Prudent Lending

There was significant stress in the power sector during the past year owing to subdued power demand, lack of power purchase agreement (PPA) tie-ups and promoter inability to infuse fresh equity, among other regulatory and contractual issues. In the renewable energy sector, declining tariffs and renegotiation of PPAs by discoms reduced the attractiveness of assets. Despite various reforms being undertaken, financial institutions remained cautious about lending to both conventional and renewable energy projects, at least in the short run. Leading financiers share their views on the sector’s performance and outlook…

What have been the most noteworthy achievements of the power sector in the past one year?

Gopal Agarwal

The power sector has gathered some momentum in the recent past. Some of the key recent developments are enumerated below:

  • The Cabinet Committee on Economic Affairs has approved amendments to the mega power policy and thus the time period for submission of final mega certificates to the tax authorities stands extended from 60 months to 120 months for 25 power projects with provisional certificates. In the absence of fresh PPAs by state discoms, this was a big respite.
  • The April 2017 Supreme Court ruling disallowing some of the private players from claiming compensatory tariff for power generated by their imported coal-based power plants created ripples in the industry. Although the court clarified that changes in coal prices due to Indonesian regulations cannot be construed as “change in law” as per the PPA, the shortage in domestic coal supply as per the National Coal Distribution Policy has been accepted as “change in law”. This should help projects that are suffering due to inadequate coal supply under the fuel supply agreement (FSA).
  • The government has recently introduced a new coal linkage policy, known as the Scheme for Harnessing and Allocating Koyla Transparently in India (SHAKTI). The scheme is expected to resolve the fuel supply issues of more than 50,000 MW of power plants awaiting fuel supply and also reduce power costs to consumers. As per this scheme, coal linkage would be given to all the projects that had earlier received letters of assurance from the government on the ground that they would achieve project completion by March 2022. Any new coal linkage to private developers will be given through competitive bidding.
  • The government has come out with a policy to introduce flexibility in the utilisation of domestic coal for reducing the cost of power generation. As per this policy, states can provide coal allocated to them for use in private generating stations, which will supply power in lieu of the transfer of such coal. This would facilitate the utilisation of stranded power projects and reduce the cost of power for discoms.
  • In the renewable space too, there has been the introduction of competitive bidding for the wind segment. India’s ambitious green energy programme took a giant leap with the country’s first wind energy auction for 1,000 MW recording a low tariff of Rs 3.46 per unit, mirroring the steep fall in the solar power segment.
  • In the solar segment, competitive bidding for solar park-based projects in Madhya Pradesh and Rajasthan witnessed new benchmarks in tariffs. Bidding for 500 MW of capacity at the Bhadla Solar Park recorded the lowest solar tariff of Rs 2.44 per unit. Solar tariffs fell to this level following a series of auctions in the recent past. In the rooftop space too, the government awarded many projects based on competitive bidding.
  • The government has introduced new guidelines for the tariff-based competitive bidding process for solar projects. These guidelines allow compensation to developers in case of offtake constraints due to the non-availability of transmission networks or backdown.
  • Ujwal Discom Assurance Yojana (UDAY) has resulted in an improvement in the discoms’ financial and operational health. As per the Seventh Monitoring Committee report published in April 2017, for the March-December 2016 period, aggregate technical and commercial losses fell to 22.86 per cent from 23.84 per cent in financial year 2016, and the gap between costs and tariffs declined to Re 0.47 per kWh from Re 0.56 per kWh in financial year 2016.
  • The government has also shown keen interest in resolving the issues relating to stranded/stressed power projects based on coal, and has formed various committees to evaluate and suggest suitable measures for the same.
  • In 2016-17, a renewable capacity addition of 11.2 GW was achieved (the highest in a year).

P.R. Jaishankar

India’s power sector has seen several sweeping changes in the recent past. Power generation has increased significantly during the past few years and India’s installed generation capacity stands at over 330 GW as of July 2017. Domestic coal production has also improved and India has moved from a coal-scarce to a coal-surplus situation. This has led to a reduction in coal imports, thereby resulting in a reduced cost of power to utilities. The UDAY scheme, introduced to fix the precarious financial condition of state discoms, has led to savings of Rs 150 billion till March 2017 for the states participating in the scheme. These states have taken over the targeted debt of over Rs 2 trillion of their discoms. Further, the government is promoting renewables in a big way. The share of renewables in India’s energy mix has increased from about 13 per cent as of February 2015 (when the government announced ambitious targets for renewable energy) to about 18 per cent in July 2017.

