CREO INVESTING IN DISTRIBUTED GENERATION IN INDIA THE CREO SYNDICATE SEPTEMBER 2017

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1 CREO INVESTING IN DISTRIBUTED GENERATION IN INDIA THE CREO SYNDICATE SEPTEMBER 2017

2 THE CREO SYNDICATE IS A not-for-profit network organization that is helping catalyze more private capital into low carbon, resource efficient and environmental solutions to accelerate the transition to a cleaner and more sustainable global economy and society. CREO believes that wealth owners, as well as their family offices and foundations, have a leadership role to play in this transition. Working with an established network of private investors, CREO provides an expert and peer-to-peer educational platform that promotes collaboration and resource sharing to enable more private investors to execute their investment theses for commercial return and measurable impact. For more information, please visit The information provided in this document is for informational purposes only and does not constitute a solicitation, offer or sale of securities. Neither the investment examples cited, nor the CREO Syndicate s mention of examples, constitute investment advice or a recommendation to purchase or sell any securities. The CREO Syndicate is not, and does not provide services as an investment advisor, investment analyst, broker, dealer, market-maker, investment banker or underwriter. The CREO Syndicate does not receive any compensation or fee for citing investment examples in this document or any consideration as a result of any discussion or transaction with respect to any such investments.

3 TABLE OF CONTENTS I. Executive Summary...4 II. Introduction...8 III. Market Overview...10 A. India s Power System...11 B. Segment Overviews: Market Size, Trends & Investment...15 Rooftop PV...15 Solar Home Systems...17 Mini and Microgrids...17 C. Stakeholder Ecosystem...19 D. Role of Government & Policy...23 IV. Market Analysis...25 A. Business Models & Project Structures...26 B. Financing Landscape, Vehicles & Expected Returns...30 Rooftop PV...31 Mini and Microgrids...32 Solar Home Systems...34 C. Risk Factors...35 Rooftop PV...35 Mini and Microgrids...37 Solar Home Systems...39 V. Opportunities...41 A. Catalytic Solutions...42 B. Commercial Opportunities...44 VI. Investment Considerations...46 B. Impact Analysis...48 C. Legal, Tax, and Regulatory...52 VII. Conclusion...57 VII. Acknowledgement & References...59 TABLE OF CONTENTS 3

4 EXECUTIVE SUMMARY

5 This report is designed to serve as a primer and companion for those considering investing in distributed clean energy systems in India. India has emerged as a booming market for renewables in recent years. While the vast majority of capacity deployed to date has been at utility scale and for large commercial and industrial (C&I) customers, a significant opportunity remains for additional investment to scale smaller, distributed systems. Three market segments are the focus of the study: 1 Grid-connected rooftop photovoltaic solar (PV) systems Systems <100kW in size serving small C&I customers and households 2 Off-grid mini and microgrids Distributed systems, ranging in size from 2kW-50kW, serving rural villages 3 Solar home systems (SHS) Integrated modular packages for households ranging from 20W-250W Investment in off grid solar home systems and mini and microgrids has the potential to deliver impact through improving energy access, and scaling deployment of rooftop systems for residences and small C&I can meaningfully reduce CO 2 emissions. In particular, India has seen dramatic change in the past decade as the ongoing transformation of the country s electricity system has brought significant growth in both renewable and conventional thermal generation. An ambitious government deployment target of 100 GW by 2022, of which 40 GW is rooftop PV, combined with the implementation of policies to meet this goal, have driven growth. But the transformation is not yet complete. Over 3,600 rural villages were still lacking access entirely as of Q India is forecast to be the world s largest contributor to new electricity demand through And as the third largest greenhouse gas emitter in the world, continued growth in renewables deployment is poised to have a substantial impact on India s emissions profile going forward. Taken together, India s march towards electrification and the tremendous market potential for renewables point toward latent demand, which is apparent in all three segments covered in this report. KEY FINDINGS The stakeholder ecosystem in India for distributed generation is complex. Foreign investors must navigate a wide range of national and state regulatory bodies, public and private financial institutions, an evolving landscape of young developers and vendors and legal and tax considerations. This report provides a snapshot of these issues. EXECUTIVE SUMMARY 5

6 Moreover, each vertical covered herein is at different stages of market maturation and faces unique challenges in terms of business model risk and financing gaps. Still, current challenges present significant opportunities for investors able to successfully navigate the ecosystem. Global trends like cost declines in hardware and continued downstream technology innovation have enabled new business models to take hold and carve niches in the Indian power ecosystem. Nevertheless, access to capital has been the most significant barrier to scale. Concessionary capital, grants, lending from development financial institutions and early stage equity have fueled much of the growth and deployment to date. As the distributed generation market in India matures, there will be a need to move beyond these early stage vehicles into structures that bring enough capital to scale up. Opportunities exist today across a range of structures: direct equity investments, investments in projects, partnerships with local financial institutions, and participation in innovative financing vehicles managed by other foreign entities. Risk profiles vary for each market segment and investment type. Three major risks relevant to foreign investors have persisted across the markets: credit, currency risk, and insufficient debt tenures currency as a direct risk, credit and debt tenures as risks to developers and local financing partners. Many emerging developers and customers have been unable to access debt markets due to their lack of sufficient credit. Collateral lending requirements have been prohibitive. Emerging developers in all three verticals struggle to find low-cost debt for sufficiently long tenures to support growth. The market lacks sufficient cost-effective tools to mitigate foreign exchange(fx) risk on top of the other business model and market challenges. Across the three market segments this report explores, there are substantial differences in the character of investment opportunity: Concessionary capital sources remain necessary to support continued growth in the mini and microgrid segment. Microgrid levelized cost of electricity (LCOE) values, while improving, remain uncompetitive with grid tariffs by a wide margin. Furthermore, the threat of grid extension to developers project sites remains a significant barrier to scale. A number of top tier developers have shown promising progress, but commercial capital has yet to enter the segment in a meaningful way. The solar home systems market on the other hand has shown strong, sustainable unit economics, but the market remains fragmented across regional and cultural boundaries, though a small number of reputable players are emerging. The maturation of SHS markets in East Africa likely offers clues to EXECUTIVE SUMMARY 6

7 future growth in India: mobile payment systems must continue to proliferate and developers must manage customer portfolio credit quality in order to scale sustainably. Rooftop PV for small C&I customers offers perhaps the most promising nearand mid-term potential for commercial returns, noting however that most development to date has occurred via larger projects of 500kW and above. Operational efficiencies at the enterprise level are poised to continue improving as companies grow. And many leading developers in this segment are reaching sufficient operating track records to access growth capital to scale. Summary findings for each segment are as follows: Rooftop PV Mini/Microgrids Solar Home Systems Market Size (2018 revenue potential) Total Addressable Market (Long term revenue potential) $3B $45M $215M $50B $20B System Size 5kW-100kW 2kW-50kW <1kW Average System LCOE 1 $ /kWh $ /kWh $ /kWh Capex Range ($/W) (dependent upon many factors) $.70 - $.85/W $ $3.10/W $ $5/W Project Ticket Size $20,000 $100,000 <$200 Project IRR Range (in INR) 12-15% over 7-8 years 8-12% over 7-8 years 12-18% over 2-3 years Investment Instruments Corporate Equity, Commercial Debt, Project Finance Concessionary Debt, Corporate Equity, Project Finance Corporate Equity, Commercial Debt Key Risk Factors Customer credit, PPA risk, product standardization Grid extension, payback period, access to capital Customer credit, market fragmentation Primary Impact Potential CO 2 Energy Access Energy Access EXECUTIVE SUMMARY 7

8 INTRODUCTION

9 Building on economic reforms originally launched in 1991, India has gained considerable momentum on an economic transformation that is propelling forward its position as a regional and global power. Infrastructure, particularly power infrastructure, is an integral part of the socioeconomic transition impacting India s 1.3 billion people, and the power system is undergoing massive growth with 50% growth in electricity supply from Yet India s electricity system is still unreliable by most standards and much of the population remains underserved. Over 200 million people in India lack access to reliable electricity, the vast majority of whom live in rural regions. 3 According to the Ministry of Power, over 3,600 villages remained without access in Q There is economic and political urgency to create access to electricity, but many in India recognize that 20 th century approaches to infrastructure are insufficient to power the country. The centralized generation model in India continues to fail to provide customers with reliable power. Extension of this system is not expected to reach much of the country s rural population, nor significantly improve reliability for existing customers. To maintain momentum on its socioeconomic transition, India simply must build new infrastructure and in a low-carbon manner. As urbanization and industrialization continue, India is forecast to be the world s largest contributor to new electricity demand through Global trends in solar technology overlay India s internal economic transformation. Like the rest of the world, India has seen the costs of distributed photovoltaic solar hardware drop and downstream financing innovation proliferate, rendering distributed systems an economically attractive option for customers today. The lack of reliable power from centralized generation and cost savings potential have been the two key internal drivers of deployment of distributed renewable energy systems to date. The emissions profile of generation developed to meet this demand will impact global efforts to combat the effects of climate change. Many lessons learned from more mature solar markets will apply to scaling India s distributed solar markets; but many will not. Often customers in India s addressable markets do not have formal credit scores or verifiable credit histories. Access to low-cost finance to support commercialization will accordingly remain a significant challenge. Regional and cultural boundaries may limit the scalability of certain business models and create a fragmented marketplace. Yet the potential impact of successful commercialization of rooftop PV systems, off-grid solar home systems and mini and microgrids cannot be ignored. First time electrification and improved access to power for millions of people may significantly improve socioeconomic conditions in areas where it is most needed. Widespread deployment is expected to improve the carbon intensity of India s power generation while displacing existing and future fossil fuel generation. This report explores a broad range of considerations facing investors as they consider potential investments in these segments in India. INTRODUCTION 9

10 MARKET OVERVIEW

11 INDIA S POWER SYSTEM The electricity system in India has undergone a rapid transformation in recent years. Significant growth in generation capacity from both conventional sources and renewables has created a mature power market fueled mostly with fossil-based thermal generation though with substantial contributions from renewables and large hydro. The country had over 330 GW of generation capacity as of May 2017, and much of the fleet was built out in the last decade. Figure 1. India s Power Generation Profile, May 2017 (MW) Coal Gas Oil Hydro Nuclear Renewables 221,620 57,260 44,594 6, ,185 The recent build-out has met significant system needs: deficits in both energy and peak availability have shrunk significantly from 2010 (-10.1% and -12.7%, respectively) to 2017 (<1% each thus far). Looking forward, the market rebalancing is likely to cause a new set of issues. The CEA s anticipated power supply position for fiscal year (ending March 2018) is forecasting a power surplus of 8.8% and peak surplus of 6.8%. 5 Plant load factors (PLF) for traditional thermal generation are suffering and only project to get worse as new capacity comes online. This has been the result of both overbuilding of thermal generation and poor investment decisions from developers. The projected near-term generation surplus may well mask significant latent power demand. India is forecast to be the world s largest contributor to new electricity demand through 2040 due in part to rapid urbanization and continued industrialization. Widespread deployment of consumer air conditioning alone is expected to add over 130 GW of peak electricity demand by This demand must be met by significant new capacity. In addition to the aggressive renewable capacity build-out, extensive new fossil fuel generation is also planned. MARKET OVERVIEW 11

