The sheer number of conventional projects being develop­ed in India has put huge pressure on the domestic banking community, which provides almost all of the sector’s non-recourse debt requirements. The lack of any significant migration of deals into the bond market places added weight on banks’ balance sheets.

In this context, the biggest lenders, which are frequently owned or con­trol­led by the state, have hit their exposure limits for power deals. There could be some relief in the new financial year, which starts in April, but deals have been slower to close in recent months, and banks have been more careful with less creditworthy developers.

Projects are either based on regulat­ed tariff terms, in which interest rate movements can be passed through to the offtaker, or fixed tariff terms, through a competitive bid­ding process. More and more projects are being structured with fixed tariffs, and they are at risk from recent rises in Indian interest rates.

And an increasing number of pro­jects are using partially merchant off­take structures, rather than relying entire­ly on long-term power purchase agree­ment (PPAs). In its recently published Indian Infrastructure Outlook for 2011, Fitch Ratings says that although mer­chant prices remain at high levels due to India’s chronic power deficit, a fall in prices over the last three years is likely to continue.

“In the medium term, this trend of price reduction will continue due to the gradual reduction in the power supply deficit and the weakening ability of the state utilities to pay high prices,” Fitch said. “Prices should still offer reasonable margins to competitive producers; however, the ability to earn super-normal profits may no longer be possible. The base case tariff assumption of around Rs3.5/kWh in the financial forecast models of many Fitch-rated projects should still be sustainable,” the agency added.

Foreign injections

Foreign commercial lenders are keeping their distance from greenfield deals, and are still not completely comfortable with the risks that domestic banks will take. Projects do not often meet the due diligence requirements of international lenders, and they are typically unwilling to supply debt with a tenor over 10 years. “I don’t see it changing easily. I’m not seeing a large appetite at international banks for Indian projects, except for some really top-quality sponsors,” says one lender.

But on the face of it, foreign lending looks relatively com­petitive against domestic debt. Current rupee pricing on con­ventional power projects is at around 11.5%-12%. Fol­low­ing rises in Indian base rates and a fall in potential lend­ers due to some banks breaching exposure limits, lending rates to power projects have risen by over 100bp in the last year, and are now perhaps 300bp higher than three years ago.

A greenfield coal-fired project with debt tenor of 12-14 years being develop­ed by a sponsor rated AA or AAA locally might attain debt pricing at around 11%, while the price for an A-rated developer could be 12-12.5%, accord­ing to one banking source.

Unhedged foreign debt is priced at around 7%, but finding a currency hedge with a sufficiently attractive price and tenor is difficult, participants say. Fully hedged foreign debt could reach a price of around 12.5%, but finding hedges with suffi­ciently long tenors is difficult. However, there is some expectation that dollar lending rates will remain low, while Indian debt pricing for power projects could rise further to catch up with upward swings in the country’s central bank’s rates.

In this context, Reliance Power, India’s largest private power plant developer, has decided that market condi­tions will support the replacement of around 30% of the Rs146 billion ($3.2 billion) in debt for its 4,000MW Sasan ultra mega power project (UMPP), which was initially closed in April 2009 using debt sourc­ed exclusively from the Indian market.

The Sasan plant is to use super-critical technology to supply power to 14 offtakers in 7 Indian states, under power purchase agreements which last 25 years. The tariff is set at Rs1.19 per kWh and the plant was recently registered with the Clean Development Mechanism executive board as a generator of certified emis­sions reduc­tions. The registration prompted bitter com­plaints from environmental cam­paign­ers, which protested that what­ever the benefits of super­critical boilers over older coal technologies, carbon credits should not be available to a fuel like coal at all.

The deal was a measure of the depth of India’s domestic banking market, and Standard Chartered was mandated to arrange commercial funding for 30% of undrawn senior debt within three years of financial close.

Is it the hour of the ECB?

The opportunity to close an external commercial borrowing (ECB) facility has opened up a pocket of opportunity for foreign commercial banks, and will free up some capital for the large number of Indian banks that lent to the project. Reliance also intends to expand the plant, but the ECB is related to the deal closed in 2009.

The common terms agreement for the ECB is currently being negotiated. Together, Bank of China (BOC), China Development Bank (CDB) and The Ex­port Import Bank of China (Chexim), are to supply $1.1 billion. US Exim is expected to provide around $900 million, while around $300 mil­lion is to come from as many as five or six foreign commercial lenders.

The ECA commitments come on the back of equipment supplies. Shanghai Electric is supplying the boiler and tur­bine generators, and the coal mining equip­ment will be supplied by US and Chinese firms.

The Chinese tranche has a tenor of three years construction plus 10 years and would be the first part of an expected $12 billion in loans from China to Reliance, which fall under a memor­andum of under­stand­ing that signed in October 2010.

The loan from US Ex-Im attracted criticism from environmental groups, but eventually won the approval of its board, thanks to the diplomatic decision of Reliance to build some renewable capacity too, and probably buy that equipment from US suppliers. The tenor on this tranche is 3+12 years.

