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Power Projects Facing Significant Fuel Risks: Fitch Ratings

  • Fitch Ratings has come out with its special report on power projects. According to the rating agency, due to the increasing cost of imported coal, which has doubled to about USD120/tonne currently (over FY09 prices), the variable cost of power generation has surged.Coal shortages and rising international prices affect credit qualityRising Cost of Generation: With the sector heading for a sizable coal shortage and the proposed coal rationing in India, many generators will be compelled to source costlier imported coal. Fitch Ratings estimates this would increase the cost of generation to at least INR4.41/kilowatt/hour - assuming use of 100% imported coal - from the current average of around INR2.29/kWh. Due to the increasing cost of imported coal, which has doubled to about USD120/tonne currently (over FY09 prices), the variable cost of power generation has surged.
  • Passing on Fuel Costs: Power projects, which have no provisions to pass on fuel costs, face massive pressure from these rising costs. This could mean a severe shrinkage in margins and, in some cases, even render projects unviable at current average spot tariff levels. Merchant power prices have been declining steadily over the last four years and are currently in the INR 3.75/kWh – INR4/kWh band.Significant Merchant Capacities Affected: Fitch estimates the debt relating to merchant capacities of at least 8,500 megawatts (as of November 2011) will be exposed to increased cost of generation due to non-availability of domestic coal, should the coal rationing policy be introduced. The policy would give priority to generators that have a long term power purchase agreement (PPA) with fixed tariff with state electricity boards (SEBs), but even these may have to source some imported coal to some extent.
  • Weakening Counterparty Credit Quality: With mounting accumulated losses and increasing debt levels, the counterparty credit profiles of several utilities has significantly weakened, particularly given reluctance to raise tariffs to reflect the enhanced cost of power generation. Although India faces chronic power shortages, the weak financial position of the utilities places a limitation on their ability to purchase expensive power, thus magnifying off-take risk for projects.Debt Restructuring Needed: Fitch believes that without substantial equity injections and/or debt restructuring, many merchant power projects that either do not have domestic fuel supply arrangements or are unable to exploit captive sources (therefore having to rely on imported coal) are unlikely to meet the obligations on their bank debt in a timely manner as projects become operational in the next 12-18 months.
  • DSCR Under Pressure: Based on current financial structures, Fitch believes that the financial margins of power projects that are forced to absorb high costs of imported coal will come under severe pressure, further depressing already fragile Debt Service Coverage Ratios (DSCR). Projects that have substantial dependence on imported coal are most likely to default on their debt obligations.

Increasing Cost of Imported Coal

  • The shortage of domestic coal (See Coal Shortage Impedes India’s Power Sector Growth dated 20 June 2011, available at www.fitchratings.com ) is causing many projects to seek international supplies to meet at least a portion of their requirements, even if they are substantially more expensive. This is driving production costs higher. Importing non-coking coal is on the rise. Government-owned Coal India Ltd (CIL) has projected an overall coal shortage of about 142m tonnes in FY12, which will have to be met from more expensive imports. Aside from this, imported coal costs have more than doubled to USD120 per tonne compared with about USD 60/tonne in FY09. Figure 1 below shows the historical Australian coal price movements, which is one of the major sources of imports to India.

Investments in Newer Power Projects to be Affected

  • Dependence on imported coal as commodity prices rise, coupled with falling merchant power prices, is likely to cause substantial deterioration in the credit quality of greenfield thermal power projects, which are under construction. Also, this would likely cause a loss of potential investments in the sector, both debt and equity. The commercial banks have already started slowing down lending in the sector. According to Fitch, these projects need to decide whether to ensure predictable revenues by settling for lower tariffs (that may barely cover the higher cost of generation) through long-term contracted sales or remain exposed to volatile spot power tariffs that, while offering more margin against rising fuel costs, suffer from lack of offtake and price certainty.
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