August 2012

SRI LANKA POWER SECTOR FIRING THE RAIN

Published by :

RAM Ratings (Lanka) Limited

(P B - 1636)

No. 11, Melbourne Avenue, Colombo 4 Sri Lanka

T F E W

+94 112 553089 +94 112 503551 +94 112 553090 ram@ram.com.lk www.ram.com.lk

AUGUST 2012

SRI LANKA POWER SECTOR FIRING THE RAIN

OVERVIEW
Analytical Contacts:

Senila Jawfer Senior Financial Analyst (94)11 2553089 senila@ram.com.lk Prashani Illangasekera Manager Ratings (94)11 2503551 prashani@ram.com.lk

Drawing parallels to many emerging economies in the world, Sri Lanka has been grappling to meet the rising demand for power. Reaping the benefits of the peace dividend, the countrys economy has been showing robust growth, in turn accelerating the demand for power. In the interest of speedy capacity augmentation and as Sri Lankas large hydro power resources have already been utilized, the industry has diversified to thermal power, resulting in a gradual shift in the industry power mix. As such, in order to meet the surging demand for power, the Government of Sri Lanka (GOSL) has focused on increasing installed capacity via thermal generation; however, given the longtailed nature of these investments, the dependence on the private sector, consisting of Independent Power Producers (IPPs) is expected to grow in the short-medium term. Over the past decade, the private sectors contribution has continued to rise, with the sector fulfilling around 43% of the countrys power requirements during 2011, compared to less than 10% in 2000. The countrys IPP sector comprised 115 producers as at end-December 2011, with 90 players focusing on mini-hydro power. That said, in terms of power generation, thermal sources accounted for nearly 86% of total units in 2011, given the high capacity of these plants. Despite its high cost, the rising demand and the lack of diversity in Sri Lankas energy resources will compel the nation to rely more on thermal power, which is expected to contribute increasingly towards satisfying the countrys power requirements going forward. That said increasing reliance on thermal sources is expected to give rise to a range of other concerns; given Sri Lankas lack of coal resources the country will have to rely on increasingly expensive coal imports which is likely to impinge upon the trade deficit. As such, the importance of diversifying the countrys energy sources cannot be over emphasized.

Published by :

RAM Ratings (Lanka) Limited

(P B - 1636)

No. 11, Melbourne Avenue, Colombo 4 Sri Lanka

T F E W

+94 112 553089 +94 112 503551 +94 112 553090 ram@ram.com.lk www.ram.com.lk

Elsewhere, with regards to the performance of the IPP sector, RAM Ratings Lanka observes that given the poor rainfall in 2011 and the first half of 2012, hydro power producers have recorded weakening performance indicators; the situation has been further exacerbated by the near 7% reduction of tariffs (for power purchase agreements based on avoided cost basis). Conversely, thermal power producers have benefitted from increased capacity utilization, as the Ceylon Electricity Board (CEB) had relied more on thermal power. This emphasizes the need for IPPs to diversify their energy sources. Meanwhile, based on publicly available information, RAM Ratings Lanka observes that the financial profile of the IPPs was moderate during the year. Given the rise in fuel prices and resultant increases in working capital requirements, IPPs operating thermal powered plants had to rely on short-term borrowings, thus pushing up gearing levels. That said, the cash protection metrics of the sector remained relatively good. As the nation grapples to address the issue of rising demand, RAM Ratings Lanka opines that the IPP sector is well poised to benefit from the demand-supply gap. The overall favorable economic prospects, increased investments in the industrial and manufacturing sectors, coupled with the governments long -term vision of electrifying all households is expected to augur well for the IPPs, which are expected to see rising demand in the medium term. Conversely on a more macro scale, it is imperative that suitable policy measures are adopted to diversify the countrys energy sources as well as increase private sector participation, particularly in the nonconventional renewable energy (NCRE) segment.

