A little bit of interest

GREENBACKS AND BANKS HAVE always gone hand in hand. But even though banks have invested close to $3 billion (Rs 13,560 crore) in India’s low-carbon economy last year—from renewable energy to more efficient transportation in large and mid-size companies—they are still apprehensive about investing in startups, be it in clean energy or any other sector.

Much of it is due to the sector's own, unique problems. For instance, the revenue stream is more complex in clean energy, as the intermittent power output from solar and wind power can have a direct impact on cash flows. Electricity produced by windmills, for instance, will depend, to a large extent, on the speed and direction of the wind.

Vivek Mehra, managing director, sustainability, SME and sustainable investment management, Yes Bank, explains: “Commercial banks are simply unwilling to gamble on technologies which aren’t fully developed, or companies that are not asset heavy or do not have a good track record. They move in once the project and technology become mainstream—acquire critical mass and become cost competitive compared to similar products. So the initial funding will have to come from venture capitalists, government agencies, and multilateral agencies like
the International Finance Corporation and the Asian Development Bank.’’

Take the renewable energy space, for instance. As a banker explains, the majority of the projects are of the 25 megawatt (MW) to 50 MW size. “Many of these entrepreneurs don’t have strong balance sheets or track records. And frankly, we would be more comfortable funding one, big, known player with a 500 MW project than 20 smaller ones. It will also require much more due diligence and loads of paperwork to fund the smaller guys,” says Mehra.

“Most investments have come in wind power projects and now solar power is taking off,’’ says Charanjit Singh, a research analyst with HSBC. He adds that solar technology is changing rapidly and may achieve retail grid (when cost of generation will equal commercial tariff) by 2015. Already over 2008-10, the cost of solar technology has declined by around 50%.

Indeed, some of the projects that Yes Bank has funded—a Rs 64 crore term loan to Jain Irrigation to develop a 13.2 MW wind farm, a Rs 34 crore term loan to Sriram EPC to create a 7.5 MW poultry waste-to-energy power plant—are to companies with an existing track record in other businesses. Given the small-ticket size of these projects, such doses of limited investments may not be enough.

According to an HSBC report titled Sizing India’s Climate Economy, published in January this year, the “low carbon goods and services market’’ (read energy-efficient devices and services and money saved from the use of renewable energy and nuclear energy) will need an investment of $135 billion in 2020. This includes budgetary support of $19 billion for nuclear electricity and $26 billion in transport efficiency (like the Delhi Metro Rail Corporation). It’s a huge leap from the $22 billion invested in green infrastructure between 2004 and 2010.

But even if you strip these out, and other renewable energy projects, India’s financial system will still need to find large sums to build green infrastructure. And with no set targets or deadlines by the governments, wary banks can continue to wait. What that means is a lot of the intent won’t translate into anything tangible unless the financial apparatus is ready to price and then carry the risks.

LAST YEAR, THE COUNTRY added 3.2 gigawatts or 3,200 MW in the renewable energy space. If the total cost of such installations was Rs 15,000 crore and the projects had a debt-equity ratio of 70:30 then at least Rs 10,500 crore must have come as debt from the banks. It shows that there is an adequate amount of bank finance available in India to support good quality, renewable energy projects, and clean-tech devices.

But the experience of lenders to India’s most publicised green energy project hasn’t been edifying either. In 2007, a consortium of 24 banks lent nearly €1.5 billion (Rs 9,654 crore) to fund Suzlon’s (a leading wind energy company) expansion abroad. Suzlon nearly went under and had to renegotiate its debt of Rs 12,000 crore, which included a two-year repayment moratorium. While there were a host of reasons behind Suzlon’s woes, from the high cost of acquisitions to the economic slowdown to cracks on blades, this episode exposed the inexperience of green entrepreneurs.

Little wonder that the 35 energy servicing companies (ESCOs) listed with the Bureau of Energy Efficiency (BEE), a government organisation dedicated to promoting energy-efficient devices and setting efficiency standards—mostly small companies—are likely to face difficulties in raising funds. These firms are the first level of intervention for industrial units to go green. They make the initial investment in energy-efficient devices or processes on behalf of companies. For example, Delhi-based Asian Electronics has already installed energy-saving load management system panels at the Indore Municipal Corporation, Ujjain Municipal Corporation, and a host of other municipal corporations. It has also installed electronic controls and occupancy sensors for the air conditioners at the prime minister’s office and government offices such as Shram Shakti Bhawan and Transport Bhawan in New Delhi. It recoups its investment by charging a percentage of the savings on power over a period of time.

But as Ajay Mathur, director general, BEE, concedes: “What happens if the promised savings on the electricity bill do not happen? If it is far lower than what was expected? Since the company that borrowed from the bank has no other source of income, it is in no position to return the loan.” That’s another risk banks are worried about.

In March 2010, though, BEE came out with a partial risk-guarantee fund facility called Energy Efficiency Financing Platform—a joint initiative of the BEE and HSBC. It’s a fund that promises to pay back 50% of the loan amount to the bank in case the borrower defaults, for a token guarantee fee. “The initial corpus of Rs 100 crore, to be increased over a period of time, will provide some degree of confidence to the lender because he knows that even in a worst-case scenario, 50% of his loan is secured,” says Mathur.

