Counterparty risk associated with delay/default in regular payments by distribution companies is one of the most critical risks for power producers. Nearly 88% of the power offtake from power producers in India happens through long-term tie-ups with distribution companies. Traditionally, discoms in India, are owned by state and have been suffering due to leakages in transmission and distribution system, poor collection efficiencies, tariff controls etc.
Power producers enter into power purchase agreements (PPA) with the discoms for sale of power on key contractual terms such as tenure, tariff, billing and payment security mechanism. However, the poor financial health of the discoms raises the price at which power producers can raise capital due to the risk on receivables. Further, delays in payment to power producers has serious cash flow implications for power producers, hurting their long term business viability. To reduce both, the perception and the quantum of this risk for investors, the government has ensured multiple levels of payment security in renewable energy PPAs, such as letter of credit, default escrow agreement, payment security fund, tripartite agreement and state government guarantee. This is called a payment security mechanism. Following list briefly describes each:
Payment security mechanisms have had a positive impact in improving the credit rating of renewable energy projects and in ensuring certainty of payments from state discoms. In February 2017, SECI was made a beneficiary of a tripartite agreement between the Government of India, state governments and RBI. NTPC has been beneficiary to such a tripartite agreement since 2002. ICRA (a credit rating agency) enhanced the credit rating of SECI from AA- to AA+, with the tripartite agreement providing additional security against payment default by discoms. Thus, a payment security mechanism (tripartite agreement in this case) can also be an effective mechanism to reduce or forego additional risk premiums reducing lending rates for renewable energy projects.
Figure 1 briefly explains how a payment security mechanism works with the help of an example of SECI’s payment security fund for VGF scheme under JNNSM. The arrows marked with numbers represent the sequence of events for the use of PSM to cure default by a discom.