Improving economics to drive investments in renewables

At Rs 6-6.5 cr per Mw, total investment is estimated at Rs 10 lakh crore by 2022

Renewables now make a lot more economic sense. It's better economics that is now driving investments in the wind and solar power segments. Over the past five years, even though India was well placed to harness the power of wind and sun, renewable energy capacity grew at a slow pace. At the start of 2015, the country's installed capacity of renewable energy stood at about 33,000 megawatt (Mw) including about 23,000 Mw from wind and 3,300 Mw from solar - compared to its total power generation capacity of around 258,700 Mw (60 per cent, which is coal-based). A recent presentation by R S Anand of Indian Institute of Technology Kanpur has pegged the renewable energy generation potential from commercially exploitable resources at 895,000 Mw.

While that speaks of the long-term potential, in the medium-term and given that India's power demand is set to increase, the government is looking to give a boost to renewable energy by adding fresh capacities of 60,000 Mw in wind and 100,000 Mw in solar by 2022. At an estimated cost of Rs 6-6.5 crore per Mw, India will need nearly Rs 10 lakh crore to achieve the targets.

Importantly, the thrust on renewables is likely to bear better results this time, as a lot has changed in recent years. In July 2014, the government reintroduced accelerated depreciation on wind energy projects. It also corrected unfavourable duty structures for solar as well as wind projects. Although the incentives make the deal sweeter, the biggest change that has swept the renewables space is the drop in costs, which has enhanced project viability.

Explains Navneet Singh, executive director and head (infrastructure group) at Avendus Capital: "The renewable energy space is witnessing investments, because of technical advancements the costs have started to come down, whereas on thermal power side costs have started going up. So, now there is parity happening on the pricing front in the wind power segment."

Singh says investors do not like to operate in a subsidy-based model as there is always a fear that subsidies might be withdrawn. Now with grid-parity in sight, investors will, then, be dependent on commercial viability. When that happens, a lot of investments will come in. There are other reasons as well.

Mohit Khullar, director, Equirus Capital, says: "Globally, there is a push towards green energy and the governments are giving fillip to solar and wind power. Renewable power also makes commercial sense now as the capex costs are getting rationalised which has led to improvement in ROIs (return on investments). Additionally, there was uncertainty around coal supply till some time back; so people started looking at alternative energy with more rigor".

Explaining the math, Sandeep Upadhyay, senior vice-president and head of infrastructure solutions group at Centrum Capital, says: "While capital costs have inched up from Rs 6 crore per Mw to Rs 6.75 crore per Mw in wind space, many state governments have raised tariffs from Rs 4 per unit to Rs 5.50-6 per unit. Also, thanks to technology advances, the PLF (plant load factor) of most projects is ranging between 21 and 23 per cent even in low wind density areas. This has led to an attractive post-tax equity IRR (internal rate of return) between 16 and 19 per cent."

In solar, Upadhyay says the capital cost per Mw has plunged from Rs 18 crore in 2009 to approximately Rs 6.5 crore. There has been significant improvement in technology besides a dramatic fall in silicon prices (key raw material used in solar panels). Going ahead, given the glut in the supply of solar panels in Europe and other regions, capital costs should fall further stabilising around Rs 5.5 crore per Mw.

Other experts, too, believe the trend in capital costs will remain benign. Thus, the equity IRR at 16-17 per cent (at 18-20 per cent PLF) though slightly lower compared to wind power, will improve even as tariffs, which are down from well over Rs 15 a unit in 2009 to Rs 5-7 a unit currently, decline further.

"When solar tariffs start coming down, it comes at parity to thermal tariffs, thereby reducing commercial risks (such as payments from state electricity boards or SEBs). Wind has already reached that area. In solar power, parity should come in two years," says Singh of Avendus Capital.

Going ahead, domestic coal prices are also likely to rise gradually. The recent auction of coal blocks, which saw companies bid aggressively to secure coal mines are another indicator. These factors could hasten the process of achieving pricing parity.

Not surprisingly, the renewable space is drawing the attention of large investors (see table). Recently, Dilip Shanghavi, India's richest man and promoter of Sun Pharmaceutical Industries, along with family and associates also committed Rs 1,800 crore of investment in India's largest wind equipment maker, Suzlon.

The initial public offering (IPO) market, too, should see increased activity. While the recent Inox Wind IPO got strong response, experts say institutional placement programmes (IPPs) with 1,000 Mw of operational portfolio are ripe candidates and in the next three-four years, there could be at least 10 such IPPs hitting the market.

Merger and acquisition (M&A) activity in the solar space, though, might take some time to fructify. "The solar space is still in the formative stage. It will largely be an organic growth story and lesser M&A's. The companies/projects are too dispersed in solar," says Singh.

However, for renewables, there are a few hurdles - in the form of weak financials of SEBs, the key buyers of electricity. Since the cost of renewable power is currently higher, SEBs are reluctant even as various governments have mandated them to buy a certain portion of their power from renewable sources.

Investors, though, seem to have found a way out. IIFL Research analysts say: "Most of the players targeting this space are looking at fresh investments in states where SEBs' payment track record has been good like Gujarat, Maharashtra and Madhya Pradesh."

The other issue that needs to be sorted out is the patchy pace of execution (see chart). The past five-to-six years have seen solar installations of only 3,300 Mw. While Mercom Capital Group forecasts 1,800 Mw with some upside for 2015 (calendar year), it is far small than government's target of 100,000 Mw by 2020.

"Most of the industry is confused as they are constantly bombarded with new policies, goals, drafts and revisions," says Raj Prabhu, CEO and co-founder of Mercom Capital Group. "The last time the National Solar Mission conducted a solar auction was in October 2013 - the industry just wants to see execution," he adds.

Analysts at IIFL Research believe the current industry's fundamentals, investment capacity of players and weak financials of SEBs might cap the aggressive renewable energy installations target (compounded annual growth rate of 25-30 per cent) of 175,000 Mw by 2022. The research house believes 10-15 per cent growth per annum in new installations is achievable.

With larger projects, the size of funding is going up and so are the land requirements, both of which are key monitorables. Although funding might not be as big an issue, the sector is already experimenting with a hybrid model that houses both solar and wind installations on the same piece of land.