‘Pooled’ pricing of coal unfair

In resource management terms, ‘pooling’ is referred to as grouping together of assets, and related strategies for minimising risk and enhancing performance. The same concept, introduced by US bankers to manage sticky housing mortgages, triggered the financial crisis in 2008.

The analogy helps understand the Union Government’s prescription to force every user of thermal coal to share the cost of imported fuel, in order to bail out a smaller section of private investors in power generation.

Creating risky assets

In the middle of the last decade the government adopted a mammoth thermal power capacity addition programme, without much readiness on the coal production front. Coal, the government preferred to believe, would be abundant — and started granting linkages.

Once the linkage was awarded, Coal India (CIL) — the State-owned commercial monopoly — issued a ‘letter of assurance’ (LoA), to be treated as a ticket for a private sector investor to claim 70 per cent project finance. And, similar to the rush for 2G spectrum or coal blocks, ‘investors’ made a beeline for thermal power generation.

Some of them were gripped by an overwhelming feel-good factor. Others, with prior experience in producing ‘mouth fresheners’ or developing real-estate, saw an opportunity to make easy money. ‘Project plans’, aided with ‘linkage’, were trading at a premium.

Distress signals were evident from as early as 2008-09, as CIL started reporting ‘negative balance’ of coal to the linkage committee.

But at that time, all caution was thrown to the winds. Linkages rained. Banks preferred to shut their eyes and ears to the ongoing debate on environmental restrictions, stifling growth of the mining sector, and kept sanctioning loans based on LoAs.

To complete the recipe of disaster, policymakers allowed the private sector to enter into aggressively priced power purchase agreements with various State utilities, through tariff-based bidding, without much room to pass on volatility in cost of fuel.

The investors thought they would mint money through higher capacity utilisation and open market sales of part of the generation. But, state-owned power companies found the proposition ‘risky’ and stuck to the age-old formula of selling power on a less remunerative ‘cost-plus’ basis, leaving room to recover fluctuations in coal prices.

Meanwhile, the champions of market economy lauded private sector for its “risk appetite”.

The mess

The bubble burst once CIL dragged its feet in honouring those LoAs. Under government pressure, the coal company finally committed 65 per cent domestic supplies — less than the normative requirement of 80 per cent to break even — to all units either commissioned since April 2009, or to be commissioned till March 2015.

Nearly 15,000 MW of private sector capacities — already on stream, at an estimated cost of Rs 75,000 crore — turned unviable. With a cap on electricity tariff, they cannot afford to use costly imported fuel to mitigate 9 million tonne (mt) supply gap. The fate of another 20,000 MW private capacities, under implementation, hangs in the balance. Up to Rs 52,000 crore of equity finance is in the doldrums. Also at stake is a substantial part of the projected Rs 1,23,000 crore loan finance in these projects.

On the other hand, approximately 25,000 MW capacities (including 10,000 MW already in place), implemented by state-owned sector, are relatively safe. They can pass on the cost of imported fuel. Since most such utilities, like NTPC, have a large pool of existing capacities with an adequate supply of domestic coal, there should not be much impact on the average cost of electricity either.

Assuming NTPC consumes 134 million tonnes of domestic coal of 4,200 calorific value, electricity consumers may have to shell out an additional 4 paise a unit on an average, to help the company mitigate 2.5 mt short-supply of domestic coal (in 4,300 MW new capacities) through imports.

Bundling of assets

There is little doubt that private investment in India’s power sector is in trouble and CIL has a role in it. It is equally true that the investors invited the trouble by virtue of their aggressive business decisions. And, the government has not merely failed to curb such unhealthy competition, but ended up fuelling the bubble.

Ideally, the government could have taken note of its tariff policy faux pas and offered bailout package to the affected investors. But, it prefers to place the burden on electricity consumers. CIL is asked to import requisite varieties of thermal coal to create a common pool of fuel. Consumers will be charged the average weighted price of the pooled resources.

In other words, electricity consumers of the country’s 75,000-80,000 MW strong State-owned facilities — which followed a safer business model — will now pay for the reckless business decisions of some private sector players.

But that’s not all. Average quality thermal coal is at least three times more costly in the international market. Naturally, the higher the quantity of imports through this mechanism, the sharper will be the rise in prices of domestic coal. A very rough estimate suggests, price of average domestic thermal coal (4200 GCV) may go up by 20 per cent, if the government mitigates a total shortfall of 15 mt in 2012-13 through price-pooling. The price rise will be a sharper 40 per cent, to cater to the projected 36 mt shortfall in 2014-15.

Risky proposition

The rise in coal prices may send shockwaves through the country’s cash-starved distribution utilities.They have already run up an aggregate borrowing of over Rs 2,00,000 crore to finance day-to-day operations. With pressure mounting on them to bridge this finance gap, power tariff across the nation started spiralling.

A sharp rise in cost of coal may either add to their under-recovery, leading to a fresh pile-up of borrowings to banks, or non-payment of coal and electricity dues as is already evident in many States. And, that may not help generators — including those in the private sector — either.

Lehman lesson

In essence, the government proposes to spread the financial risk of those stranded assets to the entire system such that power becomes expensive for all. The expectation is that private assets will be able to utilise the situation in their favour. But, it forgets two aspects. First, if the low average tariff of electricity traded on the grid is any indicator, such a step may stunt demand, upsetting growth prospects.

The US is yet to recover from the aftershock of spreading risk.

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