Solar industry stakeholders are a worried lot nowadays.
The record low tariffs, which have fallen below Rs.5 per kilowatt hour (kWh) to Rs.4.34 per unit, are raising uncomfortable questions about profitability and business viability.
According to research firm Mercom Capital Group, many projects which were won at low tariffs are awaiting financial closure.
“Most” domestic banks are unwilling to fund them due to concerns over the internal rate of return, or IRR, Mercom says.
Developers are hoping that EPC (engineering, procurement and construction) and interest costs will continue to fall, ensuring commercial viability. But if prices do not fall as expected, then the bids may run into trouble.
Analysts who track the sector say intense competition has substantially lowered the project returns (IRRs), reducing the margin of safety.
“Strong competition has led to developers lowering target IRRs to meet their development commitments, but the margins remain sufficient to cover the limited risks,” says Kameswara Rao, partner at PricewaterhouseCoopers Pvt. Ltd (PwC).
But rating agency ICRA Ltd’s calculations show that if one considers the borrowing or the funding cost at around 11%, then the companies can find it difficult to generate double-digit returns (IRR).
“In ICRA’s estimates, the project IRR for a solar PV (photovoltaic) project, with tariff at Rs.5/kWh, project cost at Rs.5.5 crore/MW, cost of debt funding at 11.5% over a tenure of 12 years, and PLF at 19%, would remain below 10%, with the cumulative average debt service coverage ratio (DSCR) at 1.09 times,” ICRA said in a note. “With a longer debt maturity of 18 years, the average DSCR would however improve to an estimated 1.19 times. Nevertheless, for a 1% drop in PLF and for a Rs.0.5 crore/MW increase in capital cost (in each individual scenario), the project cash flows would be adversely affected, with the average DSCR declining by an estimated 0.08 time.”
PLF is utilization level or the plant load factor.
The developers and investors Mercom spoke to estimate an IRR of 13-15%. This is based on a lending rate of 10-12%. Rates abroad are lower. But if one considers hedging costs, the cost advantage will not be that high.
According to Kameswara Rao of PwC, recent bids are won by credible companies that have arrangements with lenders and investors. So, they do not face financing challenges.
Another industry observer agrees funding may not be a challenge. What will be a challenge, however, is costs and return ratios. According to this person, projects won below Rs.4.6 per unit will have “thin” margins and ensuring financial viability over two decades will be a major challenge.
Of course, none of these people are questioning the tariff trajectory. But a steep fall in a short period and a lack of clarity on costs and returns are making investors turn increasingly sceptical.