N-powering India - Wait & Watch

India needs more power. The country's peak time power shortfall is 14.8% of demand
and this gap is expected to widen. Currently, India's total power generation stands at 124 GW. Of that, coal comprises 55%, hydroelectric 26%, natural gas 10%, renewable
5% and nuclear energy only 3%.

Background of the India-US nuclear deal

The primary reason for India's poor nuclear power production has been chronic
uranium shortage, which incidentally was the main driving force for the India-US
nuclear deal. India won the right to buy nuclear energy supplies after the 45-country
Nuclear Suppliers Group granted a waiver for sales to the country outside the nuclear Non-Proliferation Treaty on Sept. 6, 2008. This deal ends a 34-year embargo and gives India the right to buy nuclear reactors from abroad and access nuclear fuel from the global market.

Estimated market size

According to a recent McKinsey report, the demand for power is likely to rise from the current ~120 GW to ~360 GW by 2017. The total power generation capacity will have to be pushed up by ~240 GW. Assuming that the share of nuclear energy grows to 7% (as estimated by many analysts), India would need nuclear power generation of ~25,000 MW. Also, if we assume that all nuclear power reactors are of 1000 MW size, with each costing ~USD 4 billion, the total market size, in terms of value, would be ~USD 100 billion.

Market structure and players

The nuclear power generation business is capital-intensive. A nuclear power plant costs Rs. 18-19 crore per MW capacity to build, against Rs 4-5 crore for a coal-fired plant or Rs 3-4 crore for one running on gas. So, the ensuing market structure is likely to omprise of many large sized players and still be fragmented in nature. For instance, USD 1.2 billion GVK group, BHEL, L&T, Tata Power, Jindal and Videocon are among the 40 companies in contention for contracts to build nuclear reactors and ancillary infrastructure. This fragmented market structure may result in priceundercutting and lower returns on investment (ROI) initially for all players. Currently, only one player, Nuclear Power Corporation of India Ltd (NPCIL), with an installed capacity of 6,500 MW, operates in the market. NPCIL operates only 40% of its capacity, mainly on account of lack of uranium supplies.

Drivers

Huge market size: The opportunity worth USD 100 billion is the prime driver for the market. Almost 40 domestic companies were vying to enter the market even before the US Congress cleared the deal. Cost structure of the business: In a conventional plant, fuel costs constitute 50% of the total cost and capital expenditure constitutes the remaining 50%. In a nuclear plant, the capital expenditure makes up for 80% of the total cost while fuel costs account for only 20% of the total cost. In the long term, a nuclear plant becomes cheaper to run than a conventional unit. This implies that the business will be of a fixed cost nature and will not be subject to the vagaries of raw material prices.

Entry Barriers

India's Atomic Energy Act of 1962 allows only government-owned companies i.e. with at least a 51% GOI (Government of India) stake, to enter the market. However, this will be amended soon to allow private players to enter the market.

Lack of a public-private partnership (PPP) model: This model is needed to sort out issues like power purchase agreements, tariffs, taxes and liabilities in the event of an accident. Currently, the GOI bears the liability for the cost of damages, in case of an accident. Long gestation period and high initial costs: A nuclear plant takes 3-5 years to build as against 2-3 years for a conventional thermal plant. Also, in the initial stages, electricity from a nuclear plant costs Rs 6.5 per unit as against Rs 2.5-3.0 from conventional units. All of these may result in component supply contracts encashment only after the plant becomes operational and starts generating cash inflows. The long gestation period and low initial returns may dissuade small players from entering the market.

Opportunities

The recent financial crisis in the US is estimated to be ~USD 2 trillion in size. To fill out this void, the US government will try to increase the GDP as fast as possible. This may lead to increased sale of nuclear power technology and wares to India. The ease of availability of technology and wares may attract more players and increase the total market size. The above-mentioned opportunity may also help India to wrest the deal along with fuel supply agreements from US vendors. This will also increase competition among all foreign vendors (for instance France) and will help Indian companies in clinching better deals.

Threats

Dependence on foreign fuel supplies: This has been a threat in the past too. Although fuel supply agreements may be incorporated in the deal, there is a lack of assured indigenous supply. India's uranium mines are mainly in Jharkhand, Andhra Pradesh and Madhya Pradesh, which are Naxalite (terrorist) infested territories, and much of these mines are thus out of bounds for exploration. Another uranium ore site in Meghalaya faces serious environmental objections. There has been a good find in Domiasiat near the Bangladesh border, but that too is subject to security issues. Also, Indian uranium is poor in quality. The ore concentrations are only 300 parts per million (ppm) as against optimally required 600-700 ppm. Going forward, this will be a threat, as any consolidation among suppliers will lead to disruption of supplies and losses in the business.

Conclusion

Given the long gestation period, the earnings stream will be visible after a long time. Investors can follow a wait and watch policy for entering this market.
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