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Opportunities in Indian Power Sector: Concerns of International Investors, Shri R V Shahi, Former Secretary, Ministry of Power

After a lapse of more than a year, the IPO's of Adani Power and NHPC have again demonstrated the interests of domestic and international investors in Indian power sector. In the last few years, after radical restructuring of the electricity industry, post Electricity Act 2003 and host of other policy initiatives, the profile of power sector is changing, in fact, changing quite rapidly. Even 12 years after Private Power Policy of 1991, we could get hardly about 7,000 MW of private power by 2002, which was not even 10% of total power sector capacity. Now, private power constitutes almost 25,000 MW, which is 17% of the total capacity of about 1,50,000 MW. And, in last 3 to 4 years, the projects which have been brought above the ground and are under execution present even a better picture about private sector involvement. At present, out of a total of about 81,000 MW capacity under construction, about 22,000 MW, i.e. about 27% is by private sector. This trend is likely to continue. In fact, when the Ultra Mega Projects start showing up their contribution, the profile of power sector would have tilted significantly towards private sector contribution.

Interests of international investors in Indian power sector are growing. Last week, at the invitation of J.M. Financial, and as facilitated by them, I had twelve meetings in Singapore on 17th and 18th of August, 2009 and four meetings in Hong Kong on 19th August, 2009, which included a luncheon meeting at each of these two places. I had the opportunity to interact, during these meetings, with a number of Senior Representatives of as many as twenty four Investment Companies. Each one of them has large investment base and they are all internationally reputed organisations. The objective of these meetings was to have an upto date appreciation of interests of international investors in India, especially in Indian power sector, to understand their concerns and to clarify how these concerns are being mitigated and could be mitigated. The format of these interactions consisted of a brief overview of Indian power sector and an update on investment opportunities, which was provided by me. This was followed, in each of the meetings, by discussions, which covered their concerns and my response. I propose to cover in this paper - (a) A brief outline of a detailed overview I gave as an update on investment opportunities in Indian power sector, and (b) Gists of investors' concerns and my response to these concerns. As a part of the update on investment opportunities, which I presented, I also tried to predict and cover what could be the concerns of the international investors.

Firstly, an outline of the update on Indian power sector and opportunities:

  • The Government continues to plan power sector programme on the basis of the target that Indian economy, over a long period of time, would be targeted to grow at around 9%. The slowdown effect for 2009 and 2010 would eventually go away and the previous momentum would be regained. It may be recalled that during the five year period 2004-05 to 2008-09 the Indian economy grew at an average rate of 8.5% inspite of the lower GDP growth of only 6.8% during 2008-09.

  • During the current year, the manufacturing sector has started picking up and the growth reflected by index of industrial production (IIP), just released for the month of June 2009, gives the jump to 7.8% compared to 2.7% in May, 2009. This is indicative of commencement of a good recovery in Indian economy.

  • The growth projection for 2009-10, post the last general election, when the new Government has assumed office, by almost all the international forecasts, has increased as compared to the projection made before election by .5% to 0.8% and these forecasts range between 6.3% to 7.0%. As per "the Economist" except for two to three countries in the world, the forecasts for most others are negative for 2009 and marginally positive for 2010.

  • The stock market performance of power related stocks presents a much better picture about the power sector. As on 11th August, 2009, the improvement in the Sensex, as compared to 52 week low, was recorded to be about 96% higher at 15,075 Sensex, the Nifty at 4,471 is 98.48% higher than 52 week low. As compared to these BSE Power Index registered an increase of 121%, some of the stocks recorded improvement in the range of 220 to 250%.

  • In the power sector, demand was never an issue, is not an issue now, and is not likely to be an issue atleast in next 10 to 15 years. We have witnessed many ups and downs in all other industries. But, even in the worst period of poor manufacturing growth, India experienced power shortage in most parts of the country. We continue to believe that during the period of 25 years (2007-32), for which Integrated Energy Policy has been formulated by the Government of India, unless we have an 8 to 9% growth in electricity sector, the shortage situation may not only continue but may even worsen. It is this premise that puts Indian power sector at a different pedestal and, therefore, the sector offers unparalleled and unique opportunities to invest.

