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Do CERC regulations impact view on NTPC? - Views on News from Equitymaster

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Do CERC regulations impact view on NTPC?

Dec 11, 2013

The power sector regulator Central Electricity Regulatory Commission (CERC) reviews the power tariff regulations every five years. The current regulations end in FY14 i.e. on 31st March 2014. As such, for the five year period starting 1st April 2014, the regulator is working on the new tariff regulations for which it has issued a draft notification.

The stock of NTPC declined sharply yesterday in reaction to the proposed regulations. First of all let us summarize the key aspects of the proposed regulations.

The following are the key changes proposed in the draft:

  • The plant load factor (PLF, which is nothing but capacity utilization rate) has been mentioned as a mode of incentive (Rs 0.5 per unit) as against the plant availability factor (PAF, which is nothing but the maximum time that it can produce electricity over a given period). Normative PLF stands at 85%.
  • NTPC was so far allowed to gross up the tax at the corporate tax rates rather than the actual tax rates (which were lower due to various incentives and benefits). This will no longer be allowed, thereby impacting the profits and thus the returns.
  • Power companies are provided various incentives. One of which is to keep the station heat rates lower. A plant is considered to be more efficient when the heat rate is lower. The same has been reduced to 2,375 kcal/kwh from 2,425 kcal/kwh. This figure is considered quite low, which means that the norms have been tightened to ensure that power generators focus on efficiency.
  • The assured return on equity (RoE) has remained unchanged at 15.5%.
  • For recovering the fixed costs, the minimum required PAF remains unchanged at 85%.
Being a highly regulated industry, investors need to keep in mind that such regulatory risks do remain. However, we believe that the knee jerk reaction of the markets to the draft regulations was completely unwarranted. The final regulations are expected to come out by March 2014.

NTPC's management is of the view that in the past there have been substantial differences between what was proposed and what ended up as the final regulations. As per the management, generation companies are consulted only after the drafts are released. As such, given that NTPC provides one-third of the country's power supply, its views will be given due weightage.

The management added that parameters such as providing incentives on the basis of PLF rather than PAF would not make sense given that the former is pretty much out of a generation company's control as factors such as power demand and fuel supply pretty much drive the generation volumes and therefore the capacity utilisation or PLF.

As regards the tax arbitrage, the management is of the view that the tax benefit that companies get should be treated as an incentive and that it would take up this point with CERC. Not to mention that the financial closures for the future capacities of about 20 GW have been done based on grossing up the taxes. Grossing up of taxes does help NTPC earn ROEs way in excess of the regulated return of 15.5%. However since the government is targeting to bring down the cost of electricity it may insist that NTPC discontinues the practice of grossing up taxes.

As regards the point relating to the incentives based on the station heat rates, it should not be a problem for NTPC as the company pretty much sets the benchmark for efficient running of plants in the country. But as the management pointed out, it will be discussing the same with CERC.

What should investors do?

We maintain our positive view on NTPC given it is the best managed power generation company in the country and as such continues to be the best bet from the generation space. Plus, with the company making efforts to improve its fuel supply chain its operating performance is expected to only get better. While we maintain our Hold view on the stock from a long term perspective, a gentle reminder that no stock should form more than 4-5% of investors' portfolio.

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