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Renew | November 2013

Intense competition to limit growth potential of solar IPPs

Stiff competition has been witnessed in various state solar bids due to sharp drop in capital costs in the last two years, but going ahead, the trend is likely to reverse, says CRISIL Research.

Independent power producers (IPPs) are at disadvantage when compared to non-IPPs. The non-IPPs enjoy accelerated depreciation benefit for their solar power projects under different state policies, which have been competitively bid and awarded at a tariff of about Rs 6.5 per unit.

According to a latest report by CRISIL Research, this levelised tariff is significantly lower than Rs 9.4 per unit, a level that is required to achieve reasonable equity internal rate of return (IRR) of 16 per cent. ´Stiff competition from players availing the benefit of accelerated depreciation has impacted the business case for IPPs,´ says Rahul Prithiani Director, CRISIL Research.

Going forward, players are unlikely to enjoy the advantage of falling capital costs as solar module prices are expected to stabilise in 2013. ´Thus, we believe that IPPs would have to significantly slow down their expansion plans,´added Prithiani.

Stiff competition in various state solar bids witnessed a sharp drop in capital costs in the last two years. This prompted several states including Tamil Nadu, Rajasthan, Andhra Pradesh and Karnataka to invite bids to set up solar projects in their states. Players other than IPPs (non-IPPs), who can set off accelerated depreciation (refer box) against profits from other businesses, have bid aggressively in the last year.

Non-IPPs such as Mohan Breweries and Essel Mining have bid at Rs 6.5 per unit or below whereas IPPs like Welspun and Azure Power have bid in the range of Rs 8-9 per unit. Thus, IPPs are compelled to match

such low tariffs as projects under most state solar policies are awarded at the lowest bid (L1).

Declining trend in capital costs to reverse in 2013-14

While aggressive bidding was also witnessed in Jawaharlal Nehru National Solar Mission (JNNSM) Phase 1 in December 2011, the sharp fall in capital costs supported project returns. However, this benefit is expected to diminish as solar module prices, which form about 50 per cent of capital costs, are estimated to stabilise. Our view is driven by the continuing consolidation in the industry coupled with rising solar power capacity additions in China and Japan. CRISIL expects module prices to average at $0.70 per watt in 2013 from $0.79 per watt in 2012. However, this drop in module prices is expected to be offset by sharp rupee depreciation. Thus, it is expected that capital costs is likely to rise marginally to Rs 82-84 million per MW in 2013-14 from Rs 80-82 million in 2012-13.

Returns of IPPs to be strained

IPPs enjoy a 10-year tax holiday under section 80 IA and consequently do not avail accelerated depreciation. Thus, an IPP would require tariffs of about Rs 9.4 per unit to earn a reasonable equity IRR of 16 per cent. Based on the interaction with industry players, we have assumed a capital cost of Rs 83 million per MW, plant load factor (PLF) of 19 per cent, debt to equity of 70:30 and borrowing costs of 12.5 per cent.

The levelised tariff determined based on L1 bidding was Rs 6.5 per unit in case of Tamil Nadu (with a 5 per cent escalation clause for a period of 10 years), Rajasthan and Andhra Pradesh. Even if IPPs obtain foreign funding at a lower interest rate of 9 per cent (including hedging costs), a trend prevalent among IPPs and equity IRR is estimated to be only 8 per cent. Therefore, rising competition from players availing accelerated depreciation would significantly slow down the expansion plans of IPPs. This is evident in recent tenders where about 80 per cent of the bids were placed by non-IPPs.

In view of stiff competition from players who are able to utilise accelerated depreciation benefit, we believe, going forward, IPPs will have to bid from their profitable parent company or other subsidiaries for availing accelerated depreciation. This will enable them to compete with non-IPPs. On the other hand, IPPs without such an option will be at a significant disadvantage, thus limiting their growth potential.

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