Power Sector Under Fuel Security Threat

The Power Index has witnessed a small rally in this month so far. The index rose by 2 per cent as many investors saw some buying opportunity. Despite the fundamentals being the same, what prompted this rally? The question uppermost in the minds of the investors is whether this is the right time to buy the power stocks.

In the March quarter the sector widened its losses. The overall profitability has gone for a toss since an increasing number of companies have reported losses. The profit of the sector has declined by 22 per cent (YOY basis) despite a surge of 22 per cent in the topline. Apart from the usual reasons of coal shortages and lower tariffs, there is the added fury of the exchange rate which is still over the Rs 55 per dollar mark, thus making coal imports expensive.

Coal India, as per a news report in DNA, has cut its supplies to 62 captive power plants which include big names such as the Tata Power Company. Earlier this month, Coal India discontinued coal supplies to Lanco Infra. Now this looks like a safety measure as the company is under pressure to meet its coal production targets as well as to sign and honour the fuel supply agreements with the power utilities. Lanco’s coal supply was suspended on the grounds that it has not signed any power purchase agreement. The DNA has said that the 62 coal supply agreements were suspended on the grounds that these companies failed to pay commitment guarantees within the stipulated period.

Meanwhile, the issue of coal pricing has emerged again. CIL has said that it will increase the coal prices by 5-15 per cent in a selected few blocks at two of its subsidiaries viz. Eastern Coalfields Ltd (ECL) and Western Coalfields Ltd (WCL). Due to this, the power companies using the coal from these blocks will have to raise power tariffs which will be met with agitation from the government and the public.

Also, the much-awaited Fuel Supply Agreement Pact, as directed by the prime minister, is yet to be completed. According to a media report, only 15 out of the 49 eligible power producers have signed this agreement. This rate is very slow and the companies need domestic coal at this time when there is a very high exchange rate.

Amidst this chaos, NTPC has cut its capacity addition target to 14,500 MW by 2017 while Tata Power has also said that it will keep on hold its plans to add imported coal-based capacity due to the highly regulatory environment in coal producing counties like India and Indonesia.

The recent index of mineral production of mining has indicated a 35 per cent decline in coal production in April 2012. Under such circumstances the worries of the power sector have touched a new peak. The sector wants more coal for incremental capacities which looks impossible. The power equipment companies will also have problems as less supply has forced them to cut down the generation target and there by their order book will further tumble.

This negative picture though has a silver lining as some of the SEBs have allowed the power utilities to hike the power tariffs. However, it should be noted that coal supply is the key input for the thermal power sector, a prime prime source of power generation in India. In these circumstances we advise investors to avoid the power sector except for a few chosen companies like CESC and PowerGrid.