Morgan Stanley Research has downgraded the Indian utilities industry, citing the threat from renewable power. These risks were not unknown, but the brokerage firm goes further and says the market is yet to fully price-in the impact of solar power, becoming the cheapest form of new electricity generation.
As demand remains subdued and renewable power achieves grid parity or becomes the cheapest source of new electricity, thermal power units will be unable to compete, making them redundant, or so the argument goes.
It will not face an abrupt end though. Given that storage technology costs are yet to achieve grid parity, thermal power plants will continue to meet the base load or core demand. So thermal plants already having power purchase agreements (PPAs) and assured of minimum returns, have nothing to worry about.
But plants that are under construction and yet to be commissioned stare at an uncertain future as cheap renewable power can make electricity distribution companies (discoms) averse to conventional energy. “It is clear that over the next few years, the state electricity boards will think hard before signing even short- or medium-term (3-10 years) coal-based PPAs given that solar has achieved grid parity and PPAs using domestic coal always face inflation risk,” adds Morgan Stanley.
The impact will be more pronounced on the plants that do not have PPAs and are dependent on short-term or merchant power markets. These plants will find it difficult to compete with cheap power from renewables. According to Morgan Stanley, there is 26,000 megawatts (MW) of merchant coal capacity—15,000MW operational and 11,000MW under construction. Around half of this is said to have a high-cost base, rendering them uncompetitive.
That brings us to the financial impact. What will happen if these plants fail or are unable to meet financial covenants? Roughly three-fourths of the capital cost is funded by banks or financial institutions. Assuming a project capital cost of Rs6 crore per MW, 13,000MW (half of 26,000MW merchant capacity) that has a high- cost base will have a debt component of Rs58,500 crore.
The transformation can inflict financial pressure on existing private power plants also, if discoms curtail thermal power purchases opting for cheap renewable energy whose supplies are set to rise.
Thermal power capacities are already operating at low utilization levels due to excess capacities and slow growth in demand. Earlier this year, India Ratings and Research estimates pegged the private sector coal-based capacity of 45,000MW with a debt of nearly Rs1.9 trillion to be operating at sub-par levels of less than 50% utilization levels. Plants in the relatively smaller companies are already facing debt servicing challenges, India Ratings said in a note released last February.
If renewable power indeed replaces thermal as the preferred choice of energy by discoms, then a large part of the current and forthcoming thermal capacities with no PPAs can become redundant. That can have profound impact on lenders who are yet to overcome the recent wave of bad loans. They would be better off preparing contingency and risk mitigation plans.