CEB default risks major service disruptions, says Fitch Ratings

• Affirms CEB’s National Long-Term Rating at ‘BB+(lka)’, outlook stable

A default by Ceylon Electricity Board (CEB) would lead to severe service disruption, with the entity accounting for about 73 percent of generation capacity at end-2023, rating agency Fitch said.

It stressed that a default would also make it difficult for CEB to source feedstock used for power generation, such as heavy oil and coal, which are imported. 

Independent power producer (IPP) agreements - about 27 percent of generation capacity - will also be affected, Fitch said. These are external arrangements with no clear alternatives and most of them use imported oil in their operations.

A non-payment by CEB would dampen the state and its related entities’ ability to raise debt, as CEB’s project loans are also the state’s obligations. Some of these loans are provided by bilateral and multilateral agencies and channelled through the government to develop the country’s power infrastructure. 

“Thus, a default on these project loans could be tantamount to a government default. We expect support to continue, despite the state’s weak financials, as CEB fulfils an essential public service,” the agency said in a rating commentary.

Fitch Ratings affirmed CEB’s National Long-Term Rating at ‘BB+(lka)’. The Outlook is Stable. Fitch also affirmed the National Long-Term Rating of CEB’s outstanding senior unsecured debentures at ‘BB+(lka)’.

CEB’s ratings are equalised with the Sri Lankan sovereign rating (Long-Term Local-Currency Issuer Default Rating CCC-) under Fitch’s Government-Related Entities (GRE) Rating Criteria. 

Fitch said the rating is based on its assessment that there is a very high likelihood that CEB, the country’s monopoly electricity transmitter and distributor, would continue to receive government support.

“We expect state support to continue, as the government would want to ensure an uninterrupted power supply,” it said.

Government support to CEB has included direct grants, two-step loans from multinational agencies (about 19 percent of CEB’s outstanding debt), equity injections and guarantees on bank loans for some of the investment projects and working-capital requirements. 

The government converted CEB’s outstanding payables to the IPPs and national oil supplier Ceylon Petroleum Corporation (CPC) into equity at end-2023.

Generation costs fell in tandem with the rise in hydropower to 31 percent of the generation mix in 1H24 (1H23: 23 percent), while thermal coal prices dropped by 32 percent yoy. Thermal coal fuels over 36 percent of the country’s generation mix, and Fitch expects prices to fall by 20 percent in 2024 and 10 percent in 2025. CEB’s financing costs will also fall amid lower interest rates. CEB has also reduced tariffs twice in 2024 by a cumulative 44.5 percent.

CEB has operated on a cost-reflective tariff mechanism since June 2023, which is revised quarterly to ensure operating costs are covered. 

“Our base case forecast assumes the tariff framework will remain in place, as any deviation is a key risk to CEB’s balance sheet. The quarterly tariff revision due in September 2024 is yet to be finalised, pending regulatory approval. Tariff revisions in the preceding four quarters were implemented within one-month of the quarter-end,” Fitch said.

Fitch said it estimates CEB’s EBITDA to have improved to       Rs. 180 billion in 2023, from a negative EBITDA of Rs. 65 billion in 2022, following the revised tariff framework. 

“We forecast EBITDA will remain around Rs. 160 billion in the next two years under the tariff framework. We estimate cash flow from operations to have jumped to Rs. 30 billion in 2023, from negative Rs. 58 billion in 2022. 
“However, we expect capex will require external debt funding, although leverage should remain around 2x in the next few years,” Fitch said.

CEB restructuring subject to execution risk

The new Electricity Act includes provisions to unbundle CEB’s generation, transmission and distribution into separate entities. 

Fitch said it believes the unbundling will improve CEB’s efficiency and competitiveness. The utility is already preparing separate financials, maintains separate bank accounts and is in the process of allocating assets and liabilities for the three units. 

“However, we believe the restructuring faces execution risks and may be contingent on the outcome of Sri Lanka’s general election on 14 November,” Fitch said.