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May 2012
The Ministry of New and Renewable Energy (MNRE) estimates total potential at 15,380 MW
amended grid code to ensure smoother offtake and transmission of RE power by utilities. Under the Central Financial Assistance (CFA) Scheme of the MNRE, capital subsidy is now provided to both private and State projects and for renovation & modernisation of SHP plants. Besides, technical support is being provided to SHP units through Alternate Hydro Energy Center (AHEC), IIT, Roorkee. Notwithstanding these inherent advantages and the regulatory support available, several constraints continue to impede growth of the SHP sector: The single biggest challenge is the construction risk, given that most SHP projects are located in remote, hilly/mountainous regions with severe infrastructural constraints. The locational hurdles also serve to prolong the gestation period and push up the per-MW capital costs even as the power evacuation and transmission facilities at the sites remain inadequate. Further, the preferential tariff being offered to developers in some states are not attractive enough for developers. Timely adjustment of power tariffs by regulators to ensure that the tariffs fully cover the capital costs likely to be incurred by developers would remain critical for the viability of SHP plants. The lack of consistency in SHP tariff norms across states hinders investments in the sector with several states having tariffs which do not ensure adequate returns on investments. Besides, Renewable Purchase Obligations (RPO) regulations also vary across states. While the Renewable Energy Certificate framework should now enable the obligated entities (such as distribution utilities and open access customers) to meet the national level RPO as recommended by NAPCC, it is still in the initial stages of implementation. Hence, the extent to which the SERCs make efforts to align their respective RPO norms with the NAPCC recommendation and strictly monitor and impose penalty for shortfalls in RPO would have a critical bearing on the implementation of the Renewable Energy Certificate framework. While the Renewable Energy Certificates are being traded on the power exchanges for market-based price discovery (with the ceiling and floor levels as set by CERC), the overall risk profile for SHP projects adopting the REC framework remains high, given the absence of a strong enforcement and penalty mechanism for ensuring RPOs by several SERCs as of now. Post-commissioning the biggest risk that SHPs face is hydrological risks, that is, the risk of availability of adequate water flow for generating power. This is so because the revenues of SHPs are linked to the actual units generated and sold. Hydrological risks arise mainly because of three factors: faulty estimates, environmental changes, and diversion of water upstream. ICRA also notes that while SHP projects could potentially benefit from Certified Emission Reduction (CER) units, uncertainties still remain over the approval and registration of such projects, given the clause of additionality in the Clean Development Mechanism (CDM)2. Moreover, there are uncertainties over the pricing of the CERs post-2012 as well, since the commitment period of the Kyoto Protocol ends in 2012. BACKGROUND Hydropower represents use of water resources towards generation of pollution free and inflation free energy due to absence of fuel costs. Apart from the clean and cost economic nature of power, the other key advantage includes an inherent ability for instantaneous starting, stopping and load variations which helps in improving reliability of power system. Hydro power projects are generally categorized in two segments i.e. small and large hydro. Small hydro3 refers to hydro electric projects with capacity generation less than 25 MW, which are typically canal based or run of the river type, while large hydro refers to projects of greater than 25 MW and are located on rivers and can be either of run of the river type or associated with large dams. A planned development of hydropower projects in India started only in the post independent era, with the first 50 years after independence seeing a hydro capacity addition of 21,644 MW, most of them being large hydro. Since the development was mainly in the Central sector and the State Electricity Boards (SEBs) were more or less tuned to the central planning system, relatively less importance was given to small projects.
