Large developers in the renewable energy sector have enough options to boost returns and will compete in auctions scheduled for this year, according to a new report by the Institute for Energy Economics and Financial Analysis (IEEFA).
The renewable energy capacity in India has jumped almost tenfold over the last decade, from 12 GW in 2010 to around 110 GW in March 2022. But the question is whether India will be able to continue its renewables growth trajectory as witnessed in the past, given fresh challenges in the sector.
The IEEFA report states the turmoil in global supply chains caused by the Covid-19 pandemic and the Russia-Ukraine war have pushed up components costs. Renewable energy developers also face higher financing costs as surging inflation has forced central banks to tighten monetary policy, pushing up interest rates.
Hiowever, these challenges will probably not have a lasting impact on India’s renewable energy story.
“We believe India will be able to continue its renewable energy capacity addition trajectory because current supply chain challenges will ease in the short-to-medium term, and the industry has enough cushion to absorb these downside risks,” said IEEFA Energy Finance Analyst Shantanu Srivastava.
The report states the rise in solar module prices is an aberration. IEEFA expects long-term average prices to revert to sub-$0.20 (before duties and taxes) levels from the current level of $0.28.
“Central and state nodal agencies should proceed with their pipeline of renewable energy auctions, given that interest from the large companies in the sector should continue, even in these unprecedented times,” said Ankur Saboo, an infrastructure finance specialist.
The report highlights various options before large renewable energy companies to enhance their return on equity and cushion against downward risks. According to Srivastava and Saboo, large renewable energy developers can lean on bond markets to refinance project debt at lower rates and take advantage of a non-amortization period on debt repayments.
Margins on in-house engineering, procurement, and construction (EPC) also increase returns. Selling stakes in operational projects to strategic investors such as global oil and gas majors and financial investors like infrastructure investment trusts (InvITs) is another avenue for developers to increase returns. Finally, selling carbon credits to developed economies is increasingly considered a viable source of additional income for developers, further enhancing their returns.
The report shows how these measures can help a solar power project and a hybrid wind-solar power project to enhance their equity returns. It finds that refinancing at a 100 basis point lower rate of interest can help add 2% to a hybrid wind-solar power project’s equity internal rate of return (IRR).
In addition, bond market refinancing can help add another 2% to the equity IRR, in-house EPC can add up to 6%, and selling operational assets can add 4%. Revenues from carbon credit trading can add 3% to equity IRR, taking the total upside potential to 17%, over and above the baseline returns.
According to Srivastava, as attractive as the equity IRRs look, it is essential to note that sensitivity towards interest rates and raw material prices is extremely high and the margins of error minuscule. In worst-case scenarios, developers with a tight grip on capital and financing costs will be better prepared to weather any storm, he added.
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