More Risks Than Returns

Financiers’ perspective

Stressed assets were a constant problem for the power sector in the past year. At the same time, significant developments such as the mandatory adoption of letter of credit (LC) as a payment security mechanism in power purchase agreements (PPAs), the expected launch of the second phase of the Ujwal Discom Assurance Yojana (UDAY) and proposed reforms under the new tariff policy provided some assurance to lenders. Leading financiers in the power sector shared their views on its performance and the future outlook…

What is your assessment of the power sector’s progress in the past 12 months?

P.R. Jaishankar

The energy landscape in India has changed drastically in recent years. While coal-fired generation has seen increasing pressure due to over-capacity and low utilisation, the renewable energy and transmission segments are gaining prominence. India’s installed generation capacity stands at over 360 GW as of July 2019, of which more than 80 GW is based on renewables.

While the power sector has made swift progress in terms of capacity addition, it has witnessed an increasing amount of stress over the past few years due to several reasons. As per recent estimates, around 66,000 MW of capacity is facing varying degrees of financial stress. This includes 54,800 MW of coal-based power, 6,830 MW of gas-based power and 4,570 MW of hydropower with lenders having an exposure of around Rs 3,000 billion. The key reasons for the stress include projects being set up without coal linkages, lack of PPAs, aggressive bidding by developers, contractual and tariff-related disputes, promoters’ inability to infuse working capital, delay in project implementation and subsequent cost overruns.

The ongoing crisis in the distribution segment due to the poor financial health of discoms has adversely impacted the power sector. According to information available on the power ministry’s PRAAPTI portal, discoms owed Rs 746.55 billion for the power bought from gencos as of end-July 2019. Of this, the overdue amount stood at Rs 550.68 billion. In addition, the recent attempts by state discoms to renegotiate PPAs may not bode well for both domestic and foreign investors in the sector. As per official data, FDI in the power sector declined from Rs 104 billion in 2017-18 to Rs 73 billion in 2018-19. In view of the existing state of affairs, the government has made it mandatory for the state discoms to offer LCs as a payment security mechanism in PPAs. This has been done to ensure timely payments by the states to electricity generation utilities.

Since the power sector constitutes about 55 per cent of the gross bank credit of scheduled commercial banks in India, it is important to resolve the stress in the sector to avoid a spillover to the other sectors of the economy. The effective implementation of the Insolvency and Bankruptcy Code can help in improving the recovery rate of stressed assets in the sector.

