Over the past two years, aggressive bidding and falling capital costs have induced a lower-for-longer tariff scenario in the solar and wind power sectors. While the impact has been felt by all stakeholders, it is especially pronounced for financiers as energy revenues are directly linked to their returns. As domestic financiers struggle to keep up with thinning margins, international financial agencies are making the market more competitive by offering low-cost debt capital. At the Renewable Energy Invest Summit held in October 2018, in the “Technical Session on financing challenges”, industry leaders discussed the challenges faced by renewable energy financiers, the possible solutions and the way forward for the sector. Excerpts…
The government has taken note of the challenges in the financing of projects and has solved them one by one. Discoms were facing financial stress and banks did not want to lend money to them. In 2015, the minister of new and renewable energy, Piyush Goyal, took the initiative to create a rupee bond market to restructure discom finances. This led to the formation of the Ujwal Discom Assurance Yojana (UDAY), which later raised $50 billion in rupee-denominated bonds to pay off the debt piled up by the ailing discoms. Currently, there has been a lot of talk about public sector financial institutions asking their private counterparts to step up and cover the offtake risks. However, to get funds from private players, the risks in the market should be reduced.
Initially, solar project developers earned a 20-25 per cent rate of return due to the low interest rates and the resultant rise in liquidity. The decrease in the cost of equipment helped the developers as well. The flourishing industry attracted more players, which resulted in the thinning of margins for all players. This change in market dynamics is leading to overbidding. In a low-tariff scenario, some players have started compromising on project quality. To ensure the financial viability of developers at this bleak time, the debt-servicing coverage ratio of developers should be disclosed while bidding for projects. In the next five years, the profitability of projects will be adversely affected due to the upward trend in interest rates.
Dr Ashok Haldia
When PTC India Financial Services started funding in 2010, we wondered whether funding renewable energy projects would be viable or not. Today, the sector has matured significantly. The risk in the renewables sector is far less than the risk in the power sector. The challenge in the renewable energy market today is obtaining funding from the right kind of financial institution. Since 2010, the market has introduced innovative sources of funding for projects and funds like “infrastructure tax funds”. Moreover, new developers have entered the market and have successfully mitigated the market risk. Hence, to achieve the target of developing 175 GW of renewable energy in the country, government support should reduce and the focus should be shifted to a market-based mechanism.
The structure of contracts and constant changes in open access regulations and transmission arrangements are the real issues in the country. Going forward, the private sector has a great opportunity and should, therefore, come forward to take the benefit of the untapped potential. Also, if reverse bidding is taking place, tariff determination should be completely left to the market. Government intervention in terms of setting a cap on tariffs should be avoided. Lastly, handling risks is better than facing uncertainties. Developers and financial institutions can handle the risks, provided the government works on reducing the uncertainties.
There are different stages in project development. At the early stages, the risks are high; therefore, the developer expects higher returns. While in the end renewable energy projects are stable and financially able to compete with projects producing conventional energy, this issue should be addressed while making a financial product.
As the share of electricity generated through renewable sources increases in the total energy mix, developers should not expect the government to cover their market risk. Therefore, at least private developers should learn to manage the market risk without relying on the stable feed-in tariffs and subsidies provided by the government.
When Sweden started developing wind projects across the country 10 years ago, it focused on the coordination of all the authorities involved in the implementation of the projects. The country provided no direct subsidies to the developers but concentrated on training all the stakeholders, including civil servants, to mitigate market risks. With this, the long-term costs of wind projects came down. The country’s decision to act as a facilitator to developers gave rich dividends.
In India, policymakers should learn from the havoc created by the safeguard duties and also keep in mind that constant tinkering in policies should not affect stakeholders who have already made their decisions. The strengthening of the entire supply chain, right from sourcing the raw material to the construction of the project, is also necessary.
