Cheapest Electricity Tag: Will Solar Be Able To Retain Its Reputation?

Gurh Tehsil, Rewa District, Madhya Pradesh witnessed history on Friday, 10th February 2017. The green national drive of the government got its major fuel for growth- ‘A record low of the solar tariff of Rs 2.97 /kWh’! , Courtesy - Rewa Ultra Mega Power Project, world’s largest solar power plant.

Why is this so significant? Let's draw a comparison. Successful thermal bids stand anywhere between Rs 3.93 – 4.98/kWh. Following the trend, the wind also broke records with crashing bid of Rs 3.46 a kWhr with most of the states offering the feed-in tariff of about Rs 4-6/kWh. All the above stated the clear stance of solar as the chief contender for India’s future power capacity addition, breaking the psychological barrier of being an expensive source of energy.

While there is a little doubt that solar suddenly appears to be amongst the cheapest energy sources, there is also a big question mark on the financial sustainability of these crashing tariffs and the highly aggressive bidding behaviour of the companies.

The first and the foremost thing to notice is that this development is not owing to the technology breakthrough. Not 100%, but majority part of the financial feasibility came from the declining solar modules prices which added to the luck of the companies bidding. A recent report by Bridge to India, a renewable consultancy, spells that any dislocation in module sourcing or a price stabilisation in future will spell trouble for these winning bidders.

Joy Saxena, Executive Director Finance, Vikram Solar, explains how 90% of the module demand is met by Chinese imports, which is dumped at dirt cheap rates in India at the back of export subsidy provided by their government to the tune of 15-17%. How long can this sustain, is a big question and poses a serious threat to the tariffs.

“Auction based project allocation process has forced developers to be very aggressive, accept low returns as well as inadequate risk pricing. In such a scenario, any unexpected movement in equipment prices, exchange rate or interest rates will spell trouble for project developers”, says Vinay Rustagi, MD, Bridge to India.

Apart from the solar module crash, a lot of other factors make a contribution including the size and location of the projects, payment guarantees, deemed generation benefit, longer construction timeline, yearly tariff escalation, exchange rate etc.

“Most of the developers today, in order to build their pipeline, are taking a highly optimistic view on all the above risks and are building their base cases below the normally expected equity IRR levels. They keep pushing the EPC contractors and suppliers to continue to reduce costs and offer better credit terms”, says Gagan Virmani, CEO, Mysun, who also project repercussions on the overall project quality, including long-term sustainability of the supplier.

Now, IRR is the internal rate of return which the BTI report says comes out to be 14.20%, significantly below the benchmark expectations of 18%, for the average harmonised tariff of Rs 4.31/kWh. What low equity IRR states are the fact that the Indian developers are not fully pricing their risks and too much faith is being placed on an optimistic future scenario.

The developers might be able to bridge the gap by focussing on the optimisation of the technical and financial project parameters or make favourable speculations on future equipment prices, land sale values to defend their project returns. But again, that is the question of the great‘might’.

We have witnessed in the past how aggressive bids results in low margins. Any increase in input costs in the future, such as pricier imports, could potentially push many of these projects into unprofitability.

Rahul Gupta, CEO, Raysexpert, is optimistic about the tariffs but worries on the government regulations and policies as well. “The policies are not framed in a way that they provide the viability gap funding or support to make these rates financially feasible. Especially with the uncertainty of GST & non-compliance of RPO obligations, the rosy picture will get dull soon”, says Rahul. He also raises fears that these low tariffs can be negative for the growth of Solar in India as it will lead to corner cutting measures and cost cutting in the construction of the project.

Solar players were left high and dry in the Budget as they were expecting some clarity on the GST. Now even a slight change in any of the risk factors such as GST will have a huge impact on the already stretched project returns.

This also calls for the mention of the delayed payment issue of the DISCOMS. The guaranteed offtake of the generated capacity has been the eternal issue of this sector.

Eventually, the cycle will show a negative impact on the business model and the balance sheets of these developers. Quite similar to the past events where the global leaders went bankrupt with their aggressive bidding behaviour and asset aggregation approach.

Gagan pitches for the price discovery mechanism instead of a reverse auction for the long term sustainability of the solar industry, especially as solar industry is still quite new.

However, all is not all fluke. Vinay stands strongly on the sustainability of these tariffs. “They are most definitely here to stay as the cheapest source of power!”. “One of the fundamental attraction of solar technology is that it is still in its early stages of growth and further technology advancements will continue to make solar power progressively cheaper over the years”.