Mukul Modi and Kumar Bibhu

  • The developments over the past 12 months could be dubbed as interesting. Though they may not have a significant impact in the short term, they will prove to be game changers in the medium and long term. Over the past 12 months, the government has initiated several new schemes such as the  Pradhan Mantri Sahaj Bijli Har Ghar Yojana (Saubhagya), issued policy directives for the hydro sector and hinted at next-generation discom reforms. Some of the key highlights of the past year are as follows:
  • The Saubhagya scheme towards 100 per cent electrification of households across India has been a major initiative of the government in 2018-19. Under the scheme, 26.2 million additional households were electrified as of March 31, 2019. This scheme is likely to have a significant impact on demand, especially in the household sector.
    Another significant development has been higher capacity addition in the renewable energy sector as compared to the conventional energy (non– renewable energy) sector. In line with the past trends, capacity addition through conventional sources declined in 2018-19. Coal-fired plants accounted for merely 3.4 GW of the total capacity added during the year whereas renewable energy capacity addition stood at 8.5 GW. A similar trend is expected to continue in the future as well. By financial year 2030, renewable energy sources (solar and wind) are expected to constitute more than 50 per cent of the installed capacity, whereas the share of coal will decline to 32 per cent of the total installed capacity. (Source: Draft Report on Optimal Generation Capacity Mix for 2029-30, CEA, February 2019)
  • The power sector faced domestic coal shortages during the year, which was reflected in the rising coal imports. Coal import increased by around 13 per cent to 235 million tonnes (mt). Considering the current fuel supply agreements and the production plans of Coal India Limited, coal shortage is expected to persist in the next year as well, though it will reduce.
  • There was continued emphasis on discom reforms. The government has taken several steps to improve the condition of discoms in the past. Schemes like UDAY had an impact on the operational performance of discoms. For example, the average AT&C losses reduced from 20.7 per cent to 18.7 per cent and the ACS-ARR gap from around Re 0.59 per kWh to Re 0.17 per kWh during the period 2016–18. Further, in the past 12 months, the government has either initiated or proposed next-generation reforms in the distribution sector. Initiatives like mandatory LC as a payment security mechanism, linking of additional debt from PFC/REC to UDAY compliances and late payment surcharge could have a significant bearing on the health of discoms. Further, a new tariff policy is likely to empower consumers through content and carriage separation.
  • The hydropower sector has also not seen major growth in the past two decades, due to which the government introduced promotional measures through a policy directive in March 2019. This includes providing renewable energy status and new funding provisions to large hydel projects, which may spur capacity addition. Also, large hydro projects would be allowed back-loading of tariff after increasing the project life to 40 years, increasing the debt repayment period to 18 years and introducing an escalating tariff of 2 per cent per annum. Apart from this, the power sector continued to be plagued by non-performing assets (NPAs) of large conventional generation projects. The government has taken various measures to address this issue such as:
  • Introduction of medium-term PPAs for stressed independent power producers (IPPs) under the aggregator model. Further, discoms cannot cancel PPAs for projects, where delays in commissioning are beyond the control of IPPs.
  • Introduction of the Shakti scheme for IPPs with or without PPAs. It also earmarked more coal for the power sector via a forward e-auction.
  • Late payment surcharge and mandatory LC for discoms

Dr Pawan Singh

While the past year witnessed continued thrust on the renewable sector with the government backing its growth to the hilt, the sector has faced issues such as undersubscription of bids, negotiations after the competitive bidding process, and bidders’ discomfort with the ceiling tariffs in the bidding process. However,  Andhra Pradesh’s call for the renegotiation of already concluded PPAs seems to have been the last straw. It has caused huge uncertainties for developers, lenders and investors, and put a huge question mark on the entire business environment of the country.

The power sector is plagued with some inherent risks associated with discom payment to the power generators. In this regard, the Ministry of Power has recently issued an order, directing the National Load Despatch Centre (NLDC) and the regional load despatch centres to despatch power only after it is intimated by the generating company and distribution companies that an LC for the desired quantum of power has been opened. While the provision regarding maintenance of an adequate payment security mechanism by way of an LC was already provided in the PPAs, it was not adhered to by most of the discoms. It is envisaged that this move will contribute favourably to building the trust and confidence of power developers and allay their concerns regarding delayed/non-payment  of dues.

The initiative of the Central Electricity Authority (CEA) to address the issues related to delayed payments by discoms is another step highlighting the seriousness of the government to address the power sector’s woes. In view of the same, the CEA is planning to maintain a database of all outstanding dues of renewable developers with distribution companies.

Another positive development has been the convergence of the power and mobility sectors, leading to the initial growth of the e-mobility space. There is clear government focus on the accelerated development of charging infrastructure for electric vehicles (EVs) in the country. In this regard, the Ministry of Power published the “Charging Infrastructure for Electric Vehicles – Guidelines and Standards” on December 14, 2019.

What are the sector’s unaddressed issues and concerns?

P.R. Jaishankar

The distribution segment is the Achilles’ heel of India’s power sector. The major causes of distress in the sector are the high cost of power purchase, flawed planning, persistent AT&C losses, inefficiencies in capital expenditure and skewed tariffs. The UDAY scheme, launched in 2015, to revive ailing state-owned electricity discoms, has not been able to significantly improve the health of discoms. As per a CRISIL study, the aggregate external debt of discoms is likely to increase to pre-UDAY levels of Rs 2,600 billion by the end of 2019-20.

