New Delhi: At approximately 70 percent of generation, coal is the dominant fuel for electricity in India. Most coal in India, (again, approximately 70%) is used for power generation. For various reasons, including coal's historic cost-competitiveness, energy security, incumbency and ability to provide baseload power; many believe that coal is likely to remain the dominant fuel for power generation in India.
Many majority government-owned entities — such as Coal India and Indian Railways — rely heavily on revenues from coal production and transportation. Coal power generation is directly proportional to coal consumption in the form of coal sales for Coal India and corresponding coal transportation fees for the Indian Railways. Coal, therefore, directly affects the revenues, cash flows, and the financial health of these entities, said IEEFA (Institute for Energy Economics and Financial Analysis) in its latest report.
Coal power generation is, however, under pressure from the increasing penetration of low-cost, domestic renewable energy into India's power system. This trend was initiated under India's solar and wind targets in the previous decade. It has been further strengthened under India's commitment to the Nationally Determined Contributions (NDCs) in the Paris Agreement, in which renewable energy capacity is supposed to increase to 40 percent of generation capacity, or 350 gigawatts (GW), in absolute terms by 2030.
This effect — coal power being under pressure — is known as climate transition risk. It connects climate-related policy, legal, technology, and market changes to the financial health of assets, companies, and sovereigns. The implications for coal are not only via countries' climate targets, but also arise from the rapidly falling costs of renewable energy and related technologies, such as battery energy storage systems (BESS), and their interplay with policies and markets.
This raises the question: What is the likely impact of transition risk brought about by the rapidly falling costs of renewable energy and BESS on Coal India? This risk exists despite the fact that Coal India (has so far enjoyed) de facto monopoly that enjoys price certainty. It currently not only supplies more than 80 percent of domestic coal and more than 60 percent of all coal used in India, but also enjoys government-supported cost-plus pricing.
Despite Coal India's seemingly comfortable position, its climate transition risk is significant. In fact, it appears that transition risk has been partially factored into how financial markets perceive Coal India over time. As evident from the chart below, Coal India's stock market valuation has seen progressive, ongoing, and serious erosion, despite steady growth in the market itself over the last five years.
Source: Yahoo Finance via IEEFA
This risk is going to increase as renewable energy becomes increasingly cost-competitive, as evident from recent auctions resulting in record low tariffs at Rs 2.36/kWh. This is likely to influence policy and markets to further support greater uptake of renewable energy at the expense of coal power, which would have direct consequences for Coal India's revenues and cash flows via reduced coal sales, even if it continues to enjoy a de-facto monopoly along with price certainty, said IEEFA in a report.
Calculation of this risk requires the identification of likely scenarios with high renewable energy penetration, above and beyond India's NDCs. In fact, given the rapidly falling costs of renewable energy and battery storage, a recent analysis at the Lawrence Berkeley Laboratory shows that the most cost-effective option for India to manage its power supply options to 2030 is to deploy 450GW of renewable energy, at least 100GW (one third) higher than implied by India's NDCs.
This ambitious renewable energy scenario (i.e. 450 GW by 2030), which is also recognised by the Indian government as an aspirational target, has been missed by most financial analysts, primarily due to the belief in coal power's dominance. For example, a recent valuation, which is representative of the financial analyst industry, pegged renewable energy penetration at 310 GW by 2030 (ie slightly lower than the NDCs), and calculated the value of Coal India at Rs 1.47 lakh crore or US$19.73billion.
To assess the impact of this high-renewables scenario, we started with the US$19.73bn valuation, and modified it to explore the impact of 450GW of renewable energy capacity by 2030. In this process, we assumed that the impact of increased renewable energy generation would be directly correlated with decreased coal power generation which would then ripple down to reduced coal production for Coal India, resulting in lower revenues, lower cash flows, and lower valuations.
We found that the high-renewables scenario (450 GW by 2030) results in an approximately 14 percent reduction in the valuation of Coal India, a significant decline. Given that the share of renewable energy generation increases by about 10 percent compared to the original valuation, there appears to be a near one-to-one correspondence in the percentage point increase in renewable energy's share of power generation and the percentage decrease in Coal India's valuation.
On the one hand, this linear relationship between the increase in renewable energy's share of power generation and the percentage decrease in Coal India's valuation indicates Coal India's stable position. On the other hand, given this potential (and significant) reduction in valuation, Coal India — and the government of India — should not only acknowledge this risk but also explore avenues for reducing it, potentially diversifying Coal India into climate-friendlier activities such as mining iron ore or lithium, or investing more in renewable projects than is currently planned.
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