By Dominic Scott, Senior Associate, Regulatory Assistance Project
India’s massive investment in storage
India has laid out an ambitious plan to add 300 GW of renewable generation capacity by 2032, more than doubling the existing capacity. To accommodate the generation variability of this fleet, India plans to expand its (hydro) pumped storage capacity to around 100 GW by 2036. This represents a more than 12-fold increase from the roughly 8 GW at present. Achieving this goal would require a steep increase in annual additions, starting at around 3 GW per year and ultimately growing by tens of gigawatts each year.
The investment will require vast sums of money. The cost of developing 100 GW of pumped storage capacity is estimated at Rs 5.8 trillion, or $64.4 billion. Long-term pumped storage contracts with discoms in India are expected to be awarded via tariff-based competitive bidding, as per the current practice.
The value that these facilities create for the Indian power system will depend not only on their deployment but also on how they are operated. Smart agreements, such as financially settled contracts (FSCs), could support the efficient, flexible operation of pumped storage resources, maximise their value for the system and help lower costs for Indian consumers.
How existing contracts work, and how they don’t Long-term contracting for pumped storage in India has historically been based on power purchase agreements (PPAs) for physical energy. Most recent tenders structure PPAs for pumped storage projects in two components: availability payment and charging energy structure.
Availability payment
This is the backbone of the contract. The discom pays the developer a fixed annual amount based on contracted capacity, conditional on meeting availability norms. This payment covers capital recovery, debt servicing, fixed operations and maintenance costs, and return on equity. It resembles a capacity payment or a fixed cost recovery model, similar to thermal PPAs. The availability payment could be discovered through an auction, which may help keep costs down, or it could be administratively determined.
Availability norms often require 90 per cent availability during peak windows. But like availability requirements for thermal contracted capacity in Indian PPAs, these tend to be weakly linked to system conditions. Requirements may include peak windows, but these are typically defined over broad time blocks and do not strongly differentiate between high- and low-value hours.
Charging energy structure
Charging energy – to move water from the lower to the upper reservoir – can be handled in different ways.
In a simple model, the discom supplies off-peak charging energy at its own cost. In return, the pumped storage plant returns (discharges) peak energy at moments identified by the discom or potentially by the load despatch centre. The tariff structure includes payment for any variable operations and maintenance costs, in addition to any likely small pre-agreed margin.
A more sophisticated model allows the storage operator to buy charging electricity from the market to provide peak energy at identified moments. The tariff structure is as before, except that the contracting discom or big consumer also reimburses the storage operator for the cost of charging energy.
How existing contract frameworks fall short
The PPA model sends weak and blunt signals for the operator to provide the highest value to both the system and consumers.
The charging energy structure, whether supplied by the discom or procured from the market, is a cost pass-through from the perspective of the pumped storage project operator, limiting the role of market signals in guiding efficient despatch. Similarly, the operator’s incentive to discharge during the most valuable moments is delinked from market price signals. Further, the penalty regime for unavailability leaves the unit operator indifferent to unavailability during the 10 per cent of hours when it matters most and the 10 per cent of hours when it is least critical.
The set-up relies on the discom, potentially on the instruction of the load despatch centre (LDC) to schedule the resource efficiently. Yet, in the absence of retail competition, the discom does not have strong incentives to drive operational efficiency. And the LDC’s mandate centres on system security and operational reliability, rather than optimisation against real-time price signals.
An example of inefficiency, consider the 10 per cent period of the year when market price spreads are at their greatest and are attainable within the capabilities of the storage unit, the peak energy market price reaches Rs 10 per kWh and the lowest feasible cost of charging is Rs 2 per kWh. Assuming a resource efficiency of 75 per cent and, for simplicity, zero other variable costs, the effective cost per discharged kWh is Rs 2/0.75 = Rs 2.67, and the spread is Rs 10 – Rs 2.67 = Rs 7.33. This represents the additional value that the energy offers to the market during this window.
