India has ambitious targets in its renewable energy programme, but a stumbling block could be financing these ambitions. A CPI-ISB report on financial challenges in meeting the renewable energy targets throws up some interesting facts, such as the low involvement of banks in the sector and how counter factors are depressing positives like a good flow of equity
Team FE
The widespread blackouts that brought much of India to a sputtering halt in 2012 were a dramatic signal of a power sector that requires attention. But a challenge no less central to India?s future is that of the country?s goals for renewable energy.
The national government?s ambitious goals for solar energy, coupled with the country?s rapid progress in developing wind energy, raise many questions regarding the sources and costs of the investment that will be needed to install and operate this infrastructure.
Under the Jawaharlal Nehru National Solar Mission (JNNSM), grid-connected solar PV capacity increased by 165% in 2011 to reach 427 mw. However, the ambitious targets for 4,000-10,000 mw by 2017 and 20,000 mw by 2022 may be hard to achieve under current policies and programmes, and financing may be the biggest obstacle. Likewise, with 16 gw installed, India had already become the world?s fifth-largest market for wind by 2011, but ambitious plans for further expansion to 31 gw by 2017 will face similarly daunting policy and financing problems.
In a CPI-ISB report, Meeting India?s Renewable Energy Targets: The Financing Challenge, Climate Policy Initiative (CPI) analyses the challenges for designing national policy that will attract the investment needed to spur rapid growth in wind and solar energy at a reasonable cost. CPI has conducted detailed financial modelling of actual Indian renewable projects; numerous interviews with developers, financiers and policy makers; and examined in depth the idiosyncrasies of Indian financial markets. This report describes and analyses the impact of national and state policies on various classes of renewable energy investors, as well as overall relative costs or benefits of policies on the final cost of renewable energy projects. The focus is particularly on the cost and availability of equity and debt, respectively, and the consequent implications for Indian renewable and financial policy.
The high cost of debt High interest rates is the most pressing problem currently facing the financing of renewable energy. A financial modelling of actual renewable energy projects in India and elsewhere indicates that the higher cost and inferior terms of debt in India may raise the cost of renewable energy by 24-32% compared to similar projects financed in the US or Europe.
A declining availability of debt for renewable energy projects, whether high-cost or not, may become an impediment. Interviews with lenders and analysis of debt markets indicate that many lenders may be reaching the limit for the amount of money they will lend to the sector. Their withdrawal from the market may restrict project development. Continued high borrowing by the government and related regulatory restrictions are likely to keep interest rates high.
Even if the cost of debt goes down, analysis suggests that loan terms?including short tenors and variable interest rates?will become more significant impediments, especially in lower interest rate environments.
Uncertain future of equity
Interviews with investors and developers suggest that neither the cost nor availability of equity is currently a major problem. In fact, analysis suggests that when adjusted for differences due to the less attractive nature of debt in India, expected returns on equity (ROE) in India may actually be lower than in the US or Europe, despite potentially higher country risks.
Attractive, low-cost equity may be less available in the future. First, as debt becomes less available, current equity investors may not be able to recycle their investment capital into new projects by borrowing against the operating projects. Second, as the market matures, many investors may no longer be willing to invest at relatively low returns in order to establish a strategic foothold as they currently appear to be doing in solar photovoltaic (PV) projects.
?As as far as equity is concerned, big action is happening in solar energy, while wind is depressed, but with the budget announcements, we expect more equity to flow in the sector. The problem is with the viability of the contracts as Indian companies are competing with their foreign counterparts and hence want parity,? says Prodipto Ghosh, distinguished fellow at The Energy and Resources Institute.
Ghosh adds that wind companies will have access to more commercial borrowing, with the government now planning to offer concessional loans to the renewable sector from the National Clean Energy Fund. As per estimates, the fund has a corpus worth R14,000 crore. General Indian financial market conditions are the main cause of high interest rates for renewable energy. Growth, high inflation, competing investment needs and country risks all contribute. A shallow bond market and regulatory restrictions on foreign capital flows also add to the problem, while the cost of currency swaps and country risk negate the advantages that could come from access to lower-cost foreign debt.
Regulation hassles
Regulation and structure of the Indian power sector also raise significant issues. State-level policies?including the financial weakness of the state electricity boards that buy much of the output from renewable generators?increase project risk. National policies designed to weave state policies together, particularly the recently established Renewable Energy Certificate (REC) market, do not adequately reflect the realities of financial markets or state-level risks. Analysis shows that renewable energy policy lessons from the US and Europe may not apply to India?s financial realities. The economy and financial markets in which renewable energy policies operate partly determine the effectiveness of these policies. The significant differences between India and developed world financial markets, including the high cost of debt and what that means for the impact of policy, means that policy levers used to decrease financing costs in the US and Europe have less impact in India.
In the context of probing possible solutions to bring lower-cost, long-term debt into the Indian renewable energy market and given that renewable energy will require some financial support in the medium term, until renewable energy costs reach a degree of parity with conventional sources of electricity, the report poses the question: ?Within a portfolio of policies, is it more effective to close the gap between renewable energy costs and alternatives through subsidies, tax benefits, or other support mechanisms, or through concessional debt, or a mix of two or more??
