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A finance structure that matches India’s ambitions for renewable energy sector

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The Government of India has set targets of 175 GW renewable electricity (RE) capacity by 2022 and 450 GW RE capacity by 2030. These are ambitious targets.

By January 2020, against a total installed capacity of almost 370 GW of power, renewable power consisting of solar, wind bio-power and hydro, accounts for only about 86 GW. Clearly the immediate target of achieving 175 GW by 2022 is challenging, leave aside the target for 2030.

Accelerating the deployment of renewable power would need action on a number of fronts. Amending the Electricity Act is one to bring about payment security, contract sanctity and improving the financial position of discoms. The Government would need to manoeuvre deftly since the proposed amendments are being opposed by many states. In addition, the Government is focusing on a number of measures on the legislative, regulatory and policy side of promotion of renewable power.

While focus on these areas is noteworthy an area that has been largely ignored is the financing side of renewable energy. A target of 100GW over next 2 years will need almost Rs. 350,000 crores of debt and Rs. 120,000 crores of equity.

Let us park the equity on the side at the moment. With greater fund availability from foreign and domestic investors and a greater interest in sustainability projects, equity raising can be challenging though achievable provided we can demonstrate a lot more effort on legislative, regulatory and policy stability.

However, a key prerequisite for equity investment would be the availability of long term debt at reasonable costs. Availability of debt at reasonable cost is also important to bring down the cost of renewable power. For example, in the lowest bid of about Re 1 per unit achieved in the Middle East, a significant contribution was that of extremely low cost of long term financing.

It is unfortunate that commercial banks are shy of funding the renewable sector. Most of the funding for the renewable sector has come from Rural Electrification Corporation (REC), Power Finance Corporation (PFC), Indian Renewable Energy Development Agency (IREDA) and a few private sector non-banking finance companies (NBFCs).

Funding by banks – both private sector and public sector – has been sparse to say the least. Banks have been reluctant to lend in general but have been perceiving an unreasonable high risk for renewable power space.

Some developers have had the ability to access the dollar bond market which is a useful source. The hedging cost of long term dollar debt, however, is quite onerous making debt and profit and loss (P&L) management under accounting standards a challenge. This increases the landed cost of debt.

On the whole the experience of lenders to large scale utility projects has been good with low non-performing assets (NPAs). Such large scale projects are backed by state and centre through long term power purchase agreements (PPAs). The lowest credit risk is the PPAs with central undertakings like NTPC and SECI.

The PPAs with states are of varying risk depending upon the credit rating of the individual states and their payment record. There have been a few issues in some state PPAs with delays in payments including cases where the state has opened up the PPAs for re-negotiation.

However, it is incorrect to tar the whole sector due to such truant cases which will in any case be skirted in the future by developers, investors and lenders. Credit ratings of rooftop and Critical National Infrastructure (CNI) projects vary depending on the business model and the counterparty credit risk in the latter. On the whole, it can be argued that these sub-sector differentiations are an issue of debt pricing and should not be used to club the whole sector under doubtful categories.

Unlike other priority sector lending obligations, banks are not mandated to lend to RE projects. Given the long term sustainability impact, it is time to rethink this perhaps.

It is also possible to take inspiration from the already existing concept of Renewable Purchase Obligations (RPO) and Renewable Energy Certificates (REC). The State Electricity Regulatory Commissions (SERC) mandate the purchase of the minimum level of renewable energy out of the total consumption in the area of a distribution licensee under the RPO.

The obligated entities have the option of purchasing RECs to meet their purchase obligations. RECs also known as green energy certificates are tradeable and provide proof that energy has been generated from renewable sources.

Each REC represents the environmental benefits of 1MWh of renewable energy generation. Buying RECs is not equivalent to buying electricity. Instead, RECs represent the clean energy attributes of renewable electricity. A REC is produced when a renewable energy source generates one megawatt-hour (MWh) of electricity and delivers it to the grid. RECs are traded on an exchange. Purchasing RECs also supports the renewable energy market by providing a demand signal to the market, which in turns encourages more supply of renewable energy.

Let us say, on similar lines, we now create a concept of Renewable Financing Certificates (RFC) along with Renewable Financing Obligation (RFO). RFC combined with RFO opens up a major catalyst for financing of RE projects and simultaneously incentivises banks for financing RE projects.

Under the proposed concept, an obligation (RFO) on lenders has to be placed towards financing RE projects, which the lenders can fulfil by lending to RE projects or by buying RFCs. Else a penal amount will be levied on them. Similar to REC and RPO, the working mechanism for RFC and RFO can be devised.

RFO will ensure a fixed annual target for lenders towards RE financing and award of RFCs for each of RE project financed which can later be traded on exchanges and sold to other obligated lenders who have not met their requirement under RFO.

A penal amount equivalent to RFC capped price could be levied on lenders not fulfilling their RFO requirement. This will have a multiplier effect in terms of addition of installed RE capacity, lower reliance on fossil fuels and a positive environmental impact.

As in case of RECs, this mechanism will need policy actions for RFC/RFO and can be implemented with the joint support of RBI, Ministry of Finance, Ministry of Power, and Ministry of New and Renewable Energy.

A RFC can be produced when a lender will finance a renewable energy project, wherein one RFC will be equivalent to one megawatt (MW) of capacity financed. The RFC issued can be linked to MW proportionate debt to equity ratio.

For example if a lender has funded 75% of a 100 MW project the RFC issued will be equivalent to 75MH. A RFC once sold should not be allowed to be purchased back by the seller. All RFCs can be uniquely numbered and generally can include information such as where they were generated, the type of renewable resource that was financed, and a date stamp of financial closure.

The exchange of RFCs can be tracked and recorded. Purchasing RFCs will also support the renewable energy market by providing a sense of available financing opportunities in RE to the market, which in turn will encourage more renewable energy projects.

The broad contours of such a financing scheme can be as under:

    • A central level agency designated by RBI/Ministry of Finance for registering lenders and borrowers and for assigning and tracking respective RFO/RFCs
    • Scheduled banks and registered NBFC lenders to be included in the ambit of Obligated Entities under RFC
    • RFC to have central registry similar to REC and to be traded at designated power exchanges
    • Every 1 MW of RE financed by a lender may be eligible for 1 RFC or any other appropriate number
    • Lenders should have an annual RFO. It is estimated that even a 1% obligation will bring in a funding capability of almost Rs 125,000 crore
    • RFO targets could be met by financing RE projects or by purchasing tradeable RFC from power exchanges
    • Lenders with surplus RFC over and above their RFO requirement can sell them at power exchanges within the pre-approved forbearance and floor price
    • Lenders not meeting their RFO requirement be penalised equivalent to forbearance amount of RFC (as set by nodal central agency) for their shortfall
    • Later provision can be made for swap ability of RFC and REC based on a predetermined ratio, to further support the RFC mechanism and provide an incentive to FIs to sell their excess RFC to obligated entities under REC mechanism as well

Giving a thrust to financing of renewable energy projects is even more important given the focus on ‘Atmanirbhar Bharat’ and its applicability to the renewable power sector which imports almost 85% of the sector’s capital equipment. The large targets of this sector will remain hollow promises unless appropriate thrust is given on the funding side.