NDUSTRY STRUCTURE :

Power sector continues to be dominated by state-owned CEB

The local power sector continues to be dominated by the state-owned CEB - the sole entity with the right to all aspects of the value chain comprising generation, transmission and distribution of power. With regard to the latter, all areas except for the distribution in the Western and the Southern Coastal areas of the country are undertaken by Lanka Electricity Company, which is majority owned by the CEB. The CEBs control is likely to continue in the power sector owing to the Sri Lanka Electricity Act of 2009 (the Act). As per the Act, only state or public institutions will be eligible for licences for electricity generation of more than a capacity of 25 megawatts (MW). Conversely, private-sector participants can obtain licences to generate electricity so long as the plants capacity is less than 25 MW. We note that private sector participation, has been increasing, accounting for as much as a third of the sectors installed capacity from 2000 -2010 (refer to Chart 1). The private sectors (which is primarily oil-based thermal power plants) share of installed capacity had dipped in 2011, as the first stage of the coal power plant commenced by the CEB had added 300 MW to the national grid; this concurrently increased the CEBs share of installed capacity to 66% (2010: 62%).

Chart 1: Installed capacity composition

100% 90% 80%

Installed Capacity (%)

70% 60%

50%
40% 30% 20% 10% 0% Private CEB 2000 10% 90% 2001 10% 90% 2002 12% 88% 2003 18% 82% 2004 23% 77% 2005 27% 73% 2006 28% 72% 2007 28% 72% 2008 34% 66% 2009 35% 65% 2010 38% 62% 2011 34% 66%

Source: Central Bank of Sri Lanka- Economic and Social Statistics 2012, RAM Ratings Lanka

IPP contribution expected to be significant in the short-medium term In terms of power generation, the IPPs contribution to satisfying the nations power requirement has been augmenting. The private sector fulfilled 43% of power demand as at end-2011 to the total power demand (refer to Chart 2) as opposed to 40% in the previous year. Despite the CEB having a greater share of the installed capacity in 2011, the increasing contribution to units generated by the IPPs reflects its significance in the power sector to meet the rising demand. As the country grapples with the problem of growing demand we opine that contribution from IPPs is expected to increase going forward. Although, GOSLs major power plant projects currently underway are expected to help increase generation capacity by 44% in 2016, in the short-medium term, IPPs are expected to remain significant contributors to power generation in order to meet the growing demand.

Chart 2: Power generation mix between CEB and IPPs

100% 90%

Units Generated (%)

80% 70% 60%

50%
40% 30% 20% 10% 0% Private CEB 2000 15% 85% 2001 20% 80% 2002 23% 77% 2003 25% 75% 2004 30% 70% 2005 39% 61% 2006 37% 63% 2007 39% 61% 2008 42% 58% 2009 45% 55% 2010 40% 60% 2011 43% 57%

Source: Central Bank of Sri Lanka- Economic and Social Statistics 2012, RAM Ratings Lanka

OWER MIX :

Gradual shift in the power mix

Meanwhile, the countrys power-generation industry had been wholly reliant on hydro sources in the past. However, this dependency had rendered the sector vulnerable to fluctuations in rainfall. In the interest of speedy capacity augmentation and as Sri Lankas large reserves of hydro power have already been utilised, the CEB had diversified to thermal power, resulting in a gradual shift in the industry power mix (refer to Chart 3). In 2011, as the first stage of Norochcholai coal power plant was complete and added 300 MW to the national grid, the installed capacity of thermal power plants made up 54% of the power mix. However, IPPs remain the majority contributor to thermal power. Most IPPs operate petroleum fuel based thermal power plants and some operate coal-based thermal power plants. A minority are engaged in mini-hydro power production, each of which adds less than 10 MW to the national grid (refer to Table 1).

