Expect bruises, not bubbles in India’s solar market

The Indian solar market is growing at a breathtaking speed: This year alone, by more than 300%, next year perhaps by 150%. Competition is as intense as the market is enthusiastic. Projects are being won at record low tariffs – tariffs that many observers doubt will leave investors with acceptable returns. Will these projects be “stranded solar assets”? Is there a bubble in the making? Richard Martin has recently asked this question in the MIT Technology Review (refer). My answer is a clear “no”. Here is why.

  • Some investors will be disappointed with returns as competition remains stiff
  • Power demand in India is high and growing – it is a solid business opportunity
  • In future, as financial engineering becomes more complex, there might be more room for speculation

Bubbles are typically seen in the stock, commodity and real estate markets, which have a tendency to detach themselves from economic fundamentals and propel valuations to excessive heights, driven by a mix of unreasonable expectations and speculation. We are currently watching in awe, if the Chinese stock market is a bubble about to burst. Is solar in India comparable?

There is some degree of unreasonable expectations and speculations in solar in India. Not all investors will be happy, not all developer strategies will work out. Overly aggressive bids might lead to projects that don’t make sufficient returns to warrant the risks, or even be loss making. However, we are talking about a bandwidth of 5-8% in the equity returns – a bruise, not a total write-off.

Moreover, there is no reason why individual projects that fail should have a negative impact on the market as a whole. The worst that can happen is: some projects will not get built and some other projects get built but underperform (e.g. because quality and technology corners have been cut), and some investors and banks will lose money. Also, some investors with high hopes but without a unique selling proposition or a pliable strategy will be disappointed. It’s normal business risk.

There is even a good chance that low-margin projects might get refinanced in the future, probably while being bundled into larger portfolios. This option partially depends on the continued availability of low cost equity and debt in the US, in Europe and in Japan. In some parts of the world, this cheap money might build infrastructure that is not required (a bubble).

Generating power in India, however, is actually a fairly safe bet in terms of providing something that is fundamentally needed. The country has a power deficit and demand will likely grow. Indians, on average consume only around 1,000 kWh a year – less then 10% of the consumption of an average American. As opposed to earlier “green” (read: artificial), incentive-driven solar markets that came to an abrupt halt after 2008 (Italy, Spain), the Indian solar market is driven by the country’s vast thirst for energy and solar is rapidly becoming a competitive choice even without government support (refer). Let’s put this market into perspective, too: Solar currently makes up only 1% of India’s energy supply. If the government’s ambitious target is realized it will be just over 10%.

Even, if you take a pessimistic view and believe that India’s economy and energy demand will not grow so fast and that, with current investments in the power market, there might be overcapacity, it is unlikely that solar assets will be hit. Since the marginal cost of generating a unit of solar power is zero, it would make little sense to throttle solar power plants and much more sense to reduce generation from fossil fuels. Thus, if anything, there is a risk of stranded fossil fuel assets in India (refer).

Could a bubble emerge in the future? The solar projects we currently see in India can generate stable returns through PPAs fixed over a long period of time. In the future, investors might take more risks, by, for example, selling power through speculative shorter-term deals (for instance at the power exchange). In addition, there might be market aggregators trying to sell such portfolios at unreasonable valuations and assumptions about future revenues to insufficiently informed and/or highly speculative investors (currently, there are very few aggregators). At some point, these portfolios might even be repackaged and resold in a way that obscures risks (as sub-prime mortgages were sold through credit default swaps before 2008). Then, we might see a bubble emerging. We have to observe closely, for example, how “Yieldcos” are developing, that sell Indian asset owning companies to investors in the e.g. the US (as SunEdison is doing).

Currently, however, the market is far away from generating a bubble.

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