Concept Paper
Utility Instruments - Possible solution for Stressed Assets
Easy bank funding in last decade (FY 2001-2010) being made available to various promoters and business houses in India led to significant investments in various sectors such Road, Power, Textile, Steel, etc. Funding done by banks based on aggressive and sometimes unrealistic assumption are responsible for the stress in the this sector. In this decade (FY 2011-FY 2020) we have seen an alarming increase in non-performing assets. Gross Non-Performing Assets (NPAs) of all Scheduled Commercial Banks have increased from Rs.69,300 Cr in 2009 to Rs. 9,33,609 Cr in 2019.
RBI has time and again come up with various guidelines in order to resolve stress in NPAs and reclassify them to standard assets. Government of India also brought Insolvency and Bankruptcy Code into force in 2016 in order to bring about quick resolution of NPAs. However, results have not been very encouraging.
These stressed assets that have turned NPA, are in the various stages of resolution and some of them are lying idle for want of additional funding, raw materials, labour, regulatory approvals and countless other reasons. The NPAs with the banks have also increased the capital requirements of various Private and Public Sector (PSBs) Banks. Re-capitalization of PSBs year-on-year has also impacted the fiscal expenditure of the Government in each year’s Budget. Low capitalization ratios have even constrained several banks from providing new funding to various sectors which are critical to fuel the growth and economy.
Bankers in India have also become risk averse and have stopped proving funding for critical infrastructure in various green field and brown field projects. Much of their time is being devoted to managing their Balance Sheet due to these stressed assets rather than engaging in lending activities. Hence it is critical, that Banks lending book is free from all these NPAs so that Bankers and Banking Industry can refocus on lending, project financing,trade finance and usual banking activities.
Utility Instruments:
One of the solutions for resolution of stressed asset and reducing the NPAs in the books of lenders can be issuing “Utility Instruments”. A typical project which is NPA especially in the Infrastructure space is funded by a mix of Debt (from Banks) and Equity infused by the Promoters/Investor in the Company. What if an instrument is introduced which replaces all the Debt and Equity in the Company?
The question of course arises:
1) Who will subscribe to these Utility Instruments?
2) What will be the return on these Utilities Instruments? – when the project is not even able to service the Interest, forget servicing of Principal and Return on Equity
The answers to above questions will be explained in detail with a help of an example of a Non-operating Stressed Power Generating Company and is an NPA asset in the books of the Bankers.
How will it work?
In order to explain “Utility Instruments” further, let us take an example of a typical Power Generation Company. POGECO Ltd has set up a Coal Fired Thermal Power Plant of 1000 MW at Rs. 5 Cr per MW with a Debt to Equity ratio of 70:30. Balance sheet of such a company would broadly look as under:
Table 1
| Liabilities | Amount (Rs. Cr) | Assets | Amount (Rs. Cr) |
| Equity | 1500 | Fixed Assets | 5000 |
| Debt | 3500 | ||
| Total | 5000 | Total | 5000 |
Let us assume that all the regulatory approvals are in place (if Government wants to resolve stress, Governments will have to speed up its own act). Let us also assume that the plant is already set up and COD (Commercial Operation Date) has been achieved. This model could even work where projects is incomplete in that case Utility Instruments will have to be issued to complete the project or there can be bridge financing until the plant is operational and Utility Instruments can be issued once plant is operational.
To make the concept easier to explain, let us assume plant is operational but not functioning and under stress due to lack of Power Purchase Agree (PPA), lack of working capital funding to meet O&M, Coal purchase cost etc.
Typical Cost Components of POGECO Ltd.
