An offtaker is an entity which contracts, via Power Purchase Agreements (PPA), the purchase of power generated from specific power projects for a defined time period at a defined price. At the utility scale end of the spectrum offtakers are most often electricity distribution companies (discoms), and the risk associated with entering into PPA’s with them (offtake risk) may be best understood by separating it into its two constituent parts. First is the risk that the power plant may be restricted from operating at its optimal Plant Load Factor (PLF), which is often referred to as curtailment risk. Second is the risk that the power once generated and dispatched, may not be paid for in a timely manner. The first risk is driven by both technical and commercial considerations whereas the latter risk is largely a function of the offtakers ability to meet its financial obligations. From the power producers’ perspective the former results in an irrecoverable hit to projected revenue (unless contractual protections exist for recovery), whereas the latter pushes projected cash inflows further out into time. Both erode investor returns.
When evaluating capital deployments in power projects, one of the first things that investors do is attempt to gauge total project risk. Detailing and measuring the constituents of total project risk can be a contentious exercise, but at the cost of oversimplification, one may argue that they fall into three broad buckets, namely, execution Risk, operation & maintenance (O&M) risk and offtake risk. In the case of traditional forms of power generation such as coal & gas fired plants, the three buckets are all reasonably and equally full. After all, such plants are fairly complicated to build with long gestation periods (execution risk). Once built, running them is also complex, involving overcoming technical, fuel supply & labour challenges (O&M Risk). Finally, there is offtake risk to consider.
RE (solar & wind) on the other hand is much simpler. In comparison to coal & gas fired plants, RE plants are far easier to construct both in terms of complexity as well as time taken. Once built, they are also far easier to operate and maintain. The first two buckets are thus fairly empty from a risk perspective for RE, leaving the last bucket, namely offtake risk, accounting for an overwhelming share of total project risk. Understanding what lies in this third bucket is therefore particularly important in the case of RE.
Let’s first consider the risk of an RE power plant being restricted from operating at its optimal PLF. This usually happens for a couple of reasons. The first reason is technical. In some cases, the infrastructure that transmits power from the generator to the discom may be inadequate or in otherwise poor condition. In other cases the discoms offtake mix may simply have too great a share of RE, creating problems due to RE’s inherently intermittent nature, which peaks at the sunniest & windiest time(s) of the day. In such cases, the transmission infrastructure may be inadequate to integrate such bursts, or the discom may be unable to absorb them within its demand profile, or both.
Commercial factors may also restrict RE plants from operating at optimal PLF’s. Discoms purchase power from a multitude of power producers, across many generation types, under different contractual frameworks, and at different PPA tariffs. When faced with excess supply, they may initiate actions forcing RE power producers to temporarily refrain from generating and dispatching power. RE can be particularly prone to such curtailment due to the ease with which generation can be switched off. There is increasing anecdotal evidence in India of such commercially driven curtailment being selectively enforced on high tariff RE projects. This is often done under the garb of maintaining “grid stability” to circumvent the must run status accorded to RE in India.
This brings us to the risk associated with the discoms ability to meet its financial obligations; in this case, the risk that while it offtakes all the power, it fails to pay for it in a timely manner. This falls squarely in the nature of credit risk. Poor financial health can force discoms to delay payments, often for periods extending to several months at a time. This pushes project cash inflows further out into time, eroding investor returns. In severe cases, RE power producers may also be forced to tap working capital facilities just to meet their project debt servicing deadlines. In such cases the unanticipated interest expense associated with such facilities further exacerbate return erosion.
Having understood the various components of RE specific offtake risk, it’s important to recognize that the ability to measure them at the time of project evaluation varies from component to component. For example, the general state of transmission assets to be used to evacuate power can be broadly determined upfront. However, paucity of data makes ascertaining correlations between curtailment and share of RE in a discoms offtake mix and/or PPA tariff levels far more challenging, at least in the Indian context. Also from an India perspective, some resources certainly exist to gain an insight into the credit profiles of offtakers. For example, some years ago the Ministry of Power began publishing an annual review of discoms, grading them in terms of operational and financial health. Such gradings whilst certainly helpful, differ from credit ratings, the objective of which is to assess the ability of an entity to meet its financial obligations via an assessment of probability of default.
Renewable energy is unique in many respects including from the perspective of its risk profile. However, much more needs to be done, including in India, to enable those who deploy capital towards this unique generating source to better measure risk, so that they may in turn better determine the returns they should target.
