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Reaching India’s Renewable Energy Targets: Effective Project Allocation Mechanisms

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Published: May, 2015

The Government of India has set ambitious renewable energy targets for 2022, in order to achieve its climate goals and enhance energy security. Given India’s budget constraints, a cost-effective policy path will be crucial to achieving these targets.

One way to reduce the cost of government support needed to achieve its renewable energy targets is through the tariffs it uses to procure renewable energy. Federal and regional governments in India have procured renewable energy through two mechanisms: feed-in tariffs, where the government fixes tariffs (i.e., the rate at which electricity is procured) for projects which are allotted on a first-come, first-serve basis; and auctions, where project developers quote tariffs to the government and are selected based on predefined technical and financial criteria. Typically, wind power has been procured through feed-in tariffs, and solar power through auctions.

Auctions for renewable energy are gaining popularity around the world due to their potential as a more cost-effective mechanism for the government. In this context, we examined auctions in India and elsewhere to answer two questions. First, have auctions been effective, or in other words, are they desirable as a project allocation mechanism? Second, how can they be designed to achieve India’s renewable energy targets, or in other words, how can they be made feasible?

We found that auctions are almost always cost-effective and have led to fair project allocation in most cases, but so far have not resulted in adequate deployment. We also found that high risk of certain factors can hurt the effectiveness of auctions, but that the right policy designs can lower risk to make auctions more feasible for renewable energy.

Effectiveness

We assessed whether auctions are desirable as a project selection mechanism by examining 20 renewable energy auctions around the world with respect to cost-effectiveness, deployment effectiveness, and the design to encourage market development.

Cost-effectiveness

We define cost-effectiveness as a reduction in tariffs due to auctions when compared with a baseline feed-in tariff. Given that government cost of support is directly proportional to these tariffs, this reduction translates to a reduction in government cost of support. In this context, we also examined whether auctions are discovering tariffs that are close to the rate of renewable electricity that a competitive market would discover, and whether transaction costs impact cost-effectiveness.

Auctions were almost always cost-effective. Auction-discovered tariffs were almost always lower than the baseline feed-in tariffs for the auctions we studied, meaning they were almost always cost-effective. We observed savings of up to 58% from the baseline feed-in tariff. 47% of the auctions had savings of greater than 20%; 24% had savings of 10-20%; and 29% had savings of up to 10%.

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Second, auction-discovered tariffs for solar projects in India have moved closer to market tariffs. Auction-discovered tariffs moved from within 23-35% of competitive tariffs in 2010-2011 to within 1-6% by 2012-2013.

Third, when we looked at whether auctions might lead to increased costs for project developers, we did not find any additional transaction costs when compared with feed-in tariffs. However, developers are concerned about the indirect financing costs due to uncertainty about auction outcomes.

Deployment effectiveness

We define deployment effectiveness as the ability of auctions to deploy the capacity of renewable energy intended through these auctions.

Among the auctions we studied, although some auctions were able to deploy capacity successfully, many were not able to deploy the full intended
amount. Only 17% of the auctions had greater than 75% deployment of the capacity auctioned, while 8% had 50-75% deployment, and 75% had less than 25% deployment.

Deployment effectiveness can be improved with better risk management. Poor risk management is the primary reason for the failure of auctions in deployment effectiveness. Changes to policy design could improve this.

Market development

We define market development as whether an auction ensured high competition and therefore reduced risks to deployment. This would help the long-term development of competitive markets, which would then result in improved market efficiency, including long-term cost-effectiveness, over time.

We found that auctions led to fair allocation of projects in the majority of cases, when policy was designed to encourage high participation and limit allowed capacity per bidder. Among the auctions we examined, around 2/3rds of the auctions were competitive or moderately concentrated, meaning that capacity was allocated to a large number of developers. Capacity allocations in approximately 1/3rd of the auctions were highly concentrated, with a few dominant developers garnering the majority of the capacity auctioned.

Feasibility

We examined how to best design auctions to reach India’s renewable energy targets by assessing seven risks which might affect their success. We found that auctions can achieve cost-effectiveness and deployment effectiveness with the right policy design.

Cost-effectiveness is affected most by auction design risk, which is risk related to the design of auctions such as the volume of capacity to be auctioned and type of bidding. In particular, an auction is not cost-effective when there is not enough competition for the capacity auctioned. Controlling the renewable capacity auctioned and encouraging participation from project developers can result in sufficient competition and thus cost-effectiveness.

Deployment effectiveness is most affected by auction design risk, completion risk, which is the risk of all factors that could delay the commissioning of projects, and financial risk, which is the risk of projects not being able to raise finance due to low bid prices or high off-taker risk. We found that auction design risk to deployment effectiveness in terms of underbidding can be best managed by imposing strong penalties for not commissioning the projects. Addressing problems associated with delays in transmission interconnection through support policies for transmission infrastructure expansion, and problems associated with poor financial health of the off-taker through a payment security mechanism, can minimize completion and financial risks.

We also found that it is important to consider both cost-effectiveness and deployment effectiveness together. Designing auctions with the sole objective of cost-effectiveness, as in the case of auctions in which all bidders were asked to match the lowest bid, could negatively affect deployment. Auctions that were balanced in their objectives and managed risks well have demonstrated that both cost and deployment effectiveness can be achieved together.

Auctions for wind power

Given significant developer resistance to wind energy auctions in India, we gave special attention to how wind auctions could be designed to meet India’s wind energy goals.

In the cases we examined, although wind power auctions have been cost-effective, they did not meet deployment targets due to poor risk management, primarily underbidding risk and completion risk. We suggest mitigating underbidding risk through penalties for not commissioning on time, and completion risk through preemptive measures such as providing regulatory permits prior to holding site-specific auctions.

Policy Implications

Our analysis indicates that, if designed appropriately to manage risks, auctions can deploy renewable energy capacity in a cost-effective and fair manner. The following policy design features would likely make auctions more successful:

  • To increase cost-effectiveness, ensure sufficient competition by setting the volume of capacity auctioned well within the market’s ability to supply.
  • To improve deployment effectiveness, impose strong penalties for delays in commissioning projects, implement support policies to improve transmission infrastructure, and provide government guarantees to reduce off-taker risk.
  • Use auction design elements that can mitigate risks to achieve both cost-effectiveness and deployment effectiveness together. For the specific case of wind energy in India, introduce auctions in a controlled environment, in which the project site is already identified, transmission infrastructure is planned, and resource assessment studies are completed prior to bidding.