Five Porter Model

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13th March 2009

Industry Research Report On Indian Power Sector FOR INSTITUTIONAL CLIENTS

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Segments of the industry Overall Generation Growth

Industry Overview Power is a critical component of any economy’s infrastructure without which its development and growth is a big hindrance. An economy’s growth, development and ability to handle global competition, all depends on the availability, reliability and quality of the power sector. The demand for power is growing exponentially so the scope of growth of this sector is immense. This sector is dominated primarily by Public Sector Undertakings (PSU). The State and Central Government account for 58% and 32% of the generation capac-ity respectively while the private sector accounts for a mere 10%. A major part of the transmission and distribution factors are han-dled by the state utilities. The private sector is gradually making its presence felt in the power sector in distribution and is making a foray into transmission. Power sector is mainly funded through budgetary support and external borrowings were opened to private sector in 1991. Segments of the industry 1 • Power Generation • Power Transmission • Power Distribution

Power Generation The overall generation in the country has increased from 264 billion units (BUs) during 1990-91 to 704.47 BUs during 2007-08 depict-ing a tremendous growth. There has been significant improvement in the growth in actual generation over the last few years. As compared to annual growth rate of about 3.1% at the end of 9th Plan and initial years of 10th Plan, the growth in generation during 2006-07 and 2007-08 was at the rate of 7.3% and 6.33% respectively. There has been a signifi-cant improvement in hydro generation to the extent of 8.88% in 2007-08. www.hemonline.com For Private Circulation Only 2 Hem Institutional Research Desk

Generation achievement for the period April 08 – January 09 has been 93.0% of the target. Growth in installed Capacity since 6th Plan

Energy Generation during Cumulative period Apr. 08 to Jan. 09

Generation achievement during the period April 08 – Jan. 09 has been 93.0% of the target and growth rate was 2.53% as compared to generation during the corresponding period last year indicating in-crease in operating efficiency. During the same period, the growth in thermal generation has been 5.56% whereas a decline in hydro and nuclear generation due to less water inflows and from nuclear power plants due to low availability of fuel. Growth of installed Capacity since 6th Plan (in MW) Source: Ministry of Power

India has witnessed a huge growth in the installed capacity since decades. Installed capacity has increased manifold since 6th Plan. Of the total installed capacity of 1,47,402.81 MW, 52.5 percent is in the state sector, 34 percent in the central sector, and only about 13.5 percent is in the private sector. Larger share of renewable power in the total installed capacity mix is the emerging trend. www.hemonline.com For Private Circulation Only 3 Hem Institutional Research Desk

All India Annual per Capita consumption of Electricity

Sources to generate power A significant portion of the current generation comes from thermal plants (64.6 percent), followed by hydro (24.7 percent), renewable resources (7.7 percent) and nuclear (2.9 percent) plants. Thermal power (coal) accounts for much of the power produced to the extent of 77,458.88 MW which is 53.3 percent of total thermal generation but the government plans to shift energy generation from thermal to hydro.

Per Capita Consumption of electricity Per Capita consumption of power in India has grown significantly since 1990s. Per Capita consumption has registered 124.26% growth from 566.70 kWh in 2002-03 to 704.20 kWh in 2007-08. Further, 11th Five Year Plan plans to increase per capita consump-tion to 1000 kWh by 2012.

All India Annual per Capita consumption of Electricity www.hemonline.com For Private Circulation Only 4 Hem Institutional Research Desk

All India Thermal PLF % Power Supply Position

Plant Load Factor PLF of generating plants has improved consistently over the last five plan periods. Overall PLF of thermal power stations during the period Apr 08-Jan 09 has been 75.78% against 77.7% in the corre-sponding period of last year. PLF of central plants in Apr-Sep 2008 was 80.47 per cent while that of state sector units was 67.79 per cent. Highest ever Plant Load Factor (PLF) of 78.75% at National Level was achieved during 2007-08 as against 77.03% achieved during 2006-07. All sectors viz. Central, State and Private had improved PLF as compared with previous year. Among all the sectors (Cen-tral, State and Private) PLF of 90.77% achieved by Private Sector stations was highest at the National level. PLF of 104.14 % of Unit #1 of 110 MW of Sabarmati generating Station of M/s Torrent Power under private sector was the highest ever PLF achieved by any unit so far. PLF of 101.80 % of Unit #2 of Dadri (NCTPP) (210MW) of NTPC was the highest among all Central Sector units. This was also the highest ever PLF achieved by any Central Sector station unit so far. PLF of 100.15 % of Unit #6 of Kota TPS (195MW) of M/s Rajasthan Rajya Vidhyut Ut-padan Nigam

Limited was the highest among all State Sector units. This was also the highest ever PLF achieved by any State Sector station unit so far.

