BHEL's Power Struggle

The senior managers of a three-year-old thermal power plant in North India say that the Chinese equipment they installed has been giving them trouble due to low quality. They are not alone. Around the country, power plants have claimed that they bought cheaper Chinese boilers, turbines and generators in preference to Indian equipment only to see them malfunction too quickly.

On the surface, it looks like a demand for better quality. But look closer and it is clear that a quite different battle is brewing. It is one way the local industry is reacting to the Chinese invasion into the country’s power equipment sector.

But not everyone is unhappy. Take Lanco Infratech, in the power business for more than two decades. It has enough confidence in its Chinese suppliers to have them equip half its requirements for the next four years. Lanco is clearly not the only one vouching for the viability of Chinese equipment. Between 2004 and 2007, firms in China accounted for equipment in 18 power plants in India.

The debate over the quality of Chinese equipment is a side show to the main drama — the rapid entry of Chinese firms that has seen the state-owned market leader Bharat Heavy Electricals Ltd. (BHEL) losing ground.

India’s power sector was dominated by state firms for long. BHEL was the equipment supplier and the National Thermal Power Corporation (NTPC) was a dominant force in power production. But today a host of new entrants, such as Reliance Power, Adani Power and Lanco, are serious players.

Over the past five years, private players have been increasingly moving away from the state behemoth because of its low production capacity, delayed delivery performance and cost factors.

The reasons for importing equipment from China are simple: They are cheap and are delivered on time. But there is one factor that clinches the deal for the Chinese. They bundle their equipment with easy financing from large Chinese lenders. The cocktail is simply irresistible for the Indians.

As India steps up the rate at which it adds power generation capacity to fuel an economy growing at 9 percent, there may be room for both Indian and Chinese players. But it will be interesting to watch how Indian companies, especially BHEL, fight to regain their primacy on their home turf.

Why Cross the Great Wall?
The rush for equipment from China was triggered by the massive expansion plans for power generation in India. The country’s demand for power is expected to increase by 315,000 MW by 2017, requiring an investment of $600 billion (Rs. 2,580,000 crore) if the economy continues to grow at 8 percent, a McKinsey report said in 2008. At present, India has an installed capacity of 144,565 MW. Indian power manufacturers did not have the required capacity to meet this rising demand.

A senior manager with a Gujarat plant which has bought equipment from China says it had become difficult for companies to deal with BHEL as they were rarely on schedule. “The Chinese, because they do their business on a massive scale, are better able to stick to the delivery schedule. That makes a huge difference for us,” he says, adding that the quality of Chinese equipment is vouched for by the fact that they dominate every stream of the equipment business worldwide.

In a conventional plant using BHEL equipment, for every unit of power the producer needs to put in Rs. 2 as fixed cost and Rs. 1.2 as fuel cost. Power generation companies try to reduce the fixed cost as much as possible. For instance, reducing the fixed cost from Rs. 2 to Rs 1.4 or Rs. 1.5, which is possible with Chinese equipment, makes the scenario very competitive and power producers can win bids.

The Chinese have another ace up their sleeve: The ability to provide cheap financing for the equipment they sell. Financing is a problem because regulations require power generation companies to have a debt equity ratio of 30:70. If someone like Reliance wants to expand their capacity by thousands of megawatts over the next two or three years, it is difficult for them to raise so much money at a high interest rate. Therefore, they look for alternatives.

In order to lend teeth to their equipment suppliers, Chinese banks have stepped in to lend to Indian power sector majors. Last December, Reliance Power struck a deal for $1.1 billion (Rs. 5,000 crore) in loans from three Chinese banks — Bank of China, China Development Bank and the Export Import Bank of China — and the loans are tied to procuring equipment from Chinese companies. Lanco Infratech decided to tie up around $2.64 billion (Rs. 12,000 crore) from Chinese lenders.

An executive with a well-known power utility said there is a big difference in the rate of interest charged by Indian and Chinese banks. While Indian banks charge around 10 to 13 percent interest on loans, Chinese banks charge only 4 to 6 percent.

These deals have set alarm bells ringing among the policy-making circles in the power sector. “There has to be some monitoring of these financing deals. As of now, the whole system is geared in favour of the Chinese as there is no quality control in bidding and with Chinese lending, there would be an increase in companies buying Chinese products,” says T.C. Arora, senior vice president, Astonfield Renewable.

BHEL chairman B.P. Rao had earlier urged the central government to impose a customs duty on Chinese imports. The Planning Commission has also prepared a report — which is awaiting Cabinet approval — on imposing duties.

The industry association Assocham has put its own spin on the issue. It said last year that power plant equipment worth around 50,000 MW capacity was ordered by Indian power producers from Chinese suppliers, resulting in a loss of about Rs 50,000 crore to the domestic equipment manufacturing market.

The Issue of Quality
Red flags have also been raised over the issue of quality in the past three years after a series of incidents at plants using equipment from Chinese suppliers.

Insiders in the power industry say that at least six plants that were set up with Chinese technology have faced critical problems in the past three years. These plants include the Sagardighi Thermal Power Plant set up by the West Bengal Power Development Corporation Limited, the Durgapur Thermal Power project and the Yamunanagar plant of the Haryana Power Generation Company Ltd (HPGCL).

