The COP26 target of 500GW of RE capacity envisages a 3-4x increment of operating assets in 9 years. This would oblige a total overhaul of the SEBs, something India needs to do for internal reasons.
Now that the dust on COP26 and India’s ambitious commitments has settled, it is worth taking stock and identifying what is needed to achieve these ambitious targets. For renewables, the target is 500GW of RE (renewable energy) capacity by 2030, also to decarbonize 50% of the power sector. Meeting these impressive targets would oblige an investment of up $500 bn in generation and transmission, with further investments for storage. No longer a fringe or start-up sector its prospects deserve serious scrutiny.
SECTOR GROWTH
India will miss the 175GW target set for 2022 (current capacity is 150GW, operating plus under construction). While performance in the years 2020-2021 has been obscured by COVID (7.8GW increment p.a.), the capacity addition in 2022 is expected to pick up in the range 13-14GW and in 2023 in the range of 17-18GW (both forecasts by CRISIL). ICRA forecasts a slightly lower capacity addition of 12.5GW in 2022 rising to 16GW in 2023. These separate forecasts are supported by the backlog of awarded bids (under implementation) of 58GW in the period 2019-2021 (55GW per ICRA).
To achieve the 2030 target, 350 GW of additional capacity would need to be installed, i.e., 45 GW capacity p.a. This is over 3x the maximum capacity added in a single year.
While these capacity numbers seem high in light of the historical record, the actual demand for power, given GDP growth, could be even higher. Assuming the historical energy elasticity of demand of 1.2x, given trend line GDP growth, and faster growth for clean energy given net-zero commitments (i.e. targeted RE for battery storage, charging of electric vehicles, and to power green hydrogen), electricity capacity would need to be around 800-900GW by 2030.
RE as a percentage of capacity would increase from the current 40% to over 70%, considering limited coal capacity addition as per CEA projections. The actual proportion of RE power supply to the grid would still be only 30-35% by 2030. Whether we look at a need of 350GW of RE capacity from a supply perspective or a much higher number from a demand perspective, this leaves the burden of meeting the gap on solar power. How is the sector performing?
LOW TARIFFS AND SECTOR RISKS
Reverse bidding, with a fall in capital costs, and the availability of cheaper sources of capital (such as USD bonds), led to the significant decline of discovered solar power tariffs in 2016-17, ensuring price competitiveness to discoms. However, since then, solar sector risks have only increased, resulting in rising tariffs from recent bids. Reasons for this include execution challenges, increasing import duties, delayed payments by DISCOMS, delayed PPA approvals, and even two sets of PPA breakages.
The latest analysis from CEEW and the IEA finds that India’s solar and wind tariffs have dropped by over 80% and 60%, respectively, since 2014. Solar PV tariffs declined to INR 1.99/kWh ($0.026/kWh) by Dec. 2020, rising to INR 2.17/kWh in Dec. 2021. Aggressive bidding by central PSUs and private IPPs alike has resulted in a squeeze on equity returns: INR equity IRR expectations fell from 15% in 2020 to 13% in H1, 2021; the slide is reported to be continuing.
In the meantime, for solar, the average price of imported solar PV modules (Mono PERC) has increased by over 35% over the past 12 months (currently USD 0.25/khwp, before import duties of 40% under the PLI scheme), putting upward pressure on capital costs for solar power projects. Tariffs below INR 2.5/kwh are barely viable. This is even before the inevitable rise of interest rates in 2022. The increase in module price, financing costs, and mismatch of risk and reward could affect investment decisions.
The wind energy sector, in stress, since auctions were introduced in February 2017, has seen capacity addition fall consistently from 5.5 GW in FY 17 to something below 2GW in FY21 and each of the last few years. The more competitive domestic industry, even with a large, local upstream MSME supply chain, simply cannot deliver at the capital costs commensurate with the low tariffs expectations.
IPP STRESS
Given the mismatch between tariffs and risks, fewer IPPs are being created, leaving the sector devoid of MSME start-ups. Only the larger IPPs are growing because of their ability to raise funds given scale rather than earnings. But even these players, having won tenders at low tariffs, for which they need to eventually deploy the capital they have raised in highly liquid markets post-COVID, have been delaying execution without any major penalty.
In the meantime, for even the larger, diversified parties, payment delays and low investment returns are acting as a drag on their trend line growth. Consequently, even larger players are routinely selling operating assets, which is fine for financial firms, but not a good sign for IPPs for whom size increases the ability to raise more capital.
DISCOM FINANCES MATTER
The dues to RE gencos from discoms in eight key states have gone up by 43% to INR 194 billion as of December 2021 from INR 136 billion as of July 2021, nearly 12 months of billings. The resulting cost of working capital for delayed payments affects the returns from existing projects and the ability to make fresh investments.
The Hon’ble Power Minister has been quoted as saying, “No investment will come if they find that power is not paid for…how would I achieve 500GW (RE by 2030). But I cannot have a rule for RE only.” The malaise in the discoms has to be resolved in entirety and not just for RE gencos.
CLIMATE FINANCE
Utility reform, viz. improving the finances of discoms, protecting signed contracts, and enhancing the independence of regulators, is central to India’s interests. Developed countries and climate finance have no role in paying for the huge losses which are dragging down the prospects of the renewable energy sector. This is India’s responsibility and successive governments and states have been ducking the issue since it was created in 1984, leading to multiple hits on the economy and ultimately making manufacturing in India uncompetitive.
Climate finance investments would not be available to provide working capital funding to insolvent discoms. They can at best fund low-return (c. INR 13% IRR) and de-risked investments in generating assets, which is not the present case. IPPs need to bid risk-adjusted, realistic tariffs at which they will build projects on a timely basis. Bidding to gain option value from changes in module prices has to be deterred.
PROSPECTS
The COP26 target of 500GW of RE capacity envisages a 3-4x increment of operating assets in 9 years. This would oblige a total overhaul of the SEBs, something India needs to do for internal reasons. Much like reducing urban air pollution, which also helps with mitigating GHG emissions. Adding so much RE capacity would help meet the 50% decarbonized power target, but this would require tremendous investments in storage and peaking capacity.
A dynamic industry, with a large requirement of foreign capital, needs forward-looking regulations and ongoing policy support. For too many reasons and not just the RE industry alone, there is no alternative to meaningful utility reform.
Sunil Jain is Operating Partner (Energy Transition) Essar Capital. Himraj Dang is an independent consultant.