Power Supply Position While India continues to face a shortage of power, deficit at the peak hours dipped to 13.8 per cent during April-December 2008 compared to 14.9 per cent a year ago. While peak demand has not fallen, higher availability of power at peak hours rose sharply re-sulting in a decline in shortage. www.hemonline.com For Private Circulation Only 5 Hem Institutional Research Desk

Transmission lines have witnessed mani-fold growth since 1997. “Establishment and Operation of Re-gional and National Power Grids to facili-tate transfer of power within and across the regions with reliability, security and economy, on sound commercial princi-ples".

Power Transmission Transmission of electricity is defined as bulk transfer of power over a long distance at a high voltage, generally of 132 kV and above. Indian power system is demarcated into five independent regional grids viz. Northern, Eastern, Western, Southern, and North-eastern Regions. All the regional grids, except Eastern and North-eastern Regions, operate independently with only a limited exchange of power across the regions. In India bulk transmission has increased from 3708 ckm in 1950 to more than 2,65,000 ckm today. While the predominant technology for electricity transmission and distri-bution has been Alternating Current (AC) technology, High Voltage Direct Current (HVDC) technology has also been used for inter-connection of all regional grids across the country and for bulk transmission of power over long distances. Creation of National Grid Ministry of Power has envisaged the establishment of an integrated National Power Grid in the country by the year 2012 with an inter-regional power transfer capacity of about 37,700 MW. POWER-GRID is working towards achieving its mission of “Establishment and Operation of Regional and National Power Grids to facilitate transfer of power within and across the regions with reliability, se-curity and economy, on sound commercial principles". www.hemonline.com For Private Circulation Only 6 Hem Institutional Research Desk

Inter-regional power transfer capacity is to be enhanced to 37,000 MW by 2012 through creation of “Transmission Super Highways”.

Initially, considering wide variations in electrical parameters in the regional grids, primarily HVDC interconnections were established between the regions. This was completed in the year 2002, thereby achieving inter-regional power transfer capacity of 5000 MW. In the next phase, inter-regional connectivity is planned to be strengthened with hybrid system consisting of high capacity EHV/UHV AC and HVDC links. Such a National Power Grid is envisaged to disperse power not only from Mega sized generation projects but also to enable transfer of bulk power from one part of the country to another in different operational scenarios say, in varying climatic conditions across the country: Summer, Winter, Monsoon etc. Commissioning of links under this phase has already begun with the commissioning of 2000 MW Talcher-II HVDC Bi-pole, Raipur – Rourkela 400kV D/C AC transmission line having Series Compensation, augmentation of Gazuwaka HVDC (500MW) back to back link and Tala transmission system. The inter-regional transfer capacity of 16,200 MW is available as on date. Further strengthening of National Power Grid is envisaged through high capacity AC EHV lines, 765 kV UHV AC lines/ HVDC lines. This phase is planned to be implemented by 2012 when inter-regional power transfer capacity

will be enhanced to about 37,700 MW by the end of XI Plan, depending upon planned growth of generation capacity. (Source: Ministry of Power)

Perspective Plan for Transmission The country’s transmission perspective plan for eleventh plan fo-cuses on the strengthening of National Power Grid through addition of over 60,000 ckm of Transmission Network by 2012. Such an integrated grid shall carry 60% of the power generated in the coun-try. The existing inter-regional power transfer capacity is 17,000 MW, which is to be further enhanced to 37,000 MW by 2012 through creation of “Transmission Super Highways”. Based on the expected generation capacity addition in XI plan, an investment of about 75,000 Crore is envisaged in Central Sector and Rs. 65,000 Crore is envisaged in the State Sector. www.hemonline.com For Private Circulation Only 7 Hem Institutional Research Desk

At the national level 98% feeders and 89% of consumers have been metered so far. 100% feeder metering has been achieved in 20 States. AT&C losses have been bought down be-low 20% in 215 APDRP towns in the country, of which 163 towns have been brought below 15%.

Power Distribution Apart from an extensive transmission system network at 500kv HVDC, 400kv, 220 kv, 132kv and 66kv which has developed to transmit the Power from the generating station to the grid substa-tions, a vast network of sub transmission in distribution system has also come up for the utilization of the power by the ultimate con-sumers. The Ministry of Power took various initiatives towards re-forms and other policy measures for helping the state power Utili-ties to bring improvement in their efficiency towards bringing about commercial viability in the power sector. Some of the major initia-tives were: establishment of regulatory mechanism at central and state level, restructuring of the state power Utilities, metering of feeders & consumers, energy accounting & auditing, securitization of outstanding dues of CPSUs etc. At the national level 98% feed-ers and 89% of consumers have been metered so far. 100% feeder metering has been achieved in 20 States.

