Month: August 2017

InvITs are infrastructure investment trusts set up pursuant to SEBI Regulations 2014 for investment in infrastructure projects. Money raised from InvITs is used to repay external debt and buy back equity investments in underlying project companies. Recently, IRB and Sterlite power successfully launched the first two InvITs for road and power transmission projects by raising INR 50.3 Bn (USD 775 million) and INR 22.5 Bn (USD 345 million) respectively. Other infrastructure and energy asset developers are expected to follow suit later this year.

SEBI regulations mandate a minimum of 80% of assets under an InvIT to be revenue generating for at least a year and at least 90% of distributable cash flow from underlying projects to be transferred to the InvIT unit holders. Thus, unit holders are assured periodic payments from distributable cash flows. An InvIT can only borrow up to 49% of its asset value on a consolidated basis. The overall InvIT structure is akin to a yieldco with tighter regulatory oversight because of its trust structure and attractive tax benefits:

 Tax benefits SPV·         Exemption from dividend distribution tax
 
 
·         Interest payments to InvIT not subject to withholding tax
InvIT·         Exemption from corporate income tax
 
 
·         Exemption from dividend distribution tax
·         TDS of 5% (subject to Double Taxation Avoidance Agreement) on interest payments to non- resident unit holders

These tax benefits are worth an estimated additional yield of 0.5–1.0% on total investment.

Some solar developers are also believed to be exploring possibility of launching solar InvITs. Certainly, the structure has some advantages in comparison to conventional IPO route because of the various tax and regulatory benefits. An additional benefit is that by retiring bank debt in existing projects, the InvIT sponsors can free up bank debt appetite for their pipeline projects.

We understand that the IRB InvIT with an enterprise value of INR 59 Bn and average post tax EBITDA of INR 7.3 Bn results in a pre-tax yield of around 12.5% for its unit holders, while Sterlite’s InvIT with an enterprise value of INR 37 Bn and average post tax EBITDA of INR 4 Bn offers pre-tax yield of about 11%. The lower yield expectation from transmission projects is possibly due to their more stable cash flows compared to road projects where revenues depend on traffic growth assumptions. The two InvITs were oversubscribed in primary market, but fall in their prices post listing indicates a stronger yield requirement from the secondary market.

The key issue for solar InvIT feasibility is the return expectation and/or risk perception of solar projects in the institutional investor market, which demands low-risk, stable returns. We expect such investors to seek a higher pre-tax yield (12-14%) from solar InvITs because of the various sector risks – mainly grid curtailment, DISCOM payment risk and long-term plant performance risk. As a result, we believe that the InvIT route will be available only to highly credible developers with strong track record of executing solar projects with best-in-class standards.

Indian solar developers typically factor in a 15-20% annualised fall in the cost of solar modules when bidding for new projects. The assumed price decline may have been even higher in some of the recent auctions. Price increases in the last 2-3 months, therefore, have come as a shock to the sector. Against an expectation of USD 0.28/Wp, prices for the current quarter are being quoted at about USD 0.34/Wp. Goods and Services Tax (GST) rate of 5% has further added to the cost increase. Higher costs and constrained supply as Chinese suppliers renege on module supply contracts are presenting new challenges for Indian developers.

Explosive capacity addition, coupled with a reduced polysilicon supply in China is primarily responsible for module price increases;

Up to 1 GW of projects, due for completion in the remaining year, may get delayed as a result of higher prices and/or uncertain supply status;

Projects also face the risk of imposition of anti-dumping duties, which could be announced as early as September 2017;

China was expected to add 33 GW of solar PV capacity in 2017 but it has already added over 34.9 GW in the first seven months, with 24 GW being added in June and July alone. This explosive capacity addition, coupled with reduced polysilicon supply, has led to drying up of inventories and price increases across the value chain. However, China demand is expected to slow down for the remaining part of the year to just 5-10 GW. A significant part of this new capacity is to be added under the Top Runner program using high efficiency mono and mono PERC solar modules. That should mean a return to an oversupply situation for poly-crystalline modules used in India.

However, some manufacturers insist that prices will continue to be high until the end of the year. They expect strong demand from the US as the Trump administration explores imposition of safeguard duties, which would come into effect in January at the earliest. The prospect of duties is forcing developers in the US to rush ongoing projects or even stockpile modules for future projects.

