By Prof. Gireesh Shrimali, Energy Economics and Business, Monterey Institute of International Studies; and a Fellow at Climate Policy Initiative’s CPI-ISB Energy and Environment Program at ISB
Auctions for wind energy have the potential to bring down the costs of wind energy in India. However, these auctions have not happened due to opposition from wind developers. This commentary explores the reasons behind this opposition and suggests ways to ensure effective and efficient wind deployment in India.
The promise of reverse auctions for wind energy
Reverse auctions for renewable energy, where developers bid on the discount they are willing to offer on a fixed tariff, are gaining popularity around the world, including California, Brazil, and South Africa . Auctions are not only efficient – i.e., in delivering the lowest cost – but also fair – i.e., in allocating capacity to developers without bias.
India has had successful experience with solar energy auctions. In the Jawaharlal Nehru National Solar Mission (JNNSM), the lowest bids have come down by approximately 60% compared to the fixed tariffs published by the Central Electricity Regulatory Commission (CERC) less than three years ago). This success suggests that India should use these auctions for other renewable technologies – in particular, for the dominant and established technology, wind – as well.
India is one of the leaders – in fact, fifth – in the world in terms of installed wind energy capacity, totaling approximately 18GW by the end of 2012. This capacity has come online with the help of state-level fixed tariffs and complementary federal incentives, such as Accelerated Depreciation (AD) as well as Generation Based Incentives (GBI).
However, these fixed tariffs, also known as preferential or feed-in tariffs, are typically determined by the government, which raises the risk of either rent seeking – i.e., creating windfall profits for developers that eventually get the projects – when the tariffs are too high or adverse selection – i.e., only high risk projects participating – when the tariffs are too low. Further, it can be argued that the government does not have the best market information and, therefore, due to this issue of asymmetric information, should not be in the business of setting market prices.
So, appropriately designed auctions, which allow for price discovery, given bidding by developers that have the best market information, appear like a good solution for the wind power industry as well.
The absence of reverse auctions for wind energy
However, all attempts to hold auctions for wind energy in India have failed so far.
In 2012, Karnataka was the first state to attempt a wind energy auction. This wind energy auction was stalled due to a lawsuit asserting that the auction was in violation of the Electricity Act of 2003 which, though it allows states to announce preferential tariffs based on CERC’s recommendation, does not allow them to hold auctions.
This issue could be fixed only at by the central government which would need to issue appropriate guidelines according to the Electricity Act of 2003. Since the Karnataka lawsuit, the Ministry of New and Renewable Energy (MNRE) has come up with these guidelines; however, they cover all renewable energy sources, except wind energy.
Another state, Rajasthan, has also tried twice to do a wind energy auction, and has been stalled both times. The proposed wind energy auction towards the end of 2012 was cancelled due to pushback during consultations, on grounds similar to Karnataka . Rajasthan got around this obstacle by the Rajasthan Renewable Energy Corporation (RREC), an independent and clearly unbiased entity, getting a trading license. However, the second proposed auction, to be helped by RREC in June 2013, has again been stalled due to a lawsuit, alleging that wind energy auctions would cause a 47% plunge in turbine installations.
What is happening, and why?
The stalling of auctions has primarily been due to opposition from wind energy developers, via the Indian Wind Energy Association (INWEA). Therefore, it is tempting to assert that the main obstacle for holding wind auctions is the INWEA. However, to understand why, it is pertinent to investigate this matter in more detail.
The auctions have been stalled by INWEA under the legal framework; however, the reasons quoted by INWEA are that, in absence of the preferential tariffs, the risks for the developers are too high – in particular, the wind resource risk as well as the transmission interconnection risk. Another common refrain is that auctions don’t work in the long-term, due to the winner’s curse issue, where non-serious players bid aggressively, only to default later.
But, careful examination reveals that these issues with auctions don’t hold to careful scrutiny. Aren’t the risks quoted by INWEA typical risks borne by wind farm developers word-wide? And, doesn’t carefully designed pre-qualification criteria – e.g., resource assessment and transmission interconnection studies, such as in California Reverse Auction Mechanism (RAM) – combined with bid-bonds – e.g., in JNNSM, which penalize non-performance, take care of the winner’s curse issue? In fact, recent auctions in Brazil, which combine these elements, have created widespread participation, and have brought the price of wind power down to grid party.
