Understanding Recent Solar Tariffs in India You may have seen recent news articles of NTPC solar reverse auctions in India yielding Rs. 4.63/kWh by SunEdison in Nov 2015 (500 MW) breaking the Rs. 5 /kWh barrier in Andhra Pradesh. This was followed by a Rs. 4.63/kWh win by SB Energy (backed by Bharti and Softbank), a Rs. 4.34/kWh win by Fortum Finnsurya in an NTPC auction in Bhadla, Rajasthan in January 2016. A number of other players have won auctions at reasonably similar prices. If you dig through the details in news articles, you find that the PPA was for 25 years, and the counterparty was NTPC (essentially backed by the Government of India), a credit-worthy off taker. SunEdison MD, Pashupathy Gopalan, also commented:"... that the cost of capital for the project could be half a percentage point lower because NTPC will be evacuating power from the plant. ... With the government providing land and assured evacuation of power, the project is different from past solar tenders in India in many ways, and SunEdison is confident of making healthy returns..." Is there a way to make sense of these bids? Actually, there is indeed a relatively simple way to understand the bids, and key cost drivers and potential levels, via a levelized cost of energy (LCOE) calculation introduced in a companion article. The levelized cost of energy at its simplest is a ratio, with costs in the numerator (capital costs or capex + operations cost or opex) divided by the expected amount of energy produced (in kWh) in the denominator. This gives units of Rs-per-kWh and values such as 4.63 mentioned above. A wrinkle is that future values of both costs and energy produced respectively are "discounted" by a factor 1/(1+i)^k where i is the interest rate (or weighted average cost of capital), and k is the year number.

This formula requires us to obtain 5 numbers to plug in: two cost numbers (Capex, Opex), a energy yield number, and a cost of capital (i.e. interest rate i), and a term (or PPA duration) N. Lets get each of these numbers! CAPEX: India happens to have one of the lowest installed capital costs for solar PV in the world. The Central Electricity Regulatory Commission (CERC) estimates that this is about USD 0.76 / Wp in 2016, but we can assume that in 2015 the number was about USD 0.80/Wp in late 2015 for utility-scale bidders. Assuming an exchange rate of Rs. 65/USD, this translates to Rs. 52/Wp of CAPEX (including land cost). The CERC estimate also shows another interesting fact that solar PV module (i.e. panel) cost is about 62% of capex; and this component has been dropping in price by 10% per year, largely spurred by manufacturing learning curves and drop in polysilicon prices. OPEX: Solar PV systems are relatively easy to maintain with low-cost labor. They need to be cleaned periodically (~once a week) to avoid a >5% drop in performance (or worse if left uncleaned for longer). Some companies are even testing robotic cleaning to do it more often (it consumes some power, but costs less on the long run since wage inflation is avoided). Vegetation nearby needs to be managed to reduce the dust blown up; and shadowing on modules. Power electronics may need to be replaced in 10 or 25 years depending upon warranty terms. A small inventory of modules may need to be kept for replacing low performance or failed modules. CERC also introduced a deviation settlement mechanism (DSM) where there are penalties for misprediction of output beyond 15% of production. Based upon industry information, the cumulative OPEX costs is expected to be bounded by 2% of Capex per year. {note, as Capex plummets, and DSM risks increase, this ratio may tend to go upwards} Energy Yield: Many parts of India are blessed with very good sunshine, especially states like Rajasthan, Andhra Pradesh, Gujarat, Telangana, Madhya Pradesh, Maharastra, Tamil Nadu and Karnataka. The Ministry of New and Renewable Energy (MNRE) has a nice map showing the average "global horizontal irradiance" (GHI) solar resource in kWh/m^2/day for different parts of India. The number ranges from 5.5-6 kWh/m^2/day in good solar sites. As explained in the Solar Economics 101 article, this results in roughly 5.5-6 kWh/day/kWp of energy yield, i.e. 2007 - 2190 kWh/year/kWp, i.e. annual energy production per 1 kW-peak of installed capacity. I am assuming the lower end, i.e. 5.5 kWh/day/kWp at the module level, and discount this to 5 kWh/day/kWp at the system level (or 1825 kWh/year/kWp) accounting for balancing losses, average effects of dust, wiring and inverter inefficiencies (implying a system plant load factor (or capacity factor) of 20.8%). Assuming a well-maintained system, solar PV production tends to decline (or depreciate) 0.5% per year (this is also reflected in linear production warranties offered by all tier-1 PV manufacturers). We have to scale down production accordingly Interest Rate (Weighted Average Cost of Capital): Solar PV plant projects are financed by 70% debt, and 30% equity. I am assuming that the after-tax cost of debt (assuming a 30% tax rate) is at a rate about 10% for a 25 year term. This implies a nominal debt rate of about 14%. Now usually in India, the cost of equity (or demanded equity internal-rate-of-return (IRR)) is between 15-20%. Since the sun rises every day (and the yearly irradiance averages are relatively stable; and solar PV equipment is relatively long lived), I am assuming the lower end or 15% Cost of equity at a market beta of 1. At 70% of post-tax debt capital at rate of 10% , and 30% equity capital at rate of 15%, this yields a weighted average cost of capital of 11.5%. Lets round this off to get a weighted average cost of capital (WACC) i = 12%.