2
Project owners need to prove non-viability without the CDM benefits. Small hydro power projects are further classified as: Up to 100 kW 101 kW 2 MW 2 MW to 25 MW
3,500
3,000
350
Cogen, 8% Biomass, 5%
80 84
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Wind, 70%
Source: Ministry of Renewable Energy Total Renewable Energy (RE) capacity- 23130 Mw
As seen from Chart I, SHP capacity in the country has reported a cumulative annual growth rate (CAGR) of 10% over the period 2004-05 to 2011-12 to reach 3300 MW by January 2012. A capacity addition target of 1400 MW, about 133% higher than the previous plan target was set for the eleventh plan period (2007-12), of which 1325 MW has already been added. Further, as can be seen from Chart 2, small hydro installations comprise the second largest share of ~ 15 % (after wind energy which accounts for almost 70%) of the total renewable energy installed in the country. Although the actual addition has been more or less in line with the targets set, the pace of capacity expansion has increased only recently, with a sizable increase in capacity has been witnessed in last four financial years supported by favourable fiscal policies (such as accelerated depreciation benefit, tax holiday under section 80 IA soft loans by Indian Renewable Energy Development Authority, IREDA and nil/concessional customs/excise duty benefits), state level incentives (detailed later), financial support from MNRE4, improving tariffs and CDM revenues. Besides these incentives, inherent advantages like short
4
In order to accelerate development of small hydropower in the country, MNES is providing incentives like financial support for Detailed Project Report preparation & survey & investigation activities (to the Government Department & Agencies);For renovation, modernization and capacity up-rating of old SHP stations (to the Government sector); for development/up-gradation of water-mills; capital subsidy and interest subsidy for commercial projects.
Karnataka 856 Himachal Pradesh 441 Maharashtra 280 Andhra Pradesh 193 Punjab 155 Kerala 142 Uttarakhand 147 J&K 131 NE states 281 others 572 Total 3,198 Source: Ministry of Renewable Energy
Himachal Pradesh, 15 %
Uttarakhan d, 12%
Chattisgarh , 8%
Execution and evacuation challenges are relatively high for SHP plants; with procedural delays, inadequate evacuation and access infrastructure and lack of good quality data being the major barriers in development of SHP potential.... The execution and evacuation challenges faced by SHP projects are much higher than other renewable energy sources for a variety of reasons. Firstly, water being a state subject, the SHP projects are governed by state policies and the potential sites are allotted by the State Governments to private developers. The projects involve time consuming process for allotment of sites by states and statutory clearances including land acquisition, forest clearance, irrigation clearance etc in the absence of any provision for a single window clearance. In addition, the projects have relatively longer gestation period in completing the projects (vis-a-vis other RE sources like wind, biomass, solar or cogen) due to difficult terrain and limited
Biomass 4.5-5.5 50-80 Wind 5.5-6.5 15-30 Small Hydro 6.0-10 30-60 Solar PV 10.0-12.0 20 Cogeneration 4.5-5.0 4.0* * assuming purchased bagasse Source: Ministry of Renewable Energy, ICRA estimates
Capital costs for new SHP plants typically tend to be between Rs. 8-10 crores for plants in Himalayan and North Eastern region and between Rs. 6-8 crores/MW for other regions. The levelised energy cost for SHPs tend to be in the Rs 3.5-4.5/unit which is comparable with wind (and also coal based power plants not having captive mines) but lower than biomass and solar projects. This arises out of the fact that PLFs tend to be higher for SHP- between 30-40% in Southern India and between 40-60% in the Himalayan and NE regions- as compared to wind or solar. While biomass plants tend to have better PLFs this is offset by the fact that such plants have relatively higher fuel & O&M costs and higher auxiliary consumption which makes biomass power much more expensive. Apart from cost competitiveness, the other major advantage of SHPs is flexibility with respect to scheduling. Firstly, SHPs typically have an inherent ability for instantaneous starting, stopping and load variations (solar and wind have similar flexibility but not so with biomass and cogen). Secondly, SHPs usually have a limited pondage capacity thus in off seasons when they are generating less than full capacity water can be stored during off-peak hours and utilised during peak hours thus making them suitable as peaking capacities (in peak season they usually run as base loads). Further, for SHPs their maximum power production is in the summer and monsoon months, and a significant part of the generation season coincides with peak seasonal demand in India. Thus subject to adequate hydrology, SHP plants can be operated as peak load stations and are well-suited for merchant operations. CERCs tariff regulations for SHP plants are a key positive from the regulatory perspective;
