Solar power in India - A financial analysis

January - 2012

Table of contents

A. Executive summary

B. Power sector overview

I. Indian power sector: Overview

II. Indian renewables sector: Overview

III. 2003 Electricity act

C. Solar sector

I. Solar potential in India

II. Jawaharlal Nehru National Solar Mission

III. Incentives offered by Government of India

IV. Solar India: Key investment highlights and concerns

V. Recent developments: Solar

D. Solar technologies: PV and CSP

E. Case study

F. Conclusion

Executive summary

India’s strong economic growth, combined with country’s industrialization, increasing population and increased access to power has led to rising demand for power in the country

Historically, the supply has consistently lagged the demand in the country by c.10%, and expected to worsen further

Government of India has set very ambitious targets to plug the gap, the big push coming from renewables

With the strong commitment from Government, and the various announced incentives, the renewables, particularly solar, presents an opportunity to earn very attractive returns over a longer time frame

India has significant potential for generating renewable energy, particularly in hydro, wind and solar

This study presents a case ‘for’ and ‘against’ investing in the solar sector, identifying the potential returns on offer taking into account the current regulatory framework

Indian power sector: Overview

Source: World Bank, Global Insights and broker research reports.

India’s rapidly expanding economy is presenting many problems for the Indian Government, not least the fact that around one third of Indians do not currently have access to electricity

Despite making up 17% of the world’s population, India only has a 3% share of the world’s energy consumption

Population growth to further increase energy demand

India’s per capita consumption is significantly below other comparable emerging markets, including the world average

India’s consumption per capita of 704 kW/annum is more at par with Philippines than China, which has a consumption per capital of 2,585 kW/annum

Consumption per capita Population growth rate

(kW / annum)

Indian power sector: Overview (cont’d)

Source: Global Insights, CEA and broker reports.

GDP is closely related to energy production, and insufficient capacity is currently having a negative impact on GDP growth

GDP has grown at rates of between 6.5 – 9% per year over the past 3 years; the ability to maintain these rates is threatened by the lack of capacity

GDP growth rate

Demand for energy in India has continually exceeded production capacity; with a peak historic energy shortage of 12.7% in 2009-2010

Despite Government’s attempts to improve situation, energy gap has continued to increase

(TWh) (GW)

Generation demand and supply Peak capacity demand and supply

Indian power sector: Overview (cont’d)

Source: MNRE, CEA and broker research reports.

To address this gap, the GoI has targeted an expansion of its power capacity to 342GW by 2017 from 209GW currently, through series of 5-year plans

This equates to a yearly addition of approximately 18GW, a projection that was restated in the Government’s 5 year plan

Main source of power is from thermal power plants (59% of the total installed capacity)

Hydro contributes 19%, whilst renewable accounts for 11%, nuclear for 2% and the remaining 9% is held as captive

Originally the expectation of the government’s current 5 year plan, covering the period 2007 – 2012, was to add an additional 93GW of capacity across the period, 15% of which was to be generated from renewable sources

If the Government is to come close to meeting this target in the near future, renewable energy technologies will play a major role in making it possible

Targets for increased capacity vs. Actual installation

(GW)

Current installed capacity by type: 209.1 GW

Indian renewables sector: Overview

Source: Ministry of New and Renewable Energy.

Note: Capacities as of 1/31/2012.

Excluding large hydro projects, renewable energy generation currently makes up 11% of generating capacity in the country (c.23GW)

Government targets to set up 74GW of renewable energy by 2022

Implies that c.51GW of renewable energy capacity needs to be added over the next ten years

Government’s commitment to the sector can be seen via its recent performance as shown in the below table:

State Renewable Purchase Obligations (RPOs):

State-wide RPOs require states to purchase up to a minimum of 10% of annual energy requirements from renewable sources by 2012

Scheduled to increase to 20% by 2020

Technology Target for 2011-12

Achievement during the month of Jan-12

Achievement during 2011-12

MW % of total

Wind 2,400 101 2,023 16,179 70%

Small Hydro 350 48 258 3,300 14%

Biomass 460 25 146 1,143 5%

Bagasse 20 285 1,953 8%

Solar 200 292 446 481 2%

Waste to Energy 25 1 1 74 0.3%

Total (MW) 3,435 486 3,159 23,130 100%

2003 Electricity Act

2003 Electricity Act introduced a number of reforms to the Indian power market, essentially opening up the electricity market up to the private sector

These changes included:

removing the requirement to obtain a license to set up a generation plant

providing more open access to the transmission networks, and,

introducing competition for the distributors by providing open access to consumers

Under the legislation electricity generators can either sell to the local State Electricity Board under a 15-20 year PPA or negotiate custom PPAs with industrial customers

Merchant contracts tend to be shorter in duration (5-10 years) but are usually much more lucrative

Source: Broker research reports.

