Managing Fuel Supply & Price Uncertainty

Sushil Maroo

August 1, 2014

• Increasing installed capacity and improving utilization factor of power plants is critical for meeting the rising energy needs of a fast growing nation

• Fuel Security is paramount to the stability and growth of the power sector

• Emergence of fuel shortages and escalating fuel costs has posed the most significant challenge to Industry, Regulators, Governments and Banks since the introduction of the Electricity Act in 2003

• Addressing fuel security is the need of the hour for the return of confidence and capital to the Power sector

• This requires a joint effort from all constituents to offer short term, medium term and long term solutions to the power sector fuel crisis

2

Improved fuel availability is paramount for boosting power generation

Affordable power is linked to risk mitigation for stakeholders and increased generation

• Companies, Lenders and other financial investors today look at Power as a sector fraught with risks – Coal “Scam” and potential cancellation of coal blocks – Delays in environmental approvals and land acquisition affecting project implementation, costs and

adherence to PPA ‘s – Poor financial condition of SEB’s and payment issues – Change of goal post after project implementation has commenced based on stated Govt policy – e.g.

. – Sale of Power from plants with captive blocks

• These stakeholders price in this risk affecting consumer end power prices – Lenders charge commercial rates of interest – ranging from 12-14% - across the world infrastructure

financing happens at rates well below normal corporate lending rates

– Equity return expectations of financial investors are comparable to stock market returns – globally , risk averse, yield oriented investors help finance infrastructure assets at significant discounts to equity market returns

– Companies price in risks of project delays, cost overruns and SEB defaults while bidding for PPA’s – Removal of uncertainties will enable bidding at moderate ROE and competitive tariffs

3

Coal Supply

India has the 5th largest coal reserves globally

Source: CMPDI

Power is coal industry’s major customer

India has substantial resources of coal and power sector is the largest consumer

5

1,25,908.94,

42%

1,42,506.29,

47%

33,149.22, 11%

Proved Indicated Inferred

Proved, indicated and inferred Coal Resources in Million Tonnes(as on 1.4.2014)

69%

7%

4%

3%

17%

Power (utility & captive) Steel and Washery Cement Sponge Iron

Others

Sector wise consumption/supply of coal for 2011-12(Total – 680.6 million tonnes)

6

Demand has outstripped pace of coal production

Coal Production vs Consumption (in Mn Tonnes)

Source: Coal Controller

Demand for coal reached 557 MT in 2012 with imports rising to 68.89 MT to meet domestic shortages

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-120

100

200

300

400

500

600

Production Consumption

Net imports

Solution # 1: Boost Coal India output

Source: Annual Report of CIL FY 2012-13

Accounting for 86% of coal production, improving productivity of CIL’s operating mines is the low hanging fruit

FY 07-08 FY 08-09 FY 09-10 FY 10-11 FY 11-12 FY 12-13

86%

88%84%

80%82%

86%

372

400415 423

433

466

Mill

ion

To

nn

es

7

Solution # 2: Boost captive coal production

8

Captive Mines Production

2008 2009 2010 2011 2012 2013 2014 2015e 2016e 2017e0

20

40

60

80

100

120

37

44

50 50 52 5249

59

78

98

mt

Source: Company Data, Morgan Stanley Research Estimates

Solution # 3 Linkages to Commissioned plants

9

• Fuel starved power projects have large

investments which need to be salvaged

⁻ Create Enabling framework for coal supply under FSA

⁻ Allow PPA under Section 62

⁻ Do away with predetermined project lists

⁻ Rationalization of coal linkages

⁻ Allow Inter Plant transfer of coal among all companies

⁻ Revisit blended coal price pooling

Capacity (MW) Investment (Rs cr)0

20000

40000

60000

80000

100000

120000

140000

160000

180000

39038

157730

25843

105490

10305

29895

Under recovery of fixed/ variable costProjects with coal linkage related issuesProjects with captive coal block related issues

Capacity and Investment Stuck

Solution # 4 - Open up mining

• Auction out mines without end use restrictions

• Allow entry of private sector and international players to create efficiencies, competition and boost supply

• The world’s largest producers of mineral resources have all created efficient world scale mining assets and companies by encouraging competition and commercial mining – USA – Australia – Canada – South Africa – Indonesia

10

Solution # 5 - Logistics Infrastructure

17% of the power demand located near the pit head and the remaining 83% depends on rail transportation. However, current rail network is highly choked.

