India’s Prime Minister Narendra Modi reaffirmed India’s ambitious renewable energy goal at the United Nations Climate Action Summit in New York in September: India is committed to increase its renewable power capacity, primarily via solar and wind, to 175 gigawatts by 2022, with a further rise to 450 gigawatts at an unspecified date. These commitments represent a significant increase from the 83 gigawatts currently installed, and the 35.5 gigawatts installed in March 2014.1
India is a high-growth country with mounting energy needs, yet has had difficulty maintaining a stable coal supply for electricity generation. To pursue its goals, the Indian government has been implementing purchase obligations for renewable energy, while reducing the payment risk the generators face from the weaker credits of state-owned distribution companies. Key measures include recapitalizing state-owned distribution companies, and bringing government-owned utilities with stronger financials into the renewable market. They buy power from generators and sell it to state-owned distribution companies through back-to-back power purchase agreements or PPAs.
Renewable energy brings significant economic advantages to India in addition to environmental benefits. With the fast decline of solar panel and wind turbine prices, renewable energy now costs about a third less than coal-fired power,2 which has traditionally been the cheapest source of power generation in India.
In line with other power projects in India, debt capital typically represents 70%–75% of renewable projects’ capital structure. Yet, as onshore liquidity remains tight, renewable energy companies have increasingly relied on international bond markets to refinance bank loans for projects that have achieved satisfactory operational track records. Indian renewable energy companies have issued $2.7 billion in green bonds so far this year, bringing the total value of outstanding dollar-denominated Indian renewable energy bonds to $5.2 billion.3
These securities are typically structured as project bonds, supported by a group of solar and wind projects with combined capacity ranging from 500-1,000 megawatts and placed into a ring-fenced restricted group. There are several enhancements that we think make renewable energy bonds a good investment opportunity for credit investors to consider:
- Credit profiles are anchored by long-term fixed-price PPAs (typically 25 years) with state-owned distribution companies, central government-backed off-takers or private companies. This potentially leads to predictable revenue streams and debt-servicing over the long term.
- Senior secured lenders may benefit from security interests over material assets and PPAs. Forward-looking covenants, reserving mechanisms, amortization schedules and other structural features mitigate liquidity risk and facilitate deleveraging.
- These projects are likely to benefit from supportive shareholders with deep pockets and commitments to good corporate governance and social practices. For example, a large sovereign wealth fund is the majority shareholder in a leading independent Indian renewable power producer.
Regulatory risks and other considerations
A significant portion of renewable energy PPAs are contracted with India’s state-owned electricity distribution companies, which are usually loss-making and have weak financial strength due to high aggregate technical and commercial (AT&C) losses4 and below-cost sales. These renewable power projects often receive late payments from off-takers and are exposed to receivables risk. In addition, there has been speculation that the state government of Andhra Pradesh wants to renegotiate renewable energy PPAs. To be sure, the central government has strongly urged the state government to stop renegotiating contracts for renewable power projects. Moreover, the legally binding nature of PPAs has been recognized by the Appellate Tribunal for Electricity and the Supreme Court of India in several previous cases. Nonetheless, this remains an event risk for the sector.
We should note that since 2017 wind energy projects have moved from a feed-in tariff structure to an auction-bidding structure – so both solar and wind energy projects are now almost entirely awarded through a competitive bidding process. Competitive pricing naturally gives companies that can access scale economics and low cost of capital a competitive advantage, pushing smaller players out of the market and leading to consolidation in the sector.
We believe there are pockets of value in the Indian renewable energy sector and that companies with leading market positions, high quality off-takers, supportive equity sponsors and tight bond structures make favorable investment candidates. As every Indian renewable energy credit has different off-takers, bond structures and leverage metrics, our bottom-up research allows us to analyze evolving factors by project, company, and sector to identify what we believe to be the best investment ideas for our clients. 1: Source: Ministry of New and Renewable Energy
2: Source: Central Electricity Authority of India; CRISIL Research; BloombergNEF 1H2019 LCOE Update
3: J.P. Morgan Asia Credit Index as of 30 Sep 2019
4: AT&C loss (aggregate technical and commercial losses) is a measure of overall efficiency of the distribution business.