APTEL says no to compensatory tariff for Tata, Adani Power

The Appellate Tribunal for Electricity (APTEL) today struck down a 2014 order by the Central Electricity Regulatory Commission (CERC) that granted compensatory tariff or Tata Power and Adani Power, holding that the central regulator did not have the power to allow for it.Both Tata Power and Adani Power stocks tanked 4.28 percent and 3.07 percent respectively post the news flash.  The CERC had in February 2014 ruled that Tata and Adani will be allowed to increase tariffs temporarily to compensate for additional fuel costs that they were incurring due to expensive coal imports in their plants in Mundra, Gujarat.SL Rao, former chairman of CERC says that the decision of compensatory tariff was not well thought. Rao further says that Adani might have to shut down power plan if no solution is derived to cover the company’s losses. The news is a rude shock for both companies, says Murtuza Arsiwalla of Kotak Institutional Equities, adding that stocks were already pricing in the order. Benefit of Rs 15-20 per share was expected from CERC order, which now reversed, will weigh on the stock price.Arsiwalla expects Rs 50-60 crore loss for Tata Power post the decision. Harshvardhan Dole, Vice President at Institutional Equities, IIFL says that APTEL had clarified that tests will be conducted to know the basis on which compensatory tariff was allowed for Tata and Adani.The news will hit Adani Power hard as the company is accounting for Rs 500 crore per quarter due to the compensatory tariff, Dole says. The fundamental issue, Dole, say is whether CERC or any other institution has the right to grant compensatory tariff on any ground. More clarity on the issue is needed, he adds. Both analysts say the companies are likely to approach the Supreme Court for a review of the order.However, in an interview to CNBC-TV18, Anil Sardana, MD of Tata Power says that the while APTEL has struck down the compensatory tariff under Section 79 (in relation to CERC’s powers), it has accepted it under Force Majeure.Below is the transcript of Murtuza Arsiwalla, Harshvardhan Dole and SL Rao’s interview with Ekta Batra and Anuj Singhal on CNBC-TV18.Ekta: Your first reaction. It is a disappointment that Adani Power is in fact down 6.5 percent as we speak and Tata Power in the red as well.Arsiwalla: Given that CERC and the various sub-committees that had been formed had ruled in favour of a compensatory tariff in the form of public interest. The news and given that how necessary it was to maintain the profitability or the financials of both Adani and Tata Power, this comes as a bit of a rude shock. The stock price was pricing in a favourable order from the Appellate Tribunal For Electricity (APTEL) and definitely, this comes as a shock for the investors.Anuj: So, just to take forward that point, the stock had rallied quite a bit and as you said, it had actually factored in a positive decision. Now that it has gone against them, what kind of derating can we expect? Arsiwalla: The benefit of this order would have been of the level of almost Rs 15-20 per share. Some of it built in, not all of it built in. So, there was some in between, so you could easily see the stock go down below Rs 60 comfortably. Of course, you would rule that both Tata and Adani would appeal in the Supreme Court against the order of the APTEL given that that is the last level of the judiciary. But definitely, not one that would go down well for both these companies.Ekta: So, it is not a shut case. We expect Tata Power as well as Adani Power to appeal to the Supreme Court.Arsiwalla: Yes.Ekta: As per what we have, in Q3, FY16, there was a loss of around Rs 157 crore for the Mundra Ultra Mega Power Plant (UMPP) for Tata Power. So, as things stand, that kind of quarterly loss should continue. There should not be any sort of change in estimates is it is status quo.Arsiwalla: If you look at Tata Power’s case, they are actually not accounting for the compensatory tariff, they were adopting more conservative policy. As far as the loss number of Rs 157 crore that you quoted for Q3, that they did include an element of one-time non-recurring provision. So, the number, the recurring loss number would be around Rs 60-70 crore. What had happened over the period of this time, where the compensatory order was asked for is that coal prices have continued to trend weak and if one were to recollect, the first time that the Central Electricity Regulatory Commission (CERC) ruled in favour of a compensatory tariff, the requirement was more about Rs 0.60 per unit in the case of Mundra which has already come down to about Rs 0.30 per unit. So, the weak coal prices had already diluted the need for the compensatory tariff.Nonetheless, yes there is a loss of about Rs 60-70 crore still on a quarterly basis.Ekta: Your first reaction to both Tata Power and Adani and what would you recommend to your clients given this news?Dole: There is no denying that it has come as a rude shock, but the manner in which proceedings were being conducted at APTEL, it was quite clear that they were always going to test the basis on which CERC has awarded the compensatory tariff. And mind you, if you read the CERC’s order in detail, it had categorically said that they are not in favour of renegotiating the power purchase agreements (PPA). They do not want the contractual terms to be challenged because if those do not hold the test of the law, they had granted the compensatory tariff only considering the socialist angle in that that there is a power plant ready and in case 8,000 megawatts of capacity goes offline, it will have a serious impact on the end consumer tariff as well as the overall grid security.Anisha: It seems like it is going to be a bigger negative for Adani Power given the fact that they were already booking revenue basis their compensatory tariff. And that is my question. Do they now think that now they will have to write off the revenues that they have booked, because Adani Power in case has been booking revenues inclusive of the compensatory tariff for all its different power