Ambit Capital Pvt Ltd.

Power Sector
Ambit Capital Pvt Ltd.
SECTOR UPDATE

CERC's Renewable Energy Tariff

Regulations to boost sector
In line with the objective to attract new investments in the power sector, and
specifically, to promote renewable energy, the CERC, which regulates inter-state
power sector, announced new tariff regulations for grid-connected renewable
energy power projects. These regulations assure developers of a higher return
on the equity invested and indirect incentives if the developer can contain capital
and operational costs.

In India, only 8.7% of the total grid-connected power capacity is attributable to

the renewable energy segment. Thus at an installed base of 13,242MW, this
segment constitutes merely 21% of the potential 62,853MW from only small hydro
and wind power. The potential of solar, biomass and waste-based power projects
is estimated to be a further 625,500MW, of which solar-based projects alone
contribute 600,000MW. Thus, the solar segment alone has the potential to fuel
India's entire present electricity requirement.

We believe that the overriding philosophy of these new regulations is to promote

power generation from renewable energy sources by giving a preferential/
differential tariff to such projects. This, we believe, will go a long way to help
achieve the target of 15% of total generation from renewable energy sources by
2020, a target set under the National Action Plan on Climate Change.

What the new CERC regulations entail

1. The new CERC regulations for renewable energy tariffs includes biomass,
non-fossil fuel-based cogeneration, small hydropower projects (up to
25MW), solar power projects (photovoltaic thermal, and hybrid), and any
other technology as approved by the Ministry of Renewable Energy (MNRE).

2. They allow a higher return on equity (RoE) for renewable energy power
projects than that allowed for fossil fuel (coal and gas) -based power projects.
They ensure that developers earn 19% pre-tax RoE for the first ten years,
and 24% pre-tax RoE in the remaining period while specifying that the returns
would be adjusted for capital subsidies and accelerated depreciation benefits,
if any, availed by the developer.

3. The regulations have also specified the capital cost and the normative
operational costs that would be considered for tariff determination.

4. Thus, the regulations enable a developer to know, upfront, the tariff that
they can earn. Hence, a developer who manages to implement a project in
less than the specified capital cost and / or operate the power project at
lower costs would earn an even higher return.

5. While the useful life of renewable energy projects has been specified to range
from 20 years for biomass projects to 35 years for small hydroprojects (up to
25MW), the tariff would be spread over a different period ranging from 13
years for wind projects to 35 years for small hydroprojects.
Analyst
Mehul Mukati
Tel.: +91-22-3043 3211
mehulmukati@ambitcapital.com

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Exhibit 1: Useful life and tariff period

RE Source Useful Life Tariff Period
Wind 25 years 13 years
Biomass, non-fossil fuel cogeneration 20 years 13 years
Small hydro <5MW 35 years
35 years
Small hydro >5MW 13 years
Solar PV / Thermal 25 years 25 years
Source: CERC, Ambit Capital research

6. A provision allows the CERC to determine tariffs on a case-by-case basis for

renewable energy sources such as solar power and other emerging
technologies.

7. The various normative parameters would be reviewed by the regulator each

year, and the regulation itself would be reviewed every three years. The present
regulations are applicable until FY13.

Our view
These regulations, along with the state regulators mandating minimum electricity
purchases from renewable energy sources, are expected to lead to higher growth
in the renewable energy segment. We expect Thermax, Praj Industries, Moser
Baer and Suzlon to benefit on account of higher order inflows from developers
intending to set up renewable energy power projects.

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Annexure: Key highlights of the CERC renewable energy tariff

regulations
The CERC renewable energy tariff regulations include the following types of
renewable energy sources:

Exhibit 2: Eligible renewable energy sources

Type Highlights
Biomass l Waste produced during agricultural and forestry operations (straws, stalks etc.)
l Produced as a by-product of agricultural processing operations (husks, shells, de-oiled
cakes)
l Wood produced in dedicated energy productions

Hybrid Solar Thermal l Wood waste produced in some industrial operations

l Which uses other forms of energy inputs along with solar thermal; and
l Wherein at least 75% of electricity is generated from solar power components

Non-fossil fuel based l The process in which more than one form of energy (e.g. steam and electricity) are co-
generation produced in a sequential manner by use of biomass
l Subject to cogeneration eligibility criteria as per Regulation 4(4)

Small Hydro l Hydropower plants with station capacity up to 25MW

Solar PV power l Solar photovoltaic power projects that use sunlight for direct conversion into electricity via
photo voltaic technology