12 Figure 2. India thermal power plant load factors India thermal power plant load factors 90% 85% 80% 75% 70% Ownership Central government 65% 60% 55% 50% System-wide State government Private Source: Government of India Ministry of Power India is the world s third largest greenhouse gas emitter today, emitting ~600M metric tons of CO 2 per year and forecasted to increase to 1B metric tons per year within five years. With forecasted growth in both power supply and demand, changes in the country s generation mix over the next few decades will have a significant impact on its emissions profile. Deployment of renewable energy both at utility scale and distributed systems will be necessary to reduce the carbon intensity of power production. Installed capacity from renewable sources increased 80% between March 2014 and March New solar capacity additions in 2017 are forecast to reach 8.8 GW, an increase of 76% over 2016, which would make India the third biggest solar market globally. As of June 2017, India had 14 GW of installed utility-scale PV capacity. 7 As discussed further below, an ambitious government deployment target of 100 GW by 2022 and implementation of polices to meet this goal have driven growth. Record low bids for recent solar auctions have seen prices offered by developers as low as of INR 2.44 (~$0.037)/kWh. Utilities now seek a similarly low tariff, which has led to delays in PPA signings, tenders, and auctions. Growth in new utility-scale solar projects is expected to slow significantly in the near-term as the grid particularly in certain early-mover states takes on substantial new capacity from recently-tendered projects coming online. Over the past year, the pace of new tender announcements (-68%) and completed auctions (-59%) has slowed down significantly. 8 Anecdotally, many offtakers are further attempting to renegotiate existing PPAs. Given continued significant price declines, PPAs signed only two years ago are significantly higher than those being bid today. While India moves toward a near-term generation surplus driven by lowpriced renewable power, the benefits are not all translating to consumers. With the bulk of recent renewable capacity growth occurring in the utility-scale segment, the market may be facing a case of too much, too soon. MARKET OVERVIEW 12

13 Grid reliability has improved as the supply-demand gap has narrowed, but in most areas, remains well below developed market standards. Per the Central Electricity Authority (CEA), ~27% of all power produced in India is either lost due to dissipation from wires or theft. The lack of reliable grid power has been a major catalyst for growth in distributed generation. State-owned distribution companies (commonly referred to as DISCOMs ) play an important role in delivering utility-scale generation to consumers. These entities have been mired in financial troubles for years, prompting Modi s government to implement a debt-relief and operational improvement scheme ( UDAY ) in Q This effort allowed state governments, which own the DISCOMs, to take over 75% of their debt (~$61B at the time) and pay back lenders by selling bonds. UDAY has been largely successful thus far in reducing the debt burden, but DISCOMs are still losing money. Figure 3. Financial losses by DISCOMs (aggregated) 9 $ BILLIONS FY09-10 FY10-11 FY11-12 FY12-13 FY13-14 FY14-15 Participating states have issued bonds of approximately ~$36 billion which addresses 86% of the debt envisaged in Memorandum of Understanding (MoU) executed under UDAY. A further reduction in the gap between their aggregate cost of supply (ACS) and aggregate rate of realization (ARR) is necessary DISCOMs lost an average of 0.5 rupees per kwh in 2016/17. Deployment of metering infrastructure, improved billing and collection processes, and enhanced theft mitigation efforts are key initiatives for these entities to become solvent again. Rural Access Much of rural India is still without access to reliable electricity. Estimates of the number of households and villages vary as government statistics are unreliable. As grid quality and reliability issues persist, government-subsidized kerosene, at a cost to the government of ~$5 billion annually, has been the primary source of lighting for 43% of rural India, despite the growing electrification rate. 10 With the government set to eliminate the kerosene subsidy, latent demand for distributed solar may become more apparent. 11 Even if the government declares it has achieved its electrification objectives, many households will remain without electricity. The government considers a village officially electrified once 10% of households and some public The Climate Group and Goldman Sachs estimated 77 million households without adequate access and a further 20 million receiving less than 4 hours of electricity per day. MARKET OVERVIEW 13

14 places such as schools receive electricity. Reliable data is a challenge in these segments much of the data for existing analyses stems from the 2011 census and thus does not account for recent progress, which has been significant. Over half of the underserved (for electricity) rural households are in five states: Uttar Pradesh, Bihar, Odisha, West Bengal and Madhya Pradesh. Figure 4. Rural population underserved for power by state 12 Further, those households deemed by the government to have access may not necessarily have consistent, reliable power. In fact, according to BNEF and the Council on Energy, Environment and Water, the majority of households in certain states only have power for <8 hours per day. Figure 5. Duration of households electricity access (2015) 100% 80% 60% 40% 20% >20 hrs >8 hrs and <20 hrs >4 hrs and <8 hrs <4 hrs 0% Bihar Jharkhand Utter Pradesh Madhya Pradesh Odisha West Bengal MARKET OVERVIEW 14

15 These households and villages that are grid-connected, but have unreliable access, represent a significant addressable market segment for the traditionally off-grid solutions covered in this publication. Distributed systems can drastically improve customers duration of electricity access. SEGMENT OVERVIEWS: MARKET SIZE, TRENDS & INVESTMENT The core segments of this report are at different stages of market growth. Rooftop PV is the largest segment in terms of capacity deployed to date and dollars invested. Solar home systems (SHS) markets are proving to be scalable, but have remain fragmented to date with only a handful of developers beyond regional-scale. Mini and microgrids are projected to remain a relatively small market through the mid-term, but continue to attract significant market attention because they represent significant long-term potential. Rooftop PV Market Size (entire rooftop segment, including systems >100kW) India had 1396 MW of installed rooftop PV capacity at the end of Q1 2017, with 65% of this installed capacity (903 MW) for commercial and industrial (C&I) customers. Publicly-owned systems (state governments, municipalities as off-takers) comprised 189 MW and residential systems 304 MW. 13 Figure 6. Total installed rooftop PV capacity (Q1 2017) Total installed capacity: 1,396 MW as of March 31, Commercial Industrial Public Sector Residential Rooftop PV has maintained only a ~10-12% share of overall solar capacity in India, which is much lower than other large global markets including the US (46%), Germany (73%) and China (18%). As growth in the utility-scale segment potentially slows, this percentage may rise in the coming years OPEX 2 CAPEX 2 India added 678 MW of rooftop solar capacity in FY , growing at 81% year-over-year. According to Bridge to India, 11.9 GW of new rooftop solar capacity is forecast to be added between 2017 and 2021, to reach a total rooftop solar capacity of 13.2 GW by This would be a 9x growth in market size in only four years. While a significant growth rate, it would still be insufficient for the country to reach the government s stated goal of having 40 GW of installed rooftop capacity by Accordingly, a parliamentary panel in July 2017 issued a recommendation to reduce the 40 GW target by half. While not final, anecdotal evidence suggests the market assumes a new target of ~20GW to eventually be formalized. MARKET OVERVIEW 15

16 Figure 7. Forecast annual rooftop PV capacity additions ( ) 14 Projections for rooftop solar capacity 4,000 We expect India s total rooftop solar capacity to reach 13.2 GW by ,500 Annual capacity installation, MW 3,000 2,500 2,000 1,500 1, Residential Public sector Commercial Industrial 0 Until e 2018e 2019e 2020e 2021e Trends & Investment Two distinct trends have emerged which reflect dynamics in more developed global markets: significant hardware cost reductions and an increasing share of deployment from third party-financed systems. The third-party ownership model saw new capacity addition of 162 MW in FY , accounting for 24% of total market (up from 12% in FY and 19% in FY ). Installed system costs have come down by ~45% over the past five years, with ~12% annual reductions each of the last four years. Figure 8. Average system cost (500kW industrial rooftop) BTI India Rooftop Solar EPC Price Index System cost ( /Wp) Module Inverter BOS and others 0 March 2012 March 2013 March 2014 March 2015 March 2016 March 2017 MARKET OVERVIEW 16

17 The divergence among electricity tariff structures between customer classes have been a key driver of rooftop PV adoption. In general, commercial customers face significantly higher rates than industrial and residential users. Improved reliability and more stable access to power, as mentioned throughout this report, are also important factors. C&I customers account for more than 50% of India s total power demand and can realize significant energy cost savings through the installation of rooftop solar systems. 17 The chart below outlines how rooftop PV compares to grid tariffs for customers in different states. Figure 9. State-by-state comparison of electricity tariffs Rooftop solar LCOE 100 Average industrial tariffs Average commerical tariffs Average domestic tariffs 20 0 Delhi Uttar Pradesh Maharashtra Gujarat Rajasthan Karmataka Haryana Tamil Nadu Punjab Andhra Pradesh An estimated $610M was invested in the rooftop PV segment between FY As costs come down, more liquidity enters the market, and developers become more efficient, the cost of capital for these projects continues to fall. Anecdotally, and discussed in more detail in Section IV, the cost of debt has come down to ~12-13% from ~17-18% only three years ago. Access to still-lower-cost sources of capital will be necessary for this segment to scale: BNEF estimates that the market will require $50B in investment to reach its 40 GW goal by Mini/Micro Grids and Solar Home Systems Market Size The total addressable market of off-grid segment in India is valued at a $20B annual revenue potential. BNEF estimates that 2.9 MW of mini and microgrids were serving over 75,000 households in India by the end of FY2016. The Climate Group estimates that this market could be 900,000 households by With an average monthly tariff of $5/household, the market would be worth $45M. As such, this will be a small market for the foreseeable future and it will likely take a long time to fully realize the $20B market potential. The Climate Group further estimates that with financing, 7.2 million underserved households will be able to afford a solar home system (SHS) by Per conversations with leading SHS developers, there were approximately MARKET OVERVIEW 17

18 620,000 SHS units sold by the end of However, much of that early deployment has occurred via government subsidy programs. Trends & Investment The significant government investment in these segments has largely been implemented to date through the Rural Electrification Corporation (REC). REC has been appointed as the nodal agency for implementation of DDUGJY (Deendayal Upadhyaya Gram Jyoti Yojana), as well as the coordinating agency for rolling out UDAY (Ujwal Discom Assurance Yojana) for the DISCOMs. REC is a key player in the ecosystem, providing financial assistance to state electricity boards, state governments, central/state power utilities, independent power producers, rural electric cooperatives and private sector utilities. According to a 2016 BNEF survey, the top tier of mini and microgrid developers had only raised ~$16M in equity and $6.25M in debt in the prior three years. 20 Foundations, DFIs and impact investors have committed a significantly larger amount of grants and concessionary capital in recent years, though actual capital allocations have been somewhat slow to scale. For instance, the Rockefeller Foundation is in the midst of allocating $75M to its Smart Power India initiative providing grants to developers. In total, roughly ~$100M of aggregate investment has been made or allocated in the segment to date across capital classes. MARKET OVERVIEW 18

19 STAKEHOLDER ECOSYSTEM The stakeholder ecosystem for distributed energy in India is complex. Several relevant policies governing the interaction of stakeholders are outlined on page 23. Below are brief overviews of key stakeholder groups financing the deployment of these solutions. Early Stage Investors Local early stage equity investors are few today. Indian venture capital itself is still a developing ecosystem which mostly has been focused on the information technology (IT), consumer internet and e-commerce sectors. As of 2016, there were only a handful of early stage investors INFUSE, Aavishkaar, Global Environment Fund, Ncubate, and Green India Venture Fund investing solely in the clean energy sector. Many offshore entities are playing an active role. Family offices, impact investors and foreign VCs have paid increasing attention to these segments in recent years. While dollar amounts are still quite small, the direction of recent capital flows reflects their interest. Yet most of these investments have been in the form of corporate equity. Early stage debt (venture debt) continues to be a major need in the market as tenor, terms, and structure of the available lending does not match the needs of many emerging companies. Figure 10. Representative stakeholder map (not exhaustive) 21 MARKET OVERVIEW 19

