Month: November 2017

Since 2014, around 29 GW of utility scale solar tenders have been issued in India. Most of this capacity (81%, 23.5 GW) has been tendered by NTPC, Solar Energy Corporation of India Limited (SECI), distribution companies (DISCOMs) and other public sector entities for project development by private sector. But there is also a sizeable 19% (5.5 GW) tendered in the form of EPC contracts, where capital investment will be made by NTPC and other public sector companies including Karnataka Renewable Energy Development Limited (KREDL) and Andhra Pradesh Power Generation Corporation Limited (APGENCO).

It is interesting to note that actual progress on these two types of tenders is very different. For project development tenders, 36% (8.5 GW) of total issued capacity has been commissioned and 7% of the capacity has been cancelled. In contrast, for EPC tenders, only 18% (930 MW) has been commissioned and as much as 29% stands cancelled.

Figure: Status of projects under project development and EPC tenders issued since 2014

Source: BRIDGE TO INDIA research

The poor progress in EPC tenders is as predicted by us last year. Despite that, public sector companies continue to bring out more EPC tenders – more than 50% of new tenders issued in Q3 2017 were structured as EPC contracts.

Power from EPC tender based projects is significantly more expensive than from project development tenders;

Most EPC tenders issued by public sector companies face long or indefinite delays in allocation;

Participation of state-owned companies at a time of aggressive competition among private companies is difficult to understand;

As against an average 2-5 months taken between announcement and allocation of project development tenders, allocation of EPC tenders by public sector companies has taken an average of 6-8 months. Some of these tenders including NLC Tamil Nadu 500 MW and NLC Odisha 250 MW were issued almost a year ago but they have not yet been allocated. Moreover, some tenders including CIL 200 MW and KREDL 200 MW have been issued, cancelled and subsequently reissued with modified requirements. The frequent cancellations as well as delays reflect low market interest for such tenders.

EPC tenders from public sector companies stipulate more stringent technical specifications resulting in higher execution costs (and presumably, better quality). Moreover, many EPC tenders have domestic content requirement (DCR) stipulation again resulting in 5-7% extra capital expenditure. Higher capital expenditure coupled with conservative financial assumptions means that the final tariff offered to the DISCOMs is about 20-30% higher than that offered by private sector developers, who are willing to make more aggressive operating and financial assumptions. DISCOMs are understandably not too keen on buy such power.

Perhaps because of slow progress in EPC tenders, we have observed a strange practice where public sector companies are now bidding aggressively against private sector competitors in project development tenders. Recent cases include NLC winning 709 MW capacity in the Tamil Nadu 1,500 MW tender and Gujarat Industries Power Company Limited (GIPCL) and Gujarat State Electricity Corporation Limited (GSECL) together winning a total of 150 MW in the Gujarat Urja Vikas Nigam Limited (GUVNL) 500 MW tender. As per our estimates, expected returns for both these tenders are significantly below market expectations.

There was a strong public sector role envisaged in development of solar projects back in 2013/14, when capital costs were much higher and investment appetite of private sector was not established. Today, when there is ample private capital available for the solar sector at very attractive terms and when there is a slowdown in tender issuance, there is absolutely no justification for public sector to crowd out private investments. The government needs to rethink the role of public sector companies in clean energy sector.

The Ministry of New and Renewable Energy (MNRE) has announced a new RE rollout plan entailing 91 GW of new solar and wind project tenders by March 2020. It is an ambitious attempt by the new MNRE administration to address private sector concerns about slowing project pipeline and lack of a clear roadmap. It envisages 67 GW of new solar project tenders and 24 GW of new wind project tenders by March 2020 as well as 20 GW of integrated solar module manufacturing capacity addition. With these planned projects, the new Minister for power and new and renewable energy, R.K. Singh, believes that India would “…comfortably achieve a rather conservative RE target of 175 GW by 2022 and even exceed it….”

The new plan provides new annual targets – 17 GW of solar projects are expected to be tendered out by March 2018, another 30 GW in the next 12 months and a further 30 GW in the subsequent 12 months. Similarly, 4 GW of wind projects are expected to be tendered out by March 2018, another 10 GW in the next 12 months and a further 10 GW in the subsequent 12 months. In total, it equates to issuing new tenders of 3.5 GW capacity every month – in contrast to an average of less than 0.6 GW every month in the last year. The plan includes development of up to 10 GW of capacity to come from floating solar power projects, offshore wind and hybrid solar-wind power systems.

The Minister has also separately laid out broad contours of a new domestic manufacturing policy– 30% capital subsidy is proposed to be allocated to integrated manufacturers (from polysilicon extraction to module manufacturing) on the basis of auctions. The winning bidders shall also be given priority in specific project development tenders.

