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Cover Story | January 2017

Green shoots in RECs

RECs, which did not find takers till last year, gained prominence after Supreme Court upheld the constitutional validity of RPOs.

Renewable energy certificate (REC) mechanism, a market-based instrument introduced in 2010 to promote renewable energy and facilitate compliance of renewable purchase obligations (RPOs), has not received an enthusiastic response from the obligatory entities till recently. Lax enforcement of the mechanism mainly by the state electricity regulatory commissions (SERCs) is said to be the major reason for the same, which has affected investment inflows into clean energy systems such as renewable energy sources (RES).

However, rising demand in the first half of the current fiscal, particularly for non-solar RECs, is raising hopes that the green shoots are emerging for the environmental instrument. This has come about in the wake of the Supreme Court judgement last year which has upheld the constitutional validity of RPO norms. This resulted in record gains in demand for RECs, particularly non-solar ones, in the first half of the current financial year.

RECs represent environmental attribute, but are not related to carbon credits. These two mechanisms will operate independent of each other. Thus, the revenue streams for a renewable energy (RE) generator under REC mechanism include revenue from the sale of electricity component of RE generation and the revenue from the sale of environmental attributes in the form of RECs. The RPOs were envisaged to play an important role in the deployment of renewable generation capacity.

At the Paris Summit 2015, India has committed to reduce emission intensity by 33 per cent by 2030 and achieve 40 per cent cumulative electric power installed capacity from non-fossil fuel based energy resources by 2030 as part of the global initiative to counter global warming. In line with this commitment, the Centre has announced a target of increasing power generation capacity of RES to 175 GW, including 100 GW of Solar and 60 GW of wind, by 2022. The current capacity share of RE power, including hydro and nuclear, is around 30 per cent.

By end-September 2016, the share of RE generation was at 45,916.95 MW or 14.90 per cent of the country´s total generating capacity of 308038.28 MW. Among RES segments, small hydro segment was at 4323.37 MW; wind at 28082.95 MW; biomass power at 4882.33 MW; waste to energy at 115.08 MW and solar at 8513.23 MW.

Excluding small hydro, which is not part of the RPO mechanism, the RPO component comes to 13.5 per cent. However, there is a lot of distance to cover for RES ramp up in the next five years.

In July 2016, the Centre has issued an order fixing the total level of RPOs to be achieved by 2018-19 at 17 per cent, including 10.25 per cent for non-solar and 6.75 per cent for solar RPOs, and based on this target, SERCs have to set year-wise targets in their respective states. This target is more ambitious compared to the target set by National Action Plan on Climate Change (NAPCC) earlier at 15 per cent by 2020.

Some states were objecting to the Centre fixing up targets without taking the RES´ distribution across different states, which is quite uneven.

According to RPOs, a certain percentage of a state´s electricity generation must come from clean energy sources. RECs are divided into two categories - Solar Certificates and Non-Solar Certificates. States and utilities, which can´t meet their renewable energy requirements, can buy RECs from power exchanges like Indian Energy Exchange (IEX) and Power Exchange of India (PXIL). These power exchanges have already set the ball rolling in terms of trading in RECs.

Renewable sources are not distributed evenly across country and that inhibits SERCs from specifying higher renewable purchase obligation. RECs are aimed at addressing the mismatch between availability of RE resources in state and the requirement of the obligated entities to meet the renewable purchase obligation (RPO). RECs seek to create a nationwide renewable energy market, overcoming geographical constraints and provide flexibility to achieve RPO compliance.

The REC once issued shall remain valid for One thousand and ninety-five days from the date of issuance and up to March 31, 2017, whichever is later.

Success of the RPO policy primarily depends on ensuring that obligated entities comply with this mechanism. This can be enforced through stricter compliance regulations and penalties for non-obligating entities. ´Possibly, if non-compliant entities can be mandated to purchase RECs corresponding to their obligation for a calculated period of around 6 months - 1 year in the past, this may support clearing out of the current pending RECs that are lying unredeemed. Also, provisions in state solar policies/regulations acting towards RPO compliance such as that mentioned in the solar policy of Delhi will work towards the success of this initiative,´ said Amit Kumar, Partner - Energy & Utilities, PricewaterhouseCoopers (PwC).

´RECs have definitely contributed to compliance of RPOs at the National level,´ Says Kumar. Although a significant percentage of obligated entities initially were not disposed towards the mechanism of RECs, overall the stir created by this mechanism has been constant and was heightened by a Supreme Court order in May 2015 regarding upholding RPOs that led to an increased number of such entities becoming compliant.

As of December 2016, 5,373 MW projects were accredited under the REC mechanism and a total of 35.72 million REC certificates have, so far, been issued since the launch of this mechanism in 2011, of which 17.46 million have been redeemed.

The National Tariff Policy (NTP) released in 2016 specifies that 8 per cent of electricity consumption should be from solar energy by March 2022. This provides a benchmark that the states should achieve and accordingly select states have made provisions in their policies, Delhi´s solar policy for instance mandates that private power distribution companies meet at least 75 per cent of their solar RPO within Delhi. MNRE is also actively pursuing states to meet these targets. Additionally, the NTP also mandates new coal-/lignite-based thermal plants to procure renewable capacity.

