This article was published on mylaw.net on March 14, 2011. The link is http://www.mylaw.net/Article/ByArticleId/860/
Project Finance Challenges for Indian Solar Power- Deepto Roy
The Government of India has, in the last two years, been concentrating on solar power, apparently apanacea for the ever-growing demand-supply gap in power generation. Significant policy steps have been initiated through the ambitious Jawaharlal Nehru National Solar Mission (“the JNSSM”), with the mandate of adding a mind-boggling twenty gigawatts of solar power (at an investment of Rupees Ninety thousand crores) by 2020.
Since solar power is much more expensive – even compared to other forms of renewable energy – with capital expenditure required in the region of Rupees Fourteen to Sixteen crores per megawatt (“MW”), the JNSMM follows a unique model of ‘bundling’ solar units with cheaper thermal power from the unallocated capacity of central power plants. The allotment of thermal power from central power stations is in high demand in states that have power shortage, and therefore, access to this thermal power provided the incentive necessary for these states to purchase the bundled solar power as well. The nodal agency for power purchase is NTPC Vidyut Vyapar Nigam Limited (“the NVVN”), a wholly owned subsidiary of the National Thermal Power Corporation (“the NTPC”).
Other policy steps include the imposition of renewable purchase obligations on utilities so that they are compelled to purchase a percentage of their total requirement from solar power generators, and a regulated ‘feed-in’ tariff of the Central Electricity Regulatory Commission (“the CERC”).
The initial bidding saw interest from several international companies and many experts have predicted that India will overtake Germany as the global leader in solar energy production.
A real roadblock that solar power developers face is the availability of long-term project finance. The JNSSM itself envisages that seventy per cent of the fund requirement will come through debt. That number is very far from realisation.
Unlike regular corporate finance, which is based on an evaluation of the financial performance of a company (such as its cash flows, cash reserves, and total assets), project finance involves lending to ‘standalone’ assets, that is, the lenders only have access to the cash flows from a particular asset (the project or plant that is being financed). Project lenders have limited or no recourse to the other assets or cash flows of the promoter companies. The weaknesses of the asset and the contractual framework surrounding it directly affect the feasibility of finance. Project finance is challenging for solar projects for a variety of reasons.
Hyper-competition and unsustainable tariffs
For the JNNSM bids, developers were required to provide a discount over the CERC feed-in tariff. This resulted in some unbelievable bids, with bidders offering discounts up to fifty per cent. From a financial perspective, these tariffs are simply unsustainable.
Lack of scale
Under the JNSSM, no single developer can develop projects with total capacity in excess of five MW to allow a larger number of developers to participate. However, this restricts developers from leveraging scale. In an industry where the typical plant load factor (“PLF“) is very low, larger projects have a much lower risk profile.
Uncertain technology, uncertain developers
Solar technology is ever evolving. Since most Indian developers have no experience in developing or operating solar plants, their ability to integrate this technology is suspect. To top this, projects that have qualified in the initial phase of the JNSSM are required to implement their projects within remarkably stringent timelines, which may be impossible to implement.
Bankability’ of the NVVN’s PPA
The NVVN’s standard Power Purchase Agreement (“PPA”) is not ‘bankable’ in many respects (bankability refers to the ability of a contract to ensure revenues to the developer, so that the bank can rely on it to finance the project). The key drawbacks are:
1. The lack of a ‘take or pay’ obligation on NVVN – that is, the obligation to make payments irrespective of whether the buyer actually purchases the power, thus shielding the developer from situations where the buyer fails to off-take the power.
2. The NVVN has no obligation to make payments to the developer in case a utility company fails to make payments to NVVN under their agreements with NVVN – that is, the entire payment risk is passed on to the developer, with NVVN only acting as a go-between.
This is highly unusual and creates significant doubts with respect to the project cash-flows. Indian state utilities, since the days of Dabhol, are infamous for not honouring contractual obligations and delaying payments. It was anticipated that NVVN, being a subsidiary of the AAA-rated NTPC, would be responsible for payments under the PPA as this significantly reduce this risk. This has not happened.
Lack of security
In case of solar power, unlike conventional power, the project assets devalue rapidly and lenders do not have much confidence in their ability to sell the assets and recover the debt. Apart from the project revenues, the lenders have no other recourse, since no direct government support (such as guarantees and shortfall undertakings) has been provided.
At present, the number of solar plants actually connected to the grid is laughably low, with the total capacity of all solar plants connected to the grid being fourteen MW only. Developers, particularly with plants in remote areas (say, the Thar desert in Rajasthan) will find interconnection a significant impediment, particularly since the national grid company, Power Grid Corporation of India Limited, consistently fails to implement their interconnection projects within projected timelines.
Lack of lender confidence
Indian lenders have never been comfortable financing renewable power on a project finance basis and this lack of confidence is hurting their solar lending capabilities as well. They have not developed the technical capability to assess the risks of a solar power project and are, understandably, hesitant to finance these projects.
Despite various issues, there is concentrated movement to make project finance accessible to solar power developers. The Ministry of Renewable Energy (“the MNRE”) has set up a group of public sector banks, under the leadership of the State Bank of India, to explore steps that are required – such as making more inexpensive funds available – to make solar projects more viable. Some solutions include banks issuing long-term tax-free bonds to fund solar projects, and credit guarantees to projects from the Indian Renewable Energy Development Agency (“the IREDA”).
The MNRE has also proposed budgetary support from the NVVN. This means that even if the utilities fail to make payments, the NVVN would still be able to pay the developers. This will significantly reduce the credit risk for the banks.
International development agencies, including the International Finance Corporation and the Asian Development Bank, have come out in support of renewable projects and are considering proposals to advance funds that can be used for on-lending or equity investments in renewable energy projects. Other international organisations and green funds are also expected to contribute.
Another possibility is that projects would be funded on a balance sheet basis. However, given the significant capital requirements, a robust solar sector will definitely require active project finance support.