Powering the future,- Alternate energy

Once dismissed as kooky ideas spawned by impractical environmentalists, alternative energies are now part of the energy plans and policies of most nations. “Governments all over the world recognise the importance of renewable energy as fossil fuels are finite,” & now aggressively planning investments in renewable energy projects. “Worldwide, the renewable energy industry is growing at 20-30 per cent per annum. Demand exceeds supply in some sectors such as wind energy, and companies are generating returns in excess of their cost of capital.

Fifteen European Union nations, including Spain and Germany, who are world leaders in renewables, have committed to generating 20 per cent of the energy using alternative technologies by 2020. India has also put in place several renewable initiatives and the country is now the world’s fourth-largest generator of wind energy with an installed capacity of 7,093 MW.

Entrepreneurs are venturing into solar power because of the phenomenal growth potential. The United Nations Environment Programme Report (2007) states that renewable energy projects received a record $100 billion (Rs 4,40,000 crore then) in investment in 2006, up from $80 billion (Rs 360,000 crore then) in 2005. Interestingly, venture capitalists are now some of the biggest investors in alternative energy, and their track record of almost single-handedly creating the computer and bio-technology industries is also boosting the industry’s prospects. With glaciers melting, weather patterns changing and the hole in the ozone layer getting larger, western public opinion is increasingly pushing politicians to search for greener energy. In Asian countries such as India and China, there are also more mercantile reasons to follow suit.

India currently produces 130,000 MW of energy a year and this figure will need to double within the next decade. The cost of building the mostly coal-fired plants slated to produce this energy will be a staggering Rs 5,34,000 crore. The environmental and health costs will be even steeper. India is already the world’s fifth-largest polluter, and hospitals across the country are reporting sharp increases in lung and breathing problems, from asthma to cancer. India’s oil bill has also shot up from $7.5 billion (Rs 26,250 crore then) in 1996 to a whopping $50 billion (Rs 2,20,000 crore). By 2010, when Indian consumers are estimated to own 15 million cars, the country’s oil consumption will be twice today’s 2.1 million barrels a day, the US Energy Information Administration says. With global oil production barely 1 million barrels over the global consumption rate of 81 million barrels a day, the surge in demand from India (and China) could eventually lead global demand to outstrip supply, causing fuel prices to shoot up to $100 a barrel. This could cause India’s oil bill to quadruple to $200 billion a year by 2025! More significantly, India will be the only major economy in the world other than Japan importing 90 per cent of its oil needs, a strategic lacuna.

So why hasn’t the alternative energy revolution already happened? Until, recently, the technology just wasn’t there and the cost of producing a MW of wind or solar power was up to five times that of fossil fuels. Now, the costs are evening out, but the challenge for the alternative energy industry is to achieve the scale necessary to become competitive. Standing in the way of this is the powerful oil and gas lobby, which has consistently tried to tie down the alternative energy industry like a bonsai tree. There are only two ways of combating the environmental and human cost of using fossil fuels. “If the government levies an energy tax, like a tax on the pollution caused due to use of conventional energy, it can then try to cover the (environmental and human) cost. This is a rational option but not a social one, as the common man will suffer. The alternative is to provide renewable energy a privileged market: no taxes, zero interest rates, and a new tariff law.”

According to US media reports, the Bush administration, after a series of meetings with a group of energy industry representatives and lobbyists, drew up a controversial National Energy Plan, which doled out $33 billion in public subsidies and tax cuts to the oil, coal, and nuclear power industries. In India, the privatisation of oil exploration has also created a huge anti-alternative energy lobby led by oil companies such as Reliance, Essar Oil and Videocon, in cahoots with auto companies. A sign of their power came when New Delhi recently withdrew a Rs 1 lakh per car subsidy it was about to give the Reva, India’s first electric car.

More importantly, supporters of alternative energy insist that the “full cost” of using fossil fuels is hidden — and could even be higher than the cost of many alternative technologies — because the health, environmental, and defence costs associated with using fossil fuels are not built into their purchase cost. For example, The US-based International Center for Technology Advancement says a gallon of gasoline in the US that costs consumers about $3 (Rs 120) would end up costing the nation about $15 (Rs 600), if the full cost of the medical costs associated with treating people suffering from pollution-related illness, the economic costs of the days lost at work because of people ill with pollution-related problems, the cost of cleaning up the environmental damages caused by fossil fuels and astronomical defence costs associated with oil security were added up.

