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Power tariffs based on negative price of coal will only dim the market

If the input for a product is priced negative, or much below zero, for a period of 25 years, can the pricing for that product be sustainable? The product here is power for which a Rs 96,971-crore reduction in tariff has been promised by 11 coal block winners by pricing coal 'negative'.

The price of coal from the auctioned coal block has no correlation to the actual cost of production. Since coal blocks earmarked for the power sector were put on reverse auction - those who bid the lowest below the reserve price get the block - it is expected power tariffs will come down.

"No commodity is free and certainly no commodity comes for a negative price. This is not the market price for coal. What these bids will do is get stuck power plants to start generating power. Either they will continue to supply at the bid price and continue to make losses for 25 years though lesser than earlier when their power plants were idle, or they will bid higher for capacity charges," said Rajiv Mishra, managing director, CLP India.

Power generated from coal produced from auctioned blocks is expected to be cheaper than coal supplied by Coal India, which is called linkage coal. The government is even planning to auction coal linkages but "coal from blocks auctioned and to be auctioned is likely to be bid aggressively for both quality and supply security, and so likely to be cheaper than linkage auction", said Kameswara Rao, leader, energy, mining and utilities at PricewaterhouseCoopers.

The impact of coal auction on tariffs will, however, be localised as the capacity auctioned represents only six per cent of the existing thermal generation capacity. The allocation to government companies is much larger, but the gains will depend on how efficiently they can develop them, pointed out Rao.

"The tariffs should be largely sustainable over the mine life, but will be a burden on companies' balance sheets and over time they may seek to divest them," he added.

While there is a fear that the operators of these blocks might try to recover their coal cost by building it on in the fixed (plant and machinery) component of power, officials said it might not be easy.

The Union power ministry had on April 16, 2015, issued a direction to the Central Electricity Regulatory Commission, asking it to ensure their tariff of power produced from auctioned coal blocks do not exceed what has already been concluded under the power purchase agreement (PPA) with the distribution companies.

The directive also identified six components of fuel price or energy charges, while clearly laying down the principle on which such components would be priced. But it is not clear how the government will ensure a fixed component of power tariff does not go up. "The government has stated higher costs should not be passed into fixed costs, but it's not easy to ring-fence this for past PPAs. Also, a lot of mining spend is fixed cost in nature; so the issue needs proper deliberation," said Rao.

According to industry insiders, bids for coal blocks for the power sector were aggressive more out of the desperation to get coal than a realistic estimate of costs.

Mishra said "There was not a single rupee being made in capacity charge. And as a result, large capacity was stuck. There was big risk in the system both for debt and equity. Auction will enable them to start generating but whether they make profit, I am not sure."

According to him, there will be tariff pressure downwards, negative price for 25 years is not a realistic solution. "That price has to be recovered somewhere less, so tariffs will not effectively come down."

source: http://www.business-standard.com