?Renewable energy products are relatively expensive and so we have been providing incentives and subsidies for solar water heating system, solar cookers, solar home lighting systems, solar lanterns, solar street lighting systems, solar pumps, family-type biogas plants, small wind turbines, water mills,? said an official from the ministry of new and renewable energy. The government provided R137.62 crore as subsidy to various beneficiaries in the country on solar water heaters in the past three years.
Besides, the ministry has released R103.05 crore in 2009-10, R287.05 crore in 2010-11, R589.76 crore in 2011-12 and R300.85 crore during 2012-13 up to January 31, 2013, for solar lights, water pumping systems, off-grid power plants and solar water heaters.
Low bank support
The report says domestic banks restrict lending flows to renewable power projects which limits the availability of debt for renewable energy projects. Analysis reveals that less than one-third of public sector banks lend to renewable energy projects. The situation is worse for private sector banks, where less than one-fifth lend to renewable projects. Banks cite non-familiarity with the renewable energy sector as well as the perceived riskiness as the major reason for not lending to renewable energy projects. Even among banks that lend to these projects, the amount is restricted.
Commercial banks in India cap investments in infrastructure at 10-15% of their total domestic advances based on the Reserve Bank of India (RBI) prudential lending norms. At present, the renewable energy sector is coupled with the power sector, which is governed by (implicit and self-enforced) sub-sector limits in the range of 4.5-5%. During the last few years, due to large capacity additions?primarily of coal-based power projects?commercial banks in India almost reached their lending limits for the power sector, potentially leaving limited funds for renewable power projects.
Says BK Divakara, general manager (credit), Corporation Bank, ?Renewable energy as a whole is a segment where we do not take large exposures. We are very selective when it comes to renewable energy because the technology is fast changing and the cost of initial capital is very high. So there are risks with regard to the projects that we lend to becoming redundant or having long gestation periods. Thus we are not aggressive to lending to solar projects which have the above mentioned risks associated with it. However, as the technology is quite stable in windmills, we find them safer to lend to.?
Conversations with banks and developers confirmed that they are worried not only about banks not lending to renewable power due to power sector lending limits, but also about the (resulting) increased cost of debt. In February 2011, Andhra Bank noted that ?many banks are close to exhausting their internal limits set for infrastructure firms?. In April 2012, SBI Capital added that there is a need to categorise the solar power sector as a priority sector to increase funds available for solar power development. Further, Solarsis noted that ?shortage of debt capital in the country is adding 50-100 basis points to the variable component of the interest rate?.
Says Rana Kapoor, MD & CEO, Yes Bank, ?We have been cautious to not grow excessively, but to chase growth that is in sunrise sectors. These sectors are somewhat less impacted with what is happening in domestic economy and they have less connectedness with the global economy. For example, some pockets of renewable energy continue to be promising. So I think if you continue to be selective and sectoral in terms of your segmentation approach, there are still opportunities to grow.?
Other developing countries have bridged the financing gap in unorthodox but successful ways. The Brazilian Development Bank (BNDES) is an especially promising example. The bank plays a major role in almost every renewable project in the country, often by offering long-term loans at below market rates. BNDES?s role in financing renewable energy has led to lower prices and, arguably, enhanced the performance of other policies such as wind energy auctions designed to create competition amongst potential wind park developers.
Poor REC market
With the expiration of the generation-based incentive (for wind and solar) and the lapse of accelerated depreciation (for wind), the Indian government is expecting the Renewable Energy Certificate market to take up the slack. The rationale for the new market mechanism is that, although India has huge renewable energy potential,its sources are geographically dispersed; for example, in Delhi, the potential for renewable energy is insignificant, whereas some states have excess renewable energy sources (for example, wind in Gujarat). However, in states with abundant renewable sources, the incremental cost of renewable energy above other conventional sources discourages local distribution licensees from purchasing renewable power beyond the level mandated by state policy. Thus, there should be an opportunity to reduce the costs of renewable energy for India as a whole by tapping the additional, relatively low-cost opportunities in states rich with renewable resources.
To address this mismatch and to reach the ambitious national-level targets, the government launched a market-based mechanism in 2011 in the form of Renewable Energy Certificates. Under this mechanism, certificates are issued to renewable energy power generators, which can be sold later in recognised power exchanges.RECs have been widely touted by many analysts as the solution to drive investment into renewable energy generation.
However, the report says the actual performance of REC market trading shows that the current number of certificates issued is less than 4% of the technical REC demand potential, indicating that the full potential of REC markets is far from being realised. Analysis indicates that RECs are not considered viable financial instruments by investors yet, and several changes are needed if the REC mechanism is to deliver its intended results. The report claims that the REC mechanism, as currently structured and executed, is unlikely to achieve most of the government?s objectives for the mechanism.
It advocates that to create a stable market for RECs and reduce demand uncertainty, stricter compliance laws and enforcement of state-level RPOs will be required. Further, to make RECs viable financial instruments, the government will need to not only declare state-level, long-term targets along with their annual targets, but also enable well-functioning secondary markets.