Solar Financing

How attractive is the Indian market for financiers?

The global renewable energy sector presents a diverse picture of development, with some countries achieving a considerable level of penetration and others lagging behind. The level of growth is a factor of the policy, regulatory, financial and tax benefits offered by the country as well as the targets set by them. Expectedly, countries that have a lower share of renewables have greater scope for development. India, for instance, which has a renewable generation share of 10 per cent, a large renewable energy target and high electricity demand, has scope to integrate much more renewable capacity than a country like Germany, where renewable generation is already at over 40 per cent of the total energy mix.

The transition to a higher share of renewables, of course calls for a substantial amount of financing. According to an estimate by the International Finance Corporation, India will need $450 billion to finance its 2030 target of 450 GW of renewable capacity. Of this, the majority share would be needed for the development of solar power, which  is likely to contribute the maximum among all renewables in India. Towards this, the greening of flows (capital flow marked for green infrastructure development) is essential to achieve the country’s renewable energy targets faster.

Looking at the past financing trends, renewables, especially solar, have emerged as one of the most attractive infrastructure sectors for investment. The government’s policies have de-risked the business to the extent that some of the world’s lowest solar and wind power tariffs are witnessed in India. The regulated returns from the sector under fixed tariffs and the long-term nature of cash flows have attracted some of the largest pension and sovereign wealth funds that look for businesses with strong fundamentals and provide low but steady returns. A look at the credit rating profiles of the major players in this space also shows a consistently rising trend, with some large IPPs and their projects even carrying a rating of A and above. Renewable energy businesses at the holding company level are beginning to stabilise, but due to their rapid pace of growth, they continue to deliver single-digit cash returns to investors.

However, investors need to be cautious given the various risks that can affect the profitability of a solar project in India. Frequent changes in policies and regulations are key among those risks. Take, for instance, the duties on imports. Despite a long-standing concern over safeguard duties, the government is now proposing to impose basic customs duty on imported solar modules. The industry is still seeking clarity on whether these duties will be imposed on modules sourced from special economic zones. Another key risk pertains to module price trends. Modules constitute around 64 per cent of the total project cost. Any change in module costs has a considerable impact on returns. There is a substantial lag of 8-12 months between bidding and procuring modules for a large-scale solar project. Any rise in module prices during this time significantly reduces the returns (and vice versa) and jeopardises project development. Take the case of one of ACME’s solar projects – the developer had to cancel it, apparently due to a mismatch between its expected module cost at the time of bidding and the actual cost at the time of sourcing. There are many such factors that have made a large number of investors, especially on the debt side, wary of investing significant sums in the solar space.

At a virtual conference, “Solar Power in India”, organised recently by Renewable Watch, senior executives from leading companies including Piramal Enterprises, ICRA, Indian Renewable Energy Development Agency Limited (IREDA), IIFCL Projects Limited and the CPP Investment Board talked about the emerging financing trends in the solar power space, new sources of funding and the risks that investors need to watch out for. The following are the highlights and key takeaways from the discussion.

Positive signs

The performance of the solar power industry in the country and world over during the Covid-19 crisis has been noteworthy. India witnessed three consecutive historic bids during the lockdown period. These were: the country’s first round-the-clock tender in May 2020, the world’s largest manufacturing-linked solar tender of $6 billion in June 2020, and the Solar Energy Corporation of India’s (SECI) Tranche IX auction in July 2020 with a historically low tariff. The latest tender (and the two before) is a clear manifestation of the Indian solar segment’s resilience and vibrant ecosystem and of the strong push by the government. It also underlines India’s position as one of the most attractive destinations for solar energy investments globally. The success of these tenders is the result of several positive trends in the domestic as well as global solar power segment.

  • Tariffs continue to fall: Between January 2019 and May 2020, most of the newly auctioned solar projects have seen tariffs in the range of Rs 2.50-Rs 2.87 per kWh, even with the presence of safeguard duties on imported modules. Interestingly, seven of the 10 tenders issued during this period discovered winning tariffs of under Rs 2.55 per kWh, well below the ceiling. Most of these tenders were fully subscribed, even at such low tariffs. Out of the 10 successful auctions, only two specific cases involved tenders that were undersubscribed by more than 60 per cent. In fact, SECI’s latest auction (July 2020) witnessed a record low bid of Rs 2.36 per kWh. The 2 GW auction of interstate transmission system (ISTS)-connected solar projects (Tranche IX) saw several domestic and global IPPs bid for project capacities. The L1 (lowest) tariff, quoted by Spanish developer SolarpackCorporacionTecnologica SA, is about 3.3 per cent lower than the previous lowest quoted tariff of Rs 2.44 per kWh in the country.
  • Entry of foreign investor-backed players: The Indian solar space is witnessing the entry of a large number of international investors with deep pockets and a huge appetite for risk. The latest SECI tender saw seven winning bidders, all backed by foreign investors. Spanish company Solarpack won 300 MW at the lowest tariff of Rs 2.36 per unit. At Rs 2.37 per unit, Italy’s Enel Green Power, Germany’s IB Vogt and New York-based Eden Renewables won 300 MW each, while Canadian developer AMP Energy won 100 MW. Finally, at Rs 2.38 per unit, Ayana Renewable Power backed by the CDC Group, the UK’s development finance institution, won 300 MW, and ReNew Power, backed by a bouquet of investors including Goldman Sachs, won 400 MW.
  • Interest by oil majors: Oil companies are increasingly turning to solar and wind power for their field operations as they seek to reduce their carbon footprint. According to a report by consulting firm IHS Markit, these companies announced 28 renewable energy-powered projects in 2018 and 2019 compared with 15 such projects announced during the period 2000 to 2017. This trend has grown in 2020, bringing in large investments from these deep-pocketed players into the solar space.
  • New sources of finance: A slew of new options such as green bonds and InvITs have become popular for raising funds. Investors are also looking at acquiring assets and consolidation is likely to continue as they expand their portfolios. Mergers and acquisitions (M&As) have become favourable as companies look to demerge their liabilities and acquire well-performing assets. A large number of global players have entered the Indian solar market with the bandwidth to withstand profit margin pressures. Meanwhile, it has become difficult for many developers to remain profitable owing to the unrealistic tariffs for winning projects, the depreciation of the rupee and the high cost of debt. These companies are, therefore, becoming a target for M&As.
  • MNRE’s green window: In order to attract private capital, the Ministry of New and Renewable Energy (MNRE) had, in December 2019, announced the setting up of India’s first Green Window within IREDA. A Green Window is designed as a dedicated facility within an existing institution and is driven by its mission to develop markets that are otherwise financially underserved. A large number of financial institutions are getting aligned to this initiative, thereby sending a positive signal to the market.
  • Proactive regulators: The regulators have in the past been proactive in handling some of the key issues raised by developers, such as the removal of ceiling tariffs and the enforcement of a payment security mechanism like advance letters of credit (LCs) in favour of renewable energy developers. Under the recently issued Draft Electricity Act (Amendment), 2020 and the proposed tariff policy, several progressive measures are being planned for the sector such as the introduction of a common pan-Indian renewable purchase obligation trajectory with a stringent penalty mechanism.