A site inspection report by the Central Electricity Authority in 2008 at Sagardighi showed that the turbine rotor had failed when the plant was running on full load and found problems with piping systems in the boiler. The inspection team found inefficiencies in the Yamunanagar and Durgapur projects as well. The Chinese vendor, Dongfang, which supplied equipment to two of these projects, denied there was anything wrong with its parts while a senior HPGCL official refused comment.

So why are Indian promoters not running away from Chinese suppliers?

“It is not that the Indian industry is unaware of the criticism against Chinese products. But the problem is that the entire focus of tendering in India today is on being competitive. There has to be some sort of techno-commercial evaluation built into the system to ensure that sub-standard
equipment is not used,” says professor A.G. Iyer.

An analyst with a multilateral agency says the hype about Chinese banks lending to Indian power sector companies hinged on the fact that the lenders were ‘Chinese’. “The OECD countries also have some form of export financing. Really, the market should be allowed to decide from where you need to import or get financing,” he said.  

Also, some companies don’t buy the accusation that the Chinese are selling sub-standard goods. “By 2015, half our power equipment will be sourced from the Chinese,” says Prakash Vaid, senior vice president at Lanco. That Chinese equipment is of bad quality is a myth, he says. “If we buy any longer from GE or Alstom, the project will just not be viable. With Indian suppliers, while the project will be viable, delivery schedule is a problem.”

According to Li Qi, chief representative of Dongfang Electric Corporation in India, the company did not enjoy an undue price advantage compared to Indian companies like BHEL. “The only advantage that we have is on the delivery schedule, which makes the projects that use our equipment more viable.” This year, the total capacity of Dongfang in China will increase from 37 GW to 42 GW, “which makes us the largest power equipment manufacturer in China and possibly in the world.”

Despite the criticism on the lack of quality control, the Chinese vendors have their hands full in India. The three principal Chinese suppliers, Dongfang, Shanghai Electric Corporation and Harbin, account for 18 projects for which equipment was ordered between 2004 and 2007.

An executive with a company in talks with Chinese banks said it was not correct to assume that they chose Chinese equipment only because it was cheap. Stricter adherence to deadlines and the delivery schedule is also a factor in companies giving orders to Chinese manufacturers. “It is unfortunate that we have a belief that anything with a ‘made in China’ tag has to bad. It is not so,” the executive said.

What Ails BHEL?
A  report published by Bank of America and Merrill Lynch this January says that one of the serious risks faced by Indian power equipment maker BHEL is that of Chinese companies undercutting them. A cost comparison in the study suggests that an average Chinese vendor’s pricing for a BTG (Boiler Turbine Generator) would be around Rs. 1.6 crore per MW. The same would cost around Rs. 2.6 crore per MW if it were to be supplied by BHEL. Lower interest rates in China substantially contribute to the ability of Chinese companies to maintain low rates.

BHEL’s main problem was its low capacity that leads to huge delivery delays. In 2003, for instance, it had a capacity of 5,000 MW annually while the domestic market, which was opening up, needed 8,000 MW. A delay of, say, six months to a year, can add at least 10 percent to costs. If an equipment costs Rs 4.5 crore per MW, its cost can go up by at least Rs 45 lakh.

This and the fact that Chinese equipment was cheaper, saw Reliance venturing out in 2005-06.

However, the customer loses the price advantage when taking into account the life-cycle cost of the equipment made in China. The Bank of America and Merrill Lynch report says that equipment supplied by BHEL is superior to Chinese products after accounting for parameters such as auxiliary consumption, heat rate, plant load factor and metallurgy.

Auxillary consumption accounts for the energy used by auxiliaries such as cooling towers, while heat rate measures the ability of a machine to convert heat into power.

Plant load factor refers to the ability of a plant to perform to its rated capacity.

“The technical and commercial superiority of BHEL plants leads to its customer deriving 10 percent higher free cash-flow to equity (FCFE) when compared with  a Chinese power plant even after factoring-in lower funding cost of Chinese plants from China EXIM,” says the study, which primarily focuses on BHEL.

Taking On the Competition
While the government decides on a policy regarding the import of Chinese power manufacturing equipment, BHEL has come up with a two-pronged strategy to take on the Chinese with their own rules of the game.

BHEL wants to use its cash surplus of nearly Rs. 10,000 crore to set up a new subsidiary that will function as its financing arm for power projects. The next board meeting will take up the report that is being prepared by its advisor Crisil on the road map for the new unit. With more than 70 per cent of its revenues coming from the power sector, the new unit is seen as an integral part of the public sector company’s strategy to see off competition from Chinese suppliers and its domestic peers.

“As financing has been a problem for power generation companies, forcing them to approach Chinese banks, a power financing firm will at least partly cater to this need. In the process, we also make sure that we get access to equipment orders,” says a company official on conditions of anonymity. So, while financing a power company’s project, BHEL will make sure its clients also make it the preferred supplier for power projects.
The other step is to try and expand its order book, BHEL has also been forming joint ventures with state utilities to set up and operate super critical thermal power plant. Like in the case of the financing arm, this move will again partly alter the profile of the public sector giant, which has focused on manufacturing so far.

BHEL has already set up JVs with the governments of Madhya Pradesh, Tamil Nadu and Karnataka to build power plants. Here again, BHEL becomes the preferred supplier of power equipments for these projects. Officials say that the company is in talks with other state governments including those of Andhra Pradesh, Kerala and Maharashtra for similar ventures.

The fight has just begun.