This puts the US Ex-Im loan, but not the Chinese loan, stretching further than the tenor of many of the Indian lenders. In the initial deal, which closed almost two years ago, three banks signed up to provide loans with a tenor of 5 years construction plus 15 years, while the remaining lenders agreed to 15 years in total.

The total replacement debt under the ECB, in excess of $2 billion, is a significantly larger amount than the $1-1.5 billion that the developer had expected to source in dollars when it closed the initial deal. The exact reduction of the Indian facilities has yet to be integrated into the ECB arrangement and the change for each bank will depend somewhat on their exposure to the Reliance group.

Reliance has not decided, either, how exactly it will hedge the Ex-Im and Chinese tranches. “The liquidity in the Indian market dries up substantially after 10 years. As a corollary to that, the hedge becomes more and more expensive,” says one market source.

A successful close of the ECB on Sasan might determine whether Reliance will follow the same route for its Rs175 billion Krishnapatnam UMPP. Reliance closed the syndication of Rs132 billion debt for this 4 GW coal-fired project in the middle of 2010. The 15-year debt is priced at 11.25% and equipment is again coming from Shanghai Electric. Reliance is in talks with Chinese banks over a loan of around $1 billion, a similar size to funding on Sasan, according to one source close to the process.

Block party

One of the main differences between Krishnapatnam and Sasan is how they procure their coal. Sasan has captive coal mines, while Krishnapatnam is to burn 100% imported coal. With many developers offering a fixed tariff in a competitive bidding process, getting hold of coal at low prices is crucial.

High global coal prices have increased the pressure on sponsors to tie down the feedstock and larger developers have moved to acquire mining assets in Indonesia and Australia, with some looking to obtain supplies from South Africa and Mozambique.

Sponsors in India face several issues with coal supply. There is uncertainty over how much and how reliably the state-controlled Coal India can provide fuel, so developers have begun to look at other options such as finding captive supplies or looking abroad for imports.

The development of captive coal deposits can be chal­lenging, particularly for sponsors with no track record. Land acquisition, environmental requirements and contractual arrangements with specialist operators all need to be settled during a fast enough timeframe. Coal mining blocks may be developed by a consortium of companies, which have differing needs in terms of commissioning dates.

To obtain domestic coal from Coal India, a linkage contract with a government committee, a kind of letter of intent, is agreed with the project and replaced at a later stage with a formal coal supply agreement. Lending from Indian banks is usually closed using the initial coal linkage contract with conditions precedent requiring the developer to obtain the formal supply agreement. The lack of formal coal supply agreement early on is not an attractive proposition for foreign banks, one source notes.

Under current market conditions, sponsors being supplied by Coal India might expect a rationing of supplies, says Srinivasan Nandakumar, senior direc­tor, infrastructure and project finance, at Fitch in India. Sourcing the remaining coal can leave margins exposed further down the project’s lifespan, Nandakumar adds. For projects that depend on imported coal, developers may lack sufficient negotiating power with foreign producing. “Foreign miners are not inclined to enter into long-term contracts – mostly they are short-term contracts. Clearly, for a developer, that is a risky strategy,” he says.

Reliance’s Krishnapatnam project is to import 100% of its coal and has a long-term supply agreement with Reli­ance Coal Resources, which is to supply coal from different sources, including the spot market and Indonesian mining assets it bought from Sugico for $1.6 billion.

A lighter choice

A tougher stance from government environmental authorities has caused delays to some coal-fired projects and made developers and lenders re-evaluate projects and the location of captive mines. Gas-fired projects require less land than coal projects, and face fewer environmental hurdles, but avail­ability of gas continues to hold back growth.

Currently, gas-fired power makes up 11% of national output, putting it behind coal-fired output, at 53%, and hydroelectric power, which has a 22% share. Historically, some operational gas-fired projects have not received the feedstock they expected, and this has driven down some plants’ load factors. The most creative attempt to get round supply constraints – Enron’s Dhabol plant – is still a byword for the risks to foreign sponsors of poor fuel choices.

Many Indian oil and gas fields have been opened up to private exploration but confidence in gas-fired power has been eroded by government rules on gas allocation, with other sectors such as fertiliser plants given greater priority.

While the more environmentally friendly aspect of gas-fired plants is an attractive element, a lack of secure domestic gas supply contracts through take-or-pay mechanisms re­mains a deterrent, says Aditya Aggarwal, managing director at IDFC Project Equity. “And if one were to set up a gas-fired project on the basis of imported gas, those projects may not be as competitive as a domestic coal-fired project,” he says.

Reliance has made significant gas finds, and the speed at which such fields can be brought to market, along with rising levels of LNG imports, will be important drivers of the role of gas in India’s generation mix.

“Even if projects secure the supply of natural gas under the Government of India’s administered price mechanism, they are unlikely to be immune from volatility in prices, which will likely retain some linkage to global trends,” Fitch predicts.