Chart 3: Trend in power mix (based on installed capacity)

100% 90% 80%

Power mix (%)

70%
60% 50% 40% 30% 20% 10% 0% Other * Hydro Thermal 2000 0% 35% 65% 2001 0% 39% 61% 2002 0% 39% 61% 2003 0% 44% 56% 2004 0% 44% 55% 2005 0% 46% 54% 2006 0% 46% 54% 2007 0% 46% 54% 2008 0% 49% 51% 2009 0% 48% 52% 2010 2% 49% 49% 2011 1% 44% 54%

Source: Central Bank of Sri Lanka-Economic and Social Statistics, RAM Ratings Lanka *Other includes bio-mass, solar and wind power

Table 1: Installed capacity and Power generation mix for IPPs Capacity in MW Units Generated in GWh

Hydro Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 12 24 34 40 73 84 107 117 138 172 175 192

Thermal

Other

Hydro %

Thermal %

Other %

Hydro

Thermal

Other

Hydro %

Thermal %

Other %

174 174 193 355 452 567 567 567 737 742 842 842

0 0 0 0 0 0 0 0 12 12 42 47

6% 12% 15% 10% 14% 13% 16% 17% 16% 19% 17% 18%

94% 88% 85% 90% 86% 87% 84% 83% 83% 80% 80% 78%

0% 0% 0% 0% 0% 0% 0% 0% 1% 1% 4% 4%

43 65 103 120 206 277 345 344 428 525 646 602

917 1170 1248 1711 2064 3152 3082 3528 3680 3883 3601 4253

0 0 0 0 0 0 0 0 6 23 83 113

4% 5% 8% 7% 9% 8% 10% 9% 10% 12% 15% 12%

96% 95% 92% 93% 91% 92% 90% 91% 89% 88% 83% 86%

0% 0% 0% 0% 0% 0% 0% 0% 0% 1% 2% 2%

Source: Economic and Social Statistics, RAM Ratings Lanka

Thermal power to spearhead energy generation?

According to the CEBs long-term generation plans, thermal power is expected to spearhead the countrys energy generation by 2022; with coal making up 72.8%, gas turbines at 6% and petroleum at 3.7%. While coal stands a cheaper alternative to oil, relying on coal would still be an expensive option for the country; particularly given that Sri Lanka does not have its own coal resources, and considering the anticipated increase in demand for coal from developing countries and resultant price increases1 in the long run, is likely to impinge upon the countrys trade balance and foreign exchange reserves. Industry analysts opine that focus on biomass, solar and wind which are renewable sources would provide a more sustainable energy mix in the long-term; currently these contribute to 1% of total power ge neration. However, the countrys current reliance on oil due to lower hydro power generation is viewed with concern considering the rising global demand for oil, coupled with the instability and turmoil in the Middle Eastern regions, which is expected to drive up the oil prices going forward, subsequently impacting generation costs.

ERFORMANCE OF THE POWER SECTOR IN 2011:

Consistent rise in demand

The demand for power is supported by the overall economic expansion, growing investments in the manufacturing and the industrial segments, and rising population. The countrys macro -economic landscape has propelled amid the brighter prospects following the end-of the 30 year ethnic conflict. As such, in 2011, the countrys Gross Domestic Product (GDP) grew at 8.30% year-on-year (y-o-y) with a corresponding growth in the average electricity consumption per capita by 6.90% y-o-y. Although the total installed capacity increased to 3,141.08 MW in 2011 from 2,818.02 MW in 2010, the power sector is grappling to meet the rising demand. Going forward, the demand for power is expected to accelerate on the back of the expanding economy. The GOSL has already ventured into new projects gearing itself to meet the increased demand (refer to Table 2). While the CEBs long-term generation plan targets a capacity of 5,430 MW by 2020, industry analysts believe that a greater installed capacity would be required to meet the rising demand.

Chart 4: Economic growth and average electricity consumption per capita

10.00%
8.00%

Growth (%)

6.00% 4.00% 2.00% 0.00% -2.00%

2005 6.03% 6.20%

2006 6.78% 7.70%

2007 5.08% 6.80%

2008 0.48% 6.00%

2009 -0.72% 3.50%

2010 8.72% 8.00%

2011 6.90% 8.30%

Average electricity consumption per capita GDP

Source: CEB Statistical Digests, Central Bank of Sri Lanka, RAM Ratings Lanka

Table 2: Projects underway Projects Installed Capacity (MW) 300 600 150 120 500 Phase Phase I Phase II Initial Initial Status Complete Commenced Complete Commenced Commenced Target/Completion Year 2011 2014 2012 2015 2016

