April 6, 2011

April 6, 2011

Highlights

Government to develop policy for geothermal

power Barriers continue to plague Indian renewable

power resource development

Geothermal Power: Straight From The Earth

April 6, 2011 April 6, 2011

Geothermal Power: Straight from the Core

W ith the government readying a policy on geothermal energy, some of the country’s largest private companies in the energy sector

are betting high on one of the cleanest sources of power.

What Is Geothermal Energy?

The word geothermal comes from the Greek words geo (earth) and therme (heat). So, geothermal energy is heat from within the Earth.

We can recover this heat as steam or hot water and use it to heat buildings or generate electricity.

Geothermal energy is generated deep inside the Earth. The Earth’s core has two layers: a solid iron core and an outer core made of very

hot melted rock, called magma. Deep underground, the rocks and water absorb the heat from this magma. The temperature of the rocks

and water gets hotter and hotter as you go deeper underground.

Geothermal energy is used to produce electricity by digging deep wells and pumping the heated underground water or steam to the sur-

face.

Geothermal Power Plants

Geothermal power plants use hydrothermal resources that

have water (hydro) and heat (thermal).

Geothermal plants require high temperature (300°F to

700°F) which may come from either dry steam wells or

hot water wells.

These resources can be used by drilling wells into the

Earth and piping the steam or hot water to the surface.

Geothermal wells are usually dug one to two miles deep.

Types of Geothermal Plants

There are three basic types of geothermal power plants:

Dry steam plants use steam piped directly from a

geothermal reservoir to turn the generator turbines.

The first geothermal power plant was built in 1904 in

Tuscany, Italy, where natural steam erupted from the

Earth.

Flash steam plants take high-pressure hot water from deep inside the Earth and convert it to steam to drive the generator turbines.

When the steam cools, it condenses to water and is injected back into the ground to be used over and over again. Most geothermal

power plants are flash steam plants.

Binary cycle power plants transfer the heat from geothermal hot water to another liquid. The heat causes the second liquid to turn

to steam which is used to drive a generator turbine.

In India, till date there has not been any comprehensive policy on the development of geothermal as sources of energy. In the past, en-

ergy planners and policy makers in India have generally supported conventional sources of energy for a variety of social and political

reasons. Coal and oil based thermal power was preferred to hydel power due to its short gestation period and marginal physical dis-

placement of people.

The government has formed a a working group for a national policy on geothermal energy. But no timeframe has been set for the same.

However, two Indian companies are very keen on developing this source of energy development — Tata Power and Thermax.

Tata Power has already signed a memorandum of understanding with the Gujarat government to set up a geothermal power plant in that

state. Tata Power already holds stake in Geodynamics, operating an Australian basin with an enhanced geo-thermal system. It has also

Courtesy: http://www.reuk.co.uk/Eden-Project-Geothermal-Power-Plant.htm

April 6, 2011 April 6, 2011

got a licence to develop a 240-mw unit in Indonesia.

While the government may be keen on development of renewable sources of energy, there are several hurdles. These include financial

as well as regulatory hurdles.

Although subsidies and financial incentives were given to the development of renewable energy technologies, the total invest-

ment in these technologies is too small and mostly on an experimental basis.

While calculating internal rate of return for any power project, hidden or indirect subsidies on pricing of resources (like coal)

and infrastructure (subsidy on freight) are not taken into account in the case of conventional sources of energy.

Lack of adequate financial resources has been a chronic problem for commercialization of renewable energy power plants.

It is often argued that many times it is risk coverage rather than capital cost that is a limiting factor in rapid commercialisation

Cumbersome regulatory procedures are another deterrent.

PRU View

We believe that given the barriers to development of existing renewable sources of energy, it will take a long time for setting up of

the policy framework and for companies to be able to start commercial operations from geothermal plants.

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April 6, 2011 April 6, 2011

India’s Foreign Trade

Rising exports may cushion ` against high crude prices: Oil forms the largest chunk of India’s imports and rising crude prices

hurt the ` as the country would have to pay more in $ to buy oil. But the rupee has appreciated to 44.58 per dollar on March 31 from

45.93 at the end of November despite Brent crude May futures rising. (Mint, April 4, 2011)

PRU Analysis

While exports from India recorded a 31.4% year-on-year surge

during April 2010-February 2011, imports rose by a slower 18%.

India exported $23.6 billion (over `1.05 trillion) worth of goods

in February, the highest in a single month, up from $20.60 billion

in January and $22.5 billion in December. The break-up of ex-

ports for February is not out yet and hence it is difficult to high-

light the growth sectors.