Accelerated power development and reforms programme (APDRP) The Accelerated Power Development Reforms Programme (APDRP) was launched in 2002-03 for implementation in the 10th Plan as additional central assistance to the states for strengthening and up gradation of sub-transmission and distribution systems of high-density load centers like towns and industrial areas. The main objectives of the programme were to reduce AT&C loss, reduction of commercial loss and to improve quality and reliability of supply. Although at national level the AT&C loss of state power utilities has not shown much improvement over the past three years, the loss has come down in towns where APDRP has been implemented. Some of the utilities which adopted various interventions as envis-aged under the programme have shown significant reduction in AT&C loss. AT&C losses have been bought down below 20% in 215 APDRP towns in the country, of which 163 towns have been brought below 15%. www.hemonline.com For Private Circulation Only 8 Hem Institutional Research Desk

Even the Electricity Act 2003 aims to en-courage investments, thereby increasing competition. It is very hard to achieve economies of scale for a new entrant. GOI still has huge coal reserves because of which suppliers cannot exert much pressure.

Porter’s Model

Competition: Number of players present in the industry is not large, thereby reducing the intensity of rivalry. Further, switching costs are even high which hinders competition. Thus it can be said that the competition is not high currently except in the Ultra Mega Power Projects which are allotted through competitive bidding process. Threat of Entry: Barriers to entry are high, especially in the trans-mission and distribution segments, which are largely state monopo-lies. Also, entering the power generation business requires heavy investment initially. The other barriers are fuel linkages, payment guarantees from state governments that buy power and retail distri-bution license. Bargaining Power of Suppliers: The raw material for the power industry is mainly coal, suppliers of which cannot negotiate much as the price is regularized by government. Other raw materials are water and nuclear which are even regularized by government. Thus, suppliers don’t have bargaining power. Bargaining Power of Buyers: Bargaining power of retail custom-ers is low, as power is in short supply both for industrial and do-mestic customers. However, government is a big buyer and payment by government can be erratic, as has been seen in the past. Further price of power is fixed by government bodies because of which buyers cannot exert pressure. Substitute Products: Electricity does not have clear cut substitute except batteries which are used significantly nowadays but cannot violate the immense importance of power. www.hemonline.com For Private Circulation Only 9 Hem Institutional Research Desk

The return on investment has been raised from 14% to 15.5%. Per capita availability of electricity is to be increased to over 1,000 units by 2012.

Investment Rationale Return on Equity The Central Electricity Regulatory Commission (CERC) has issued new tariff regulations for the next five years. A recent CERC order states that the return on investment has been raised from 14% to 15.5% which will not only attract investment in current market conditions and generate sufficient resources for further growth in the sector but also take care of consumer’s interests. An additional return on equity of 0.5 per cent will be made available to the pro-jects that are commissioned within the scheduled time. Considering the investment pattern of 70:30 debtequity, utilities are required to build up sufficient internal accruals to meet the target of investing at least 30% of capital cost in the form of equity. A higher invest-ment in the form of equity will also help the entities in negotiating and availing loans at competitive terms and conditions. While in-creasing profit margin on hand CERC has decided to incentivise efficiency gains and to periodically pass the improvements to con-sumers. Accordingly, the availability target for recovery of fixed cost for thermal power plants has been raised from 80% to 85%. Further, new hydro power projects have been appropriately insu-lated from hydrological risk during the first ten years of their opera-tions. This move of CERC has opened doors for new entrants to capture a good market share and make reasonable profits. National Electricity Policy 2003 In addition to the Electricity Act, the government laid out the Na-tional Electricity Policy to accelerate development of the power sector. The National Electricity Policy aims to achieve the follow-ing objectives: • Financial turnaround and commercial viability of the elec-tricity sector. • Demand to be fully met by 2012. Energy and peaking shortages to be overcome and adequate spinning reserve to be available. Per capita availability of electricity to be in-creased to over 1,000 units by 2012. Minimum lifeline con-sumption of 1 unit/household/day as a merit good by 2012. • Supply reliable power of specified standards in an efficient manner and at reasonable rates.

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Distribution licensees would be free to undertake generation and generating companies would be free to take up distri-bution businesses. As per the Electricity (Amendment) Act, 2007, no License is required for sale from captive units.

