Solar power is emerging as a key renewable source of power in India as the government is pushing through policies to support its development, given its focus on preventing climate change by encouraging green power, and, at the same time, diversifying its energy mix. The Gujarat State Solar Policy and the Centre’s Jawaharlal Nehru National Solar Mission (JNNSM) are at the forefront of solar power development in India. In 2011-12, India’s solar power capacities increased to nearly 940 MW from 20 MW in 2010-11. Besides favourable government policies, particularly Gujarat’s solar policy, a sharp decline in capital costs over 2011 drove this rapid expansion.

Capacity additions

Power distribution companies are mandated by their respective State Electricity Regulatory Commissions (SERCs) to procure at least 0.25 per cent of their power requirements from solar power as part of their solar renewable purchase obligations (RPO). As solar power is nearly four times as expensive as conventional coal-based power, the power producers are compensated at higher cost-reflective tariffs. Both JNNSM and Gujarat State Solar Policy encourage capacity additions and investments by facilitating long-term offtake agreements for solar power between project developers and distribution companies (discoms) at cost-reflective preferential tariffs.

Globally, solar module (which accounts for nearly half of the capital costs in PV (photovoltaic) projects) prices crashed due to massive capacity additions by China. Moreover, demand in key European markets — Germany, Spain and Italy — also dried up, precipitating the decline in module prices. Global solar photovoltaic (PV) module capacity was estimated at 50 GW at the end of 2011, while demand stood at 25-30 GW. As a result, capital costs fell by 30 per cent over 2010 level, to Rs.10 crore per MW by end-2011.

Due to the continued over-capacity in global markets, we expect capital costs to decline to Rs.8.7-9 crore per MW in 2012, falling only by 12 per cent compared to the previous year. The pace of decline in module prices will slow down in 2012 as module suppliers in the U.S. and Europe are staring at eroding profitability, and even bankruptcy in some cases. Further, the weak rupee will limit decline in capital costs, as most of the equipment has to be imported.

Expecting a steeper decline in the capital costs, many solar power producers have bid aggressively in JNNSM batch 2 (350 MW bid out in December 2011), resulting in a decline of nearly 25 per cent (at Rs.8.8 per unit) in the average tariffs bid, compared to JNNSM batch 1 (150 MW bid out in December 2010). However, based on our expectations of capital costs, a levelised tariff of Rs.9 per unit is necessary for healthy returns. But nearly half the bids in batch 2 of JNNSM are below Rs.9 per unit and about a fourth bids are below Rs.8.5 per unit, making these investments highly risky.

The viability of these projects hinges on the developer’s ability to reduce borrowing costs. However, access to lower cost foreign funds is often linked to foreign equipment supplies through developmental financial institutions. But, players opting for crystalline PV technology in JNNSM batch 2 will find it difficult to tap these funds as they are required to procure crystalline PV equipment domestically.

In order to access low-cost foreign funds, the thin-film technology, on which the restrictive domestic procurement clause is not applicable, needs to be used.

In comparison, the tariff of Rs.10.37 per unit offered under Gujarat’s solar policy provides more attractive returns for project developers. There is also a strong upside to these returns as players can obtain cheap foreign debt as there is no domestic content clause under Gujarat’s solar policy. Going forward, the momentum of future capacity addition hinges critically on the extent of decline in capital costs, and aggressiveness in bidding for these projects.

The author is Director, Crisil Research, a division of Crisil