Trade deficit — the difference between a country’s imports and its total exports — has been lower than last year on account of a

slower growth in imports, particularly oil imports. A muted growth in refinery throughput (production of petroleum products) has

been the cause of slower growth in oil imports. Oil imports rose by 12.4% while non-oil imports increased by 20.4% on a year-on-

year basis.

India’s trade with China has been rising, suggests RBI data. Merchandise trade between the two countries rose from $12.7 billion

in 2004-05 to $42.4 billion in 2009-10. However, trade balance in favour of China increased from $1.5 billion to $19.2 billion dur-

ing the same period, reflecting an imbalance against India.

China's policy to keep its currency, the Renminbi or Yuan, artificially undervalued gives it a huge economic advantage and impacts

India's trade. By artificially undervaluing it, we mean the Central Bank intervenes in currency market and does not let the value of

Yuan change as per market dynamics. This has become a cause of worry for the policy makers across the globe.

The share of India’s imports from China has significantly risen to 10.7% during 2009-10 from 7.3% in 2004-05. China also ac-

counts for a lion’s share in the balance of trade of the US. Hence, economies across the globe are exerting pressure on China to

revalue its currency.

Engineering Exports Scaling New Heights

Engineering exports cross USD 50 bn mark in April-February: Breaching the crucial $50-billion-mark, India's engineering

exports grew by over 80 per cent in the April-February period of the current fiscal which is expected to end with $57 billion. (The Eco-

nomic Times, March 30, 2011)

PRU Analysis

India is one of the fastest growing engineering exporters in the world, growing at CAGR of 10.65% for the period 2005-06 to 2009-10.

During 2009-10, there was a drop in engineering exports by about 16 % (Y-o-Y) which was primarily due to global recession espe-

cially in USA & Europe. With the exception of the slowdown in 2009-10, engineering exports have been experiencing steady growth

year on year for the past five years.

According to the Engineering Export Promotion Council (EEPC), a trade body set up by the Union commerce ministry to promote ex-

ports of engineering products, exports during the first 11 months of FY10-11 (April – February) stood at $ 52.7 billion. Exports grew

by almost 80% Y-o-Y basis over $29.4 billion in the corresponding period last year.

About 40% of the total engineering exports go to developed countries, especially Europe and USA. During In 2009-10, exports to

Europe constituted about 24% of the total exports.

The impressive export numbers of FY10-11, have been driven by orders from the US, Latin American and Middle East markets.

India's Trade Statistics

April-February 2010-11

$ Million % growth

Y-o-Y

Exports (including re-exports) 208,229 31.4

Imports 305,299 18

Trade Balance -97,069

April 6, 2011 April 6, 2011

Engineering export include exports of goods, transport equipment,

capital goods, other machinery/equipment and light engineering

products like castings, forgings and fasteners etc.

However, in spite of this scenario, India has a low share (about

1%) in the world engineering exports. India’s engineering exports

is also accounts for a low percentage of total exports.

For the year FY10-11 (April–February), export of engineering

goods and services constituted for about 25% of the total exports.

This is still low compared to China or other developed countries.

It can be mentioned here that India’s total exports for the same

period is $208 billion.

The reasons for the same could be

SMEs comprise 60-65% of the engineering sector in In-

dia. Most of the SME players have not achieved econo-

mies of scale or the required technological capability to

be globally competitive.

Infrastructural and procedural inadequacies have been

making Indian exports uncompetitive in terms of cost

and timelines.

To rectify the situation and in order to achieve the target of $92 billion by 2013-14, as set by the Union ministry of commerce and

industry, the government needs to take certain concrete measures.

Extension of TUFS scheme for sourcing of capital goods, machinery and equipment. This will help engineering SMEs buy

new and advanced machinery for enhancing production as well as for improving quality of the products.

TUF scheme provides 10% capital subsidy in addition to 5% reimbursement on the machinery.

Government can create a fund through private public partnership (PPP model) to boost R&D in the Indian engineering sector.

Measures like incentivizing commercialization of indigenous developed technology, marketing of the developed technology

to ensure sustainability of R&D etc will go a long way in modernization of this sector.

Government can set up skill development fund to encourage capital equipment purchases on easy finance as well as impart

training in areas where technology upgradation is being initiated.

Higher level of participation of FDI will definitely help improve the technological capabilities.

