Modi Powers Forward

Over the past several months, Prime Minister Narendra Modi’s government has made large strides towards the goal of increasing renewable energy penetration in India. Growing dependence on expensive imports of coal, natural gas, and oil has sparked a desire to diversify India’s energy supply portfolio and thereby enhance energy security, reliability, and affordability. As climate and energy issues have gained mindshare over the past few years, most of the globe is now rooting for India’s success in this effort, and also waiting with bated breath to see signs of progress. The choices that India makes today in regards to its energy sector will shape the global energy supply and demand balance for many decades to come.

In February 2015, as part of the Union Budget, India set an ambitious goal to add 175 GW renewable energy capacity by 2022, including 100 GW from solar (including 60 GW utility-scale and 40 GW rooftop), 60 GW from wind, 10 GW from biomass, and 5 GW from small hydro. More recently, ahead of December’s climate change summit in Paris, India submitted a plan to the UN’s climate office which takes the previous targets a step further. India is now aiming to produce 40% of its installed electricity capacity by 2030 from non-fossil fuels, outstripping China’s 20% target and the United States’ 30% target, and necessitating an installed renewable capacity base of approximately 350 GW. Notably, however, the government has not committed to any reductions in carbon emissions, reiterating its stance that poverty alleviation is paramount and it does not want to risk hampering economic growth. As a result, India’s state-owned coal company, Coal India, which accounts for 80% of total Indian coal production, plans to double output over the next five years. The government acquiesced, however, to a reduction in carbon intensity of approximately 35% over 2005 levels by 2030.

In the wake of the February announcement of the national targets, the prime minister’s well publicized and visible efforts to spur the sector have been fruitful in attracting the attention of capital providers, governments, and industry participants. At the time the targets were announced in February, 200 companies made proposals at the RE-Invest 2015 summit to install 266 GW of new renewable energy capacity, far exceeding the ambitious 175 GW target (though not all of these proposals have been backed by actual financial commitments). Other examples of this newfound momentum include a joint venture by SoftBank, Bharti Enterprises and Taiwan’s Foxconn Technology to develop alternative energy plants across India, and SunEdison’s plans to commit $15 billion to renewable energy in India over the next seven years. In addition, Prime Minister Modi continues to garner international support for India’s renewable energy industry through his active international diplomacy. Several energy-related memorandums of understanding (MOUs) have been signed with countries including China, France, and Mongolia, which aim to catalyze the sharing of technical expertise and knowledge and thereby jumpstart the growth of India’s renewable energy industry. During his recent trip to the United States, at a roundtable with energy industry business leaders, Modi reiterated his goal that India should become the clean energy capital of the world and solicited the expertise of American energy companies. Most recently, after discussions between Prime Minister Modi and Chancellor Merkel, Germany committed a package of $2.25 billion towards renewable energy (especially solar) development in India as part of a larger initiative to establish a “Climate and Renewable Alliance” between the two countries.

Together, Modi’s ambitious targets and international efforts may give India’s renewable energy industry a much-needed kick start. First of all, the ambitious targets have put India on the map when it comes to renewable energy and climate change policy. Especially in the wake of the recent submission to the UN climate office, it is expected that India will have more clout to play a leading role during negotiations in Paris. The international diplomacy and MOUs, additionally, will also help attract much-needed international talent and technical expertise to the sector. Transfer of technology, especially if unencumbered by local content requirements, will allow the Indian renewable energy sector to leapfrog the growing pains that sectors in other countries have had to face. Most importantly, the ambitious targets have sparked a flurry of interest and activity that should help drive down development risk and financing costs for new renewable energy projects, allowing them to compete more effectively with traditional fossil-fuel power generation.

However, many have raised questions about the attainability of India’s ambitious goals. For example, with less than 4 GW of installed solar capacity today (compared to 33 GW in China and 20 GW in the United States), India would be required to add almost 14 GW of new capacity per year to meet the solar target by 2022, which would require total investment to the tune of $120 billion. For comparison, India has been adding only ~1.0 – 1.5 GW of new solar generation capacity annually over the past couple of years. Growth in wind generation capacity, on the other hand, is looking even less promising, and has actually decelerated in recent years due to uncertainty in the tax and subsidy regime.

