Cerc Renewable Energy Tariff Regulations - 2009-09-25

Ambit Capital Pvt Ltd. Ambit Capital Pvt Ltd. SECTOR UPDATE

Power Sector CERC's Renewable Energy Tariff Regulations to boost sector In line with the objective to attract new investments in the power sector, and specifically, to promote renewable energy, the CERC, which regulates inter-state power sector, announced new tariff regulations for grid-connected renewable energy power projects. These regulations assure developers of a higher return on the equity invested and indirect incentives if the developer can contain capital and operational costs. In India, only 8.7% of the total grid-connected power capacity is attributable to the renewable energy segment. Thus at an installed base of 13,242MW, this segment constitutes merely 21% of the potential 62,853MW from only small hydro and wind power. The potential of solar, biomass and waste-based power projects is estimated to be a further 625,500MW, of which solar-based projects alone contribute 600,000MW. Thus, the solar segment alone has the potential to fuel India's entire present electricity requirement. We believe that the overriding philosophy of these new regulations is to promote power generation from renewable energy sources by giving a preferential/ differential tariff to such projects. This, we believe, will go a long way to help achieve the target of 15% of total generation from renewable energy sources by 2020, a target set under the National Action Plan on Climate Change.

What the new CERC regulations entail 1. The new CERC regulations for renewable energy tariffs includes biomass, non-fossil fuel-based cogeneration, small hydropower projects (up to 25MW), solar power projects (photovoltaic thermal, and hybrid), and any other technology as approved by the Ministry of Renewable Energy (MNRE). 2. They allow a higher return on equity (RoE) for renewable energy power projects than that allowed for fossil fuel (coal and gas) -based power projects. They ensure that developers earn 19% pre-tax RoE for the first ten years, and 24% pre-tax RoE in the remaining period while specifying that the returns would be adjusted for capital subsidies and accelerated depreciation benefits, if any, availed by the developer. 3. The regulations have also specified the capital cost and the normative operational costs that would be considered for tariff determination. 4. Thus, the regulations enable a developer to know, upfront, the tariff that they can earn. Hence, a developer who manages to implement a project in less than the specified capital cost and / or operate the power project at lower costs would earn an even higher return.

Analyst Mehul Mukati Tel.: +91-22-3043 3211 [email protected]

5. While the useful life of renewable energy projects has been specified to range from 20 years for biomass projects to 35 years for small hydroprojects (up to 25MW), the tariff would be spread over a different period ranging from 13 years for wind projects to 35 years for small hydroprojects.

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Ambit Capital Pvt Ltd. Exhibit 1: Useful life and tariff period RE Source Wind Biomass, non-fossil fuel cogeneration Small hydro <5MW Small hydro >5MW Solar PV / Thermal

Useful Life 25 years 20 years 35 years 25 years

Tariff Period 13 years 13 years 35 years 13 years 25 years

Source: CERC, Ambit Capital research

6. A provision allows the CERC to determine tariffs on a case-by-case basis for renewable energy sources such as solar power and other emerging technologies. 7. The various normative parameters would be reviewed by the regulator each year, and the regulation itself would be reviewed every three years. The present regulations are applicable until FY13.

Our view These regulations, along with the state regulators mandating minimum electricity purchases from renewable energy sources, are expected to lead to higher growth in the renewable energy segment. We expect Thermax, Praj Industries, Moser Baer and Suzlon to benefit on account of higher order inflows from developers intending to set up renewable energy power projects.

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Ambit Capital Pvt Ltd. Annexure: Key highlights of the CERC renewable energy tariff regulations The CERC renewable energy tariff regulations include the following types of renewable energy sources: Exhibit 2: Eligible renewable energy sources Type Biomass

Highlights

l

Waste produced during agricultural and forestry operations (straws, stalks etc.) Produced as a by-product of agricultural processing operations (husks, shells, de-oiled cakes) Wood produced in dedicated energy productions

Hybrid Solar Thermal

l l l

Wood waste produced in some industrial operations Which uses other forms of energy inputs along with solar thermal; and Wherein at least 75% of electricity is generated from solar power components

Non-fossil fuel based generation

l l

The process in which more than one form of energy (e.g. steam and electricity) are coproduced in a sequential manner by use of biomass Subject to cogeneration eligibility criteria as per Regulation 4(4)

Small Hydro

l

Hydropower plants with station capacity up to 25MW

Solar PV power

l

Solar photovoltaic power projects that use sunlight for direct conversion into electricity via photo voltaic technology

