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ICICIdirect | Equity Research

April 01, 2009| Power

Power EVENT UPDATE

Revision of UI guidelines by CERC

The Central Electricity Regulatory Commission (CERC) has notified new unscheduled interchange (UI) rules with the primary objective of rationalising the UI rates and enforcing a better grid discipline. The new guideline is applicable to all generating stations, beneficiaries and other sellers and buyers involved in the transaction from April 1, 2009.

The prescribed guideline is applicable to all the generating stations. However, the stations that are using coal, lignite or gas under the administrative price mechanism (APM) are not entitled to charge UI at a rate higher than Rs 4.08 per Kwh. The earlier limit was Rs 4.06 per Kwh under this regulation.

Under the new regulations, UI charges have been reduced for different frequency levels. The peak UI charges have witnessed a correction of 26.5% from Rs 10.0 per Kwh to Rs 7.35 per Kwh. The regulator has also imposed a cap of 12% of the scheduled volume or 150 MW (whichever is lower) on the volumes traded in the UI market at any given time block.

Impact Short-term rates are expected to take a hit due to reduction in the UI charges negative for players

selling power on merchant basis Jindal Steel & Power, GMR Infrastructure, Lanco Infratech

Volumes are expected to take a dip in the short-term trading market negative for PTC India Diesel generators are expected to turn unviable under the new guidelines negative for Tata Power,

captive power plants

Margins of naphtha-based generators are expected to be negatively impacted negative for GMR Infrastructure, NTPC, Lanco Infratech

Marginally positive for coal, lignite and gas-based generators operating under APM positive for NTPC, Neyveli Lignite

Financial health of ailing SEBs are likely to improve with correction in the UI rates We are factoring in the negative impact on gas-based assets and marginally positive impact on coal-based assets of NTPC. We expect new guidelines to be neutral for NTPC and continue to retain our PERFORMER rating on the stock.

Exhibit 1: Changes in UI rates and UI cap at different frequencies

0

0.75

1.5

2.25

3

3.75

4.5

49.02 49.12 49.22 49.32 49.42 49.52 49.62 49.72 49.82 49.92 50.02 50.12 50.22 50.32 50.42 50.52

Frequency (Hz)

Rs/K

wh

.

Revised UI cap Original UI Cap

Source: CERC, ICICIdirect.com Research

Jitesh Bhanot jitesh.bhanot@icicidirect.com

0

2

4

6

8

10

12

49 49.1 49.2 49.3 49.4 49.5 49.6 49.7 49.8 49.9 50 50.1 50.2 50.3 50.4 50.

Frequency (Hz)

Rs/K

wh

Revised UI charges Original UI charges

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Definition Unscheduled interchange is the difference between the actual generation and the scheduled generation from the generators perspective.

The generators and beneficiaries are required to provide the generation and drawal schedule a day in advance. Any deviation from the scheduled generation and drawal on the day of operation is settled through UI.

Overview of UI mechanism The sector is primarily dominated by generators that are operating under the regulatory framework and are not allowed to profiteer under the regulations. In addition to the regulated returns promised, they are allowed to sell power under the UI mechanism, which enables the companies to earn additional profits. UI charges are to be paid in accordance with the new guideline (Exhibit 1) for over drawal by the buyer or the beneficiary and under injection by the generating station or the seller.

CERC has been deciding the ceiling on UI rates in accordance with the costliest type of generation available. Earlier it was based on diesel-based generators and later on naphtha based generators. Since its inception in 2000, UI charges have been moving at an upward trajectory gradually on account of the rise in fuel prices. Under the recent guidelines they have been reduced on account of reduction in naphtha prices by more than 50% over the past year. With the ceiling of Rs 7.35 per Kwh, we expect the diesel-based generators to turn unviable, thus negatively impacting the volumes in the power market.

Exhibit 2: Movement of UI charges in the past at different frequencies

0

2

4

6

8

10

12

49.02 49.12 49.22 49.32 49.42 49.52 49.62 49.72 49.82 49.92 50.02 50.12 50.22 50.32 50.42 50.52

Frequency (Hz)

Rs/K

wh

.