20 Included below are select firms who have made investments in the focus sectors of this primer: Capricorn Investment Group Khosla Impact LGT Impact Ventures Opes Impact Fund Rianta Capital International Development Financial Institutions (DFIs) International development banks have brought the most significant volume of capital to the sector in recent years and continue to play a catalytic role in scaling emerging developer business models. These entities offer a full range of financing tools and play an important, permanent role in the financing ecosystem because of their ability to withstand macro shocks in global markets. They typically offer long-term, low-interest loans to local Indian institutions who in turn provide direct financing to companies and projects. In aggregate, ~$3B in recent financing has been announced. Select recent deals include: Name(s) Date Announced Amount Local Partners Focus Segments Structure Status World Bank, International Bank for Reconstruction May 2016 $625M SBI C&I rooftop solar and Development (IBRD) 22 Low interest loan for direct lending June 2017 announced first tranche of projects Asian Development Bank (ADB) October 2016 $500M Punjab National Bank Rooftop Solar Low interest loan for direct lending May 2017 announced signing of first $100M tranche USAID 23 November 2016 $75M RBL Bank Off grid, rooftop PV Loan guarantee KfW 24 May 2015 $1.1B IREDA Solar, including rooftop PV Low interest loan for direct lending $100M tranche committed to IREDA; $30M backed by 1st loss credit enhancement Domestic Development Financial Institutions Rural Electrification Corporation (REC) REC is a key player in the ecosystem, providing financial assistance to state electricity boards, state governments, central/state power utilities, independent power producers, rural electric cooperatives and private sector utilities. Indian Renewable Energy Development Agency (IREDA) IREDA is a public financial institution that promotes, develops and extends financial assistance for renewable energy, energy efficiency and conservation projects. Small Industries Development Bank of India (SIDBI) as the primary financial institution for small businesses in India, SIDBI provides both direct financing as well as re-financing products from other primary lenders. National Bank for Agriculture and Rural Development (NABARD) this entity implements capital subsidy programs for rooftop PV systems in addition to direct financial assistance and loans to other intermediaries. MARKET OVERVIEW 20

21 State Bank of India (SBI) the largest bank in India plays an important role in both direct lending, but also facilitating a number of the international credit facilities outlined above. Punjab National Bank (PNB) similarly, PNB offers direct lending as well as with support from international agencies. Banks & Non-Banking Financial Corporations (NBFCs) The Indian banking system is comprised of public sector banks, private sector banks, foreign banks, co-operative banks and regional rural banks. Public sector banks have been most active in lending to utility-scale renewables, along with an increasing number of private banks as the industry has matured in recent years. Interest rates have come down broadly, in line with interest rate moves across the Indian economy. The Government has identified renewable energy as one its priority sectors, among other sectors critical to the Indian economy such as microfinance and agricultural lending. While 40% of bank lending must be to these priority sectors, increased debt availability for developers has not materialized for the focus segments of this report. Utility scale and large-scale C&I rooftop developers are seeing better access to debt by mid-2017, but the lending has not meaningfully increased for the smaller players. Challenges among public sector banks pose a continued threat to financing for distributed renewables. Public sector banks hold ~70% market share of outstanding loans (across sectors) and these entities balance sheets are under stress due to an increase in bad loans. Observers indicate that raising new equity to de-risk balance sheets will be challenging and the government may not step in. Larger questions of bank viability may result in consolidation. In this environment, it remains unlikely that public banks will have an appetite for financing renewables until such stress issues are resolved. NBFCs can also play a role in lending to the distributed energy markets in India, although activity has been limited to date. These entities have strong relationships with customers in both rural and urban areas based on their histories providing automobile loans, home loans, personal loans and loans against property. Encourage Capital, an outcomes-focused private equity firm, believes that there is a GW market opportunity for rooftop solar amongst industrial small and medium enterprises (SMEs) that can be financed by specialized financial institutions, and is developing investment strategies to support the growth of this market. The main difference between banks and NBFCs is that NBFCs cannot accept demand deposits nor are they eligible for deposit insurance from the Indian equivalent of the US FDIC. As of March 2016, there were 11,682 NBFCs registered with the Reserve Bank of India. 25 Access to debt has been a major barrier to scale because local commercial banks have been reluctant to enter the sector in a meaningful way. Many emerging startups in the focus segments of this report do not have the track record nor the collateral to secure senior debt. Many also have yet to reach operating margins to be able to service debt. Debt accessibility has remained a challenge even though interest rates have declined by ~200bps in India over the past two years. Microfinance Institutions (MFIs) These entities have historically been active in providing funding to individuals, households, and unregistered microenterprises that have not had access to the traditional banking system. Some have been playing a role in helping finance off-grid clean energy solutions, but with little success or scale. Their MARKET OVERVIEW 21

22 role in the financing ecosystem may continue to be relevant going forward, however, they are perhaps the best-positioned to finance equipment for productive loads in conjunction with reliable energy access. Philanthropy Given the potential climate, socioeconomic and health impacts associated with electrification and deployment of clean energy infrastructure, foundations and philanthropies have paid significant attention to these markets in recent years. Among other initiatives and investments, the Rockefeller Foundation has established the Smart Power for Rural Development (SPRD) program and commissioned a new organization, Smart Power India, for implementation. As of Q2 2017, the SPRD had partnered with seven developers (ESCOs) operating 100+ mini-grids in Uttar Pradesh, Bihar and Jharkhand. 26 SPI is focusing on key model challenges, including mitigating the risk of grid extension as well as stimulating productive load and microenterprise development. Grants and concessionary capital in the former low interest debt have been made available to a number of developers in recent years. Active in this area have been: David and Lucile Packard Foundation Hilti Foundation John D. and Catherine T. MacArthur Foundation Schmidt Foundation Shell Foundation William and Flora Hewlett Foundation As discussed in Section IV, MFIs represent partnership opportunities for those investors seeking to stimulate productive load interventions. Coordination between MFIs and DG system developers may be important to facilitate lending for refrigeration equipment and other micro production capex to drive small enterprise growth in rural villages. Productive power growth is an important system element on two fronts: meaningful socio-economic impact for residents and reliable load (revenue) for developers. How such coordination between energy access investors and MFIs takes place is a complex question, but one worthy of further exploration. International Institutional Investors Foreign-based institutional investors have in recent years entered the Indian market to finance utility-scale and large C&I renewables projects. Some of these entities are exploring strategies to finance projects in the smaller segments defined in this report while new funds are being stood up solely focused on distributed asset finance. These funds collectively represent a new, but emerging and important component of the financing ecosystem. Pension funds, endowments and institutional asset managers are active in the broader renewables market and may be potential future entrants into the smaller distributed verticals as market conditions continue to improve. Strategic Investors The involvement of strategic investors is an important recent inflection point for the market. International utilities, large EPCs and project developers, and global OEMs have all made investments in these sectors. Select participants include: Enel Green Power Engie General Electric Royal Dutch Shell MARKET OVERVIEW 22

23 ROLE OF GOVERNMENT & POLICY The power sector in India, like much of the rest of the world, is highly-regulated. Investments in this sector are subject to national and state level policies, a complex (and sometimes overlapping) mix of agencies and semi-national entities responsible for their implementation and risks surrounding their future stability and changes. India has had supportive renewable energy policies in place for years, though Prime Minister Narendra Modi s choice to make renewables central to his government s national energy strategy was a major catalyst for the accelerated deployment in recent years. The government has set ambitious deployment targets and promulgated a number of policies to support those objectives. The Jawaharlal Nehru National Solar Mission (JNNSM) has targets of 40 GW of rooftop solar and 60 GW of utility-scale solar installed by Notably, a parliamentary panel in July 2017 recommended rolling back the rooftop goal to 20 MW during the same period. While not official, anecdotal evidence suggests that many developers believe this reduction to eventually be formalized. India s commitment to the Paris Accord includes a target to increase the share of non-fossil based power capacity from current 30% to 40% by It also commits to reducing carbon emissions per unit GDP to 35% below 2005 levels. The government has announced a goal of reaching 100% village electrification by May 2018 and universal household electrification in Included below are brief overviews of representative policies relevant to each segment. This list is not exhaustive other publications have outlined the full spectrum of policy considerations in these segments. 27 While there are a range of financial support mechanisms for these markets, there is no central resource for accessing subsidies as programs are administered by different nodal agencies at the state and local levels. The processing and administration timelines for many such programs are long and opaque, which has made accessing funds challenging for developers. A list of recent policy changes and developments is included in the section on Market Risk Factors. Rooftop PV As the utility-scale segment of the Indian solar market continues to mature, policymaker focus has shifted recently to stimulating rooftop deployment. The Ministry of New and Renewable Energy (MNRE) has allocated $750M in funding for a 30% capital subsidy for rooftop solar for residential, government and social institutions similar to the ITC structure in the United States. 28 C&I entities are unable to access this subsidy, however. They pay high tariffs by comparison to residential and government customers but can take advantage of accelerated depreciation provisions which improve the economics of deployment. The national government has also recommended mandatory rooftop solar installations for buildings exceeding specified size and/or power consumption thresholds under the model Building Bye Laws. As of May 2017, four states and a union territory (Uttar Pradesh, Haryana, Chandigarh and Chhattisgarh) have adopted these regulations so far. MARKET OVERVIEW 23

24 Mini/Microgrids and Solar Home Systems India s current federal budget allocates $740M to achieve 100% nationwide village electrification by May There were 3,618 un-electrified villages left out of the total 18,452 identified under the Rural Electrification component of Deen Dayal Upadhyay Gram Jyoti Yojana (DDUGJY), Piyush Goyal, former Minister for New and Renewable Energy (MNRE) noted in July Under the program, 6,015 villages were electrified in FY As shown below, the National Institution for Transforming India and BNEF have estimated the total cost of the program both DDG and grid extension initiatives at $6.1B over four years ( ). Figure 11. DDUGJY rural electrification program estimated cost ( ) Total Target (MW) Cost, INR bn ($m) Target (MW) Cost, INR bn ($m) Target (MW) Cost, INR bn ($m) Target (MW) Cost, INR bn ($m) Target (MW) Cost, INR bn ($m) To electrify 18,452 un-electrified villages (1.4) (153.7) (229.2) (364.0) (748.2) To electrify un-electrified areas in electrified villages (6.7) (1,071.7) (1,617.7) (2,696.2) (5392.5) Total (8.1) (1255.4) (1,846.9) (3060.2) (6140.7) Going back to 2000, the national government has implemented a number of policies targeting rural electrification. These programs provided targets and timelines for village electrification as well as various forms of financial assistance, including capital subsidies of up to 40%, generous loan terms from the Rural Electrification Corporation (REC), grants, and interest subsidies. As of 2015, the Deen Dayal Upadhyaya Gram Jyoti Yojana (DDUGJY) program was the umbrella initiative created to guide plans for 100% rural electrification both via grid extension and off-grid system development. The government allocated $11B for fulfillment of these objectives, and as mentioned earlier, $740M is in the current fiscal year s budget. Financial support is distributed as 75-90% direct grants and the remaining percentage as loans to public and private sector DISCOMs and utilities. The National Tariff Policy (NTP) released in 2016 provides guidelines for the interaction between the grid and mini/microgrids. Only one state thus far, Uttar Pradesh, has implemented the guidelines, which has created a surge of investment in the region. MNRE is soliciting comments on its Draft Mini- Grid Policy released in The final policy, if and when it is ratified and then implemented by state governments, would provide much-desired clarity for the market. Project development procedures, tariff structures and coordination with DISCOMs would stand to be codified in transparent fashion. In early August 2017, the government indicated it would formally phase out subsidies for kerosene. 30 It directed state oil companies to continually raising prices on kerosene every two weeks until the subsidy was completely removed from the market. While the market effect is unknown, and some expect kerosene to continue to be partially subsidized in the mid-term, this policy would improve the cost-effectiveness of distributed renewable systems relative to the legacy fuel. MARKET OVERVIEW 24

