Following delays in signing power purchase agreements (PPAs) under various state solar policies, developers have shifted focus to solar projects initiated under the Central Government’s National Solar Mission which received bids nearly three times the capacity on offer.
However, Crisil Research expects only half of these capacities to be commissioned as returns are expected to be under pressure on account of aggressive bidding and risk arising from non-availability of domestic solar cells.
The strong interest of developers in Jawaharlal Nehru National Solar Mission (JNNSM) Phase-II was evident from the quantum of bids received, a steep 2,170 MW of bids were received against the tendered 750 MW. Clearly, developers were enthused by the adequate payment security mechanism and good track record of payments under JNNSM, which has been a key concern for solar power projects under State solar policies.
The government invited bids in two categories based on the source of solar cells and modules — one in which developer is free to use any source for equipment, and the other where equipment has to be sourced domestically.
Competition was more intense for 375 MW bid under the ‘open category’, that is, the category where there are no restrictions on the import of cells and modules. Bids received in the open category were four times the available capacity against two times in the 375 MW bid under the ‘domestic content requirement’ (DCR) category, in which the cells and modules used will have to be of domestic make.
The stronger interest in the open category was on account of imported modules being 5-7 per cent cheaper than domestic modules and availability of foreign funding through developmental finance institutions, where, typically, the interest costs are nearly 300 basis points lower (after hedging costs) than the domestic cost of funds.
With the successful conclusion of the bidding process in March 2014, the more pertinent question is what kind of returns the players will make.
Bidding under the JNNSM Phase-II was based on viability gap funding (VGF). VGF is a mechanism where the government provides a capital grant to enhance project feasibility. To assess the viability of these bids, we calculated the VGF required to earn a minimum equity internal rate of return (IRR) of about 16 per cent.
Solar power projects
Solar power projects also enjoy accelerated depreciation of 80 per cent in the first year of operations. Thus, players who can set off accelerated depreciation against profits from other businesses can bid more aggressively compared to others. Most independent power producers do not have access to accelerated depreciation as they operate their projects under different special purpose vehicles (SPVs) that, in the early years of operations, do not have adequate profits to benefit from the accelerated depreciation scheme.
Based on current prices, capital costs under the open category are about Rs.6.80 crore per MW. However, players availing themselves of accelerated depreciation (typically includes entities from other businesses with limited execution experience in solar projects) incur 5-6 per cent higher capital costs given that the entire project execution would be outsourced.
As mentioned above, manufacturing costs for solar modules are also higher in India. Thus, for projects awarded under DCR category, the capital cost would be 5-7 per cent higher compared to the open category.
Plant load factor
Based on the latest all-India average plant load factor (PLF), we have assumed a PLF of 19 per cent, debt-to-equity ratio of 70:30 and domestic lending rate of 13 per cent for our return calculations.
Our analysis reveals that there is a significant gap between the weighted average VGF quoted by players and the VGF required for healthy returns. Due to aggressive bidding, returns will be under pressure with equity IRRs estimated at only 8-11 per cent in the open category and 10-13 per cent in the DCR category. Hence, as per our assumptions based on domestic cost of funds, only capacity of less than 100 MW will have adequate returns.
Moreover, there is a significant risk of solar cells availability in the DCR category due to inadequate domestic operational capacities. This is on account of large scale capacity shutdowns in India following sharp decline of about 60 per cent in global module prices over the last two years which rendered the financial position of domestic cell and module manufacturers extremely weak.
A confluence of the above factors will result in commissioning of only half of the 750 MW bid out under JNNSM Phase-II. The capacities that are expected to come up will be in locations such as Rajasthan where PLFs are relatively high at about 21 per cent. Also, developers who have access to low-cost foreign funds which boost returns by about 200-250 basis points, would be able to commission their projects.
For the balance 50 per cent of the capacity under JNNSM Phase-II, we believe that there could either be renegotiation of power purchase agreements as witnessed under conventional power projects or liquidation of bank guarantee of Rs.3 crore per MW.