More than a sunrise industry
Of the estimated 10,000 MW of installed solar capacity in India, 9,000 MW is reportedly in the utility-scale segment. Utility-scale solar refers to solar projects that inject electricity to the grid on the basis of contracts (power purchase agreements, or PPAs) entered into with entities such as state-owned electricity distribution companies (discoms), which are generally known as offtakers.
Project developers typically house each project in a distinct special purpose vehicle (SPV). This, in turn, executes the PPA at a predetermined tariff for a predetermined duration, usually 25 years. Even when project execution risks of a typical thermal power project using coal or gas have been mitigated, and assuming a secure PPA is in hand, it continues to be exposed to input (coal or gas) supply and cost risks resulting in an element of unpredictability in its earnings.
For a solar project in similar circumstances, there is guaranteed supply of the input (sunlight) at zero cost for the entire life of the project, resulting in highly predictable and lowrisk profitability. This key differentiating feature makes the risk and return profile of an equity investment in an operational solar project look a lot like a fixed-income instrument. Keep in mind, the global bond market is approximately double the size of its equity counterpart.
This means there is a deep pool of potential investors across the globe who have a natural affinity to the utility-scale solar story in India. However, the two main challenges they have to overcome are developing comfort on the security of PPAs (offtake credit risk) and ascertaining an appropriate entry point into the market. It is with this backdrop that two crucial enabling conditions need to be seen: that of NTPC offtake and the introduction of infrastructure investment trusts (InvIT).
NTPC raises money regularly in the international capital markets, and investors in every major financial capital have a view on the strength of its balance sheet. On the flip side, even the best-rated state-level discom would find it challenging to generate traction with a global investor. These investors just do not have the bandwidth to navigate their way through myriad state-specific issues.
So, by getting NTPC to execute PPAs, the government is sending a clear message to the global investor community on the security of the PPAs and signalling a quasi-sovereign backing. One can be certain that foreign investors are taking notice. So what about a suitable entry point for investors? This is where InvIT’s come into the picture. In its most basic avatar, an InvIT is a vehicle that pools funds from unit holders for further investment into infrastructure assets including solar — with each asset typically housed in its own SPV.
A key benefit of investing in an InvIT is that dividend distributions from the SPVs move upstream to the InvIT and onwards to its unit holders in a tax-efficient manner. So, profits generated by a utility-scale solar SPV suddenly become more valuable under an InvIT umbrella, rather than if the SPV remains directly owned by the promoter or developer company.
All this points to the future emergence of a three-stage ownership pattern in the typical 25-year life of any utility-scale solar SPV, with the owner at each stage performing a distinct role in line with its core competencies and risk appetite of its shareholders/unit holders. At the first stage will be an asset developer, who will bid for capacity and cobble together the various pieces that constitute a project and continue to directly own the project SPV until it achieves a certain level of profitability.
At the tail end will be an asset manager, who will acquire the SPV once the project debt has been fully repaid, house it under an InvIT umbrella and operate it as a fixed income-generating vehicle with little or no risk for the remaining life of the PPA.
In between will be an asset trader who will purchase the SPV from the asset developer, house it under an Inv-IT umbrella and sell it to the asset manager for capital gains once the SPV project debt has been fully repaid. This has some crucial implications for asset developers who initially bid for capacity and lock in tariffs.
There will be a ready and deep secondary market for utility-scale solar SPVs. So, while prevailing utilityscale solar tariff levels appear to generate low returns for the asset developer, when evaluated from the traditional thermal approach of ‘bid, develop, own, operate and lock in capital for 25 years’, the ability to readily recycle the initial equity capital several times over the same period has a very significant impact in uplifting these returns.
So, maybe, there is some logic to the prevailing utility-scale solar tariffs after all.