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Government passing the buck to project developers

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Last week, we wrote about the proposed MNRE scheme to procure round-the-clock renewable power with blending with thermal power. As we noted, the need for firm, predictable power is all too clear. But it is odd that the government is asking the project developers to provide a solution for this. Not only is the scheme beyond scope of most renewable developers, it is also unlikely to receive reasonable bids from thermal IPPs because of their stressed financials and limited competition. The responsibility of blending power from different sources should instead lie with the grid operator, load despatch centres and DISCOMs.

The government is expecting project developers to bear additional risk and responsibility that they are not suited for;

In the integrated project development-cum-manufacturing tender, the winning bidders have demanded cross-subsidy equivalent to more than 4x the capital cost of investing in manufacturing business;

The developers and DISCOMs seem unwilling parties in this wasteful approach;

If the government persists with the scheme, it would be forced to pay over the odds for blended power. We have seen this recently with module manufacturing. After failing to incentivise domestic manufacturing over many years, the government launched integrated project development-cum-manufacturing tender in May 2018. The tender was repeatedly undersubscribed, cancelled and modified. In the end, the government is believed to have awarded 4,000 MW capacity to Azure and Adani (exact capacity still not confirmed) at a tariff of INR 2.92/ kWh, 14% higher than average tariff for SECI solar tenders in the last year.

This is a stupendous waste. In present value terms, the extra tariff is equivalent to a cross-subsidy of INR 20.2 billion (USD 285 million) per GW of cell and module manufacturing capacity, almost 4x the total capital cost of investing in such facility. The subsidy is potentially even higher because power generation projects are expected to come up over an extended period of 5 years when power tariffs could be much lower than seen in the last year. In effect, the government is asking DISCOMs (in turn, the end consumer) to bear the burden for poor competitiveness of domestic manufacturing business and its own failure to support the same.

There are several other instances where we believe that the government is mistakenly expecting to pass additional risk and responsibility to project developers:

SECI’s 7,500 MW tender for projects in Leh-Ladakh region with over 2,000 km of high voltage transmission lines in developer scope,

Forecasting and scheduling responsibility imposed on individual power projects rather than on grid management agencies,

Focusing on provision of storage capacity at individual power project level rather than at transmission and/ or distribution level.

These proposals suggest an implicit admission of failure by the government agencies in fulfilling their obligations. But growing risk aversion means that the developers may shun these proposals altogether or extract too high a price. On their part, the DISCOMs may refuse to buy costly power thereby scuppering the government proposals.

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Complex tender designs on the way

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MNRE has issued a draft scheme for procuring renewable power, blended with thermal power, on a round-the-clock basis with 80% overall availability. The scheme is technology agnostic. Minimum 51% of power outcome is required to come from renewable sources – with or without storage solutions. Thermal power may be supplied from existing power plants. Bidders are expected to quote a composite tariff with two separate components for variable costs and fixed costs.

Vanilla renewable power is not able to address evening peak power demand in summer months, the biggest headache for DISCOMs in meeting power demand;

The proposed scheme may not attract very competitive bids because of limited number of potential bidders with thermal power capacity;

The potential change in business model from commoditized must-run structure to predictable power is both a challenge and an opportunity for renewable project developers;

As thermal power cannot be ramped up or down in sync with renewable power output variations, storage is expected to play the bridging role. With proposed mandatory blending of thermal power, the scheme remains beyond scope of most renewable power developers. They don’t have access to any in-house thermal capacity and it is implausible that they would take the risk on a third party thermal IPP for a period of 25 years. That leaves only a handful of IPPs straddling both renewable and thermal power sectors – mainly NTPC, Adani, Tata Power, CLP and Sembcorp – potentially interested in the scheme. However, some pure thermal IPPs like Jindals may be induced to make a foray into renewable power. We suspect that because of limited number of potential bidders, the scheme would not attract very competitive bids and may therefore not be cost attractive for the DISCOMs.

The scheme is designed to mitigate the intermittency and variability challenges of renewable power. For DISCOMs, the biggest headache today in meeting customer demand is providing evening peak power in summer months. This evening spike is not catered to by solar or wind power. Prices on power exchanges typically shoot up to INR 6.00-8.00/ kWh in the evenings when power is available at other times of the day at about INR 2.80-3.50/ kWh. As a result, the DISCOMs remain dependent on thermal power (predominantly coal) and are reluctant to increase procurement of renewable power. To make matters worse, peak power demand has been increasing faster than average power demand in the last few years.

Figure: Peak power and low power demand times during the day

Source: Electricity Demand Pattern Analysis by POSOCO, 2016

Faced with resistance from DISCOMs in buying vanilla renewable power, MNRE and SECI have been looking at alternate procurement approaches. SECI has already issued – i) a 1,200 MW solar-wind-storage hybrid tender with provision for up to six hours of morning and evening peak output; and a ii) 400 MW renewable-storage hybrid tender to provide round-the-clock power to Delhi and Dadra & Nagar Haveli. It remains to be seen if the DISCOMs would be willing to pay for the expensive storage-based power, a key reason for failure of grid-scale storage to take off so far. 

We see the move away from commoditized must-run-take-or-pay structure to predictable power as inevitable. Renewable power can only grow by adapting to meet market requirement. It is both a challenge and an opportunity for renewable project developers. Having focused solely on reducing LCOE so far, the developers now need to develop new technology skill sets and adjust their business model. Technically savvy developers would see this transition as an opportunity to differentiate themselves and hopefully, earn better risk-adjusted returns.