25 MARKET ANALYSIS

26 BUSINESS MODELS & PROJECT STRUCTURES India has a relatively dynamic distributed generation market. Each of the three verticals in this report (Rooftop PV, Microgrids, and Solar Home Systems) is at a different stage of growth and is facing a unique set of challenges and gaps, though some gaps are prevalent across the entire market. For any of the segments to grow to scale, they must see additional capital available to developers and on better terms than prevailing market rates today. Financing challenges for previous developers across these markets have been well-documented. This section outlines the primary issues facing new investors. Rooftop PV Rooftop PV installers in India have business models that look quite similar to those in the US and other mature solar markets, particularly in their earlier growth stages. Developers seek to acquire customers and install solar generating systems on their rooftops. The systems themselves are also quite similar, in many cases utilizing hardware sourced from the same Asian OEMs. A typical 20kW rooftop system in India costs ~$15,000. For smaller projects without a need for a transformer, ~40-50% of system costs are for the panel, 20-25% for the inverter and the remainder for the balance of system (BOS) and EPC margin. In the capex model, the customer buys the system outright from the developer. In the third-party ownership model, developers will own and operate the system, selling power to customers through a PPA. Investors can finance these assets directly or via the developer s enterprise. The market for smaller systems as defined in this report is fragmented. While larger C&I installers such as CleanMax Solar, Azure Power and Amplus Solar carry significant brand recognition and funding, companies in this segment are much less established and well-recognized. There are over 100 installers operating in regional markets across the country. A select number are listed in Appendix I. Mini & Microgrids Mini and microgrid systems will typically utilize one or more local source of generation, most commonly solar, to provide electricity directly to rural homes and small business. Typical components include hardware such as controllers, inverters, batteries as well as basic distribution infrastructure to connect to end-use customers. Systems range in size depending on the number of potential users and the size of an anchor load (if present). The terms minigrid and microgrid for purposes of this report will refer to systems between 2kW and 50kW. Ticket sizes for typical systems are roughly $100,000. MARKET ANALYSIS 26

27 Figure 12. Typical mini and microgrid structure 31 Solar PV Wind Biomass AC/DC CONVERTER FINAL LOAD Household consumers Night lighting Lights, fans, appliances Mobile charging Hydro Wind-solar hybrid Commercial consumers Day lighting Lights, fans, computers, equipment Reliability is key The Microgrid Investment Accelerator has aggregated data on recently deployed and shovel-ready microgrid projects in Uttar Pradesh and Bihar two states in the lower-tier of major states for ease of doing business 32. The installed capital costs of microgrids including hardware components, engineering and installation are included below. Note, land and transmission/distribution costs are excluded from all but the turnkey row. The range wide cost ranges are indicative of the challenge of doing business in different sub-regions access to equipment and personnel varies greatly. Figure 13. Installed cost of microgrids ($/kw) 33 Turnkey Microgrid PV + storage Micro-hydro Biomass Diesel $1.5-$6.6K $1.7-$3K $2.7-$5K $0.750K $1.45K Comparing tariff rates and levelized cost of electricity (LCOE) between renewable energy microgrids in different regions and with traditional alternatives (diesel and kerosene) and grid extension can be challenging. Variance among regional fuel pricing as well as variance among developer costs and tariffs even locally further complicates the comparison. Accurately modeling and MARKET ANALYSIS 27

28 sizing microgrid projects based on forecasted load, user connections and load growth is one of the most difficult issues facing developers today. It is one of the key factors dictating project profitability and attract commercial investment. Size matters. Figure 14. Microgrid LCOE estimates 34 Microgrid Public Utility Diesel Fuel $.25-$.70/kWh $.054/kWh $0.26/kWh This table clearly shows a core challenge for commercial investors in this segment: microgrid LCOEs are uncompetitive with grid tariffs by a wide margin. Even if LCOEs come down with scale, grid extension (with continued government subsidy support) will remain a cheaper option for customers. Anchor loads stable, predictable commercial electricity demand from a cell phone tower or water pump, for example, are increasingly important for system revenue stability. Some developers have built their entire business models around them. Beyond homes, these systems are often designed to provide power for small enterprises and community organizations. Anchor loads can have a more predictable and stable revenue stream and thereby help attract investment in larger systems that provide access and productive use power. 35 Billing and collection can take place either via mobile payment systems or field agents. Business models vary between developers: while mobile payments are more efficient, there is value to having a local human presence to maintain customer relationships and for valuable data collection. This topic is further addressed in the Risk Factors section below. Appliance-level forecasting is necessary to estimate individual household needs, but such an undertaking can vastly increase the soft costs associated with origination and development. Based on stakeholder interviews, developers appear to take their own approaches to this problem. This lack of standardization among approach and data is a major barrier for investors (as discussed further below in Section IV). Solar Home Systems This category includes a range of system sizes, from those that supply electricity for basic mobile phone charging stations to fully-integrated home systems with lighting and appliances. Hardware packages range accordingly. Relative to their more mature peers in Africa, Indian solar homes companies are not just selling systems to those without grid access. Increasingly, homes in villages with the grid (albeit unreliable) are turning to these integrated residential solar packages as means to boost electricity reliability. Deployment of solar home systems in India have occurred largely via two models pay as you go (PAYG) or third-party finance. PAYG has a few variations in the market, but is generally structured where the developer will own the system and the customer will (pre)pay for energy days of operation. Third party finance models are generally structured as lease-to-own with an up-front deposit (~30% depending on system size). These contracts tend to be ~3 years before the customer owns the system outright. MARKET ANALYSIS 28

29 Figure 15. Representative SHS product package 36 Technology advances in remote monitoring and control capabilities have enabled PAYG to become viable in India. The uptake of mobile money in the country has lagged East African nations, which has historically hampered the operational efficiency of the model. The need to have personnel on site locally, regularly, to collect cash has been an overhead expense that the slim-margin business can t generally afford. This remains an issue today, but cloud-connected, remote operation capabilities have improved functionality. Widespread adoption of mobile payment systems presents a significant opportunity in the market today. Anecdotally, systems are beginning to rapidly take hold following the demonetization period announced in late Should mobile payment system scale rapidly, billing and payment overhead for distributed systems may decrease significantly. To date, leading PAYG companies have proven sustainable unit economics as they have grown. Hardware costs continue to fall upstream and economies of scale can be realized as companies grow. Annual revenue figures per customer vary depending on system size, but realistically each system can generate ~30% EBT margins. With efficient management of overhead, appropriate credit risk mitigation strategies and sustainable growth strategies, these companies can continue to expand. Additional discussion of financing this growth follows in the next Section. MARKET ANALYSIS 29

30 FINANCING LANDSCAPE Many broad gaps will be familiar to US clean energy investors as they mirror similar issues faced in the US ecosystem over the past two decades. The return on investment (ROI) targets and time horizons for venture capital and private equity do not align well with typical commercialization trajectories of developers. Corporate liquidity events in immature industry verticals are likely years away; larger private equity check writers have only very recently entered the market. 37 More project financing is needed to scale these segments. The lack of operating track records and project performance data contribute to a high cost of project debt, if it is available at all. Business model risk, market adoption risk, and technology risk all remain factors, though progress toward mitigating each has continued. Where capital is available, the risk profile both perceived and real dictates a high cost of capital for these projects. Both project investments and direct corporate equity investments are available to investors today. Some of the larger developers in the market are seeking to sell stakes in new and existing projects. Investors seeking yield may have opportunities to invest in single- or aggregated groups of projects. Crosscutting Issues Structural dynamics within the Indian financial sector have exacerbated many of these issues. Stakeholders have highlighted three primary factors in the banking sector as most significant: Collateral requirements: debt from banks for startups and small and medium enterprises (SMEs) in India (regardless of sector) is widely unavailable due to stringent lending requirements for collateral usually property or a building. 38 Cumbersome lending processes: loan application procedures require a burdensome amount of paperwork and loan disbursement processes are far too lengthy for companies needing to deploy capital in a timely fashion. Loan officer sophistication: many loan officers and officials do not have sufficient understanding of business models and market dynamics in these sectors and therefore even when data is available cannot accurate assess credit profiles and market needs. NBFCs, development financial institutions (DFIs) and concessionary lenders have stepped in to partially fill the void left by banks, though more is required. The Big Three: Credit, Debt Tenures, and Currency Risk Many business model and traditional market risks remain in these segments. Three additional issues compound those risks for investors, developers and financial institutions and have thus limited commercial activity. Opportunities to mitigate these issues are outlined in the following section. MARKET ANALYSIS 30

31 Credit: typical customers in these segments are rural households and SMEs with limited or no credit history. Even more established SMEs for grid-connected rooftop PV in most cases do not have sufficient credit histories to attract low-cost capital. With a higher cost of capital inherently necessary to manage customer default risk, project costs increase for developers, IRRs drop, and in many cases, customers face higher tariffs to compensate. At the developer level, startups and emerging companies do not have access to debt necessary to scale their operations and reach economies of scale. Currency Risk: foreign investors seeking to finance long-term assets in India generally need to provide debt in local currency. The Indian rupee (INR) has depreciated on average ~4.6% annually against the US dollar over the past decade. 39 The currency is further subject to macro risks typical of all emerging market currencies. These can be compounded given the length of the desired debt tenor for the DG assets in question. This reality presents a largely suboptimal situation for investors seeking to manage these risks today: invest in local currency at market rates and face generally short-term tenures and high hedging costs. The time, soft costs and rates associated with this process make it uneconomical for many. Debt Tenures: for developers who are able to access the debt markets, the tenures of available loans are too short. Developers across both mini and microgrids as well as rooftop PV seek debt with 8-10 year horizons, while the market typically offers 3-5 years (5-7 years on the high end). Developers are also forced to match customer payments and deposit figures with their own loan tenures, which is a challenge for some customers willingness to pay. Rooftop PV To date, financing small C&I and residential rooftop PV has been limited, as market participants are mostly focused on the upper end of the market (projects of 500kW and above). Commercial debt for deployment in these segments has mainly come through existing credit lines for developers who also have existing businesses in larger C&I or utility-scale projects. Business models and pricing have evolved quickly from 8-10-year payback periods just a few years ago, down to 5-7 years today and many commercial lenders are closely monitoring the segment. Anecdotal data from banks having financed large rooftop projects shows the cost of capital has come down to its current levels from 17-18% just ~3 years ago. Yet this lending is still happening only for developers focused on large projects with C&I offtakers with good credit. MARKET ANALYSIS 31

