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Green | July 2012

JNNSM bids below Rs 9 per unit risky

The pace of reduction in capital costs is expected to moderate in 2012. This will exert pressure on the margins of players, who have bid below Rs 9 per unit under batch 2 of Jawaharlal Nehru National Solar Mission (JNNSM), unless they can access low-cost foreign debt, says a CRISIL Research report.

Solar power is emerging as an important source of power in India with the Government of India pushing through policies to meet its larger agenda of encouraging green power and diversifying its energy mix. The Gujarat state solar policy and the centre’s Jawaharlal Nehru National Solar Mission (JNNSM) are at the forefront of solar power development in India, with the Gujarat solar policy contributing to almost 70 per cent of the capacity additions in 2011-12.

In addition to government support in the form of solar power purchase obligations for state distribution utilities, a rapid decline in capital costs of solar photovoltaic (PV) projects also encouraged capacity additions, taking the total generating capacity from a mere 20 MW in 2010-11 to 940 MW in 2011-12. CRISIL Research, however, believes that the pace of reduction in capital costs of solar PV projects is expected to moderate in 2012 resulting in pressure on the profitability of players who have bid aggressively below Rs 9 per unit under batch 2 of JNNSM.

Almost half the bids under JNSSM have been below Rs 9 per unit and about a fourth of the bids below Rs 8.5 per unit, making these investments highly risky.

Favourable government policies powering solar power demand

Both JNNSM and Gujarat’s solar policy encourage capacity additions and investments by facilitating long term offtake agreements between project developers and distribution companies (discoms) at preferential tariffs. As solar power is nearly four times as expensive as conventional coal-based power, the power producers need to be compensated at higher cost-reflective tariffs. In order to spur demand for the more expensive solar power, states have been mandated to procure 0.25 per cent of their power requirements from solar power under the solar renewable purchase obligation (RPO).

Solar PV projects become cheaper as supply glut causes module prices to crash

While government policies are encouraging offtake, the falling capital cost of solar photovoltaic (PV) projects is giving solar power a further boost. Capital costs fell by 30 per cent (y-o-y) to Rs 100 million per MW by the end of 2011. The fall in costs was driven by a 50 per cent drop in the prices of solar PV modules, which account for almost half the capital costs of a PV project. The sharp fall in capital costs has improved the returns from the projects that were commissioned in 2011-12.

Module prices crashed due to the aggressive capacity build-up by China in 2010 and 2011 even as demand in key European markets dried up. The significant additions to module capacities by the Chinese have resulted in overcapacity of nearly 50 per cent in the global module market. The unprecedented growth in solar power installations coinciding with the withdrawal of incentives to solar power generators in key markets such as Germany, Spain and Italy has led to pressure on module prices.

Decline in module prices will slow down in 2012

It is expected that the pace of decline in module prices will moderate in 2012 due to the significant erosion in the margins of module suppliers in 2011 and increasing consolidation in the global module industry. Several manufacturers across US and Europe have announced production cuts while players including Solyndra (USA), Q Cells (Germany) and Solar Millennium (Germany) have filed for bankruptcy. Moreover, rising rupee depreciation is also likely to reduce the impact of falling module prices on capital costs. As a result of the increasing consolidation in the global module industry and a depreciating rupee, it is expected that capital costs will decline by only 10-13 per cent (y-o-y) to Rs 87-90 million per MW in 2012. Whereas, some players who have made aggressive bids for batch 2 JNNSM projects expect a sharper price decline, which is unlikely to materialise.

Aggressive bids for batch 2 JNNSM projects at risk, low cost debt critical to viability

Expecting a steeper decline in the capital costs of solar PV projects, players have bid aggressively in JNNSM batch 2 (350 MW bid out in December 2011) bringing down the average tariff to Rs 8.8 per unit from Rs 11.6 per unit in batch 1 (150 MW bid out in December 2010). However, given CRISIL Research’s expectations of capital cost of Rs 87-90 million MW, a levelised tariff of Rs 9 per unit is necessary for healthy equity internal rate of returns (IRRs) of around 15 per cent at a plant load factor of 19 per cent, debt to equity of 70:30 and borrowing costs of 13 per cent. Nearly half the bids in batch 2 of JNNSM have bid below Rs 9 per unit, and about a fourth have bid below Rs 8.5 per unit, making these investments highly risky.

Access to low-cost funds will be critical for viability of JNNSM projects

As seen from the sensitivity analysis, the viability of these projects hinges on the developer’s ability to reduce borrowing costs. However, access to lower cost foreign funds is often linked to foreign equipment supplies.

JNNSM batch 2 players opting for crystalline PV technology will find it difficult to tap these funds as they are required to procure crystalline PV technology domestically. Hence, access to cheap foreign debt and, consequently, viability of projects that have bid below Rs 9 per unit will depend on:

• Sourcing thin-film technology on which the restrictive domestic clause is not applicable
• Promoter strength and strong balance sheet of parent company
• Ability to control hedging costs: Players with export-oriented businesses enjoy a natural hedge against currency movement and can lower their foreign debt costs even further.

Agencies such as US EXIM, kfW Germany, Asian Development Bank (ADB) and International Finance Corporation (IFC) have been active in lending to Indian solar power companies. Low cost Chinese financing is also emerging as an attractive option for these players.

In comparison, Gujarat solar policy tariffs are more attractive

In comparison, the Gujarat solar policy tariffs of Rs 10.37 per unit are more attractive for project developers, yielding equity IRRs of 18-22 per cent. There is also a strong upside to these returns as players can obtain cheap foreign debt as there is no domestic content clause under Gujarat policy.

Capacity additions of 3.0 GW entailing investments of Rs 350 bn may materialise in the next 3 years

It is expected that around 2.8-3.2 GW of solar power generation capacities will be added over the next three years (2011-12 to 2013-14), facilitated by the continuing decline in capital costs and strong policy push.

The new installations would entail investments of Rs 350 billion and include 500 MW of solar thermal capacities awarded under JNNSM in 2010, which are expected to be commissioned in 2012-13.

However, given the weak financials of state discoms and the high cost of solar power, sustaining the demand for solar power would hinge upon the strict enforcement of penalties on states that fail to meet their mandated purchase obligation. Other issues such as delays pertaining to land acquisition, availability of adequate transmission infrastructure and government funding support would also need to be addressed to achieve the desired growth in solar power capacities.
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