Price rise .. A shot in the arm!

Couple of days ago, one of my friends was asking me what would be the solution to the ailing power sector crisis in India. If we drew Porter's five forces model for the Power sector presently every force is dragging the sector down. Regulatory issues, Human resource issues, Lack of funds, lack of fuel, In adequate price and more to say the least. It looks like a vicious cycle with each leading to the other. So, what was one thing that could be done to revive the sector?

The answer was precisely given by the Central Electricity Regulatory Commission by allowing a pass through of increased fuel cost and agreeing to revise the power purchase agreement. No wonder, the stocks of the listed power generating companies soared by more than 5% in a single session, due to the hopes created by this judgement. Infact, this may be the single regulation that will have the maximum impact on the sector. But, how does it impact?

When a power generation company is about to set up the plant, they sign an agreement with the customer for the sale of electricity at a particular price. This agreement is more commonly called as "Power Purchase Agreement". This forms the basis for all the electricity bills that we pay. Typically in this contract, the electricity generation cost is planned and with a small escalation in prices, the power generation companies quote the price for the next 25 years. These values remain valid till the end of the 25 years!

Here comes the interesting part. In the cost of electricity generation, fuel cost alone constitutes more than 60%. So any undue increase in the fuel cost leads to a huge increase in the overall cost of electricity. Since, these undue increases cannot be allowed to, the power generation companies will be forced to sell or at times not sell electricity at all. While power generation companies do plan for price hikes, huge reliance on imported fuel supplies cannot be really planned for. This precisely happened with the coal that was being imported from Indonesia. Since, the amount of coal produced in India is not enough, many companies tied up with Indonesian coal companies for the supply of coal for long term supplies. When these tie-ups were formed Indonesian coal was cheap and hence all the companies bid aggressively for selling electricity. Couple of years ago, Indonesian Govt. increased the export duty on Coal significantly leading to almost an increase of 40-50% in the cost of coal being imported from Indonesia. This price hike was never expected in such a short duration and left every power generation company depending on Indonesian coal in quandary.  The other party of the Power Purchase agreement, which are typically the Govt. run electricity distribution companies did not agree to bear this additional cost. So, far the past 3 years power generation companies have been fighting battles to allow for this price hike.

After huge deliberations, the regulatory commission which oversees this price settlement passed a judgment to allow for a price hike. Even though the formula for price hike is not decided, the impact is significant considering the fact that this has been the biggest and one of the first of its kind in India. This is a shot in the arm for all the power generation  companies which were holding back from investing further and were reeling under losses of multiple crores per day.

But, what about the ability of the electricity distribution companies to cater to the increased price. Indian electricity distribution companies are the most loss making entities across the value chain of electricity. They are forced to buy the electricity and are not allowed to charge the consumers the rate at which they can survive. On top of that are the huge subsidies that are forced upon them by the active governments and also the impositions by politicians to ensure free power to their electorate etc. Last year Govt. had to bail out some of the electricity distribution companies from an inevitable bankruptcy. Also the ongoing protest by a leading politician protesting against the electricity price hike, would make any future hikes turbulent. Owing to all these, the distribution companies may be forced to take the biggest hit.

But, at least it is some movement forward and now the focus can be shifted to the distribution companies and hopefully some concrete solution will come soon.