Why Power Generating companies in India are in trouble?

–If you are on this post just for stock related information, let me state upfront that I am negative on all power generation companies in India – NTPC, NHPC, JSW Energy, Monnet Ispat, Reliance Power, Adani Power…the whole shebang. If you are curious why (and this is more personal, than just relating to stocks), read on.

It came as a revealation to me that in India, Power Generation was not the constraint for uninterrupted power supply, but the State Electricity Boards (SEBs) were the constraint.

Let me explain.

First, the basics of power. We get electricity through to our homes due to three stages – power generation (at the power plant – thermal, hydel, nuclear etc), power transmission (through all those wires and transformers you see along the highways) and power distribution (at your local power plant, local transformer in your colonies etc.). That said, let’s move ahead.

We have all heard the following data ad nauseam time and again –

a) The growth of the economy, calls for a matching rate of growth in infrastructure facilities. The growth rate of demand for power in developing countries is generally higher than that of Gross Domestic Product (GDP). In India, its around 1.5 times GDP. That is, if our GDP is growing at 8% annually, we need to increase our power output by 12% (10% atleast).

b) India is planning to nearly treble its electricity capacity to almost 450 GW by 2020 from around 167 GW currently, which means a yearly addition of nearly 23 GW for the next 9-10 years.

c) In spite of rapid power generation, figures available with the Central Electricity Authority show an average power deficit of 6.4% across the country in November. The national average of peak hour shortage during the month was 8.7%. The deficit was highest in the western region, where peak hour shortage was at 15.6%.

d) The Electricity Act 2003 repealed a old legacy of 1910 and another of 1948 and had, in one stroke, forced the inevitability of total reforms in the electricity sector. The best beneficiary of the Act being the industry – large and small – and the commercial establishments which had been hitherto bearing the brunt of the SEB onslaught in terms of high tariff, unstable supply, impossible conditions and the wrath of a state monopoly. After the Act went through, generation of electricity did not require any approvals from any body so long as the same is used for own use. The new-found freedom allowed commercial and industrial users to set up their generation facilities and the industry was supposed to install power generation capacities to profit from the paucity in the country.

I thought there was a definite need (and hence a business opportunity) to set up power generation plants, supply uninterrupted power to consumers and make a lot of money.

Till I read this article in the Economic Times –

“Cash-strapped state power utilities have cut offtake from thermal power generators, hitting their output and driving down tariffs in the short-term market. State power utilities, which buy the entire output of thermal power generators such as NTPC, Adani Power and Monnet Ispat, have cut off take because of a cash crunch and are resorting to load shedding, industry experts said.”

“NTPC sells most of its power under long-term power purchase agreements. With states back tracking, the company’s net profit has taken a hit, rising only 1.12% in 2010-11. The situation is grim at electricity trade markets too. Private power producers such as Adani Power and Monnet Ispat say states purchase power at 11 a unit during elections, but resort to load shedding in the normal course. A top executive at Monnet Power said the company was forced to sell electricity at 0.50 per KWH in January, as there was no demand from states.”

Think about the article for a while.

You’d probably think that SEBs being a part of the State Government are being subject to discrimination, since the State has only so much money to buy electricity, after doling out a million sops to the aam aadmi (these sops sometimes include laptops and TVs).

You’d also be inclined to think the issue to be simplistic – why not buy power and pass on the costs to consumers? Why should the State Govt. have any say in this? The SEB supplies me power, and if I use that power for 24hrs a day, I pay for 24hrs a day. Why is the SEB reluctant to buy power, when I, the consumer am willing to pay for 24hrs of uninterrupted power supply?

The issue is a little more complicated than that.

Tariff increases have continuously lagged increases in costs of fuel and salaries (due to obvious political pressures), and widening inefficiencies (transmission and distribution losses, power theft with 18% pilferage and faulty metering) have added to the woes of SEBs. Sum total of all cash  losses of SEBs and distribution companies in India have jumped 4.4 times between FY07-09 to Rs. 2.5 trillion, and expanding by nearly Rs. 1 trillion a year (In A Raja’s standard, 1 lakh crore). The SEBs are losing money on almost every unit they sell. With increased growth come increased losses in case of SEBs.

To arrest these losses, many state-owned distribution companies are suspending power supply for hours, even in the winter when demand is low, because they are unable to pay for power. This has forced many generation companies to scale back production.

And then there is the newly set up Central Electricity Regulatory Commission (CERC), which is supposed to manage tariffs and transmission. Why are they not able to solve this problem? Simply because they only have a say in inter-state transmission of electricity and not intra-state distribution, which is in the hands of the state SEBs. So, we have more committees and lesser solutions.

So, what are we doing about all this?

The Union Ministry of Power is working on a set of guidelines (to be ready in 2-3 months), which will address issues of SEBs such as collection and billing efficiencies, long term power purchase agreements etc. However, we do know in India, there is no dearth of reports and laws and guidelines (and committees and GoMs and empowered GoMs). Implementation of these guidelines would probably take another decade.

What is the bottom line? The collateral damage is that suppliers (i.e., power generation companies) are seeing their payment cycles elongated on an ongoing basis and are having to scale down on ambitious projects to generate electricity. In the long run, its bound to hurt everybody.

I personally don’t see a bright road ahead for these power generation companies for atleast the next 2-3 years. And I need not feel sorry for them, because in the end, I would be one who would be suffering. And that’s the bottomline, because some committee said so.

So yeah, coming to the stock related part and why I am negative on power generation companies – Debtor days will increase as SEBs don’t have enough money; Ambitious projects will be scaled down as the current supply is not being bought by SEBs and hence impacting cashflows; the situation for atleast 2-3 years looks bleak to me (till the million committees sort this issue out) for all the below mentioned companies. Maybe suppliers to these power generation companies like Neyveli Lignite also can get affected.

Almost all SEBs borrow money from Banks to fund this huge deficit (and for ongoing capital expenditure) and Banks are happy to lend as they are guaranteed by the State Govt. However, I don’t know for how long the party can continue. Even in the situation of a bailout by the Central Govt., the Banks are bound to take a hit. I have no idea of the exposure each bank has to a SEB though – and hence can’t comment on Bank stocks.

General data on current power generation companies: NTPC (current capacity 33GW, 75GW by 2017), NHPC (current capacity 5GW, 10GW by 2016), Tata Power (3GW), Reliance Power (everything is in the air, and in planning stage. Supposedly planning 35GW. Good luck with that), Adani Power (current capacity 2GW, planning 17GW by 2016), Lanco Infratech (current capacity 2GW, 18GW in planning), SJVN (current capacity 1.5GW), Torrent Power (current capacity 1.7GW), JSW Energy, Monnet Ispat among many others.

Disclosure: No position in any of the above mentioned stocks.

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