Quite how the new plan makes sense in the current political and financial set up with weak power demand growth and stretched DISCOM finances is not clear to us. It seems more like a simple mathematical exercise rather than a well-considered, rigorously debated plan. We noted last week that the 175 GW target for 2022 is too ambitious in the context of India’s power needs and actual performance is lagging significantly behind targets compelling the government into making ever bolder announcements. The new plan has no detail on how it will address shortcomings of the earlier plan except the Minister stating that Renewable Purchase Obligations (RPOs) are mandatory and need to be adhered to strictly.

We find it hard to take the new plan seriously when it probably doesn’t even have support from other parts of the central government. The state governments and DISCOMs will also fiercely resist any encroachment on their decision-making authority. It lacks sufficient detail, is off-putting for all stakeholders and instead of providing comfort to the private sector, it unfortunately presents a picture of disarray and confusion.

The Directorate General of Anti-Dumping and Allied Duty (DGAD) is currently completing an investigation into imports of solar cells and modules from China, Taiwan and Malaysia subsequent to a petition filed by The Indian Solar Manufacturer’s Association (ISMA). The petition is similar to an earlier petition filed in 2012, wherein DGAD had recommended an anti-dumping duty of USD 0.11-0.81/Wp on cells and modules but the Ministry of Finance ultimately decided to not impose any duties to protect downstream project development activity.

This time around, the industry is almost unanimously of the view that an anti-dumping duty will be announced soon as the government is keen to support local manufacturing. But the government still faces a dilemma as to how to balance the needs of solar manufacturers vs project developers and investors?

First, we should assess if the imposition of anti-dumping duty will provide the envisioned boost to domestic manufacturing? The Chinese manufacturers dominate Indian market because their products are about 10% cheaper than Indian counterparts. Most of the Indian manufacturers have sub-scale capacities, high cost base and are completely reliant on imported technology and raw materials. High cost of capital and electricity, poor infrastructure and lack of domestic eco-system means that the odds are stacked against them. Trade barriers may provide short-term relief but are unlikely to change long-term competitiveness of domestic manufacturers. That is why many leading Indian and international companies including Welspun, Sterling & Wilson, Trina Solar, Longi Solar, JA Solar etc have examined setting up manufacturing capacity in India but ultimately decided against it. Despite ten-fold growth in domestic demand in the last four years, Adani is the only new player to make a notable greenfield manufacturing investment so far.

Actual domestic production of modules and cells in FY 2016-17 was a mere 1,746 MW and 591 MW as against total demand of 9,188 MW. Though duties should provide existing domestic manufacturers with an opportunity to grow sales at profitable prices, the key question is whether India will be able to attract enough investments to create a thriving solar manufacturing sector. The European Union and USA have both imposed various protectionist measures in the past, but imports have kept rising and domestic manufacturing has not taken off. The Chinese have been expanding internationally and may be able to circumvent duties by routing exports from other locations.

As per our analysis, if anti-dumping duty is announced in the near future, it will impact about 10,000 MW of pipeline projects. Imposition of 30% duty will increase project cost by about 18%. Developers, already struggling with price rises due to GST and import duties, have no room to absorb additional costs. Unless these projects are grandfathered or the DISCOMs are willing to renegotiate PPAs, the risk of project abandonment for many of these projects is very high. The sector is already reeling from a slowdown in new project procurement and petition has increased uncertainty about the future of upcoming tenders.

The government faces a tough task of striking a right balance between the ambitious ‘National Solar Mission’ and ‘Make in India’ initiative. In our opinion, the imposition of anti-dumping duty will significantly disrupt the former without giving any material impetus to the latter.

Please read our full report on anti-dumping duty and its impact on different stakeholders.

Recently, there was a news report that the Indian government wants to issue a single 20 GW solar tender to boost solar project development and domestic manufacturing. R.K. Singh, the new Minister for Power and New and Renewable Energy, has also publicly stated that he wants to auction 4.5 GW of wind power contracts in the next few months followed by 20 GW in the next two years for expediting achievement of ambitious clean energy targets. To put these announcements in perspective, India’s total operational solar capacity is 18 GW and the maximum wind capacity commissioned in a year so far is 5.4 GW in 2016-17.

There was record solar and wind power capacity of 5.5 GW and 5.4 GW respectively commissioned in 2016-17 but that was still significantly below the combined yearly target of 16 GW. 2017-18 capacity numbers are also likely to come well under targets.The new central government regime, under pressure from slowing procurement and issues relating to GST, import duties and anti-dumping duty, seems compelled into making bold announcements. But these mega-announcements are not convincing.

