Renewable energy is booming, but so are legal risks for investors
- Asia Pacific
- Ethics, Compliance and Governance
- Security Risk Management
Renewable energy is booming, but so are legal risks for investors
When Prime Minister Narendra Modi told delegates at the 2015 Paris climate talks that India would install 500 gigawatts (GW) of renewable energy capacity by 2030, many saw it as a pipedream. And yet, in pursuit of this target, New Delhi has aggressively enforced renewable energy purchase obligations for state governments across the country. Federal government funding for renewables increased five-fold during Modi’s first term, from USD 431m in 2014 to USD 2.2bn by the end of 2018. Policy measures – including improved rules for the awarding of contracts, and the establishment of dispute resolution measures for projects – have also increased private sector competition.
Such sustained policy efforts, mainly focused on solar and onshore wind development, have quickly made Indian renewables exports some of the world’s cheapest. For solar in particular, the country’s total capacity is now 35 GW, scaling up from 11 megawatts (MW) in 2010 (by comparison, the UK has some 13,000 MW of solar capacity; Japan 62,000 MW). Large solar projects continue to appear across key resource-rich states including Rajasthan, Gujarat, and Andhra Pradesh, with tenders offered under multiple government schemes.
As a result, India is emerging as the world’s biggest market for venture capital and private equity investment in renewable energy, seeing more than USD 3.2bn of capital inflows in the last three years. With its 2030 target in mind, the government is likely to further simplify tendering processes and improve auction rules in the coming years to further boost foreign direct investment.
Contract, non-payment and litigation risks
While such strong government commitment bodes well for the sector and provides clarity for potential investors, it also remains fraught with contract and legal risks. With their dependence on the co-operation of state governments that regulate land laws and oversee the state-owned companies that set the power tariffs, projects remain susceptible to politicised disruption.
For example, most states lack adequate policies regarding government land allocation for renewables projects. Although the introduction of the “single window” clearance mechanism by some states (such as Gujarat and Rajasthan) has streamlined land acquisition approvals, challenges surrounding fragmented land ownership and disputed land titles persist.
Contract and non-payment risks have also increased in recent years, with several state governments (such as Punjab and Andhra Pradesh) and public utilities firms (in states such as Jharkhand) seeking to renegotiate Power Purchase Agreements (PPAs), with the objective of lowering the tariffs paid to private producers. In Andhra Pradesh, such a renegotiation was triggered by sudden political changes, illustrating how easily state-level political risks can upend the policy environment.
Tumultuous politics aside, the strained public finances of many states amid India’s surging COVID-19 epidemic has seen payment delays, bankruptcies, and ultimately the invoking of force majeure clauses by distribution companies (DISCOMs). These heightened litigation risks are likely to persist in the sector in the coming months, exacerbated by the high pendency of cases in state courts and India’s poor record at resolution of commercial disputes. For instance, the World Bank estimates it takes an average of 1,445 days for a company to resolve a commercial dispute through a local first-instance court; almost three times the average for OECD high-income economies. This may in turn prompt developers to seek out-of-court settlements or pursue international arbitration against state governments – ultimately undermining the sector’s overall attractiveness, despite the positive regulatory steps of recent years.
Social risks, activism and legal challenges
While India’s solar boom has garnered significant international attention, there are mounting concerns over its long-term environmental and social impact. Large-scale projects – which comprise the preponderant share of India’s overall solar capacity – are exempted from environmental reviews and public consultations. Rather, the biggest projects are incentivised through various government schemes and tend to be fast-tracked. In addition, a draft notification of a planned amendment to environmental impact assessment rules, released earlier this year, also provides for large solar plants to be exempted from such assessments (among 39 other types of projects).
While this streamlines access for developers and investors, the failure to consider projects’ impact on local environments and livelihoods when selecting sites is likely to create longer term operational and reputational risks. Activists contend that pastoral communities, landless labourers and others who depend on common lands are not adequately consulted nor fairly compensated before solar projects are established. This may trigger local community unrest or even legal challenges; at least 15 cases have been filed since 2011 against solar projects in Rajasthan alone. Land disputes leading to protests have also been reported in Madhya Pradesh’s Neemuch district and Gujarat’s Charanka region. Besides causing project delays, expensive court cases and the prospect of compensation for communities threatens to significantly increase overall project costs. Perhaps more seriously, poorly implemented projects carry higher risks of experiencing unforeseen operational difficulties, thereby eroding the value of assets in the longer term.
Sustainable investing and the need to be ‘litigation-ready’
Foreign investors can significantly offset this range of risks by assessing the political, policy and compliance environment for the renewables sector in the state where they wish to invest. This should include a consideration of variables such as upcoming elections, fiscal health, and dispute resolution options. Further, while state officials may be ready to bypass various reviews, investors should undertake their own land and community assessments as part of their due diligence processes. Whilst avoiding an individual project’s potential pitfalls, doing so could also help set the tone for more sustainable investments in India’s renewables sector in the years ahead.
Will the sun continue shining on India’s renewables sector? Most probably, at least for the foreseeable future, but we should not underestimate the profound effect that COVID-19 will continue to have on investments and contractual obligations for businesses across the country. In addition, India’s economic slowdown – which the pandemic has transformed into a full-blown macro-economic crisis – will compound pre-existing fraud and compliance concerns, including in the renewables sector. Business-critical issues involving local partners and lenders will continue to emerge, requiring significant resources and potential legal remedies to resolve. Investors should hence brace themselves for a rapidly evolving dispute environment post-COVID-19. Organisations that take time to evaluate their ‘litigation readiness’, by mobilising key information and analysis early in the process, will stand the best chance of achieving both short-term resolution and longer-term recovery.