The Hindu Business Line : Natural resources in the energy piece of the growth jigsaw

The focus is now squarely on access to natural resources, and this trend transcends all forms of generation — whether coal-based, hydel or alternative forms such as wind.

ANISH DE, ASSOCIATE DIRECTOR, ERNST & YOUNG

Growth has been a continuing theme, more so these days. “Idle weeds are fast in growth,” declares the Bard in King Richard III. But the ‘India growth story’ is far from idle talk, you’d agree, though the pace and spread of growth can be endlessly debated upon. Holding a key to the unfolding growth jigsaw may be the energy piece, and within it, natural resources, observes Anish De, Associate Director, Ernst & Young.

“Growth is energy-hungry. Even with all progressive measures for improving energy efficiency, and reducing the energy intensity of economic growth, the Indian economy will inevitably throw up huge demand. Supplies will struggle to catch up,” he foresees, in a recent e-mail interaction with Business Line.

Anish is of the view that the biggest impact of accelerating demand will be on energy resources. “This has already started to happen. For economic supplies it is important to proactively secure supplies. In fact, countries like China have been working overtime to secure energy resources across the world. India needs to accelerate the pace of action, or else the growth story can be significantly affected.”

The power sector of the country is price-sensitive and this will remain a critical issue, he opines. “However the country cannot afford not to secure its energy supplies economically and efficiently. For this it will have to chart a deliberate and proactive path towards reaching the development goals that it has set for itself,” adds Anish.

Excerpts from the interview:

Aren’t we already seeing many positive signs in the energy scenario?

One has to acknowledge that over the years, Indian power generation operations have matured tremendously. Chronic inefficiencies characterised by non-standard plant load factors (PLF) and high station heat rates (SHR) are a matter of the past across the country.

As compared to a mere 60 per cent in 1994-95, the PLF of thermal power stations rose to 74.3 per cent in 2004-05. The SHR has also shown remarkable increase and in general these are either within the benchmarks established by the Central Electricity Regulatory Commission (CERC), or in close proximity for bulk of the utility owned generation capacity.

With the advent of competitive tariff bidding, it appears that the customers are also set to benefit from the higher efficiency levels through lower tariffs emerging out of the competitive bids.

You mentioned that natural resources hold the key?

True. The focus is now squarely on access to natural resources, and this trend transcends all forms of generation capacity. For coal based thermal generation this implies access to low cost coal supplies. Hydrology of the river basins is making tremendous difference to the prospects and valuations of hydro-electricity projects.

Even in the alternative energy sector access to resources plays a key role. Witness the rush for land banks on high wind velocity tracts.

Do you see any patterns in the rush for natural resources?

The reasons for these changes are several. However the maximum impact is on account of two key factors. The first is the India growth story, which has placed tremendous demands on the power sector in the country.

To even achieve a modest GDP (gross domestic product) growth target of 6.5 per cent per annum and the rural electrification targets that the country has set for itself, it is reliably estimated that the country will need in excess of 1,00,000 MW of additional installed capacity in the Eleventh Plan, and a similar quantity in the subsequent plan period. If the aspirational targets of 9-10 per cent GDP growth were to be achieved, the requirements would be far higher.

To illustrate this further, electricity generation has an elasticity of 1.1-1.2 with GDP growth. This implies that for every percentage of GDP growth, electricity generation has to increase by 1.1 per cent to 1.2 per cent.

Thus an incremental 3 per cent GDP growth over and above the base target of 6.5 per cent, the installed capacity would need to grow additionally by 3.3-3.6 per cent. This would imply an additional 35,000 - 40,000 MW over and above the 1,00,000 MW that needs to be added for achieving the base target.

Sounds daunting…?

This is clearly a daunting task considering that the country will not be able to achieve even 25,000 MW of capacity additions during the Tenth Plan period (2002-07). However the country is making some concrete moves to keep pace with the challenges.