Solar thermal power l That which uses sunlight for direct conversion into electricity through Concentrated Solar
Power technology based on either line focus or point focus principle

Renewable Energy l Power plants other than conventional power plants generating grid quality electricity from
Power Plants renewable energy sources
l Renewable energy sources include: small hydro, wind, solar (including integration with
combined cycle), biomass, biofuel cogeneration, urban/municipal waste and other
sources as approved by MNRE
Source: CERC, Ambit Capital research

Useful life
The tariff regulations specify the useful life of each of the different types of
renewable energy. The definition states that useful life begins from the date of
commercial operations (CoD). The useful life for different forms of energy is given
below:

l Wind 25 years

l Biomass, non-fossil fuel cogeneration 20 years

l Small hydro 35 years

l Solar PV/thermal 25 years

Eligibility criteria (Regulation 4)

Renewable energy projects that seek to be eligible for tariffs under these
regulations require to conform to the criteria as stated below:

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Exhibit 3: Eligibility criteria for being covered under these regulations

RE source Key criteria Other criteria
Wind l Should be located at wind sites with minimum AWD to be measured
annual wind density (AWD) of 200W/m2 at hub height of 50 meters
using new wind turbine-generators
Small hydro l Should be located at sites approved by the state Project to be set up using new plant and
nodal agency/state government machinery
Should have station capacity of up to 25MW
Biomass l Should use Rankine Cycle technology by the Project to be set up using new plant and
Fossil fuel use up to max. of 15% of annual fuel machinery
consumption is permitted
Non-fossil fuel l Should be in accordance with the definition Project to be set up using new plant and
-based l Sum of useful power output and ½ of useful thermal machinery
co-generation output >45% of facility's energy consumption Topping cycle mode of co-generation:
during season facility which uses non-fossil fuel input for
power generation and utilises thermal
energy generated for useful heat
applications in industrial activities
simultaneously
Solar PV/ l Should be based on techonologies approved by
Thermal MNRE
Source: CERC, Ambit Capital research

The control period is the period for which these regulations are applicable. The
regulations have defined a control period of three years, the first year being the
present fiscal i.e. FY10.

Tariff period is defined as the period for which the tariff set under these
regulations would be applicable. The tariff period for different renewable energy
sources has been defined thus:

1. Small hydro < 5MW 35 years

2. Solar PV / thermal 25 years

3. All others 13 years

Project specific tariff

The CERC would determine tariffs on a case-by-case basis for the following types
of projects:

1. Renewable energy projects commissioned before the notification of these

guidelines and for which no PPA has been signed

2. Municipal solid waste

3. Hybrid solar thermal projects

4. Solar PV/thermal projects, if the developer so opts for

5. Biomass projects not using Rankine Cycle technology

6. Any other new renewable energy source/technology approved by MNRE

The CERC will determine generic tariffs at least six months prior to the beginning
of each year of the control period.

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The regulations both outline and detail the tariff structure for renewable energy
projects. The regulations prescribe a single part tariff with the fixed cost consisting
of the following components:

1. Return on equity

2. Interest on loan capital

3. Depreciation

4. Interest on working capital

5. Operation & maintenance (O&M) expenses

The regulations also specify that renewable technologies which partially use non-
renewable energy sources as fuel, would in addition to the above fixed costs,
have a fuel cost component.

These regulations have also specified the tariff design. The regulations state that
the regulator (CERC) would determine the generic tariff on a levelised basis for
the tariff period for all projects. In addition, for projects that also have a fuel cost
component, the fuel cost would be determined on an annual basis.

The discount rate to be used for determining the levelised tariff is WACC (weighted
average cost of capital) for the project.

The regulations clearly state that the costs are to be levelised over the useful life
of the projects, though the tariff so determined would be applicable only for the
tariff period. This is important, as can be seen from the table below:

Exhibit 4: Useful life and tariff period

RE Source Useful Life Tariff Period
Wind 25 years 13 years
Biomass, non-fossil fuel cogeneration 20 years 13 years
Small hydro <5MW 35 years
35 years
Small hydro >5MW 13 years
Solar PV / Thermal 25 years 25 years
Source: CERC, Ambit Capital research

The regulations also clearly state that renewable energy projects (as per these
regulations) would not be subject to merit order despatch, and are to be treated
as 'must run' power plants. The only two exceptions to this are: (1) biomass
projects more than 10MW, and (2) non-fossil fuel-based co-generation projects.
The IEGC (Indian Electricity Grid Code) would be applicable to these projects, as
also the CERC Unscheduled Interchange (UI) regulations.