India has done great work in the renewable energy sector. However, a lot of challenges remain to be solved. First, the country needs to make sure that every household is electrified. Apart from social reasons, energy generation is required to achieve constant and substantial economic growth. The importance of increasing the share of renewables in the total energy mix cannot be ignored. More so, for Indian cities, which are probably the most polluted cities in the world. The issue of pollution in Delhi cannot be attributed entirely to agricultural practices like burning of fields. The pollution on a daily basis comes from the use of petrol and diesel cars. Greater use of renewable energy with cleaner modes of transportation in Delhi can, therefore, lead to less harmful air.
India is the most exposed economy in the world when it comes to oil prices. If the country needs to have a stable economy, it cannot be exposed continuously to the uncertainty of oil prices. The cost of renewable energy is also coming down, which makes it a great time to shift to renewables. We also have the challenges of offtake risk and access to land. There are some macro challenges as well like the financial health of discoms and the volatility in foreign exchange rates. The stress in the banking system adds to these macro challenges.
There are, however, immense opportunities. Europe is flush with money. Most of the institutional investors there invest in bonds that have negative or zero interest rates. These investors are now looking for a higher yield, which is available for Indian bonds.
While the policymakers have done a good job of increasing the renewables capacity, a lot needs to be accomplished to channelise more private capital. And to attract more private capital, the prevalence of green bonds in personal as well as corporate portfolios is necessary. In India, the use of these bonds is limited in the portfolio of investors willing to invest in debt. Moreover, it is not mandatory to have a share of the total institutional portfolio invested in green bonds. Also, there is a need for an institutional guarantee mechanism as the credit rating of the offtaker is very poor. This mechanism could compensate for the low credit rating of the offtaker, leading to the infusion of capital from pension funds across the globe. Going forward, the focus on priority sector lending for the renewable energy sector could open a new arena for the mushrooming growth in the retail segment, which is at a nascent stage in India. The country has done well on the utility, commercial and industrial scale, but the retail segment has lagged behind. The use of green bonds can help this segment grow.
Today, most renewable energy projects are not classified as investment grade as the rating of the offtaker is poor. These offtakers are government entities. A guarantee mechanism will be able to compensate for the lack of credit rating of the off-taker and help in attracting huge amounts of capital from various pension funds.
It is interesting to see the recent developments in the renewable energy market in India – falling tariffs, rising competition and entrepreneurial flair. There is no dearth of finance in Europe. In Germany, an onshore wind project can be financed at an interest rate of 2 per cent. Similarly, in the UK finance is available at low interest rates. In European countries, institutional investors are investing over nine times more money in renewable energy projects than they were 10 years ago. However, India faces challenges in financing, which are more on account of faults in the public policy framework and not just due to the stress faced by the banking sector.
India has progressed in the sector despite the 9 per cent interest rate. Going forward, the country should consider whether the reverse bidding process and the resultant low tariffs have done any good for investor confidence in the long run.
Also, corporate power purchase agreements (PPAs) are common in the European and American markets, and are now slowly being used in India as well. The issue of discom preparedness in handling this change remains. Going forward, refinancing of projects with long-term capital would help developers calculate a reasonable internal rate of return.
The country is currently dealing with payment security concerns from discoms. This issue has prevailed in the market for a long time. UDAY improved the status of the discoms to a certain extent; however, the issue has not been permanently fixed. I would recommend two solutions. First, developers should be entitled to a deemed generation benefit in which they are paid for the electricity generated even if it is not evacuated due to issues faced by the grid. The need for this benefit will arise in the future when more and more renewable energy is integrated with the grid, leading to instability. Some countries do follow this “take or pay” system for the evacuation of electricity generated and this model should be replicated in the Indian market. The second solution is to increase the credit to discoms in order to address the payment security issue.
In the past eight years, we have seen a decrease in pricing. However, in the past 6-12 months, tariffs have stabilised and are not expected to go down further. Going forward, the cap on tariffs set in some auctions should go away, as it puts pressure on developers as well as bankers.