  • India has been used to adding less than 25,000 MW capacity every five year. This is targeted to rise to more than 70,000 MW in the Eleventh Plan, 100,000 MW in next Plan (2012-17) and later on more than 150,000 MW every five year. For doing this, the domestic manufacturing capacity for power plant equipment including balance of plants is being jacked up not only in the Government controlled BHEL, but also by facilitating three to four more major manufacturers of main power plant equipment to set up their factories.

  • The reform initiatives in power sector, which started with Electricity Act 2003, followed by National Electricity Policy (2005), Tariff Policy (2006), Policy on Captive Plants (2005), Policy on Merchant Plants (2006), Ultra Mega Project Policy (2006), Revised Hydro Power Policy (2008) etc. have been and are being implemented seriously and comprehensively. A number of Policy interventions both by Government and by Regulatory Commissions are formulated and put in place to take care of any loose ends that exist in further facilitating growth of the sector and development of electricity market.

  • In fact, India's economic growth is substantially structured around heavy capital spending in development of infrastructure. In the Eleventh Plan, almost US $ 500 billion is estimated for infrastructure sector. Power is the largest at 40% with about 200 billion US $, remaining 60% is accounted for by Railways, National Highways, State Roads, Ports, Airports and Telecommunication.

  • Since India's power development programmes rely heavily on fossil fuels, several initiatives have been formulated through nine National Missions under the National Action Plan on Climate Change. These are being monitored by the Prime Minister's Council on Climate Change at the highest level.

  • In last few weeks, two IPO's - one of Adani Power, a major private sector player, and another of NHPC, the largest public sector hydropower company, were hugely oversubscribed 22 to 24 times. This adequately reflects investors interests and preference for power sector.

  • Apart from the above factual descriptions, which have been briefly outlined, I also brought out a few major issues of concerns and the remedial measures which have been taken and are being taken to address them. These are outlined below:

    • Fuel

    • Coal Linkage

    • Captive Coal Block

    • Import

    • Acquisition of coal mines abroad

    • Increasing Gas Production

    • LNG Turbines to expand

    • Transmission Capacity

    • Additional 30% cushion in capacity planned

    • Grant of Open Access

    • CERC's New Regulation of 7th August 2009 (Short, Medium & Long term Access)

    • Procedure Streamlined

    • State's discretion reduced

    • Manufacturing Constraints

    • BHEL's capacity increased from 5,000 MW to 10, 000 MW per year , to increase further to 15, 000 MW and then 20, 000 MW in next 3 to 5 years

    • L & T and MHI JV Setting up factory for Turbine -Generator

    • ALSTOM & BHARAT FORGE setting up another factory

    • A few others also are Planning

    • Financing

    • Sectoral Capping increased, may increase further

    • Group Capping may be reviewed

    • Mega power benefits being reviewed to make it more attractive.

Concerns of Investors:

From the discussions that followed, in each of the sixteen meetings, I was convinced that in a number of areas what was needed was to clarify the fine points of Policies and Rules of the Government and the Regulations of the Regulatory Commissions. It is also very clear that there would be a need to constantly and periodically interact with these organisations in order that communication gaps are removed and there is greater clarity on various issues that bother them. Such interactions would be extremely useful even to revisit some of the Policies and Procedures to make them more effective. Right level of comfort, among investors, about the sector is of great importance for us. Their satisfaction about the health of the sector, the likely growth and returns on investments is not only relevant to us, but it must be considered very important because the sector needs huge investments. Though there were several issues which were raised and clarified, I would try to discuss only a few important issues out of them.