The regulator has set the following definitions to determine tariffs

Capital cost: for a renewable energy project would include all capital work,
including: (1) plant and machinery, (2) civil work, (3) erection and commissioning,
(4) financing, including interest during construction, and (5) evacuation
infrastructure up to inter-connection point.

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Debt-equity ratio (DER): would be considered at 70:30 for generic determined

tariff. In case of project specific tariffs, the equity component cannot exceed 30%
of the total capital for tariff purposes. Thus, as with all other non-renewable
power projects, DER would be considered at 70:30, if equity component is greater
than or equal to 30% of the total capital. If the equity component is below 30%
of the total capital, then the actual DER would be considered for tariff
determination.

The regulations specify that any equity invested in foreign currency is to be

converted on the date of each investment.

Loan and interest on long-term loan: The regulations have specified the loan
tenure and the benchmark interest rate to be used for tariff determination. The
loan tenure would be assumed to be ten years, and the interest rate would have
to be the average long-term PLR of SBI in the previous year plus 150bps.

In addition, the regulations state that no moratorium is to be considered, and

that repayment would be considered from the first year itself. However, the amount
of interest on the loan cannot exceed the amount of annual depreciation.

Depreciation: The regulations specify that depreciation can be claimed only on

the capital cost allowed by the CERC, and that 10% of the value base (i.e. capital
cost allowed by CERC) would be assumed to be the salvage value. Thus,
depreciation would be allowed on only 90% of the value base of the project.

Further, the regulations state that a 'Differential Depreciation Approach' would

be used with a depreciation rate of 7% p.a. for the period of the loan tenure (i.e.
the first ten years) and the balance would be the depreciation up to the end of
the useful life on a straight line basis.

The regulations specify that in the first year of operation, only prorate depreciation
can be claimed.

Return on equity: The regulations allow for a pre-tax return on equity at 19%
p.a. for the first ten years, and at 24% p.a. for the remaining useful life of the
renewable energy project.

Working capital loan: The regulations allow for the working capital on the
following basis

Exhibit 5: Normative working capital norms

WC component Wind / small hydro / solar PV / Biomass / non-fossil fuel
solar thermal cogeneration
O&M expenses 1 month 1 month
Receivables 2 months 2 months
Maintenance spares 15% of O&M expenses 15% of O&M expenses
Fuel NA 4 months at normative PLF
Source: CERC, Ambit Capital research

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O&M expenses: are to be considered on a normative basis as specified by the

CERC. An escalation of 5.72% p.a. over the tariff period would be allowed.

Rebate: The CERC through these regulations allows for a 2% rebate, in case
payment is made through a letter of credit and a 1% rebate, if payment is made
through any other mode within one month of bill presentation.

Late payment surcharge: The CERC regulations similarly allow the developer
to charge late payment charges of 1.25%/ month if the delay is beyond 60 days
from the date of the bill.

Sharing of CDM benefits: The CERC is aware that project developers avail
CDM benefits,, and hence has specified a clear benefit sharing mechanism as
follows:

Exhibit 6: Structure for sharing CDM benefits

Year / period Developer's share Beneficiaries' share
Year 1 100% Nil
Year 2 90% 10%
Year 3 80% 20%
Year 4 70% 30%
Year 5 60% 40%
Year 6 onwards 50% 50%
Source: CERC, Ambit Capital research

Subsidy/incentive: The CERC is also aware of the other income tax benefits
available to renewable energy project developers. Hence, for tariff determination,
the CERC will take into account all the subsidies and/or incentives, including
accelerated depreciation benefits.

The CERC has outlined in these regulations the following principles to be

considered for ascertaining the income-tax benefit on account of accelerated
depreciation: (a) to be based on normative capital cost, and (b) capitalisation in
H2 of the fiscal year

The per unit benefit of the subsidy/incentive is to be derived on a levelised basis

using WACC as the discount factor.

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Exhibit 7: Summary of Normative parameters for tariff determination

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Note: $ indexation to be allowed as per formula;

* escalation of 5.72% p.a. allowed;
# for generic regulator determined tariff. For solar PV/thermal projects, the developer has the option of requesting the regulator for
specific tariffs, which would be determined on a case-by-case basis
Source: CERC, Ambit Capital research

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Explanation of Investment Rating

Investment Rating Expected return

(over 12-Month period from date of initial rating )
Buy >15%
Hold 5% to 15%
Sell <5%

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Ambit Capital Pvt Ltd.
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