A New Renewable Energy Tariff Structure to Ease Pressure on Indian Discoms

An interim solution to buy time for discoms to make durable, long-term reforms

June 2020 saw Solar Energy Corporation of India’s (SECI) auction deliver yet another record low solar power tariff in the Indian market with Rs 2.36/kWh with zero indexation for 25 years.

SECI awarded 2 gigawatts (GW) of solar capacity development to developers including Enel (Italy), Amp Energy (Canada), Eden Renewables (France), IB Vogt (Germany), Ayana Renewables (backed by CDC Group of UK) and ReNew Power (India) with the lowest tariff bid range of Rs 2.36-2.38/kWh (~US$31/MWh) with zero indexation for inflation for 25 years.

Nominal versus real tariffs

While zero indexation has been the norm for SECI’s utility-scale solar and wind auctions – roughly 25GW to date –the exception was the May 2020 auction of 400 megawatts (MW) of round-the-clock (RTC) renewable power supply.

The auction, won by ReNew Power with a semi-firmed wholesale tariff of Rs 2.90/kWh (US$39/MWh), was a first-of-its-kind for India. It provided an annual escalation of 3% on the quoted tariff up to year 15 of the 25-year power purchase agreement (PPA). From year 15 to year 25 (the last 11 years of the PPA) the tariff is Rs 4.39/kWh (US$59/MWh) as there is no indexation after year 15.

Coal versus renewables

The winner of the long-term race between RE (with Rs 4/kWh) is well established. Unfortunately, the state-owned power distribution companies (discoms) have not been able to take full advantage of the low cost of RE owing to a combination of the decline in electricity demand and their legacy thermal power contracts with a two-part tariff structure.

For a thermal tariff of >Rs 4/kWh, discoms pay a fixed capacity charge of ~Rs 2/kWh for the contracted capacity in the PPA – even if no power is drawn from the plant. The remaining >Rs 2/kWh is the variable charge (landed fuel cost + production costs) which is paid for every unit of power drawn from the plant. Also, the variable charge increases with inflation in landed fuel costs and currency (for plants reliant on imported coal).

Until we see a sustained return of strong electricity demand growth in 2021, discoms saddled with under-utilised two-part thermal capacity will only have an incentive to shift away from coal when RE tariffs achieve parity with the variable charge for coal. For that to happen, RE tariffs need to fall a further 15% beyond even the recently recorded lows of Rs 2.36/kWh, to achieve levels of ~Rs 2/kWh.

The curious case of Indian discoms

Against this backdrop, discoms face a growing number of structural and financial challenges compounded by COVID-19, as highlighted in IEEFA’s August 2020 report The Curious Case of India’s Discoms. Chief among them are high aggregate technical and commercial (AT&C) losses, expensive thermal PPAs and a cross-subsidy burden due to a varying tariff structure amongst the different categories of discom customers, combined with the provision of below-cost electricity to the rural population.

As a result, discoms’ overdues to power producers jumped 65% from Rs 76,701 crore (US$10.5bn) outstanding in June 2019 to Rs126,655 crore (US$17.2bn) as of September 2020. Any structural reforms that could have lasting impact require time – a luxury that discoms can ill afford in the current COVID-19 crisis. We recommend an interim solution that will immediately ease near-term financial pressure on discoms, buying them time to implement the kind of lasting solutions mentioned in the above mentioned report.

As against the prevailing system of flat RE tariffs, IEEFA and the Council on Energy, Environment and Water – Centre for Energy Finance (CEEW-CEF) recommend in their October 2020 report that a partially indexed tariff structure should be profitably explored for future renewable capacity PPAs. Specifically, a lower first year tariff of Rs2/kWh, rising at a pre-determined index rate (below the inflation rate) for the first 15 years, and then remaining flat at the year 15 rate for the 10- year balance of PPA life.

Let us consider the example of India’s latest record low solar tariff of Rs 2.36/kWh (US$32/MWh) with zero indexation. Under our proposed tariff structure, the tariff for the first year is Rs 2.00/kWh (US$27/MWh), allowing annual escalation of 2.20% until year 15 and 0% escalation after year 15. This partially indexed tariff structure will offer developers the same post-tax equity return as a flat tariff structure.

Any indexed tariff structure will have to appeal to developers, who are by now fairly accustomed to operating in a fixed tariff environment in India. The broader financing ecosystem will also have to be flexible to accommodate project debt terms that are reflective of upward sloping revenue profiles that accompany indexation.

The success of the auction for 400MW of RTC renewable power supply suggests that developers may be willing to accept such a tariff structure. The following table compares key metrics between the flat and indexed tariff structure.