  1. A number of project developers, implementing merchant plants, are projecting that these plants will be able to, on a sustained basis, over a long period of time, sell power at rates between Rs. 7 to Rs. 10 per kwhr. The investors are concerned whether such an expectation is reasonable. I could find that similar concerns are prevalent even among organisations in the Indian financial sector, consisting of both lenders and equity providers. My clarification was on following lines. In keeping with the objective of Electricity Act and Electricity Policy, Government of India and Regulatory Commissions are keen that electricity market should develop, and that the present volume of 3% of power, which is being traded through Trading Licensees or through Power Exchanges, is far too inadequate to develop such a market. Ministry of Power came out with a document on Merchant Plants in late 2006, after getting valuable feedback from a well attended Pre Bid Conference, and attempted to tie-up the required inputs, so that power projects on merchant basis are developed. In the new Hydro Power Policy, it has been stipulated that 40% of power could be kept outside PPA and sold on merchant basis. In the transmission system planning exercise, almost 30% cushion in capacity is being created, so that power from merchant plants could be sold to undetermined destinations from time to time. The aim is that in next five to seven years, power transacted is increased to almost 15% of the total as compared to 3% as at present. Therefore, as the volume of such power progressively increases the excessive price regime which is being experienced today is bound to come down. It needs to be recognised that the whole idea of market development is that competition is created, and competition drives down the price in the larger interest of consumers. Therefore, it may not be reasonable to expect that the excessive price regime would continue. However, since the progress on merchant capacity would be gradual, shortages would continue. In the interim period, therefore, the developers would have the first mover advantage and definitely get much better prices in the initial years. It also needs to be emphasised that since the risks associated with merchant plants are of higher order than for the capacities locked through long term PPA, the prices would be always significantly higher in these cases, though not as high as they are now.

  2. As a corollary to the earlier point, most of the investors were also concerned whether through Government interventions or regulatory notification, price of such power would be capped. This concern obviously was based on some of the reports which appeared in the press sometime back. My response was as follows. Indian power sector faces the situation of huge shortage and this is likely to continue. We need to get much larger power generation capacities. If we recall the initial days of liberalisation in telecommunication sector, we experienced excessive telephone call rates on mobile phones, in the range of Rs. 16 per minute. Such rates and other factors enthused a number of players to get into the sector. And, as the number of players increased, supply started gradually reaching the level of demand, competition started playing its role and in a period of about six to seven years, consumers started experiencing the positive effect of competition in terms of price, and, more importantly, quality of service. We do not need to cap the price through extraneous regulatory interventions. What is needed is that Government and Regulators facilitate larger number of players, leading to much larger generation capacities, to get to a situation that supply side somewhat over takes the demand. It is this phenomenon which will automatically bring down the price. What is important to note, as I clarified to them, that this type of understanding and appreciation of the issue exists both in the Government and among the regulatory institutions.

  3. A number of developers of merchant plants are trying to participate in the Competitive Bidding process initiated by the distribution utilities for procurement of power under Case-I Bidding. This process has been slow and in many cases State utilities have not been able to formulate clear Bid papers which has resulted in not only delayed decisions but also in some cases cancellation of the whole exercise. It was clarified to the investors that the Guidelines on Case-I Bidding, which have now been notified by the Ministry of Power, take care of a number of ambiguities and problems which were faced in some of the cases in the past. Also, in the recent weeks a few States have come out with Bids inviting the project developers to provide power to them during defined time frame. This development, that the developers could initiate the projects on a merchant basis and then subsequently arrange long term PPA for a good part of their capacity through Case-I Bidding, and also keep aside a proportion of the capacity for short term trading, is indeed a healthy development. This is bound to create a positive impact and an upside on returns. This issue also has been better understood and appreciated by lenders and they are now more or less agreeable to fund projects which are able to tie-up about 60% of their capacity on the basis of PPA, which could be subsequently finalised, and keep the balance about 40% for trading.

  4. Often we come across reports about shortage of coal adversely affecting the power generation, even among the existing power plants. When larger number of new plants get commissioned, the situation is going to worsen. Coal sector has remained untouched of any type of reform. The Bill to reform the sector has been languishing. Consequently its adverse effect appears inevitable. My explanation was on following lines. It is true that Coal Mines Denationalisation Bill has remained pending with the Parliament for almost nine years. A new Coal Act to correspond to Electricity Act 2003 is indeed a necessity. In the previous Government, which depended heavily on the support of the Left Group, it was quite clear that the legislation on coal would be hard to push through. The political configuration of the new Government is definitely more favourable for such reforms which have remained pending. Coal sector reform is overdue. Progress of power sector is closely linked to what happens in the coal sector. We could definitely expect better and more favourable initiatives in the coal industry now. In any case, even in the old Government, based on the suggestion and articulation of the Ministry of Power, the second best option, if not the first best, could definitely be secured by Government liberalising comprehensively the Captive Coal Block Allotment Policy. Almost 20 billion tonnes of coal reserves, sufficient for more than 75,000 MW capacity, have been earmarked for captive development. What is needed is that power developers vigoursly pursue the implementation. A few irritants have been observed and both Ministry of Power and Ministry of Coal are alive to these difficulties. In select cases, in which developments of coal mines may not match with the development of power projects for reasons beyond their control, the Ministry of Coal has even recognised the need for a tapering coal linkage by Coal India, during such transition period. As regards shortage of coal supply, certain amount of import would be necessary. If about 10% of requirement is planned to be met through such imports, a proposition which appears reasonable, the difficulties experienced would be substantially minimised. The silver lining is that Power Ministry and Power Industry have recognised this and are gearing up to meet this challenge. In addition a number of public sector and private companies are also acquiring coal mines abroad which will enhance the level of confidence about coal supply.

