CERC Draft Regulations FY19-FY24 Are Favourable For Generators: India Ratings

India Ratings and Research (Ind-Ra) opines that the draft Central Electricity Regulatory Commission guidelines for the financial year 2018-19 to financial year 2023-24 block period are favourable for power generators, as the regulator has maintained the status quo on most of the parameters as against Ind-Ra’s expectation of a lower return on equity and change in debt:equity ratio in favour of debt.

Ind-Ra estimates the annual fixed cost to decline by 1.4 percent, as per the new guidelines, largely driven by the changes in the working capital norms. CERC has tightened the working capital norms by lowering the normative inventory and receivable period allowed by 10 days and 15 days, respectively. Moreover, the regulator has changed the rate of interest on working capital to one year MCLR+350 basis points as against the earlier guideline of SBI base rate +350 basis points. Both the factors combined are likely to lower the interest on the working capital component. Additionally, CERC has lowered the arbitrage available to generators on the late payment surcharge (LPSC) by lowering the LPSC rate to 1.25 percent from 1.5 percent.

However, there will be an increase in the billable energy charge rate (ECR), driven by

1. An increase in normative auxiliary energy consumption.
2. An allowance of additional 85kcal/kg GCV loss on account of variations during storage at generating stations.
3. An increase in the normative allowance in transit losses. Ind-Ra expects the ECR to increase by 6 paisa/kWh under the new tariff guidelines.

Reduction In Normative Availability, Declaration Made Quarterly

In the proposed norms, CERC has reduced the normative availability to 83 percent from 85 percent, which would improve fixed cost recovery. However the basis of declaration has been changed to quarterly from annually. As per the guidelines, under-recoveries in a quarter cannot be recovered in the later part of the year.

No Change In Leverage Profile

As against earlier expectations of an increase in the leverage ratio of generators on account of an expected decline in RoE, EBITDA and increase in D:E ratio, Ind-Ra expects no major impact on the leverage profile as the overall impact on EBITDA remains neutral with no change in the proposed D:E ratio. Ind-Ra believes that any decline in aggregate revenue requirement due to working capital changes is likely to be offset by higher energy charges as allowed under the new guidelines.

Note: The guidelines discussed in the report are draft in nature. Ind-Ra expects the final guidelines to be released by March 2019. The impact of final guidelines would be assessed separately by Ind-Ra.

Analysis Of Draft Guidelines

RoE Remains Unchanged-A Big Relief

CERC has kept RoE unchanged at 15.5 percent contrary to Ind-Ra’s expectation of a decline. Ind-Ra believes this is a big relief to thermal power generators, as this would protect their cash flows. Ind-Ra’s view on the possibility of a lower RoE was based on the demand by distribution utilities to reduce tariffs, disincentivise capacity addition given the surplus capacity prevalent in the system and the overall reduction in the risk-free rate in the economy. However in the current regulations, the regulator hasn't allowed the additional return of 0.5 percent which the FY14-FY19 regulations had allowed if the project was commissioned within the timelines.

Debt: Equity Remains Unchanged-A Prudential Move

CERC has also left the D:E ratio unchanged at 70:30. This is because a higher D:E allowance would have resulted in higher net leverage (debt/EBITDA) and lower interest coverage. There was a belief that to lower the tariff for distribution utilities, the D:E ratio might be altered to 80:20 so as to lower the equity component which provides a higher return at 15.5 percent than debt which has a lower cost of 9 percent- 12 percent.

Change In Depreciable Value Of The Asset–To Increase Tariffs Marginally

The draft guidelines have lowered the salvage value of the asset to 5 percent from 10 percent. Thus, power generators would now be able to recover 95 percent of the asset value through depreciation charge, as against the earlier allowance for only 90 percent recovery of the asset value. Moreover, the regulator has kept the depreciation rates unchanged. For thermal power generators, the overall depreciation on the plant and machinery would be 5.28 percent and for civil structures it would be 3.34 percent. Other things equal, a lower salvage value is likely to result in a marginal increase in the levelised tariff for power generators.