Norochcholai Coal Power Plant Upper Kotmale Hydro Power Plant Uma-Oya Hydro Power Project Trincomalee Coal Power Plant

Source: Central Bank of Sri Lanka, RAM Ratings Lanka

Power outages The need to diversify energy sources is evident from the detrimental impacts of power outages in any particular region. Electricity outages discourage investments and disrupt economic activity. A study by the United States Agency for International Development (USAID) estimates that outages in Sri Lanka and Bangladesh in the past have cost the economies an equivalent of one-half of percentage point of GDP in 2004 and 2008. Although power outages had reduced over the years, technical failures of late in Sri Lanka had resulted in power outages in the country; the Norochcholai coal power plant had been experiencing technical difficulties and deprived the grid of 300 MW. Amid adverse weather conditions and weaker hydro power generation, such technical difficulties in the nations thermal power plants, the only other significant back up source of energy, cuts back on the amount of power that can be supplied to the grid. In light of this, RAM Ratings Lanka opines that diverse sources of energy are crucial to lessen the impact of power supply interruptions.

Future of Coal Power: Asoka Abeygunawardene

High generation cost result in higher tariff rates In 2011, due to the adverse weather conditions, the CEB had to rely on more expensive thermal power generation which made up a higher proportion of the mix in 2011 (refer to Chart 5). In 2009 and 2010 the average cost of generation of CEBs thermal power plants were at 14.33 LKR/kWh and 15.77 LKR/kWh, much expensive in comparison to cost of generation of its hydro power plants at 1.71 LKR/kWh and 1.17 LKR/kWh respectively during the same periods. With global primary energy demand projected to grow 36% from 2008 to 2035, oil prices are expected to increase 50%-100% by 20302. As Sri Lanka is dependent on petroleum oil for thermal power generation currently and has less diverse energy reserves (refer to Table 4), the rise in oil prices would further impact the average cost of electricity generation. Due to the higher cost of thermal generation, as well as attempts to stem losses for the CEB, the average tariff rates to households were also revised upwards in 2011 (refer to Table 4) with further revisions made in February 2012.
Chart 5: Power mix (based on electricity units generated)

Other 1%

2010

Other 1%

2011

Thermal 47%

Hydro 40%

Hydro 52%

Thermal 59%

Source: Central Bank of Sri Lanka Economics and Social Statistics 2012, RAM Ratings Lanka

Table 3: Energy reserves of SAARC members states Coal (million tons) Afghanistan Bhutan Bangladesh India Maldives Nepal Pakistan Sri Lanka 440 2 884 90,085 NA 17,550 NA 108,961 Oil (million barrels) NA 12 5,700 324 150 6,186 Natural Gas (trillion cubic feet) 15 8 39 33 95 Hydropower (megawatts) 25,000 30,000 330 150,000 42,000 45,000 2,000 294,330 Biomass (million tons) 18-27 27 0 139 0 27 NA 12 205

Source: Energy Trade in South Asia Opportunities and Challenges-ADB December 2011, RAM Ratings Lanka

Energy Trade in South Asia Opportunities and Challenges-ADB December 2011

Table 4: Tariff Revisions 2009-2012 Domestic (LKR/unit) Industrial (LKR/unit) 2009 10.42 13.02 2010 10.42 13.02 2011 10.49 13.05 2012 13.97 12.87

Source: Ministry of Finance and Planning Annual Report 2011, RAM Ratings Lanka

Based on the current projects underway, which include the use of coal, the energy sources are expected to see some diversity, reducing the heavy dependence on petroleum fuels. This would improve the general energy security and also reduce the cost of generation. However, we expect the tariff rates to households to increase in the short-medium term in light of the increasing crude oil prices as well as until the country has achieved sufficient diversification of its sources of power to meet the rising demand.

ATING CONSIDERATIONS FOR IPPs :

RAM Ratings Lankas assessment of an IPPs credit profile is based on several areas of risk; these include operational, construction, fuel supply, customer concentration and financial profile.