Electricity Act 2003It is rare that a country such as India replaces an act with a new one, as was the case with the Electricity Act 2003, where all references to the previous legislation were literally removed. The Act opened up the power sector to competition and created a progressive envi-ronment to encourage wide-ranging reforms in the sector. It also envisaged reducing regional imbalances by creating an enabling environment for the inter-state sale of power. The salient features of the Act are as follows: • The generation sector was de-licensed and captive genera-tion was freely permitted, but hydro projects would need clearance from the Central Electricity Authority. However, licensing control over transmission, distribution and trading continues to exist. • Distribution licensees would be free to undertake genera-tion and generating companies would be free to take up dis-tribution businesses. • Introduction of open access in transmission and in time bound manner in distribution; SERCs were to frame regula-tions within one year regarding phasing-in of open access. • Separation of transmission and trading business, the intro-duction of the concept of power trading as a distinct activ-ity, and the introduction of a spot market for bulk electric-ity. As per the Electricity (Amendment) Act, 2007, no License is re-quired for sale from captive units. 11th Five Yr PlanThe National Electricity Policy (NEP) stipulates power for all by 2012 and annual per capita consumption of electricity to rise to 1000 units from the present level of 631 units. To fulfill the objec-tives of the NEP, a capacity addition of 78,577 MW has been pro-posed for the 11th plan. This capacity addition is expected to pro-vide a growth of 9.5 % to the power sector. www.hemonline.com For Private Circulation Only 11 Hem Institutional Research Desk

CAPACITY ADDITION TAR-GET/FEASIBLE DURING 11TH PLAN YEAR WISEThe projects worth Rs.1,92,200 crore were outstanding as on December 2008 quar-ter. In January, additional investments in the power sector totaling Rs.41,000 crore were announced during ‘Vibrant Gujarat Global Investors Summit’.

Capacity addition The electricity industry is witnessing a surge in capacity expansion with large investment outlay. The projects worth Rs.1,92,200 crore were outstanding as on December 2008 quarter. In January, addi-tional investments in the power sector totaling Rs.41,000 crore were announced during ‘Vibrant Gujarat Global Investors Summit’. A large portion of these projects announced were to develop power plants based on renewable sources of energy. The companies that made these announcements include Tata Power, Elecrotherm India, Gujarat NRE Coke and IDFC Projects, among others. Adding a generation capacity of 1,454 mw, the industry announced completion of 12 projects entailing an investment of Rs.7,776 crore during the December 2008 quarter. Additional three units with a total capacity of 615 mw were commissioned during January 2009. www.hemonline.com For Private Circulation Only 12 Hem Institutional Research Desk

Power Sector: Net Sales Growth (%) Source: CMIE

Power Sector: PAT growth (%) Source: CMIE

Financial Performance of the sector The power sector reported healthy financial performance in current market conditions backed by a 26.4 per cent rise in net sales while the total income of the sector rose at a slower pace which led to a 24.20 per cent during the quarter ended December 2008. Other in-come as a proportion of total income dipped from 5.3 per cent to 3.6 percent. Raw material cost accelerated by 35.90 per cent which was on account of increased use of imported coal and secondary sources of fuel for generation. A 12 per cent rise in domestic prices of coal was announced in December 2007. Growth in power and fuel expenses eased to 12.7 per cent compared to the preceding quarter. The profitability of the sector at the EBDIT level rose to 10.00 per cent from 8.00 per cent during December 2007. The net profit margin contracted 1.60 per cent points to 15.6 percent during quarter ended December 2008. However, there has been a sharp rise in interest expense but the sector still has registered a huge growth of 12.70 per cent points in quarter ended December 2008 as com-pared to negative growth for the corresponding quarter last fiscal. All the top five companies comprising the electricity industry re-corded a sharp growth in net sales during the December 2008 quar-ter. Higher sales realizations led to this surge. NTPC, the largest company comprising the industry registered a 21.3 per cent increase in net sales over the year-ago quarter. NPM of the company too expanded to 18.6 per cent from 17.6 per cent for corresponding quarter last year. Reliance Infrastructure led the pack recording a robust 78.80 per cent growth in sales to the tune of Rs.2,678.8 crores. Power Grid Corporation of India, the only power transmis-sion and distribution company registered a PBDIT and net profit margin of 83.6 per cent and 23.5 per cent, respectively. Higher profitability at the PBDIT level during the quarter was registered by JaiPrakash Hydro. Net sales of Neyveli Lignite dipped by 1.9 per cent to Rs.662 crore. It was the only company included in our sam-ple to record lower sales. The healthy growth in revenues could not be converted into higher profits by Tata Power. Of the 16 companies, eight companies witnessed higher PBDIT while profitability of seven of these companies expanded during the December 2008 quarter. (Figure: Annexure 1) www.hemonline.com For Private Circulation Only 13 Hem Institutional Research Desk

Development of ultra mega power projects (UMPPs) has been identified as thrust area. Up to 100% FDI is allowed in respect of projects relating to electricity generation, transmission and distribution, other than atomic reactor power plants.