Given the oil and auto industries have more than a trillion dollars in revenues and have planned investments of nearly $50 billion by 2010, Governments are worry that hurting these industries could dampen growth and damage other industries, such as shipping and ports, steel, petrochemicals, auto ancillaries, and rubber. But supporters of alternative energy, say these losses would be balanced by the totally new industries renewables would create, in the same way that the IT revolution initially cost jobs and killed some industries, such as answering services, but went on to boost global growth.

Significantly, with renewable energy technology maturing and awareness rising, many consumers are sidestepping such policy conundrums and turning into early adopters of these technologies. Still, no alternative energy technology is even close to fulfilling its full promise. More than technological changes, consumers will have to change their attitudes and habits before alternative energy can become what it should — the only energy. Imagine mankind powered by infinite renewable energy. The benefits are driving governments, businesses and individuals all over the world to follow that dream. They know there is no real alternative.

Mid Term policy review- Copious foreign flows

The surging capital inflows continue to pose a policy challenge for the Reserve Bank of India (RBI), as it undertakes its mid-term policy review on October 30, despite some measures taken to contain unregulated inflows. The central bank is unlikely to signal any easing of monetary policy with surplus liquidity in the system, as any lowering of interest rates at this point, could hold upside risks to inflation.The copious capital inflows have forced the RBI to mop up close to $43 billion of foreign exchange since April and $20.5 billion since September alone, to curb rupee appreciation. The rupee has appreciated by over 11 per cent against the dollar since January.

The Prime Minister's Economic Advisory Council had estimated that an increase in the forex reserves of the RBI of $26 billion in 2007-08 could be consistent with the current real growth of the economy, moderate monetary expansion ( 17.5 per cent) and a tolerable inflation rate (4 per cent). "In the current financial year up to early October 2007 itself, forex reserves have increased by over $50 billion and tackling this problem is the most crucial policy dilemma.Of the Rs 1,75,000 crore infused into the system on account of RBI's intervention in the forex market, the RBI has absorbed Rs 1,12,000 crore through issue of bonds under its market stabilisation scheme (MSS) and around Rs 31,500 crore through increase in cash reserve requirements, leaving Rs 30,000 crore of liquidity infused via interventions in the foreign exchange market still to be sterilized.

The central bank has in the last one year raised the CRR or the portion of deposits that banks are required to park with it, by 200 basis points to 7 per cent to absorb the surplus liquidity. The RBI in consultation with the government has also successively raised the MSS ceiling to Rs 2,00,000 crore.The outstanding MSS as of October 26 was around Rs 1,77,000 crore. Out of the margin of Rs 23,000 crore, the RBI will absorb Rs 11,000 crore under its MSS in the two days following the policy review.

The government, however, is not likely to hike the MSS ceiling further this year, considering the fiscal cost involved. At Rs 2,00,000 crore outstanding, the annual cost to the government is already around Rs 14,000. The RBI could by raising the CRR by 50 basis points, absorb another about Rs 15.000 crore.However, the RBI may not want to hike the CRR in the upcoming policy, instead awaiting further curbs by the government on capital inflows.


Sebi has imposed controls on use of participatory notes for investments in equities to stem surging capital flows and make them more transparent. These measures are however unlikely to have any significant impact on foreign portfolio inflows.The RBI Governor, in his speech at the Peterson Institute for International Economics in Washington earlier this month, said, "Risks from global developments continue to persist, especially in the form of inflationary pressures, re-pricing of risks by financial markets and the possibility of a downturn in some of the asset classes. Excessive leveraging has enhanced the vulnerability of the global financial system."

While, there has been a slowdown in credit growth to 23 per cent year-on-year, on October 12, from 29 per cent a year earlier, it is close to the RBI's projected growth of 24-25 per cent for 2007-08. With credit off take expected to pick up in the second half of the year, the RBI may not want to endanger the gains on inflation control front, by lowering either the repo or the reverse repo rate. The wholesale price index inflation stood at 3.3 per cent y-o-y for the week-ended September 29, though the consumer price index at 7.3 per cent, was seen hardening further. The high growth in money supply, at 21.8 per cent, is still above the RBI's target of 17-17.5 per cent. The concerns about overheating of the economy also persist against the backdrop of continued high growth in gross domestic product. According to the Central Statistical Organisation, during the first quarter of 2007-08, the real GDP grew by 9.3 per cent on the back of 9.1 per cent in the last quarter of 2006-07.

