The past year saw weak financier sentiment for the renewable energy sector. Diminishing lender appetite, liquidity crunch owing to banking sector issues, and renegotiation of power purchase agreements (PPAs) are some of the factors that have contributed to reduced investments in the sector. At the same time, bond issuances have helped developers raise significant capital to invest in ongoing and under-development projects. Meanwhile, strong policy support from the government in the form of relaxation of land acquisition timelines and implementation of payment security measures has strengthened the regulatory ecosystem for the sector. Financiers share their views on the key developments in renewables financing, challenges, emerging financial instruments and the outlook for the next year. Excerpts…
How has the renewables financing environment evolved over the past year? What have been the key positives?
Renewable energy financing has witnessed a downward shift over the past year primarily due to concerns regarding the sanctity of PPAs in some states, low credit appetite of lenders, rating downgrades of some of the large companies and reduced financing by non-banking financial companies (NBFCs), which were earlier active in this sector. To fill this gap, leading independent power producers (IPPs) issued significant bonds over the past one year. ReNew Power raised $700 million, Greenko $1.3 billion, Azure $350 million and Adani Green $850 million. While the bond issuances assisted in refinancing operational projects, a few IPPs such as SoftBank were able to achieve financial closure for under-implementation projects by raising external commercial bonds. Also noteworthy is the increasing participation of public sector NBFCs such as the Power Finance Corporation, Rural Electrification Corporation (REC) and Indian Renewable Energy Development Agency in financial closures, and infrastructure development funds (IDFs) in the refinancing of renewable energy projects, which were earlier dominated by private sector financial institutions.
As regards the key positives, we have observed that strong policy support from the MNRE has significantly strengthened the regulatory framework. These include extension of timelines for land acquisition, compensation for grid backdown, and provision of early commissioning incentives. Further, the ministry has ensured strict enforcement of payment security clauses in PPAs (through establishment of letters of credit) as well as the must-run status of renewable energy projects to bring in regulatory discipline among all stakeholders including discoms.
India has set a target of 175 GW of installed renewable energy capacity by March 2022, and 450 GW by 2030. According to a report by Wood Mackenzie, the country has emerged as the market leader in Asia-Pacific with the lowest renewable energy cost. It is followed by Australia. High quality solar resources, increasing market scale and competition have pushed solar costs in India down to half the level of those in many other countries in this region.
Asset finance and the public market are still the dominant forms of renewable energy financing in India. As per a report by the Centre for Financial Analysis, calendar year 2018 saw funding to 54 accounts with a combined lending of Rs 305 billion, of which around Rs 245 billion (about 80 per cent) was towards the renewable energy sector. The majority (about 75 per cent) of this debt came from private sector lenders. Many developers/groups attempted to raise equity through initial public offerings (IPOs). Developers also relied on private equity (PE) funds. As per estimates, the renewable energy sector would require an investment of $500 billion – $700 billion over the next decade. This translates into an annual debt requirement of about $40 billion from all sources, which is huge by any standards.
Dr Pawan Singh
Over the past 12 months, the renewable energy sector has been grappling with several issues, which have resulted in a downturn. The low tariff caps in recent bids have turned out to be a bane for the segment and several prospective investors/developers have flagged the diminishing returns as a key concern. In addition, the brazen manner in which discoms have tried to breach their contractual offtake obligations, resulting in unnecessary delays in payments, has created negative sentiments for the sector as a whole. Meanwhile, the financial sector has itself seen tightening of the noose around fund disbursements in the renewable space.
Despite this, there has been a strong commitment from the government towards the sector, especially in light of the Paris agreement, which focuses on the reduction of the carbon footprint. Recently, the MoP has directed the National Load Despatch Centre (NLDC) and regional load despatch centres (RLDCs) to despatch power only after it is intimated by the distribution companies that a letter of credit for the desired quantum of power has been opened, which is definitely a welcome move.