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30

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50

60

0

10

20

30

40

50

60

2005-06 2006-07 2007-08 2008-09 2009-10 2010-11*

Engineering Exports ($ bn) Y-o-Y Growth(%)

Indian Engineering Exports and Growth Rates

(RHS)

April 6, 2011 April 6, 2011

Steel : New Strategy

JSW revives London listing plans: With its international operations getting streamlined or in some cases seeing a turnaround,

JSW Steel, India’s third- largest steelmaker, has revived its plans to list on the London Stock Exchange.(Business Standard, April 4,

2011)

PRU Analysis:

In recent times, India’s three largest steel makers – Steel Authority of India Ltd (SAIL), Tata Steel and JSW Steel — have been look-

ing out in Australia, US and South Africa for mining assets in order to meet their raw material requirements.

India’s steel industry has witnessed a period of robust growth, driven by the huge thrust on infrastructure development and robust auto-

mobile growth. According to CMIE, production grew by all most 8% in FY10-11 to 64.5 million tonnes. It is expected to grow by

10.9% in FY11-12. Steel industry is expected to add 39 million tonnes of finished steel capacity during FY11-13. Hence, raw material

requirement has also gone up.

JSW steel has mining assets in US, Chile and Mozambique. Its US mine has 123 million reserves of coking coal. It can produce 1 mil-

lion tonnes per annum and which can go up to 3 million tonnes in three years. The Billevista Mine in Chile was expected to start iron

ore production in December, 2010. However, both the mines are expected to start production by FY12 only.

The company however has no plans to use the Chilean iron ore production for its steel plants in India. It has an annual requirement of 5

million tonnes of coking coal. With no captive resource, JSW imports the entire amount from Australia. In future it will be using the

US coking coal for feeding its plants in India.

It can be mentioned here that coal mines in Mozambique have 80% of thermal coal and rest coking coal. Hence, JSW Steel will be us-

ing 20% coking coal in future. The Mozambique unit is still in exploration

stage.

The company has plans to put all its overseas coking coal and iron ore min-

ing assets into single unit and get listed on London Stock Exchange. The

mining assets will be consolidated in its Netherlands subsidiary called JSW

Netherlands.

Earlier, the company had plans to get listed in the US.

The spot as well as contract prices of iron ore and coking coal have been very high and volatile in recent times. This increases the cost

pressure on the companies and, hence, affects their margins. Steel

maker’s main motive behind acquisition of mining assets is to

hedge against the price movement.

But JSW steel’s spin-off of mining assets and plans of listing on

London exchange could be beneficial for the following reasons:

Reducing the leverage on the books Total debt at the end

of Q3FY10-11 stood at Rs11,585 crore.

It will continue to have rights over the assets.

This move will infuse funds into the company which

will enable it to carry on with the capex plans. With debt

–equity ratio of 1.29 balance sheet is strained already.

The move also helps creating value for the mining as-

sets , and thereby improves valuation of the parent com-

pany as well.

Current FY13

Iron Ore 10-15% 17-20%

Coking Coal 0% 12-15%

Raw Material Integration

April 6, 2011

Cotton Yarn: Caught In A Cleft Stick Overview:

India’s textile industry holds a lot of significance for the country in terms of output, investments and employment. It constitutes 14%

of the industrial production, 4% of the GDP and 17% of its export earnings.

The industry consists of organised mills as well as unorganised small scale enterprises. The organised mill sector consists of composite

mills where spinning, weaving and processing activities are carried out under a single roof.

India is the largest exporter of yarn in the world with an export share of about 25%. Cotton yarn constitutes about 75% of the total yarn

production.

In recent times, high price of raw cotton as well as cotton yarn has been badly hitting the textile industry in India. In a recent move, the

government has decided to lift the ban on cotton yarn exports which was imposed earlier in December 2010.

The Indian government had earlier capped cotton yarn exports to 720 million kg in December 2010 for the current financial year (up to

March 31, 2011). The move was aimed at controlling yarn prices and also to ensure availability of yarn for domestic consumption.

However, cotton yarn industry has been facing various challenges like rising power costs, lack of integration and no economies of

scale, high labour costs, dependency on imported technology, and appreciation of rupee (after FII inflow) which impacts exports.

Under the current backdrop, we will focus on cotton yarn Industry and will be analyzing its challenges and outlook.

Production Trend:

Cotton yarn production in India has witnessed a

volatile growth rate since 2005-06 till 2010-11. In

the years 2005-06, 2006-07 it recorded growth

rates of 12% and 11% respectively.

It recorded negative growth rates of 4% and 21%

respectively in the years 2008-09 and 2009-10.

Global meltdown can be the main reason for the

production downtrend.

For 2010-11 the growth rate is around 11%.