Operational risk
The IPPs ability to generate revenue, plays a major role in determining its capacity to fulfill its financial obligations. An IPPs revenue levels are dependent on several factors, such as its power purchase agreement (PPA) tariff structure, source of generation, weather conditions and fuel costs. The PPA, underscores the viability of the power project, is the most important contract supporting an IPPs creditworthiness. RAM Ratings Lanka reviews the PPA to identify potential loopholes in the contract that may have a negative impact on the projects ability to generate revenue, and ultimately affect its credit rating. Currently, in Sri Lanka thermal powered plants tariffs are based on two components - capacity and energy charges. The capacity charge represents debt obligations as well as returns to the shareholders and a fixed maintenance charge whilst the energy charge takes into account fuel costs and variable maintenance costs. Meanwhile, the tariff rates for small power producers, although prev iously based on a principle of avoided cost is now based a more cost reflective structure; PPAs signed after 2008 follow 3-tier tariff system over their 20year span and is fixed upfront. Under these PPAs, CEB factors in the cost of financing, construction, maintenance and expected profits when arriving at tariff levels. Meanwhile, IPPs which had signed PPAs prior to January 2008, have the option of switching to the current structure or abiding by the agreed tariff. As such, we understand that some older projects that are still under the avoided cost method and companies under these contracts have been adversely affected by the reduction in tariff rates in 2011 (refer to Chart 6).

Chart 6: Avoided cost tariff rate revisions

14.00 12.00 10.00

LKR/kWh

8.00 6.00
4.00 2.00 0.00 2000 3.11 2.76 2001 4.20 4.00 2002 5.13 4.91 2003 6.06 5.85 2004 5.70 4.95 2005 6.05 5.30 2006 6.73 5.82 2007 7.64 6.94 2008 9.65 8.94 2009 11.17 10.59 2010 11.94 11.09 2011 11.19 10.23

Dry Season (LKR/kWh)

Wet Season (LKR/kWh)

Source: RAM Ratings Lanka

Understandably, the source of generation is also a crucial factor in determining revenue. Generally, during prolonged periods of rain, thermal dispatch declines and vice versa. For instance, in 2011, the protracted drought in Sri Lanka affected all hydropower IPPs resulting in the country having to rely on thermal sources. Resultantly, (based on publicly available information) hydropower IPPS such as Vidullanka PLC, Vallibel Power Erathna PLC, Hydro Power Free Lanka PLC recorded saw a contract ion in revenue during the FYE 31 March 2012 (FY Mar 2012). The situation was further exacerbated by a reduction in the avoided cost based tariff. Conversely, Hemas Power PLC which operates both thermal and hydro power plants was able to somewhat insulate itself owing to its diverse power mix, thus underscoring the importance of diversity. With more reliance being placed on thermal power, overall Hemas Power PLC saw revenues increase during FY Mar 2012 (refer to Chart 7); this was also contributed by the pass-through effect of the fuel price hike towards the latter part of the fiscal year. Looking ahead, the reliance on thermal power is expected to persist, at least in the short-term as the country continues to suffer from poor rainfall. As such, hydro power operators are likely to see contracting revenues.

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Chart 7: Revenue trends of sample listed IPPs

600.00

6,000.00

Revenue (LKR million)

400.00 300.00

4,000.00 3,000.00

200.00
100.00 0.00 FY Mar 2009 FY Mar 2010 FY Mar 2011 FY Mar 2012

2,000.00
1,000.00 0.00

Vallibel Power Free Lanka Vidullanka Hemas Power

365.83
0.00 230.27 4,870.45

437.69
114.92 324.88 2,867.40

533.59
135.19 362.85 3,411.90

377.91
56.42 252.35 4,510.00

Source: Respective Annual Reports, RAM Ratings Lanka Vallibel Power Erathna PLC= Vallibel Power; Hydro Power Free Lanka PLC= Free Lanka; Vidullanka PLC=Vidullanka;Hemas Power PLC=Hemas Power

