Where is the money in solar?

Indian policymakers have created a grand plan for solar power in the country, and the rubber is about to hit the road. In the first phase of the Jawaharlal Nehru National Solar Mission (NSM), about 650 MW will be distributed to the 40 most aggressive bidders from over 350 aspirants. Of this, 150 MW is solar photovoltaic (PV), which will go to the winning 30 participants from 300+ aspirants. Bids are due on November 16.

The Central Electricity Regulatory Commission (CERC) has set a price of Rs 17.91 per unit of PV power. In the NSM process, bidders have to indicate how much of a discount off this price would they be willing to accept for their projects. Those who are willing to take the biggest discounts will win.

The word on the street is that the bidding is going to be aggressive. With some bone-chilling numbers being bandied around informally in solar circles, the solar gold rush many had anticipated is fading fast like a desert mirage. Many cross-sectoral hopefuls, with little prior exposure to anything remotely connected to energy generation, had jumped onto the solar bandwagon, convinced that solar offered disproportionately high and stable 30-year returns. Now that they are faced with the reality of tariff bidding, most are wondering, where is the money in solar?

Let’s take a quick look at what drives PV economics. Since solar is considerably more expensive than conventional power, it requires a subsidy to drive demand and capacity. Once a subsidy mechanism is established (as it is with the NSM), allocations are awarded to developers, who in turn contract with manufacturers and EPC contractors to build the solar power plants. Once built, these plants need to be operated and maintained for 25-30 years. The economics of solar projects is driven by some select parameters: how good is solar radiation, how much does the power plant cost, what is the efficiency of the power plant, what is the cost of the financing and, of course, what is the tariff that supports all of these costs and leaves enough for a decent return?

Now let’s turn our attention to the varying objectives of the companies in the fray. Some companies very clearly want to be one of the five largest solar players in India over the long haul and have the financial capital to get there. Others are looking to build a decent-sized business that they could sell as consolidation becomes inevitable in a maturing industry. Still others can be designated as developers (akin to real estate developers); their objective is to build and sell repeatedly, so that their own capital is not locked in these projects for an extended period. These players typically absorb the initial construction and performance risk, and once the projects are built and relatively de-risked, they sell them to insurance companies or pension funds as long-term stable investments. Then there are those manufacturers who have put substantial capital into expansion of manufacturing capacity, which they want to secure by procuring generation capacity. It’s much easier to place your product in projects you own than to compete with others in a buyer-led marketplace. And lastly, there are the opportunists and speculators who are looking to make a quick buck by flipping their projects to the more serious guys at the earliest opportunity.

This is where game theory really starts to kick in. In addition to pulling all the levers under one’s control, one has to face the unpleasant question: How irrational should I expect others to be, and in order to counter them, how irrational can I myself afford to be? In other words, how much of a compromise am I willing to accept in order to be a winning bidder? The playing field here, unfortunately, is not level. The willingness and ability of some to compromise far exceeds the willingness and ability of others. What seems inevitable, however, is that the winning bids will not leave room for decent returns.

So who are the likely winners?

No matter who wins in the bidding, the technology that is likely to do quite well is thin film PV. This is because thin film costs less than crystalline and cost, as we know, is going to be a critical factor. Financially justifying crystalline PV will be near-impossible, unless suppliers are willing to take it on the chin in order to build some presence in the programme.

Integrated players such as those who are in manufacturing and generation are better positioned to go deeper on the discounts. After all, they can choose to make their returns from the sale of PV modules or from energy generation.

Recently capitalised solar companies are likely to be aggressive bidders. They need to show traction to their investors, and it’s hard to show traction if you fail to get an “allocation” or a chunk of MWs allotted to you by the government.

Lastly, the bulge bracket Indian conglomerate with a large and/or growing power generation business will be there in the winners’ circle. For this type of player, absorbing a loss on a leader project is relatively easy, but not having a seat at the solar table will appear costly.

And who will lose?

There will be two types of losers. Those who, in spite of best efforts and scaled-back return expectations, are not able to get to the irrational (from their perspective) levels required to win. This includes professional foreign companies that have built solar projects elsewhere in the world, and that we hope would bring their experience and skills to India, but are unlikely to win because their knowledge of costs and hurdle rates will put them out of the race. And there are those who, without fully doing their homework and in a moment of impulsive boldness, actually do submit a winning tariff. For the latter group, pursuit of the solar mission is likely to turn out to be a rather costly endeavour.

Our policymakers should also keep in mind that introducing competition into a nascent programme is a risky strategy. While some safeguards have been built into the system to discourage “adventurous” bids (it is telescopically more expensive to bid a higher discount), this has only put irrational bidding beyond the reach of some, rather than eliminate it entirely. If the entire PV capacity in this round is awarded to bidders who are ready to sacrifice returns in order to acquire an allocation, does this create a strong enough foundation on which gigawatts of capacity can be built? We know that the early gold rush was created by the expectation of substantial profits. If there is no money in solar, will private sector capital still flow as freely?
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