  5. When India implements the Integrated Energy Policy which takes its capacity from present 150 GW to 800 GW, the present profile of power sector may further shift towards coal based power plants. Impact of this growth from the point of view of global warming will definitely be experienced, but more importantly India will be under tremendous pressure to moderate its plans based on fossil fuels. India's position on global warming and climate change has been clearly articulated by the Prime Minister in recent months. Per capita CO2 emissions in India is one of the lowest in the world. At present it is 1 tonne per head per year as compared to global average of 4 tonnes, European countries - 10 tonnes, U.S.A. - 19 tonnes and China - 3 tonnes. India has a long way to go in increasing the per capita electricity consumption. What has been stated by the Indian Government that not only now but never in the future India's per capita emission of CO2 shall exceed the average of industrialised nations. When we are able to implement the Integrated Energy Policy covering the period of 2007-32, even if the dependence on coal continues in the manner provided, the above commitment on the carbon emission shall be met. Power industry is now deploying the latest Super Critical Technology requiring less coal consumption than the Sub Critical Technology deployed hitherto. Besides, all forms of energy technology including nuclear, hydro, solar, wind, bio-mass etc. are being extensively brought in during the expansion phase of the Indian power industry. This period will see hydro projects aggregating to 150 GW (upto the potential) wind capacity 45 GW (upto the potential) getting developed. Similar efforts would be made on other technologies.

  6. In almost all the seventeen meetings the issue regarding quality of Chinese equipment was raised. The concern was that since the Indian domestic manufacturing capacity is inadequate, a good part of the demand is being met by outside manufacturers, and among them the Chinese equipment constitutes almost 75%. When a few power plants in India, which had main power plant equipment from China, were commissioned, it is true that some of them had to undergo rather longer teething problems. I have gathered from various power generation companies that now they are, by and large, satisfied with the Chinese power plants. In any case, my recommendation to the developers is that in their Equipment Supply Contracts they could make appropriate provisions for quality checks and inspections by their own engineers or by internationally reputed inspection agencies. This is what NTPC did when we had similar perceptions about BHEL equipment in late 70's and early 80's, a practice which is continuing even now. This has done well both for BHEL and for Indian power sector. The concern, however, is of a different type. If Chinese manufacturers do not create reasonable manufacturing facilities in India for major repairs of important machines like turbine, rotar and generator, shifting of these machines to their manufacturing plants would mean considerable loss of generation. It will be advisable for them to set up these facilities of repair in India. If it is not done, the developers need to workout exercises to determine the trade off between likely loss of generation and reduced cost of Chinese equipment. If these equipment are 20 to 25% cheaper, the economics could still workout. Finally, as regards this concern, we must take note of the fact that Chinese power industry is a great growth story - they have more than 7,00,000 MW of capacity, mostly domestically manufactured, a fact which cannot be just set aside.

  7. As per the Integrated Energy Policy, as also in line with recent Government announcements, it appears that India is going in a big way to set up nuclear power plants. Obviously, arrangements for fuel supply on a long term will be made without which these projects will be unworkable. But, the concern is that in view of a number of countries going in for nuclear capacity and because of limited manufacturing capability around the world, the cost of nuclear power plant is rising very fast. In such a situation the projected capacity may be doubtful. It is true that the nuclear power capacity is less than 3% of the total capacity today. The Integrated Energy Policy projects that by 2032 nuclear capacity may be of the order of 7% of the total, which means almost 55-60,000 MW up from 4,100 MW as at present. Having said this, the project development companies would always be conscious of the economic viability of the project. Obviously, if the cost of power works out to be significantly higher because of excessively high cost of equipment, the targets will have to be moderated. If the capital cost is in the range of Rs. 5 Crores per MW that would appear to be within manageable limits, the moment it gets into the higher cost bracket, the viability will be in question. Similarly, unless the fuel availability is tied-up over the entire project life cycle, but in any case not less than 25 years, and if, price indexation of fuel is uncertain, again the project viability would be under question. Project developers will tie these aspects up properly before committing huge investments.

