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Merchant of power

Naveen Jindal has propelled his steel and power company into India’s—and the world’s—most profitable power producers by focussing on the wildly lucrative merchant power business. Will his competitors stop his dream run?

Rishi Joshi | Print Edition: October 4, 2009

On a hot and muggy Tuesday evening, 39-year-old industrialist Naveen Jindal greets us at the company headquarters at Delhi’s Bhikaji Cama Place. Jindal is already well known as a Member of Parliament from Kurukshetra, as a national champion shooter and for winning a Supreme Court case filed against him for flying the Indian flag atop his company headquarters.

He can add one more badge to his list of accomplishments: Power baron. “Please don’t be surprised with our group’s success in power,” he tells us. “I have personally spearheaded our power initiatives and today both steel and power businesses are equally important for us.”

Jindal Steel and Power Ltd (JSPL)—of which Jindal is the Managing Director—has had an astonishing rise from being a low-cost manufacturing of steel and sponge iron to one of the main contenders in the high stakes game of power generation in India. Moreover, the company, through a series of savvy decisions—and a little bit of luck—has managed to rake in huge profits and posted a Return on Equity (RoE) that has left even global power players like AES behind in a cloud of coal dust (see charts).

It has managed to accomplish all of this by becoming a pioneer in an emerging—and perhaps, the most profitable— segment in the power businesses today: Merchant Power, a sector which eschews Power Purchasing Agreements (PPAs) for the opportunity to flog units of power in the open market at higher prices.

Jindal’s rise to the top of the power industry heap started off more innocuously, with the company selling excess power from its captive units in the short-term market. By 2007-08, after selling almost 100 MW from these units, realisation dawned. “There were two reasons why I felt that we should expand operations in power generation,” says Jindal.

“For one, India has an acute power shortage. Then, even for our steel plants, our power requirements would gradually increase as we expanded our manufacturing facilities,” he adds. Jindal’s core team set about chalking up a blueprint for its power foray. In 2002, JSPL decided to build a 1,000-MW plant through its 100 per cent subsidiary Jindal Power Ltd (JPL) in Raigarh district of Chattisgarh—India’s first mega power project in the private sector.

One of the big reasons that JSPL has achieved phenomenal success is due to its dogged adherence to cost cutting. First, JSPL planned to construct its plant on a non-engineering, procurement and construction (EPC) format—most companies prefer an EPC arrangement, where an outsourced contractor designs and constructs the plant. Instead, JSPL decided to execute the project on its own. Says Sushil Maroo, Deputy MD, JSPL: “We wanted costs to be very low and, therefore, did not appoint an EPC contractor. Since we did have experience in executing small power projects, we decided to go ahead on our own.” This move alone helped the company shave 3-4 per cent off the project cost, or around Rs 100 crore.

JSPL’S RECIPE FOR HIGH MARGINS
Sells power at spot prices of Rs 7 per unit vs industry average of Rs 3.
Avoid long-term Power Purchase Agreements, which stipulate regulated prices.
Execute own projects and operate own plants, resulting in large cost savings.
Own captive mines, which provide cheap coal and eliminate supply chain headaches.

JSPL also decided not to appoint any operations and maintenance contractors in order to reduce the running costs of the plant, using its own team instead. Doing so resulted in a savings of 8-10 paise per unit of power, which translated into an annual savings of over Rs 60 crore. Another crucial move: setting up its own coal mines, which the Chattisgarh government helped it to do by allotting the firm coal blocks for the project in compliance with the state’s industrial policy. The company is likely to cut down its cost of coal by 30 per cent—or Rs 150 crore annually— due to its captive mines.

Perhaps, the most prescient of moves was its decision to operate the Rs 4,500-crore Raigarh plant on a merchant basis. This meant not entering into any long-term PPAs with state-run grids and instead operating as a merchant power plant, which generates electricity to sell in the open market. Clearly, JSPL had already cast a canny eye at the Electricity Act 2003, which delicensed generation and encouraged captive and merchant power plants. Jindal and his team were banking on short-term tariffs remaining much above the competitive tariff levels largely due to a significant fluctuation in the power demand during the day as well as across the year in India, a nation plagued by a peak power deficit of 12 per cent and an energy deficit of 9 per cent.

The timing of the Raigarh plant couldn’t have been more fortuitous. Around that time, there was a sudden spurt in the demand for power. As power-starved areas in India practically begged for relief, JSPL was able to satiate the shortfall by selling power to State Electricity Boards (SEBs) of Punjab, Haryana, Rajasthan and Maharashtra at about Rs 7 per unit versus the regulated price of about Rs 3. Not surprisingly, JSPL posted sensational numbers in its first year of operation alone: the firm reported net income of Rs 1,581 crore out of revenues of Rs 3,257 crore and a stratospheric RoE of 166 per cent—outstripping global industry veterans such as AES. Not surprisingly, while share of the power division in sales increased from 11 per cent in FY08 to 35 per cent in FY09, its profit contribution rose from 19 per cent in FY08 to a whopping 53 per cent.

JSPL’s power party, however, may soon be under threat by a host of industry players, who have watched from the sidelines till now but will soon dive into the fray in a big way. Capacity additions by a herd of large developers—including NTPC, Tata Power, Lanco Infratech, Reliance Power, Adani Power, amongst others—is expected to ramp up merchant (short-term power) capacities from 4 GW (1 GW=1,000 MW) currently to 11 GW by FY12 and 30 GW by FY17. Further, cement, aluminium and free alloy companies are diverting their surplus power or reducing their normal output to sell power in the spot market. This could impact Jindal. Says Ram Modi, an analyst with Dolat Capital: “More supplies will inevitably mean a correction of rates.” However, considering the mammoth demand for power in India, the hit may not be so significant.

Bolstered, no doubt, by India’s perennial power shortage, JSPL is implementing a five-fold jump in its installed generation capacity from 1,333 MW in FY09 to 6,100 MWby FY14. Also in the works: a brownfield expansion of 2,400 MWat its Raipur plant costing Rs 12,000 crore, of which Rs 3,600 crore will come from the firm’s internal accruals. The company has signed a memorandum of understanding with the governments of Chattisgarh and Jharkhand for over 2,500 MW projects. JSPL also has aggressive plans in hydropower with projects ranging from 100-1,000 MW in Nepal, Himachal Pradesh and Arunachal Pradesh. Plus, the company is eyeing the renewable energy space by asking the Rajasthan government for a go-ahead to build a 500- MWsolar farm. It is widely believed that Jindal’s success has pushed the company to consider an IPO sometime soon.

Still, JSPL needs to watch its flanks. Some think that the high proportion of merchant power in its portfolio may make it difficult to supply power from its plant due to transmission capacity constraints of the PowerGrid Corporation of India, thereby upending its lucrative business model. Says Raaj Kumar, CEO, GMR Energy: “The PowerGrid bases its transmission capacity on long-term PPAs and a model almost entirely based on merchant power may not be viable.” JSPL, though, doesn’t anticipate problems.

“We are on the western grid where there is already high power demand,” says Maroo. Then, there is the ominous spectre of regulators placing a cap on spot realisations, an area already under regulatory scrutiny. Says Prasad Baji, an analyst with Edelweiss Securities: “Cost of power for consumers in India is among the highest in the world. Political parties are voicing their concern now and this might mean a cap on merchant power prices.”

Until then, JSPL is assured of posting the kind of numbers that will continue to make it the poster child—and the envy—of the industry.

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