Key among such moves is the flagship Ultra Mega Power Project (UMPP) program for building power stations of 4,000 MW each, to be awarded through competitive bidding. Similar moves are afoot for awarding large hydroelectric projects through competitive bidding. Plans are also in the making for creating merchant generation capacity that will participate in competitive power markets.

And the second factor, of maximum impact?

Competitive bidding is the second reason adding to the rush for natural resources.

With technology now being largely standardised, and the comparative advantage in costs on account of technological advances being minimal, the largest cost differentials arise on account of access to lower cost natural resources.

The differences are often stark. For example, for F Grade coal, the prices of Coal India Limited (CIL) and its subsidiaries ranges from Rs 565 per tonne to Rs 875 per tonne. In contrast it is commonly believed that the private sector can mine coal for as low as Rs 300 per tonne (although it can widely vary depending on mine geology).

Such differences can make very significant differences to project economics. In particular, if a plant is to operate on a merchant basis and sell into the competitive power market, access to low cost resources can have a huge impact on the competitiveness and profitability of the power plants. No wonder that there is a huge queue from the private sector for allocation of captive coal mine blocks.

How do you anticipate Indian demand impacting international markets?

That’s for sure. The implications are not limited to domestic resources alone. To supplement domestic coal supplies and overcome the huge differences between supply and demand of domestic coal (CIL supplies have been historically increasing at 3-4 per cent per annum, whereas the actual requirements dictate a 7-8 per cent increase in supplies), the country has been looking at imported coal based power stations.

However, the prices of imported coal have tended to be extremely volatile in the recent past. It is important to avoid exposure to such price volatility.

Even though the current bid guidelines permit the costs to be linked to coal indices (and those for shipping), access to firm supplies and prices enhance the competitive position of the bidders. For this reason Indian companies intending to participate in competitive bidding have been actively scouting for captive coal mines abroad (particularly in Indonesia).

In fact the large Indian demand is progressively changing the market dynamics, and rising prices are resulting in lower coal based generation in Europe, which largely relies on imported coal. Clearly, India is now a major player in the international fuels market.

Should we be pitching our hopes on gas, which we increasingly hear about, as the emerging source?

With large domestic finds, gas is going to become a favoured fuel for a significant proportion of the new capacity to be established.

The recent gas discoveries, particularly those made in the eastern offshore areas have brought new hope for many existing gas-based projects, particularly in the power sector which, due to shortage of gas, either remain under-utilised or are forced to run on much costlier liquid fuels such as naphtha, which drives up the cost significantly.

Traditionally, most of India’s gas supply has flowed from the western coast of the country, mainly from the gas fields in the Bombay High region.

However, in recent years with world-class discoveries being made in the eastern offshore areas, the focus as far as gas supply is concerned is shifting towards the east.

While the new gas discoveries have provided a fillip to exploration and production (E&P) activities throughout the country, a major portion of these upstream investments is expected to place in the eastern offshore regions, in the blocks adjacent to those in which the discoveries have been made.

Is gas price a matter of concern?

The price of gas remains a key unknown at this time. In particular, since gas is generally benchmarked to international gas prices, the international market dynamics will inevitably play a role in determining the price.

Further, gas has multiple uses beyond power generation, in fertiliser production, industrial processes, petrochemicals, city gas, etc. Hence, the power sector will have to compete with the other user sectors for gas supplies.

International gas prices have witnessed considerable volatility in the recent past, and have a marked correlation with crude prices. The prices peaked in 2005-06, but have considerably softened since then, as evident from the prices recorded at Henry Hub, the key American gas market that is often used as reference.

It is apparent that wide variations in prices can wreak havoc on the competitiveness of power supplies. Having said so, power is likely to become an anchor consumer for gas, and the large offtake offered becomes the basis for infrastructure development – particularly pipelines.

Hence, it is essential that gas users obtain a reasonable deal for themselves, including contracts with either fixed prices, or those operating within a narrow price band.

D. MURALI

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