The renewable energy sector is flooded with players competing for a larger share of the market. In this regard, open access has been conceived as an important tool to give developers an option to sell power to offtakers of their choice and not just be restricted to power purchase agreements (PPAs) with discoms. Industrial and commercial consumers often procure power through open access by signing third-party PPAs. However, multiple regulatory risks have burdened this model of power procurement. Moreover, additional surcharges levied on open access customers, even as renewable energy tariffs have fallen considerably, have only worked against the expansion of this market. Renewable Watch presents the perspective of various industry stakeholders on third-party PPAs with regard to renewable power.
What are the risks associated with third-party PPAs as compared to PPAs signed with discoms?
One of the most significant risks in third-party PPAs is obtaining an open access licence. This is enhanced by the lack of availability of open access projects, the time taken for obtaining the necessary licences, stringent regulatory requirements, charges levied for open access, high cross-subsidy surcharges and additional surcharges. The option to enter into third-party PPAs is therefore available only to customers with large demand and deep pockets. The creditworthiness of the power offtaker, lack of a regulatory framework and standardisation of these PPAs are some of the other risks. Meanwhile, obtaining financing for such projects continues to be an issue for developers.
Generally, third-party PPAs are of shorter tenors as compared to those with discoms, which are typically of 25 years, and hence the revenue is not certain throughout the project life. Moreover, there are risks associated with changes in open access charges such as cross-subsidy charges, wheeling/transmission charges and losses. These charges are determined by the state regulator every year and any variation in them can adversely impact the delivered cost to the customer and hence, the viability of the project. A number of states have recently introduced an additional surcharge over and above these charges, which further increases the delivered cost of power to the customer. In addition, credit assessments of customers (in the case of private entities) remain a challenge. Also, with falling tariffs, customers may seek a reduction in the agreed tariffs/dishonour the PPA. Countering this through a legal recourse of PPA enforcement is time consuming. Further, banking regulations and their implementation are ambiguous in many states.
The main risk associated with third-party PPAs is the high offtake risk of private clients. Even though most discoms are financially weak and some have poor payment records, most developers are happy to sign long-term PPAs, which carry quasi-sovereign risks. In contrast, private company default risks are considered to be very high, particularly when power prices are falling and open access charges continue to be volatile. Unfortunately, the legal sanctity of contracts is poor in India and developers do not feel that they can rely on courts for the timely resolution of disputes. Second, a private company’s business can witness huge changes over 5-10 years whereas the length of a typical long-term PPA is 15-25 years. That makes it difficult to assess the long-term bankability of such clients.
What are the benefits of third-party PPAs? Given that the risks are greater for these, are the returns justified?
The tariff is not regulated for merchant PPAs and therefore it is easier to negotiate on commercial terms. These PPAs can be customised to meet specific requirements, as may be the case for the developer or the offtaker. Commercial advantages in pricing have proven to be a key driver in this segment.
Notwithstanding the risks, third-party PPAs present a major opportunity for customers as against discom PPAs, wherein the discom credit risk does not have to be addressed. In addition, various state solar policies grant waivers for electricity duty, and wheeling and transmission charges while allowing banking of power to encourage competition in the segment. These factors are not only beneficial for the customer but also assist in the overall growth of the sector.
There are multiple benefits of third-party PPAs. Since their tariffs are higher than those discovered in auctions, the returns are also higher. Besides, there is the advantage of limited competition as the PPAs are negotiated bilaterally. Shorter payment cycles reduce the payment risks. Moreover, there is a better credit worthiness of customers (as compared to discoms), if selected with adequate diligence.
A third-party PPA is only beneficial if it reduces risks for private clients having a very strong financial status (applicable to only 5-10 per cent of the total market), or if it provides higher returns as compared to a PPA signed with a discom. Typically, the returns in the private PPA business have not been significantly higher, which is why developers have been reluctant to consider such projects. However, in the current scenario, when pricing in solar and wind auctions is being squeezed and project pipeline visibility is poor, some developers are exploring the private PPA option.