Favorable demographics, coupled with rising pur-

chasing power, will fuel the domestic demand for

cotton yarn. Export demand is also expected to

revive due to recovery in the western economies,

especially in the USA.

According to CMIE, yarn production is expected to grow by around 7.5% during 2011-13.

Pricing Trend:

Both domestic and international prices of cotton had risen in the past one year due to tight demand supply conditions. Globally cotton

supply was hit by floods in major producing countries like China and Pakistan.

In recent time’s cotton prices in domestic market peaked to record levels. Domestic prices also follow international pricing trends.

Average prices of Shankar 6 (LS) variety increased by almost 110% Y-o-Y basis to `157.60 during February, 2011.

Cotton yarn prices have been firm as well in line with high cotton prices, the raw material for manufacturing yarn. Prices of cotton

yarn cone (40S) touched `219.30 in the same month, a 37% Y-o-Y growth.

Source: CMIE

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1000

1500

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3000

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2005-06 2006-07 2007-08 2008-09 2009-10 2010-2011

Cotton Yarn Production(000' tonnes) Growth rate(%)

Cotton Yarn Production (000' tonnes) and Growth Rates

(RHS)

April 6, 2011

In the current scenario, with government allowing ex-

port of another 50 million kg of cotton yarn (670 mil-

lion tonnes had been exported till March 31, 2011), the

current yarn prices are not expected to soften in the near

future.

Note: Total export quota was 720 million kg for FY10-

11.

Capacity Additions:

In order to meet the rising demand for yarn, the manu-

facturers of both cotton as well as blended yarn industry

have lined up major capacity additions in next two

years.

According to CMIE, a total capacity of 17.4 lakh spin-

dles is expected to get commissioned during 2011-13 all

over India. Of these, huge capacities are expected to come up in Madhya Pradesh, Andhra Pradesh and Tamil Nadu.

One of the major projects announced in January-February 2011 is that of Alok Industries with an investment of `1000 crore in Sil-

vassa. This will have a capacity of 3.5 lakh spindles.

Export Scenario:

Yarn exports witnessed CAGR of 9.5% during

2005-06 to 2008-09. However, during 2009-10,

exports fell by almost 16%, Y-o-Y basis, due to the

global meltdown. During 2010-11(till December), it

grew by almost 9%.

India is the largest exporter of yarn currently. The

government has a tough task of ensuring raw mate-

rial availability for the domestic fabric manufactur-

ers at reasonable price as well take care of the inter-

est of the yarn exporters.

If government caps cotton yarn exports in order to

control the domestic price, it hits the interest of the

exporters. For 2010-11, Government has capped

the yarn exports at 720 million kg.

Industry Issues:

Rising prices of cotton: Cotton is the basic raw material for the cotton yarn industry. India has enjoyed a surplus for a long time;

hence it had a clear advantage on the cost front. However, domestic prices have been high due increased MSP (minimum support

price) as well as high international prices.

India has the advantage of low labour cost. However, the production process in competing countries such as China, Thailand and

Taiwan are highly mechanized. Hence their productivity is considerably higher.

Power cost: It constitutes about 15-20% of the total cost of productions. The cost of power has gone up recently, affecting the

bottom line of the manufacturers.

Labour cost: Labour cost has gone up for the mills. Minimum wages have gone up over `200 as against `110–120 paid earlier.

Wages have gone up from 4 % of costs to 6 % now.

Incentive in cotton exports: Profitability has been badly hit due to the high input cost. This makes raw cotton exports more lucra-

tive, hassle free with less investment.

Source:CMIE

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1000

2005-06 2006-07 2007-08 2008-09 2009-10 2010-11*

Cotton and Blended Yarn Exports(000' tonnes) Y-o-Y Growth(%)

Yarn exports (000' tonnes) and Growth Rates

(RHS)

Source:CMIE

April 6, 2011 April 6, 2011

Profitability and Outlook:

Companies in the cotton and blended yarn industry have been

delivering improved performance since Q3FY09. Even if the in-

dustry has been hit due to high raw material prices, the bottom

line have been improving on quarterly basis due to healthy rise in

volumes. In some cases, the yarn manufacturers are able to pass

on the hike to the consumers (fabric manufacturers).

But the sector is still very unorganized and lacks economies of

scale. In spite of government initiatives, especially in the form of

TUFS, the industry still remains fragmented. The sector remains

highly vulnerable to external shocks, such as international prices

and foreign exchange rate movement in future.

