The "ultra low" price bids of Lanco Infratech and Tata Power for the two ultra-mega power projects (UMPP) at Sasan (MP) and Mundra (Gujarat) have surprised, even shocked, many within and outside the industry. The sceptics, who always doubted the viability of the UMPP concept, are now saying the bids are unrealistic and are speculating on likely problems for the winners in achieving financial closure.
Yet, if anything, the two bids probably show what good project planning can do and how, historically, tariffs in the power sector have been artificially high due to various reasons, not the least of which is government policy. That the first competitively bid power projects of this scale and size should project such interesting and low tariffs is a statement in itself and proves that the existing system of "awarding" projects on a two-part tariff structure is inefficient.
What is different now for Lanco and Tata Power to be able to bid such low prices? Two factors can be identified straightaway. First, the size of the projects and, second, the captive coal-mine in the case of the Sasan project. This will be the first time that 800 mega-watt super-critical boilers will be employed in the country for power generation — 660 MW is the highest output till now. This enables better fuel combustion and higher energy efficiency in the power generation process.
Second, Sasan will be a pithead project with a captive coal-mine. There have been other pit-head projects in the country, most notably NTPC's 3,000 MW Talcher super-thermal power project, but this is the first time the power generator will own the coal mine. This will help the company lock in value across the chain, from mining to generation.
Efficient bidding
Indeed, the fuel cost will be cheaper as it will come without the margins of the mining company. Lanco has estimated a fuel cost of just 30 paise in its tariff of Rs 1.196 per unit quoted for the Sasan project, which clearly reveals the benefits of captive coal mining.
Of course, in Lanco's case, an added advantage is that it is experienced in the infrastructure business and has its own construction division, which can build the project. In other words, Lanco has control over the entire value chain, beginning with mining and construction and ending with power generation. This has, without doubt, defined the difference between it and the next lowest bidder, Reliance Energy (Rs 1.29 per unit).
On a broader level, the UMPP bids show how the competitive bidding process is more efficient and enables better tariff discovery compared to the current method of fixing tariffs in two parts — fixed and variable — plus an agreed return on capital. A prime reason for the high tariffs across the sector today is this two-part tariff structure, which does not offer much incentive to the generator to control costs.
Having said that, it should also be said that it is early days yet for the two UMPP projects. While the government should be pleased with the outcome of the bids, it will be a challenge for the winners from Day One.
The hurdles
Financial closure will be the first hurdle to cross, as bankers have to be convinced of the project economics. The UMPP model is one that lenders, used to fixed returns and secure power purchase agreements, are not accustomed to. Securing their confidence as well as the best rates possible is vital for the winners because more than three-fourths of the project cost will be funded by debt.
The second hurdle will be on equipment supply. BHEL may be prepared to produce and supply super-critical boilers and turbines but it is quite possible that imports would be more economical, especially if they are from China. Indeed, one other factor behind Lanco's low price bid could be that it plans to import its equipment from China. But the challenge here will be quality parameters and delivery schedules. On the latter, there may not be much worry because China is now reported to have huge idle capacity (as much as 75,000 MW, say some reports) with power equipment manufacturers. The former, however, is an unknown quantity because this is the first time Chinese equipment will be used for power generation on such a big scale.
Finally, the clearances — environmental and others — and the power evacuation system need to be addressed. While Power Finance Corporation, as the lead agency, is supposed to address the clearance issues, the latter will not be under the control of either Lanco or Tata Power and, given the scale of the project, will need to be implemented simultaneously.
The stock market, for its part, appears to have given the thumbs-up, if its reaction to the bids is any indication. The stocks of both Lanco Infratech and Tata Power surged 7 per cent and 6 per cent respectively the day the bids were announced. It is now up to the winners to justify the market's enthusiasm.