Risks Embedded in Energy & Infrastructure Sector

Major Investment Risks in Energy - Power Generation Sector

• Coal blocks for thermal power plants. High grade coal is in shortage in emerging markets. Getting coal blocks for nearest coal mine is of essence to the succcess of power plant. Recently many companies have started importing coals from other countries but the transportation cost increases the cost per unit trememdously significantly reducing the ROI.
• Land allocation is another major risk faced by developers. As it require clearances from residents, avaition, forest and several other departments before land could be allocated for commissioning of power plant.
• Timely competion of power plant and within budget is major risk. Based on historic data 70% of energy & infrastructure projects overrun cost by almost 100%.
• Macro enonomic risks. As it take 5-7 years for commissioning of power generation projects. And there after the payback period is usually about 10 years. even though power generation companies are more resistant to economic cycles, but if the split between residential and commercial demand is skwed more towards commercial and industrial sector, the risks decline in demand increases with decline in GDP growth.
• Political Risks. In emerging markets government plays very crucial role in the success of infrastructure projects. For example in power sector in India, there is only one Power Transmission Company which is quasi government body. Hence every power generation plant needs to work with Power Transmission Company to transmit power from plant to consumers. Secondly in emerging markets majority of public utility companies are owned by government, hence state or central government is the largest buyer of power. Therefore any change in power at the center or state level combined with change in leadership at the PSUs can signigicantly impact the profitability of power plant negatively or positively.
• Several other risks include cultural risk, social risk, management risk, corporate risk.

Rest to come tomorrow .... keep tuned to this blog

Emerging Markets - Benefits of Investing in Power & Infrastructure Sector

Power & Infrastructure Sector in emerging markets is still somewhat immune to recent financial meltdown as evident by some of the recent deals in the sector and closing of new private equity funds.

Some of the most important benefits of investing in Power and Infrastructure Sector are:

• Significant underlying asset base, whether through ownership of, or contractual or concession based rights to the economic benefits of, the asset base;
• Relatively low volatility return, given that, in general, the main risks to cash flows can be quantified and mitigated through contractual agreements and other means;
• Primary value creation through optimization of capital structure with less of a focus on planned transformational and operational change than would typically be seen with a private equity asset;
• Low correlation of returns to macro-economic cycles, given the essential nature of assets and services provided by the businesses, which leads to high barriers to entry and relative price inelasticity;
• Partial correlation of returns to inflation; and
• Potential for material capital growth including gains from refinancing.

Blog on Risks of Investing in Power & Infrastructure Sector will posted tomorrow.

Palak (Jane)