Crude Oil: On an Upsurge

Oil firms to lose Rs 174,126 crore on fuel sales in 2011-12: Indian Oil, Bharat Petroleum and Hindustan Petroleum will "at

current international crude oil prices lose Rs 174,126 crore in revenues on selling diesel, domestic LPG and kerosene below their im-

ported cost in 2011-12 fiscal, a government official said. (The Economic Times, April 4, 2011)

PRU Analysis

Crude oil prices touched a 30-month peak, on account of a combination of supply and demand factors. Disruptions from the Middle-

East and OPEC’s plan of not increasing supply until the next meeting, are expected to result in supply constraints. Strong demand from

the US and other emerging economies is likely to drive demand in the coming months.

Rising crude oil prices will adversely affect the public sector oil marketing companies (OMCs) because they sell three sensitive petro-

leum products (diesel, kerosene under PDS & LPG for domestic use) at government-controlled rates. For the financial year 2010-11,

estimated losses of the oil marketing companies (OMCs, such as Indian Oil Corporation, Hindustan Petroleum or Bharat Petroleum)

stand at `78,061 crore, but so far the government has provided only Rs 20,911 crore in compensation.

The oil companies are estimated to lose `1.74 lakh crore on selling fuel at government-controlled rates during the financial year 2011-

10. The three oil companies will currently lose a record `16.76 per litre on diesel, `28.33 a litre on kerosene and `315.86 per 14.2-kg

domestic LPG cylinder, estimate media reports. It is estimated that public sector companies will lose around 68% more than what they

lost when crude oil touched an all-time high in 2008-09. The reason could be the rising consumption of petro-products.

Global rig count rises week on week

Globally too, there is evidence of increasing demand for mineral oils. Baker Hughes Inc reported that the US rig count rose to 1,776

units working, up from 1,465 rigs in the comparable period a year ago. The count is the highest since December 2008, when there were

1,790 rigs working. Statistics for international oil rigs deployed reflects an increase of 28 rigs to 1,189 rigs as at the end of February

2010 compared to January 2010. This is expected to augur well for companies in the offshore oil drilling business.

PRU View

We believe that the surge in international crude oil prices will have a different effect on companies in the petroleum value chain. While

oil exploration companies — ONGC, Oil India, Cairn & HOEC — are expected to do well, those in the downstream sector (OMCs,

Essar Oil & RIL) will record a poor show. Companies in petroleum logistics, including pipeline infrastructure (like GAIL) and offshore

drilling —Aban Offshore, Great Offshore, Punj Lloyd, Mercator Lines & Varun Shipping — are likely to benefit from the rising de-

mand. With rising oil prices, oil companies, too, tend to increase their exploration and development activities.

April 6, 2011

Iron Ore Export Ban Lifted

Karnataka iron ore export ban set to go: SC gives the state two weeks to frame export rules.The Supreme Court on Tuesday gave

the Karnataka government two weeks to put in place new rules for exporting iron ore from the state. The state had banned iron ore exports

last July following allegations of corruption.(Business Standard, April 6, 2011).

PRU Analysis

The Supreme Court has directed the Karnataka government to lift the ban on iron ore exports from April 20, 2011. The court has granted

15 days to the government to create the required infrastructure in order to check illegal mining in the state.

It can be mentioned here that earlier during July, 2010 iron ore exports were banned to check illegal mining activities in the state.

India is the third largest exporter of iron ore. It shipped around 117.37 million tonnes of this steel making raw material in 2009-10. How-

ever, after the ban was imposed in July last year, export come down to 75.11 million tonne in 2010-11 (April-January period). It witnessed

a decline of 18% Y-o-Y basis.

Karnataka is a one of the leading producer of iron ore with average annual production of 30 million tonnes per annum. Most of it gets ex-

ported and exports to China account for about 95%.

The ban however won’t be able to boost the export of

iron ore in future. Indian iron ore has become uncom-

petitive in the world market after a 20% export duty

was imposed in the recent budget. Subsequently, an

increase in railway freights have affected exports as

well.

Price of Indian iron ore is quoted at $160 a tonne right

now, compared to $180 a tonne for ore from China.

Recently iron ore prices have been very volatile in the

international market. With export duty of 20%, Indian

ore becomes uncompetitive at $192 per tonne.

India’s largest private sector exporter, Sesa Goa, will

benefit the most from this move. Exports from Karna-

taka accounts for over 10% of its total exports. The

company reported a 26 % drop in ore exports at

700,000 tonnes for FY10-11 from Karnataka, com-

pared to the corresponding period in the previous year .

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Production(million tonnes) Exports(%)of Production

Iron ore production and export movment in India

(RHS)

April 6, 2011

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