Now, if the storage operator is not available during these peak moments but is available during the remaining 90 per cent of the time, the availability penalty does not kick in and thus does not provide an incentive to “hit” these moments. While the operator also forgoes the pass-through of its costs, it does not incur those costs either, leaving it net neutral on this front. The only loss is the pre-agreed margin payment on each unit of energy. This is typically small, say Re 1 per kWh, and insignificant compared to the efficient benchmark a merchant storage unit faces, losing Rs 7.33 on each kWh missed during this window. This highlights the inefficiencies of the PPA model:
It diverts activity away from the market and deprives it of liquidity.
Signals for operation are delinked from market prices and may struggle to guide the use of the resource in ways that maximise value to the overall energy system. For instance, the PPA may not provide system-aligned incentives to ensure availability in 90 per cent of the highest-value target hours needed to beat annual availability thresholds, or during the highest-value hours within a day.
This can inflate the overall system cost borne by the consumer and mean that reliability is not achieved at the lowest cost.
Greater sophistication in PPA design – for instance, more tightly defined availability windows, or allowing the unit to sell to the market above its availability requirements – can address some of these issues. Nevertheless, the potential for improvement will be limited by the disconnect from real-time price signals to guide operation inherent in the PPA contracting approach.
How FSCs can help
Long-term bilateral FSCs are not widely used for hydro pumped storage projects in India. We have therefore outlined here the contours of an FSC (specifically a call option) that could set India on a strong path for the future. Our formulation of this contract focuses on the storage unit’s energy arbitrage value stream, in part because India does not yet have competitive markets for capacity and ancillary services.
A call option could provide strong incentives for market participation and for efficient operation. It provides fixed regular (usually monthly) payments for the contract lifetime to the storage resource. In return, the resource is required to return to the contracting discom or big designated consumer the spreads it should earn from the market when operated efficiently and within the bounds of its operating capabilities.
This “clawback” mechanism motivates the operator to procure the charging energy at the cheapest moments and to discharge at the highest price moments. The value of this clawback will depend on market prices and the obligation would be triggered during periods that maximise the value of the stored energy. For instance, if price patterns and plant capabilities allow for a given daily discharge, the obligation will apply to the hours in which the average price difference between the cheapest and highest price hours is the highest, as long as they cover costs such as inefficiency losses in the charge-to-discharge cycle. Returning to the numerical example provided earlier, the clawback obligation would be set at Rs 7.33 per kWh during these windows, aligning with the efficiently formed incentive for merchant storage resources.
The call option directs energy charging and discharging into the market, supporting liquidity and guiding the operation of the storage unit to maximise system value.
If the storage unit can be more productively used to deliver other ancillary services, the operator is free to do so, comparing the rents from these alternative services with the opportunity cost of the clawback mechanism. The call option allocates more operational and market risk to the storage operator, which may be better positioned to manage it under competitive conditions. Bearing greater risk, these pumped project owners may ask for higher supplementary payments. Nevertheless, competition allows the storage operators who can manage this risk most effectively to flourish, ultimately allowing efficiency benefits to be passed on to consumers in the form of lower tariffs.
FSCs can support India’s storage vision
India’s storage ambition is bold. Delivering its potential at the lowest cost will require a combination of capital and the right market architecture. Physical PPAs have served an important role in getting projects financed. However, the incentives they provide are not fully aligned with market signals and can motivate inefficient scheduling that leaves valuable flexibility untapped. PPAs guarantee revenue for the investor but do not maximise value for consumers or the system.
Financially settled contracts offer a better path forward. In this article, we have put forward the call option and outlined its positive effects (the March 2026 CfD pilot launched by the Ministry of New and Renewable Energy is another possible design). By tying revenues to the value storage creates in the market, they give operators strong incentives to charge and discharge at moments that matter most for the power system. This supports liquidity in electricity markets, improves system efficiency and ensures that the enormous investment India is planning delivers the greatest possible value for consumers. By combining its ambitious storage targets with smart contract design, India can build the capacity it needs and ensure that those resources unlock the full flexibility of a renewables-powered grid.
(With inputs from Alejandro Hernandez, Raj Addepalli, Deborah Bynum and Ashwini Swain, Regulatory Assistance Project)