We need to even understand the cost components of a power generation company. Normally for any power generating company, costs can be classified into two major categories – Variable Costs and Fixed Costs. These cost components are further broken down and cost assumptions used in our example is even explained as under:
Variable Cost for a power company would include following components
Table 2
| Sr | Cost Component | Assumption |
| 1 | Coal purchase cost | Rs. 4000 per Tonne (4000 Gross Calorific Value – GCV) (incl. transportation, taxes etc) |
| 2 | Secondary fuel purchase cost | Rs. 0.10 per kwh |
Fixed cost of a power generation company would include following components
Table 3
| Sr | Cost Component | Assumption |
| 1 | Operation & Maintenance (O&M) | Rs. 15 lakhs per MW p.a. (including maintenance capex) |
| 2 | Depreciation on Fixed Assets | Rs. 200 Cr p.a. assuming a 25 yrs plant life |
| 3 | Interest on Long Term Debt | 12% p.a. |
| 4 | Interest on Working Capital | 12% p.a. |
| 5 | Return on Equity | 15% – Promoter/Investor will expect some return on his investment or else he will not be interested in carrying out the operations). This is generally even recovered from the consumers in the tariff in a typical PPA |
Other assumptions:
Table 4
| Sr | Particulars | Assumption |
| 1 | Plant Load Factor (PLF) | 85% |
| 2 | Auxiliary Consumption | 9% |
| 3 | Station Heat rate | 2500 kcal/kWh |
| 4 | Working capital requirement | 1 month Coal Inventory and 1 month Receivables |
Assuming the above cost components, a typical Profit and Loss account of POGECO Ltd would look like following had it been operating under normal circumstances:
Table 5
| Sr | Particulars | Total for the year (Amt Rs. Cr) | Per unit (Amt in Rs/Kwh) | % of Tariff (B) |
| A | Revenue | 2,973 | 4.39 | 100% |
| B | Variable Cost – Fuel Cost | 1,929 | 2.85 | 65% |
| C | Fixed Cost | |||
| i | O&M | 150 | 0.22 | 5% |
| ii | Depreciation | 200 | 0.3 | 7% |
| iii | Interest on Long Term Loan | 420 | 0.62 | 14% |
| iv | Interest on Working Capital Loan | 48 | 0.07 | 2% |
| Total Fixed Cost | 818 | 1.21 | 28% | |
| D | Profit Before Tax (PBT) | 226 | 0.33 | 7% |
Let us critically analyse the above cost components.
As you can see from the above table, 28% of the cost is Fixed cost (in the first year). Normally this cost would gradually go down over the years as the debt gets paid and the Interest cost on long term loan would gradually decrease. However, costs of other components will not decrease over the years and will remain constant throughout the plant life.
Any Investor putting in his time, money and effort would want a normal return on his investment. Hence, PBT of Rs. 226 Cr is nothing but 15% return on Rs. 1,500 Cr equity investment. Accordingly, PBT would represent about 7% of the tariff which will be charged to the consumers of POGECO Ltd.
From a consumers’ perspective he will be paying ~ 35% of the power tariff on account of O&M, Depreciation, Interest and Return of Equity. As a consumer, he would be interested in reducing these components to the maximum extent. That is why, we have all the Regulatory Authorities that are regulating and monitoring these components of the Tariff.
In several cases regulatory authorities have not given approvals for Power Purchase Agreement (PPA) or tariffs are too low to make the plant viable due to Fixed cost components. In several cases, Tariffs stipulated by the Regulator is too low to facilitate principal payments of debt or have adequate return on the equity.
Several plants even have issues related to coal supply, however with the increase in production by Coal India Limited (CIL) and various government schemes for supply of coal to Power Producers, a plant in general that is having a PPA would manage to get Fuel Supply Agreement with CIL for the supply of fuel. Hence this issue has not been particularly factored in this concept paper and in this example
In India we also have seen issue relating to gold plating of the projects or cost escalations/overruns due to delays. In such a scenario, per MW cost of setting up the power plant is much higher than Rs 4 Cr – 5 Cr per MW (as assumed in our example). In such an event the consumers would be paying more than 35% of the tariff in Fixed Costs component.
So to put it in different perspective, the stress in POGECO Ltd will be due to following conflicting factors among various parties:
1) Consumers and Regulator will want to minimize the Tariff/Revenue i.e. component A from tariff and in Profit & Loss statement (refer table 5)
2) Bankers or Debt providers will want to ensure their Interest and principal gets paid hence they will not be interested in reducing component C ii, C iii, & C iv (i.e. Depreciation and Interest) from tariff and Profit & Loss statement (refer table 5). The reason for including Depreciation here is, although in the P&L, it is a non cash item, but commensurate cash flows will be utilized to service the principal portion of the debt.
3) Investors/Promoters will want to maximize his return, hence they will try to increase component C ii & D (i.e. Depreciation and PBT) from tariff and in Profit & Loss statement (table 5).
So what could be the solution for making POGECO Ltd viable, that ensures principal payment to Banks, return of Investment/equity of Promoter/Investor and Tariff reduction for consumers.
The key is to eliminate various components of the Fixed Costs, This will benefit the consumer and at the same time this has to be done along with ensuring investments of the Banks and Investors are returned. Now the question is how do we do that?
How Do we reduce the Fixed Cost components?
Step 1 – Issue Utility Instruments to the end Consumers of the power
To make it easier to understand let us assume a town with 30 lakhs consumers/ families/ connections is consuming electricity from POGECO Ltd. Further it is assumed that there is no distribution company, distribution lines are already set up and cost related to distribution/distributions losses is not involved. These consumers are directly purchasing power from POGECO Ltd. These 30 lakhs consumers on an average would consume about 180-190 units per month which is about 6,776 Million Units of electricity requirement.
