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Will states live up to the ambitions of the central government?

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As part of the 60 GW target for utility scale solar, the central government is taking the lead at present through projects developed under National Solar Mission.  But states are expected to play a bigger role over time and develop 20 GW of capacity (refer). In percentage terms, this seems very reasonable given that state policy projects already account for around 60% of the installed solar capacity and 65% of total project pipeline of 10.8 GW in India. However, state policy projects generally tend to suffer significant delays and policy uncertainty.

Policy flip-flops at the state allocation level, including recent one in Madhya Pradesh, have hurt investor confidence

If central government allocations are exhausted early, as planned, will states be able to sustain demand?

India needs to ensure that enough thought and center-state co-ordination goes into plan for state-level allocations

We have seen too many state government flip-flops in the past on solar policies and project allocations. Some prominent examples include: Chhattisgarh changing project allocation criteria after holding a bidding process and observing the results, Bihar not announcing the results after calling for bids and Tamil Nadu cancelling its bidding process several times before recently allocating projects at a fixed tariff.

It now seems that recent allocations in both Telangana and Madhya Pradesh have also hit a speed bump. Madhya Pradesh seems to be reluctant to sign PPAs with companies such as Hero Future Energies and Renew Power. The stated reason is that these bidders have quoted prices materially higher than the lowest bidder, Sky Power. While Sky Power has been issued Letters of Interest (LOI), the other have not yet received it. There is also some confusion for Telangana allocations where the peculiar sub-station level bid process has led to a scenario where a developer with a more competitive bid of say, INR 5.40/ kWh may not be allocated any capacity but other developer with higher bid of INR 5.50/ kWh may be allocated capacity.

Even though central government led allocations have faced their own set of issues, the state project uncertainties are hurting investor confidence much more significantly. And it leads us to ponder whether state allocations will continue to remain a weak link in India ambitious targets.

The larger issue is that the state DISCOMs ultimately need to offtake most of the power being allocated even by the central government, i.e., the entire 60 GW. Both NTPC and SECI are allocating projects after getting consent from the states. Even though central government led allocations provide the cheapest way to meet the state’s RPOs, both NTPC and SECI are still facing challenges getting the required commitment from states. Even if they do, the question is – once states meet their RPO requirements through central government tenders, will they still have the appetite to allocate projects under their own policies? Also, the central government wants to allocate its entire quota in this year itself and then move out for states to take over. If it does, will states be able to sustain the demand and not lead to boom and bust scenario?

We know that the state allocations will need to be a bigger demand driver than the central allocations India has to meet its ambitious targets. We can’t stress enough on the financial health of state DISCOMs and its implication on India’s solar goals. However, before we hit that roadblock, we need to ensure that enough thought and center-state co-ordination goes into state allocations so that we don’t scare away the investors before the appetite for solar power procurement is exhausted.

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A New Approach to Improve DISCOM Health

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The poor financial health of India’s power distribution companies (DISCOMs) is deemed to be the weakest link in the Indian power sector and a huge headache for project developers.  It is not just critical for the revival of the power sector but also for the health of public sector banks. Recent estimates by CRISIL suggest that poor progress on tariff reforms and high AT&C losses have cost led to accumulated DISCOM losses of INR 3.75 trillion (USD 56 billion). To put this in perspective: this is equivalent to around 2.7% of India’s GDP.

Central government wants states to issue bonds for raising funds at 8.5-9% to refinance power firms’ current high-cost loans (13-14%)

In return for reforms, central government will offer funds from schemes such as the Integrated Power Development System and Deen Dayal Upadhyaya Gram Jyoti Yojana

The long term growth prospects of the solar sector are contingent upon the financial health of the DISCOMs

In a positive and much needed development, India’s power minister Piyush Goyal recently clarified that the central government cannot be a bailout bank for debt-ridden DISCOMs and that states will have to find their own way out of the crisis (refer). Instead, the central government sees its role as limited to nudging state governments into reforms using a carrot and stick approach. In line with that, the central government is proposing that state governments push through urgent reforms to improve the financial situation of the DISCOMs. Some of the reforms proposed are: i) states should issue bonds for raising funds at 8.5-9% to refinance high-cost loans (13-14%) of DISCOMs; ii) cut the aggregate technical and commercial losses to 15% (currently the average is above 25%; in some states like Jharkhand (42%) and Uttar Pradesh (32%) it is even higher), and; iii) ensure 100% metering and keep the heavily subsidised farm sector on a separate grid.

