With the Covid-19 crisis casting a shadow over new investment plans, lenders remained wary in 2020, especially on account of a liquidity crunch owing to banking sector issues, and regulatory and contractual uncertainties in the renewable energy space. However, the deal market continued to attract both buyers and sellers as investors acquired projects to expand portfolios while development activities were delayed. Meanwhile, mid-size companies chose the exit route due to unsustainable circumstances and the hypercompetitive market landscape. Industry leaders share their views on the evolving financial landscape for renewables, the key challenges and possible solutions, and emerging financial instruments. Excerpts…
How has financing in the renewable power space evolved over the past 10 years? What have been the key positives?
The renewable energy sector has witnessed a capacity addition of 73 GW over the 10-year period April 2010 to March 2020. The majority of this capacity came online in the past five years, driven by favourable policy support, improved tariff competitiveness and the short gestation period of such projects. The sector witnessed the entry of a large number of players during this period, on the back of large-scale investments from global private equity players, sovereign funds, pension funds and utilities. Debt funding for these projects came primarily from domestic banks and financial institutions (FIs) during the under-construction stage, with a few players being able to fund this through the capital market route. Post commissioning and demonstration of the track record, the debt funding is typically refinanced either through the capital market route or banks/FIs. Larger IPPs have been able to refinance debt funding for operational assets through foreign currency bonds.
Renewable energy project financing in India has evolved from a handful of specialised domestic lenders to a more diversified set of financiers including domestic banks and non-banking finance companies, foreign banks, development finance institutions (DFIs) and multilateral institutions. In addition, many big sponsors have been able to tap international bond markets against portfolios of operating renewable energy assets.
In India, renewable energy financing continues to be largely project finance based, with a major part of it being funded by banks. Most renewable energy projects have a 70 per cent debt requirement which has historically been met by domestic lenders, and this trend continues today. Capital markets have definitely grown, but not at the required pace.
What are the key concerns for financiers in the renewable energy space?
The key concerns emanate from the execution challenges related to land acquisition and transmission connectivity in the case of under-construction projects, leading to delays in commissioning, cost overruns and a slowdwon in cash flow generation. In the case of operational projects, the risk of delayed payments from offtakers remains a major concern, followed by under-performance vis-à-vis the appraised generation estimate. In the recent past, concerns have come up on the regulatory front, with the Andhra Pradesh government attempting to renegotiate tariff for signed power purchase agreements (PPAs); the matter is under litigation. Other regulatory challenges are delays in approving PPAs and change-in-law claims by regulators. Grid curtailment is another concern.
Projects in the developed world observe a long cycle of development followed by a stage when they are shovel-ready. Given the relatively shorter bidding timelines in India, development and construction timelines are commingled, which makes risk assessment more challenging. Also, uncertainties around cost (modules or turbines, exchange rates, etc.) due to staggered cost fixations make financing harder. Other key risks faced by financiers are overestimation of resource availability, poor financial health of discoms and uncertainty regarding the continuation of policy support for the sector in terms of provision of must-run status and sanctity of PPA tariffs. The reputation and the track record of sponsors or promoters are also key for financiers.
There are actually quite a few concerns for financiers. First and foremost is the regulatory uncertainty at both the central and the state level, with no stability in the policy frameworks. Clear examples of this are the confusion regarding the safeguard duties on solar module imports, and the inability of states to stick to PPAs. The second issue is related to land acquisition and transmission availability, leading to delays in project commissioning. The final concern is that even when projects are operational, there is a risk of payment delays for power offtake – mostly from state utilities. Thus, financing concerns exist at every step of the project, be it pre-development, during execution or during operations.
“Counterparty credit risk is one of the prominent risks for renewable energy IPPs.” -Sabyasachi Majumdar
Which are the most preferred modes of financing currently? Do you think the surge in M&A activity will continue?
The debt funding for new projects is likely to largely come from domestic banks/FIs and the equity funding is expected to come through a mix of fresh equity from principal investors and the recycling of operational assets. With respect to merger and acquisition (M&A) deals, the renewable energy sector has witnessed active acquisitions over the past two to three years, with about 9 GW of renewable energy assets witnessing partial to full sale of equity stake. The acquisitions were driven by a mix of reasons – divestments by private equity platforms to provide returns to investors; divestments by certain corporate groups to reduce leverage; and monetisation of operational assets by certain sponsors to fund future growth. The valuation of assets has varied across these transactions based on the generation track record, tariff rates of the projects and the balance PPA tenure. M&A activity is likely to continue in the near term with assets being put on the block by certain developers for partial to full stake sale. There are about 4 GW of renewable energy assets on the block for sale of partial to full stake.
At the construction stage, renewable energy projects in India raise financing mostly from commercial banks and specialised private and government lending institutions. Foreign banks and DFIs have also started taking an active interest in this space. In the refinancing space, other than domestic banks, local infrastructure debt funds and foreign bond investors have been playing an active role. At present, there is low interest shown by domestic insurance, pension and provident funds. These institutions will need to play a greater role to finance the large growth expected in the renewables market.
On the M&A side, India is seeing significant activity. Diminishing availability of capital for smaller players is leading to consolidation and larger deal sizes. Current M&A deals are partially driven by a warehousing strategy for ultimate exits through potential infrastructure investment trusts (InvITs). With the market heading towards domination by very large players, small-scale players would find it hard to survive. The market is also trending towards the “develop and hold strategy” rather than “develop and sell”. A simple back-of-the-envelope calculation shows that India needs to add 20-35 GW of renewable energy capacity in the next 10 years to achieve its ambitious target of 280 GW-430 GW by 2030. Given the expected growth, a lot of activity is anticipated in the M&A market in India.