Limited work can be carried out in the monsoon season which is usually at least 4 months and also in winter season in the upper reaches of Himalayas
Capital costs Levellised Tariff (Rs./Unit) 7.70 7.00 6.00 5.50 4.14 3.54 4.88 4.16
Below 5 MW 5 MW to 25 MW Below 5 MW 5 MW to 25 MW
Some of the key tariff norms are presented in the following bullet list: Generic tariff estimation based on effective Capacity Utilisation Factor (CUFs) across various states in India and normative capital and operating cost parameters; option open for projectspecific tariff for new RE technologies. Single part levellised tariffs, that is, uniform across the tariff period. Fairly remunerative 21% pre-tax return on equity (20% for the first 10 years and 24% thereafter), over the useful life of 35 years Depreciation per annum shall be based on Differential Depreciation Approach' over loan period beyond loan tenure over useful life computed on Straight Line Method. The depreciation rate for the first 12 years of the Tariff Period shall be 5.83% per annum and the remaining depreciation shall be spread over the remaining useful life of the project from 13th year onwards. The value base for the purpose of depreciation shall be the Capital Cost of the asset admitted by the Commission. The Salvage value of the asset shall be considered as 10% and depreciation shall be allowed up to maximum of 90% of the Capital Cost of the asset. Availment of tax benefit under the Accelerated Depreciation (AD) route is suitably factored in so as to keep the overall pre-tax return on equity from the RE assets at an average of 21%. Upside potential from CDM benefits be retained by the generator to some extent; this could add to project returns.
However adequate hydrology (thus maintaining normative CUF) and ability to limit capital costs at normative levels remain key viability factors... While these norms are a positive from the regulatory perspective, SHP projects remain exposed to many risks. First, the actual pre-tax project IRR that such projects would earn will remain contingent on the key variables (such as CUF, capital cost, funding pattern and cost of funding) conforming to the CERCs assumptions. Any negative deviationsfor instance, the actual CUF being lower than the one assumed in the CERC guidelines or the capital cost being higher than the normative costare likely to have an adverse effect on returns, given the single-part nature of tariffs. In case of small hydro projects, CUF is an important parameter and is a measure of the estimated energy likely to be generated as a percentage of maximum energy that could have been generated with full capacity utilization of the installed capacity of the project. The CUF for a hydel project would depend to a large extent on parameters such as the prevailing hydrology in the river basin and rainfall (or snowall) in the catchment area. Thus, project developers are exposed to the risk (referred to as hydrology risks) that if in a particular year water availability falls below normative levels, which is not unusual, the developers revenues will fall short of what is required for earning the stipulated returns given that revenues are linked to actual generation. In ICRAs experience, hydrological risk is the single largest risk that a SHP faces post commissioning and a number of SHPs rated by it have seen underperformance with respect to design energy 6. This underperformance typically arises from two reasons. Firstly, because of inaccurate estimates about design energy in the first place7. Secondly, because of natural factors such as adverse weather patterns affecting rainfall (and/or) snowfall or environmental degradation resulting in either reduced waterflows or flooding or excessive siltation which affects plant performance. Finally, in some cases diversion of water upstream for irrigation or other uses.
6
Design energy is the energy which is expected to be generated in 90% of the years of the projects operational life. 7 Estimation of design energy is usually based on hydrological data provided by bodies such as WAPCOS, CWC and State Irrigation Deptts.