In order to meet these established targets, states have been promoting generation via renewable forms of energy by instituting various enablers in the form of incentives and facilitating easier compliances for such projects. SERC´s such as Uttarakhand Electricity Regulatory Commission (UERC) and JERC (Goa and UT´s) have further imposed penalties for non-compliance of RPO targets involving fines on the non-compliant entities.

´Inconsistency in the solar RPO norms across the states, shortfall in RPO compliance by distribution utilities and absence of stricter enforcement by SERCs continue to remain regulatory challenges for the sector,´ said Sabyasachi Majumdar, Senior Vice President, ICRA.

In a June 2016 report, ICRA said that the SERC in Tamil Nadu has significantly increased solar RPO norm from 0.5 per cent in 2015-16 to 5 per cent in 2017-18, while SERC in Maharashtra has gradually increased the RPO norm from 0.5 per cent last fiscal to 3.5 per cent in 2019-20. ´Such extensions in solar RPO trajectory coupled with upward revision in RPO norms are positive developments for the domestic solar energy sector,´ Majumdar said.

By May 2016, SERCs in 24 states have declared solar RPO targets for this fiscal, which vary from 0.2 per cent to 2.5 per cent for the obligated entities (discoms). Two states with large solar potential - Rajasthan and Gujarat - were yet to announce the solar RPO targets beyond 2016-17. Thus, bringing the RPO norms in line with the solar RPO target of 8 per cent for 2021-22 as per National Tariff Policy (NTP), 2016, remains crucial in our view, ICRA said.

States have declared independent figures for both these RPOs - solar and non-solar. These target figures vary from state to state with states such as Goa having RPO targets for the year 2015-16 of 3.55 per cent to states such as Gujarat having an RPO target of 9 per cent, Tamil Nadu 9.5 per cent, Rajasthan 10.2 per cent and Himachal Pradesh 11.25 per cent. Further different distribution companies in Karnataka have separate RPOs ranging from 5.25 per cent to 10.25 per cent. The achievement of RPOs also differs from state to state with states such as Himachal Pradesh and Tamil Nadu meeting almost double of their RPO targets, while states such as Odisha and Kerala lagging far behind, meeting less than one-fifth of their RPO targets, according to PwC.

Addressing the state power ministers from across the country at Vadodara in October, Union Power Minister, Piyush Goyal expressed his anguish that some states were not fulfilling their legal obligations. ´It started with wind and now we see that happening in solar as well. There should be stricter penalties for states not fulfilling their RPO commitment,´ he said.

As per the Model Regulation evolved by Forum of Regulators (FOR), in case of default the concerned SERC may direct obligated entity to deposit into a separate fund to purchase the shortfall of REC at forbearance price. However, in case of genuine difficulty in complying with the renewable purchase obligation because of non-availability of certificates, the obligated entity can approach the Commission for carry forward of compliance requirement to the next year. But most of the SERCs were either allowing carry forward or allowed the obligatory entities to expire.

In a way, CERC and other state regulators are reluctant to fine or force the distributors in buying the RECs. This means that interest in new RE plants may wane, failing the purpose of REC mechanism. But the only solace is that many projects are opting out of RECs of late, and in the wake of falling costs, particularly for solar PV projects, the developers are bidding for prices below Rs.5 per kWh.

States such as Himachal Pradesh, Karnataka, Tamil Nadu, Mizoram, Meghalaya and Arunachal Pradesh are leading in meeting their RPO targets, whereas states such as Odisha and Kerala lag behind their RPO targets, according to PwC.

The main problem is that though there is enough supply of RECs on the energy exchanges, there is not enough demand as states are not forcing their utilities and industries to meet their RPOs. While the obligated entities include power distribution companies (discoms), open access consumers and industries consuming captive power there are some corporate and institutions which buy RECs under CSR and individuals on voluntary basis.

A simple study of data for the first eight months (from April-November 2016) compiled by the REC Registry of India has thrown up several surprises. Non-Solar RECs have witnessed a significantly higher demand of nearly 51 per cent at 20,55,542 RECs compared to the previous fiscal at 13,63,174. On the other hand, Solar REC redemptions saw a marginal dip of about one per cent from 2,86,877 to 2,83,863 certificates.

There were drastic reductions in RECs issuances due to impact of CERC´s 4th amendment to RECs regulations, which made REC issuances more stringent and removed plants generating renewable power for captive consumption from the list of plants eligible for obtaining RECs. ´This is expected to reduce the number of RECs being issued in the future and will hence work in favour of clearing the backlog of RECs that exists currently,´ said Kumar.

As was expected, during the first eight months of the current fiscal, solar RECs issuances drifted 41.16 per cent from 15,63,721 certificates in 2015-6 to 9,20,081 certificates during the current fiscal, while non-solar issuances fell 38 per cent from 51,86,552 RECs to 32,11,970 RECs.

The trading has been lacklustre in the first half of the fiscal as there is no urgency for states to buy REC until the end of the fiscal year in March when they have to meet their compliance numbers. This delay has led to low trading in RECs, making price discovery difficult in the short term.

