The future of RPOs and RECs

The future of RPOs and RECs

The Renewable Purchase Obligation (RPO) mechanism in India sits awkwardly between the older generation-based incentives for renewable energies and the coming parity. Half supply side push, half demand side pull, is an incomplete framework in a rapidly changing power market. In the long run, it can become relevant only as a measure of success in implementing renewables in India, not as a specific driver for them. The following are notes taken during an excellent, closed-door roundtable on the subject organised by Ashwin Gambhir of Prayas in Delhi on the 10th of June 2013.

  • The RPO mechanism does not yet create a functioning market, its future is uncertain
  • Renewable Energy Certificates (RECs) equally are not yet a functioning market. They are regarded as a potential upside by investors, but not as a foundation or driver for a business decision.
  • As parity of renewables has arrived and will continue to deepen, RPOs will become a measure of success, rather than a driver of policies. The REC market might well become irrelevant.

There are a number of factors that undermine the current RPO market and by extension, the REC market in India. The most obvious and important is the fact that (now that almost all states have set themselves RPO targets), non compliance is not penalized; and if it is penalized, the penalty would have to be paid by mostly indebted state electricity boards. This is compounded by another, counterproductive trend: RPO targets are not ambitious enough to create a market pull. Some states such as Rajasthan have reduced their target to match the actual renewable energy production. Very few states have escalating RPO targets. Tamil Nadu has set a target lower than its (considerable) renewable power generation.

The REC market has its own challenges, over and above the unpredictable demand from RPOs. There is an illusionary offtake stability given the floor and forebearance prices. However, as prices are fixed, volumes traded become volatile. Only around 50% of RECs are actually sold, trading languishes during the early months of a financial year. This makes RECs not-bankable. Most developers pursuing REC projects get their returns through the accelerated depreciation benefit. RECs, if they generate revenue, are a potential upside. There are a number of further bottlenecks and open questions, involving, for instance the lack of market aggregators (trading is only allowed through the energy exchanges), the discussion about vintage RECs or clarifications on whether captive and off-grid renewable energy plants can generate RECs.

Various public institutions, including the CERC, the SERCs, the Ministry of Power, the Planning Commission and the PMO are working hard to fix the various challenges around the mechanism. The challenges can all be fixed.

However, there looms a larger question on what the role of RPOs can be under conditions of grid parity, when renewables no longer need to be incentivised but make commercial sense on their own. In such a scenario, REC revenues would be an additional ‘green benefit’. India needs to decide whether it wants to reward and pay extra for renewables just for being ‘green’. There is no political consensus on that. Under parity, the RPO mechanism would presumably evolve from being a market driver (through penalization and encouraging of incentivising policies) to being a measure of success.

Parity in renewables does not necessarily mean rapid adoption. The governments still needs to create a level playing field for them with respect to grid access. In turn parity needs to account for related costs of grid upgradation and balancing. Investment risks are still substantial in heavily frontloaded renewables projects. Reducing those and improving financing conditions will be a key concern. Also, as long as the costs of renewables keep falling, there is an ‘incentive to wait’. Here, RECs could play a role in creating an early mover advantage through a falling additional green benefit.

Tobias likes to write about solar business models, solar and energy policy and wider issues of sustainability, development and growth.

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