What has been the trend for third-party PPAs in the solar and wind energy space?
In the solar and wind energy space, particularly solar, there has been an increase in third-party PPAs. While the rooftop solar segment has garnered significant interest, the market for large ground-mounted solar projects is also expected to grow. Even though there are only a few open access customers for renewable energy projects, the momentum is picking up gradually as these are easier to implement. In addition, considering the prevalent grid issues, distributed generation needs a greater push and, therefore, growth is expected in this sector.
Tariffs for wind and solar third-party PPAs have been higher than those of discoms. In fact, the tenor for third-party PPAs is shorter (between 5 and 12 years) as compared to PPAs with discoms that are usually for a period of 25 years. Customers tend to be agnostic towards technology, wind or solar, as their objective is to reduce the cost of power. However, with falling solar tariffs, customers now increasingly prefer solar over wind. This is because solar results in lower banked energy as compared to wind owing to its high daytime generation, especially in the summer months.
The private PPA market accounts for a very small portion of the overall wind and solar energy market. Even though it is difficult to obtain hard data, in my opinion, the market size has been declining for many years. At present, most of the activities are concentrated in Karnataka, which has an attractive policy with a 10-year waiver on most open access charges. As the cost of solar energy comes down, developers can reduce the term of the PPA to 10-15 years and still get the required returns.
What are the regulatory challenges associated with these PPAs?
Challenges persist in the renewable energy segment. Grid connectivity regulations for rooftop solar plants need greater clarity and standardisation as regulations vary across states. This, in turn, leads to lack of clarity in the PPA terms. In addition, third-party ownership issues remain unresolved. To this end, a case was filed in 2015 by Amplus Infrastructure Developers against the Uttarakhand Electricity Regulatory Commission in the Appellate Tribunal for Electricity, challenging the order that the third-party model for rooftop solar plants is outside the ambit of renewable energy regulations and therefore not eligible for preferential tariffs. However, there has been no clarification on the judgment, leading to ambiguities in the regulation and the model.
The challenges generally pertain to the changes in open access charges as these are determined every year. Given that the market is price-sensitive, a slight variation in these charges can adversely impact the final cost of power and hence the viability of the project.
There are major regulatory barriers to the growth of the private PPA market. First, open access regulations in most states are volatile and vary from year to year. States have been using open access charges as a tool to disincentivise the market. In the past, some states have blocked open access overnight because state-owned discoms were not happy with the growth of this market. Group captive regulations have also become more restrictive. Second, as the renewable energy sector grows and the regulatory regime moves from favourable to neutral, we expect a series of new regulations (withdrawal of must-run status, forecasting regime with strict penalties for non-compliance, time-of-day tariffs, etc.), which will be more challenging for developers.
What is the outlook for third-party PPAs in the wind and solar energy market?
For third-party PPAs to become more prevalent in the renewable energy sector, waivers for additional charges should continue. In addition, issues revolving around the grant of open access licences at reasonable rates should be addressed. Since there is lack of access to grid power in various parts of the country, the third-party PPA model for power consumption is an option that is likely to see significant growth in the near future. Moreover, group captive PPAs may become popular in the renewable energy sector in the coming years.
The current electricity market structure is highly regulated and involves cross subsidisation, which is not quite conducive for the development of a robust open access market. This is because discoms would always have a disadvantage to allow such transactions, especially in a scenario where demand and supply are balanced. For the open access market to grow and attract long-term capital, a robust market mechanism is important which, when coupled with consistency in regulations at the state level, will enable investors to take a longer-term view of the risk/reward equation in this category of projects.
Our outlook for this market is negative because of the high offtake and regulatory risks. The market will be restricted to select pockets – for example, Karnataka with its highly favourable open access policy and highly bankable clients who need to comply with renewable purchase obligation requirements. As long as there is surplus power and discoms remain financially stressed, the regulatory climate will be hostile for third-party PPAs.