The adage “One man’s food is another man’s poison” (by Lucretius) sounds prophetic in the wake of the recent power blackout faced by large parts ofIndia. The fact that parts of rural India had access to electricity through distributed, off grid renewable energy systems, while urban India, including the National Capital Region, was in darkness, has acted as a wakeup call. Also, India’s gas woes, where matters tend to get worse than you think they would, underlines the need to focus on renewable energy. It does not help that coal allocation is now the subject of what could be the mother of all scams.
Global trends in renewable energy
As per the REN 21, Global Status Report, 2012- global new investment in renewables rose 17 per cent to a record $257 billion in 2011.
One of the highlights of 2011 was the strong performance of solar power, which blew past wind power, the biggest single sector for investment in recent years (although total wind power capacity added in 2011 was higher than for solar). The top five countries for total investment were China, which led the world for the third year running, followed closely by the US, Germany, Italy and India. India displayed the fastest expansion in investment of any large renewable market in the world, with a 62 per cent growth.
Solar PV grew the fastest of all renewable technologies during the period from end-2006 through 2011, with operating capacity increasing by an average of 58 per cent annually, followed by concentrating solar thermal power (CSP), which increased almost 37 per cent annually over this period from a small base, and wind power 26 per cent
India in the solar space
With about 250-300 clear, sunny days in a year, India's potential to generate solar power far exceeds its current domestic requirements. Solar irradiance in India varies from 4 to 7 kWh/m2, which makes it amongst the best places in the world for solar energy generation. India launched its ambitious national solar mission (JNNSM) which gave the sector much needed boost to develop this sector. In this backdrop, various other states have come up with their own solar policies, which augur well for this sector.
The result has just started reflecting in numbers, where grid connected solar power has risen from 10MW in December 2010 to over 1,000 MW recently. Charanka Solar park, which was commissioned in April this year, had 214 MW commissioned, thereby becoming the world's largest photovoltaic power station.
Changing solar dynamics
There was a time around four years back where the benchmark cost for 1 MW of Solar was Rs 16 crore ($3 million). This has come down to around Rs 8 crore ($ 1.5 million) per MW currently, largely due to the fall in prices of the panels and modules. Also, there has been efficiency gains as a result of which PLFs have increased. Some plants using trackers experienced PLFs close to 30 per cent in the peak season this year, which clearly improves the overall financials.
Also, as compared to other energy forms, there are no input (raw material) issues, and the time to commission is among the lowest, once the land and financial closure is attained.
The key concern like most things pertaining to power remains the health of State Electricity Boards (SEBs). Payment delays could just change the whole picture, especially in terms of returns.
Also, there is a concern that with solar power prices falling, will SEBs and governments that have signed higher rate PPAs really respect them. Clearly, this is a moral hazard and with the government’s dilly-dallying on treaties and agreements, one can never be too sure!
Although the other route (APPC+ REC) is economically better, but there is no enforceability of RPOs. Again, the financial viability of things from an SEB perspective comes into play. The focus should be on survival first and sustainability later.
A peek into the future
Amongst the domestic players, we are already seeing signs of consolidation setting in. Corporates that had announced grand plans have decided to go slow. Many marginal players are selling off their plants. Intermediaries tell me that bulk of the current Gujarat plants have changed ownership using innovative structures. In the medium run (3-5 years), we expect the stage to be led by 5-10 large players and 5-10 significant sized players, with others/ HNIs on the fringes.
Given the current over capacity on the modules and panels side, their prices will continue to fall for some time, though at a more benign pace than earlier.
After the quick fall in tariffs last year, we expect them to stabilise around Rs 7 to Rs 9 per unit, before falling again. We believe technology is the game changer. Expect a paradigm shift, which will increase efficiencies and reduce the costs further in the medium run and help solar energy gain its rightful place.
Sense of returns
At an indicative level, a sensibly bid project would see overall IRRs of ~14-16 per cent. With normal cost Indian loans, one can see equity IRRs in the range of 16-18 per cent. If one is able to reduce the debt cost through foreign loans or innovative structures, the equity IRRs could increase to 18-20 per cent. CERs, though valued at an all-time low now, have the potential of adding returns by another 100 to 150 bps. If you have attained scale, and have an attractive pipeline, an IPO flip (of course in a better capital market scenario) has the potential of generating 23-25 per cent equity IRRs.
Why is this the best time for PE funds to invest?
In general, renewable energy segments provide a steady state return over a long period. By definition, they are more suited to pension funds and other long-term investors. However, they also provide a limited window of opportunity to PE funds and other investors with a smaller horizon, if one can get into the sector ahead of the curve and “generate alpha” in the process.
We have had this experience with wind energy, which saw a flurry of deals, but the valuations play catches up very fast and then no longer remain as remunerative for PE funds except for platform deals. As of now, most of the solar energy players are in need of funds and are still talking of sensible valuations. If a PE firm were to back the right team at this time, they would be able to add to the competitive strengths of their investee company because in this space, ready availability of funds itself is a differentiating factor. Also, backed with funding, one could be in a position to sensibly chose and bid for more lucrative projects. The first-mover advantage on the capital markets side would also help in adding positively at the time of exit.
After some time (say 12-18 months), the commoditisation of this business will set in and valuations will also inch up, thereby reducing the overall returns for investors.
By then hopefully, other solar segments like micro-grids and off grids would boom. Till such time, keep searching for right teams in the solar space and backing them.
(Om Prakash Periwal, CFA takes care of the renewable energy segment at ICICI Securities, Corporate Finance)