What is the investor perception of the renewable energy segment considering low tariffs, and increased land acquisition, transmission and offtaker risks?
Low tariffs are largely a result of intensive bidding in initial tenders. This has normalised over time, with tariffs displaying an upward trend in recent tenders. Further, the government has shown flexibility in increasing the ceiling tariff to attract bidding interest. Land acquisition has been a challenge mainly in the implementation of large capacity wind projects won under the bidding regime, while on the transmission side there has been a continued push by the government for the implementation of capacity aligned with renewable energy commissioning. Also, a key concern for investors continues to be ailing state discoms. The introduction of credible intermediary procurers like SECI and NTPC has helped attract investor/ lender interest.
The targeted increase of renewable energy capacity to 175 GW requires significant investments. According to the International Finance Corporation, India will need $450 billion to finance its 2030 clean energy target. Assuming a typical 70:30 debt-equity ratio, the debt funding requirements will be around $315 billion through 2030. However, financing of renewable energy in India continues to face multiple issues, such as a short tenore of loans, high capital costs and lack of adequate debt financing, as well as sector-specific issues.
Renewable energy projects do not achieve ratings higher than BBB or A, whereas investors mostly invest in bonds rated AA or of higher credit rating. According to SEBI, more than 90 per cent of bond trading in 2016-17 and 2017-18 took place for AA- and AAA rated securities. The corporate bond market in India needs to be deepened through structural reforms. Credit enhancement is one such scheme, under which an institution with a high credit rating like IIFCL (an AAA-rated company) provides guarantee for servicing of bond issuance by a project company. This enhances the rating of bond issuance to a level that is comfortable for long-term investors.
The renewable energy sector has witnessed heightened activity in the past decade, especially over the past four to five years. An ambitious target of 175 GW of installed capacity set by the government met with a promising response from investors, domestic and foreign alike. As a result, capacity addition during 2014-18 grew at a CAGR of about 20 per cent. In the past decade, the sector received a total FDI inflow of $7.83 billion, whereas the total investment in the sector stood at $42 billion, of which about $11 billion was invested in 2018 alone.
At the same time, there are various concerns relating to low tariffs, land acquisition troubles, transmission bottlenecks and offtaker risks. These have resulted in many projects becoming unviable with potential bidders giving the entire bidding process a miss. Further, discom health has always remained a matter of concern. Indications from some of the discoms to cancel/renegotiate their PPA obligations have heightened the concerns. With the commissioning of more wind and solar projects, transmission is likely to be a major bottleneck. In view of this, developers are looking for projects in solar parks where the desired infrastructure is already in place.
Dr Pawan Singh
Investors are grappling with business decisions taken in the renewables space such as low tariffs, PPA negotiations, tariff caps in the bidding process and land acquisition delays, which impact the rate of return for investors.
However, what seems to be extremely disconcerting for any investor is the impunity with which the discoms have breached their contractual obligations. A case in point is a state discom that had called for the renegotiation of already concluded PPAs, discomfiting the investors. This has led to huge uncertainties for not only developers and investors, but also for lenders. It has put the entire business environment of the sector in question.
Meanwhile, renewable generators have been generally recognised as “must run” power plants. That said, going by the IEGC 2010, the state load despatch centres have the right to restrict even renewable energy generators in the interest of grid safety. On the positive side, the states have recognised the issue of grid congestion and have invited competitive bids for the development of transmission systems.
The year has seen high M&A activity with some of the biggest players exiting the business. Do you expect this trend to continue in the coming years?
As a lender, we see merger and acquisition (M&A) developments as an overall positive for the sector. We believe this leads to consolidation towards large serious players with a diversified pool of assets backed by sponsors that have the requisite financial wherewithal. We have moved past the stage where players with 1 GW of capacity were considered large. The base has now increased to 5 GW and the next base is expected to be 10 GW.