The carrot offered in return for reforms is funds from schemes such as the Integrated Power Development System and Deen Dayal Upadhyaya Gram Jyoti Yojana. These funds could be linked to the performance of states on reforms.

The root cause for past failures to stabilise DISCOM finances lies in heavy and often short-sighted political interference, leading to – amongst other things – unsustainably low power tariffs. In turn, DISCOMs have always banked on the state and central governments to bail them out at regular intervals. With the central government now refusing to give ad hoc funding to DISCOMs, the pressure to reform is rising.

In face of a looming power sector crisis in the country, there is an urgent need to raise power tariffs and remove inefficiencies. In the short term, solar power might benefit from a power crisis. However, in the long term, the growth of the solar sector is closely linked to the health of the grid, DISCOM finances and the overall economy. As with most other pending reforms, the states seem to be at the steering wheel and not the central government. We hope that economic sense and mature politics will prevail over short term political gains and populism and result in the much awaited power sector reforms.

Other announcements

Last week, the Solar Energy Corporation of India (SECI) announced a Viability Gap Funding (VGF) based allocation of 500 MW in Maharashtra and 250 MW in Gujarat (refer). Also, NTPC announced a new EPC tender for 750 MW in Andhra Pradesh (refer).

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Parliament’s Monsoon Session and what it meant for the Solar Sector

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The Indian Parliament recently concluded a literally washed out monsoon session. The key Amendments for Electricity Act 2003, which the Parliamentary Standing Committee had already recommended was ready but not tabled (refer here to read why this matters for the solar sector). Another important proposal to amend the National Tariff Policy 2005 has been severely watered down (refer here to read about its proposed impact on the solar sector).

Amendments to the Electricity Act are ready but could not be introduced in the parliament.

Dropping of the compulsory adherence clause in the amendment to the National Tariff Policy will undermine the impact of the reform.

Written replies to questions raised by parliamentarians revealed several aspects of various government initiatives.

Amendments to the Electricity Act are the cornerstone – the legislation will reorder the regulatory landscape for the entire power sector in the country. This includes an enhancement of Renewable Purchase Obligation (RPO) targets, introduction of Renewable Generation Obligation (RGO) targets, penalties on RPO and RGO non-compliance, ease of doing business for renewable micro-grids for rural electrification and other, broader power sector reforms such as separation of content and carriage.

Amendments proposed for the National Tariff Policy 2005 originally had provisions to allow for cost-free interstate transmission of renewable power, procurement of bundled solar power by DISCOMs from conventional power generators on a cost plus basis, easy pass-through of RPO compliance cost and several other, larger tariff structure related reforms for the power sector. State regulatory commissions, however, claimed that several amendments were infringing upon the state rights. Subsequently, the government has dropped the compulsory adherence clause of the amendments, making it more of a guideline. BRIDGE TO INDIA believes that as a result, the impact of the reform will be undermined.

Interestingly, the written replies by the Ministry of New and Renewable Energy (MNRE) to questions asked by parliamentarians revealed a lot about the government’s thinking on solar. The government provided the latest breakup and timeline of the 100 GW target (refer, refer) and announced several plans to reduce the cost of financing for renewable projects (refer).  It also provided clarity on various initiatives for achieving  the 40 GW rooftop target solar plan and incentives (refer) and financial status of the National Clean Energy Fund (refer).

As the parliament session showed, the Indian political system has little appetite for big-bang reforms in the power sector. The central government is keen to drive change but it is dependent on state governments to come onboard.  The treacherous issues of high transmission, distribution and commercial losses, including theft, and insolvent DISCOMs remain the weakest links in the sector.

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A status check on Dollar dominated bids for solar projects in India

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India has been discussing dollar dominated bids for solar projects in the country for some time now. The rationale is to attract low cost international capital and reduce hedging costs by pooling currency risk with the ultimate objective of reducing the cost of solar power. An initial allocation for 1 GW of projects is believed to be in planning stages and guidelines on bidding process are expected within the next couple of months.