Term (or PPA Life) N: This is easy: N= 25 years, as per the NTPC contract that we got from the news article. If you have a shorter term loan or shorter term PPA (eg: 10 or 15 years), it is important to adjust this number lower, and estimate some kind of residual value (i.e. what you will earn upon renewal after 10-15 years). If we plug these numbers into a simple spreadsheet, and chug, and ask what LCOE numbers we get for N (term) = 10, 20, 25, 30 years, we get the values of Rs. 5.16 / kWh (10 years), Rs. 4.1 (20 years), Rs. 3.94 (25 years), Rs. 3.86 (30 years). Remember that this is levelized COST, not PPA price. I have not factored in any accelerated depreciation benefits etc in this calculation. Lets pick the 25-year number, i.e. Rs. 3.94/kWh levelized cost; and PPA price of Rs. 4.63 / kWh, this yields an pre-tax margin of 17.5% (i.e. Rs. 0.69/kWh). Not bad (and maybe explains the healthy margin mentioned above). Again, I would like to emphasize that the numbers are based upon assumptions above. What happens if the assumptions change? This can be explored via a sensitivity analysis. Lets now look at the sensitivities of our financial calculation. Sensitivity to PPA Term (N): First we see that if the PPA term, N, is lower, say 10 years, the LCOE is Rs. 5.16 /kWh (not assuming any residual value). Its also interesting that the drop in LCOE continues to Rs. 4.1 for 20 years, but tapers off to Rs. 3.86 / kWh for 30 years (i.e. only 24 paise/kWh reduction going from 20 years to 30 years). In other words, 20-25 year terms are "good enough" to get decent LCOE, for a given cost of capital. Sensitivity to interest rate / WACC (i): What if we halve the interest rate (or weighted average cost of capital) to a wildly unrealistic 6% ? The LCOE numbers come out as Rs. 4.31/kWh (10 years), Rs. 3.03/kWh (20 years), Rs. 2.80/kWh (25 years), Rs. 2.65/kWh (30 years). Note that all numbers are down, but the 25 and 30 year numbers are down more both in absolute and percentage terms! This is the power of compounding with a smaller rate. Interestingly note that the 10 year number is down (from Rs. 5.16 to 4.31), but not as much as the 25 year number (from Rs. 3.94 to Rs. 2.80). If we assume WACC (i) of 8% (similar to US and developed markets) the LCOE numbers turn out as Rs. 4.59/kWh (10 years), Rs. 3.37/kWh (20 years), Rs. 3.17/kWh (25 years), Rs. 3.05/kWh (30 years). In summary, interest rates (or weighted cost of capital) matters, especially for longer PPA terms to reduce the "headline" solar tariff. What if you have a higher cost of equity and debt ? Lets say 20% cost of equity and 12% after-tax cost of debt (or 17% nominal interest rate of debt) at a 30 - 70 equity to debt ratio. The weighted average cost of capital (WACC) is now ~14.5%. The LCOE numbers turn out as Rs. 5.53/kWh (10 years), Rs. 4.56/kWh (20 years), Rs. 4.43/kWh (25 years), Rs. 4.38/kWh (30 years). What this implies is that a higher cost player will not be competitive, since they can barely afford the 4.63/kWh bids. Sensitivity to Capital Costs (CAPEX): If we raise installed Capex to $1/Wp (from 0.8/Wp), i.e. 25% higher CAPEX, we see that LCOE numbers zoom upwards linearly by 25% to Rs. 6.45/kWh (10 years), Rs. 5.12/kWh (20 years), Rs. 4.93/kWh (25 years), Rs. 4.83/kWh (30 years). This should not be surprising in retrospect, because LCOE is linearly related to costs, and Capex dominates total costs (and opex is a fixed %-capex per year).