While discoms have enjoyed the benefit of debt reduction, they have been slow to implement the structural reforms required for a turnaround. For instance, AT&C losses reduced by only 400 bps till December 2018 as compared to a target reduction of 900 bps from pre-UDAY levels. Further, the average tariff increase was merely 3 per cent per annum, as against regular tariff hikes of 5-6 per cent per annum required under the UDAY scheme. As most states are facing fiscal constraints, discoms need to become commercially viable themselves through prudent tariff hikes and a material reduction in AT&C losses. This calls for urgent structural reforms on the part of discoms. Ensuring cost-reflective tariffs and a significant reduction in AT&C losses through measures such as smart metering are the need of the hour. Further, the government must lay emphasis on the development of smart grids to link the source of power to users through the integration of renewable energy sources, smart transmission and distribution. This could reduce the stress in the ailing power sector, and allay the concerns of generating companies, investors and lenders.

Mukul Modi and Kumar Bibhu

The power sector in India is plagued by various issues. These issues can be classified as commercial, regulatory, financial and technical. Over the years, the government has taken several steps to overcome these challenges. However, some critical issues still remain unaddressed. These include:

  • Poor financial health of discoms: The government has introduced various schemes in the past such as UDAY and the financial restructuring package. However, the key concerns associated with high AT&C losses, and inadequate and infrequent tariff revisions still persist. As a result, discom debt is expected to reach the pre-UDAY levels of Rs 2,600 billion by 2019-20, as per a CRISIL newsletter. Therefore, without making the discoms commercially viable on a stand-alone basis, the woes of the power sector will remain unaddressed. In this regard, technological intervention in the form of smart meters, prepaid billing, privatisation/franchise model, etc. has the potential to bring in change.
  • Fuel related constrains: The sector is also facing fuel supply constraints and supply bottlenecks. This shortfall is increasingly being met through imports, which stood at 164 mt in 2018-19 (only non-coking coal). Gas-based plants are also facing fuel supply problems. Further, there are uncertainties regarding the pass-through of the additional fuel import bill to power tariff. Government initiatives like SHAKTI and linkage rationalisation have helped alleviate the problem to some extent. The auction of coal blocks is likely to help in the medium to long term.
  • Funding-related issues: Due to the prevalent stress in the banking sector, huge NPAs in the power sector, coupled with banks/financial institutions reaching their sectoral exposure limits for the power sector, have reduced the appetite of banks for lending to the sector. Further, the slow resolution of stressed assets in the sector and the chances of PPA renegotiation are also impacting the investment sentiment.
  • Environment-related issues: The Ministry of Environment, Forest and Climate Change notified the revised environmental norms in December 2015. These norms are to be complied with by 2021-22. Compliance with such norms would require investment in new technologies such as flue gas desulphurisation (FGD) and selective catalytic reduction.

Dr Pawan Singh

  • Higher AT&C losses remain a grave concern for the sector. Achieving a 15 per cent AT&C loss level on an all-India basis as stipulated under the UDAY scheme would require improvement in revenue collection, especially from domestic power consumers electrified under Saubhagya. Some of the key Saubhagya beneficiary states continue to report AT&C losses in excess of 25 per cent. These include Jammu & Kashmir, Uttar Pradesh, Madhya Pradesh, Bihar and Rajasthan. Their discoms will have to take corrective measures.
  • A large number of stressed thermal assets still remain unresolved resulting in continued pain in the power sector as well as the banking/NBFC sector. While several initiatives have been taken for the resolution of stressed assets in the power sector, including SAMADHAN and Sashakt schemes, the actual progress has been few and far between. In the cases where it has been achieved, there have been inordinate delays, increasing uncertainty in the sector. The state of incomplete projects is even worse and these are invariably being pushed towards liquidation, implying a significant reduction in the value realisation of the project assets.
  • Another concern that the renewable industry has been facing in the past few months is inordinate delays in payment to renewable energy developers from the discoms. A clear-cut precedent needs to be set that discoms cannot renege on their contractual obligations under the PPAs. If the discoms do not honour the contractual obligation, it poses an additional risk to the lenders. More importantly, such risks cannot be ascertained and envisaged while assessing the financial viability of projects.
  • Another issue that needs attention is the cost of electricity for large consumers, which needs to be reduced by providing them the freedom to choose their suppliers. This will benefit the power producers as well as the manufacturing sector. In effect, this requires captive and open access provisions in the Electricity Act, 2003. In my view, open access has a huge potential for the growth of not only the renewables sector, but also the large- and medium-scale industries. In the past, several states have come out with their open access policies but the actual implementation is not worth elaborating.