Reduction In Normative Plant Availability-Beneficial To Generators

The guidelines have also lowered the normative plant availability factor to 83 percent from 85 percent, triggered by the shortage of coal and uncertainty of assured coal supply. The same was highlighted by CERC in the tariff regulations for FY14-FY19. Ind-Ra believes this would improve fixed cost recovery as plants were unable to reach 85 percent normative plant availability for the want of coal. The regulator has also proposed the declaration of normative availability on quarterly basis, compared to annual in the earlier regulations. Ind-Ra views this as a credit negative for generators because under-recoveries in a quarter cannot be recovered in the later part of the year. Thus, if a plant were to undergo a major maintenance for above 15 days, there would be loss of plant availability which cannot be recovered in subsequent quarters, leading to fixed cost under-recoveries.

Change In Basis Of Capacity Charge Recovery

The commission has proposed a change in the basis of capacity charge recovery, by segregating the recovery in two parts, namely capacity charge during peak hours and capacity charge during non-peak hours. Though it's not immediately clear, if the same is likely to result in any disallowance, the recovery of capacity charge has been made more granular and the basis of calculation has been changed to quarterly from yearly. Ind-Ra believes this move would ensure even distribution of capacity charge declaration and capacity is available during the peak hours.

The capacity charge rate for the peak hours has been proposed at 25 percent more than that of the off-peak hours. The number of peak hours and off-peak hours would be declared by the regional load dispatch centre on a monthly basis in advance, and the peak hours would not be less than four hours in a day. Additionally, the incentive structure has been segregated into peak and non-peak incentives, with energy supplied above the normative plant load factor during the peak hours getting 65 paisa/kWh while non-peak hours getting 50 paisa/kWh, compared to the earlier flat incentive of 50 paisa/kWh.

Balanced Approach On Operational Parameters

The regulator has tightened some norms while relaxing the ones on the operational front. The gross station heat rate has been lowered to 2,410 kcal/kWh form 2,450 kcal/kWh for the plants with unit capacities from 200-250 MW while it has been kept same for other unit capacities. Ind-Ra opines the same would reduce ECR by around 3 paise/unit, assuming a coal cost of Rs 3,000/tonne (GCV: 4,000 kcal/kg). If the plants are unable to lower the station heat rate to the desired levels, the same would result in an under-recovery on energy charges. Although the auxiliary energy consumption remains the same for units of 200 MW, CERC has relaxed the norms for the units above 300 MW to 5.75 percent from 5.25 percent. The draft guidelines also propose a higher coal transit loss at 1.2 percent from 0.8 percent earlier for the transportation distances longer than 1,000 km from mines.

Change In Late Payment Surcharge

CERC has proposed to reduce the LPSC to 15 percent per annum (1.25 percent per month) from 18 percent per annum (1.5 percent per month). This change would correct a long pending demand of distribution utilities as borrowing rates for most generators were much lower at 9 percent-12 percent while they were being paid at 18 percent by the utilities for delays in bill payments.

Tightening Of Working Capital Norms

The regulator has proposed to tighten the working capital norms by reducing the inventory and receivable days by 10 and 15 days, respectively, thus lowering the normative working capital requirement. Additionally, the interest rate is linked to SBI MCLR compared to SBI base rate. This is likely to result in a more dynamic change in interest rates. Ind-Ra believes the above two changes would result in a 1.4 percent decline in annual fixed cost (AFC).

Gain Sharing Norms Made Unfavourable For Generators

The proposed regulations have lowered the percentage share of gains between generators and beneficiaries to 50:50 from 60:40 in favour of the beneficiaries on operational norms in terms of station heat rate, auxiliary consumption and secondary fuel consumption. However, the benefits of debt refinancing, loan restructuring or changes in interest rate on the loans which were earlier shared between generators and beneficiaries in 1:2 ratio will now be shared equally, resulting in additional savings to the generators thus incentivising them to lower the interest rates through refinancing of loans.

India Ratings and Research, a wholly owned subsidiary of Fitch Group, is a SEBI and RBI accredited credit rating agency operating in the Indian credit market.