After 07.01.08 After 26.04.07 After 30.09.04 After 30.01.04 Before 30.01.04

Source: CERC, ICICIdirect.com Research

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Other regulations under new UI guidelines

Limits being imposed on UI volume

A cap has been put on overdrawal or under-injection of electricity by buyers and generators, respectively. When the frequency is below 49.5 Hz, the overdrawal of electricity by a buyer has been capped at 12% of the scheduled drawal or 150 MW, whichever is lower (at any given time block). On a daily aggregate basis, the cap has been put at 3%. Similarly, under-injection from the schedule by a generating station has been capped at 12% at a given time block and at 3% on a daily aggregate basis. Consequence for overdrawal

Overdrawal beyond permissible limits would make the respective entities and the CEO/MD liable for penal action under Sections 142 and 149 of the Electricity Act, 2003. Permissible operating range narrowed

The permissible operating range for the grid has been narrowed by 0.4 Hz. The earlier operating range was 49.0-50.5 Hz; the new operating range has been fixed at 49.2-50.3 Hz. The quality of electricity has been further improved by imposing a narrower range on the frequency.

Penalty on breaching UI limits

In addition to the UI charges that are stipulated in Exhibit 1, an additional UI charge at a rate equivalent to 40% of the UI rate corresponding to the frequency of 49.2 Hz shall be applicable. The peak UI charges including the penalty will increase to Rs 10.3 per Kwh from Rs 7.35 per Kwh at 49.20 Hz.

Exhibit 3: UI charges and penalties

0

2

4

6

8

10

12

49.22 49.32 49.42 49.52 49.62 49.72 49.82 49.92 50.02 50.12 50.22 50.32

Frequency (Hz)

Rs/K

wh

.

Rates including penalty Rates excluding penalty

Source: Company, ICICIdirect.com Research

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Impact of new guidelines

The power market in India is dominated by sellers as the peak deficit (13.8%) is quite high. With the incentive being capped at Rs 7.35 per Kwh, we expect the traded volume to reduce. Volumes are also expected to get adversely impacted due to the cap of 12% of scheduled drawal or 150 MW (whichever is lower) on the maximum overdrawal and 3% on a daily aggregate basis.

In our estimates, nearly 50% of the short-term trades in CY08 have taken place at a price above Rs 7.35 per Kwh. The number of sellers is expected to reduce due to correction in the rates. As a result, the deficit in the system is expected to increase. However, keeping in mind the fact that elections are due in this quarter the impact may be felt with a lag effect.

We also expect the guideline to help in reducing the pressure on the transmission infrastructure, thereby guaranteeing better utilisation of assets by the transmission sector and improving the incentives available to the transmission utilities.

Distribution companies are expected to start procuring the electricity in a more planned manner. Many utilities delay the setting up of a power project and rely on overdrawal from the grid for meeting the consumer demand, which is expected to reduce with the implementation of this guideline. We expect the guidelines to create a positive environment for setting up new power projects for meeting the consumer demand.

Generators

The provisions will have an impact on a wide range of generating stations in the sector. Major generators that will be negatively impacted are private sector players like GMR Infrastructure, Lanco Infratech, Tata Power and Jindal steel & Power as they operate under the short-term power market.

Factoring in the negative impact of the guideline on the gas and naphtha based portfolio and positive impact on the coal-based plants the overall impact on NTPC would be neutral. Gas-based generators that comprise nearly 14% of the total capacity of the company are expected to be negatively impacted. Since the availability of gas under the APM is uncertain, the gas-based portfolio will feel the minor impact of the new guidelines. Rajiv Gandhi CCP (350 MW), which is using liquid fuel will also be impacted due to the new guidelines as naphtha based generators are expected to lose out. However, the UI cap has increased marginally from Rs 4.06 per Kwh to Rs 4.08 per Kwh. It will be marginally positive for all the generating plants of the company.

The impact on Neyveli Lignite will be marginally positive as the UI was capped by the earlier provision, which is relaxed by Rs 0.02 paisa per Kwh.

Power trading market

PTC India will be adversely impacted by the new UI regulations. The power trading market is at a nascent stage and is primarily dominated by short-term trades. Nearly 50% of the volumes, which were witnessed in CY08 in the short-term market, were booked at a rate in excess of Rs 7.35 per Kwh. For PTC, nearly 46% of the total volumes traded in FY08 were coming from short-term trades. In FY09E we are expecting 55% of the total volumes to come from short-term trades. This segment is expected to witness a significant correction in volumes from Q2FY10. We expect the policy to show up on the volumes with a lag effect considering the elections and the summer season in Q1FY10.

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RATING RATIONALE

ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Outperformer, Performer, Hold and Underperformer. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Outperformer (OP): 20% or more; Performer (P): Between 10% and 20%; Hold (H): +10% return; Underperformer (U): -10% or more; Pankaj Pandey Head Research pankaj.pandey@icicidirect.com

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