Changing Financing Landscape: Lenders warm up to the renewable energy sector

Lenders warm up to the renewable energy sector

With significant growth in India’s renewable energy sector in recent years, the renewable financing landscape too has seen a gradual transformation. Back in 2010-11, there was considerable scepticism regarding renewables. As project technologies were new, the risk component was high, which prevented banks and financial institutions from funding such projects. The internal rate of return (IRR) offered by renewable energy projects was as low as 5-6 per cent. However, lenders still placed their bets on an eventual shift towards unconventional energy sources and commenced financing activity in this space. Over time, financing activity has been supported by funds raised from the market (for on-lending purposes), the introduction of new financing products and formulation  of risk mitigation strategies.

With stable technologies, competitive tariffs and a fairly short gestation period (of less than one year) for renewable projects, financial players have become more willing to extend financial support to these projects, as the risk-revenue models are better understood.

The Indian renewable energy market has also seen the entry of a number of global developers. While some are looking to reap long-term benefits (and thus are accepting lower IRRs), others are using this as an avenue for investment given that they are facing lack of investment options elsewhere in the world. Factors that have worked in favour of India are the allowance of 100 per cent foreign direct investment (FDI) in the renewable energy sector under the automatic route, increase in public investment in infrastructure generation and greater focus on the sustainability of projects. However, falling tariffs have again brought the viability of solar and wind projects into question. While the new tariffs (Rs 2.44 per unit for solar and Rs 3.46 per unit for wind) are very competitive with coal-based energy tariffs, lenders are looking at the cost-side dynamics closely. Factors like the financing structure of the project, risk matrix, contractual commitments, security mechanisms and agreements with suppliers are being taken into account to gauge the overall project viability.

Key areas of concern

While the financing scenario has evolved, there are still a few areas of concern, especially for foreign investors. Although they are willing to invest in the country’s clean energy segment, there is a concern regarding the risks associated with a project. While risks related to currency and lower input prices are known and can be dealt with, it is the issue of transparency that is of greater concern. In order to deal with the latter, foreign investors are engaging local partners to gain knowledge about the market and ensure transparency. Political risks with regard to the time taken to secure the requisite approvals and the absence of a transparent dispute resolution mechanism have continued to bother foreign investors. Another key concern is the weak enforcement of legal provisions for the protection of technology rights.

Future outlook

Globally, financiers are witnessing three major trends – greater electrification, decentralisation of power generation and storage, and digitisation. These three trends together are set to transform the entire power sector over the next decade and lead to a new financing paradigm. For instance, in the US and Europe, new project structures such as energy cooperatives at the community level are emerging, leading to the clustering of small projects into one large project, which could be easier to finance.

In India, there is significant scope for designing innovative financing instruments. Banks, for instance, could meet the initial funding requirements, and upon stabilisation of returns, renewable energy players could tap the equity market through initial public offerings. In addition, new institutions have to be formed to fund rooftop projects.

Going forward, solar tariffs, which have so far been declining due to market competition, are expected to plunge further to the sub-Rs 2 per unit levels with further technological advancements. Specifically, storage capacity costs are expected to drop steeply over the next three to five years. Meanwhile, competitive bidding in the wind segment and increased signing of power purchase agreements are positive signs for the future. As compared to its global counterparts, India should reap the benefits of the demographic dividend and focus on providing affordable energy to the growing middle class. This will in turn help make renewables a mainstream source of energy.

Based on a round table discussion by Dr Ashok Haldia, Managing Director and Chief Executive Officer, PTC India Financial Services Limited; Mukul Modi, Senior Vice-President, SBI Capital Markets Limited; Mark Moriarty, Chief Operating Officer, CMS; and Normen Kegler, Advisory Council Convenor Co-Chair, Independent Power Producers Forum, at the recently held POWER-GEN India and Central Asia 2017 conference