An Assessment of India’s Energy Choices: Financial Performance and Risk Perception Vinit Atal, Climate Policy Initiative Gireesh Shrimali, Climate Policy Initiative May 2018 A Four-Report Series by Climate Policy Initiative & Indian School of Business May 2018 An Assessment of India’s Energy Choices: Financial Performance and Risk Perception About the Series: An Assessment of India’s Energy Choices This report is part of a four-report series that looks at the future of renewable energy in India along different economic dimensions. The four reports in the series are: Social Costs of Coal-Based Electricity in India: Estimates of Impact on Health and Agriculture Ashwini Chhatre, Indian School of Business What it Means for the Economy, Jobs, and Energy Security Dr. Meeta Keswani Mehra, JNU and Dr. Saptarshi Mukherjee, IIT Financial Performance and Risk Perception Vinit Atal and Gireesh Shrimali, Climate Policy Initiative Managing India’s Renewable Energy Integration through Flexibility Vivek Sen, Saurabh Trivedi, and Gireesh Shrimali, Climate Policy Initiative Acknowledgements The authors of this report would like to acknowledge the interviewees from various banks, power project developers and other financial institutions who were interviewed for this study. We would also like to acknowledge Vivek Sen, Deepak Gupta, Dr. Christoph Wolff, Vikas Mehta, Dr. P.C. Maithani, and Deepak Krishnan for their guidance and review. Special thanks to Elysha Davila and Angel Jacob for editing and review, and Tim Varga for graphics. Descriptors Sector Electricity/Power Region India Keywords Power; Fossil fuels; Renewable energy; Fossil Fuel energy; Risk; Risk perception; India. Contact Dr. Gireesh Shrimali [email protected] Copyright © 2018 Climate Policy Initiative www.climatepolicyinitiative.org All rights reserved. For private circulation only A CPI Report 2 May 2018 An Assessment of India’s Energy Choices: Financial Performance and Risk Perception About Climate Policy Initiative With deep expertise in policy and finance, Climate Policy Initiative works to improve the most important energy and land use practices around the world. Our mission is to help governments, businesses, and financial institutions drive growth while addressing climate risk. CPI works in places that provide the most potential for policy impact including Brazil, Europe, India, Indonesia, and the United States. CPI’s India program is registered with the name, “Climate Policy Foundation” under Section 8 of the Companies Act, 2013. About ISB The Indian School of Business (ISB) is a global business school offering world-class management education across its two campuses – Hyderabad and Mohali. The School has grown at a rapid pace since its inception and already has several notable accomplishments to its credit – it is the youngest school ever to consistently rank among the top Global MBA programmes, the first institution in South Asia to receive the prestigious AACSB accreditation, one of the largest providers of Executive Education in Asia, and the most research productive Indian management institution. A vibrant pool of research- oriented resident faculty and strong academic associations with leading global B-schools, have helped the ISB fast emerge as a premier global Business school in the emerging markets. For more details visit www.isb.edu. About Shakti Sustainable Energy Foundation This initiative has been partially supported by Shakti Sustainable Energy Foundation. Shakti Sustainable Energy Foundation works to strengthen the energy security of India by aiding the design and implementation of policies that support renewable energy, energy efficiency and sustainable transport solutions. For more details, please visit www.shaktifoundation.in. The views/analysis expressed in this report do not necessarily reflect the views of Shakti Sustainable Energy Foundation. The foundation also does not guarantee the accuracy of any data included in this publication nor does it accept any responsibility for the consequences of its use. A CPI Report 3 May 2018 An Assessment of India’s Energy Choices: Financial Performance and Risk Perception Executive Summary India has prioritized electricity access as a key driver of We answer these questions using two approaches – ex socio-economic development. Each year, as part of the post empirical analysis of financial performance data of country’s successive National Electricity Plans, the gov- power-producing companies, and primary research with ernment has set targets that scale up electrical capacity investors in the sector to understand their perceptions additions. of the risk and the areas of concern. India has also set ambitious targets for renewable energy in the context of climate change commitments, with a goal to increase the proportion of renewable How have the renewable energy and fossil energy sources in the country’s electricity generation mix to up to 40% by 2030 from 14% as of March, 2016. fuel power sectors fared financially in the past with respect to risk and risk-adjusted returns? These dual electricity generation targets require signif- icant investment. The total investment requirements for generation capacity addition is estimated to be INR 10.3 trillion during the period 2017-2022, which includes the We find that the renewable energy power sector has funds required for renewable energy sources capacity been less risky than the fossil fuel power sector. The addition, as well as the advance action on the projects listed renewable energy power sector in India has his- coming up during the years 2022-27. The total fund torically exhibited half as much systematic (or non-di- requirement for the period 2022-27 is estimated to be versifiable) risk as the listed fossil fuel power sector. INR 6.1 trillion (Draft National Electricity Plan, 2016). Using past trends as an indicator of future performance, This represents a massive opportunity for investors to there is reason to believe this trend will continue in the make profitable investments in the power sector, using absence of major upheavals to the sector. This presents both fossil fuel and renewable energy technologies. evidence for continued growth of the renewable energy Policymakers need to design policies to reduce barriers power sector in spite of gradual easing of policy support to investment to be able to reach government targets from the government. for each technology. Renewable energy power has been a more lucrative This paper is part of a four-part series produced by investment than fossil fuel power. Renewable energy Climate Policy Initiative that compares renewable power portfolios have historically shown more attractive energy and fossil fuel based power along different investment characteristics including, on average, 12% dimensions including social costs, macroeconomic higher annual returns, 20% lower annual volatility, and impacts, environmental impact, financial risk, and flexi- 61% higher risk-adjusted returns. Thus, a portfolio of bility considerations. renewable energy power companies would be deemed more efficient than a portfolio of fossil fuel power com- This particular study seeks to study and compare the panies, as per the modern portfolio theory, providing historical and present-day financial performance and an investor with a given risk appetite higher returns in risk profile of the renewable energy and fossil fuel comparison. power sectors, in order to inform investors and policy- makers, by answering questions such as: Stock returns for both renewable energy and fossil fuel power companies are robustly correlated with • How have the renewable energy and fossil fuel market returns. Using econometric methods, we were power sectors fared financially in the past with unable to determine whether other relevant factors respect to risk and risk-adjusted returns? such as company size, value, leverage, coal prices, rupee • How does investors’ risk perception of the exchange rate, and term premium are robustly priced renewable energy and fossil fuel power sectors into the stock returns. differ? • What factors contribute to the differing risk perceptions of the renewable energy and fossil fuel power sectors? A CPI Report 4 May 2018 An Assessment of India’s Energy Choices: Financial Performance and Risk Perception The main risk factors driving the risk perception of both renewable energy and fossil fuels are counter- How does investors’ risk perception of the party, grid, and financial risks. These risks together renewable energy and fossil fuel power account for 50% - 54% of the total risk premium. Further, sectors differ? for the fossil fuel power sector, the resource risk and power market risk are also significant, contributing to 26% of the total risk premium. Accordingly, policy and market interventions targeting Investors perceive renewable energy power invest- the mitigation of barriers associated with these risks ments to be less risky than fossil fuel power invest- have the highest potential for reducing the cost of ments. The expected returns on debt to the fossil fuel capital for investments, by up to 4% of the cost of debt power sector is at least 80 basis points (bps) higher of renewable energy investments, and up to 5.1% of the than for expected returns on debt for the renewable cost of debt for fossil fuel energy investments. energy power sector. The higher risk perception of the thermal power sector may be attributed to sourcing Counterparty risk is the most significant risk by far. issues and import dependency for coal and