BS

Special Export Zone ( SEZ). Business proposition or land grabbing opportunity

On the face of it, setting up a special economic zone (SEZ) seems to be the hottest business to get into. At last count, 263 companies had received formal approvals to set up SEZs, and another 169 had been granted in-principle clearance by the government. Reliance Industries is pumping in Rs 30,000 crore into two SEZs in Maharashtra and another Rs 40,000 crore into a third in Haryana; DLF is investing over Rs 31,000 crore in four units in Amritsar, Ambala, Ludhiana and Gurgaon; and the DS group has a Rs 12,000-crore plan for two SEZs in Haryana and Himachal Pradesh. Others such as Bharat Forge, Videocon, Suzlon, etc., are investing over Rs 1,000 crore each in SEZs in places such as Pune and Mangalore.

Together, they hope to buy, develop and lease out over 300,000 hectares of land. These SEZs will house factories, IT parks, office space, warehouses, residential apartments and malls. A few may morph into cities. All that will call for a cumulative investment of Rs 3,30,000 crore (based on a bare minimum of Rs 138 per sq. ft needed to buy and develop the land). Some, like infrastructure consulting firm Feedback Ventures, put the figure at Rs 5,50,000 crore. That is the equivalent of pumping 10-17 per cent of India’s GDP into one grand realty development plan: corporate India’s biggest investment rush, at least on paper. But amidst all that hype, one fundamental question has been lost: Can SEZs be a viable, profitable and sustainable business venture? Can they earn a decent return on the thousands of crores about to be invested?

The world over, the majority of successful SEZs have been built with government capital. There are few precedents of private capital building economic zones or earning returns out of them. Of course, hundreds of private companies have invested billions of dollars in building their factories and offices within SEZs. That is different. What we are talking about here is the money needed to set up and maintain an SEZ. So far, money for that has largely come from governments.

Dubai’s Jebel Ali Free Zone, one of the world’s most successful zones and home to over 5,000 businesses, is perhaps the best example. In the 1980s, Dubai’s ruler, the late Sheikh Rashid bin Saeed Al Maktoum, pumped in $3 billion in a port in Jebel Ali. It later became the Jebel Ali Free Zone and much of the initial investment (worth $9 billion at current prices) was virtually written off before the zone was handed over to the Jebel Ali Free Zone Authority (JAFZA) for management.

Today, JAFZA is a commercial organisation. But it is financially supported by the Dubai government, its sole owner. JAFZA’s mandate is to attract investments, create jobs, and promote trade and industry. Profits, and a reasonable rate of return on the capital invested, are only secondary objectives. Moreover, it has almost unlimited access to cheap capital, funded through the government’s oil revenues. Finally, the Dubai government’s tax largesse makes India’s fiscal incentives pale in comparison. For units within SEZs, Dubai offers a complete 50-year corporate and personal income tax holiday (India offers a 100 per cent tax waiver only for five years). JAFZA is one of the world’s most successful zones from an investment promotion perspective, but perhaps not from a return on capital point of view. After two decades of operations, profits have just crossed $100 million.

Similarly, China’s successful SEZs were initially capitalised with government money. These were then leveraged for bank lending (again encouraged by the government). Mostly, the government set up and funded the SEZs. Their mandate was not profit, but investment promotion. They were to be more like development agencies than profitable corporations. Some obvious conclusions can be drawn from the global experience so far. SEZs are great for countries seeking to promote investments; they are great for companies seeking world-class infrastructure and big tax breaks; but companies that set up SEZs don’t make much profits. But India is a completely different story. Largely, it is private capital that is waiting to build SEZs. But private capital comes at a cost. So, what kind of returns can India’s SEZ builders expect?

