National Thermal Power Corporation (NTPC) and Huaneng Power are the largest government owned power generators in India and China respectively. The two of them collectively serve the energy needs of the largest population group in the world. But the similarities end there. The dynamics of the energy sector differ like chalk and cheese between the two countries. China’s booming infrastructure and India’s limping one are testimony to that. But there is one problem that is common to the efficiency and profitability levels of the two electricity giants. Power tariffs.

From generating 620 bn units in 1990, China's power generation had multiplied almost 6.5 times by the end of 2011. That's an average annual growth of around 10% during this 20 year period. During this very period, India's power generation has multiplied by just around 3.2 times, or an average annual growth of 6%. So, while China's power generation has kept pace with its GDP growth, India's has lagged far behind. And this is the reason why power shortage remains one of the key bottlenecks in India’s infrastructure plans as of today.

Both India and China are heavily dependent on coal as a key input for thermal power stations. Given the environmental concerns, coal has increasingly become a scarce commodity. Coal fired stations form a majority of China's power generation (78% as compared to 65% in India). Hence the increasing demand and rising coal costs have been a key concern for power producers in both the countries. Importing large quantities of coal has also become unviable due to the taxes levied. The only way to sustain the business is to pass on the rise in costs to the consumers by way of higher tariffs.

Despite persistent high inflation, China has recently decided to bite the bullet in raising electricity tariffs. This is because any widespread power shortages could complicate China's efforts to foster economic growth, which is still at healthy levels but has been slowing amid weakened demand for its exports. In India, however, it is a different story all together! The central and state governments are still debating over hike in power tariffs after a gap of nearly 4 to 5 years.

Although NTPC’s operating margins were suppressed in the first half of FY12 (around 20%), they still remained comfortable higher than that of Huaneng Power (around 8%). Also, NTPC generates higher revenue per MW of installed capacity. This is while NTPC’s generation capacity is about 70% of Huaneng Power. Even in terms of leverage, NTPC has displayed a better financial track record than Huaneng. While the former's stands at 0.7 times, the latter's ratio is at 3.2 times. As far as the return on equity is concerned, one reason it is low for Huaneng Power (around 10%) is that Chinese power regulations cap the rate at 10%. As compared to this, India caps the return on equity for power generation companies at 15.5%.

But going forward, the profitability of Indian power generators depends on their ability to scale up capacities and sell electricity at profitable rates. While the former depends on sufficient coal linkages, the latter depends on tariff revisions at regular intervals. Without these power producers in India despite being more efficient than their Chinese counterparts may end up destroying shareholder value.

By Equitymaster – India's leading 'independent' equity research initiative. Trusted by over a million members all over the world, Equitymaster is known for its well-researched, unbiased and honest opinions on the Indian stock markets.

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