Meanwhile, profitability trends will also vary across IPPs based on the source of generation, capacity utilization levels, tariff rates, exposure to exchange rate risks as well as fuel costs. Generally, thermal powered plants have higher operational and maintenance (O&M) costs thus leading to thinner profitability margins, whilst hydro power operators command relatively wide margins. Overall, during 2011 the IPP industry saw weakening profitability indicators owing to several factors; hydro power producers were negatively impacted by the poor rainfall which contributed to low generation levels, whilst the reduction of the avoided-cost based tariff by around 7% also impinged upon profitability. On the other hand, notwithstanding the better top line, thermal power producers also saw declining net profit margins, partially contributed by the sharp depreciation of the domestic currency against the greenback which resulted in significant exchange losses. As depicted in Chart 8, overall the sector saw a narrowing of profit margins.

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Revenue (LKR million)

500.00

5,000.00

Chart 8: OPBDIT margins for sample listed IPPs

Source: Respective Annual Reports, RAM Ratings Lanka Vallibel Power Erathna PLC= Vallibel Power; Hydro Power Free Lanka PLC= Free Lanka; Vidullanka PLC=Vidullanka;Hemas Power PLC=Hemas Power

Construction risk
Successful completions of projects for most IPPs An IPPs revenue risk only comes in after the plants construction has been completed and it has been commissioned. Failure to complete on time can lead to cash flow deficiencies; under the PPA, the IPP failing to achieve the agreed milestones can be construed as a default. The construction phase invariably poses the single largest risk; credit-rating agencies only upgrade an IPPs rating upon elimination of this risk. We note that Vallibel Power had successfully commissioned 2 new hydro-power plants in 2011 and Hemas Power had commissioned the 2.4 MW Magalganga hydropower plant in the same year. Meanwhile, the latter, Vidullanka, and Free Lanka have invested in projects that are still underway (refer to Table 6). Delays in completing the projects would reduce the cash flows to the IPP, in this regard, Vidullanka may encounter cost overruns as construction of Ethamalla Ella MHPP has been halted on the directive of the Central Environmental Authority and is currently delayed due to legal reasons.

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Table 5: IPPs projects and new investments IPP Operational Projects Erathna MHPP Denawaka Ganga MHPP Kiriwaneliya MHPP Sanquhar Estate Delta Estate Heladhanavi Limited Hemas Power Magalganga Hydropower Giddawa Power Plant Agra-Oya Gurugoda Hydro (Pvt) Ltd Batathota MHPP Bambarabatuoya MHPP Installed capacity (MW) 10.00 7.20 4.65 1.60 1.60 100.00 2.40 2.00 2.60 1.20 2.00 3.20 1.2 New projects Installed Capacity (MW)

Vallibel Power Free Lanka

Other MHPPs Biomass

5.40 3.00

Lower Kotmale MHPP Madugeta MHPP Wembiyagoda MHPP Hal Oya MHPP

4.00 2.50 1.30 0.80

Vidullanka

Ganthuna MHPP Source: Respective Annual Reports, RAM Ratings Lanka

Fuel-Supply Risk
All fuel-supply agreements with state-owned CPC Fuel-supply risk is assessed by reviewing the arrangement between the IPP and its fuel supplier. In Sri Lanka, all fuel-supply agreements are with state-owned Ceylon Petroleum Corporation. Fuel cost is by far the largest operating expense of a power plant. Again, the PPA becomes a focus point here as well in determining market risk, if any. Meanwhile, RAM Ratings Lanka also evaluates the risk of fuel supply not being available to fire the power plant. Understanding the suppliers procurement and delivery processes is also important in order to assess the certainty of the IPPs fuel supply. On this note, some comfort can be derived from the existence of onsite fuel storage as a back-up in the event of any supply interruption.

