India is facing a rapidly growing energy demand, which will likely double by 2030. In order to meet this demand, India has set one of the most ambitious renewable energy targets in the world—100 gigawatts (GW) of solar power by 2022 (pib.nic.in, December 15, 2015). This target is good for the Indian economy, the climate, and the 80 million households that currently lack access to electricity.
To put this target in perspective, the current leader in solar power capacity, China, had a total installed solar capacity of around 43.5 GW at the end of 2015 (bp.com, 2015 Review)). India’s renewable energy target of 175 GW by 2022, comprise 100 GW of solar capacity, 60 GW of wind power, 5 GW of small hydro and 10 GW of bio-energy.
The solar capacity target includes 60 GW of utility-scale solar power and 40 GW of rooftop solar power. By March-end 2016, India had installed a total capacity of 6.7 GW, with 6 GW of utility-scale projects and 0.7 GW of rooftop solar projects (mnre.gov.in).
While utility-scale solar power seems to be growing in line with the 60 GW target, rooftop solar power growth is still way behind the annual level required to meet the 40 GW target, and needs to accelerate quickly. In order for the rooftop solar industry to reach 40 GW from current levels, the industry must add around 6.5 GW of capacity annually, implying a compounded annual growth rate (CAGR) of 94 per cent, in current annual capacity.
However, there are three key barriers to the growth of rooftop solar power in India: high upfront costs of installation, low availability of debt finance, and perceived performance risk.
Barriers to growth in rooftop solar
The size of a typical rooftop solar installation for commercial and industrial customers is around 150-200 kW, costing more than INR 10 million. Commercial and industrial consumers are reluctant to invest such a high amount upfront, especially for a non-core business activity. In addition, banks are reluctant to lend to rooftop solar projects because there are high perceived risks and limited information on the performance and track records of rooftop solar investments. They prefer lending to large utility-scale projects; this has limited the availability of debt finance for the rooftop solar sector.
Finally, because rooftop solar power is a relatively new technology in India, many potential customers are concerned with performance risk, that is, a perception that the technology may not perform as expected over its lifetime. Additionally, since there are many new entrepreneurs in the rooftop solar market, with no or little track record, it has been difficult for consumers to trust them.
The potential of third party financing
In order to expand the rooftop solar industry in India, there is a need to develop policy solutions, innovative business models, and financial instruments which can address these barriers. One promising solution is a third party financing model.
Globally, the third party financing model for rooftop solar power has been a significant driver of growth in the rooftop solar industry. A new report by Climate Policy Initiative (CPI, 2016), examines the model’s potential in India, and specifically the driving factors, challenges, and solutions to manage those challenges.
Under a third party financing model, a rooftop solar developer, who is the third party, installs, owns, and operates a rooftop solar plant on a consumer’s property. The consumer agrees to purchase electricity from the developer at a specified price over a long-term contract, typically for 15 to 25 years. The success of the third party financing model hinges on the fact that developers are in a better position to manage the financing challenges and performance risk of rooftop solar power, and the model shifts these responsibilities from the consumer to the developer.
Currently in India, the third party financing model supports around 102 MW of rooftop solar installations (bridgetoindia.com, May 31, 2016). The industry believes that there is potential to increase the total installed capacity under the third party financing model to more than 20 GW by 2022, more than half of the 2022 rooftop solar power target with a similar amount of capacity coming through the CAPEX model.
Challenges to third party financing model
However, the third party financing model will need to overcome certain challenges. The most significant challenge to the third party financing model is low access to debt finance. Since the rooftop solar sector is new and transaction costs are high (due to the smaller size of projects), banks don’t yet feel comfortable lending to projects. Due to low access to debt finance, the third party financing model has been mostly driven by equity finance in India, which has limited potential for scale in the way it is currently used.
Consumer credit risk is the second biggest challenge to the third party financing model. This is caused by several factors, including low availability of credit assessment procedures, low enforceability of agreements, and lengthy and costly legal processes in the case of a dispute or payment default.
Policy changes and financial instruments could address these two challenges. Government entities, industry players, financing agencies and other stakeholders will need to work together to implement these recommendations.
First, to increase access to debt finance for rooftop solar power, the Ministry of New and Renewable Energy (MNRE) can work with development banks to provide a system of training to bankers in India on how to assess rooftop solar projects, how to process solar loans, and the dynamics of the rooftop solar industry and associated risks. Since the main reason for banks’ reluctance to lend to rooftop solar industry is that bank officials are not well-trained in assessing rooftop solar projects appropriately, this is an immediate step that could help increase access to debt finance.
Second, to reduce consumer credit risk, DISCOMs can be made a party to the power purchase agreements between the consumer and third party financer, with the responsibility of collecting monthly payments from the consumer. In case of default, DISCOMs can terminate power supply from the grid. As a last resort, 100 per cent power from the rooftop solar project could be purchased by DISCOMs at a predetermined rate. This would comfort banks as there would be a guaranteed purchaser.
There are also several key financial solutions that could help address these challenges.
The India Innovation Lab for Green Finance, a public-private initiative in India to identify and help develop green finance instruments, is currently assisting in the development of two instruments which have the potential to drive significant investment into third party financing for rooftop solar power.
Loans for Small & Medium Enterprises (Loans4SME), is a peer-to-peer lending platform that could help improve access to debt financing for the rooftop solar industry. It would create a marketplace to catalyse debt investments by connecting creditworthy businesses with debt investors. The platform will first assess each company via a credit scoring model to ensure that the companies only take on liabilities they can comfortably repay. Once the company lists its credit requirements on the platform, platform coordinators will work with both the borrowers and lenders to structure and close the transaction. With a 5 per cent market share of the rooftop solar sector, Loans4SME has the potential to finance the addition of 800 MW of rooftop solar capacity and provide 590 million USD in debt financing.
Rooftop solar sector private financing facility, could increase access to debt financing for the rooftop solar industry by structuring a large number of small projects together so that the aggregate deal size is large enough and of sufficient credit quality to attract more attention from investors, especially institutional investors. The facility would build a warehouse line of credit that would provide loans to creditworthy rooftop solar projects over a period not exceeding 24 months. In the next phase, it would refinance the warehouse line by issuing green asset-backed security (ABS) bonds. The facility could bring an additional 32.3 billion USD of capital to the rooftop solar sector, reduce the cost of debt by up to 3 per cent, initially adding 180 MW of capacity and then, around 500 MW by 2022.
These policy changes and financial instruments can together unleash the potential in India’s rooftop solar industry and put it back on track to achieve the government’s target of 40 GW of rooftop solar power by 2022.
Climate Policy Initiative, 2016. The Drivers and Challenges of Third Party Financing for Rooftop Solar Power in India. Retrieved from: http://climatepolicyinitiative.org/publication/third-party-financing-rooftop-solar-power-india.