Spurt In Imported Coal Prices To Negatively Impact The Power Value Chain

The 60 percent rise in imported coal prices (Richard Bay Index) between April-October 2016 is likely to negatively impact the power sector value chain, says India Ratings and Research.

The distribution companies (discoms), independent power producers (IPPs) with non-escalable fuel cost, merchant IPPs and ports relying on imported coal for the bulk of their volumes will face volume and profitability pressures.

The increase in imported coal prices was more pronounced in October 2016, wherein prices rose by 25 percent to around $85 per tonne from $68 per tonne in September 2016.

Distribution Companies

India Ratings notes, that historically the ability of the discoms to pass on fuel cost increases to the end-consumers has been limited and delayed due to the political intervention in the tariffs. The regulatory commissions can allow a pass-through of such costs, by way of power purchase and fuel cost adjustment (PPFCA), since power purchase cost is an uncontrollable expense for the discoms.

However, anecdotal evidence suggests that most state regulatory commissions have not allowed for such PPFCA adjustments on an actual and timely basis, which has led to an escalation in the power purchase cost of discoms, without a commensurate increase in revenues.

Merchant Independent Power Producers

India Ratings expects merchant IPPs, which sell power through the merchant route, to be impacted significantly since the prices on the exchanges/bilateral trades have not moved up at the same rate (2 percent month-on-month), as the rise in variable cost of generation (25 percent ) in October 2016, on account of the imported coal price increases. Thus leading to a significant compression in their gross margins, which have fallen to zero in October 2016.

Hence the viability of merchant IPPs on imported coal is doubtful in the current price scenario.

Impact On Regulated Power Plants

India Ratings expects the hike in fuel costs to be credit neutral for the power generators, which operate their plants on the cost plus return on equity (ROE) model.

The plants running on cost plus ROE are allowed a complete pass-through of such costs to the consumers by way of the monthly fuel cost adjustment in the bills, thus insulating these plants from any adverse movement in coal prices.

However, with higher fuel costs, the impact of under-recovery/over-recovery, if any, on the variable cost due to lower/better performance than the operating normative parameters (station heat rate, auxiliary consumption) is likely to lead to a higher level of absolute disincentives/incentives respectively.

Impact On Volume Of Coal Imported

The overall dependence of imported coal in India declined during financial year 2015-16, as the output from Coal India Ltd. increased significantly over financial year 2014-15 and FY16, leading to a 10 percent decline in the overall non-coking coal imports in India to 156.4 metric tonne in FY16.

India Ratings notes, that the volume de-growth of non-coking coal wasn't as sharp in FY16, despite the lower prices, because other end-user industries, namely cement and non-ferrous metals, found it cheaper to use imported coal to fire their kilns/boilers. However, with the rise in prices of imported coal, these end-user industries are looking at alternative fuel sources, which could pressurise imported coal volumes from these players.

Impact on IPPs With Non-escalable Fuel Cost

India Ratings notes, that with the decline in coal costs, the stress on the imported coal based plants namely Adani Power Ltd.'s 1,980 megawatt plant in Mundra and Tata Power Company Ltd.'s 4,000 megawatt plant in Mundra under its subsidiary Coastal Gujarat Power Ltd. had reduced, despite the absence of compensatory tariff. However, with the prices of imported coal rising again and judgement awaited on the applicability of the force majeure clause in the power purchase agreement, the stress levels would start building up again on these generators with non-escalable fuel costs.

(India Ratings and Research, a wholly owned subsidiary of Fitch Group, is a SEBI and RBI accredited credit rating agency operating in the Indian credit market.)