Ambitious targets and the use of fiscal policy instruments to achieve them are important. The country needs to also focus on the sustainable use of scarce land to ensure ecological justice as well as energy security through clean energy. The country has 2.5 per cent of the total land of the world. Of this, one third, that is, 100 million hectares, is degraded. There are other issues as well. Land productivity and water tables are both going down, while population growth is uncontrollable. In India, 2 hectares of land is diverted to generate 1 MW of solar energy. On the other hand, old wind energy plants use 12 hectares per MW. Together, for 100 GW of solar energy and 60 GW of wind energy, 1 billion hectares of land will need to be diverted. My advice would be to use 100 million hectares of degraded land for the development of upcoming solar and wind power projects. There is a concept of land degradation neutrality in the sustainable development goals, which aims to combat desertification by restoring degraded land and soil by 2030. In line with this concept, it is preferable to use less productive land for the development of solar plants. If agricultural land is used, an equivalent amount should become productive somewhere else in the country. When the carbon trading market starts moving, there will be incentive for all solar developers to go for carbon trading as the quantity of carbon in soil is more than the carbon in the air and forests combined. To achieve this target, a land degradation neutrality fund has been launched with a corpus of $300 million. The fund will focus on risk mitigation of projects by adopting sustainable management practices. The Indian Renewable Energy Development Agency (IREDA) can come up with an interesting business model that links both land and renewable energy without the involvement of any subsidy. There could be public-private partnerships in such models as well. If successful, these models can be replicated in other countries that face similar issues. It is better to start integrating the use of degraded land in the business model now to avoid catastrophic consequences 10 years down the line.
The State Bank of India (SBI) is promoting renewable energy in a big way and we are also not experiencing any issues of non-performing assets. We have set some parameters through which we decide a project.
The renewable energy sector is not facing any challenges with respect to the implementation of projects. However, debt financing and debt servicing are major issues. There are projects that are on the verge of completion but the PPAs have not been signed, or are being renegotiated at the last moment. There are instances where grid connectivity is not achieved even after the commissioning of the project. These issues send a wrong signal to bankers, who then avoid giving finance for renewable energy projects. Also, the central government and the Reserve Bank of India should consider giving renewable energy priority sector lending status. Currently, rooftop solar projects come under this status but the funding is restricted to just Rs 150 million. Going forward, the government should consider including utility-scale solar projects in priority sector lending as well. This will be a huge incentive for developers investing in renewable energy and will help the government achieve its ambitious target. The Ministry of New and Renewable Energy should also consider a policy along the lines of the hybrid annuity model (HAM) used in the road sector. SBI and the World Bank have jointly announced the provision of Rs 23.2 billion in credit facilities to be used for the development of grid-connected rooftop solar projects under the SBI-World Bank Grid Connected Rooftop Solar PV Programme. The bank remains committed to providing funds to developers.
A lender who has decided to lend money for a renewable energy project first looks at the stability of cash flows from the project. This stability of cash flows is only possible due to stability in tariffs and import regulations. Changes in policies from time to time are imperative as the sector is developing in the country. However, the projects that are in the pipeline need to be grandfathered in order to ensure stability, while the changes in policies continue. The availability of finance for projects will not be an issue if the policymakers ensure that stability exists in the market.
The amount of debt being provided in India is currently around $6 billion to $10 billion per year. However, to meet the set targets, $15 billion to $20 billion of capital inflow is necessary. Public sector institutions like IREDA are doing a good job to disperse credit to developers. But no one is systematically trying to accelerate market transformation to crowd in private capital.
It is true that a transformation in the market mechanism is needed to reduce the role of the government as well as to tap private capital. Countries like the UK and Australia have dedicated funds or a series of funds that are focused on derisking new projects. These funds are used primarily for small projects that have problems securing finances. These projects have excellent project preparation facilities and comply with international standards but are not able to get loans from banks.
Building the right structure of the institutions that manage such funds is tricky. These funds should not be a part of IREDA as they would adversely affect the agency’s balance sheet. The institutions offering these funds should provide market rate products as they are dealing with a high-risk market. The capital can be pooled by the government while the management could be IREDA’s responsibility. Institutions like NABARD can also be given the responsibility to manage such funds.
India can experiment by aggregating small off-grid solar projects across the country and float a tender for it. Off-grid players will benefit by gaining scale while the government can receive a better price through reverse bidding.