Other states
The adjoining chart illustrates the adverse impact on IRRs in the scenario of less-than-normative CUFs. At the same time, the single part tariff structure could result in an SHP developer earning much higher returns if actual generation is in excess (which should be deemed as an incentive for higher generation/productivity). Chart 4: IRR sensitivity to CUF levels (<5MW) MW)
Pre tax IRR sensitivity to CUF levels- for (less than 5MW SHPs)
27.0%
27.0%
25.0% 23.0%
21.0%
Pre-tax IRR
Pre-tax IRR
25.0% 23.0%
21.0% 19.0% 17.0% 15.0%
13.0%
11.0% 9.0% 7.0% 40% CUF (N-5%) 45% CUF 50% CUF (N+5%) (Normative) Project IRR Equity IRR
13.0%
11.0% 9.0% 7.0% 40% PLF (N-5%) 45% PLF (Normative) Project IRR Equity IRR 50% PLF (N+5%)
Source: ICRA estimates Another risk, in ICRAs view is the ability of the project developer to contain the capital costs within normative levels. This risk is more pronounced in case of SHPs located in north and north eastern states given the mountainous terrain, comparatively higher cost of transportation and long interconnecting transmission lines from project site to the interconnecting sub-station. Considering this, CERC has fixed the normative cost of Rs 6-6.7 crore/MW for HP, Uttaranchal and NE states, while setting the normative cost of Rs 4.8-5.2 crore/MW for other states. Unlike other RE technologies, a hydel power project does not incur variable costs (typically corresponding to usage of fuels bagasse, biomass, etc.). The fixed costs such as depreciation, RoE and interest are derivatives of the capital cost. Even O&M costs can be determined as a percentage of the capital cost. The charts below depict the IRR sensitivity (based on CERC norms) to plant capital costs:
Another issue with SHPs with respect to debt servicing arises out of the fact that while generation and hence cashflows are highly seasonal, debt repayment is usually spread over the entire year relatively evenly which results in possibility of seasonal mismatches.
Pre-tax IRR
10.0%
9.0% 8.0%
Normative
N*1.10
Equity IRR
Source: ICRA estimates Recent amendments to grid code augur well for SHP plants In the matter of grid integration, the recent amendments in Grid Code are a positive for SHP plants with less than 10 MW capacity. As per the amendments, renewable energy power plants including SHP plants with installed capacity of less than 10 MW (excluding higher capacity SHP plants and non-fossil fuel based cogeneration plants) will be treated as MUST RUN power plants and will not be subjected to merit order dispatch principles. Also, the allowed variation of up to (+/-) 30% of the schedule and the burden of applicable Unscheduled Interchange (UI) charges to be shared among system users on an all-India basis and not on project developers and permission to fine-tune schedules (based on the forecast) as close as three hours before the actual generation should facilitate further integration of SHP projects. Present tariff regulations across states are inconsistent....further tariffs in some of the key states are inadequate... Table 4: SHP Tariff Rates for FY 2012-13- Key States
States Himachal Pradesh Dec-07 6.5 projects comm before Mar 07Rs 5.5 cr; projects comm during FY08 & FY09- Rs 6 cr; projects comm after April 096.3-7.0 45% 14% 2.94 Date of latest SHP order by SERC Normative capital cost Normative PLF ROE % SERC tariff (Rs/unit) Royalty for <5MW- upto 12 yrs-nil; next 18yrs-12%;balance life-18%
45%
Pre-tax, 19% p.a. for 1st 10 yrs; Pretax 24% p.a 11th yr onwards
4.75 > 1 MW and upto and including 5 MW: Rs 5.52 crore/MW; >5 MW to 25 MW: Rs 5.02 crore/ mw 5.2
30%
16%
30% 30%
Pre-tax, 19% p.a. for 1st 10 yrs; Pretax 24% p.a 11th yr onwards 14%
Source: SERC's tariff orders and ICRA Research Note: #: this is for FY 2012-13 While the CERC has put in place tariff norms for SHP plants, State Electricity Regulatory Commissions (SERCs) have been deciding tariff in their respective States. Power being a concurrent subject, 23 State Governments have so far announced policies for private sector participation for the development of SHP projects and setting of tariffs. The SHP tariffs set by the SERCs, being single part, vary widely across States, as Table 4 shows. The divergence is attributable mainly to the varying normative assumptions made for the key parameters, like capital costs, capacity utilisation factor (CUF), O&M expenses, water royalty charges and grid connectivity. 8
down for 2011-12 by SERCs vary between 1% and 11% (Refer to Chart 3 a& chart 4 in ICRAs note on wind energy published in January 2012 for greater details) as against the 7% recommended by NAPCC. The remaining 13 states are yet to issue RPO targets.
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