As of now, there is only one balance sheet in India where you could expect to find some answers — that of Mahindra World City Developers, the Mahindra Gesco subsidiary that set up the 1,400-acre Mahindra World City SEZ near Chennai in 2002. It carries accumulated losses of Rs 35.4 crore on a net worth of Rs 138.5 crore — that is the price to pay in the early stages of an SEZ business. Things are improving, though — revenues grew from Rs 36.7 crore in FY05 to Rs 86.89 crore in FY06. The operational losses of Rs 4.09 crore (FY06) have since given way to an EBIDTA (earnings before interest, depreciation, tax and amortisation) of Rs 11.87 crore (FY06). It reported Rs 2.14 crore net profit last year, but this was drained away by the dividend that was paid on preference shares. It is yet to show positive earnings per share. This is the paradox. The Mahindra experience, and that of SEZs worldwide, clearly show that this is a tough business. Yet, there is a mad rush to acquire SEZ clearances and buy thousands of hectares of land.

Most seem to believe there is truckloads of money to be made. The suspicion, though, is that many are hoping to build land banks and cash in on rising property prices. All the players are expecting returns far greater than what Mahindra World City or even JAFZA have managed so far. Reliance expects good returns: revenues of over Rs 1,000 crore when about 90 per cent of the first phase of the project is sold out; a loss of over Rs 80 crore in the first year, but annual profits of over Rs 300 crore in a few years; and an internal rate of return (IRR) of 16 per cent on the first phase investment of about Rs 4,000 crore. Of course, these are only unofficial estimates, and their veracity is questionable. But it does give some indication of what large groups expect from their SEZ investments.

Broadly, there are four phases in the life of an SEZ. The first, and the most difficult, is the ‘development’ phase. This is when the promoter starts leasing out the land after acquiring and developing it. Already, there is a huge cost — both financial and political — associated with land acquisition. Only a few projects have received large pockets of land from the government. The rest must buy land on their own. Land costs are soaring, and legal and procedural delays, and social and political opposition are wrecking project schedules.

Once the land is acquired, the commitment to developing is where the serious SEZ promoters stand out from those merely looking for quick profits. That is because land development calls for big, upfront capital investments. To begin with, roughly 40 per cent of the land acquired is not saleable. The government dictates that at least 25 per cent should be reserved for open spaces. This apart, some land will also be lost due to geographical factors — there may be small hills, water bodies, etc. Roads could take up at least another 12.5 per cent of the land. “The moment an SEZ promoter acquires the land, he loses almost half of it. Only half the land will be saleable.

“If it takes $82 million (Rs 370 crore) to acquire 1,000 hectares, it will take another $250 million (Rs 1,125 crore) to develop it, For example, it costs roughly Rs 1.4 crore to lay a kilometre of two-laned road. And that is only the beginning. More needs to be done to match what Shenzhen or JAFZA has to offer. “A 2,000-MW power plant will cost Rs 8,000 crore; a desalination plant will cost Rs 800 crore; an airport with just one runway will cost Rs 150 crore-200 crore; a port with only one jetty and two berths will cost Rs 500 crore.

Reliance had initially started off with a Rs 25,000-crore budget for its SEZs in Maharashtra. Soon, it realised that it had to build a dam in order to meet the water requirements of the one million people who will eventually live there. It also felt the need for a second port in Rewas. It also figured that the initial plan for a 1,600-MW power plant was inadequate and has now opted for a 2,000-MW plant. The result: the project cost has escalated to Rs 30,000 crore.

The rough benchmark is an investment of around Rs 1.2 crore per acre. Now, most of these investments have to be made upfront. Unless you build the infrastructure and offer it on tap from day one, companies will not come and invest. Obviously, these have to be factored into the cost of land when it is leased out. Here is the problem: in the development phase of an SEZ, customers will not be willing to pay a premium on land. “When we set up Mahindra World City, prospective tenants would walk in and ask why we were charging so much when the adjacent land was so cheap.

In the development phase, SEZs suck up huge amounts of capital. And most of the capital has to come as equity from the promoters. This can be tricky. Now, with the RBI asking banks to treat SEZ projects as real estate, loans will be even harder to get. Moreover, cost of such debt has also risen. “As a result of higher provisioning norms (that real estate projects demand), cost of bank credit to SEZs could increase by 1-2 per cent. “Besides, real estate projects are not permitted to go for external commercial borrowings (where the cost of debt is cheaper — only 5-6 per cent plus the currency risk).Only the serious players will have the capital to make the investments this phase will demand. However, this phase will also see the most land speculation. The less serious players, pursuing realty arbitrage, will have a field day parcelling out the land and selling it.

