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Event update: Power Utilities; Draft regulations - Positive for new plants but older plants penalized; No cut in RoE

Event

The Central Electricity Regulatory Commission (CERC) has floated draft regulations on tariffs for the power sector applicable between FY20 and FY24. The regulations are expected to be finalized by the last week of Feb 2019. The proposed regulations is better for power assets, barring the proposed reduction in equity for older power assets

Key provisions and highlights

• The CERC has maintained the base RoE at 15.5% for thermal generation and 16.5% for hydro generation with pondage. This has come as a major positive for the sector.
• Generation

o  Capacity charge recovery on a quarterly basis versus annual earlier: The recovery of fixed charge (capacity charge) has been linked to availability on a quarterly basis (instead of annual). Besides, the recovery of capacity charge on peak hours has higher weightage by 30% (instead of 25% - for six peak hours). As per the draft, higher availability at off peak hours will not be not allowed to be offset against peak hours, whereas the vice versa has been permitted.

o  Energy charge - Relief on gross calorific value (GCV): As expected, CERC’s proposal permits a loss of 85kCal/GCV between unloading and firing point. Note that NTPC recorded 5-6% under recovery on fuel due to change in 2014 tariff regulations (for FY15–FY19E) that required measuring GCV from firing point to unloading point. Despite favorable recommendations from Central Electricity Authority (CEA), the case did not reach a conclusion at CERC. We expect the new proposal to do away with the entire under recovery from fuel cost.

o  Incentive increased on peak hours: Incentive at peak hours has been increased to 65paise/kwh (+) while off peak is at 50 ps/Kwh (ó)

o  Sharing increased in favour of consumer: Sharing of gains on account of controllable factors including interest cost refinancing has been decreased to 50: 50 (versus 60:40).

o  O&M expenses exclude security expenses: The base O&M expense for FY20E has been reduced compared to FY19, as new base expenses exclude security expenses (to be recovered separately on actuals). Allowed O&M expenses have been escalated at a lower rate of 3.2% for thermal and 4.7% for hydro assets.

o  Operational norms relaxed: Operational norms have been marginally relaxed with lower efficiency norms and higher auxiliary norms.

• Transmission: Maximum availability incentive for DC system has been cut by 80bps (asset will earn additional 1.2% return instead of 2% additional maximum RoE).
• Working Capital norms tightened: Working capital norms have been tightened with receivables days reduced to 45 days (from 60 days), offset by late payment surcharge of 1.25% available from 45 days (instead of 60 days).
• Negative for older assets: Assets that have completed their useful life will see their equity base reduce leading to reduction in return on equity allowed under fixed charge recovery. The equity base will be reduced to the extent of cumulative depreciation offset by cumulative repayment. We estimate NTPC’s equity base to reduce by Rs52bn and Rs12bn in FY20E and FY21E, respectively (details in subsequent sections).

Outlook and View

We believe the proposed draft regulation is positive for the generation and transmission sector, with the base RoE being maintained at 15.5% and 16.5%, respectively, which was a major concern for the markets. While the relief on GCV and minor relaxation in O&M norms is a positive for generation companies, the same has been offset partially by the reduction in equity base for power plants (equity base of older power plants). The reduction in number of days to make payment without penalty has reduced the adverse impact of working capital norms. We reiterate our Outperformer rating on NTPC and Power Grid (trading at 1.0x and 1.4x, respectively), given the sharp fall in their stock prices.