The dividends of merchant power

The prospect of merchant power is the second factor that is fuelling power stocks. Developers need not tie up all their power with state electricity boards (SEBs). Instead, they could tie up 50 to 75 per cent and sell the remaining as merchant power, provided they can fund this (merchant) part on their own or on the strength of their balance sheet.

Jindal Steel & Power (JSPL) is setting up a 1,000 mw plant in Chhattisgarh. But it has tied up only 600-700 mw power with the customers, while hoping to sell the remaining as merchant power.

"If the revenue stream from the tied-up portion is enough to take care of my repayment schedule, lenders don't mind," said R K Saraf, president (power), JSPL.

An analyst who tracks investments for a Singapore-based foreign institutional investor, said, "The story doing the round in stock market circles is that companies that have been allocated coal blocks can make a lot of money by selling power at merchant rates."

Instead of selling all their power at Rs 2.50 a unit, the power companies could sell a quarter of their power at Rs 5 a unit given the power shortages, the analyst added.

''There's a potential upside through capacity addition and having a mix of government-mandated tariff and selling merchant power,'' Lanco's Babu agreed.

The investors are being encouraged by the fact that an increasing number of people, including the biggest buyers, the SEBs, are willing to buy expensive power.

''You need power to run any business, whether it is retail, IT or a special economic zone. People don't have a choice, but to buy expensive power,'' said an expert. For instance, cities such as Delhi and Mumbai have been buying power at Rs 7 a unit to meet the shortage during peak hours.

''Somehow, states are able to buy expensive power and pay for it. The price of power is no longer an issue, availability is an issue,'' said Harry Dhaul, director-general, Independent Power Producers Association of India.

This is a big departure from the earlier practice when SEBs were reluctant to pay more than Rs 2.20 a unit, the rate at which NTPC sells base-load power to the SEBs. The low price that cash-strapped SEBs were willing to pay has long been a sticking point over private participation in generation projects. Now, things are changing as the shortages become more acute. For instance, Maharashtra's peak power deficit of 5,500 mw has forced the state board to selectively buy relatively expensive power.

The SEBs typically recover the additional costs by levying a "fuel cost adjustment'' or fuel surcharge. The sector operates on a cost-plus model, as the additional costs are a pass-through to the customer.

The crucial fact is that SEBs, which were once defaulting on their payments to utilities, are paying on time. If they don't, utilities stop supplies. States manage by prioritising payments to the central utilities and delaying payments to others or deferring investments (in T&D). They are increasingly paying subsidies to the electricity boards for the free or below-cost power supplied to the farmers.

But in this euphoria, are investors and developers ignoring the risks in the power sector? The SEBs continue to make losses, pricing is dictated by politics and vested interests force the states to hanging on to distribution.

Developers say that payment risk is addressed by open access, whereby the consumers have the flexibility to choose their power supplier. ''If an SEB doesn't pay, I will be happy to sell to someone else,'' said a developer. Yet, there are other risks. Power projects involve a gestation period of four to five years, when a lot of things could go wrong and some of these projects may just wither away. The fuel linkages could go wrong or the fuel prices could go haywire. Projects may not be able to achieve financial closure or run into a relocation and rehabilitation problem.

Take a port-based ultra-mega power project (UMPP) that has a committed tariff for 25 years, but is based on imported coal without any long term agreement. What happens if coal prices rise?

The apparent risks have seen interest levels waning in the later UMPPs, based on imported coal.

The Krishnapatanam project bagged by Reliance Energy is a case in point. ''REL has to still tie up coal, while the shipping rates have shot up from $17 a tonne to $50 a tonne in the last two years. Even if one ties up for coal, how does one transport it? While revenues are fixed (with a fixed tariff), the costs fluctuate,'' said an analyst who works for a foreign institutional investor.

(Concluded. The first part of this story appeared on December 20)