Mega plans, giga risks

It was meant to be Anil Ambani’s big day in more ways than one. On February 11, Reliance Power, which had just wrapped up India’s biggest IPO ever and the first from Ambani’s Reliance-Anil Dhirubhai Ambani Group, was to list on the Bombay Stock Exchange.

As much as the investors in the Rs 11,500-crore IPO, which was oversubscribed 73 times, Ambani must have been anxious. If the Reliance Power stock closed at Rs 500 against the offer price of Rs 450 (Rs 430 for retail investors), it would not just add Rs 1,13,000 crore to R-ADAG’s market value but also make the 48-year-old Ambani the richest Indian, ahead of his brother and Reliance Industries supremo Mukesh Ambani and steel czar Lakshmi Niwas Mittal.

Alas, that was not to be. Within minutes of Ambani ringing the ceremonial bell at BSE, the stock began to soar (it touched a high of Rs 599.90) but only to slip later. By the end of the day, it was at Rs 372.50—down 17 per cent from its offer price. By the end of the week (February 15), the stock had moved up to Rs 384.70 even as the Sensex—battered by fears of a recession in the US— recouped 1,485 points in that time to close at 18,115 points.

Think that’s poor showing? Banish the thought. Just consider the enviable position Ambani is in. Reliance Power has no generating assets on the ground, but is already worth Rs 86,942 crore in market value, making it the second most valuable power company in the country; its first power plant at Rosa in Uttar Pradesh won’t be commissioned before December 2009 even if there are no delays; and Reliance Power won’t turn in its first net profits before 2010-11.

In contrast, state-owned National Thermal Power Corporation (NTPC), the largest producer of power in the country with a capacity of 28,644 MW, has a market cap of Rs 1,68,207 crore, translating into a price-earning multiple of 21.54. Even Tata Power, the biggest private sector power producer, boasts a market cap of Rs 28,145 crore (a PE of 38.16), while Ambani’s other (and older) power company, Reliance Energy, is worth Rs 40,430 crore on the stock markets.

Power play

A Minnow Today… Reliance Energy is No. 3 among the top private power producers.
1.Tata Power	2,300 MW
2. RPG Group1	155 MW
3. Reliance Energy	940 MW
4. GMR	803 MW
5. Lanco	518 MW
But a giant tomorrow The Reliance Power IPO will fund 7,060 MW of power capacity.

Why are investors willing to repose so much faith in what are essentially mere plans? For two reasons: One is the premium for the Ambani surname based on the family’s historical ability to deliver riches to its investors; and the other is the sheer scale of Ambani’s ambition: he has announced plans to add 28,200 MW from 13 projects, six of which are slated to come up between December 2009 and March 2014 and the rest later (the company hasn’t disclosed project schedules yet). That makes him the most aggressive player in the private sector, although NTPC has also announced plans of increasing capacity to 75,000 MW by 2017.But this being the power sector, where beleaguered state electricity boards deter all but the bravest private producers from entering, Reliance Power won’t find the going easy.

That’s not just because of the poor state of reforms in the industry, but also because of aggressive tariffs the company has quoted to win some of its biggest projects. Take Sasan, for example. Initially won by Lanco Infratech, the ultra mega power project (UMPP) came to Reliance Power on the rebound after Lanco’s partner Globeleq Singapore pulled out due to change in ownership. However, Reliance Power had to match Lanco’s aggressive bid of Rs 1.19 per unit to bag the project.

The catch: the tariff is supposed to be fixed for the next 25 years. Similarly, the second UMPP, at Krishnapatnam, that Reliance Power bagged was due to an equally aggressive bid: it quoted a levelised tariff of Rs 2.33 per unit against Larsen & Toubro’s Rs 2.68 and Sterlite Industries’ Rs 4.18. These were the only three bidders for the project.

The problem with long-term tariffs is simple: while theoretically the revenue flows are predictable, it’s near impossible to predict how input costs, mainly of fuel, will change over 25 years. Says T. Sankaralingam, Chairman and MD, NTPC, which refrained from bidding for the Krishnapatnam project: “In the overseas coal market, long term means 3-5 years. But here we are talking of 25 years. I don’t know how it is going to be viable over the long term. That is one reason why we did not quote for Krishnapatnam. Unless you own a coal mine and are able to control costs, you are in trouble.”

He has a point. Should input costs rise, the viability of the project will get affected. “It’s difficult to squeeze out margins at lower tariffs, although not impossible,” says P. Ramesh, MD (Energy), Feedback Ventures, an infrastructure consulting firm.