What is the real issue?
This requires examining the history of the wind energy development in India. The wind energy sector in India was jump started by the federal incentive, AD, which was complementary to state-level preferential tariffs, and allowed equity investors to claim depreciation tax benefits equaling 80% of the capital expenditure in the first year of a wind farm operation. AD attracted a lot of equity investors that were not even remotely connected to the wind energy business. This also enabled vertical integration in the wind industry, where wind turbine manufacturers, such as Suzlon and Enercon India, also became wind farm developers. A side effect of this market structure is that, except for these vertically integrated players, no one really knows the breakdown of the cost components in the wind energy supply chain. Further, this equity-model appears to have promoted installation of capacity, not generation. These issues were perhaps partially mitigated by an alternative, and mutually exclusive, federal incentive GBI, which provided an INR 0.5 subsidy per unit of generation and was targeted towards a different kind of wind energy developer, the independent power producer (IPP). This “IPP-model”, based on project finance principles, was also considered to be more efficient compared to the equity-model in terms of generation. However, based on our discussions with developers, the IPP producers have not had an easy time in India, given the stronghold of the vertically integrated players on critical resources, such as land with good wind resource.
Therefore, one should expect opposition to auctions, which would move towards discovering the real cost structure in the wind energy industry, in particular, by the proponents of the equity-model, such as Suzlon.
To make matters worse, both AD and GBI expired in the beginning of 2012. This has resulted in the wind power development slowing down considerably in India – from approximately 3 GW of installed capacity in 2011 to nearly half that in 2012, indicating the crucial role of these incentives. Though GBI has been reinstated in the 2013 budget, it is not clear whether it will recover its previous budgetary allocation. This policy uncertainty has further made INWEA extremely opposed to any other policy changes, such as auctions. Further, given their complementary nature, AD and GBI were bringing in different kind of investors. In absence of AD, it is not clear whether GBI, by itself, is capable of achieving the 12th plan target.
What should the government of India (GoI) do?
First, in the light of the 12th plan goal – installation of an additional 15 GW of capacity by 2017, which is predicated on the installation of 3GW of wind capacity per year, a number based on wind capacity installation in year 2011, a year when both AD and GBI were active – it should ensure that, in order to attract investment, adequate subsidies are provided and that policy uncertainty is alleviated, so that investors are ensured a normal rate of return on their investments.
Complete elimination of federal subsidies would not work. GoI needs to recognize that the federal incentives were working in tandem with state-level incentives and, the expiry of federal subsidies, in absence of corresponding adjustments to state-level subsidies, is bound to have a negative impact on deployment. Therefore, this measure would require updating of state-level subsidies which, in order to compensate for the expired federal incentives, would potentially be higher than current levels. This may be hard to implement, given the poor financial condition of SEBs.
Thus, a more effective solution would be to use one (or both) of GBI and AD with innovative, and cost-effective, ways to provide federal subsidies – e.g., interest-rate subsidies, as suggested in our upcoming paper in Energy Policy, “Renewable deployment in India: Financing costs and implications for policy”. In any case, it is necessary that this federal policy is not only certain but is also reasonably long-lived, so as to provide confidence to investors; otherwise, India will follow the path of the U.S., where the un-predictability of the Production Tax Credit (PTC) has resulted in boom-and-bust cycles for wind energy deployment .
Second, in addition to the provision of complementary federal subsidies, GoI should ensure that states eventually move to an auction based approach to procuring power. This would not only allow for price discovery for wind energy but, more importantly, allow for SEBs to procure wind energy in a cost-effective manner and, therefore, b e welfare maximizing. This will, of course, require design of auctions with appropriate pre-qualification criteria, such as wind resource assessment and transmission interconnection studies, as well as the use of bid-bonds. Under this case, GoI can even provide necessary assistance by creating nation-wide resource assessment studies, such as ones provided by the National Renewable Energy Laboratory (NREL) in the US – e.g., via the Center for Wind Energy Technology (CWET).
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“The views expressed in this article are personal. Prof Gireesh Shrimali is a faculty at the Indian School of Business.”