The villains in the power sector’s tale of woes haven’t changed in a while: worsening asset quality and rising non-performing assets (NPAs).

Around 51 gigawatt (GW) of thermal capacity is stressed because of the non-availability of coal, lack of assured offtake, and huge under-recoveries due to disallowance on account of various factors. A further around 23 GW of capacity under construction is also potentially stressed.

That’s tantamount to around Rs4 trillion of debt under stress—and potential NPAs.

The gloom is despite the government’s and the Reserve Bank of India’s moves to ease the pressure on banks through strategic debt restructuring, which offers banks equity in lieu of stressed assets, and the scheme for sustainable structuring of stressed assets (S4A), which affords financial restructuring by allowing lenders to acquire equity.

While these schemes provide limited relief to banks by changing the capital structure and postponing the problem of poor potential cash flows, there is a lack of offtake and lack of power purchase agreements (PPAs) and availability of coal.

The offtake issue first: Discoms have shied off power purchase agreements (PPAs)—the last one was in 2016 in Uttar Pradesh for 3,800 megawatt power, only to be cancelled later. They have preferred to buy power through short-term contracts or the open market, given subdued offtake and prices, and significant capacity addition in the past five years.

Consequently, many generators have been selling electricity at throwaway prices or have switched off plants, leading to defaults on financial covenants. And with the increasing thrust on renewable energy and clean energy, the procurement of thermal power has tapered.

The perceived surplus—of generation outpacing demand—is a chimera because on the other side you have load-shedding by discoms. The truth is, discoms aren’t buying enough because of poor financials, and not because demand is low.

Besides, the ‘lack of demand’ theory does not gel with initiatives such as the Saubhagya scheme and 24x7 power-for-all, and the fact that the per capita electricity consumption in India is just a third of the world’s average.

Of late, with hours of supply increasing and coal shortage, spot prices have surged, with average tariff touching Rs4.09 per unit in September 2017. But this over-dependence on the short-term market is a short-sighted approach.

Now to coal supply: The absence of fresh coal linkages (none since 2010), restrictions on the use of linkage fuel, and cancellation of coal mines without alternative arrangements have hit thermal plants. Another fell blow—for private sector producers this time—is the rider that only long-term PPA holders can get linkage.

And the response to the past five rounds of coal auctions has been tepid, with the last one (or Tranche V) even getting cancelled. Of the 72 coal blocks auctioned and allotted so far, only a handful have started operations. Many cases have been filed in courts on the auction method, the compensation to be paid to prior allottees, and the modification of auction rules after bidding.

But the scheme for harnessing and allocating koyla (coal) transparently in India, or SHAKTI, under which the government is to provide coal linkage to developers, was successful, with a total booking of around 27.18 million tonnes of coal per annum from eight available sources. This was, however, a limited scheme and will need to be extended. The larger point is that Coal India Ltd will not be able to meet this requirement till at least 2020 even if thermal power plants run at 55% plant load factor.

In the context, three steps can help the stranded capacities from becoming NPAs.

First, stricter regulations are necessary to discourage load-shedding by discoms and to ensure quality, universal power supply to meet the 24x7 goal. This will help capture the actual demand and force discoms into competitive bidding to buy power.

Second, the issue of non-signing of PPAs by discoms can be solved through centralized procurement and allocation of capacity to states—as has been done in renewables. The concern among discoms of long-term fixed-cost liability can be overcome by sharing the risk and rewards. For instance, it could be a single-part tariff with a discom committing to procure at least 60% of the power. Where power is not bought, it could be sold in the open and the difference then borne by discoms. Similarly, if the price is high on the exchange, the upside could be shared with discoms.

Besides, PPAs can be for the medium rather than the long term, where both suppliers and discoms have the choice to review tariffs and conditions after three-five years. By then, the market may be more stable in terms of price discovery, owing to economic recovery, increased per capita power consumption, impact of electric vehicles, and infusion of more renewable energy into the grid.

Third, along with centralized procurement, the government should consider a SHAKTI scheme (second round) for constructed plants without fuel linkage so that they, too, can actively participate given the comfort of fuel source.

This centralized scheme could be extended to imported coal stations as well as hydro stations.

These steps can help minimize NPAs and haircut levels for banks, and also provide a signal to new investors who haven’t put money into the conventional power sector for more than three years.

Vivek Sharma is the senior director-energy at CRISIL Infrastructure Advisory.

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