What does a power company do when the price of its inputs go up? The answer is that the power company either absorbs the higher cost or passes it on to the customer. A basic pass versus absorb decision pertaining to power companies in India has become the pivot of a lot of controversy. The whole issue escalated when the Supreme Court this week set aside a tribunal order that permitted power companies like Tata Power and Adani Power from raising power tariffs in tune with the rise in input costs. So why is this piece of news so critical and what are the larger implications for the power companies in India?
The genesis of the entire Power Tariff issue…
The entire problem dates back to 2010 when Indonesia changed its rules pertaining to export of coal which resulted in a sharp increase in the cost of coal imported from Indonesia. Both Tata Power and Adani Power have been depending on coal imports from Indonesia to meet their coal requirement to fire their thermal power plants. Now, because of the change in the Indonesian rules, both Tata Power and Adani Power were paying higher prices for their coal imported from Indonesia. As per the power purchase agreement (PPA) signed by the power companies with the power distributors, the power tariff can be increased outside the PPA framework only in case of a Force Majeure situation.
Force Majeure refers to a situation when the original agreement or contract gets frustrated due to acts of God or factors substantially beyond the control of both the parties. In this case, both Tata Power and Adani Power had approached the Appellate Tribunal for Electricity (APTEL) for classifying this event as a Force Majeure event and permitting them to raise the power tariffs to compensate them for the higher prices of coal imported from Indonesia. In 2016, the APTEL had upheld this appeal and permitted the two power companies to hike tariffs. However, this order of the APTEL was struck down by the Supreme Court this week, making it impossible for Tata Power and Adani Power to charge higher tariffs from their customers.
How the Supreme Court decision will hit the financials of Tata Power…
The financial impact on Tata Power definitely will be hard. For example, with respect to its Coastal Gujarat Power Ltd (CGPL) unit, Tata Power has signed PPAs with the governments of Gujarat, Rajasthan and Haryana. Even if they run this plant at its minimum plant load factor (PLF), the equivalent of capacity utilization in the power industry, the company will have to incur a loss of around Rs.1000 crore annually. The bigger challenge for Tata Power will pertain to their Mundra plant, which will not be financially viable at current import prices of coal. Tata Power may, therefore, have to look at foregoing its equity to the tune of Rs.4000 crore and then invite lenders to come and take over the Mundra plant. That may also mean that the terms of the PPA could be renegotiated and a fresh PPA could be signed with the distribution companies. The only other option is to source alternate coal, but it is unlikely that they will be able to get coal at an economical price. However, Tata Power has not factored in the benefit of compensatory tariffs in its P&L account and hence the financial damage may not be too large for Tata Power.
But the hit on Adani Power could be much more severe…
The financial implications in case of Adani Power could be a little more complicated. Apart from its high leverage (debt in books), Adani Power has also been consistently booking compensatory tariffs and showing it as revenues in its books. According to analysts, over the last four years, Adani Power has already booked revenues of Rs.8800 crore as compensatory tariffs, which is actually 10% higher than the net worth of the company. In the light of the Supreme Court order, Adani will have to write off the entire Rs.8800 crore that it has taken credit for, meaning that its entire net worth could be effectively wiped out. Its debt burden of Rs.50,000 crore is another albatross around its neck.
What is the road ahead on this case?
Of course, the two companies are working towards alternate sources of fuel, but that will be easier said than done. The Supreme Court has ruled that the Force Majeure will be applicable only if it pertains to Indian laws. Since in this case it pertains to Indonesian Laws, the SC is of the view that Force Majeure will not apply. Whether the Indian power companies can cite shortage of domestic coal as the core reason and apply the Force Majeure clause, remains to be seen. This order will have a negative implication for the valuation of power companies. But more importantly, this could also lead to a de-rating of PSU banks that have a fairly large exposure to the Indian power companies. The next few weeks could see interesting developments on this front!
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