The government hopes to lower the cost of solar power by around 10%

BRIDGE TO INDIA analysis shows that cost reduction may be slightly less at about 5% but these projects may attract new capital to the sector

It is worth going through the added complexity of Dollar dominated bids only if the government is confident of using this mechanism for much larger capacity, say 10 GW or more

Under this structure, National Thermal Power Corporation (NTPC) hopes to buy solar power at a fixed tariff of about USD 5.6 cents/kWh (INR 3.6/kWh) using auction process and sell to distribution companies (DISCOMs) at around INR 5/kWh, about 10% lower than current cost. This leaves INR 1.40/kWh to cover hedging risk.

BRIDGE TO INDIA analysis shows that this is a sensible move as there is already very strong demand from international investors for Indian solar projects. But the actual tariffs realized under Dollar denominated bids will likely be less than 10% because procuring currency hedging for 25 years is not possible and it is not clear who will maintain this hedging corpus and bear the residual risk. This unhedged risk, which increases with time, is very difficult to quantify and will result in higher hedging cost.

It is important to highlight that the Dollar tariffs will remove exchange rate risk for developers and investors, but they will still bear all other India project development risk including offtake, dispatch, policy and other operational risks. Hence, developers expecting 10-11% return on projects in the USA, for example, will still expect a return premium for Indian projects to compensate for extra risks. And will the international lenders who anyway do not take any currency risk see these projects differently? The government should finesse the structure after thorough consultation with developers and lenders, distribution companies and NTPC, which is expected to be the project procurement agency. It might take another 6-8 months before all the kinks are ironed out and India actually moves forward with the first round of dollar dominated bids.

It is worth going through the added complexity of Dollar dominated bids only if the government feels confident of using this mechanism for much larger capacity, say 10 GW or more. The clear objective should be to attract large international developers for larger projects and reduce project procurement time and costs in addition to hedging costs.

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Telangana gets lowest bid at INR 5.17/kWh in India’s largest solar tender

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Financial bids were opened today (3rd August 2015) for the 2,000 MW solar tender in Telangana. This is the single largest allocation in the country till date. According to unconfirmed sources, the lowest tariff for this bid has been quoted at INR 5.17/kWh by SkyPower. Sky Power had also quoted the lowest tariff in Madhya Pradesh at INR 5.05/kWh.

Despite the manifold increase in the number and capacity of allocations in India, competition remains intense

Appetite of developers has also increased manifold and several new players have entered the market

We expect NSM bids for 420 MW in Rajasthan to witness even more intense competition

Bids for a total of 4,988 MW were submitted by 101 developers, i.e., an oversubscription of around 250%. Some of the prominent developers that had bid for these allocations include: SunEdison (580 MW), Acme Solar (510 MW of bids), Adani Power (492 MW), Renew Power (400 MW), Reliance Power (400 MW), Mytrah (350 MW), Suzlon (260 MW), Sky Power (200 MW), Shapoorji Pallonji (150 MW), Mahindra EPC (142 MW), Hero Future Energies (100 MW), Fonroche Energies (100 MW) and Energon Solar (100 MW).

It is interesting to note that even though the tariffs are aggressive, most developers have bid at tariffs that are on a higher side as compared to those quoted in Madhya Pradesh last month (refer). The primary reason for this difference is that unlike the normal 11 or 12 months provided for commissioning of projects in most states, Madhya Pradesh allowed a generous 18 months for commissioning of projects. In Telangana, the projects will likely be commissioned within 2016, whereas, in Madhya Pradesh, projects will likely be commissioned much later, i.e. in Q3 2017. Developers have bid more aggressively in Madhya Pradesh expecting greater cost reductions over the extended period. Another reason for the more aggressive bids in Madhya Pradesh is the availability of government land for lease at a comparatively low costs. Also, the larger overall size of the allocation in Telangana might have taken some heat off the competition.

This argument also has a bearing on expected results from allocations planned under the National Solar Mission (NSM) starting this month for a total capacity of 1,420 MW. Even though NSM projects are most favoured by developers resulting in more aggressive tariffs, we expect NSM bids in Andhra Pradesh to be slightly higher than those in Madhya Pradesh because of the higher cost and implementation risk of solar parks infrastructure.

In general, despite the manifold increase in capacity allocations, competition remains intense because of increasing appetite of existing players and entry of many new players. We expect this trend to continue as the sector continues to attract further players and project sizes grow resulting in more efficient procurement.

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