For India, increased module prices have led to a slowdown in new orders as developers delay procurement in the hope that prices will start falling at some point in the near future. Over 3.8 GW of new capacity is scheduled to come online in H2/2017. This includes state policy projects in Andhra Pradesh and Telangana and central policy projects in Rajasthan, Gujarat, Maharashtra, Karnataka and Uttar Pradesh. These projects were allocated 12-18 months ago at tariffs over INR 4.43/kWh and should be financially viable even at current module prices. Nonetheless, we believe that up to 1 GW of project capacity may get delayed as developers wait for better pricing and/or assured supplies.

A larger risk to Indian projects comes from a possible imposition of anti-dumping duties at home. There is a possibility that Indian authorities could recommend a provisional anti-dumping duty as early as September 2017.

The Ministry of Power has issued new “Guidelines for tariff based competitive bidding process” for solar power plants. The guidelines shall be applicable to all projects equal to or greater than 5 MW for supplying power directly/ indirectly to DISCOMs subject to approval from the respective central or state regulator. For the first time in the sector, the government also proposes to issue standard bid documents including request for selection, PPA and other ancillary documents.

The proposed changes, while still not going far enough, are a major improvement on the current framework. Introduction of standard documentation, in particular, will be of major help to developers and investors. Significant changes are discussed below.

Readiness of project site:

The guidelines specify strict timelines for completion of land acquisition, transmission connectivity and other approvals in a timebound manner to avoid project delays. If the power purchaser retains responsibility for these in the form of a solar park, then it must ensure that: i) at the time of bidding, 100% of land is identified and proof of in-principle availability of 25% of land is in place; and ii) within one month of PPA signing, 90% of land is acquired and balance 10% is acquired in the next two months. All statutory clearances and transmission connectivity feasibility should be available prior to PPA signing.

If there is no solar park available, the developer must identify 100% of land requirement at the time of bid submission and complete full land acquisition within 7 months from the date of PPA signing. It must also ensure that environment/forest clearances, approval for water and transmission technical feasibility are available as required by the power procurer.

Payment security mechanism:

In addition to a letter of credit for one-month billing, the power purchaser (DISCOM or an intermediary buyer such as NTPC/SECI) needs to establish a payment security fund equivalent to three-month billing amount. This is a major improvement over current practice and will help in reducing DISCOM payment risk perception.

Where DISCOMs are buying power through an intermediary entity such as NTPC/ SECI, they are required to procure a state government guarantee in favour of NTPC/ SECI if a tripartite agreement between the respective state government, Reserve Bank of India and the central government is not in place.

Termination compensation:

It is unbelievable that most solar PPAs in India today do not have any provision for termination compensation for a power purchase default. The new guidelines specify that the developer can terminate the PPA in case of a power purchaser default. It shall be entitled to: i) either sell the plant to the power purchaser and seek compensation equivalent to total debt outstanding plus 150% of adjusted equity, or ii) retain ownership of the plant and seek compensation equivalent to six months billing amount. The introduction of this clause will serve as a major deterrent against default and protect the developers from DISCOMs seeking to unilaterally cancelling or re-negotiating PPAs.

Compensation for offtake constraints:

The guidelines recognise that grid backdowns/ curtailment are becoming a bigger problem for the sector and seek to provide compensation to developers for the same. In the event of generation loss due to evacuation infrastructure not being ready or being unavailable for more than 50 hours in a year, the developers are allowed to sell equivalent amount of extra power over subsequent three years. In the event of back-down requests from DISCOMs, 50% of revenue shortfall will be met by the DISCOM. However, there is no compensation for any backdowns due to grid instability or safety reasons.

These clauses are positive but they still do not provide sufficient protection to the developers from curtailment or back-down risks.

Lender substitution rights:

The new standard PPA will allow substitution if the developer defaults on payments to its lender(s). Previously, substitution was permissible only if the developer had defaulted on its PPA obligations.

These changes have come after extensive consultations and aim to protect developer and investor-lender interests. As we saw with the recent Rewa tender, improved contractual documentation and risk allocation can provide more confidence to the sector and lead to a win-win arrangement for all parties.

India’s Ministry of Finance has released a mid-year macro-economic assessment of the country in the form of second volume of the Economic Survey 2016-17. The Survey reflects work of various government departments and provides valuable guidance to future policy making. The chapter on climate change and energy reiterates recent Central Electricity Authority (CEA) projections – capacity addition for coal based power is expected to be around 50 GW between 2017 and 2022 and nil between 2022 to 2027. As for renewables, the Survey takes a curiously negative view and recommends that India should ‘calibrate’ investments in renewables.