What is the current stance of investors and financiers towards the power sector? What is the industry outlook in the near to medium term?

Gopal Agarwal

Projects aggregating more than 35,000 MW are stranded due to various reasons. Some developers do not have the financial and technical strength to continue with stressed projects. However, the new investors are adopting a cautious approach and are cherry-picking deals. Large domestic and foreign players, are looking to expand their portfolios through deals that offer attractive valuations for distressed assets. With the impetus provided by the government and the increased focus of international funds and investors on the renewable energy sector, substantial investments and mergers and acquisition activity are expected. Financiers are cautious and are selectively considering fresh exposures in the thermal power sector for deserving projects. Most of the lenders are engaged in the resolution of their stressed asset portfolios through viable turnaround plans including a change in management where required. However, effecting management changes has been challenging.

In light of the plummeting solar and wind tariffs, banks are adopting a cautious approach in funding the renewable energy sector. However, international funds/financial institutions and infrastructure non-banking financial companies continue to be bullish about the renewable energy sector.

The key issues in the thermal power sector that remain to be addressed are lack of fresh PPAs, subdued power demand, lower plant load factors, inability of promoters to infuse equity/funds, substantial time and cost over-runs, absence of last-mile funding, discoms’ proposals to cancel/renegotiate already signed PPAs and shortage of coal supplies. The renewable sector is in troubled waters on account of discoms not honouring the “must-run” status of projects, falling tariffs, proposals to renegotiate/cancel already signed PPAs and delayed payments leading to a severe cash crunch.  However, as per the draft National Energy Policy (NEP), electricity demand is expected to grow fourfold from about 1.1 trillion units to about 4 trillion units by 2030, with an increase in per capita annual electricity consumption. This is expected to increase the demand for power and thus address many of the sectoral issues in the medium to long term.

Moreover, the government is taking various steps to address key issues in the sector. The push to increase the share of renewable energy is a right step towards a greener tomorrow. However, significant investments in the renewable and transmission sectors are required to achieve the government’s ambitious renewable energy target. The states are expected to come out with tenders for signing short-term PPAs. This will help in the utilisation of stranded projects and replace costly power. Although the short-term outlook for the sector appears to be bleak, with a growth in demand and recent government initiatives, the medium- to long-term outlook is promising.

P.R. Jaishankar  

Despite an improvement in coal availability, restructuring of discom debt and operationalisation of stuck projects, there are several other issues that are plaguing the sector and need to be resolved urgently. These include large underutilised capacities, subdued demand, lack of long-term PPAs, and weak discoms and their failure to honour PPAs signed earlier owing to the recent drop in renewable energy tariffs. Investors are increasingly becoming cautious about buying assets, especially in cases where offtake agreements have been signed at higher tariffs. Subdued demand and low PLFs further reduce the attractiveness of assets, be it thermal or solar.

As far as the lenders are concerned, Reserve Bank of India (RBI) data shows that bank credit to the sector has remained constant over the past one year, indicating the reluctance of banks to extend loans to a sector already beleaguered with high leverage and interest burden. While the government has taken several steps to improve the state of affairs in the sector, these measures are expected to yield positive benefits in the long run. In the near to medium term, one can expect the sentiment to remain subdued as investors and financiers gauge the outcome of ongoing reforms. As a key financier to the power sector, India Infrastructure Finance Company Limited (IIFCL) has till March 2017 sanctioned over Rs 430 billion of loans under the direct lending and takeout finance schemes to over 180 power projects across various states. We intend to further enhance our contribution to the sector in the coming years.

What would be the most effective strategies for reviving stressed assets in the sector?