The recent Economic Survey, prepared by the Ministry of Finance, argued that India should ‘calibrate’ (i.e. reduce) investments in renewables in view of the underutilization of coal fired power stations causing major losses to investors and lenders. We partly disagree with their methodology, but agree that the wider power demand-supply dynamics and inter-play between different sources of power will have an important bearing on RE demand in the coming years. India’s aggregate power demand has grown at a CAGR of 4% over the last five years, in contrast to 11% and 10% growth in coal-fired capacity and total power generation capacity respectively in the same period. Demand growth has actually slowed down to 3.7% this financial year (until September 2017) and the result is falling capacity utilization in the coal fleet and all-time lows for cost of power traded on the exchanges.

DISCOMs buy bulk of their power under long-term PPAs under a two-part tariff structure. So long as their requirement is met sufficiently from these PPAs and/or short-term power from the exchanges at prices below INR 3.50 (USD 0.05), they will be reluctant to buy new (variable) RE power. Unfortunately, the Renewable Purchase Obligations (RPOs) are not being enforced by regulators. A large majority of Renewable Energy Certificates (RECs) remain unsold. Our analysis shows that over the next 3-4 years, RE capacity will grow by only about 10 GW per annum in a status quo scenario, in contrast to the government target of over 20 GW per annum.

The current situation of low demand, increasing competition and falling tariffs is causing angst in the private investor community. Leading Indian and international investors have made large commitments to the sector drawn in by the 175 GW target but feel hamstrung. An overly ambitious target is off-putting for all stakeholders with the risk that nobody takes the government seriously. The government needs to provide strong policy vision and clarity to the sector by laying out a compelling path for realizing the 175 GW RE target, or revising it downward to make it credible.

M&A activity in the Indian renewable sector has been building up for some time but actual deals have been slow to materialize. Last month, Equis announced the sale of its 4.7 GW Asia pacific renewable IPP business to a consortium comprising Global Infrastructure Partners (GIP), China Investment Corporation and Public Sector Pension Investment Board of Canada. The Equis portfolio comprises over 600 MW of renewable assets in India including 414 MW of operational wind and 130 MW of operational solar assets. Meanwhile, First Solar sold its entire 190 MW of operational solar portfolio to IDFC Alternatives, an India based infrastructure PE fund in July 2017.

Sector M&A is highly desirable as it allows for optimal allocation of risk capital and consolidation in a highly commoditized sector;

Valuation mismatch has been preventing many deal closures but buyers have the upper hand;

Sellers need to be realistic as the longer they wait, the higher the risk of deals turning sour because of due diligence problems;

There are many positives from the M&A activity. First, the strong profile of buyers comprising sovereign wealth funds, pension funds and infrastructure PE funds brings more patient capital and is a sign of confidence in the Indian RE business. Second, the sellers free up their capital for potential use in development of further assets.

The big puzzle is that there are not more such M&A announcements. The RE business structurally lends itself to consolidation as it has almost no entry barriers and is highly commoditized. Scale brings important benefits in fund raising and portfolio management. With project development activity slowing down and the auctions becoming extremely competitive, it is natural for small to mid-sized developers to look to exit the business or simply churn their portfolio. Some of the rumoured sellers include Ostro Energy (portfolio of over 1,000 MW including under construction assets), Essel Infra (710 MW), Orange Power (600 MW), Shapoorji Pallonji (454 MW), SkyPower (350 MW), Fortum (185 MW) and FRV (100 MW). The buyers, on the other hand, are developers or investors that have raised substantial funds and are keen to deploy those to build up scale. Potential buyers include Greenko, ReNew, Hero Future, Sembcorp, Hinduja and Macquarie, amongst others.

Slow progress in deal closures can be explained by two main hurdles. First, there is still a wide valuation gap between buyers and sellers. Second, due diligence on RE assets can often throw nasty surprises. Payment delays, grid curtailment, land acquisition and poor construction quality issues can scare away buyers. Valuation mismatch is the easier of the two hurdles. Buyers are holding out for leveraged equity returns of 14-15% and we believe that sellers have no choice but to give way for more deals. If they wait for too long, they run the risk of more due diligence issues arising over time and buyers turning away. Moreover, there is a view that debt financing cost, which has been coming down for last three years, may have bottomed out. In other words, if you are an interested seller, better move fast now.