• Dedicated Freight Corridors

• Critical rail connectivity links for evacuation from large coal fields/ clusters

• New ports and upgradation of ports including draft increase

• Infrastructure needs to be build to cater to transportation and installation of increased plant unit

11

Solution # 6 - Rational land policy and faster clearances

• Land:– Address major issues such as lack of land records, compensation, R & R process , right of

way

• MOEF Clearance:– Single-window clearance and cluster approval for mines – Standard ToR for OC and UG mines should be circulated by MoEF.– Dispensation of public hearing in case of projects having only forest land.

• Forest Clearance:– Coal Companies insist for NOC from State Forest Authority even when no forest land is

involved for the project.

12

Solution # 7 - Imports to meet the shortfall

• India’s imports of coal have been rising sharply due to failure to boost local production

• Focus on domestic coal for all requirements should be target – India has adequate coal resources– Imported coal is costly – Drain on foreign exchange reserves

• In medium term, fiscal, tariff and other regulatory support important to allow imported coal to meet gap

13

2011-12 2012-13 2013-140

20

40

60

80

100

120

140

160

180

119.834710743802

145

171

Coal Imports(MT)

Imports are rising and will continue to rise as domestic output falters and imported coal becomes cheaper

Coal Cost

Coal price trends are mixed

15

May

201

1

Augus

t 201

1

Novem

ber 2

011

Febru

ary

2012

May

201

2

Augus

t 201

2

Novem

ber 2

012

Febru

ary

2013

May

201

3

Augus

t 201

3

Novem

ber 2

013

Febru

ary

2014

May

201

460.00

80.00

100.00

120.00

Indonesia Coal (US$/MT)

117

73

• Steadily rising linkage prices rising and higher e-auction allocations (c 10-12 %) are increasing effective prices for several consumers

• Imported coal prices softening but rupee depreciation has limited gains

• Rising fuel costs have hurt producers though aggressive PPA bidding has been a key factor contributing to the pain

2007 2009 2011 2012 20140

200

400

600

800

1000

1200

1400

1600

1800

2000CIL Linkage Price (Rs/Tonne)

38%

Fuel costs are getting factored into long term power prices despite some stress on old fixed tariff PPA’s

16

Rs/k

wh

Source: CERC and others

Coal availability and not cost is key risk to industry

Old PPA Terms Recent PPA terms

Tariff • Bidding capacity and variable charge to cover capital costs and fuel costs

• Bidding only on capacity charge with fuel cost a pass through

Fuel • Fuel risk primarily with power company with option available to de-risk partially by quoting escalable tariff

• Fuel risk with the Buyer.

Change in laws • Change in laws in sourcing countries for fuel or equipment not accepted in PPAs

• Impact of change in laws in countries exporting equipment and fuel covered

17

Fuel cost risk will reduce going forward

Fuel cost de-risked under new pass through regime

Gas Supply & Pricing

Gas based power faces an existential crisis

• Gas based power at market price of gas is uncompetitive with coal

• A sharp decline in domestic production and prioritization for fertilizer industry has further aggravated the viability issues

• With a low carbon footprint, limited social issues and coal shortages, gas based power is important to meet energy needs

• Focus on protecting standing gas based capacity critical

19

Gas@ 8.4 USD

Gas@ 14 USD

Captive coal

Linkage Coal

E auction0

1

2

3

4

5

6

7

8

Variable Cost of Power Generation (Rs/ Kwh)

2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

2

4

6

8

10

12

14

16

18Asia LNG Prices (US$ /mmbtu)

24,000 MW gas based capacity is at risk

20

• Gas supply for existing capacity of 16,624 MW is sufficient to operate at only c 20% PLF

• Under commissioning projects of 7,525 MW, completely stranded without any gas allocation/ supply and have no PPA

• Investment of over Rs. 1.2 lakh Crores and debt of Rs. 85k Crore at risk

Grid Non-Grid Upcoming0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

5624

738 0

4,447

1,075976

6551

528

6549

Central State Private

Gas Based Capacity (MW)

Solution # 1 - Improved domestic output and LNG facilities key to supply boost

• Restoration / improvement of KG6 supply

• Increase allocation of gas to power sector. Currently, Fertilizer sector is using approx. 30% gas while power is using 31% gas.