Systemic shortcomings in India’s energy ecosystem suggest that this rate of growth will be impossible to achieve, let alone sustain for several consecutive years. For one, implementation and enforcement of the targets (renewables purchase obligations) is incumbent upon individual states. However, states whose distribution companies have weak balance sheets will be conflicted in trying to enforce mandates they can’t realistically finance. Enforcement was also undermined by the fact that India’s targets were notoriously bereft of interim goalposts until the Ministry of New and Renewable Energy released a year-by-year breakdown of solar capacity targets by state in August. Furthermore, lagging investment in transmission and distribution infrastructure will bottleneck renewable capacity additions and weaken reliability of the already fragile electricity supply as intermittent renewables are integrated. For every dollar that is invested in generation capacity in India, only 40 cents is invested in transmission and grid infrastructure, resulting in insufficient takeaway capacity in several regions of the country. Long-awaited transmission projects have been delayed and re-budgeted several times at multiples of the original estimated cost.

In addition to the systemic shortcomings, company and project specific issues will have to continue to be ironed out to accelerate development. For power producers, the counterparty risk from having financially distressed state-owned distribution companies as offtakers raises the overall risk profile of projects, which in turn raises the cost of financing. This risk is mitigated, however, for projects in which the counterparty is an entity owned by the central government, which is more credit-worthy than the state-owned entities. Furthermore, the absence of dollar-denominated power purchase agreements makes it challenging for international companies who are wary of taking foreign exchange risk. Companies that have dollar-denominated costs (especially dollar-denominated debt and interest payments) will face additional expense to hedge the currency risk, especially given the recent appreciation of the dollar. Land acquisition continues to be a critical gating issue as well. To streamline the land acquisition process, the government introduced the concept of “solar parks”, whereby it would set aside land for solar installations as well as build the required transmission infrastructure. However, the establishment of solar parks has been stymied by the government’s inability to identify and procure suitable tracts of land. Meanwhile, bills to reform the land acquisition process continue to be mired in political chicanery in India’s parliament.

The good news is that cost parity with fossil fuel power generation, especially for solar, is in sight despite all the aforementioned challenges. Tariffs for solar have dropped ~60% over the last four years, and have the potential to drop further as costs continue to drop. Cost parity is enhanced by India’s use of expensive imported coal, which has increased 19% annually for the past four years, and expensive imported natural gas (LNG). As India’s domestic coal production grows, reliance on imported coal will decrease, but will be replaced by a growing need for LNG imports as India’s domestic natural gas resources remain underutilized. A report by Deutsche Bank suggests that the introduction of solar in India has the potential to reduce coal demand by ~8% by 2020. Because imported coal is used to generate much of the marginal power supply in India, the integration of lower operating cost renewables such as wind and solar should reduce the overall price of power and drive savings of ~$17 billion per year.

Renewable energy projects are continuing to make headway from a commercial perspective as well. According to companies like Renew Power, returns on renewable energy projects have exceeded ~20%, with further room for improvement via reductions in cost of capital, reductions in the cost of components (e.g. solar modules), and efficiencies in balance-of-system costs / design. Further cost reductions are expected to be weighted towards solar energy, as opposed to wind, because of developers’ ability to source cheaper Chinese-made panels, while local content requirements for wind projects necessitate the use of blades that are made in India. Renew Power is forecasting go-forward cost reductions of 3-5% on an annual basis, which will help maintain healthy returns in a sector that is getting more crowded with the entrance of new competitors. Furthermore, additional opportunities will emerge in the solar energy sector as the nascent residential / rooftop market gains traction in India.

As a result, despite the myriad challenges and unrealistically aggressive national targets, the future of renewable energy in India seems to be bright. Good resource potential (especially solar irradiation), a favorable policy environment which is expected to improve further, and continued power demand growth driven by robust economic growth suggests that renewable energy resources like solar and wind are logical answers to India’s energy woes. Recent improvements in project economics foreshadow the arrival of cost parity, at which point demand for renewables should continue growing without government support. Meanwhile, as policy and implementation issues are worked out by the active and eager government and private sector stakeholders, momentum will continue to build to enable the achievement of India’s ambitious renewable energy goals.

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