32 Figure 16. Cost of capital and market rate estimates for rooftop PV deployment 40 Segment Capex per W (INR/W) Debt Rates & Tenures Equity IRR (INR) Rooftop PV for C&I; ~55 for households C&I systems >100kW 10-15% for 7-12 year tenures Working capital lines at 11-15% Specialized lines just being rolled out 8.2% to 8.75% currently (pegged to 1 year MCLR) ~16%-20% Depending on tariffs, debt rate, accelerated depreciation benefits, time horizon C&I systems <25kW If available, >13.5% Residential Customer-owned systems sold as a home improvement line (with house serving as collateral) Rates same as housing finance rate %. As mentioned, the majority of rooftop capacity deployed to date has occurred via the capex model (~75%). The 3 rd party ownership model is forecast to increase its share of future deployments, but the model has proven challenging to grasp for local lenders. The length of contracts year PPAs with sub-aaa credit offtakers remains a significant hurdle. Even some installers 3-4 years of operating history has not provided enough comfort for commercial bankers. Misalignment of credit size also has emerged as an issue many lenders do not want too much exposure in their first few deals, but developers are seeking some significant volume to meet near-term growth targets. Mini & Microgrids A lack of proven operating track records and data at the enterprise level has made financing these systems challenging. The term viable mini/microgrid project can be interpreted differently by stakeholders with different return criteria. The definition employed by Smart Power India projects with a minimum project IRR of 10% and payback over 8-10 years sets a reasonable baseline. To date, nearly all mini/microgrid projects have been financed with concessionary capital from DFIs, program related investments (PRIs) from foundations, or corporate equity. Very little (if any) commercial debt has made its way into these segments. These sources are seeking to establish enterprise operating track records, allow developers to continue to refine business models and help attract commercial lending into the market. With the exception of Mera Gao (~1200 sites), the largest operators in the segment have only deployed between projects thus far and are still building operating histories. While developers are seeking debt at rates and tenures more typical for infrastructure, these small investment sizes do not translate for project finance structures and thus carry rates more in line with solar homes and rooftop PV. MARKET ANALYSIS 32

33 Figure 17. Cost of capital and market rate estimates for mini and microgrids 41 Segment Capex per W (INR/W) Debt Rates & Tenures (where available) Equity IRR Mini & Microgrids /Wp Key factors: plant size, battery sizing and length of distribution network Specialized lines IREDA: ~10% for 7+ years backed by a first loss guarantee pool Rockefeller Foundation: ~8% for ~8 years limited to Smart Power India projects ckers Finance: 10-12% for 7 year loans Working Capital/Construction Finance: 12-15% for up to 2 years ~14-18% depending on scale of operation SPI has evaluated the performance of 23 of its top cohort projects after their first year of operation, the results of which are presented below in Figure 18. Notably, these projects carried positive operating margins of ~30% regardless of the presence of an anchor load. Figure 18. Smart Power India s evaluation of 23 top-performing systems after 12 months 42 Operating performance at the unit-level is a reason for optimism. However, 30% margins are not sufficient to cover the up-front capital expenditures required for system construction and provide investors beyond concessionary and below-market lenders a commercial return. MARKET ANALYSIS 33

34 Solar Home Systems The solar home system segment in India has lagged that of East Africa by significant margins across most metrics. Only two players in the Indian market Selco and Simpa have reached a scale meaningful enough to attract debt from commercial banks for consumer lending. Many other companies in the segment remain too early. Regional and cultural boundaries are limiting factors to scale in India broadly; this market may remain highly fragmented through the mid-term. Accordingly, small developers may more easily leverage relationships with local banks to enable customer financing if the companies themselves do not have access to debt. The maturation of African markets, the business models of developers serving those areas, and the increasing sophistication of investors financing growth can offer clues to the future of financing dynamics in the Indian market. The most mature African PAYG companies sell durable systems in a high demand, large market at a gross margin of 50-80% after financing. 43 The market has generally accepted that efficient businesses can maintain sustainable EBT margins of ~30%. With such promising unit economics, many foreign VCs, family offices and private equity have entered the market. With the influx of equity capital, focus has shifted to structured debt vehicles to fuel growth and scale. Working capital facilities have been a primary focus, which has brought the issue of customer credit quality front and center of the debate. Market-based lenders seek to secure working capital loans by the developers receivables (their customers loan payments) or inventory. Models analyze inputs including system cost, system price for the customer, loan payment terms and tenor, company growth rate, corporate overhead, and sales cycle data. Such debt facilities have helped accelerate growth of many developers. Case Study: BBOXX & Oikocredit working capital facility, December 2015 (Africa) $500,000 facility for 2500 existing customers Note issued in local currency 21% interest rate in local currency Maturity 30 months, equivalent to remaining tenure of customers three-year contracts 6 months used to establish payment track record for healthy customers 30% over-collateralization helped further reduce risk Yet this quest for rapid scale has created tension between portfolio growth and quality. The SHS model inherently shifts perceived customer risk onto the developer (and thus, its investors). A delicate balance already exists between MARKET ANALYSIS 34

35 appropriately allocating this risk and mitigating customer risk to the point of spurring further adoption. This is animated practically by company management decisions to drive more growth, including lowering down payments to make sales easier, extending lease periods to increase addressable market, simplifying customer vetting processes, overly increasing commissions on acquisition. Structured finance vehicles only serve to further enhance this dynamic by shifting default risk off developers themselves and onto debt investors, which creates some misaligned incentives. Figure 19. Cost of capital and market rate estimates for solar home systems 44 Segment Capex per W (INR/W) Debt Rates & Tenures Equity IRR Solar Home Systems /Wp Key factors: battery size and panel rating Enterprise financing: ~12-15% for 5 years Priority sector lending: 10.5% but includes guarantee support End-user financing: 12-20% for up to 5 years Working Capital/Construction Finance: 12-15% for up to 2 years ~18-30% depending on product pricing and scale of enterprise operation MARKET RISK FACTORS This analysis is drawn from desk research and direct engagement with key stakeholders. Many recent reports have focused primarily on challenges facing this space those by the Microgrid Investment Accelerator (MIA), Hystra, and Dalberg to name a few. This section is not meant to be exhaustive, but rather draw upon several core findings from recent publications and include new perspective from CREO stakeholders. It is meant to outline current barriers to scale for these markets and provide investors visibility on challenges, but also to further serve as a foundation for thinking about solutions and opportunities for impact, discussed further on page 48. For mini and microgrids as well as for solar homes, business models remain largely unproven in the eyes of mainstream commercial investors. Investors continue to have difficulty assessing risk given the breadth of market and business model challenges. Poor market data availability and quality, where it is available has only compounded the problem. Rooftop PV PPA Risk: Signing up customers to long-term contracts for periods of 15+ years presents many challenges for developers. For customer acquisition, the longterm commitment is a significant hurdle. Managing credit risk for customers presents another set of challenges. These issues are both mitigated with shorter contract length. Product and Process Standardization: Establishing and propagating norms for quality control of products and processes is essential for young developers to grow efficiently. This includes the entire customer engagement cycle and pricing, processes which have proven challenging for some developers to replicate at scale. To draw an analogy to the US market, SolarCity s 2013 acquisition of Zep Solar was designed to help streamline install processes. 45 Indian developers face similar challenges. MARKET ANALYSIS 35

36 Install Timelines: Anecdotally, the time between a customer signing a deal and a grid-tied rooftop system being connected is ~6 months. Particularly in cases where a customer puts down a significant deposit, the length of this period has hampered customer relationships and word-of-mouth growth opportunities. Figure 20. Typical install timeline and phases 46 Demand Assessment Optimized Solution Design Engineering Approvals & Permits Installation & Commissioning O&M & Performance Monitoring Day 15 Day 45 Day 55 Day 100 Day 120 Site Survey and General Discussion Detailed Engineering Engineering Drawing/ Make Approval from Customer Material Supply/ Project Execution/ Approvals & Permits Commissioning & Testing O&M work Submission of Techno-Commercial Proposal Release of Work Order by Customer Soft Costs: The length of time and energy required to submit and clear subsidy applications has been prohibitive, particularly for residential users with small systems. One effect of these high transaction costs to receive the subsidies is that developers are in some cases eschewing residential users as potential candidates for rooftop solar installations and focusing on C&I customers who may be able to manage the process. 47 Customer Perception & Engagement: Customer acquisition, while getting more efficient, has proven challenging at scale. Some customers do not believe the technology will work as expected or remain durable over its lifetime. With continually falling costs and lower tariffs for newer customers, other early-adopters are seeking to renegotiate their deals. Technology & Products: Smart grid technologies, which allow for two-way flow of power, are necessary to manage the influx of rooftop PV in certain areas. Upgraded transformers that can take the added rooftop capacity and smart metering technology with proper IT infrastructure are important catalysts for deployment at scale. Energy storage offers much promise in terms of future reliability and PV system enhancement, though the sector faces its own nearterm scalability challenges. Basic metering has been a problem for DISCOMs for years, and given their financial situation, deployment of advanced products in these areas may take time. Prime Minister Modi s Made in India campaign, which provides preferential treatment to domestic manufacturers, threatens to further exacerbate the cost-effectiveness challenge as it may limit access to low-cost foreign suppliers. MARKET ANALYSIS 36

37 Lack of Quality Suppliers: The scale of companies operating in the market remains somewhat limited. Relative to more mature segments, their quality of their practices and operations is subpar. For those high-quality companies, a lack of brand recognition has hurt their ability to differentiate. Furthermore, there have been reports of Chinese hardware suppliers renegotiating supply contracts to seek price increases, due in part to increased domestic demand in China improving the price environment. Insurance: Anecdotally, a few entities have entered this market, but policies are not widely available. An example of such products is one offered by Munich Re, which transfers the risk of technical underperformance off the developer s balance sheet. 48 Joint Rooftop Ownership & Shadow Risk: In urban environments, there are many buildings whose roof is owned jointly by multiple families or enterprises, complicating customer acquisition and contracting. For residential segments in urban areas, the density of living spaces creates risk of neighbors building higher and shadowing. Net Metering: Policies across different states are not consistent and vary in terms of process, technology, and assigned stakeholder responsibilities. This variance has hampered developers ability to scale pricing and structures across regions efficiently. Mini/Microgrids Market Dynamics Grid Extension: When assessing a rural village for a new project, the threat of grid extension is perhaps the most prominent challenge facing developers in India today. Even if a microgrid is already deployed, DISCOMs are incentivized through significant government subsidies to build out their distribution grid perhaps to the same village. The uncertainty surrounding this potential future reality creates risk for developers and their investors. As discussed in Section III, Uttar Pradesh is the first state to implement the National Tariff Policy (NTP), which guides the process for negotiations between developers and DISCOMs regarding pricing and interconnection if and when the grid arrives at an off-grid project site. Pricing: Due to weaker economies of scale, mini/microgrids are likely to face strong competition on a $/kwh basis if the grid arrives at a location. 48 This differential pricing is due in part to the heavily-subsidized nature of many grid-extension projects under DDUGY. Under the government program, DISCOMs are eligible for up to a 90% capital subsidy for these grid extension projects, which allows them to structure customer tariffs at significant discounts. Timing: Uncertainty around the timing of potential grid arrival is perhaps most problematic for developers seeking to finance projects over 7, 10, 20 years. Forecasting revenue and load growth over the life of the asset is challenging on its own. Factoring in the potential for grid extension during the forecast period and most lenders sensitivity analyses would render model data unreliable. MARKET ANALYSIS 37

38 Payback Period: While discussed in more detail in the following Section, the length of investment tenor required for many of these projects carries additional risks and requires developers to master long-term risk mitigation in highly uncertain environments. Such risks include regulatory instability, technology risk, customer churn and unstable consumption. Pricing and Cost Inconsistencies: Variability between projects within the same local geography has led to both customer misperception as well as inhibiting developers to attract larger scale financing. Customers in one village pay one price, while others pay potentially significantly different tariff just miles away. According to the Microgrid Investment Accelerator s stakeholder survey, these issues were prevalent for both developers and customers. Developers confirmed a wide range of reported installation costs for similar systems in similar geographies. On the customer side, end user tariff prices varied across developers even within the same geographies. Technology & Customer Engagement: Use of remote monitoring and payment processing technology use appeared to lag behind the trend toward digital in Africa. 50 This creates personnel overhead challenges, as humans are required to be onsite to collect payments and manage customer engagement. Advanced software and remote monitoring deployment is likely to enter the market soon. Mobile payment processing is also expected to accelerate quickly though India has lagged Africa in mobile money usage to date. MARKET ANALYSIS 38

