Betting on power reforms

Power sector stocks have recently emerged as market favourites, evoking memories of the information technology and pharmaceutical booms of a few years ago and the real estate sector more recently. Listed stocks have provided investors phenomenal returns in recent weeks, while the stage is set for the initial public offering (IPO) of Reliance Power, which, at over Rs 10,000 crore, will set the record as the biggest ever. There are a number of other IPOs in the offing, by groups such as Sterlite and Jindal, and yet others may follow if the first wave is successful. All this is extremely good news for a power-starved economy, which has been losing hope about a quick end to the shortages as the reform roadmap laid out in the Electricity Act of 2003 simply failed to materialise. The Eleventh Five-Year Plan has set an extremely ambitious target for capacity creation, at over 78,000 Mw, which, on the face of it, is inconsistent with the fact that the basic requirements of the roadmap, such as open access to state grids, have not been implemented. However, recent developments, particularly the successful concessions for two ultra mega power plants (UMPPs) of 4,000 Mw each (although with a bit of a hiccup on one of them), have changed the complexion of the sector and renewed hopes that the sector had found a way round the impasse on state-level reforms.

There is clearly some merit to this optimism. The significance of private sector entities in the creation of new capacity increases the probability that the projects will be completed on time and within budgets. Both of these provide re-assurance to investors that the promoters' projections on financial returns are reasonable. The important contribution of the UMPP process to the buoyancy is that these plants have signed power purchase agreements with several states, reducing the risk of being held hostage by the financial condition of any one of them. This was precisely the problem that the first generation of private sector plants faced; the ideal solution was, of course, open access, which would allow a plant to sell to anybody who was willing and able to buy. On this consideration, the reluctance of state governments to enforce open access has been a huge hindrance to private investment in generating capacity. The UMPPs have found an intermediate solution by diversifying the risks across multiple states. Overall, given the fact that there is a huge deficit in supply and that these projects can now reduce their vulnerabilities to the vagaries of state power policies, large commitments are clearly being made with an increasing degree of confidence that things not only can, but indeed will, get better.

However, risks remain. Open access and, along with it, the unfettered movement of power across state boundaries remain a critical factor in determining the viability of private generators. In this sense, the boom in investment in the power sector is being implicitly driven by expectations that state governments will fall into line fairly quickly, even as these projects are under implementation, giving them a healthy and hospitable market into which to push their first megawatt-hours of power. Whether these expectations are realistic or misplaced, only time will tell. Perhaps the combined influence of prominent promoters and and millions of investors will be an effective force for reform.