Between 2014-15 and 2017-18, the renewable energy sector witnessed an impressive turnaround. However, the year 2018-19 saw renewable capacity addition of 8.6 GW, a decline of 27 per cent over the previous year. Many auctions saw weak investor response and were retendered. According to CRISIL, of the 64 GW projects that were auctioned by the centre and states, 26 per cent received no or lukewarm bids and another 31 per cent faced delays in allocation after being tendered in 2019-20.
India witnessed a flurry of M&A activity in the renewable energy space in the past couple of years with deals worth about $3 billion getting concluded. This was accompanied by the exit of some of the largest players on the block. Some of these exits, especially in cases where players were backed by PE funds, were in line with the charters to cash out their investments. This is typically true for funds with a medium-term investment focus. In other cases, exits were driven by the inorganic growth strategy adopted by comparatively late entrants in the sector. The same trend is expected to continue in the future as the sector matures.
Further, the government continues to set aggressive targets, with the prime minister committing the implementation of 450 GW of renewable energy capacity by 2030 at the recent United Nations Climate Summit in New York. This will need significant participation from global investors with patient capital along with further ramp-up of existing large players. Hence, we believe that consolidation will be a game changer for the industry.
Dr Pawan Singh
In the recent past, the sector has seen consolidation with quite a few M&As, and it is seen as a healthy sign for the sector. It facilitates the churning of capital by investors, thereby freeing up capital for further deployment. Also, this has facilitated the entry of global power utilities as well as global investors, opening avenues of infusion of the much required foreign capital. Consolidation is also expected to improve operations of entities and bring in operational efficiency.
Which emerging renewable energy technologies (rooftop solar, wind-solar hybrids, floating solar) are likely to attract investments during the next year?
With the infirm and intermittent nature of renewable energy, the MNRE is increasingly focusing on improving the flexibility and despatchability of renewable power and has brought out a number of tenders focused on wind-solar hybrid and hybrid with storage to meet round-the-clock requirements of discoms. We strongly believe that the flexibility of renewable power to meet peak load requirements is imperative for large-scale implementation of renewable energy in India (beyond the 80 GW already installed) and investments in technologies such as wind-solar hybrids coupled with storage (mechanical/pump-hydro/battery) are expected to increase substantially.
Developers are increasingly losing interest as central and state power discoms are lowering tariff caps, which is constraining project viability and resulting in renegotiation of tenders where counterparties disagree on pricing. The Bhadla Solar Park in Rajasthan, which saw tariff bids of Rs 2.44 per unit in May 2017, has set discom expectations for tariff bids, resulting in a solar tariff cap of around Rs 2.60 per kWh. The sharp narrowing of the gap between tariff caps and actual bid tariffs has left little headroom for developers, especially as capital costs have remained relatively constant and developers factor in a counterparty risk premium owing to payment delays of four to six months on average by state discoms. Therefore, emerging technologies may continue to face challenges over the next year. The sustainability of such tariffs can be ensured through continued availability of low-cost and long-tenor funds, as well as continued regulatory and policy support from the government.
While it may not be appropriate to classify these as new technologies, they may certainly be classified as new sub-segments for investment. The rooftop solar segment emerged as the fastest growing sub-sector with around 2,100 MW of capacity added as of June 2019. However, this appears to be meagre when compared to the ambitious target of 40 GW by 2022. Some of the challenges hampering investment in this sector are lack of a uniform net metering policy, incentives/subsidies provided largely for industrial consumers and not for the domestic sector, and lack of support from discoms. However, with a dip in installation costs and availability of commercially viable storage options, investment in this segment is likely to increase, especially in states with favourable net metering policies and high electricity tariffs.
The other two sub-sectors can at best be considered to be at their nascent stage. The government has notified the National Wind-Solar Hybrid Energy Policy to promote grid-connected hybrid systems. The policy is likely to facilitate efficient utilisation of transmission and land resources while reducing variability in power generation. This has provided certainty in terms of policy intent of the government. Therefore, this sub-sector in poised for faster growth. However, the lack of clarity on pricing may hamper the development of commercial-scale, grid-connected systems.