The state and central government sectors dominate the market in terms of ownership of power generating assets

However, since the liberalization of the energy markets, the private sector has grown from 11% to presently c.21%

Ownership of power generating assets

Solar potential in India

India presents a great potential for solar power

India receives solar energy equivalent to over 5,000 trillion kWh per year, far more than its total energy consumption

Daily average solar energy incident varies from 4 - 7 kWh per sq. m. depending on the location and time of the year

Irradiation data suggests that 0.5% of India’s land area under solar PV could meet all electricity needs of the country in 2030

Rajasthan and north Gujarat receive highest annual radiation with over 6 kWh/sq meter

Andhra Pradesh, Maharashtra, and Madhya Pradesh receive radiation of 5-6 kWh/sq m

But, still comparable to European countries with a high solar installations, such as Spain and Italy

Source: MNRE website, PV Group and broker research reports.

Jawaharlal Nehru National Solar Mission

Launched in Jan 2010 by honorable Prime Minister Dr. Manmohan Singh, JNNSM is a major initiative of the Government of India and State Governments to establish India as a global leader in solar energy

Aims to install 20GW of solar capacity by 2022 in addition to 2,000 MW of off-grid solar power

Mission will adopt a 3-phase approach:

Phase 1: Spanning the remaining period of the 11th Plan and first year of the 12th Plan (up to 2012-13)

Phase 2: remaining 4 years of the 12th Plan (2013–17)

Phase3: 13th Plan (2017–22)

Proposed roadmap:

First batch of projects allotted for Phase 1 included 150 MW of Solar PV and 470 MW of Solar Thermal

Source: MNRE website, Wikipedia.

S. No. Application segment Target for Phase I (2010-13)

Target for Phase 2 (2013-17)

Target for Phase 3 (2017-22)

1. Solar collectors 7 million sq meters 15 million sq meters 20 million sq meters

2. Off grid solar Applications 200 MW 1,000 MW 2,000 MW

3. Utility grid power, including roof top 1,000 - 2000 MW 4,000 - 10,000 MW 20,000 MW

Renewable incentives offered by GoI Preferential FiTs offered to renewable energy plants connected to state electricity grids

PPA’s signed for long period ensuring reduced risk and easier to forecast revenue stream

Considers the cost of capital and aims to provide a high per-tax equity IRR

Successfully implemented in various European countries

Source: MNRE data, other web-based available data.

Feed-in-tariffs (FiT)

80% accelerated depreciation during the initial years of operation, providing effect to substantial tax benefits and strong cash flow profile

In parallel with the GBI’s in a mutually exclusive manner

Option to either avail accelerated depreciation or GBI, but not both

Accelerated depreciation

Project developers applicable for a 10 year tax holiday

However, a minimum alternate tax (MAT) of 18.5% applicable during the period, as compared to the corporation tax rate

Preferential tax rates

Genco’s can opt for feed-in-tariff revenue structure or the REC structure

Incentives of 1 REC per MWh which can be sold in the open markets

Solar REC banding fixed at Rs. 12 per kWh – Rs. 17 per kWh

Renewable energy certificates (REC)

Carbon credits issued by the Clean Development Mechanism board for emissions reduction achieved under the rules of Kyoto Protocol

Developed western markets but Indian markets are still far behind

Carbon emission reductions (CER)

Provided to support power projects connected to distribution grid of state utilities

Maximum amount of GBI applicable for a solar project determined after deducting PPA rate (signed with state utility) from a notional amount of Rs. 17.91 per kWh

CERC reference tariff of Rs. 5.5 per kWh implies a GBI of Rs. 12.41 per kWh for solar

Generation based incentives

Solar India: Key investment highlights

Quasi-regulated sector Long term PPA’s offers a predictable and stable cash flow

profile, emphasizing the low risky nature of the sector

Global initiatives With the world economies focusing on carbon free

environment, the need for renewables becomes more strong

High margin High EBITDA and Net income margins, characterized by low

working capital, supports the financial case for renewables

Reducing costs Oversupply and severe competition among solar component

providers pushing costs down

Abundant supply Oversupply and severe competition among solar component

providers pushing costs down

Government support Sector strongly backed by the GoI, underlined by various

incentives offered aimed at providing high IRR’s

Solar India: Key concerns

Reliability on GoI

Strongly reliant on Government, which has been marred with red-tapism and criticized for slow pace of reforms

Delayed payments from SEB’s

Cash constrained and highly leveraged IPPs may find it difficult to cope with the slow and infrequent payments from the State Electricity Boards

High initial costs

Despite various technological achievements in the sector, the initial setting up costs of solar plants is still very high, with grid parity levels still far from reality

Risk of policy changes

High levels of debt on Government as a result of funding renewable subsidies can lead to reduction in incentives, as is currently the case with various European economies

Recent developments: Solar

Source: Ministry of New & Renewable Energy and broker research reports.

