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Home >Market >Mark-to-market >CERC order lights up Adani Power, but creates moral hazard

Have power sector investors popped the champagne too soon? Adani Power Ltd shares gained as much as 15% during Wednesday after a unique Central Electricity Regulatory Commission (CERC) order. The regulator paved the way for a temporary compensation package as Adani was making losses on its contracts to supply electricity to Gujarat and Haryana utilities.

On the face of it, the order is a big reprieve for Adani. The company has been making losses for the past five straight quarters. Much of it has to do with under recoveries on the 2,420 megawatts (MW) Mundra capacity (nearly half its total), where fuel costs went haywire after an Indonesian export tax and exceeded the contract supply price. So, any tariff hike or compensation package, however temporary it is, comes as a relief.

An Edelweiss Securities Ltd report estimates that a 10 paise per unit hike would increase Adani’s profit before tax by 170 crore, a 10% increase for its recent fiscal 2014 estimates. Daiwa Capital Markets is more optimistic, predicting a 24% increase in fiscal 2014 net profit for the same quantum of hike; however, its forecasts are about 17% lower than the Bloomberg consensus.

Secondly, CERC has laid some conditions that could lead to hard and bitter negotiations. It has asked the committee to consider the net profit earned from the Indonesia coal mines to the extent of coal being supplied to Mundra. Secondly, it has raised the possibility of sharing revenues from merchant power sales of Mundra (i.e. beyond the contracted quantity). Buyers could ask to lock return on equity for the company at a certain level, even zero. Perhaps, Adani would have been better off in case the CERC let it scrap these contracts.

The outcome is likely to take some time as the utilities can challenge the CERC order at the appellate tribunal.

Investors are cheering the CERC’s judgement now. It has certainly revived sentiments in the power sector and could lead to the creation of a generic compensation formula for such disputes. Shares of Tata Power Co. Ltd, which faces a similar problem, have risen as investors expect a favourable judgement for this company too. In the long run, however, CERC has created a moral hazard.

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