plants, so would they now need to write that off?Dole: Frankly, my reading is they will firstly analyse the APTEL’s order and based on their auditor’s recommendation, they will take a call. But, to me, since there is always a provision for them to go and appeal in the Supreme Court, there may not be a need for them to immediately write off or do accounting adjustments to the profits that they have already booked on account of compensatory tariff. But of course, that is the decision that the management will have to take. Prima facie, I see no reason for them to immediately reverse back.Anuj: Adani Power is now down 10 percent and that is clearly the one where there is bigger negative. How much more do you think the stocks need to de-rate from here on? Of course, we will take it forward when the companies appeal in Supreme Court, but in the interim, how much more de-rating do you think could be there?Dole: Frankly, the stock valuations are building at a point in time, that eventually this issue will get resolved and the stock will eventually trade on the normalised earnings which is the implicit assumption built into some of these consensus numbers and even therefore, the valuation of Adani Power. Assuming theoretically that the compensatory tariff does not come through, there is a huge downside even from here on for the stock. It could still continue to trade at even perhaps half the valuations what it is currently trading at.Anuj: How did you read this order because the interim order was in the favour of the companies and the final order today goes against them?Rao: Let us look at this in two different steps. The first part of this is that the UMPP project policy brings in imported coal was unfortunately not sufficiently well thought of because it should have provided for the price of the coal coming from a foreign country being governed by that local government’s rules. They did not take that into account. Indonesian government raised the coal price and therefore the price of coal, even though it belonged to coal mines of Tata, still went beyond the price that is provided in the tariff. One result of that for Tata for the last two years is that every unit of power that Mundra sold was sold at a loss and that in fact, affected Tata Power’s, as a whole, share prices quite badly. So, I think that is something to remember.Now, since the PPA does not provide for a rise in the price of this coal, the state governments that are part of the PPA are saying that you cannot change the agreement now that you have signed it. And if you are losing money, that is your problem. It is not our problem. Now, that of course is one point of view, but the fact remains that there is large sums of money that are being lost by Tata. Adani was not very clever in factoring that price increase straight away and providing the account, that is not a very clever thing to do. Tata did not do that.But the fact remains that they are both badly affected, that we cannot allow this to go on. Therefore, there are only three ways this can be done. One, the law itself has to change. Given this parliament, I do not see the law being changed. The second is for the Supreme Court to step into it and say that something has to be done to compensate Tata Power and even Adani Power. The third thing is to leave it as it is. If they leave it as it is then Adani will have to shut down. They cannot continue producing power at a loss. Even Tata has a serious problem. To the extent that they are able to mix low price domestic coal with other low price domestic coal because international coal prices have come down, that might help them. So, they have to look at ways like that. Ekta: We have some statements which have come in where the judge has said that a change in Indonesian coal regulation does not amount to a change in law. However, it can be considered under force majeure and appropriate relief to be provided to companies as per the PPA. If you had to break that statement down for us, what would it mean?Rao: What it does mean is that, as I said, the PPA is between the company that is Tata or Adani and the state governments. Now, there is an agreement. They have both signed it, they have both committed to a price. You cannot break an agreement just like that. That is the first point to remember. The only way in which an agreement can be broken is if there is a force majeure. A force majeure is an external event and over which nobody has any control. Government has no control, the company has no control, the state government that buys the power has not control. It is an external even in which case you can put the force majeure clause and ask for a change.Now, the fact that this has not happened for the last two years, that suggests that the CERC has not been very clear on whether the force majeure clause can be applied. But, it is one way out for these companies to go to the Supreme Court now and say we went in good faith, we put in USD one billion to buy coal mines in Indonesia to guarantee us the coal for the power plant that we were going to make electricity, for which we entered the PPAs, but the Indonesian government has raised the price. None of us have any control on that, so that compensation should be given to the extent of the increase. That is exactly what is being said in this APTEL thing.Now, whether the Supreme Court accepts that or not is a different matter. I expect that they will have to find some way because we are talking about our investments running in the region of what it is now, Rs 20,000-30,000 crore per power plant. We are talking about really adding a lot of power, 4,000 megawatts.Also remember, another thing is that in the last two years, while Indonesian government may raise the prices, international prices of coal have dropped very sharply. Price of coal in India have also dropped sharply. Availability of coal in India has also increased. So, if Adani and Tata have any sense, they should be getting coal from these other sources as well, mixing it with whatever coal they get from Indonesia. And sell that Indonesian coal at those higher prices to Indonesian buyers.