Why power utility stocks are likely to underperform going forward

Impact on JSW Energy, Torrent Power the highest due to sharp rise in fuel costs

The spike in the prices of fossil fuels will obviously impact energy-intensive industries. Thermal power generators and by extension, power utilities could be placed under pressure for instance. But this is a complex value-chain and understanding the impact of higher fuel prices means delving into different categories of pricing models.

Power tariffs are largely controlled, and in some cases, utilities may lack the ability to pass on escalating costs to many of their consumers. However, power producers could perhaps receive higher realisations from merchant power sales since those rates have been running higher recently.

Assuming the economy continues to recover, rising power demand could lead to stronger sustainable demand for merchant power at higher rates. The 2021-22 power consumption is thus far running at 5 per cent above pre-covid levels. But receivables from discoms are extremely elevated, at around 50 per cent higher than in Feb 2020 with receivables at around Rs 1.07 trillion (Feb 2022).  

Domestic natural gas prices are reset every six months according to a formula that takes international prices into account. Natural gas (domestic or imported) will probably be unviable for power generators, given that the cost of domestic gas is likely to rise by at least 65-70 per cent in April when the pricing formula is applied.

Coal prices are controlled under fuel supply agreements (FSA) and coal is also auctioned online by Coal India, which has consistently received high premiums in auctions (over 100 per cent in many instances) over the controlled prices in the last five months. Coal India therefore stands to gain substantially if it can produce enough coal to be sold online via the auction process where it will continue to generate strong premiums over FSA.

Two major utilities, the PSU NTPC and CESC are both insulated from changes in coal prices, despite high exposures to thermal generation. They have a combination of FSAs and pass-through coal price supply agreements in their PPA (Power Purchase Agreements). But this protection may also restrict their ability to profit from higher merchant power prices. Another non-generating utility such as Power Grid (PGCIL) uses a return on equity pricing model which means PGCIL is indifferent to coal prices.

Tata Power could be a beneficiary net-net but there may not be too much upside. Tata Power owns Indonesian coal mines which will give higher realisations. But its Ultra-Mega Power Project uses imported coal and makes losses at these prices and may need to be shut down – it is only operating at 20 per cent plant load factor.  

JSW Energy has around 66 per cent of its 3.2GW thermal capacity fuelled by imported coal and of this, some 600MW lacks PPAs. The current prices could force a shutdown for that capacity. Merchant power prices will be crucial.

Torrent Power has 2.7GW based on imported LNG of which 1.3GW which is roughly 50 per cent is without PPA. Also its 278MW PPA for Unosugen has a tariff cap of Rs 5.6/kWh (which is profitable only at gas prices of $8-9/mmbtu). Current gas prices are at above $22 so there’s a problem.

The Nifty Energy Index has comfortably outperformed the Nifty 50 scoring 35 per cent in the last 12 months versus the Nifty’s 16.5 per cent. It has also beaten the Nifty in the last month, scoring 2.4 per cent while the market benchmark has fallen 1.4 per cent. However the power utilities in the Energy index have lost ground with Tata Power, NTPC, Adani Green all giving negative returns in the last month.