Indian power traders face risk-reward imbalance

Increasing business risks and improving net margins are getting them confused.

Fitch Ratings, in a special report, says that increasing business risks and slightly improving net margins are leading to a risk-reward imbalance for Indian power traders.

"The agency expects larger traders to face low business risk due to economies of scale, higher bargaining power due to the presence of multiple contracts with a single state power utility (SPU) and a more diversified customer base compared with smaller traders", says Salil Garg, Director in Fitch's Asia Pacific Utilities team.

Key concerns include deterioration in the financial health of SPUs, an increase in rebate income, big buyer risk, delay/default in payment by SPUs, price risk and competition in margins. Delay in receipt of payment by PTC India Limited ('Fitch A1+(ind)') from SPUs in Tamil Nadu is a case in point.

The financial health of SPUs, the major customers of power traders, has deteriorated with aggregate annual book losses widening to INR295bn in FY10 from INR70bn in FY06, leading to an increase in the counterparty risk. Rebate income for power traders also increased substantially over FY10-FY11 to an average of 20% of gross margins (trading margins + net rebate income), highlighting liquidity constraints for SPUs. This is because buyers could not avail the 2% discount offered by power traders despite this being an economically attractive option.

"Despite Central Electricity Regulatory Commission freeing long-term contracts from margin cap and raising the margin to INR0.07 per unit on short-term contracts in FY10, competition for volumes has led to lower-than-expected improvement in margins, with small traders reducing their trading margins to INR0.01-INR0.02 per unit in some instances", says Mr Garg.

Fitch also notes that the biggest short-term buyers (SPUs in Tamil Nadu and Rajasthan) face huge energy deficits with the largest cash losses on a revenue and subsidy-realised basis. Hence, these states will remain net-buyers on short-term power markets and continue to act as major counterparties for power traders. This increases the risk for undiversified power traders significantly.

Traders with strong equity base and high cash balance are better placed as they have the buffer to absorb any increase in the working capital cycle in the event of delays or defaults by SPUs. The presence of a strong parent across the power value chain also lowers counterparty risk as the parent can act as both a buyer and seller for the trader. Over the past four years, the top five trading licensees have controlled over 80% of the market in terms of volumes.

"The dominance of the bigger power traders should continue by virtue of their first-mover advantage or being the preferred trader of parent companies that are expanding their generation portfolios aggressively" says Vivek Jain, Analyst in Fitch's Asia Pacific Utilities team.

Taking cognizance of the risk-reward equation, Fitch revised Tata Power Trading Company Limited's Outlook to Stable from Positive and affirmed its National Long-Term rating at 'Fitch BBB+(ind)'.