39 Site Selection & Acquisition: Reaching necessary economies of scale, (a minimum of customers, a consensus size to cover operating expenditures in a typical anchor load model) limits the number of potential sites for viable projects. First mover advantage is important in this context, as there is usually only room for one microgrid developer per village. 51 The higher density of customers, the better, therefore customer selection has tended to occur based on location rather than consumption potential developers are focused on mitigated up-front capex investment. Theft: Power theft remains an issue in all of these segments, but it is an acute challenge in rural villages. With limited on-site monitoring and remote control technologies still not universal, it is a challenging issue for developers to mitigate. Solar Home Systems Sales & Distribution: In many rural areas, adequate distribution channels are lacking. For many of these entry level products, the traditional direct sales model is unsustainable. Partnership models between developers and rural cooperatives and MFIs have only met local successes, but not at scale. Companies are approaching this challenge differently, employing a range of sales strategies and approaches to growth. Human Resources: Recruitment and management of field staff at scale is a key challenge. Commission-based contractors have tended to focus on easy sales, quickly reaching low-hanging fruits in their areas, and becoming inactive after a few months. 52 Metrics: The industry lacks a common language for and definition of key metrics. This issue is complicated by the range of business models being employed some companies offer different degrees of flexibility for payment and various ownership structures. This has made market analysis more challenging for investors who seek to understand best practices and data many metrics are not easily transferable between companies. For example, total hours served is a popular public metric, but alone is not indicative of a developer s scalability or market position, as it depends on the size of individual systems and how long they have been deployed, among other factors. Regional Replicability: The Indian market is highly fragmented along cultural and regional lines, which has forced companies to scale in clusters. As developers have attempted to scale beyond initial deployment zones, there have been challenges replicating customer acquisition. Given the small average revenue per user (ARPU), companies must scale across regional lines to reach commercial viability. MARKET ANALYSIS 39

40 Across Markets: Lack of Policy Clarity & Potentially Negative Changes As with many rapid growth industries, the policy and regulatory environment continues to evolve. There remain many gaps in existing policy. Further, new issues continue to emerge around which a lack of clarity has posed challenges. Included below are some of the current issues and recent changes of note: Scope of new 5% GST tax: while the 5% tax enacted in July 2017 clearly applies to PV modules, there is confusion over what level the tax will be set at for inverters, mounting structures and other capital goods associated with rooftop PV systems. Reduction in accelerated depreciation schedule: solar projects had been historically eligible to depreciate 80% of the asset value in the first full year of operation but this rate has been reduced to 40% from April 2017 onward. A separate line in the tax code allows for 20% annual depreciation, thus now systems can depreciate 60% of asset value in the first full productive year. Net metering variance: policies across different states are not consistent and vary in terms of process, technology, and assigned stakeholder responsibilities. 53 DISCOM involvement: insufficient training for DISCOM officials on rooftop solar installation approvals and implementation processes, delayed approvals from DISCOMs for net metering installations, and lack of proper monitoring of DISCOMs implementation performance have stymied growth in some markets. MARKET ANALYSIS 40

41 OPPORTUNITIES

42 ADDRESSING RISKS & CATALYTIC OPPORTUNITIES Certain financing gaps and challenges have persisted in the market even as business models have evolved rapidly in recent years. These gaps present near-term opportunities for philanthropy and impact-oriented family offices seeking to deliver catalytic impact. Outlined below are constructs of ideas for solutions that may help accelerate more traditional commercial capital sources into these segments and enhance scalability of promising business models. These ideas are high-level frameworks and designed to spark interest in creative approaches. The categories below have been identified by stakeholders as both underserved in the market and holding significant potential impact. Traditional philanthropy and concessionary capital sources have played a meaningful role in mitigating significant business model risk to date. These entities have helped seed a number of promising young developers. Yet macro challenges remain in the market that concessionary sources are not poised to address alone. Risk-tolerant investors may complement those activities by helping fill additional gaps in the capital stack. Currency Risk Reduction The opportunity: investors can create and pilot innovative structures seeking to address the currency risk for other foreign institutional investors. Today, many institutional investors do not want to take that risk and the operating margins for developers particularly in the off-grid segments are too thin to handle the risk as it is. For those entities seeking to access a structured debt facility to drive growth (many SHS and rooftop PV developers today), the establishment of an FX reserve account to partially absorb excessive currency depreciation losses during volatile could be attractive. A family office could maintain upside through an equity stake in a special purpose vehicle (SPV) if depreciation is lower than envisioned, which would benefit from lower depreciation. One example of a functioning solution is a fund established by the World Bank, TCX. TCX offers a suite of solutions to borrowers in hard currency in international markets while addressing the currency mismatch. These products cross-currency swaps and FX forwards allow TCX s international shareholders to offer clients long-term financing in local currency with potentially lower cost than typically incurred in one-off contracts. A swap is the typical instrument to match and hedge the multiple cash flows of a loan. An FX forward is a swap covering only a single cash flow, typically the principal of a loan. These tools could be options for new investors to consider. Unaffiliated investors can trade with TCX as long as there is confirmation of a financial relationship between the prospective counterparty and one or more TCX investors. OPPORTUNITIES 42

43 Figure 21: TCX local currency hedges 54 TCX Hedger HCY/LCY Cross Currency Swap TCX Shareholder Lender offshore onshore interests and principal repayment Disbursement of a loan denominated in LCY (but settled in HCY) Client Borrower Credit Risk Reduction Enhancements & Guarantees The opportunity: mitigating these credit risks, in part or in whole, can reduce the cost of capital for projects, attract more institutional lenders, improve project IRRs, and reduce costs for end-customers. Many stakeholders believe solutions in this area to have the most significant, realistic near-term impact on the market. One solution is to establish a US dollar-denominated facility against which developers might borrow to help bring down their cost of debt from in-country lenders. It also may open previously-inaccessible debt markets to smaller players. Core elements of customer credit and financial guarantees include: probability of default (the likelihood that payment will be delayed) exposure at default (the amount not paid due to default) recovery after default (the percentage of exposure at default that is eventually recovered) An impact investor may seek to address one or more of these elements for a developer (or its existing investor base) by establishing a vehicle that looks a lot like an insurance policy. In negotiating such a structure, the devil is in the details. Significant time and resources would need to be spent on the ground or with a trusted partner. Establishment of a reserve pool to guarantee some or all of the customer default risk would require a premium to be paid by the developer. Yet, such a premium becomes economical through an interest rate reduction from its lenders associated with the (potentially significantly) lower risk profile. In a perfectly efficient market, there would be no arbitrage opportunity here, but that may take time to develop. Further, an impact investor may seek to offer premiums below market rate for this function seeking to further enable the market. A simpler effort to play a convening role could also have an impact. Many developers have a foothold in the market, but no ability to assess credit OPPORTUNITIES 43

44 accurately. Many other stakeholders have significant local knowledge and can assess credit, but no incentive or stake in the market. A platform or convening function to align these entities could produce a natural solution for a more efficient credit assessment. This could take the form of a new consortium or new entity on the ground to leverage these natural strengths of disparate stakeholders. Aligning incentives through such a structure is an important consideration. So too is the length of time the market requires such an insurance policy. Today, the impact potential in the market is significant. The Office of the Development Commissioner (DCMSME) facilitates credit support to MSMEs through two schemes. The Credit Guarantee Fund Trust Scheme (CGTMSE) provides funds for guarantees to 133 lending institutions which then can provide collateral free loans to the SMEs (CGTMSE n.d.). The usual guarantee granted is 75-80% of the sanctioned loan amount. 55 Debt Tenor Enhancement The opportunity: develop a facility to extend developer debt facilities to the required length to better match customer contracts and longer asset life. Better alignment between debt tenures, cash flows from customer contracts and technical risk would help accelerate adoption and improve system returns. Structuring such a facility is challenging. One option is that after a certain period, the loan transfers to another party to take on the risk. However, this structure doesn t mitigate length for the borrower (which still needs to be shortened to mitigate default risk). From the perspective of the borrower, they want contracts to be shorter for purposes of technology working through the life of the agreement. A revolving capital structure special purpose vehicle (SPV) is another structural option. Recycling capital into new customer loans before repayment to better match customer debt tenures with institutional debt tenures would achieve a similar objective. COMMERCIAL OPPORTUNITIES While some market barriers persist, many have fallen in recent years. Each segment has grown dramatically in the past few years. While fragmentation varies in each vertical, in general, a small number of developers have driven much of this market growth. Many of these first-movers have successfully leveraged significant concessionary capital and low-cost development financing to establish viable operating track records. There are multiple direct equity opportunities in late-stage venture and growth equity in the rooftop PV and solar home systems verticals as of the time of this publication. Some companies have reached key inflection points in their commercialization trajectories and now offer promising commercial return potential. A second tier of developers has also emerged behind these first-movers and represent the next wave of seed stage opportunities. Project finance vehicles and new debt structures are becoming more apparent in these segments as well. As companies continue to grow, project finance OPPORTUNITIES 44

45 vehicles look increasingly viable. New project vehicles are being stood up, providing opportunities for investors to invest in pools of both existing and new projects. Many observers believe the rooftop PV segment will soon reach enough scale where asset securitization is likely to proliferate as well. Structured debt vehicles and working capital structures are also expected to play a more central role in future growth. Leading developers in the mini and microgrid segment have reached promising stages, but collectively appear to offer lower returns. Project-level efficiencies continue to improve and replicability is being proven, but the model inherently does not offer investors the same level of scalability. As new funds continue to emerge, there exists opportunity for family office investors to invest directly in these funds as key anchors. Representative deals in these categories are included below: Ztric, Small Commercial C&I Solar Ztric installs and maintains solar renewable energy systems for C&I customers using a combination of best of breed hardware and its proprietary artificial intelligence enabled technology platform. Ztric s scaling strategy combines its technology platform and a clustering approach that groups installations together to maximize efficiencies in supply chain, maintenance and costs. Unlike its competition, which typically focuses on larger system sizes, Ztric s vision is to focus on smaller rooftop systems, using technology to eliminate the inefficiencies and risks (land, transmission losses, congestion losses) associated with larger installations. Within 1.5 years of launching, Ztric has 1.2 MW of commissioned capacity, >5 MW of installation backlog, and a 40 MW active sales pipeline. Their customers credit risk is closely vetted. One of their recent clients is Magarpatta City, a highly rated private sector development of 170 residential buildings and 20 commercial buildings with an occupancy of over 50,000. Ztric is now implementing the first phase of the project: seven systems with an average size of 150kW. The next phase will implement 20 systems of 135kW each with the final phase completed throughout 2017 and Ztric estimates its integrated rooftop solutions comprising hardware, software and services typically save customers up to 50% in energy costs. Its revenue model consists of system sales with margins of up to 20% plus recurring revenue on long term maintenance contracts. Target project IRRs range from 12-20%. Customer sales and financing occur via cash sales, short term capital leases, and long-term power purchase agreements. The company plans to scale via on-balance sheet debt and the establishment of a project finance fund. The company has already raised $1.2M in equity from RKB Capital, an experienced industry player linked to founder and board chairman Peter Schleider, and has obtained a credit line from IFMR Capital, one of India s premier finance providers. The company is raising $5-10 million in the next round of equity financing to grow its business, add off-grid solutions (battery based) and expand across India. Can a vertically integrated solar model work in India? Much needs to occur in terms of market maturation before such a model could be viable and it is likely to make more strategic sense in the larger C&I and utility scale segments. Significant scale in downstream deployment capacity is necessary to validate vertical integration into upstream production. The fragmentation and scalability challenges inherent in the smaller rooftop space are not conducive to such a model. It is likely that securitization of any downstream assets would need to occur to provide enough access to low cost debt. Yet there are reasons why it has long-term appeal. Brand recognition in the Indian market goes a long way and a vertical conglomerate would capture significant customer relationships. Large C&I conglomerates have been proven across other sectors. Reports of hardware pricing pressure from Chinese OEMs may signal future supply challenges. Observers will watch the evolution of Orb Energy in India and SolarCity in the United States for clues on how a vertical model works in a maturing market. OPPORTUNITIES 45