• Continued availability of domestic gas at reasonable price – US$5-6/MMBTU

• Improvement from other domestic sources like conventional fields, CBM etc

• World class LNG terminals to boost imported gas facilities …

21

Solution # 2 - Blended costing of fuel

• Pool pricing of power by SEB / utility to provide steady ROE for all

• Blending domestic gas with costly LNG

22

Global Scenario

US Shale production is set to rise exponentially

24

2007 2008 2009 2010 2011 20120

2000

4000

6000

8000

10000

12000

U.S. Shale Production (BCF)

Source : US Energy Information Administration

• Shale gas production to grow by more than 10 Tcf, from 9.7 Tcf in 2012 to 19.8 Tcf in 2040

• US to transition from being a net importer of 1.5 Tcf of natural gas in 2012 to a net exporter of 5.8 Tcf in 2040

25

Shale is chancing US and global energy landscape

Source: BP Statistical Review June 2014

1990 1995 2000 2005 2010 2012 20130

20

40

60

80

100

US Energy Production (%age)

Liquids Natural Gas Coal

Nuclear Energy Hydroelectricity Renewables

• Contribution of Natural Gas has increased drastically from 28% in 1990 to 33% in 2013 while dependency on Coal reduced from 34% to 27%

• US energy production as a share of consumption declined substantially to ~69% in 2005 before rising back to ~83% in 2013.

1990 1995 2000 2005 2010 20130

20

40

60

80

100

US Energy Consumption (%age)

Europe’s and Eurasia thrust on renewables putting pressure on fossil fuels

26

1990 1995 2000 2005 2010 20130.0

20.0

40.0

60.0

80.0

100.0

Consumption Pattern (%age)

Liquids Natural Gas Coal Nuclear Energy Hydroelectricity Renewables

• Demand for fossil fuels decline by 16% with losses in oil (-22%) and coal (-36%) overwhelming gains in natural gas (+9%).

• Fossil fuels now account for 80% of EU energy consumption in 2013, down from 88% in 1990

1990 1995 2000 2005 2010 20130.0

20.0

40.0

60.0

80.0

100.0

Production Pattern (%age)

Liquids Natural Gas Coal

Nuclear Energy Hydroelectricity Renewables

• Production of Energy increased by merely 1% in 2013 over 1990

• Production of coal declined by 37%

China and India will be focal point of Energy

27

1990 2000 2010 2013 2015 2020 2025 2030 20350%

20%

40%

60%

80%

100%

120%

Production as Share of Consumption (%age)

India China

• India’s and China’s dependence on import of Liquid and Natural Gas continues to grow

₋ India’s consumption to touch ~1307 mt by 2035 against ~595 mt in 2013

₋ China’s consumption to touch ~4671 mt by 2035 against ~2880 mt in 2013

• Production not enough to fuel growth₋ India’s Production to increase by

108% over 2013 by 2035 against 120% increase in consumption

₋ China’s Production to increase by 56% over 2013 by 2035 against 62% increase in consumption

In Conclusion

Make Power sector a low risk, moderate returns sector • Risk mitigation to create a truly infrastructure utility model is key to delivering adequate, low

cost power to India

Measures to address short to medium term fuel issues • Stable policy regime • Easing regulatory and other constraints to boost coal and gas output • Prioritizing supplies to power industry and ready projects • Rational pricing policy for ensuring industry viability without subsidizing the inefficient

The answer to LONG TERM fuel security is a Comprehensive Energy Policy which addresses the following • Do we want to make the best use of India’s vast fuel reserves to become self sufficient? • Do we want to provide fuel at lowest possible cost to generate low cost power for the

country ? • Can we balance the interests of fuel producers, power producers and power consumers to

have a fair pricing regime for the electricity chain?

28