In December 2010 the GoI announced the winners of its first solar auction with around 610MW awarded to 35 winners

Auction had bids for c8.0x the capacity offered

c.470MW of total capacity was solar thermal, whilst the remainder was solar PV

First auction widely criticized due to

small size of the projects (maximum of 5MW)

irrational bidding, largely due to the auction rules, whereby project developers that were offering to sell electricity at the cheapest rates were selected

In August 2011 the GoI invited companies to register for the second national auction to award licenses to build 350MW of solar PV by 2013

Some modifications made to the rules and guidelines, including, maximum size of each project increased from 5MW to 20MW, and each bidder could win as much as 50MW of total capacity

In December 2011, MNRE announced generation based incentives (GBI) of Rs. 12.41 per kWh

Quantum of GBI is kept fixed, as a difference of the CERC tariff (Rs. 17.91 per kWh) and a reference tariff of Rs. 5.5 per kWh

Solar PV: Technology overview

Solar Photovoltaic (PV) is a method of generating electrical power by converting solar radiation into direct current electricity using semiconductors that exhibit the photovoltaic effect

Employs solar panels composed of a number of solar cells containing a photovoltaic material

Materials presently used for photovoltaics include monocrystalline silicon, polycrystalline silicon, amorphous silicon, cadmium telluride, and copper indium gallium selenide/sulfide

PV panels based on crystalline silicon modules encountering competition by thin-film based solar panels, which are relatively cheaper but less efficient

Source: Wikipedia and web.

Solar PV value chain

Solar thermal: Technology overview

In solar thermal energy plants, solar radiation is concentrated by mirrors or lenses to obtain higher temperatures – a technique called Concentrated Solar Power (CSP)

Solar thermal panels transfer the sun's heat, as opposed to generating electricity

Most popular application is to heat water, which then subsequently generates electricity

Source: Wikipedia and web.

Solar thermal flow chart

PPA tariff:

Merchant power prices:

GBI:

REC:

Capital cost / MW:

Capacity utilization factor:

Debt / Equity ratio:

Debt interest rate:

Debt repayment period:

Tax rate

Return on Equity

Construction period

Depreciation

O&M expenses % of sales

O&M expenses escalation

Interest on W.C.

INR 5.5 / kWh

INR 5.8 / kWh

INR 12.41 / kWh

INR 14.5 / kWh

INR 169 million

19%

70:30

13.4%

10 years

MAT @ 18.5% (1st 10 yrs)

34% thereafter

15%

18 months

7.0% (1st 10 yrs)

1.3% thereafter

10.0%

2.0%

12.89%

Key assumptions and rationale

As per latest MNRE announcement

Average of 2008-09, 2009-10, 2010-11

As per latest MNRE announcement

Average of floor and forbearance price

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

Assumptions for the base case

Assumptions for the base case

As per CERC guidelines for 2010-11

Assumptions for the base case

Assumptions for the base case

As per CERC guidelines for 2010-11

Key financials

Cash flow statement

Free cash flow analysis

Sensitivity analysis C

ap

ex /

MW

Ca

pex

/ M

W

Ca

pex

/ M

W

Targ

et IR

R

Equity value sensitivity to IRR and Capex / MW Equity value sensitivity to CUF and IRR

Equity value sensitivity to CUF and Capex / MW IRR sensitivity to CUF and Capex / MW

PPA tariff:

Merchant power prices:

GBI:

REC:

Capital cost / MW:

Capacity utilization factor:

Debt / Equity ratio:

Debt interest rate:

Debt repayment period:

Tax rate

Return on Equity

Construction period

Depreciation

O&M expenses % of sales

O&M expenses escalation

Interest on W.C.

INR 5.5 / kWh

INR 5.8 / kWh

INR 9.81 / kWh

INR 14.5 / kWh

INR 153 million

23%

70:30

13.4%

10 years

MAT @ 18.5% (1st 10 yrs)

34% thereafter

15%

18 months

7.0% (1st 10 yrs)

1.3% thereafter

10.0%

2.0%

12.89%

Key assumptions and rationale

As per latest MNRE announcement

Average of 2008-09, 2009-10, 2010-11

As per latest MNRE announcement

Average of floor and forbearance price

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

As per CERC guidelines for 2010-11

Assumptions for the base case

Assumptions for the base case

As per CERC guidelines for 2010-11

Assumptions for the base case

Assumptions for the base case

As per CERC guidelines for 2010-11

Key financials

Cash flow statement

Free cash flow analysis

Sensitivity analysis C

ap

ex /

MW

Ca

pex

/ M

W

Ca

pex

/ M

W

Targ

et IR

R

Equity value sensitivity to IRR and Capex / MW Equity value sensitivity to CUF and IRR

Equity value sensitivity to CUF and Capex / MW IRR sensitivity to CUF and Capex / MW

Concluding remarks

The Government commitment and current regulatory framework presents an attractive opportunity in the Indian renewables space

As can be seen with the above cases, the solar sector offers high rates of return in the current scenario

Evidently solar thermal, with better capacity utilization factors and lower cost of construction, seems to offer better rate of return

With the rising global competition among solar component manufacturers and, thus, the oversupply, the prices of solar PV have gone down significantly and presents an opportunity for outperformance

However, high reliance on Government and the slow pace of reforms, as evidenced by the past performance, is in itself one of the biggest inherent risks

Thus, as with any other sector, solar sector comes with a mixed bag of ‘pros’ and ‘cons’, but the recent rush from private equity players to develop the renewable energy sector says something more about the positive side of the story