the transmission, the risk-reward parameters stand positively aligned relative to the pricing. Initially, there was a bit of pessimism among the investor community; however, now there is more awareness about why this segment stands out. This has been the key driving point,” noted Jayen Shah, senior director and head, debt capital markets, IDFC Limited.
Minimum revenue risk
Transmission is one of the least risky infrastructure segments. Such projects involve a one-time investment in the form of capex. The operations and maintenance costs are low and easily manageable. The revenue generated by the asset is assured for a period of 25-35 years. It is fixed and annuity-like in nature, with only a small variable percentage.
Sujata Guhathakurta, senior executive vice-president and head, debt capital market, Kotak Mahindra Bank, explained that the pooling of receivables is a key reason for the overall low risks. “In transmission, you are not exposed to only one project; you are taking a pooled risk across the entire transmission system and against all the power utilities in the country. If anything goes wrong, the amount of hit that an individual project takes is very small,” she observed.
Under the prevailing point of connection mechanism, Power Grid Corporation of India Limited collects all transmission charges and shares the revenues with all transmission asset owners. Since transmission costs are low and given that non-payment can lead to a complete power shutdown, utilities tend to be regular in payments.
Manageable development risks
At the development and execution stage, a number of risks are associated with transmission projects including right-of-way (RoW) issues, delays in clearances, and time and cost overruns. “While the risks during construction cannot be entirely assessed, developers can manage/reduce these risks to a large extent through proper assessment and provisioning at the time of bidding. Some of these issues can be addressed through modular implementation of projects,” said Amit Bhave, director, CRISIL Limited.
Sterlite Grid remains a success story in this context as the company has been able to achieve tremendous predictability in project assessment. Pratik Agarwal, vice-chairman, Sterlite Grid, said, “We spend more man-hours and more money per bid before bidding for tenders than any other company in the country so that we know with certainty that the project can be completed at a lower price than at which we have bid.”
RoW is a key challenge during execution. However, it is worth noting that the cost of RoW procurement is typically less than 4 per cent of the entire project cost. It becomes a challenge only in case of a stalemate. As Agarwal noted, “Developers need to break down each risk and allocate the right processes, technology and people to deal with those risks.”
Going forward, RoW procurement is expected to become easier under the revised guidelines of RoW compensation. Developers are also innovating with technology, for example, through the use of monopole towers, which occupy only 5 per cent of the space as compared to regular towers.
Challenges and the way forward
The funding needs of the transmission segment have burgeoned over the past few years in response to the massive investment targets. At present, a key limiting factor is that most banks have reached their power sector exposure limits. Because the segment developed nearly five years later than generation, it is bearing the brunt of limited liquidity in the market. Stakeholders are trying to build an opinion that transmission should not be included within the sector exposure limit as the risks associated with these projects are significantly lower.
Further, there are challenges with respect to the definition of exposure norms for insurance companies, as well as the opinion of the pension and provident fund regulators on structured obligations. Significant regulatory support is needed for meeting the investment needs of the transmission segment. Streamlining of regulations will expand the scope for innovative financing structures. Banks and developers both need to work together to develop finer rational structures to fund such projects, especially at the construction stage. At present, projects are financed with 16-year tenors in mind, even though all the involved parties are aware that the project will get refinanced once it is completed.
On the bond market, Guhathakurta said, “Given the present size of the transmission business, there is enough appetite to absorb triple annuity, road bonds and AAA transmission bonds. We are trying to fragment the market into placing out the shorter tenor bonds among mutual funds and banks, and the longer tenor bonds with provident funds and insurance companies.”
Srinivas Mishra, agm, State Bank of India noted that financiers need to be supportive and upbeat about taking up these projects. He said, “Public sector banks have been more forthcoming in financing greenfield transmission projects when the risk is higher, while the participation of other banks increases at the time of refinancing the debt.” Recent trends indicate that this is changing as more capital is gravitating towards this segment.
Several investment avenues currently remain unexplored. Pension funds and insurance companies have come into the market, though with relatively small quantities of funds. There is significant opportunity for overseas lenders as there are very few projects globally with such risk-reward parameters. Funds may also be raised in the future through infrastructure investment trusts (InvITs). Meanwhile, realistic bidding is key to the future of the segment. The commercial rate of lending for transmission projects in a competitive bidding scenario with wafer-thin margins cannot survive in the long run unless bidders, backed by the investing community, are confident about the robustness of the bid assessment process.