Another way to look at this data is that since 2010, what has likely happened is a fall in capex, combined with superior access to capital (i.e. lower interest rate i, and longer tenors, N). These factors together have a multiplicative effect and impact on LCOE, and therefore on discovered reverse auction prices. Sensitivity to Energy Yield (E): This has a 1/E effect on LCOE. If we improve energy yield by 50%, without impact on Capex, LCOE will drop by 33%. Usually any method of improving E will also increase costs. As long as the net effect is better energy yield, for lower increase in costs, this will lead to lower LCOE. Our work at IBM Research - India on photonic harvesting takes this approach using commodity optics, controlled by IOT and analytics to deliver proportionally higher energy yield. This is complementary to cost (and LCOE) reduction in other factors above. In summary, we can see the rough assumptions that underpin the Rs. 4.63 and Rs. 4.34 bids made by solar developers recently in India.We see that what REALLY matters is India's world-beating installed cost of solar (i.e. capex, and low opex). Interest rates and cost of capital matter, but the term / tenure of loans matter a lot (it is crucial to get loans for 25 years, and decent interest rates then are helpful). The sensitivity analysis shows that the significant impact of interest rates (cost of capital) is primarily for the longer term PPAs (25-30 years) - a direct effect of compounding lower costs over a longer time frame. We can also see that reduction in capital costs arguably had a bigger impact in LCOE reductions since there is a linear impact. Energy yield has a reciprocal impact (i.e. 1/E) on LCOE. Going forward, we can expect a moderation in the rate of decline of capex (as supply chain efficiencies, production efficiencies and polysilicon prices moderate their declines). Reduction in interest rates (and WACC) in India could have a small impact (less than the hue-and-cry on financial TV channels will lead you to believe). There is a greater opportunity for energy yield improvements to come to the fore as an additional driver of LCOE declines. All parties deserve credit for this remarkable state of affairs: Firstly government policies have given huge impetus to the sector: aggressive targets (the 100 GW target), transparent reverse auctions, credit-worthy off takers (like NTPC) and regular payments as per PPA, macro-economic stability that reduces country risk premiums and implied equity risk premium, giving priority sector status for RE, making land available in solar-rich regions, and setting up evacuation of power (including subsidizing interstate transmission). State governments also are drawing up exciting plans both in utility-scale, open access policy (i.e. corporate PPA offtakers), and for rooftop solar. Second, the solar developers, EPC companies and solar PV & power electronics vendors for remarkable cost reductions in installed CAPEX that allows aggressive LCOE reductions. Third, the financial community for making longer tenor (larger N) loans available, and 70-30 Debt/Equity project financing at reasonable interest rates (i). International investors coming from Japan (eg: Softbank) and Europe (Fortum) where there are negative short term interest rates by their central banks are playing a key role. Exchange rate risks will be an important factor for this so-called carry trade (which is unlikely to be hedged for 20-25 year time frame). Borrowing in the wrong currency was the cause of earlier emerging market financial crisis when currencies dived: so this is a risk to be actively watched and managed (again macro stability, and lower current account deficits matter, especially to service long term

debt denominated in yen or euros). Companies like SunEdison are bringing in new models like YieldCos; and sovereign financiers like Abu Dhabi Investment Authority (ADIA) and investment banks like Goldman Sachs are directly investing in companies like Renew Power. In summary, solar energy is well on its way to be the lowest cost of energy production in India. The flood gates will open once it decisively crosses over with coal power. There are other interesting effects that happen as solar penetration increases: balancing costs and diurnal costs rise. But it is a good problem to have. More on that in future articles.