My column for Wealth Insight - Feb edition:
Core inflation is down state the headlines. Manufacturers
don’t have pricing power parrot the economists. There is one sector that beats
this trend – the energy sector.
A few days ago, the government allowed oil marketing
companies (OMC’s) to increase the price of diesel. Stock prices of OMC’s as
well as upstream exploration companies (which share the marketing losses with
the OMC’s) have rallied smartly.
Over the next three months, 23 states will increase the
price of electricity –10% to 35%. It would appear that the energy sector
provides adequate opportunity for investment. Despite this, Anil Sardana,
Managing Director of Tata Power is quoted as saying “At this stage, we are not
looking for any tangible business opportunities in India. I don’t see anything
moving on the fuel side (or) project side.” What gives?
Oil – slippery slope
The past two decades have seen successive governments follow
a “one step forward, two step back” approach to fuel (oil) pricing. In the
90’s, the government operated an “oil pool” – whose only purpose was to allow
the government to keep its liabilities “off balance sheet” while it tried to
control the final consumer price of oil on the one hand, and simultaneously
increase tax on it on the other. The resultant gap was parked in the “oil
pool”. When the pool was dismantled, there was a reasonable expectation that
market prices would rise. For some time it did. However, as global crude prices
started to rise, and consumer pressure build up, government again intervened to
stop OMC’s from increasing prices – the alternative would have been to reduce
taxes on this highly-taxed commodity. This resulted in the OMC’s reporting
losses and the government having to bail them out through use of “oil bonds”
and other mechanisms.
In this context, the recent decision to allow prices to rise
has been welcomed by economists. The assumption is that there is a “subsidy”
that is being removed. With higher prices, government deficit would fall,
reducing its need to raise additional debt. This in turn would allow interest
rates to soften, and provide a strong impetus to economic growth.
Experience however does not suggest that such a simplistic
situation is likely to play out. Even if the government is willing to face
public ire by keeping the price of diesel going up month on month, its own
borrowing is unlikely to fall – the food security bill likely to be tabled in
Parliament soon, will take care of any reduction. The motive of deregulation of
the sensitive oil sector in a pre-election year needs to be examined carefully.
As part of its deficit reduction plan, the government needs
to divest stake in public owned companies. Among others, OIL is one such on the
divestment list this time. The finance minister is wooing investors. Free
pricing of petro products is likely to go down well with potential investors.
The timing of the oil price hike suggests that it is not driven only by
administrative “reform”. The question is – will the government stay the course
and allow retail price of petro products to move in tandem with global crude
prices.
Investors will recall that just prior to the previous year
budget, the government had divested a significant chunk of ONGC – mostly to
LIC. Within days of this divestment, the budget imposed an additional tax on
ONGC, which reduced its profitability – not something the new investor would
have anticipated. Aspiring participants in petro company divestment programs
need to keep in mind the political sensitivity of the sector especially in the
context of increased user charges in many other sectors – that too coming on
the back of sustained consumer inflation. Will the government remain
“unpopular” or will it re-impose a cap on price rise closer to election?
Power sector –
elusive coal
Fuel linkage remains the bane of the power sector. 57% of
overall installed capacity is coal based. Coal India (CIL) is almost a monopoly
supplier in the country – and as with most government run monopolies – is
extremely inefficient. Despite having over $10bn in cash reserves, coal India’s
automation levels are abysmal.
CIL has among the lowest productivity per head among its
peers around the globe. CIL uses private contractors to extract coal from its
mines – at a productivity which is almost 4 times its own. International
benchmarks would be perhaps 10x as much. If CIL were to use its ample cash
reserves to increase its production from its mines that are currently operating,
shortage of coal in India would all but disappear. The clamour for easier
environmental norms is redundant – what is needed is better productivity and
deeper drilling.
In the current context however, availability of coal remains
a challenge. In a report dated march 2012, Credit Suisse had pointed out that
despite increased allocation to power, the “shortage” of coal at 80% of
capacity would be “eliminated” only in 2017.
Chart1 : Coal Supply to power sector increased Chart 2 : supply available
to 60GW capacity addition
This means that only 80% of the coal needed by these power
plants would be made available from Coal India. It also means that 49GW of
delayed projects of XI and earlier plans would not receive allocation from CIL
till 2017.
The generating capacity addition of ~55GW in the XI plan
(2007-2012) was the highest in any plan period. Capacity currently stands at
around 207GW. ICRA estimates that 85GW of thermal capacity is under
construction. Of this, 54GW is likely to come on stream in the XII plan period
(2012-2017) in the private sector.
Domestic coal is likely to be available for only ~60% of the
requirements of the power producers who already have fuel supply agreements
(FSA). Overall dependence on coal imports is estimated to go up from 12% in
FY2012, to almost 25% by FY2017 – increasing the risk in fuel supply, and
therefore project risk for producers.
Gas based power plants have suffered even more, with those
in South India operating at a plant load factor of less that 40% as gas
availability has declined (48% all India average). With gas prices likely to go
up in the next year, power prices will need to adjust for fuel costs.
All this implies that over 40GW of private sector power
producers are vulnerable from a credit perspective.
In this scenario, it is not difficult to appreciate the
concerns of the power producers. Until the policy makers work out a solution
whereby producers (and their lenders) face reasonable certainty of projects
being viable and consumers are not constantly faced with rising prices, the
energy sector will remain stressed. Without energy, India’s growth objectives
will remain a pipedream. The government
has to work towards greater efficiency and focus on productivity to increase
the availability of energy rather than to focus on increasing project
investment without ensuring either the fuel or the off-take. Not a glamorous
proposition – just plain old hard work.