– The Survey assesses social cost of renewable power to be around 3 times that of coal power at INR 11 per kWh;– Underutilization of coal fired power stations causing losses for investors and lenders is classed as the most significant contributor to “social cost of renewables”;– The Survey’s ambivalent messaging betrays lack of clarity between different parts of the government, which is a very worrying sign for the sector;

The Survey argues that various sources of energy should be prioritized based on an analysis of their holistic impact (“social cost”) on the economy. It defines social cost of a power source as an aggregate of actual cost of power generation, grid related costs, opportunity cost of land utilized, environmental and health costs from carbon emissions together with, remarkably, the opportunity cost of stranded conventional power assets. Environmental and health costs of coal usage in the sector are estimated on the basis of USD 2.9/ ton of carbon emissions (source: Revisiting the social cost of carbon – William D. Nordhaus) and USD 4.6 billion due to 115,000 pre-mature deaths every year (source: Scientific American). Not much explanation or numbers are available for other costs except that underutilization of coal fired power stations causing losses for investors and lenders is classed as the most significant contributor to “social cost of renewables”. Accordingly, the Survey concludes that social cost of renewable power is around 3 times that of coal power at INR 11 per kWh and recommends that India should ‘calibrate’ (read lower) investments in renewables to reduce this “social cost”.

We welcome the holistic approach to future planning but the Survey’s methodology is opaque, selective and debatable. It is difficult to comment on it without having full details but in our view, underutilization of coal-fired power stations is down to poor planning by various government agencies as well as shoddy investment decisions made by private developers and lenders. It is completely wrong to attribute these problems to renewables.

The survey also cites the large land area requirement for setting up of renewable power capacity as a key barrier to its adoption. This is an old argument that has been debunked several times. Solar projects typically use low-cost, non-productive land and an analysis by BRIDGE TO INDIA shows how India can install as much as 1,000 GW solar capacity in just half the desert district of Barmer, Rajasthan (equivalent to 3.5% of India’s waste land).

We agree that the renewable sector has enjoyed several government incentives including preferential access to the grid. These special benefits need to be phased out gradually to make the sector viable on a stand-alone basis as also stated recently by the draft National Energy Policy.

Overall, the Economic Survey sends a negative signal to the renewable sector. It betrays lack of clarity between different parts of the government. That is a worrying sign for the sector already dealing with problems such as contract cancellations/ renegotiations, GST and prospect of anti-dumping duties.

We have released our latest report – India Solar Compass – a quarterly update on the Indian solar market. The report contains key information and analysis including tender and project updates, leading players, financing deal flow, policy and market trends etc for Q2 2017 as well as our market forecasts for the upcoming quarters.

Q2 2017 was a landmark period in the Indian solar sector with tariffs falling below the critical threshold of INR 3.00/ kWh making solar power the cheapest new source of power in India. But this has led to all sorts of problems. As we commented in a recent blog, “Falling tariffs are a double-edged sword for the sector. They make solar power more attractive for consumers but are also making investors and lenders jittery. In the near term, they are also creating uncertainty in the minds of policy makers and creating new risks for older projects auctioned at 2-3x higher tariffs.”

India is expected to become the third biggest solar market worldwide in 2017 with estimated utility scale and rooftop solar capacity addition of 8.4 GW and 1.1 GW respectively;

Rising competition is squeezing investor returns in both primary and secondary markets;

Even as long-term market prospects remain bright, the sector faces considerable headwinds from module price rises, tender cancellations, GST and anti-dumping duty related uncertainties in the short run;

India’s total installed solar power capacity reached 15,611 MW (13,951 MW utility scale and 1,660 MW rooftop solar) on June 30, 2017. After a bumper Q1 2017 (end of FY17) when India added 3,120 MW of utility scale solar capacity, pace in Q2 2017 was relatively slow at 1,437 MW against a scheduled capacity addition of 3,300 MW. Highest capacity addition as well as slippage was from the 2,000 MW allocation in Telangana. Around 1,680 MW was due to be commissioned in Telangana during Q2 but only 640 MW came online because of delays arising from land and transmission related issues.

Total utility scale project pipeline, projects allocated to developers, stood at 12,250 MW at the end of the quarter. More than 3,000 MW of new tenders were announced, greater than the aggregate of all new tenders announced in previous three quarters. But at the same time, eight tenders with an aggregate capacity of 2,130 MW were scrapped due to DISCOMs reconsidering their power procurement options.

We expect new utility scale capacity addition of 1,565 MW and 2,265 MW in Q3 and Q4 2017 respectively. Our expectation for total rooftop solar capacity for 2017 is 1,056 MW taking total 2017 capacity addition estimate to 9,443 MW.

