Merchant Power Plants the next big thing in the Indian power sector

According to the Ministry of Power, Govt. of India, at the end of FY10, the total electricity peak demand met was only 96,600 MW resulting in a peak deficit of 13.3%.This is against the stated aim of the Government to achieve "power for all" by 2012.

The bulk of the private sector interest in power is currently in generation due to the possibility of selling power at high prices in the present supply constrained scenario. Lured by the prospect of selling power at the prevailing high short term rates resulting in higher than normal profitability, a number of developers have announced MPPs.

MPPs may be defined as power plants, which are not tied up with long-term power purchase agreements. Consistent with the risk return framework, these projects have inherently higher risks as compared to traditional power plants, leading to several challenges in development and financing of such projects. In the international context, a pure PP is one where the entire capacity is sold on the basis of short-term contracts without any capacity tied up through a long term PPA. However, in the Indian context, a large capacity pure MPP is a rarity. Presently, MPPs being financed in India have around 60-70% of the capacity tied up through long term sale arrangements to distribution companies or rading companies.

Key Enablers

The following key enablers contribute to the growth of merchant power projects in India:

Demand-supply gap in India - It is worth while noting that as per CEA, Ministry of Power, India's peak demand as on March 2009 was 109.8GW whereas the supply was 96.6GW. This resulted in peak demand shortage of around 12% in FY09. The peak deficit has almost increased by 40% from 9.5GW in FY04 to 14.1GW in FY10.

Merchant power pricing - Prices at which merchant power are currently being sold are far higher than the price at which long term PPA based power are sold. Short term or merchant prices are almost 2.4-2.5 times the long term prices.

No Performance Milestones - Long term PPAs with distribution companies are usually subject to meeting of certain performance related milestones. Non-achievement of these milestones may lead to encashment of the bid guarantee and erformance guarantee amounts. This is not applicable in case of MPPs

Open access policy in transmission - Open access is provided under Section 42 of the Electricity Act 2003, which mitigates the risk of power evacuation from MPPs. The Eleventh plan envisages an investment of INR1,400 billion in the transmission sector in India.

Some strategies that MPPs can adopt for evacuation of power are

• Set up own dedicated transmission network;
• Connect to the central transmission utilities such as PGCIL.
• Connect to the state transmission utilizes

Attractive returns in MPPs - The equity returns in MPPs are around 20-40%. However, to earn this high return, the developers are required to sell power on short term basis to discoms or traders at merchant power prices. 

Risk factors 

•  A MPP is required to absorb the full market risk and compete for customers on an on- going basis.
• Regulatory interventions by way of capping power prices or by restricting power projects from freely supplying power to the entity of their choice are another risk to which MPPs are exposed to.
• Fuel risk acts as a detrimental in path of MPPs. Any un-estimated rise in fuel prices could render a MPP uncompetitive, reducing the probability of takeoff.
• MPPs also increase the risk perception of lenders due to bottle necks in power evacuation.
• MPPs are also exposed to an adverse impact on account of changes in regulatory and tax policies. 

 Financing of MPPs

 MPPs being financed in India have around 60-70% of the power tied up through long term sale arrangements to distributing companies or trading companies or industrial consumers so as to guranatee cash flows sufficient enough o cover the debt servicing requirements. This is specified by lenders through Debt Service Coverage Ratio covenant hich requires developers to tie-up through a PPA such proportion of capacity, which is sufficient to service 1.1 to 1.3 times the annual repayment and interest obligations.

 Lenders take comfort in the ability of power traders to find buyers quicker and on more favourable terms than a generation company with no market experience. However, some lenders often stipulate that the trader should tie up ack-to-back sale arrangements within 15- 20 months of the first disbursement of fund. Failing this the lenders often reserve the right to stipulate additional conditions.

  Conclusion

 The development of MPPs is essential for the overall capacity additions required by India to bridge the emand-supply gap. The possibilities of high returns have attracted several private developers. However, the eluctance of lenders to finance a pure MPP and the high risk attached to it presents several challenges.