UMPP (ultra mega power projects) The Government of India has envisaged in its Mission, “Power to All by 2012”. Achievement of this target requires development of large capacity projects or UMPPs. Ultra Mega Power projects are a series of ambitious power projects planned by the Government of India. Development of such projects has been identified as thrust area. These are very large sized projects, approximately 4000MW each involving an estimated investment of about Rs. 16,000 crore. As of April 2008, nine UMPPs have been planned, 4 at pithead and 5 at coastal locations. • Five coastal sites at: - Mundra in Gujarat, Krishnapatnam in Andhra Pradesh, Tadri in Karnataka, Girye in Maharasthra, and Cheyyur in Tamil Nadu. • Four pithead sites at: - Sasan in Madhya Pradesh, Tilaiya in Jharkhand, Sundergarh District in Orissa and Akaltara in Chattisgarh. The contract for Mundra UMPP has been given to Tata Power while Sasan, Tilaiya and Krishnapatnam contracts have been awarded to Reliance Power Limited. These plants are estimated to cost roughly Rs. 15,000 crores each to set up. In addition Tamil Nadu has identified additional site at Marakanam. Furthermore Karnataka has also suggested an additional site at Ghataprabha in Begaum District. The completion of these UMPPs would lead to reduce the demand supply gap and efficient genera-tion of electricity.

FDI Flows

Up to 100% FDI is allowed in respect of projects relating to elec-tricity generation, transmission and distribution, other than atomic reactor power plants. There is no limit on the project cost and quan-tum of foreign direct investment. There is no discrimination be-tween domestic or foreign investors. Zero customs duty on import of capital goods for Mega Power Projects has pushed FDI flows in India. Income tax holiday for generating plants for 10 years is also an initiative by govt. The Civil Nuclear Agreement signed on Oc-tober 10, 2008, has opened the door even wider for US exports to help India meet its tremendous energy needs. This has resulted in growth for nuclear power in the country with the potential foreign entrants in the sector. www.hemonline.com For Private Circulation Only 14 Hem Institutional Research Desk

OutlookThe sector is on the path of growth led by private and public coun-terparts. In order to revamp the power sector, numbers of initiatives have been taken in the recent past, both in terms of policy pro-nouncement and programmes ranging from bringing about effi-ciency in generation segment through introduction of super critical technology to penetration of commercial energy in the rural areas and consolidation of electricity distribution system. The sector has posted decent set of results as a whole despite of current economic scenario. Higher utilisation would also help reduce the depreciation cost for the companies. While it might not be visible fully, but fall in interest rate would also help the bottomline of the companies. Power sector is highly capital intensive and hence, is highly lever-aged. The electricity generation target for the year 2008-09 has been fixed at 744.344 BU comprising of 631.270 BU thermal; 118.450 BU hydro; 19.000 BU nuclear; and 5.624 BU import from Bhutan. Outlook for the sector looks reasonable with decline in fuel prices and its availability. This would further be aided by fall in interest cost, led by falling interest rate. Therefore, in the light of rising demand for power and huge capacity expansion, the scope for the growth of the sector is vast and is expected to materialize soon. Therefore, looking at the current scenario and future growth poten-tial we expect POWER SECTOR to outperform the markets in the medium to long term (i.e., 3-5 year) thereby providing excellent investment opportunities in the sector.

Annexure 1 www.hemonline.com For Private Circulation Only 15 Hem Institutional Research Desk Disclaimer: This document is prepared on the basis of publicly available information and other sources believed to be reliable. Whilst we are not soliciting any action based on this information, all care has been taken to ensure that the facts are accurate and opinions given fair and reasonable. This information is not intended as an offer or solicitation for the purchase or sell of any financial instrument. Hem Securities Limited, Hem Finlease Private Limited, Hem Multi Commodities Pvt. Limited and any of its employees shall not be responsible for the content. The companies and its affiliates, officers, directors, and employees, including persons involved in the preparation or issuance of this material may from time to time, have long or short positions in, and buy or sell the securities there of, company (ies) mentioned here in and the same have acted upon or used the information prior to, or immediately following the publication

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