Will cut-throat competition leading to the Winner’s Curse hit solar power?

Earlier this year, I expressed worries that India was galloping ahead with solar power when experts predicted that solar panel costs would plummet. Why not wait till costs crashed?

One solar enthusiast told me the crash in costs had already happened, and I should watch out for ultra-low bids for upcoming projects. Events swiftly seemed to vindicate him. Sky Power’s winning bid was Rs 5.17/unit in Telengana. Photo Ultra had a winning bid of Rs 5.09 in Punjab. Sky Power won by bidding Rs 5.05/unit in Andhra Pradesh. And then, sensationally, SunEdison won with a bid of just Rs 4.63/unit for a 500 mw solar project in Andhra Pradesh. Thermal power is still cheaper, but its cost will rise over time with the cost of coal. Meanwhile, the solar bids are fixed for 25 years. So, over 25 years, solar power could be competitive with, or cheaper than, coal based power, especially if we add the environmental costs of the latter.

Are solar producers rejoicing in triumph? No. Many are worried. They fear that cut-throat competition is leading to what economists call the ‘winner’s curse’. In any auction, the most aggressive bid is made by the most optimistic bidder, who banks on everything coming right with no glitches and no unexpected political or economic shocks. In practice, alas, many things can — and do — go wrong. When this happens, an aggressive winner of contracts can end up with huge losses. This is the winner’s curse.

The price of solar company stocks in the US have crashed over the last year, as investors reassess the profitability of the sector. SunEdison, the biggest US solar company, has sold solar assets globally even as it has made the lowest bid ever in India.

It says that in Andhra Pradesh, other companies like Tata, Adani, Reliance and EDF made bids just 20-30 paise/unit higher than SunEdison’s. So its winning bid of Rs 4.63/unit was not hugely out of line with others. Welspun, a prominent Indian operator in the solar space, has just sold its 40% stake in a joint venture with the Leighton Group, saying it needs to reduce its high debt.

Optimists will say that asset sales in the solar space represent a mere churning of assets. Pessimists, however, will see this as evidence of a winner’s curse. India is a difficult country replete with delays, corruption, obstructionist bureaucrats, arbitrary policy changes and disregard of the sanctity of contract. These problems help explain why aggressive bidders in several infrastructure areas defaulted on loans in the last five years, taking down the banks that had lent them lakhs of crores.

The solar business is simpler, less corrupt, and probably better administered (thanks to Narendra Modi’s personal interest) than some other infrastructure sectors. Yet, the sector is still rife with risks that any prudent investor should provide for when bidding. That prudence seems to have vanished in some recent bids, so alarm bells are ringing.

Solar panel prices have not come down because of new technologies.

They have come down because of marginal improvements in old processes, and scale economies from massive production plants in China. Whether this alone can explain the huge fall in prices in unclear. Over-capacity means that at least some Chinese sales may represent distress sales below cost, which are not sustainable.

More important, the rupee has been depreciating and is likely to depreciate further. Some experts estimate that it is 15% overvalued. Any fall of the rupee will raise the cost of imported solar panels, eroding the viability of aggressive bids. Bidders that have not already hedged in the foreign currency market face serious foreign exchange risks.

Besides, evacuation of solar power requires grid investment by the public sector, and delays in this can hit profitability. Transmission infrastructure today is weak, although it is being strengthened. In Andhra Pradesh, the 500 mw project is a joint one with NTPC, reducing the risks of evacuation and sale. Land is also being provided by the state government, and this means that risks are much lower than in projects where the bidder has to do the acquisition.

Political Risks

Political risks include the unwillingness of state governments to live up to purchase commitments. Litigation between investors and state governments is massive. Delays of six to 12 months are common in paying bills. If new technologies lead to a crash in solar power prices, will state governments honour old, higher-priced contracts? Don’t bank on it.

Given the risks, it’s necessary to reduce the consequences of a possible winner’s curse. First, bidders should be asked to post big bank guarantees in future auctions. This will discourage really aggressive bids, and help offset losses if a project is abandoned halfway.

Second, the Reserve Bank should alert banks and ensure that leverage is not high for solar projects. Given the risks, they should be financed substantially by equity, maybe 50%. Many road and power projects went bust because high leverage meant they had no cushion to survive bad breaks and delays. Let that not happen in solar power.

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