The conundrum of solar power costs: Change the face of long-term PPAs

Solar power promises to be a source of unlimited and cheap power. Global focus is shifting to renewable power of which solar is expected to play a significant role. India has emerged as a leader in adopting and implementing renewable power.

Given the lower cost coupled with increasing efficiency of solar equipment,  solar tariffs in India which were in double digits in early part of last decade came down to low as Rs. 2.36 in 2020. Though, we still have miles to walk on cost of solar equipment, efficiency of technology including cost of storing.

The reasons for the fall in tariffs are largely on account of economies of scale of manufacturing coupled with improving technology. The following table shows the trajectory of solar module prices vs the global solar module manufacturing capacity.

The efficiency of an average module which was on lower side of 300 watts in 2010 is pushing the boundary today at 600 watts. Falling cost of capital is also helping further. The 10 year sovereign bond yield has dropped to less than 6% from 8.5-9% a decade back, thereby bringing down the cost of borrowing for a greenfield project.

These developments point to a continued falling cost of solar power. We have seen solar power drop below Re1 in Portugal in August this year for a 15 year PPA. But is this music to the ears to Indian off takers and customers who are locking themselves for 25 year PPAs in a downward sloping tariff trajectory?

Caught between increasing Renewable Power Obligations and falling tariffs, state power distribution companies (discoms) are shy of entering into long term PPAs. But a project developer on the other hand needs to raise equity and debt which can be done only with mitigation of output risk which comes with a long term PPA.

As a country we now need to evaluate our contractual models and explore options at a policy level to find alternate to a long term PPA.

The Indian power market is getting active with the Real Time Market opening up in power exchanges. While this is positive, a lender would not commit long term debt based on a revenue model of a nascent power market. The market needs to mature and have a track record to show past trajectory of demand and supply and enable forecast of future prices. Till then, there does not seem to be an alternate to a committed offtake model. However there can be options that can be explored within this structure.

One option could be the long term PPA is at a de-escalating tariff. The bidding can be at a base tariff x which de-escalates at say 3-5% a year. This would mean that the starting tariff as a headline number being bid may be higher but the levelised cost of tariff would be lower. While the starting tariff may be a bit higher it will improve long term sustainability of the PPA in a downward sloping cost of power. Indian lenders would also like it given they lend for 10-15 years.

The PPA can also be structured in a way which permits part of the committed capacity to be installed and sold in the open market. 

A base committed volume on long term PPA provides comfort to lenders while the market saleability reduces mutual obligation to buy and sell on producer and off taker. This will also bring more power to exchanges and deepen the market. This option can be strengthened by a contract of difference with the off taker underwriting to meet shortfall in revenue coupled with clawback of excess revenue on market power sales. This would bring PPA tariff down in case market is offering higher and vice versa. A 70/30-PPA/Non PPA mix will only impact the off-taker by 9p/unit in case the market price varies by 30p up or down over a PPA tariff of say Rs 2.50.

Another option would be to change the bidding criteria. Instead of bidding on lowest tariff the option can be to bid for the lowest project cost to be recovered at a target project IRR. Operating costs are very low at 5-10% of the overall cost. A cap can be imposed on operating cost recovery as part of bid criteria to avoid gaming. Upon meeting target project IRR, the obligation on off taker to purchase power drops off. The developer is freed from the obligation to supply power and can sell power to the market. An interesting twist would be to have a twin bid criterion with appropriate weightage spread between lowest project cost and a stipulated range of lower target project IRR. This will theoretically result in a lowest cost of power based on project cost and target project IRR which will drop off once the latter is met. This should occur much before a 25-year PPA period.

While this would entail annual computation of the recovered IRR, this should be a fairly easy arithmetical calculation. Going ahead this will bring to the market projects with recovered capital and thus can supply power to the market at extremely low cost given that only operating costs are to be recovered. This would be a disrupter to the power market.

Given the thrust on solar power by the Union government, and the fast-changing technology and cost of solar power, it is imperative that alternate contract structures be explored that balance the long-term risks of the developers with the off takers.

(Sidharath Kapur is ex-CEO of a solar developer and an expert on infrastructure and PPPs)