46 Simpa, Solar Home Systems Simpa offers individual rooftop solar systems to energy-deficient rural households and shops under a lease-to-own financing model. The customers make a small deposit to get a solar system installed and then pay for the service and equipment over time. The proprietary SmartPanel technology enables remote monitoring, credit control and proactive service, but importantly, also provides prepaid mobile like payment flexibility to customers that they use to match their outflows with variable crop-linked cash inflows. The company has expanded its product suite and financing offerings as it has grown. Simpa offers three different types of systems, ranging from basic charging stations to reinforce existing battery and UPS solutions to fully-integrated solar home systems with lighting and appliances. Cash sales and lease terms of 1-3 years are available. The company has been unit profitable for over two years, has now achieved area profitability and has line-of-sight to corporate profitability in the 12 months. A replicable regional market entry approach has shown new districts to be profitable in under one year. The Company is backed by blue chip corporates like Engie, Schneider Electric and investors like Asian Development Bank, Proparco. It has also created a unique end-user asset financing model in partnership with local banks that adds scalability and predictability to future funding sources. The company is raising $10M growth equity to match these debt sources and scale into pre-identified new areas across six Indian states. This is likely to be the last equity round before corporate profitably. Funds & Other Initiatives US-India Catalytic Solar Financing Facility: The US and Indian governments have collaborated on the $20M US-India Clean Energy Finance Initiative and the $40M US-India Catalytic Solar Finance Program. 56 A consortium of foundations, including the John D. and Catherine T. MacArthur Foundation, William and Flora Hewlett Foundation, David and Lucile Packard Foundation and Grantham Foundation have been pursuing multiple initiatives under this program. OPPORTUNITIES 46

47 INVESTMENT CONSIDERATIONS

48 IMPACT POTENTIAL Investments in SHS, mini/microgrids and grid-connected rooftop PV carry different impact profiles. Given the unreliable nature of the central electricity grid in India, all of these verticals bring an element of energy access to the customers utilizing the systems either first-time electrification or improved reliability. First-time electrification of households and small enterprises is widely believed to bring health and socioeconomic benefits. Improving energy reliability for enterprises can have a meaningful impact on business performance and growth prospects. Deployment of such clean energy infrastructure also drives emissions reductions associated with the retirement (of existing) or deferral (of new) fossil fuel generation. Eliminating the use of kerosene and diesel fuel for lighting and heating also reduces CO 2 emissions. The scope of these impacts is determined in part by the geographies in which the systems are deployed and the scale of deployment. The impact potential can be viewed most simply on a spectrum, with first-time rural electrification bringing more direct benefits to individual households and small enterprises and deployment of rooftop PV for small C&I enterprises driving more significant emissions reductions. Figure 22. Continuum of impact potential Mini/Microgrids Solar Home Systems Grid-tied Rooftop PV Energy Access Impact Potential CO 2 Reduction In addition, as seen in other mature solar markets over the past decade, scaling deployment of these systems carries significant benefits for local employment. It is estimated that growth in rooftop solar could support 238,000 new jobs over the next five years. 57 Quantification of direct health benefits for customers associated with deployment has been a challenge to date. However, a reduction in use of kerosene is believed to have a significant health advantage related to exposure and consumption of smoke and particulate matter. Broadly, deployment of solar has been found to reduce sulfur, nitrogen, particulate emissions, and reduce the rate of premature mortality from sulfate particles. Distributed solar deployment has a secondary benefit of improving water use by reducing the amount of water necessary to operate power plants. This can be a particularly acute issue in water-constrained regions. INVESTMENT CONSIDERATIONS 48

49 Rooftop PV Widespread deployment of rooftop PV for small C&I customers could potentially substantially reduce future CO 2 emissions associated with thermal coalfired generation. The impact profile of investment in this segment is more aligned with traditional climate-focused infrastructure. According to analysis by Encourage Capital, deploying rooftop PV systems on all 3 million small and medium sized enterprises in India would avoid annual emissions of million metrics tons per year. This segment alone would reduce India s annual emissions per year by >1% over 2016 levels. Reliability is a challenging metric to define as its benefits can be diffuse. However, in the context of hours per day of electricity availability, investment in this category can minimize the down time of grid-connected households and SMEs with unreliable supply. In this context, improving the capacity factor on equipment and machining operations can lead to productive use gains, which improve socioeconomic profiles. Mini & Microgrids Many of the first-time electrification benefits referenced above are also realized by deployment of these systems. Analysis by Smart Power India of the mini and microgrids deployed across 39 project sites, 1000 households and 320 microenterprises found more direct impact on socioeconomic factors than the Science Advances study note above. While the experimental methodology to yield these findings is unlikely to be as scientific, these results are included on the next page. Solar Homes Systems Historically, these systems have been deployed in rural areas and provided electricity to households for the first time. The size of the system matters small SHS and large SHS can generate very different impacts. Smaller systems are mostly for lighting and charging mobile devices. Larger ones can power small productive appliances and can potentially generate significantly larger development opportunities. These productive loads are believed to be more directly linked to socioeconomic status improvement, though data does not confirm this belief. Increasingly, SHS are being sold to customers in villages where the central grid already exists, but is unreliable. As noted in the Market Overview, over 60% of households in many Indian states only have grid electricity available <4 hours per day. Yet these households are deemed by the government to have been electrified. Solar home systems can significantly minimize the downtime associated with these outages and provide families (and small businesses) more reliable power. INVESTMENT CONSIDERATIONS 49

50 Figure 23. SPRD impact analysis of 39 project sites Promoting inclusion, 77% connected business unit owners belong to the socially excluded groups (OBC: 69%, SC/ST 8%) Creating new business opportunities, 7% of current business units have attributed starting their business to SPRD electricity Public facilities operate for longer hours, 70% of surveyed households perceived an increase in operating hours of public facilities (Markets, health facilities) Expansion of existing businesses, 11% microenterprises purchased newer appliances; 52% wanted to expand their business (e.g. mobile shops purchasing printers indicating a new line of activity) Increase in children s study hours, survey respondents felt that SPRD electricity led to an increase in children s study hours by 2 hours per day Increased incomes, microenterprises and shops reported an increase of 12-15% in monthly revenues; new businesses with greater social/economic benefits (computer training center) have come up Improved perception of safety and security, 75% of the surveyed households felt that injuries due to improper lighting have reduced Improved health, 23% households and 25% microenterprises completely stopped using diesel and kerosene for lighting purposes. Women perceived reduction in respiratory problems due to change in lighting source Transparent, industry-standard metrics for impact have been widely debated in recent years. Companies use different methodologies in quantifying their impact. Many headline datapoints can be misleading. The Global Off-Grid Lighting Association (GOGLA) has convened a working group on this topic, which released a proposed set of industry standard metrics in Q As referenced on the next page, socioeconomic improvement metrics have been much harder to quantify. Productive load interventions are a focus of many impact investors in recent years. This impact thesis holds that in addition to providing electricity access, financing refrigeration equipment or micro industrial capital equipment associated with small business operations would spur enterprise development in rural areas. Yet with minimal operating data and a dearth of scientific statistical experiments, the anecdotes of the energy ladder have remained largely unproven. A paper published in Science Advances in May 2017 released the findings of a randomized field experiment in India designed to estimate the causal INVESTMENT CONSIDERATIONS 50

51 effect of off-grid solar power on electricity access and broader socioeconomic development of 1281 rural households. While electrification rates increased by 29 to 36%, the authors found no systematic evidence for changes in savings, spending, business creation, time spent working or studying, or other broader indicators of socioeconomic development. 58 Caveats for these findings should be noted: relevant socioeconomic behaviors may take longer than one year to meaningfully change and the size of the systems analyzed did not support productive loads. Figure 24. GOGLA social impact tracking metrics 59 GOGLA social impact tracking metrics version 2.0 Metric 1ai. Improved energy access, historically 1aii. Improved energy access, currently Formula S * S L * S rep * HH (S n,j ) * S L * S rep * HH 1b. Basic energy needs met (S n,j ) * S L * S rep * F se4all 2. Livelihoods supported (S n,j * S L *B) + L 3. Status quo lighting source no longer in use (S n,j ) * S L * RR 4a. Household change in available hours of light (%) 100% * (( [average] U R /SQ.U R ) 1) 4b. Household change in available light output (%) 100% * (( [average] U LU /SQ.U LU ) 1) 5a. Savings on energy-related expenditure, per household (SQ.U C * RR * U LI ) U P 5b. Savings on energy-related expenditure, in aggregate S * S L * ((SQ.U C * RR * U LI ) U P ) 6. Greenhouse gas emissions offset S * S L * RR * SQ.U GHG (S * U p * U GHG /U LI ) Where: S = number of units sold S L S rep HH = discount for loss = discount for repeat sales = average household size S n,j = number of units sold within lifespan of products (year n-j to n) 1 F se4all B L RR [average]u R SQ.U R [average]u LU SQ.U LU SQ.U C U LI U P SQ.U GHG U GHG = Tier 1 access factor for SE4ALL framework = percentage of customers using solar products for business = number of supply chain livelihoods supported = average replacement ratio of status quo lighting for solar = average run-time of solar product = average usage per day of status quo product = average lumens of solar product = average lumens of status quo product = average annual operating cost of status quo source = average solar product lifetime = average retail price of solar product = average annual greenhouse gas emission volume of status quo source = average embodied greenhouse gas of solar product INVESTMENT CONSIDERATIONS 51

52 LEGAL & TAX CONSIDERATIONS Following are two prevalent structure that have been adopted by various players in India who are operating and managing solar energy projects: Holding Company Structure ( HCS ) A typical HCS will have a holding company ( HoldCo ) which will set up various special purpose vehicles ( SPVs ) to house each solar energy project. This helps HoldCo to ring fence its assets and at the same time enjoy the benefit of valuation of the projects by consolidating the financials of all SPVs within its ambit. HoldCo by virtue of its financial position in turn also assists SPVs to raise finances and backstop the financial obligation to the lenders. HCS can be structured as an India based HoldCo or an offshore based HoldCo depending the investor base and kind of capital that is required to fund the SPVs. From investors perspective, investors invest in the HolCo and enjoy the aggregate benefit of the valuation of all the SPVs. Yield Company Structure ( YCS ) YCS is another prevalent structure in use with respect to solar energy projects. Under YCS, solar energy projects are divided as developing and developed projects, and each set of projects are housed under a separate holding company. Thereafter, developing projects are rolled from one holding company to the other close to completion. This structure offers flexibility to the investors to invest based on their risk appetite. Developing projects offer comparatively high yield as they have a higher risk involved. Whereas, developed projects provide stable moderate returns as they have lesser risk. Regulatory Considerations Foreign investors can invest in the budding solar sector of India in the form of equity as well as debt. Solar energy projects are classified as infrastructure for the purposes of the foreign investment. In India, foreign investment in solar energy projects can be broadly made through any of the following regimes: 1 Foreign Direct Investment ( FDI ); 2 Foreign Venture Capital Investment regime, for investments made by SEBI registered Foreign Venture Capital Investors ( FVCI ); 3 Foreign Portfolio Investor regime, for investments made by registered FPI ( FPI ); and 4 External Commercial Borrowing ( ECB ). 1 FDI Regime Under FDI regime, investments can only be made in the form of pure equity or the instruments which are mandatorily convertible into equity. FDI regime segregates the sector broadly under two categories, i.e. sectors in which investment is permitted under automatic route (the sectors wherein permission of any governmental authority is not required) and approval route (the sectors wherein permission of any governmental authority is required). INVESTMENT CONSIDERATIONS 52