Such off-balance sheet comfort will perhaps encourage banks to fund ESCOs, which are basically small and mid-size companies. “But the long-term plan is to see that the lenders, banks and financial institutions, understand the risk-reward scenario so well that they no longer require the partial risk guarantee,” says Mathur. The fund is awaiting the power ministry’s nod.

The government is helping out in other ways as well, besides offering subsidies for 80% depreciation in the first year of a project, exemptions from central sales taxes, import duty concessions, etc.

Under the 2003 Electricity Act, the government has accorded state electricity regulatory commissions the power to ask state electricity boards to source a minimum percentage of electricity from renewable energy sources. The cost of producing 1 MW of solar power is anywhere between Rs 10 crore and Rs 12 crore, wind power around Rs 6 crore, while thermal is available at Rs 4 crore. It’s evident that without government intervention, these projects are not viable. The state electricity grids of states such as Tamil Nadu, for example, have been ordered to pick up 10% power from renewable sources. For those in Gujarat and Maharashtra, the mandate is 6%.

The logic, explains a Delhi-based analyst, is to average out the cost for the end customer, so that his rate per kilowatt increases only by 6 paisa to 10 paisa. “That’s the hike in tariff they are comfortable with,” he says. (While the cost per kilowatt hour varies between states, it’s usually in the range of Rs 1.14 to Rs 5.16 for domestic consumers and Rs 1.57 to Rs 8.02 for industrial usage). This also means that continuity of policies is critical for financiers to stay interested.

SO, IS EQUITY A BETTER OPTION under these circumstances? “Many of the overseas utilities went to the market for their expansion,” says HSBC’s Singh. He cites the example of Spanish power utility company Iberdrola Renovables, a leader in wind energy, whose renewable energy unit raised €4.5 billion through a primary offer. Similarly, Enel Green Power, Italy’s biggest utility in wind, solar, geothermal, and hydro power also raised €2.6 billion from the primary markets.

Other than a few companies such as Suzlon, Orient Green etc., which have tapped the capital market for funds, most small players have had to depend on venture capital players and multilateral agencies for their funding needs. Thankfully, the private equity and venture capital players have been active in the country. According to a report by the Cleantech Group, a research firm and consultancy, and auditors Deloitte India, 17 deals worth $190 million of VC investments happened in 2009 and $218 million the previous year (the number of deals was the same). Nearly 55% of this went into clean energy.

Alok Gupta, former CEO of Axis Private Equity who quit earlier this year to start his own fund, says the renewable energy space is slowly becoming attractive because of government subsidies and regulatory changes. “We look for a 20% to 25% normalised return on capital over a period of three to four years.” That also explains why VCs may be showing more interest than banks which, after all, will only make 11% to 12% on their investments and get no upside on the risk of funding a new, untried venture.

One of the most attractive models is the platform-based one. VCs own a portfolio of renewable energy projects across various technologies and geographies, which are at various stages of development. It’s easy to see why. According to ‘India’s Clean Revolution’—a report by HSBC, KPMG, The Climate Group, and Yes Bank—if a company invests in a standalone independent power producer, the return is 20% to 25%, but for a portfolio, the returns are higher at 30%.

For one, investors get better deals from suppliers across multiple projects and thereby improve operating costs. Olympus Capital has invested $35 million in Orient Green Power for producing 23 MW of biomass, 99 MW of wind and 2 MW of biogas. Global Environment Fund has invested $46 million in Greenko for setting up a 41.5 MW biomass plant and a 60 MW hydel project plant.

Another innovative model that has caught the fancy of financiers is ‘develop-to-sell’. Since most of the funding, around 80%, is required in the last stage of the project, especially in sectors such as biomass and wind energy, entrepreneurs with expertise build only the physical infrastructure for transmission and distribution. The financiers undertake project development, getting government approvals, etc. Once the construction is over, they sell it to a utility company, which pays for the last mile capital investment and achieves financial closure.

For example, Enercon India, a €1.2 billion company and a global leader in the wind energy sector, is developing two new wind firms in Rajasthan (102.4 MW in Jaisalmer) and Andhra Pradesh (50.4 MW in Nallakonda) for CLP India, a leading investor-operator.

Gupta adds that often the VCs suggest how the renewables companies should structure the power purchase agreements. “The player can make more money if he can sell 'merchant power' during peak hours than by selling it to the grid.”

ANOTHER INCENTIVE IS ON ITS WAY. Under the perform, achieve and trade (PAT) scheme, the 600 most energy-intensive companies across 28 industries such as cement, steel, fertilisers, and power, have been asked to reduce their energy consumption. The reduction is a percentage of the energy it takes to produce one tonne of the commodity the company makes. The first phase of the project is operational between now and 2015. Overall, 600 companies are expected to reduce their energy consumption by 5%.

Companies that fail to meet their targets have the option of buying energy-saving certificates from those which have exceeded their targets for compliance purposes. “Trading has been allowed to provide flexibility because if you are doing a mathematical exercise of fixing targets, then it is quite possible that the target is so large that it becomes very expensive for the company to meet it. Remember, there is no cap on the total energy used, only a percentage of it is expected to be saved,” says Mathur.

Once PAT is under way, it’s believed that companies will be pushed into energy conservation. This will improve the prospects of ESCOs and other such vendors. Tradeable PAT certificates, an outcome of energy efficiency, will give the financial system enough confidence to herald India’s next ‘Green Revolution’.