Renewable energy projects are largely going to be bank funded for at least the next one to two years, as it will still take some time for the capital markets to develop. There is an appetite for credit lines, at least where large infrastructure projects are concerned, and project-level bonds are still some time away. InvITs are a good financing solution, but it may take some time for them to pick up as they are related to the stability of cash flows.
As far as M&A activity is concerned, we can expect some level of consolidation to continue. Smaller and mid-level companies may not be able to hold on to their portfolios due to the inherent sector challenges of payment delays and contractual issues. It would make more sense for these companies to sell their portfolios to larger players at attractive prices. For this reason, M&A activity will remain crucial to raise finance in this segment, at least for the next two to three years.
“The market seems to be heading towards domination by very large players.” Bill Rogers
Which emerging segments are expected to witness an increase in investments in the coming years?
We expect the incremental bidding activity for renewable energy projects to gradually shift over the medium term from stand-alone wind or solar bids to hybrid projects blended with other sources for round-the-clock (RTC) and peak supply. This is on account of the competitive tariffs that have been discovered and the fact that hybrid projects enable efficient grid integration of renewables. The The Solar Energy Corporation of India (SECI) has floated a 5 GW tender for the supply of RTC power from renewables blended with other sources including thermal power. The performance of hybrid projects bid out so far would provide an impetus to investments in this segment. This apart, a reduction in battery cost and a demonstration of the cost economics of pumped storage hydropower projects would drive investments in the storage segment.
India needs large sums of investment in the renewable energy generation, transmission and distribution segments. The coming years will see large-scale investments in renewable energy projects that generate firm power. SECI is expected to come out with bids of significant capacity in the hybrid space, including storage and gas to source round-the-clock power. Significant upfront thinking and planning will be needed to design the bids and plan enabling infrastructure if India wants to attract competitive financing in renewable-backed firm power. Other potential green areas that may start attracting investments include electric mobility and battery storage.
As a financier, we are focused on a very niche segment, which is commercial and industrial (C&I) solar. We are not looking at large utility-scale projects. For us, C&I solar is an emerging area that has gained significant traction in recent years, and we are keenly exploring this space. Other areas of interest for us are energy efficiency, energy-as-a-service, and electric mobility, which we feel are going to become big markets in the next few years and provide a host of investment opportunities.
“Renewable energy projects are largely going to be bank funded for at least the next one to two years, as it will still take some time for the capital markets to develop.” -Sameer Tirkar
What has been the impact of Covid-19 on renewable energy financing? What is the outlook post-Covid-19?
The disruption in economic activity caused by Covid-19 is having an adverse impact on electricity demand as well as on the execution of power generation projects in the current fiscal. Nonetheless, the execution is expected to improve in the second half of the year, with the easing of supply chain restrictions. The capacity addition for the full year is expected to be 7.5-8 GW. It is likely to further improve to 11-12 GW in financial year 2022. Overall, renewable energy capacity is expected to reach 160 GW by March 2025. It will be a combination of standalone solar and wind projects and hybrid projects, with cumulative capacity addition of 74 GW during the April 2020 – March 2025 period. This would entail an investment of over Rs 4 trillion, with debt funding of about Rs 3 trillion. However, the realisation of this potential is subject to the resolution of execution challenges and timely signing of PPAs/PSAs. This apart, a sustainable improvement in the financial position of state distribution utilities remains critical, given that counterparty credit risk is one of the prominent risks for renewable energy IPPs.
Covid-19 has slowed down the pace of development and construction, but it has not been a major deterrent for the renewables sector overall. Strong support from the Ministry of New and Renewable Energy (MNRE) with respect to payments to operating plants and the extension of timelines for under-construction projects during Covid-19 has been a big positive during these uncertain times. Credit offtake has been low during this phase, but this is primarily due to commissioning timeline extensions for projects. Interest rates that have reduced during Covid-19 are likely to remain low in the near to medium term with the government expected to come forward to support sector growth. This would improve viability of operating projects and enhance new asset creation.
Electricity demand in India is already picking up and is projected to witness stable growth in the post-Covid-19 period. Diminishing credit support for new coal capex, policy support including must-run status for renewable power, investment in the green energy corridor and the MNRE blueprint for renewable energy parks would drive capacity addition over the next few years. The buildout is expected to be more back-ended depending on how policy support and the development of enabling infrastructure pans out over the next few years.
Covid-19 has definitely had some impact on renewable energy portfolios. As financiers, we have looked at this in three ways – impact on operational portfolio, on under-construction projects, and on the pipeline. However, the level of impact varies. Operational projects are safeguarded to some extent, although there have been payment delays, which are expected to be sorted in the medium term.
Under-construction projects have suffered on account of supply chain disruptions and delays in approval messing up timelines and leading to cost overruns. This, in turn, has affected project returns. Thus, these projects are slightly more critical for us. Stronger players will be able to bounce back faster, but for players that do not have sufficient equity to begin with, it will surely take some time for things to normalise. Regarding the project pipeline, there was some disruption in the first two to three months of the pandemic. However, the situation has normalised since then and pipeline development has bounced back strongly.