In the annual Budget for fiscal year 2015-2016, Indian Finance Minister Arun Jaitley revised the 2022 target for renewable energy upwards to 175 GW. 100 GW of this is allocated to solar, 60 GW to wind, 10 GW to small hydroelectric and 5 GW to biomass.
That sounds like a tall order and despite considerable interest from both the Indian and international investment community, there is skepticism from some quarters on whether such an aggressive target can be met.
While the focus of this analysis is primarily on solar since it makes up a lion’s share of the target, the broad principles touched upon can be applied to other renewable technologies as well.
Solar tariffs in India have decreased considerably in the last five years and are on target to reach grid parity (approximately ₹4.5 per kWh or $0.067) by 2018 according to some estimates. Currently, most medium sized plant operators find it challenging to generate healthy rates of return (IRR) at tariffs below ₹5 per kWh ($0.075).
One of the reasons for this is that India has a high prevailing interest rate environment (upwards of 12% annually for solar plant debt in some cases) and if you use a funding model in which debt servicing costs are factored into the Levelized Cost of Electricity (LCOE), it has a very adverse effect on IRRs.
In an effort to incentivize plant operators and mitigate some of these effects, India created a Renewable Portfolio Obligation or RPO (similar to the Renewable Portfolio Standards or RPS we have in the US) in 2008 to set a floor of 15% of total power generated as renewable energy by 2022 and followed that up a couple of years later by creating a market based Renewable Energy Certificate (REC) mechanism. It was left up to the individual states to establish clear RPO policy guidelines and enforce them, and as a result, there is large variation state-by-state in targets and enforcement.
Solar RECs are currently traded on the Indian Energy Exchange (IEX) at a market price of ₹3500 per mWh or ₹3.5 per kWh ($52.23 per mWh or $0.522 per kWh). The lack of uniformity in state-by-state RPO enforcement is illustrated by the stark disparity in buy and sell bids for solar RECs. In January 2016, there were 60x more sell bids than buys.
While the REC market in the US is by no means perfect, the EPA has comparatively coherent guidelines on how RECs are defined: for every mWh of electricity generated by a renewable source, there are two independently monetizable entities – (i) the actual electricity itself which can be sold at market price to the local utility and (ii) one REC.
Whether the directive comes from the central government or the individual states, more uniformity in RPO guidelines, enforcement and fines are required to decrease the disparity in REC sell and buy bids and ensure interest and engagement at both the plant operator and investor level. If that happens in the near future, there will be a large uptick in solar power generation and adoption as it will become very profitable for investors and operators and it will set India well on course to meet the lofty goal of 175 GW by 2022.
As an illustration of what a well enforced REC landscape looks like, the infographic below takes a hypothetical 100 MW solar plant with some standard assumptions on generation, financing and operating costs and compares the IRRs for equity investors in a REC and non-REC environment.