Concentration Risk
CEB sole off taker but risks are mitigated to some extent In Sri Lanka, the CEB is the sole off-taker; hence the IPPs debt-servicing aptitude depends on the off-takers willingness and ability to pay its dues in a timely manner. As such, the rating of an IPP cannot exceed the rating of the off-taker. In this regard, RAM Ratings Lankas assessment of the CEB is based more on its systemic importance rather than its financial profile. As such, given its systemic importance to the GOSL, we opine that financial support will be forthcoming to CEB when the need arises. That said, delays in receiving payments from CEB have at times constrained the cash flows of the IPPs, thus resulting in them having to rely on short-term borrowings to fund working capital requirements. RAM Ratings Lanka observes that this is particularly true for periods of poor rainfall, when the state-utility is compelled to rely on more expensive thermal power thus hampering its cash inflows. As such, in contrast to the previous years profit of LKR 359 million, in 2011 the CEB made losses of LKR 19.27 billion, despite a 9% growth in revenue. Furthermore, IPPs also face renewal risks if the term of the PPA expires for which the CEB has the ability to either refuse or change the terms in an unfavourable manner; that said, considering the increasing demand for power and the required support from IPPs, these risks are somewhat mitigated. 13

Financial profile
The financial profile of an IPP plays a key role in determining its credit rating; RAM Ratings Lanka takes into consideration factors such as funding structure, reliance on debt, debt repayment schedules etc. Given the nature of the industry, too much debt or an extremely aggressive debt-repayment schedule can expose project lenders to significant risks. That said an IPP with a proven and relatively stable cash-generating ability could take on additional debt without downward rating pressure, if its debt servicing aptitude is not compromised. Based on publicly available information, RAM Ratings Lanka notes that the Sri Lankan IPPs have moderate gearing levels (refer to Chart 9). As highlighted previously, increased fuel prices during the year which rendered higher working capital requirements and delays in obtaining payments from the CEB (particularly true for thermal producers) resulted in the IPPs having to rely on short-term borrowings; this had caused an increase in gearing levels. Meanwhile, IPPs with on-going projects, for example Vidullanka PLC understandably have higher debt levels. Overall, RAM Ratings Lanka also notes that the cash-protection metrics of most IPPs were relatively good.
Chart 9: Gearing ratio of sample listed IPPs
1.20 1.00

Gearing ratio

0.80

0.60
0.40 0.20 0.00 FY Mar 2009 0.00 N/A 0.98 0.32 FY Mar 2010 0.03 0.14 0.51 0.24 FY Mar 2011 0.04 0.04 0.51 0.23 FY Mar 2012 0.04 0.01 0.66 0.31

Vallibel Power Free Lanka Hemas Power Vidullanka

Source: Respective Annual Reports, RAM Ratings Lanka

Outlook for IPPs

As the nation grapples to address the issue of rising demand, RAM Ratings Lanka opines that the IPP sector is well poised to benefit from the demand-supply gap. The overall favorable economic prospects, increased investments in the industrial and manufacturing sectors, coupled with the governments long-term vision of electrifying all households is expected to augur well for the IPPs, which are expected to see rising demand in the medium term. Conversely on a more macro scale, it is imperative that suitable policy measures are adopted to diversify the countrys energy sources as well as increase private sector participation, particularly in the NCRE segment.

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StandPoint Commentary

No statement in this paper is to be construed as a recommendation to buy, sell or hold securities, or as investment advice, as it does not comment on the security's market price or suitability for any particular investor. Published by RAM Ratings (Lanka) Ltd Reproduction or transmission in any form is prohibited except by permission from RAM Ratings (Lanka) Ltd. Copyright 2012 by RAM Ratings (Lanka) Ltd

RAM Ratings Lanka receives compensation for its rating services, normally paid by the issuers of such securities or the rated entity, and somet imes third parties participating in marketing the securities, insurers, guarantors, other obligors, underwriters, etc. The receipt of this compensation has no influence on RAM Ratings Lankas credit opinions or other analytical processes. In all instances, RAM Ratings Lanka is committed to preserving the objectivity, integrity and independence of its ratings. Rating fees are communicated to clients prior to the issuance of rating opinions. While RAM Ratings Lanka reserves the right to disseminate the ratings, it receives no payment for doing so, except for subscriptions to its publications.

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