Gopal Agarwal

The government is working on various strategies for resolving the issue of stressed power projects, as discussed above. The following measures would further help in the early revival of the sector…

Thermal power

  • Coal-related: An effective strategy could be making linkage coal or captive coal available to power projects with short-term PPAs and for bilateral sales to high tension consumers through open access. This may be permitted till untied capacities are tied up through fresh long/ medium-term PPAs.
  • Power procurement: The government may nominate a centralised agency to enter into fresh long-term PPAs, which may subsequently sell power to the state discoms as per their requirement. Alternatively, these plants may offer their power to central power sector undertakings, which may, in turn, pool the power thus procured with their generated power and offer it to the state discoms. This would help reduce overall costs.
  • PPAs and tariffs: Following the Honourable Supreme Court’s order for de-allocating coal blocks, power plants with PPAs based on captive coal have become unviable. In all these cases, the tariff should be revised so that the fuel cost is recovered.

In the model standard bidding document, the variable tariff is adjusted according to the variation in the specified station heat rate. As a result, power plants with subcritical technology are at a disadvantage. In light of the practical difficulties, separate benchmarks should be adopted for subcritical and supercritical units. This will create a fair playing field for both the designs.

Renewable power

  • RPO compliance: The MNRE may stipulate penalties to ensure adherence to the RPOs. This would also facilitate the development of the renewable energy certificate market.
  • Enforcing “must run” status: “Must run” status for all renewable projects should be strictly followed by discoms to encourage more participation. There should be strict guidance by the state regulators regarding such compliance.
  • Harnessing rooftop solar energy: Rooftop solar projects will help the country in the long run to address the electricity demand-supply situation. Growth in rooftop solar is inhibited due to weak local distribution infrastructure, lack of economies of scale and heavy reliance on subsidies. Distribution companies are investing in augmenting their infrastructure and greater participation of aggregators would result in economies of scale.
  • Renegotiation/Cancellation of PPAs: The states should be instructed by the regulators to honour PPAs strictly. Any downward revision in tariff will affect the viability of projects. PPAs for wind projects should be executed upfront to improve their bankability.
  • Timely resolution of regulatory issues: Measures need to be adopted for the time-bound resolution of petitions regarding tariff determination/revision as well as routine petitions for change in law.
  • Timely payment by discoms: Suitable measures need to be implemented to ensure timely payment of bills for the power supplied to discoms. Payment delays leads to a short-term liquidity mismatch for developers. The problem is greater for small developers in the renewable sector.
  • Strengthening the transmission network: Large investments are required in transmission capacity to provide open access/sufficient reserve capacity to integrate renewables with the grid. To facilitate private participation, forest clearances should be made available prior to project implementation and this responsibility can be entrusted to the nodal agency.
  • Last-mile funding: To reduce the dependence on domestic bank credit, the government should establish a “last-mile equity fund” for the completion of stalled power projects and the fund infusion should be done in consultation with the lenders. Wherever capital is provided by a government fund, public sector entities such as NTPC and NHPC may provide support for completion/operation of these projects on the recommendation of the project lenders.

P.R. Jaishankar

The major reasons for stress in the power sector include non-availability of regular FSAs, lack of PPA tie-ups, and promoter inability to infuse equity and service debt, in addition to regulatory and contractual issues. Further, the renewable sector has seen tariffs fall to a record low of Rs 2.44 per unit, putting in question the viability of such projects due to aggressive bidding by developers.

The above issues require concerted efforts on the part of all stakeholders, generators, lenders, discoms and regulatory authorities. The government has recently strengthened the National Company Law Tribunal to deal with large stressed assets under the new insolvency regime. This move is expected to result in the speedy resolution of stressed accounts and prevent wilful defaults. Further, RBI has introduced schemes such as the Scheme for Sustainable Structuring of Stressed Assets (S4A) and the strategic debt restructuring (SDR) scheme, which are in operation to reduce the stress in the sector.

UDAY, which aims to revive ailing power discoms, may not be a panacea for addressing the financial challenges faced by the distribution segment. As a long-term solution, a certain part of the discoms’ cash flow should be earmarked for lenders. This would provide comfort to the lenders as well as lead to the effective resolution of issues in distribution. Discoms also need to work on fixing governance issues, and spend on networks, meters and IT systems.

Further, due diligence and financial restructuring by lenders to turn around stressed projects would go a long way in attracting new promoters to bring in fresh equity investments.

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