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Regulators add to the pain

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Maharashtra state regulator, MERC, has recently rejected most of the winning bids in two renewable energy tenders as it viewed the winning tariffs as too high or unreasonable. The two tenders include a 350 MW solar-wind hybrid tender by Adani Electricity, Mumbai DISCOM, and a 1,400 MW agricultural solar tender floated by Maharashtra State Electricity Development Corporation (MSEDCL, the state-government owned DISCOM). Winning tariffs in the two tenders were INR 3.35/ kWh and INR 3.16-3.30/ kWh but MERC has approved only INR 3.24/ kWh and INR 3.15/ kWh respectively. Similarly, Bihar regulator has approved only INR 3.30/ kWh against winning bids of INR 3.58-3.60/ kWh in the Bihar Renewable Energy Development Agency’s (BREDA) 250 MW solar tender.

Seeking regulatory approval after completing auction vitiates the core principle of competitive auctions;

The authorities should instead seek regulatory tariff approval upfront and prescribe a clear ceiling tariff in the tender documents;

The government needs to act urgently to restore investor confidence and transparency in the sector;

In the MSEDCL tender, only one bidder (Kosol, 10 MW, INR 3.16/ kWh) accepted the lower tariff. MSEDCL issued a revised 1,350 MW tender with a ceiling tariff of INR 3.15/ kWh but received only one bid for 5 MW (Kiran Energy, INR 3.14/ kWh).

Table: Winning bidders and tariffs in the three tenders

Source : BRIDGE TO INDIA research

Notes: In the BREDA tender, auction tariffs of INR 3.58-3.60/ kWh were subsequently revised down after a couple of rounds of negotiation between BREDA and the bidders.

It should be noted that previous bid cancellations (SECI 2,400 MW, Gujarat 700 MW, Uttar Pradesh 1,000 MW) were prompted by tendering authorities – mainly DISCOMs and government agencies – who felt the winning tariffs were too high to be acceptable.

Rejection of bids by regulators is a recent and disturbing phenomenon. The regulators are interpreting their mandate in the widest sense of ensuring that the bid tariffs are: i) consistent with market environment; and ii) in consumer interest. But seeking regulatory approval after an auction is inconsistent with the core principle of competitive auctions. Expecting developers to jump through multiple hurdles – auctions, followed by DISCOM approval and a subsequent regulatory approval – is unreasonable. Instead, the authorities should seek regulatory tariff approval upfront and prescribe a clear ceiling tariff in the tender documents.

Fluidity in the Indian renewable auctions is needlessly jeopardising investor sentiment. In an already challenging environment, the government cannot afford investors losing interest.

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2020 – year of prayer and hope

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As we commence the new year, there is much anticipation that 2020 would offer respite from the multitude of problems faced last year. A jump in new installations – from a total of an estimated 11.4 GW last year to 15.0 GW – would certainly provide relief to equipment suppliers and contractors. Most of the increase would come from utility scale solar, which is expected to jump from an estimated 7.4 GW in 2019 to 9.8 GW this year.

We summarise below other key expected trends for the new year:

In absence of industrial demand pick up, outlook for power demand is bleak with estimated growth of about 3.0-3.5% at best.

Tender issuance should still stay strong at about 35-40 GW as MNRE presses ahead to meet the 2022 target. We expect a significant move away from vanilla tenders to complex schemes including manufacturing-linked tenders, solar-wind-storage hybrid tenders and even completely technology agnostic tenders seeking firm 24×7 power.

Safeguard duty on cell and module imports is set to expire in July 2020. Prospects of extending it and/ or replacing it with customs duty are dim in our view. The developers would be keen to take advantage of duty expiry by deferring project construction, where possible, to second half of the year.

High efficiency modules technologies are finally expected to make major inroads as price differential over multi-crystalline modules falls to about USD 1-1.5 cents/W. We expect almost 50% share for mono and mono-PERC modules in 2020.

Maharashtra regulator’s decision to support net metering against the DISCOM’s recommendation has provided major relief to rooftop solar market. But overall, rooftop solar and open access are expected to have a mixed year due to continuing policy uncertainty and lack of financing. Rooftop solar growth rate has already fallen to about 20% annually as against 83% in the previous year.

Increasing RE capacity would manifest through major deviation in RE penetration across states (reaching or even exceeding 30% in some southern states) and intra-day prices (see chart below).

Financing woes are expected to persist as lenders stay extremely selective on project offtaker and developer credentials.

Figure: Intra-day power prices on exchange

Source: Indian Energy Exchange

The key development to look out for, of course, is movement on long-term reforms particularly measures to shore up DISCOM financial position. The government has been talking up reform over the last two years but there has been little progress to date:

Separation of content and carriage for power distribution;

Payment of tariff subsidies directly to consumers by state governments;

Operational efficiencies and use of smart meters to reduce T&D losses to below 15% (currently 21%);

Tariff reform and simplification including reduction of cross subsidy surcharge, gradual elimination of tariff subsidies, time-of-day pricing;

Better utilisation of 25 GW gas-fired capacity to provide peaking power for complementing RE sources;

Move away from fixed-price PPAs to market-based trading;

The most pressing issue remains the crisis created by dire DISCOM finances, which continue to get worse. 2020 may well be the year that most people remember for how government seeks to address this issue. We remain sceptical if the central government has the political will or ability to carry various stakeholders along for effective comprehensive solution. We anticipate a complex financial restructuring package along with bit use of privatisation and franchisee models for a temporary solution.

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