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IEEFA update: Risk to India’s banking sector in rising tide of stranded assets

An array of market and policy forces continues to undermine coal-fired electricity generation

SYDNEY — The thermal sector of India’s power-generation industry that accounts for US$40-60 billion in potentially stranded assets continues to pose trouble for Indian banks.

The sector’s underperformance is exemplified by unsustainably low capacity utilisation rates of less than 60% over the past two years combined with excessive financial leverage that makes debt servicing extremely difficult. Distress is exacerbated by loss-making distribution companies (DISCOMs) that have often failed to make timely payments or have sought to renegotiate tariffs on power purchase agreements (PPAs).

Out of some 40 GW of stressed coal-fired projects, 15 GW have not even been commissioned, according to a recent report by the government’s Standing Parliamentary Committee. And some 16.2 GW of coastal power plants built to operate 100% on imported coal are severely affected by the doubling of imported coal prices since 2016.

Meantime, delays in project implementation related to land acquisition and permit approvals have resulted in cost overruns, and the unavailability of coal supply contracts has been an issue as well. Granted, Coal India’s production increased by 14% from April through July, but insufficient coal railway capacity has kept Coal India from consistently keeping up with demand.

Higher prices for domestic and international coal in recent years have intensified stranded asset risks too. Combined with rising railway freight charges for coal transportation over distances of more than 500 kilometres, this trend has inflated the variable generation cost for many coal-fired plants. It stands to reason that all non-pithead coal power plants be seriously re-evaluated, and it would seem to go without saying that non-coal states would do well to invest instead in renewables and if need be, import their electricity.

ABOUT 80% OF INDIA’S COAL PRODUCTION COMES FROM CENTRAL-EASTERN INDIA, and given how coal transportation often adds prohibitively to the delivered coal price, finding an economically suitable supply for the power plants remains a huge challenge. Research we published in July shows how the coal-fired fleet in the state of Karnataka (which has a population of 68 million and no in-state coal mining capacity) operated at an unviable utilisation rate of 35% in 2017/18.

On the coal development front, the absence of long-term PPAs has kept many proposed projects from moving ahead. Projects tied to higher-cost PPAs a few years back have stalled as state DISCOMs  have either requested cancellation of PPAs or pressed for lower tariffs. Projects that have managed to win PPAs with aggressively low tariffs are financially unviable as a result.

A double whammy that is clogging up the banking and power sectors alike.

Moreover, most states now have surplus generation capacity after recent successful electricity sector reforms and because the proponents of the stranded assets in question overestimated electricity growth (lower-than-expected electricity demand growth has states unwilling to enter into expensive thermal power PPAs that generate enormous subsidies in the guise of “capacity charges.”)

To make all the stranded asset risk worse, many of these projects are based on poor-quality imported coal and outdated subcritical combustion technology. Water availability is a major constraint as well.

Competition from renewable energy poses even further risk as solar and wind power tariffs have landed over the past 15 months at between Rs2.5-3.0/kWh. As per India’s Central Electricity Authority (CEA) estimates, the tariff on a new emissions-compliant pit-head supercritical coal-fired power plant is Rs4.39/kWh (assuming plant load factor of 60%).

Coal-fired power is increasingly losing market share as states opt for cheaper generation, and India’s goal of having 175 GW of renewable energy by 2021/22—a goal now supported by accelerated deflation in renewable energy tariffs—is a factor.

Yet stranded asset risk appears to still be on the rise. The Global Coal Plant Tracker reports 39 GW of coal-fired power capacity currently under construction in India. And the government’s National Electricity Plan (NEP) 2018 optimistically projects the need for a net 46 GW coal-fired generation capacity between 2017/18 and 2026/27. Absent accelerated closures of highly polluting end-of-life coal power plants, there are also still 63 GW of coal-fired projects in various stages of pre-construction development that will simply add to the stranded asset problem if they are built.

AS PER A RESOLUTION CIRCULATED EARLIER THIS YEAR BY THE RESERVE BANK OF INDIA (RBI), the August 27, 2018, deadline for proceedings for defaulting power plants to avoid being referred to insolvency court is rapidly approaching.

The Power Ministry had recommended the RBI extend the deadline by six months to give lenders more time to switch to new, better capitalized promoters, but  RBI denied the deadline extension request.

Two of the largest stranded assets are the ultra-mega power plants in Mundra, owned by Adani Power (4.6 GW) and Tata Power (4 GW). Both plants were put up for sale for a token Rs1 each in May 2017, but neither has found a buyer. Adani Power reported a net loss of Rs825 crore (US$120 million) in the first quarter of 2018/19, a near doubling relative to the previous period, highlighting the magnitude of the equity write-down required. In the meantime, the unplanned idling of Adani Mundra has forced the state of Gujarat to buy more expensive power on the open market.

In IEEFA’s view, merely switching promoters of these stressed assets would not be a panacea for the problems caused by the structural inefficiencies in India’s coal-fired sector.

There is no easy fix, but to move forward, India must avoid crony capitalism and giving in to taxpayer funded bailouts; promoters must be forced to take up to a 100% write-off on their equity and in the worst cases have their permits revoked and land returned so as to force the abandonment of now worthless projects. Assets that have the potential to be revitalised should be recapitalised and/or sold to new players after promoters and lenders have taken the necessary write-downs.

Lessons learned from global financial crisis of 2008 and its impact on Europe and the U.S, make it clear that prolongment will only allow the situation to deteriorate further, resulting in rising interest costs. And the non-performing-asset issue is a double whammy for India’s growth as it clogs up the banking and power sectors alike, both crucial to achieving 7-8% annual GDP growth.

The RBI, in IEEFA’s view, is imposing much-needed regulatory discipline to ensure financial system stability and to advance progress in resolving a problem that has been festering for years.

The next few months could prove decisive. Taking short-term pain will clear the decks for strong, sustained national growth in the medium term.

Tim Buckley is IEEFA’s director of energy finance studies, Australasia. Kashish Shah is an IEEFA research associate.


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