  8. While the recent decision of the Central Regulatory Commission allowing access to Transmission System for different time durations of 3 years, 12 years and 25 years will be very helpful for power developers, particularly for Merchant Plants, nature of Transmission charges remains uncertain. The tariff notifications of the Regulatory Commission are quite clear. However, we expect a more comprehensive Transmission Tariff Policy from the Central Regulatory Commission soon, may be in next couple of months. This has been overdue. Tariff for inter-regional transmission of power which will be volume-cum-distance sensitive would bring about, it may be expected, better clarity and would be customer friendly. Predictability of transmission charges across the country would lead to faster investment decisions.

  9. Various steps have been taken to improve Distribution sector. But reform of Distribution is very slow. Large capacity expansion in Generation and Transmission may again get into difficulty on account of payment if financial health of the sector is not improved. Payment security, no doubt, was a major issue till 2002. We have left this problem behind us now. From 2003, in last seven years, there is practically no example of generation and transmission companies not being paid fully. Major initiatives on Distribution sector reform taken in Tenth Plan from 2002-03 and reinforced further in the Eleventh Plan (2007-12) have made visible impact. The sector is definitely able to meet its payment obligations. Indeed, further improvements are needed so that Distribution sector goes beyond just meeting the payment obligation and generates enough surplus for expansion. We may expect this in coming years. A few States have already turned around, some in 2005-06, others subsequently; and the process continues. Franchisee initiatives started, in a big way, in 2005-06 from Bhiwandi (Maharashtra), the worst distribution area from the point of view of Distribution loss, extending to Nagpur (Maharashtra) and now to Agra, Kanpur in (U.P.), four largest cities of Bihar and others would have definite positive contribution in Distribution sector reform. The model of privatisation of Distribution in Delhi has, now after six years, demonstrated that it can be replicated. We may expect action on this model in other towns - and, in any case, Franchisee model may be a transition to ultimate privatisation.

  10. On balance how we rate the growth targets of the power sector in next 10 to 15 years keeping in view the financial viability and capability not only to service but reward investments is the main issue. As explained earlier, the entire business sector in India has been able to recognise the potential of power industry. All the private business groups - large, medium or small - have definite plans to expand their business in power sector. Tata Power, Reliance, Adani Power, Essar, Jindals, GMR, GVK, Torrent, Sterlite, Lanco, Jaiprakash, CESC would all emerge major power sector players in next 5 years. Besides these, there are a host of other medium and small players, numbering not less than two dozens, who are all working on developing power projects. Also, the role of public sector companies under the Central Government and those under some of the progressive State Governments is getting enlarged and it may be expected that they would follow a much sharper and accelerated growth profile in coming years. Organisations like NTPC, NHPC, Power Grid, Satluj Jal Vidyut Nigam, Tehri Hydro Development Corporation, Neyveli Lignite Corporation, Nuclear Power Corporation, on the power generation and transmission side and PFC and REC on the financing side are bound to grow very fast. Thus, in coming 10 to 15 years central sector power companies and private sector organisations could occupy substantial proportion of the capacity profile which was hitherto occupied largely by the Electricity Board/Generation Companies under the control of State Governments. Another major change that has happened in last few years is the change in the mindset of Administrative and Political Systems in the Government. These instruments together with Regulatory institutions are now more sensitive to the changing needs of the industry on the one hand and to the requirements of attracting investments on the other. This change in the mindset is borne out by the fact that Policy changes have been happening faster than ever before. This more than adequately reflects the major shifts in assessments and perceptions about positive changes which have happened in the Indian power sector in last few years. Its risk profile has completely changed. Today, this sector presents itself as the most reliable and attractive sector to invest.