53 Investment in solar falls under automatic route. Further, the foreign investor is not required to register itself with the Indian authorities for the investment under FDI regime, barring certain registrations with Indian tax authorities. Considering that the Indian economy does not permit capital account convertibility, pricing conditions have been imposed with respect to entry and exit for foreign investors under FDI regime FPI Regime Under the FPI regime, foreign investors can invest either in equity or debt securities, but such securities should be listed securities or securities which will be listed on a recognized stock exchange in India within 2 weeks of such investment. To that extent, foreign investors looking to invest in the shares and securities of an Indian company whose shares are listed on a stock exchange, invest under FPI regime. It is also pertinent to note that FPI regime permits foreign investors to invest in India in the form of unlisted debt. FPI regime and Indian exchange control regulations do not impose any condition with respect to the returns that a foreign investor can reap with respect to the debt investment through FPI regime. Furthermore, it is pertinent to note that the foreign investors must mandatorily register themselves with a depository participant to invest under FPI regime and must obtain certain registrations with Indian tax authorities, but the process of mandatory registration is quite simple and is not time consuming. 3 FVCI Regime Under the FVCI regime, investments can be made in the form of the equity and debt instruments. However, unlike FDI regime and FPI regime, FVCI regime is slightly restrictive in terms of the sectors in which the foreign investors can invest. Recently, the framework governing FVCI regime was revised and investments under infrastructure sector was permitted. Hence, FVCI regime can also be used for the purposes of investing in solar energy projects. FVCI regime was introduced to facilitate investment in the sectors which are slightly more capital intensive in nature. In order to incentivize foreign investors, quite a few exemptions and benefits have been provided to FVCI registered foreign investors including the following: their investment is not subject to pricing conditions and they have more flexibility in deciding the nature of the security pursuant to which they want to invest. For the purposes of investing pursuant to FVCI regime, foreign investors must mandatorily register themselves with India s central bank, Reserve Bank of India ( RBI ). As compared to FPI regime, the process for obtaining registration under FVCI regime is slightly more complex and time consuming. 4 ECB Regime External commercial borrowings are commercial loans raised by Indian companies from foreign investors. Unlike FDI, FPI and FVCI regimes, ECB regime is quite closely regulated by RBI. Detailed framework has been prescribed with respect to the eligibility criteria of Indian entities for availing ECB and foreign investors to invest pursuant to ECB. Further, the restriction has been INVESTMENT CONSIDERATIONS 53

54 imposed with respect to the tenor of such loans, end uses, maximum returns etc. It is pertinent to note that Indian companies can avail ECB either in US Dollar or Indian Rupee. Tax Considerations Developer/Indian company perspective The Government of India has been providing various financial and tax incentives to promote the solar sector. The government is slowly reducing the following benefits with the decrease in the overall cost of solar power generation. 1 Direct Tax Under Section 80IA of the Income Tax Act, 1961, the solar energy companies were allowed 100% waiver on the income generated from solar energy projects for a period of any 10 years during first 15 years of the operational life of the solar power plants commissioned on or before March 31, However, the aforementioned tax holiday has been withdrawn from April Under Section 32 of the Income Tax Act, 1961, solar energy projects were eligible to avail depreciation of 80% of asset value, which could be extended to up to 100% of the asset value. However, the extent of such exemption has been curtailed to a maximum of 40% of the asset value. This will lead to spread of the depreciation to the subsequent years, hence, should not have any impact on the viability of such solar energy projects. 2 Indirect Tax India recently adopted unified tax ( GST ) with respect to indirect taxes which has subsumed almost all indirect taxes. Prior to the introduction of the GST regime, a series of central and state taxes were levied on solar devices and systems, including central excise duty on manufacture, central sales tax on inter-state sale, sales tax / value added tax ( VAT ), along with the service tax which was applicable on the services rendered in relation thereto. Although credit was available for input in relation to the indirect taxes paid, such credit was not uniformly available across central and state levies which used to lead to a cascading of taxes. Central excise was charged at a residual rate of 12.5% on the manufacture of solar cells whether or not assembled in modules or panels and equipment gadgets based on solar energy, while concessional rates varying from nil 6% were charged on specific items, including flat plate solar collectors, solar photovoltaic cells and solar tempered glass used in their manufacture. 61 Moreover, a general exemption was given for all items of machinery required for the initial setting up of a solar power generation project or facility provided, subject to a recommendation for grant of exemption from the Ministry of New and Renewable Energy. 62 In addition to the applicable excise duty, each state levied VAT at rates varying from nil 5% on the sale of solar energy devices and parts. The burden of high tax rates was further compounded by a cascading effect, since taxes were collected at two different stages by at least two different authorities with no tax set-off allowed between them. This is expected to change following the introduction of the GST regime, under which a signifi- INVESTMENT CONSIDERATIONS 54

55 cantly lower single rate of 5% is charged on the supply of solar power based devices, solar power generating systems, and parts for their manufacture, and also on solar water heaters and systems. 63 However, since the supply of electricity itself remains exempt even under the GST regime, 64 entities involved in solar power generation are unlikely to experience significant benefits, given the unavailability of refund of unutilized input tax credit on exempt supply. 65 On the other hand, entities that captively consume solar power based devices are likely to see significant benefits from the transition to the GST regime. Investors Perspective Investors can optimize their return on investment by undertaking following actions: 1 Investment from intermediate jurisdictions that have Double Taxation Avoidance Agreements ( DTAA ) India has entered into DTAA agreements with various countries. DTAA agreements help both Indian companies (which are in the business of operating and managing solar energy project) and investors by allowing them to avail benefits under DTAA with respect to capital gains, interest income, dividend income etc., which may arise on account of exit from the investment and/ or seeking returns from the investment. Investors and Indian companies can avail benefits under DTAA provided that they are able to demonstrate substance in these jurisdictions. Mauritius, Singapore, Netherlands and Cyprus are few jurisdictions which are preferred for the purposes of investments in India across sectors. More recently, the Indian government has renegotiated various DTAA agreements to discourage foreign investors from using intermediate structures without substance to minimize taxes in India. 2 Use of debt Considering that the solar energy business is income generating, companies can avail debt as a form of financing as it helps in offsetting the income generated. Debt minimizes the outflow of funds towards corporate tax, thereby indirectly assisting the growth of solar energy business. Furthermore, few DTAAs also provide for nominal tax on interest income received by an investor, thereby increasing their return on the investment. Non-convertible debentures (NCD) is one of the most favored instruments, which is used for the debt investment in India. The FPI regime sets out the framework for NCD investment in India. If investors are looking at India for a long-term period, wherein multiple investments will be undertaken, they may consider the following two investment vehicles: 1 Non-Banking Financial Company ( NBFC ) An NBFC is an Indian company registered with RBI which has the flexibility of investing in other Indian companies in various forms i.e. loans, acquisition of shares, debentures, convertible shares/debentures etc. Foreign investment in NBFCs is permitted under automatic route under FDI route wherein the INVESTMENT CONSIDERATIONS 55

56 relevant parties will have to adhere to the pricing guidelines set out above. RBI has prescribed certain credit concentration norms which each NBFC has to comply in terms of (a) the quantum of the net owned funds that NBFCs have to maintain at all times; (b) investments or lending by an NBFC in a company or group of companies. Even though NBFC regime provides a lot of flexibility for investment in India, flexibility is not available for providing returns to the investors who have invested in the NBFCs. Returns can be provided to the investors in the form of dividend, but such return is tax inefficient as the dividend can be paid out of net profit (i.e. profit of a company post around 30% corporate taxation) and an additional dividend distribution tax of around 15% is applicable on the divided at the hands of the company. Further, NBFC can provide exit to the investors by way of buy-back of shares or capital reduction, both of which are quite an elaborate and time-consuming process. Apart from the returns and exit, another factor that must considered with respect to NBFC is the RBI compliances, which have to be undertaken throughout the life of NBFCs, and time frame for obtaining a registration certificate from RBI, which can extend up to weeks. 2 Alternative Investment Fund ( AIF ) Compared to NBFCs, AIF is a relatively new concept. AIF involves setting up a manager / sponsor entity and the appointment of a trustee. Additionally, the draft of the private placement memorandum needs to be drafted and filed with Securities Exchange Board of India ( SEBI ) for their comments, post receipt and incorporation of which AIF can be set up. AIFs categorized as category I AIF, Category II AIF and Category III AIF. 66 Time frame for setting up of an AIF is around 4-6 weeks from the date the application is made to SEBI. Considering that AIF is a pooling vehicle, funds can be pooled from both offshore and onshore sources ( Unit Holders ). Even if the majority funds are pooled for offshore sources, AIF is still considered as a domestic entity hence, all the conditions set out in Section C (Regulatory Aspects) do not have to be complied by AIFs while making the investment in Indian companies. The only factor that has to be considered in this case is that the manager / sponsor entity should not be foreign owned or controlled. Unlike NBFC regime, AIFs have been granted a pass-through status, hence, the returns can be provided to the Unit Holders in much simpler and tax efficient manner. As such, AIF is advisable as an investment vehicle compared to NBFCs. INVESTMENT CONSIDERATIONS 56

57 CONCLUSION

58 There are ready, commercially viable distributed generation investment opportunities businesses and projects in India right now, though the complexity and dynamism of the market demands reasonable due diligence. While climate-minded investors may be drawn to the comparatively mature and stable market-rate returns of the Rooftop PV segment, the potential to drive access via microgrids or solar home systems may draw other frontier-minded investors. Regardless of segment, there are attractive near-term opportunities in each market. Top tier developers from each segment are raising capital at the time of publication. At the same time, funds, advisors, and bankers are actively creating a range of investment structures: direct equity, debt, project finance, partnerships with local financial institutions, and participation in innovative financing vehicles managed by other foreign entities. The need for capital to underlay the transformation of India s power infrastructure gives foreign investors the opportunity to be both catalytic to India s economy and drive impact. Distributed renewables can prevent globally relevant amounts of future CO 2 emissions and help 200 million people see newfound reliable electricity service. Given the unreliable nature of India s central power grid, systems in all of these verticals bring an element of energy access to their customers, either first-time electrification or improved reliability. First-time electrification of households and small enterprises is widely believed to bring health and socioeconomic benefits. At the same time, improved energy reliability for enterprises can have a meaningful impact on business performance and growth prospects. India has many needs. Even as business models have evolved rapidly in recent years, financing gaps and challenges have stubbornly remained, again suggesting a need for new catalytic capital. International DFIs and concessionary capital sources have played an admirably meaningful role to date, but more money is needed. There must be additional capital for developers on better terms than prevailing market rates. More project financing is needed. The lack of operating track records and project performance data have contributed to a high cost of project debt, if it is available at all. Business model risk, market adoption risk, and technology risk are all still factors, though progress toward mitigating each has continued. Despite these challenges, India s distributed renewable financing gaps create space for foreign investors to generate impacts and achieve commercial returns if they can bring the skill to manage credit risk, currency risk and debt tenures. Distributed renewable generation has the potential not only to bring savvy investors financial returns, but also the potential to unlock some of the dynamism of India s economy and India s people. CONCLUSION 58

59 ACKNOWLEDGEMENT & REFERENCES