Fundamental issues need to be addressed first for India’s second phase of power sector reforms to fully deliver. That’s according to a report titled, “Why India’s Power Utilities Need UDAY 0.0 Before 2.0,” that S&P Global Ratings published recently.
The government is likely to announce the second phase of power reforms under its Ujwal Discom Assurance Yojana (UDAY) soon. UDAY 2.0 will follow up on the government’s initiatives under UDAY 1.0 launched in 2015.
“Unless the systemic risks stemming from ailing state-owned power distribution companies are resolved, the efficacy of Uday 2.0 may be a tall order,” said S&P Global Ratings credit analyst Abhishek Dangra. “Discoms’ weak financial health and payment delays will continue to weigh on the credit profile of Indian power companies.”
Long-term fixed-price PPAs with must-run status of renewables and merit order dispatch remain a key credit strength for power companies, providing strong revenue visibility.
In the past few weeks, discoms under the new state government of Andhra Pradesh have attempted to renegotiate executed contracts, questioning the “must-run” status of renewables and resorting to curtailment in order to avoid paying under the power purchase agreements (PPAs). This puts the fundamental long-standing credit protections for the power sector at risk.
Long-term fixed-price PPAs with must-run status of renewables and merit order dispatch remain a key credit strength for power companies, providing strong revenue visibility. A must-run status guarantees dispatch on generation, barring grid stability issues. Such PPAs have helped offset the drag on power companies’ working capital due to payment delays from Discoms–an industry norm.
“We believe it is imperative for the power sector to honor the executed contracts before embarking on new ambitious plans targeting structural reforms,” said Dangra. “In the past, PPA contracts have largely remained insulated to political changes. Exposure to political risk leading to contract renegotiation can entirely defeat the purpose of fixed-price long-term contracts if states can reopen contracts at will.”
Letters of credit can provide additional protection but not replace the inherent risk of delayed payments.
Although the issue of renegotiation of executed contracts is still under judicial consideration, we expect contracts to be ultimately upheld. However, the issue will accentuate working capital pressure for power companies due to nonpayment of dues and create uncertainty on their future cash flows, until it is fully resolved.
Contractual breaches can erode investor and funding confidence at a time when banks are only lending selectively. Also, cash flow visibility will be lost and project finance, which relies solely on contractual and documentary framework, could be choked. Investors and corporates with deep pockets may be able to tide it out but not without scars.
India’s power sector issues are not new or unknown. Letters of credit can provide additional protection but not replace the inherent risk of delayed payments. We believe privatizing discoms can be a viable solution–provided the government (including state governments) sticks to meeting all contractual terms and conditions.