Net generation of 1000 MW power plant (assuming it operates at 85% PLF and 9% of Auxiliary Consumption) would roughly be ~ 6,776 million units.
Hence, POGECO Ltd would issue Utility Instruments to these 30 Lakh consumers. Each Instrument issued by POGECO Ltd would give the right to the consumer to purchase 10 units of electricity from POGECO Ltd at a discounted price per unit.
POGECO Ltd will issue 67.76 Cr Utility Instruments at Rs. 73.79 per Utility Instrument to its consumers. This will enable POGECO Ltd to generate Rs. 5000 Cr from the issuance. Math can be better explained in below table:
Table 6
| Sr | Particulars | Quantity |
| a | POGECO Ltd Capacity | 1000 MW |
| b | Net Generation @ 85% PLF and 9 % Aux Consumption | 6,77,58,60,000 units |
| c | No. Instruments to be issued with Right to Purchase 10 units (b/10) | 67,75,86,000 |
| d | Cost of Project for setting up the Power Plant | Rs. 5000 Cr |
| e | Amount to be raised per Instruments (d/c) | Rs. 73.79 |
Step 2 – Utilize the proceeds received from these Utility Instruments to pay Bankers and the Investors
A Board of Trustees can be appointed to oversee the entire process of getting the proceeds from Consumers and paying the Bankers and Investors (once the plant is made operational). An O&M contractor should be appointed that will be managing the plant and will be operating under the supervision/oversight of the Board of Trustee and the Regulator. With the proceeds from the Utility Instruments, POGECO Ltd will pay back the Debt of Rs. 3500 Cr and Equity Investment of Rs. 1500 Cr.
Investor will demand some return on investment up to the date he receives his money from Utility Instruments and the same can always be factored in the amount to be raised from the consumers from Utility Instruments.
Step 3 – Supply electricity to consumers at variable cost
The utility Instruments will not carry any Interest nor will the amount paid by consumer for purchase of Utility Instrument (Rs. 73.79 per Utility Instrument) will be repaid to the Consumers. However, with the Instruments, the Consumer has the right to purchase electricity from the POGECO Ltd at variable cost. Accordingly, each unit consumed by the consumer will cost him only Rs. 3.07 per unit vs. Rs. 4.39 per unit (he would have otherwise paid to purchase power in our example – refer Profit & Loss statement table 5 above). This is a saving of about 30% in electricity cost for the consumer!
Let us do the math on how he is getting the return on his investment of Rs. 73.79 per Utility Instrument.
Assuming a family is consuming 100 units of electricity every month. The family consumes 1200 units of electricity every year. The consumer will need to buy 120 (nos.) Utility Instruments. This will require him to pay or invest Rs. 8,855. Against this investment he will be saving Rs. 1.32 per unit of his consumption or Rs. 1,584 in the first year of investment on consumption of 1200 units of electricity (i.e. Rs. 1.32 Fixed cost x 1200 units). This works out to be about 17.88% of amount invested.
These savings would gradually reduce as discussed above (i.e. due to impact of the long term debt as it gets paid and the Interest cost on long term loan as part of Fixed Cost would gradually decrease). Yearly saving gradually reduces to Rs. 861 in the 25th year. However the Internal Rate of Return for the Consumer would still work out to be about ~15.5% over period of 25 yrs of the life of the plant.
With above analysis question related 1) Who will subscribe to these Utility Instruments and 2) What will be the return on these Utilities Instruments, is answered.
Actual workability of the concept:
Under the current scenario there would be various regulatory challenges for issuance of Utility Instruments. Enumerable factors such as costs related to distribution licensee, Distribution and Transmission costs and losses etc. will also play a role which would pose practical challenges for implementing this concept.
However, we can always think of various variation to above principal. Let us assume Tata Power (i.e. generation company) issues Utility Instruments to the consumers in Mumbai. The proceeds will be utilized to reduce the debt and/or equity component in their balance sheet.
As a consumer and holder of Utility Instrument, he will be paying normal electricity bill every month as per the existing mechanism along with other consumers. At the end of the year, Tata Power can reimburse various cost components (other than O&M Cost and Variable Cost) to the holders of these instruments.
A detailed analysis of the proposed resolution concept has been presented here using an example of a Power Company. However, this principal/concept can be applied to any Company that is capital intensive or any public utility company or any company having substantial component of operating and financial leverage and is catering to large number of consumers.