Sunday, October 30, 2011

Power Sector - Unwarranted Pessimism

Power Sector – Unwarranted Pessimism 
The recent spate of bad news about Power Sector has generated pessimism among corporates and investors who have a significant stake in the growth of this sector. However, many of these issues are of temporary in nature, and are unlikely to dent the long term prospects of this sector, which forms the backbone of the entire India growth story.
The Power sector in India has considerably matured in the last decade, with significant private sector participation across the entire value chain and several structural reforms that have made the sector reasonably robust. While there is a pressing need for the next generation of reforms to help attract investments, the current issues facing the sector are quite manageable and the sector is poised to grow and generate healthy returns on investment in the medium to long term. Let us take a closer look at some of the key issues facing the sector.
Coal supply: Short supply of coal due to workers’ strike and Telangana issue is essentially short term in nature. While this could result in lower operating rates in the current year for some of the plants in the Southern and Western states, this is unlikely to impact the industry’s long term prospects as the states and central governments work towards resolving this issue.  
The other negative development is Indonesia’s proposed selective ban on export of coal from 2014. This could affect some of the upcoming plants forcing them to look for alternative sources. However, previously signed long-term contracts are unlikely to be reneged as this could have serious negative fall-out on trade relations between the two countries, where India has significant trade advantage. 
Weak Discoms: The financial health of electricity distribution companies (discoms) across various states in India have weakened significantly over the years. The age-old problems such as unwillingness of state governments to revise power tariffs periodically, and high distribution losses due to rampant power theft have left gaping hole in the finances of these discoms. This gap has been regularly filled with debt leading to the current debt-trap situation.
The sector has, however, matured enough to isolate these problems and ring-fence it at SEB / State Govt level, and to not let it spill over to the corporates that are dependent on power sector –independent power producers, EPC contractors, power equipment manufacturers, etc.   Also, the problem has not yet assumed alarming proportions as it did in 2003, and comfort can be drawn from the fact that the revenue buoyancy of the state governments has put most states, barring a few, in a much stronger position than they had ever been in the past, to tackle any possible crisis situation in the discoms.
Several underlying strengths of the sector – steady growth in demand for power, significant private sector investment in power generation, construction of power plants and manufacture of power equipments, India’s proven coal reserves that can last over 100 years (at current consumption rates) and a strong banking sector that is geared to meet the funding needs – have all resulted in a formidable growth opportunity for the sector in the long term.  Reform of the state-owned undertakings and periodic revision of tariffs to reflect economic cost of generation can take this sector to even greater heights. 
N. Muthuraman is ex-Director Ratings, CRISIL and Co-founder of RiverBridge Investment Advisors Pvt. Ltd., a boutique financial advisory firm.
This is the blog of the Print Version published in Business Line dated 31st Oct 2011

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