What is the investment outlook for the sector for the next one to two years?

P.R. Jaishankar

The pace of capacity addition is expected to slow down over the next few years owing to the lack of PPAs, the weak financial position of players resulting in a slowdown in private sector investment, and moderating power demand. Meanwhile, investments in the transmission segment are expected to increase over the next few years, led by robust growth in both inter and intra-regional transmission as well as rising private sector participation. With regard to the government’s goal of adding 175 GW of renewable energy capacity by 2022 and increasing it to 450 GW later, there is an urgent need to invest in energy storage considering the intermittency of renewable power supply. Also, given the sustainable energy objectives of the country and the importance of coal-based power plants, there is a need for building capacity for cleaner and more efficient coal technologies.

Mukul Modi and Kumar Bibhu

In the next couple of years, the power sector is expected to witness qualitative and quantitative changes in investment. While investment in the past was mainly driven by capacity addition in generation, especially thermal generation, future investments may not follow the same trajectory. CRISIL Research estimates that only about 35 GW of conventional generation and 44 GW of interregional transmission capacities are expected to be commissioned during the period from 2018-19 to 2022-23. Some of the new avenues for investment are:

  • Pollution control technology: The total cost of installing pollution control technology in thermal power plants is Rs 3,910 billion–Rs 3,960 billion till 2030. Of this, FGDs, catalytic reducers and electrostatic precipitators alone will account for Rs 2,570 billion (as per a Centre for Science, Technology and Policy report).
  • Renewable energy: An aggregate investment of Rs 7,700 billion is envisaged till 2022-23 for achieving the renewable energy targets as per Economic Survey 2019.
  • GECs: To support renewable generation, investment in green energy corridors (GECs) and overall augmentation of the transmission infrastructure would be required. Power Grid Corporation of India Limited expects a market opportunity of Rs 500 billion for setting up GECs in India by 2022.

Dr Pawan Singh

The power sector continues to be one of the core infrastructure sectors, playing a pivotal role in the growth of the economy. Given the importance of this sector, there have been concerted efforts by the government to make it even more conducive for investments. While recent events such as delays in payments by discoms have created ripples in the investor circle, the long-term investment outlook for the sector is definitely positive.

The total FDI in the sector for the period from April 2000 to June 2018 stands at $14.18 billion, accounting for 3.64 per cent of the total FDI in the country. This is also on account of 100 per cent FDI allowed in the sector under the automatic route and the growth of the renewable sector (wind and solar power) in recent years. A large number of global power utilities have set up their offices in India and are involved in bidding and developing renewable projects in the country.

Another potential area for investment is the electric mobility space. In this regard, The Faster Adoption and Manufacturing of Electric Vehicles II (FAME II) scheme, which was notified by the union cabinet in February 2019, aims to accelerate the Government of India’s transition to a clean mobility future, with the electrification of transportation as a primary focus area. Under the Fame II scheme, the government has approved Rs 100 billion primarily to be used as incentives/subsidies. Further, an interministerial panel has recently sanctioned 5,645 electric buses for operations in 65 cities, in a move towards environment-friendly mobility. In the coming one to two years, this sector will receive greater interest from various investors (utilities, private equity investors, etc.).

That said, the future investments will depend on regulatory certainty and long-term clarity on tariffs. It would be also appropriate that price discovery happens through a transparent competitive process. Beyond this, there should be no intervention. There should be at least a cushion left for the equity investor, especially when it may be dealing with a variety of risks. There is also a need to capitalise and strengthen institutions like IREDA, PTC India Financial Services Limited and Tata Clean Tech as these are qualified to handle the huge financing needs of the renewable and other infrastructure sectors. Moreover, the prime minister is focusing on a recycle economy. Therefore, specialised institutions need to be put in place to fund projects and investments in this area.


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