Matters of concern

While there are multiple reasons to remain bullish on India’s solar growth, investors cannot ignore certain big risks, some of which have the potential to completely derail the solar segment.

  • Worsening discom health: With the country’s power demand declining and industrial and commercial activity halting due to the Covid-19 crisis, discom revenues have taken a major hit. Although renewable power plants have enjoyed must-run status even during the pandemic, their payment cycles are likely to get impacted due to increasing discom losses. Historically, the discoms’ profitability has remained low with continued heavy losses and they have not been able to pay power producers for power procured from them. The delay in payments is not a one-time default; it has become a recurring problem. In fact, some discoms have not paid power producers for as long as six months to a year. This risk of non-payment is one of the major issues in the renewable energy space and it is likely to become accentuated due to Covid-19. Renewable power producers are already struggling with low margins owing to declining tariffs, transmission and land constraints, and generation curtailment. Payment delays severely affect developers, which need to repay investors and banks, and non-payment puts the entire project at risk. Thus, in the short term, some investors may become cautious about financing solar power projects in light of Covid-19. To improve sector prospects and investor sentiment, some reforms have been planned including a Rs 900 billion bailout package for discoms amidst Covid-19 and the proposed amendment to the Electricity Act. Timely implementation of these reforms will be crucial for solar project viability.
  • With Covid-19 causing supply chain disruptions and labour shortages, many under-construction projects have been stalled. These projects have fixed running costs and are expected to be costlier than previously estimated, which, in turn, will reduce their return on equity. The rate at which capacity build-up will take place will depend on how quickly the challenges are addressed and finances arranged. For operational projects, although moratoriums have been granted on loan payments in many cases, discom liquidity and cash flows will impact project financials post the lockdown. Thus, there may be short-term working capital gaps for generators post Covid-19. To resolve this issue, there should be some provisions for soft loans. Moreover, there have been reports of lenders becoming wary of continuing their unutilised credit lines for many operational projects as they foresee risks.
  • Debt woes: Large commercial banks and domestic lending institutions have shied away from funding renewable power projects in the past due to concerns regarding project viability at such low tariffs. For the recently auctioned projects as well, cash flows will definitely be tight and the volatility of the rupee may impact project costs at a later time. Equity financing has long been the preferred route for raising capital in the solar segment and this has now become the leading mode of investment, especially with the downward trend in debt financing. Whatever debt financing is taking place is mainly in the form of loans. The decline in debt deals can be attributed to higher interest rates and cheaper alternative sources of finance such as green bonds. In the near future as well, equity financing will not be an issue, especially with the entry of a large number of funds in the Indian solar space. However, the issue in debt financing is likely to remain because of the current banking crisis.
  • Interest rates: Interest rates are the most significant determinant for tariffs in India. Typically, interest rates for renewable energy projects with a loan repayment tenor of 15-18 years vary from 10 per cent to 12 per cent. These interest rates are not fixed and change frequently over the life of the loan, in line with Reserve Bank of India guidelines, thus adding interest rate risk during the repayment period.
  • Geopolitical tensions: With the Indian solar industry dependent on China for the majority of its solar modules, the current stand-off with China and its likely impact on project prices needs to be factored in while determining tariffs. This may have a negative effect on project returns in the future.

Outlook

Most investors believe that overall financing activities, including green finance, will see a dip in the short term on the debt front. This dip is due to the ongoing pandemic and the tail-end risks resulting from lockdowns and the corresponding recessionary impact on businesses worldwide. Meanwhile, equity transactions may continue to increase.

Going forward, the solar power segment would need a slew of reforms to accelerate the pace of investments in this regulated business. The reforms would primarily need to address the issue of a weak buyer (the discoms), which may delay or default, or both, on its payments to generators. The other long-term reforms are tariff and structural measures to allow for mutualisation of the cost of this massive integration which, at present, is limited to conventional power generators and utilities, and may lead to a pile of non-performing assets in the entire power sector.

By Dolly Khattar and Khushboo Goyal

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