There has been a significant lull in announcement of utility scale solar tenders from the Solar Energy Corporation of India (SECI). It has announced only one tender – Bhadla 750 MW – this year in comparison to around 5 GW of new tenders in 2016. There have been expectations of new tenders totalling in Odisha, Chhattisgarh, Delhi, Karnataka, Andhra Pradesh and Bihar but none of these have materialised until now. Furthermore, SECI has again extended bid submission timelines for the ongoing Bhadla-III (250 MW) and Bhadla IV (500 MW) tenders. These projects were supposed to be allocated to developers in Q3 2017. Meanwhile, NTPC has also not made any progress on new guidelines for development of solar projects.

Tendering delays have been caused by multiple factors. We have written extensively about weak growth in power demand affecting DISCOM appetite to issue any new tenders. But equally importantly, the new competitive auction guidelines announced in August 2017, which require use of standard bidding documents, have impacted the timelines. We understand that delays in finalization of these documents is holding up progress of many tenders. Our discussions with sector players also suggest that the Ministry of New and Renewable Energy (MNRE) decision making has slowed down considerably, possibly due to many changes in senior personnel, including appointment of the new minister.

But the developers are getting restless. Many of them have raised funding and are waiting on the side-lines for an opportunity to bid for new projects. These developers have been left high and dry due to reduction of solar power procurement. Due to the vacuum created in the project development landscape, there is a pent-up demand forcing auction tariffs down. They are also concerned about the “looming” anti-dumping duty imposition on solar modules and how it may affect bidding behaviour.

As for the Bhadla projects, it is likely that this tender submission will get delayed again and the reverse auction will take place early next year. Whether tariff bids will be as competitive as the previous Bhadla auction is debatable. Developers such as Acme, which won 200 MW at a tariff of INR 2.44/kWh (4¢) in the auction, has recently expressed “regret” as Chinese module suppliers have increased pricing over the last 3 months lowering return expectations. Other costs have also gone up on account of GST implementation. If there were to be an auction today, we would expect tariffs to move up to INR 2.80/ kWh. But rising tariffs will create another problem – the DISCOMs may walk away creating even more problems for the sector.

For more than 2 years, there have been persistent concerns that aggressive bidding in solar auctions is storing up trouble for the sector. Fortunately for the sector and the winning bidders, equipment costs kept falling more sharply than market expectations – 20% and 25% in 2015 and 2016 respectively.

Developers have ridden the wave of falling costs and project delays to make handsome profits. Example – at the time of bidding in Madhya Pradesh 300 MW tender in Q2 2015, module cost was USD 0.52/ Wp. Using this cost and median winning tariff of INR 5.35/ kWh gives us a project IRR of 13%. But by Q4 2016, when some developers actually constructed projects stretching time limits under the tender, module costs had fallen by over 30% and actual project IRR was up to 18%.

Unsurprisingly, bidding has become increasingly more aggressive over time. It is now standard industry practice to bid based on anticipated fall in costs. Analysis of Bhadla auction in May 2017 suggests that to achieve a project IRR of 12%, developers were banking on module costs falling to USD 0.22/ Wp. The aggressive behaviour has been worsened by slowdown in tenders making developers desperate to win projects at any cost. In our report titled, Analysis of utility scale solar tenders in India, we stated, “Low equity IRRs suggest that the Indian developers, in particular, are not pricing risks fully and too much faith is being placed on everything turning out positive. The sector has been very lucky with rapid falls in solar module prices easing most of the financial and execution challenges. Any dislocation in module supply chain or even a price stabilization will spell trouble for winning bidders.”

Indeed, module costs have inched up to USD 0.36/ Wp today (+20% over 6 months), when developers were assuming that costs would fall to USD 0.25/ Wp or even lower by this time. Unfortunately, that’s not all. GST implementation has increased total project costs by about 5% and developers are further forced to bear import duties of 7.5% on modules. There is also a tangible threat of anti-dumping duties. The result is that projects allocated in the last six months (Bhadla 750 MW, NTPC 250 MW, Tamil Nadu 1,500 MW, Gujarat 500 MW) are facing an uncertain future. Our calculations suggest that based on today’s cost levels, project level returns are down to low single digits in an optimistic scenario.

This challenge is not restricted to solar power sector. As wind moves to a competitive auction regime, it inevitably faces the same concerns. Could RE suffer the same fate as thermal power or roads, where irrational pricing led to many projects being abandoned or financially distressed? Our estimation is that because of their short gestation period, well-capitalized sponsor groups and relatively small project sizes, most RE projects will come online as planned. But investors will be praying for significant reduction in costs in 2018 and delays are highly likely. We also feel that the lenders will exercise sufficient caution ensuring that they are largely protected from any downside.