Top developers in Q2 2017, on the basis of new capacity added, are Acme Solar, NTPC, ReNew, Adani and Azure. Similarly, Talesun, Hareon, JA Solar, Waaree and Lanco are ranked as top module suppliers for Q2 and ABB, Hitachi, Sungrow, SMA and TBEA are ranked as the top inverter suppliers.

Other key market trends observed during Q2:

Module prices have spiked up to US ¢ 32-33/ Wp against expectations of about US ¢ 28/ Wp due to demand pick up in China and the USA. But inverter prices have been stable at around INR 1.80/ W.

1,500 V systems market is picking up and we expect a near-complete transition to 1,500V systems in India within two years.

Trackers have been gaining market share in India – we estimate this market to grow from 450 MW in Q2 to 800 MW in Q3. However, sharp fall in module prices is likely to hurt this market in future.

Actis committed USD 500 million to SPRNG, a new solar platform in India. Debt conditions have continued to soften with interest rates coming down and lenders looking at debt tenors of up to 20 years.

M&A deal flow is expected to pick up substantially as many PE funds (Ostro, Orange and Equis, amongst others) are looking to sell out and the primary project pipeline is relatively small.

The new GST regime became applicable from July 1, 2017. Solar power systems and equipment will be taxed at 5% but there is still confusion on GST rate on equipment other than modules.

The recently released draft National Energy Policy anticipates withdrawal of all incentives and support mechanisms for renewable energy over time.

Overall, 2017 business volumes are expected to grow by 90% Y-o-Y, making India the third largest solar market worldwide. But it is still an unnerving time for project developers and investors as rising competition forces tariffs down and the sector faces headwinds from module price rises, tender cancellations, GST and anti-dumping duty related uncertainty.

NITI Aayog, India’s central planning agency, recently released the draft National Energy Policy (NEP). The document sets out national objectives and planning framework for the energy sector for the next 23 years (up to 2040). It comes at an opportune time when India is going through a critical energy transition period. Its main thrust is to let market-based mechanisms guide growth in various energy sources with minimal government intervention. And while a document of this nature is inevitably high-level in its scope, it comes across as simplistic and wishful due to lack of detail, reasoning or prioritization of different plans.

By envisioning the share of variable renewable energy (RE) in the electricity generation mix to increase from 5% in FY17 to 24-29% by 2040, the policy sets an optimistic tone for RE growth;

The policy suggests gradual withdrawal of all incentives including ‘must run’ status, renewable purchase obligation (RPO) and inter-state transmission charge waiver for the RE sector;

Emphasis on traditional large hydro as a source of balancing power and just a passing mention of storage, smart grids and electric vehicles doesn’t fit with the fast-changing technology landscape;

The policy envisions RE capacity (excluding large hydro) to grow from 58 GW at present to 597 GW by 2040 (solar 367 GW, wind 187 GW) at a CAGR of over 10% and RE share of total power output to increase from 5% at present to 24-29% by 2040. While the policy sets an optimistic vision for RE, it does not provide any specific measure to support this growth. It envisages gradual transition towards market-led growth in RE sector, which is desirable for efficient functioning of the energy market as well as long-term growth of RE. However, there needs to be greater clarity on the mechanism and time of withdrawal of incentives such as RPOs, must run status and tax benefits provided to the sector to avoid a negative impact on sector’s growth. For example, we believe that sudden withdrawal of must run status would dampen investor confidence in the market.

On RE integration issues, the draft policy proposes a combination of grid expansion, automation and smart grid based approaches. It also suggests shortening of scheduling and dispatch interval times from 15 minutes, at present, to 5 minutes and development of an ancillary services market. For grid balancing, it proposes reliance on large hydro power plants and gas-based generation.

There are two glaring deficiencies in the policy document. One, it fails to examine past problems and proposes new solutions. For example, it argues correctly that poor financial health of DISCOMs is caused due to tariff subsidies and high T&D losses but the proposed solution – entailing separation of content and carriage – has been mooted for many years without any success. Second, the document largely ignores critical role of new technologies. It vaguely suggests setting up of renewable energy management centers and roll out of smart grids across India but the most promising new technologies – electric vehicles (EVs) and energy storage – have not received the required attention. While the government is considering setting an ambitious target of 100% EVs by 2030, the draft policy’s only suggestion for EVs is to implement time-of-day tariffs.

Similarly, while other countries are already taking long strides in development of energy storage technologies through investments in R&D, incentives for manufacturing and installation of large scale storage facilities, the draft NEP merely mentions ‘the need to push development of storage technologies’.

Overall, the draft energy policy is a missed opportunity to achieve necessary transformation in the Indian energy sector.