Coal Reforms – Impact On The Indian Economy & Stock Markets

This is a very big reform which has gone un-noticed given the macro implications & positive impact on quite a few companies in the listed universe.  We are surprised ! 

It is as big as discovery of a large oil block! Or opening say aviation sector for the very first time. In oil & gas we are not even 1% in production & reserves. In coal we are 9% plus in both production & reserves of coal, yet it doesn’t get the attention it deserves.

What Exactly Are These Coal Reforms ?

Ordinance Link – https://pib.gov.in/newsite/PrintRelease.aspx?relid=197375

1. For existing power plants with no FSA – availability of domestic coal goes up. It’s a seamless transfer of mines, no EC, FC required. You start the operations on day one.
2. Commercial mining is allowed – New players can come in. Scope for FDI if the size of the blocks is good enough. Big ticket investments are likely to flow in. India is the only country where coal production is likely to double over the next decade. India is the second largest importer of coal globally. We are withdrawing from global markets will have impact on coal pricing. It is in the interest of global players to be present in India.

Finally, we will have a formidable competition to coal India. 90% of Indian coal supply is dependent on Coal India. Coal India is already the largest coal miner in the world. It affects efficiencies. It is very difficult for them to step up the production on this base & to meet our requirement. China has 20 large coal miners, and the largest miner is just 8-9% of the demand. We need private players in this space.

It’s a much needed reform !

What Does It Mean To The Indian Economy ?

Two Large First order effects – 

1] Import Substitution –

We import 235 MT coal. Almost 120 MT is substitutable. That will save you at least 1 lakh crores of forex outgo as we move forward. Which means you create more space on the trade deficit side. It will have a multiplier effect on the domestic economy as well, especially states like Jharkhand, Chattisgarh where 10% state govt revenue comes from coal related taxes. On top of it you will have big ticket FDI coming in along with better mechanization & boost to local manufacturing.

2] Discoms –

Our discoms ( power distribution companies ) are in a miserable state, as we speak they owe ~80000 crores to power producers. And almost 55000 crores is due since last 6 months or more. Now, when you replace domestic coal with imported coal, the cost goes down substantially. For imported coal, the variable cost is in the range of 2.5 to 3 rs per / kwh, and for domestic coal it is 1.5 rs, and for captive coal it is even less…so the mix of cheaper power in the overall system goes up. On a blended basis, the cost can improve by 50–70 paisa per unit as we go forward. To my mind, discoms are not going to pass on these benefits to the consumer.

We produce ~1200 billion units of power as on date & that will move towards say ~1500 billon units. Savings of even 30 paisa per unit is enough to wipe out losses of discoms across India ( FY 19 loss of Discoms was around 27000 crores ). Also, the transmission & distribution losses are coming down from 21% 3 years back to 18%. Discoms may turn profitable as we move forward. Which means they will be able to pay power generation companies on time, do more PPA’s & so on. And it impacts the power sector positively.

Isn’t There A Slowdown In Power Demand Off Late ? Is This A Cause Of Concern ?

Almost 50-52% power consumption happens in top 15-16 cities. 17% of power is consumed in agriculture & related areas. Plus there is diesel genset capacity of more than 50 GW in the system. So a drop in the power demand is not merely a function of slowdown in manufacturing alone. Yes, part of it can be attributed to manufacturing slowdown. But we should not forget the prolonged monsoon & inability of discoms to buy power has impacted the demand in the short run.

So its more of a cyclical drop, and not a cause of concern.

Electricity is superior good. As per capita incomes move up, the consumption should move up. Just look at the human development index & our power consumption, we are at 1000 units per household, vs global peers. China is north of 5000 units.

Keep in mind the EESL / LED bulb implementation we had over the last 2-3 years. This one scheme alone has reduced power consumption by 7-8 GW ! That’s 1 full year of our power demand growth, which has delayed power sector recovery by a year. Today India’s peak power demand is at 175 GW, it could have been 185 GW. Power demand is growing by 6-7% even after adjusting for 1-2% transmission & distribution efficiencies, which is a very good number. Now when you extend this trend for next 3-4 years, then we are going to run out of thermal capacity. And renewables cannot support the peak load, as most of the peak load comes after 6-7 PM ! So unless some magic happens on the power storage side, we are likely to face a supply issue. And that opens lot of investment opportunities.

What Are The Investment Opportunities / Themes That May Do Well Due To These Changes ?

For now it’s a play on power generation & coal production moving up. The Capex play on thermal power plants side may be some time away.

PSU Banks –  

Almost 25 GW capacity is under stress. Banks have already provided for most of the part, and they may not have to provide more. There were no takers for power assets as were no FSA’s & PPA’s. Now both issues are likely to get traction. So, the value of these assets has just gone up ! If the deals were happening at 3 cr per MW, now they are likely to happen at a higher price. Consolidation or resolution in the power sector is likely to be very quick since the demand visibility & coal availability factor has improved. These assets can be lapped up pretty fast which will help PSU banks which have lent to stranded power assets.

Power Stocks –

As distribution companies health gets better & demand continues to grow at 5-6%, the payment cycle & PLF’s for power plants should increase. Which means their ROE’s should show improvement. And perhaps these stocks can start trading at utility like valuations. These assets take a long time to come up, and large sums of upfront capital investment is required which acts as an entry barrier. An operational power asset has very high terminal values. Once you get decent ROE’s, the valuation re-rating can be substantial.

Coal Miners, Coal mining equipment players, underground mining etc. – Only 6-7% of India’s coal comes from underground mining. Big scope there.

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