Inflation indexation of tariffs for future solar capacity could be an interim solution to ease the financial burden of an already distressed power distribution sector and to move away from coal-fired power, a recent joint briefing note by the Institute for Energy Economics and Financial Analysis (IEEFA) and the CEEW-Centre for Energy Finance (CEF) has said.
India has had zero indexation tariffs as a norm for many years.
Meanwhile, the Indian solar power tariffs hit a record low of Rs2.36 per unit in June 2020, with zero inflation indexation for 25 years, however the state-owned power distribution companies (Discoms) have not been able to take full advantage of new cheaper renewable energy due to two-part thermal contracts which commands a fixed capacity charge even if no power is drawn.
The note proposes that solar tariffs start at a very low Rs 2.00/kilo watt per hour (kWh) for the first year of the 25-year power purchase agreement (PPA), rising at an indexed rate of 2.2 per cent of annual inflation for 15 years and then at a flat rate of 0 per cent for the remaining life of the contract.
This will purportedly help the discoms who face twin challenges of a decline in electricity demand, exacerbated by the COVID-19 crisis, and expensive and under-utilised legacy thermal power contracts at a time when ambitious growth in new renewable energy capacity is being targeted.
“Our modelling shows that the discoms could save up to Rs21,880 crore (US$3bn) over the next five-year period under a partially indexed tariff structure, even with ongoing deflation of solar tariffs. This is compared with cash outflows resulting from incremental renewable capacity auctioned under a flat tariff regime,” CEEW-CEF Adviser Gagan Sidhu said.
The notes calculations are pegged on the assumption that flat solar tariffs would decline at just 2.5 percent year-on-year for the next five years, reaching Rs2.13/kWh by 2025/26.
According to the note it is an interim solution to ease the unsustainable near-term financial pressure on discoms. The pandemic has compounded the discoms’ long-standing structural and financial issues and lower renewable tariffs achieved through indexation would give them vital breathing room to implement more durable and lasting reforms.
From a developer perspective, the proposed indexed tariff structure still results in a post-tax equity internal rate of return that is comparable to a flat tariff environment.
Front-ending tariffs at a rate of Rs2.00/kWh would not only give the discoms a breathing space it would also provide them with an added incentive to increase purchasing of renewable energy instead of coal-fired power.
Though the note says the need for indexed over flat solar tariffs to displace coal would taper off by 2025/26 as flat solar tariffs will decline below Rs2.00/kWh levels.
“The already low utilisation rates of coal-fired plants would come under further downward pressure while uptake of incremental renewable capacity would accelerate,” says IEEFA Research Analyst Kashish Shah.
This will help India to grow renewable energy capacity from the current level of 89 gigawatts (GW) to achieve its target of 450GW by 2030. It should also unlock demand for an acceleration in new investment and jobs as India climb out of the COVID-19 recession.
“However, such an ambitious rollout of renewable energy will need to be managed carefully to ease pressure on the discoms, with renewable capacity priced to reflect the current competitive environment, buoyed by strong and growing global capital markets’ interest in Indian renewable infrastructure investments” says Shah.