In recent months, financing of IPPs in India has begun to regain currency amongst international lenders. The rekindled lending appetite is both symptomatic of sectoral reform and the adoption of competitive bidding processes and an availability-based tariff regime.

The fundamental reform has been in the way the sector functions. The adoption of traditional cost "pass-through" based contracting constructs lacked viability, given the insufficient financial strength of the Indian electricity sector to support them. Consequently, it has been necessary to explore an alternative to those constructs based on a sharing of price, currency and interest rate risks between generators, offtakers and consumers, one which would ensure that, at all times, each of these parties was incentivised to perform in order to realise its commercial intent.

The enactment of the 2003 Electricity Act catalysed most states into transforming their electricity sector; from a predominantly state-owned vertically integrated electricity producer and supplier of public goods, into functionally disaggregated, commercially oriented service providers, albeit, still substantially state-owned.

By separating the myriad activities into generation, transmission, electricity aggregation (bulk supply), distribution and trading, the ensuing entities have been made more accountable for their performance resulting in gains in operation and commercial efficiency.

New regulatory regime

A new regulatory regime, comprising, the Central Electricity Regulatory Commission (CERC) and various State Electricity Regulatory Commissions (SERCs), has been set up to regulate tariffs of generating stations and regulate and approve licences for transmission, distribution and trading. This has not only ensured that the regulatory function is distanced from the state (leaving the state with the role of a policy maker), thereby providing a level playing field, but also ensured that regulatory processes have been put in place to establish and incentivise commercial behaviour between the various sector participants. Moreover, these regulators have also instituted a new level of discipline amongst sector participants and ensured objectivity in the tariff setting process for licensees.

Apart from these fundamental changes, two key initiatives herald the onset of cross border financing for IPP projects.

First, India is adopting and developing a competitive bidding framework for new projects, which has not only resulted in offtakers benefiting from robust, sustainable tariffs but has also enabled a wider consensus to be established between stakeholders on the requirement for and "least-cost" nature of, the generating capacity being contracted.

A formal structure, within which states can seek to contract for generation capacity from plants located in other states, has in turn encouraged IPPs to develop optimal capacities that are based on optimising plant technical parameters and thereby achieving optimal capital costs. The central government has also directly contributed to the bidding efficiency by successfully tendering the development of the Ultra Mega Power Project (UMPP) programme, each UMPP with a capacity of about 4,000MW.

Second, the availability based tariff (ABT) regime has been uniformly introduced across the country. This construct provides a robust incentive (and penalty) mechanism for adherence to (and deviations from) agreed dispatch schedules, thereby improving grid discipline and frequency stabilisation, resulting in better demand and supply management, flattening of the load curve, ensuring an enhanced utilisation of low-cost generating stations and most importantly, encouraging bilateral trading. A number of states, such as Andhra Pradesh, Orissa, Himachal Pradesh, have started actively resorting to bilateral trading to maximise revenues. This regime has resulted in IPPs gaining the right to sell surplus capacity to third party consumers in the event of a payment default or sub-optimal dispatch.

Aside from these sectoral factors, Indian banks and financial institutions have demonstrated an appetite for providing long term debt facilities for up to 75% of project cost in locally denominated debt – although given the large number of generation capacity financings recently closed, some of the smaller participants are expected to be close to their sectoral exposure levels.

Project selection

The confluence of these factors has spawned a large number of projects across the country, each predicated on bespoke competitive strategies. While some of these projects may not have the risk profile to find favour with international banks, there are a number of identifiable factors that make a potential IPP eminently suitable for financing in the international bank market.

The existing contracting regime places significant reliance on the generator's ability to manage, at least partially, its sales to parties other than the anchor offtaker. This enables the generator to by classified as a Mega Power Project and get additional fiscal benefits. This requires the sponsor to demonstrate not only an ability to develop a world class project, but also to identify and contract for at least a part of the capacity on terms other than typical to long term power purchase agreements.

Moreover, since even the long-term PPAs do not provide for buy-out provisions, there is an inherent tension requiring the IPP to demonstrate that it would be able to replace a defaulting offtaker, if such need arises. This in turn, requires the developer to ensure that the cost of the plant and the variable cost of generation are kept competitive, primarily by adopting hybrid EPC contracts for plant and gaining direct control over the supply and cost of fuel, which constitute a key component of cost.

Access to other facets of the business – such as electricity trading, coal sourcing and mining (for coal-based plants) – are therefore as important to managing the business risks, as is experience in commercial contracting and construction oversight. Also, a robust hedging strategy needs to be adopted to ensure that while sponsors benefit from favourable currency (INR) movements, the downside risk is well mitigated.

The above factors, significantly widen the universe of sponsors that international lenders will seek to support. A key factor in this selection is also how core the electricity generation, distribution and trading business is to the overall business of the sponsor and the ability of the sponsor to therefore develop a portfolio of generating assets with a mix of fuels which may help to alleviate the commodity concentration risk. Thus for example, a sponsor with access to domestic and imported coal may be able to better manage coal price and foreign exchange variations by substituting one source for the other to partially offset adverse effects.

Access to capital and an ability to provide a meaningful level of sponsor support is viewed as critical within the context of developing a portfolio and assuming completion related risks.

As in other countries, a significant emphasis is placed on the ability of the offtaker to support a long-term offtake in its capacity as an anchor offtaker. Given the ABT regime, the level of commercialisation achieved by the offtaker and its ability to offset the cost of idle capacity through actively supporting the trading of power to maximise dispatch, is equally relevant from the perspective of managing its financial commitments under the PPA.

Within this context, the key success factors to financing a power project, from an international bank market perspective, can be summarised as follows:

Table: Key success factors
– Sponsor's ability to create and develop world class infrastructure
– Relationships within sector, established through procurement and trading of electricity
– Ability to exercise control over supply and costs of fuel
– Ability to create a portfolio of projects using diverse local and imported fuel
– Extent to which the anchor offtaker has embraced commercialisation
– Competitiveness of tariff within the context of both the merit order of dispatch and disincentivising default.

The important criteria remain the level of competitiveness of the quoted tariff and the ability of the sponsor to proactively manage its generating costs to maintain competitiveness. Thus, while some sponsors may tend to focus on the achievability of high dispatch levels by ensuring that the plant is favourably positioned on the merit order for dispatch required to be followed by all licensees (i.e. utility offtakers), others may seek to ensure that even the financially weakest offtaker is disincentivised to default on the capacity charges payable to the IPP. For example, Reliance's Sasan project would be dispatched at all times during the day round the year even if the full tariff was required to be realised from a party other than the contracting offtakers.

Finally, in order to access international debt, it is fundamental that the developers demonstrate an ability to manage the environment and social risks to enable lenders to be in compliance with Equator Principles (or its equivalent). The use of super-critical technology, which is a pre-condition for the UMPPs, is a significant positive.

About the authors:
Abhay Rangnekar, is Managing Director and Head of Project & Export Finance, South Asia at Standard Chartered Bank.
Sameer Usgaonkar is Director, Project & Export Finance, Standard Chartered Bank.