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Among power utilities, public sector enterprises NTPC Ltd and Power Grid Corp. of India Ltd are viewed as safe investments. The companies work on a regulated business model and did not make oversize bets till now. This strategy by and large helped them avoid the pitfalls their private sector peers encountered and deliver superior stock returns.
But changing market conditions and regulations are testing this thesis, especially for NTPC. After altering the incentive formula to actual utilization instead of power plant availability, regulator Central Electricity Regulatory Commission (CERC) is now proposing to change the fuel costs calculation mechanism. Against the current mechanism of “as fired” basis, CERC stipulates that NTPC calculate the gross calorific value (GCV) of the coal “on arrival” basis.
Through this, the regulator wants to make NTPC accountable for the heat loss if any from the unloading point to the time coal gets fired. If implemented in the new format, the order can raise the company’s electricity production cost as the coal is said to see noticeable loss in GCV in transportation. The order right now does not apply to all plants. But if extrapolated, then NTPC’s earnings estimates may see significant cuts.
The development comes amid a changing power sector landscape. Increasing availability of cheaper electricity in the spot or merchant power markets means states are no longer showing enthusiasm in signing long-term power purchase agreements (PPAs).
In fact, some states are even said to be backing down on high-priced agreements and are meeting their electricity requirements through short-term contracts. These factors are raising questions about NTPC’s ability to recoup its returns from the earlier setback of the change in incentive calculation formula from plant availability to actual utilization method.
According to Edelweiss Securities Ltd, this uncertainty can weigh on the NTPC stock and drive its underperformance vis-à-vis Power Grid, whose earnings are seeing no such risks. Power Grid gained 34% in the last one year, compared to NTPC’s 16%. “The bigger challenge is whether these orders mean that the regulator is incentivizing distribution/transmission vs generation, and if so NTPC’s elusive RoE (return on equity) pick-up may get pushed back,” Edelweiss said in a note.
Of course, this is not to say NTPC is losing its competitive advantage. The order can be appealed. NTPC is still better off when compared with private electricity producers due to its strong financial position and profitable PPAs.
But changing regulations and risk to returns mean NTPC’s earnings lack Power Grid’s certainty. Further the latter’s earnings are seeing positive momentum, thanks to high capacity additions the company is expected to see this year.
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