In its report “Renewable Energy: What Cheap, Clean Energy Means for Global Utilities” released on Friday, Morgan Stanley downgraded its industry view of India Utilities to “In-Line” from “Attractive” as renewable energy is bringing major disruption to India’s thermal power sector.
“Solar power will, in our view, pressure power prices and damage margins for merchant (i.e., unhedged) generators, along the lines of what has occurred in California,” the report notes.
Report authors believe the sector is amidst a first phase of disruption and over the next 12-18 months the earnings and multiples of merchant players like, for example, JSW Energy and utilities with PPAs in place, such as NTPC and Adani Power, are likely to come under pressure.
The second phase of disruption is likely to arrive once the battery storage costs reach grid parity. In this phase there is risk of coal-based contracts being renegotiated. The third and final phase, according to Morgan Stanley, will come after existing long-term contracts and PPAs expire, which is in the range of 15-20 years.
Solar got cheaper
As the cost of solar power has fallen significantly in India, with some of the recent auctions seeing tariff bids as low as Rs. 2,44 per unit - cheaper than any other form of power generation, India has emerged the fastest growing solar market in the world through 2020. Although the government’s ambitious target to achieve 160 GWT solar and wind capacity by 2022 might not be realistic (Morgan Stanley projects 32GW of solar and 11GW of incremental wind capacity likely to be commissioned by 2022), this is still 3 times more than the current solar installed base (of 12.3 GW with around 5GW added in the last fiscal year alone).
Industry experts generally attribute fall in solar power tariffs to high competitiveness in the market, sharply declining cost of inputs (solar modules mainly) as well as cost of financing (with most players being able to raise funds outside India) among many other factors.
“While industry players and experts still debate around the sustainability of the recent solar bids and the underlying assumption, it is clear that over the next few years, the State electricity boards will think hard before signing even short- or medium-term (3-10 years) coal-based PPAs given that solar has achieved grid parity and PPAs using domestic coal always face inflation risk,” Morgan Stanely notes.
According to Morgan Stanley, two large power sector players, Tata Power and Power Grid Corporation of India (PGCIL) are positively exposed to the growth of cheap renewables.
Morgan Stanley upgraded Tata Power from “Equal-weight” to “Overweight” pointing out that the company is relatively well positioned for the rapid growth in low-cost solar power as, among peers, it generates the largest percentage of its power from renewable energy (after it acquired 1,140 MW Welspun Renewable Portfolio) and its strategy is heavily focused on shifting toward clean energy with upside potential to reach 40 per cent by 2025. “We believe renewables buildout will be a key growth driver for the stock in coming years,” the report notes.
Morgan Stanley has maintained “Overweight” on PGCIL pointing out company's wires-only business model that allows is to avoid downside risk to coal-fired plant margins. The regulated transmission utility is particularly well positioned to capture the upside opportunity from building new "green corridors" (long-haul transmission) to facilitate incremental renewables infrastructure, the report notes.
Downgrades NTPC, Adani Power, Downgraded
However, a larger number of Indian stocks are not pricing in the disruption brought by renewables, Morgan Stanley said. It downgraded NTPC from “Overweight” to “Equal-weigh” and Adani Power from “Equal-weight” to “Underweight” while it assumed coverage of Bharat Heavy Electricals (BHEL) with an “Underweight” rating and stayed its “Underweight” rating on JSW Energy.
“Although NTPC is a regulated utility (and therefore somewhat sheltered from falling power prices) with a generation business (the third-largest coal-based utility), we think the company will disappoint on commissioning new coal plants, premised on our belief that economics favor future solar additions vs coal, implying risk to earnings growth,” the report notes.
According to Morgan Stanely, NTPC offers low pipeline visibility for solar as it NTPC does not make regulated returns on solar projects (all solar projects are awarded through competitive bidding) while NTPC's conservative management team may not bid competitively enough — potentially missing out on the huge upside opportunity from the renewables expansion in India.
As for Adani Power, Morgan Stanley says the merchant portion (9 per cent) of Adani's coal-fired power plant fleet will be exposed to the risk of falling power prices as cheap solar power becomes a significant source of power.
Among merchant power generators, JSW is most exposed to competitive pressures and load factors at several of JSW's plants will continue to face pressure.
BHEL, the largest coal-based power equipment supplier in India, may face drying up new orders for thermal power equipment exacerbated by solar power now at grid parity in India, Morgan Stanley noted.
Another sector report released on Friday by India Ratings & Research maintains “Negative” outlook towards thermal power sector stating that India’s private thermal projects are staring at muted power demand, which is the effects of non-remunerative tariffs partly due to aggressive bids and some adverse perception due to falling renewable tariff.
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