Solar thermal power

l

That which uses sunlight for direct conversion into electricity through Concentrated Solar Power technology based on either line focus or point focus principle

Renewable Energy Power Plants

l

Power plants other than conventional power plants generating grid quality electricity from renewable energy sources Renewable energy sources include: small hydro, wind, solar (including integration with combined cycle), biomass, biofuel cogeneration, urban/municipal waste and other sources as approved by MNRE

l l

l

Source: CERC, Ambit Capital research

Useful life The tariff regulations specify the useful life of each of the different types of renewable energy. The definition states that useful life begins from the date of commercial operations (CoD). The useful life for different forms of energy is given below: l

Wind

25 years

l

Biomass, non-fossil fuel cogeneration

20 years

l

Small hydro

35 years

l

Solar PV/thermal

25 years

Eligibility criteria (Regulation 4) Renewable energy projects that seek to be eligible for tariffs under these regulations require to conform to the criteria as stated below:

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Ambit Capital Pvt Ltd. Exhibit 3: Eligibility criteria for being covered under these regulations RE source

Key criteria

Other criteria

Wind

l Should be located at wind sites with minimum

Small hydro

l Should be located at sites approved by the state

AWD to be measured at hub height of 50 meters using new wind turbine-generators Project to be set up using new plant and machinery

Biomass Non-fossil fuel -based co-generation

Solar PV/ Thermal

annual wind density (AWD) of 200W/m2

nodal agency/state government Should have station capacity of up to 25MW l Should use Rankine Cycle technology by the Fossil fuel use up to max. of 15% of annual fuel consumption is permitted l Should be in accordance with the definition l Sum of useful power output and ½ of useful thermal output >45% of facility's energy consumption during season

Project to be set up using new plant and machinery Project to be set up using new plant and machinery Topping cycle mode of co-generation: facility which uses non-fossil fuel input for power generation and utilises thermal energy generated for useful heat applications in industrial activities simultaneously

l Should be based on techonologies approved by

MNRE

Source: CERC, Ambit Capital research

The control period is the period for which these regulations are applicable. The regulations have defined a control period of three years, the first year being the present fiscal i.e. FY10. Tariff period is defined as the period for which the tariff set under these regulations would be applicable. The tariff period for different renewable energy sources has been defined thus: 1.

Small hydro < 5MW

35 years

2.

Solar PV / thermal

25 years

3.

All others

13 years

Project specific tariff The CERC would determine tariffs on a case-by-case basis for the following types of projects: 1.

Renewable energy projects commissioned before the notification of these guidelines and for which no PPA has been signed

2.

Municipal solid waste

3.

Hybrid solar thermal projects

4.

Solar PV/thermal projects, if the developer so opts for

5.

Biomass projects not using Rankine Cycle technology

6.

Any other new renewable energy source/technology approved by MNRE

The CERC will determine generic tariffs at least six months prior to the beginning of each year of the control period.

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Ambit Capital Pvt Ltd. The regulations both outline and detail the tariff structure for renewable energy projects. The regulations prescribe a single part tariff with the fixed cost consisting of the following components: 1.

Return on equity

2.

Interest on loan capital

3.

Depreciation

4.

Interest on working capital

5.

Operation & maintenance (O&M) expenses

The regulations also specify that renewable technologies which partially use nonrenewable energy sources as fuel, would in addition to the above fixed costs, have a fuel cost component. These regulations have also specified the tariff design. The regulations state that the regulator (CERC) would determine the generic tariff on a levelised basis for the tariff period for all projects. In addition, for projects that also have a fuel cost component, the fuel cost would be determined on an annual basis. The discount rate to be used for determining the levelised tariff is WACC (weighted average cost of capital) for the project. The regulations clearly state that the costs are to be levelised over the useful life of the projects, though the tariff so determined would be applicable only for the tariff period. This is important, as can be seen from the table below: Exhibit 4: Useful life and tariff period RE Source Wind Biomass, non-fossil fuel cogeneration Small hydro <5MW Small hydro >5MW Solar PV / Thermal

Useful Life 25 years 20 years 35 years 25 years

Tariff Period 13 years 13 years 35 years 13 years 25 years

Source: CERC, Ambit Capital research

The regulations also clearly state that renewable energy projects (as per these regulations) would not be subject to merit order despatch, and are to be treated as 'must run' power plants. The only two exceptions to this are: (1) biomass projects more than 10MW, and (2) non-fossil fuel-based co-generation projects. The IEGC (Indian Electricity Grid Code) would be applicable to these projects, as also the CERC Unscheduled Interchange (UI) regulations.

