In 2008, India’s National Action Policy on Climate Change set a renewable portfolio standard, called the Renewable Purchase Obligation (RPO), to produce 15% of the country’s electricity with renewable energy sources by 2020. Further, under the Jawaharlal Nehru National Solar Mission, the Indian government aims to develop 20,000 MW of solar energy by 2022.
To help reach these ambitious targets in a cost-effective manner, India launched a market-based mechanism called Renewable Energy Certificates (RECs) in 2010.
However, in the one year of trading so far, participation in the REC markets has been low: RECs have failed to attract investment. Though the design of the REC mechanism appears adequate, the performance of the market has been far from satisfactory. This, along with other issues, such as the cost of debt, translates to real concerns over whether India is on track to meet its ambitious targets.
So why is this happening?
In theory, the REC market is simple. Distribution companies and other obligated entities must meet RPO targets. This creates the demand side of the market. REC certificates are issued to renewable energy generators. This provides the supply side of the market. However, in practice, we begin to see a different story.
Based on our analysis, we identified eight points to why the Indian REC market is not likely to achieve government objectives.
- The REC mechanism is unlikely to encourage cost reduction in renewable energy projects by promoting market forces and competition, given that participation in the REC markets has been too low to drive any cost reduction.
- The REC mechanism is unlikely to provide incentives to drive capital investment in renewable energy projects, given that the time frame of RECs is much shorter than the investment horizon; investors discount RECs due to perceived uncertainty and risk over project life.
- It is not clear yet whether the REC mechanism provides a mechanism to limit boom and bust cycles, given that renewable energy market has not yet overheated. However, current participation and incentive levels suggest REC mechanism insufficient to dampen cycles.
- The REC mechanism is unlikely to weave together various state-level incentive and policy regimes within a national structure, given that it does not incentivize states to work toward reaching national goals.
- It is not clear yet whether the REC mechanism provides incentives incremental to other relevant policies, given that, though REC cash flows are expected to be supplementary to other policies and can work in conjunction with state policies, these have not occurred to date.
- It is not clear yet whether the REC mechanism allows for technologically differentiated incentives to support new and diverse sources of energy, given that, though the design allows for differentiation, support for new renewable sources has been weak to date.
- It is not clear yet whether the REC mechanism will reach its goals at a reasonable additional transaction cost, given that, though direct transaction cost is low to date, it is unclear how costs will evolve as market matures.
- The REC mechanism is unlikely to accomplish its goals with a reasonable additional cost due to higher perceived or real risks to developer. High risk perception of using RECs or any project usually deters investments.
It may be too early to make firm recommendations for the REC system, particularly since the largest contributor to the relative ineffectiveness of the REC market is the uneven participation and regulatory policy of the Indian states, a factor which lies partially outside the scope of REC market design. However, certain design flaws are likely to contribute to a continued weak REC market.
First, there is overdependence on state level policy and compliance. The system is dependent on stronger and more credible RPO goals from Indian states than have been observed to date. Stricter compliance laws and enforcement of RPO goals will increase confidence in the nation’s commitment to these goals, and can help develop and support long-term stable REC markets. Incentives for the enforcement agencies and states could encourage state agencies to support RPO goals. For example, one such pathway could be making RPO compliance a necessary condition for the financial structuring package currently being implemented to improve the financial condition of state electricity boards.
Second, the market lacks of reliable long-term price signals. The lack of long-term price signals, contracts, and other commitments greatly increases the risk to potential investors for their energy sales beyond year one. Creating secondary markets can reduce some of the long-term price risks that investors perceive in RECs by providing some future price certainty. States’ commitment to long-term targets along with yearly targets would encourage developers to invest in RECs and, in the long run, would also limit boom and bust cycles.
Third, there isinsufficient market transparency. A lack of certainty about pricing and the market may be decreasing the impact of market signals and increasing investor uncertainty. Single window counters for accreditation, registration, and issuance of RECs could decrease the time taken to procure RECs and encourage participation in REC markets.
The REC mechanism is an ambitious and perhaps laudable effort to make India meet its renewable energy targets. However, this effort faces many barriers and some of them, such as the non-compliance of RPO, are formidable. The success of the REC mechanism will depend on removing these barriers, but with little or no efforts in this direction so far, it’s unlikely that this will happen on a timeline that corresponds with India’s ambitious renewable energy targets.
Our report, ‘Falling Short – An Evaluation of the Indian REC Market‘, goes into more detail in evaluating the effectiveness of Indian REC markets against eight government objectives and offers suggestions for improving their design.