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The opportunities for investors in stressed power assets

   January 11, 2019        364        Suvojoy Sengupta & Pranav Potbhare

In upward economic trend and better distribution connectivity have set India’s power sector for demand growth, yet it continues to face intrinsic challenges that could still upset the applecart.

Power demand growth is now about 5% compared with historical rates of 8-10%, while thermal generation capacity has gone up significantly in the same period, apart from the addition of large capacity in the renewable energy segment. The resultant low plant load factors (PLFs) have cascaded financial pressure on banks which now have an exposure of close to ₹2 trillion to thermal power companies.

Notwithstanding the gloom, there is potential for private sector companies to contribute to recovery in the sector. The resolution process initiated through the Insolvency and Bankruptcy Code (IBC) provides an opportunity for the private sector to acquire and re-engineer operations and power sales from assets, besides earning an internal rate of return (IRR) of 15-20% on investments.

Best of stressed: while it is easy to bucket all stressed assets as problematic, there is a wide variation in the quality of the assets and their paths to profitability. Of the 34 identified assets, nine have yet to be commissioned, and only two are likely to come online in the near term. Five partially commissioned assets continue to have potential; all except one of these are positioned near expanding coal mines and have a good chance to be fully commissioned. Two assets are owned by distressed public entities and are unlikely to come into play. The remaining 18 distressed assets are fully operational with a mix of technologies, contracts and performance levels and operate at average PLFs ranging from 0% to 80%.

We analysed all the assets using a multi-factor screening framework to prioritize targets. The framework has operational, financial and qualitative parameters to determine operating cost and PLFs of the plants, of which four parameters are the most critical: cost-competitiveness based on fuel supply agreements (FSAs) and distance to coal sources, revenue risk based on percentage of capacity contracted under power-purchase agreements (PPAs), revenue-potential based on expected performance in the short-term merchant market, and capital cost based on debt and liabilities. On analysis, we see 8-10 assets with strong investment potential which could be targeted by investors.

Steps to recovery: After identifying the high-potential assets, the next step would be to carry out financial, operational and contractual interventions for enhanced profitability. Owners will need to infuse capital to complete partially commissioned assets while investigating and resolving liabilities that are attached with the plants. Plants will need to drive operational and maintenance (O&M) efficiencies to improve their current bid-rates. Optimizing coal linkages to enhance coal quality and reduce associated transportation and handling costs would also be a critical element. Owners should look to sign PPAs with healthier electricity distribution companies (discoms) or increase sales over the energy exchange, and through short-term bilateral contracts to reduce cash flow risk, while evaluating B2B energy services and commercial power sale by exploring hybrid solutions with solar developers.

With demand expected to outstrip contracted capacity, discoms are likely to enter short-term agreements. Some states are already moving towards using the short-term market. Delivering on the above interventions would be critical to cutting variable costs and improving position in the merit order.

Stressed power assets could also be valuable for other niche players. Large industrial users are exploring options to avoid setting up new captive capacity; many are looking to buy cheaper assets through the IBC. These could be projects without coal linkages or PPAs.

New policies allow flexibility in generation and map PPAs to companies instead of independent assets. Hence, progressive thermal generators are now looking to buy PPAs or coal linkages through these assets. Generation companies are also looking for cheap assets with good PPAs or coal linkages to improve portfolio efficiencies by mothballing subcritical assets to run supercritical plants in their portfolio at high PLFs.

However, more needs to be done to facilitate the recovery through policy interventions. Providing flexibility to the plants to switch FSAs could improve system efficiency and direct low-cost fuel supply from nearby coal mines to low-cost operating assets. Similarly, distribution companies and independent power producers (IPPs) too should be encouraged to optimize PPA linkages by transferring PPAs. Allowing the shift of host state obligations between states would also help the more efficient plants and the overall sector. Finally, developing better transportation linkages and optimizing rail transportation for coal could help the power sector too.

India’s power sector presents a unique opportunity for remunerative investments with an IRR of between 15% and 20%. Potential investors would do well to identify and acquire the most promising of the “stressed” assets and develop them through a combination of financial, operational and contractual interventions.

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