The second half of the financial year is the busy period for the RECs markets as most transactions take place during this period. Of the 43 lakh non-solar RECs redeemed in 2015-16, 9 lakh were sold from April September 2015, while 34 lakh were sold in the second half, reflecting 21 per cent and 79 per cent split between the two halves of the year respectively. As such, one can see a lot of improvement in the demand for RECs, particularly non-solar ones.

Also, the delay in market recovery acts as a major problem for green energy producers as they cannot get remunerative prices. The RE producers who had set up their plants basing their entire business model on RPO are also facing problems. That is because trading in the energy exchanges see a massive amount of RECs being put for sale at the floor price and the distributors are not buying their mandated RECs. Solar RECs are unlikely to witness demand rise before entry into new fiscal, with expectations rife about the possible reduction in floor and forbearance prices of this category in the new fiscal. Solar REC floor and forbearance prices were brought down in three instalments since 2010 - forbearance prices were brought down from Rs.17,000 per REC in 2010-11, to Rs.13,400 in 2012-13 and Rs.5,800 from January 1, 2015, while the floor prices were brought down from Rs.12,000, to 9,300 and ultimately to 3,500 from the respective dates.

Discom dilemma
Owing to higher costs of RE generation as compared to conventional energy in most cases, there may be adverse impact of implementing significant RPOs on the health of discoms, particularly those that are not financially very sound. However, this is unlikely because discoms currently have a say in the RPO targets being established and are not bound to sign all PPAs that come their way.

´We may consider the examples of Rajasthan and Uttar Pradesh in the current scenario, the discoms of which are considered to be amongst the financially weaker ones in the Indian market. These states signed MoUs under the UDAY scheme and even though they have significantly increased their portfolio of renewable sources of generation, their overall performance and health has remarkably improved in the recent past,´ Kumar said.

A reduction in the cost gap between conventional and renewable energy sources with increasing fossil fuel costs and advancements in RE generation technologies will further foster easier implementation of RPOs and may very soon result in states generating electricity from RE sources at tariffs that are lower than the landed cost of power when they purchase from other states, adds Kumar.

Impact of failure
Failure to enforce RPOs in certain states will hamper the motivation of other states that are actively engaged in RE generation as they may have problems in the sale of this relatively expensive power and will undermine compliance to RPOs. This will result in decreased focus on both generation and procurement of renewable electricity, says Kumar of PwC.

This will result in losses for the firms issuing RECs and dragging down their returns on investment. Subsequently, this results in an increasing number of firms not implementing projects under the REC route, rather going for other terms of power sale that involve PPAs at tariffs higher than the Average Pooled Purchase Cost (APPC). This effect is particularly profound on solar energy, compared to wind energy, which has feed-in-tariffs.

The two reasons mentioned above are the main reasons that have resulted in the actual failure of the REC mechanism and have been accentuated by the drop in floor prices of RECs from around Rs.9.5/ kWh to Rs.1.5/kWh for non-solar sources in the current scenario. This drop in prices along with the uncertainty involved in the sale of RECs further results in limited number of entities opting for developing plants under the REC route, Kumar added.

Way forward
It augurs well for the RECs to have gained prominence, albeit perforce Appellate Tribunal for Electricity´s orders of April 2015, which have pulled up several SERCs for lax enforcement of RPOs in their jurisdiction, and Supreme Court judgement upholding the validity of RECs a couple of months later. However, several states are yet to fall in line.

Central Electricity Regulatory Commission (CERC), being an apex regulator for RPOs, has to ensure that the regulations are enforced strictly in all the states in order to promote investment and rapidly building capacities in RE generation in the next five years, in line with the government targets.

The validity of RECs is presently fixed only till March 2017, creating doubts in the minds of issuers and mandated buyers of RECs. The government and regulators should bring clarity to this issue, for the long term benefit of the RE industry. The government also could give a shot at clearing the backlog of all RECs once, as it was thought of earlier.

The accelerated deployment of renewables over the medium term will be incumbent on the success of many cross-cutting reforms to improve governance in state electricity boards (SEBs), increased compliance levels of RPO and improved financial health of insolvent discoms.

As Bridge to India, Indian renewable market consultants, has said in a recent report, the ratification of climate accord based on the Paris Summit would attract a much larger global scrutiny on the country´s ability to achieve yearly renewable targets and compliance with RPO. India has to brace for that through strict enforcement of RPOs. As such this international commitment should help India attract global investments and technologies too as the environmental activity among comity of nations picks up.

There is a need for evolving diversified financing mechanisms for RE projects with a view to bring down the cost of debt and improve their economic attractiveness. Already Solar PV is bridging the cost gap with the traditional sources of electricity by offering power below Rs.5/kWh, against Rs.9 a couple of years back. For hydro and coal based projects it is in the rnge of Rs.1.5 to Rs.3.5.

Ultimately, let us hope that the parity in costs between renewable energy and traditional means of power will become a reality in a few years, making RPOs redundant and taking India towards RE power.

- BS Srinivasalu Reddy

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