Floating solar projects are steadily gaining popularity due to higher efficiency, no land acquisition issues and movability. The global installed floating solar capacity stood at 1.1 GW at the end of 2018. After the initial installation of kilowatt-size experimental plants, developers are now moving towards commercial-size projects.
Dr Pawan Singh
Rooftop solar and wind-solar hybrids look promising with seamless possibilities. However, the next big leap in the renewable energy capacity has to be coupled with storage solutions. In light of this, the recent SECI bid for wind-solar hybrids with storage appears to be exciting. It is also expected to bring in global storage expertise in the country. Besides, the e-mobility space appears promising.
Open access projects are also expected to attract investments, especially given the declining tariffs and tariff caps in projects under the bidding process. However, clarity on long-term open access approvals is required from the lender’s perspective. It is envisaged that certainty on open access approvals will facilitate the debt funding of such projects.
What are some of the new financial instruments being deployed in the sector? What is your outlook for next year?
New financing options such as infrastructure investment trusts (InvITs) are coming up and their offtake can improve with continued regulatory support to attract investor interest. The Reserve Bank of India has also recently allowed banks to lend to InvITs, which is a key enabler. Further broadening of the bond space, including the dollar bond market, is required for refinancing Indian lenders and credit enhancement structures can play an important role in this. Takeout financing by specialist infrastructure institutions will facilitate timely exit of banks, reduce asset-liability mismatch, and channelise sustainable development finance into this sector. While IDFs have been active in refinancing renewable energy projects, they too need to scale up significantly.
While we continue to monitor the resolution of PPA issues in certain states, the long-term outlook remains positive considering the clear strategic intent of the government towards this sector. With improvement in the liquidity scenario and the progressive resolution of stressed assets in the banking sector, financing of renewable energy by all domestic financial institutions including public sector banks is expected to improve. We firmly believe that consolidation will further support for the growth of this industry.
Instruments such as alternative investment funds must be promoted to aggregate the cash flows of small-sized renewable energy projects to access capital markets. Further, banks must be incentivised to move their loan books to capital markets instead of holding loans till the portfolio matures. A strong asset-backed securitisation market will encourage banks to offload loan books to capital markets and help realise upfront pricing gains.
Over the past 18 months, new financing instruments for renewable energy projects have evolved significantly. The period witnessed some marquee deals in the country like the first-ever renewable energy-focused InvIT. Some of the major players are now planning the launch of similar InvITs. At the same time, a few players have attempted to raise debt through overseas bonds. Further, many other established players are planning to launch their IPOs. Another significant source of funding for the sector came from multilateral institutions. The Asian Infrastructure Investment Bank provided a $100 billion loan to an NBFC for renewable energy funding. In many cases, this was driven by the need to deleverage the balance sheet or monetise assets, whereas in other cases the aim was to raise funds for the next round of consolidation in the sector. However, not all attempts were successful due to prevalent market conditions and concerns. Considering the ambitious targets set by the government and huge outlays involved, developers may continue to explore different instruments for financing renewable energy projects.
Dr Pawan Singh
Traditionally, long-term project loans from banks and NBFCs have provided a fillip to the renewables sector. However, of late, there have been several instances where developers have raised capital through the bond route, thereby tapping into the coveted debt capital markets. Typically, raising of capital through bonds requires mitigation of project risks by making projects operational and aggregating capacities to diversify risks. Considering this, it is envisaged that the long-term model for financing of renewable energy projects is expected to converge to funding of an under construction project by banks and NBFCs by way of term loans. These facilities may choose to exit once the project starts receiving healthy cash flows through the money raised by the bonds route. Further, there is a need for products such as partial credit enhancement and full credit enhancement.