The regulator has set the following definitions to determine tariffs Capital cost: for a renewable energy project would include all capital work, including: (1) plant and machinery, (2) civil work, (3) erection and commissioning, (4) financing, including interest during construction, and (5) evacuation infrastructure up to inter-connection point.

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Ambit Capital Pvt Ltd. Debt-equity ratio (DER): would be considered at 70:30 for generic determined tariff. In case of project specific tariffs, the equity component cannot exceed 30% of the total capital for tariff purposes. Thus, as with all other non-renewable power projects, DER would be considered at 70:30, if equity component is greater than or equal to 30% of the total capital. If the equity component is below 30% of the total capital, then the actual DER would be considered for tariff determination. The regulations specify that any equity invested in foreign currency is to be converted on the date of each investment. Loan and interest on long-term loan: The regulations have specified the loan tenure and the benchmark interest rate to be used for tariff determination. The loan tenure would be assumed to be ten years, and the interest rate would have to be the average long-term PLR of SBI in the previous year plus 150bps. In addition, the regulations state that no moratorium is to be considered, and that repayment would be considered from the first year itself. However, the amount of interest on the loan cannot exceed the amount of annual depreciation. Depreciation: The regulations specify that depreciation can be claimed only on the capital cost allowed by the CERC, and that 10% of the value base (i.e. capital cost allowed by CERC) would be assumed to be the salvage value. Thus, depreciation would be allowed on only 90% of the value base of the project. Further, the regulations state that a 'Differential Depreciation Approach' would be used with a depreciation rate of 7% p.a. for the period of the loan tenure (i.e. the first ten years) and the balance would be the depreciation up to the end of the useful life on a straight line basis. The regulations specify that in the first year of operation, only prorate depreciation can be claimed. Return on equity: The regulations allow for a pre-tax return on equity at 19% p.a. for the first ten years, and at 24% p.a. for the remaining useful life of the renewable energy project. Working capital loan: The regulations allow for the working capital on the following basis Exhibit 5: Normative working capital norms WC component

Wind / small hydro / solar PV / solar thermal

Biomass / non-fossil fuel cogeneration

O&M expenses Receivables Maintenance spares Fuel

1 month 2 months 15% of O&M expenses NA

1 month 2 months 15% of O&M expenses 4 months at normative PLF

Source: CERC, Ambit Capital research

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Ambit Capital Pvt Ltd. O&M expenses: are to be considered on a normative basis as specified by the CERC. An escalation of 5.72% p.a. over the tariff period would be allowed. Rebate: The CERC through these regulations allows for a 2% rebate, in case payment is made through a letter of credit and a 1% rebate, if payment is made through any other mode within one month of bill presentation. Late payment surcharge: The CERC regulations similarly allow the developer to charge late payment charges of 1.25%/ month if the delay is beyond 60 days from the date of the bill. Sharing of CDM benefits: The CERC is aware that project developers avail CDM benefits,, and hence has specified a clear benefit sharing mechanism as follows: Exhibit 6: Structure for sharing CDM benefits Year / period

Developer's share

Beneficiaries' share

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 onwards

100% 90% 80% 70% 60% 50%

Nil 10% 20% 30% 40% 50%

Source: CERC, Ambit Capital research

Subsidy/incentive: The CERC is also aware of the other income tax benefits available to renewable energy project developers. Hence, for tariff determination, the CERC will take into account all the subsidies and/or incentives, including accelerated depreciation benefits. The CERC has outlined in these regulations the following principles to be considered for ascertaining the income-tax benefit on account of accelerated depreciation: (a) to be based on normative capital cost, and (b) capitalisation in H2 of the fiscal year The per unit benefit of the subsidy/incentive is to be derived on a levelised basis using WACC as the discount factor.

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Ambit Capital Pvt Ltd. Exhibit 7: Summary of Normative parameters for tariff determination

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Note: $ indexation to be allowed as per formula; * escalation of 5.72% p.a. allowed; # for generic regulator determined tariff. For solar PV/thermal projects, the developer has the option of requesting the regulator for specific tariffs, which would be determined on a case-by-case basis Source: CERC, Ambit Capital research

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Ambit Capital Pvt Ltd.

Explanation of Investment Rating Investment Rating

Expected return (over 12-Month period from date of initial rating )

Buy

>15%

Hold

5% to 15%

Sell

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Ambit Capital Pvt Ltd.

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