Just one minor clarification: SEZ promoters cannot sell the land, they can only lease it. However, 30- to 60-year lease agreements can be structured smartly to work around this constraint. Here, up to 95 per cent of the land cost is paid upfront as a deposit, and a nominal lease rental is paid over the tenure. From a cash flow point of view, this is as good as a sale.

If an SEZ reaches this stage, co-developers could contribute 20-30 per cent of the project cost, and internal accruals (primarily in the form of advances from prospective occupants) could bring in 40 per cent. Revenues from the project are good enough to start servicing the debt. Further borrowing becomes easier and promoters can tap into innovative debt instruments. Securitising future lease rentals is one option. At this stage the SEZ also earns forex income. So, it can borrow cheap dollar funds — at least 300 basis points lower than domestic rates — from offshore banking units (OBUs). (The RBI has allowed OBUs to be set up in SEZs. OBUs can borrow cheaply from international sources, and lend to units located in the SEZ and SEZ developers. Repayments must be in dollars, eliminating currency risks and costs associated with hedging the same.) Still, promoters are unlikely to earn returns in this phase.

The third payback phase is when the real money starts flowing in. But it could take eight years for an SEZ to reach this phase. By now, the SEZ should have a strong brand equity and have several success stories among the units operating there. The ‘cluster effect’ would have started to kick in. Companies will be queuing up to buy land and will be willing to pay a huge premium for it. The project will generate enough returns to foot any further investments.

Now comes the industry’s worst kept business secret: the more land the SEZ promoter has at this stage, the bigger his windfall. The land could be selling at 20-30 times the cost of acquisition and development. And whatever land is acquired has to be acquired now, before the actual development begins. Later, prices will shoot up. Hence, the current rush to build up huge land banks running into thousands of hectares. There is one economic philosophy that the SEZ business runs on — the more land you buy, the more capital you pump into it, and the longer you hold on to both, the greater your return.

SEZ builders must have the capacity to inject the capital early and wait for returns — it takes a minimum of eight years to take the project into the payback stage. “Relative appreciation of land value has to be higher than the holding cost of capital. If you can achieve this, you are making

This is where the serious players will score over the speculators. Their returns will be far higher than those who parcelled out the land earlier. “IRRs of 35 per cent are not unheard of. The average IRR could be 20-25 per cent. After this, the final annuity phase becomes easy. Here, the SEZ generates a steady stream of income and needs minimum management. Utilities and facilities management are, perhaps, the only requirements.

To understand an SEZ business, take the balance sheet of a realty company and merge it with that of a municipal corporation. Realty companies buy land, develop it, and sell or lease it. Municipal corporations provide infrastructure and utilities for a fee — generally a combination of user charges and subsidies through tax revenues. An SEZ must do both. Initially, land lease will dominate revenues, but with time, utility, maintenance and administrative charges will account for a larger chunk. Beyond the 10th year, an SEZ balance sheet will be similar to that of a municipal corporation.

Unfortunately, many SEZ builders see this more as a grand realty development opportunity than as an infrastructure business — buy, build, sell. That model may bring profits in the short to medium term, but is unlikely to help the nation’s objectives of investment and export promotion. On the contrary, they could wreck India’s SEZ dreams by increasing competition and affecting the profitability of the serious players. They may also leave investors with bitter experiences or may simply unproductively lock up land. “Large numbers of SEZs will limit the success of all zones. It is prudent to believe that only a few zones near metros will be successful. The rest will be a drain.

Experts believe that there is a huge amount of excess capacity building up in the SEZ space. For example, in the NCR-Rajasthan belt, there are 24 SEZs coming up in 53,000 hectares of land. Is there enough room for all of them? Sure, much of this capacity could be used up by hordes of domestic companies not caring much for sophisticated infrastructure, but hungry for the tax breaks that SEZ status will bring. Still, the excess supply is unlikely to go away. If all the 300,000 hectares are indeed developed, roughly 225,000 acres of industrial plots will be created. To fill this, an investment of Rs 45,00,000 crore will be required. However, in the past five years the entire Indian industry has seen combined investment (government, private and foreign) of only 7 per cent of that amount. Obviously, there are bound to be many casualties among India’s SEZ builders, both big and small.

source- BW