“Promoters generally ensure their projects earn 20-25 per cent return on equity. But I don’t know if all projects can manage that,’’ he adds. Consultants reckon everyone will profit from Sasan at a tariff of around Rs 1.50 per unit.

The promise & pitfalls Reliance Power’s hurdles are as big as its opportunities. Opportunities The gap between demand and supply of power is rising. By 2015, peak deficit may touch 30,000-35,000 MW nationwide Thanks to escrow accounts, power producers have better payment security from the state electricity boards Reliance Power has a greater ability to raise funds from markets than some of its competitors such as NTPC Risks It has bid aggressively for the ultra mega power projects. Fuel supply for some of its projects hasn't been tied up yet. For example, Dadri and Krishnapatnam project haven't tied up coal and gas supplies, respectively There might be delays in procuring equipment for the projects. Currently, major vendors like BHEL and Alstom are short of capacity Some of its power plants such as Shahapur Coal and Urthing Sobla may end up as "merchant plants" since they have no long-term deals for sale of electricity

Then, there are other risks. Reliance Power, which did not respond to BT’s queries, is yet to tie up fuel supplies for some of its projects. The Krishnapatnam project will run on imported coal, but when BT went to press, the company hadn’t struck any sourcing agreements.

Already, global coal prices are soaring and there’s talk of it going the oil way, which is high up. Its 7,480-MW Dadri project, which will use gas instead of coal, is in a jam too as the row between Reliance Industries and Anil Ambani’ Reliance Natural Resources over supply of gas from the KG basin is yet to be settled.

L.V. Nagarajan, MD, Karnataka Power Corporation, points out that Reliance Power is trying to do what NTPC did over 30 years. “If NTPC was born in a demand-led era, then Reliance is born at the doorstep of a competitive era. It will not have the comforts of the cost-plus era. Converting uncertainty of future into profits for today will be the real challenge for Reliance Power,” says Nagarajan.

Among the other uncertainties that it faces are possible delays in buying equipment for the plants since vendors are said to be facing a capacity constraint.

Bharat Heavy Electricals Ltd (BHEL), for example, has a lead-time of 34-36 months from order booking to delivery; that period used to be 12-14 months as recently as three years ago.

That apart, some of Reliance Power’s units such as Shahapur Coal (Maharashtra) or Urthing Sobla (Uttarakhand) don’t yet have long-term power purchase agreements. That means they could end up being “merchant” plants that generate power only as and when there is a market for it and, therefore, carry higher financial risks.

Competitors, however, point out that Reliance Power has structured its tariff bids smartly. Sankaralingam, for example, says that Reliance Power’s bids typically have low fixed costs versus variable costs. “The implications of this are serious: On the one side, fixed cost is low. So even if you don’t perform, the penalty is low because it is linked to fixed cost.

The variable cost is more. One will start earning the incentive even below the prescribed level of plant load factor,” says Sankaralingam.

Part of the risks that Reliance Power runs is due to regulatory reasons. Take the case of ultra mega power projects. Experts say that while the central government inviting competitive bids is a good strategy, it must allow the private sector investor to decide the location and the extent of import content in terms of equipment and fuel. Says V. Ranganathan, a professor and energy expert at IIM Bangalore: “Even now, it is a place for gorilla warriors who can make money more by legal interpretations and twisting rules than by cost attractiveness.Thus, the picture is not at all clear how Reliance Power would fare in this market.”

A new game

While that’s a concern, it’s also reflective of the changes that are taking place in the power sector. Until recently, for a state-owned power producer like NTPC that operated on a cost-plus basis, what mattered more was project management. But, as KPMG’s Associate Director Hiranyava Bhadra notes, the new system of tariff-based bidding for UMPPs has shifted the focus from project development to other competitive factors such as fuel sourcing, equipment planning and financing.

This is a shift that may work in favour of private players such as Reliance Power and Tata Power, who have greater flexibility to strike partnerships. Says Prasad R. Menon, MD, Tata Power: “Bidding is new not only to PSUs but also to us in the private sector. It’s an experience we are going through.” Menon, whose company has 10,000 MW of projects up its sleeve, also points out that a company will not make aggressive bids if it doesn’t see some strategic value in the project.

So, how will India’s power sector look, say, 10 years from now, when peak power deficit could touch as high as 33,000 MW compared to 14,000 MW currently? “Power sector today is where telecom was 10 years ago. A decade hence, it will be where telecom is today,’’ predicts V. Raghuraman, Principal Advisor (Energy), CII. It’s a perceptive comment, and Anil Ambani may well manage to do in power what his Reliance Communications (which is currently #2, but with new GSM licences could leap to #1 position) has done in telecom. In fact, that’s precisely what Reliance Power’s enthusiastic investors may be betting on.