Is Unconditional Letter of Credit the Answer to Solar, Wind Payment Issues?

Can mandatory letters of credit solve the persistent issue of payment delays by DISCOMs?


Cases of payment delays to renewable generators have become common and on the rise. However, the Ministry of Power has given these developers a shot in the arm by introducing mandatory letters of credit which is a bold step to make the payment security mechanism more robust to ensure timely payments by distribution companies.

Renewable energy project developers, owners, generators, independent power producers (IPPs) are facing payment delays as well as curtailment issues across states. The delay in payments has primarily been due to the operational mismanagement and stressed balance sheets of these DISCOMS. Due to this risk, many investors have completely stayed away from the Indian power sector. Mercom previously reported on payment delays becoming a problem for solar and wind project developers in India, especially in Andhra Pradesh, Tamil Nadu, and Telangana.

Now, with the help of regional and national load despatch centers (RLDC and NLDC), the government is focused on tackling this widespread problem to help make things easier for the project developers.

In February 2019, the Ministry of Power had established a committee to recommend solutions for payment delays by DISCOMs.

In June 2019, Minister for Power, R. K. Singh, had announced the approval of a proposal to make it mandatory for distribution licensees to open and maintain adequate Letter of Credit (LC) as payment security mechanism under power purchase agreements.

Then in August 2019,  the Ministry of New and Renewable Energy (MNRE) issued a clarification regarding fixed charges in the newly released payment security mechanism regulations.

Mercom interacted with several industry stakeholders to understand how they perceive this move by the government and if this is going to solve the payment problems.

Some of the developers stated that it is a welcome move, but they also raised questions regarding its implementation. A few others were skeptical, “All this is good on paper. But, if you can’t get the states to honor the power purchase agreements, how will you enforce this? It would be great if they enforce, but how?”

A government official said that this time around, the government would leave no stone unturned to provide a fair playing ground for renewable energy project developers and independent power producers. The government official said, “Everything is being taken into consideration, letter of credit and whether it will be unconditional, and if the defaulting DISCOMs will be allowed to purchase energy from the exchange if they do not enter power purchase agreements.”

Recently, the  Ministry of Power issued procedural guidelines for the scheduling of power to distribution companies in case of non-maintenance of a line of credit under the payment security mechanism. According to these guidelines, power will be scheduled for dispatch after a written communication is provided to the load despatch center that the letter of credit for the power to be supplied has been opened. The notification must specify the duration of supply. This communication will be provided by the DISCOM and confirmed by the power generator.

Once this was done, some DISCOMs tried to find a loophole and issued a conditional letter of credit for the power procurement. When this was brought to the notice of the authorities, a new directive was issued by the Ministry of Power ordering the DISCOMs to issue unconditional letters of credit against the power they desired to procure.

This directive has made the entire payment security mechanism foolproof on paper. Unconditional letter of credit means the generator will be ensured payment as DISCOMs approval will not be required to encash the letter of credit with the banks.

The government official further added, “The Ministry of Power is completely aware of the issues being faced by the generators. They are aware of the falling tariffs and know that the generators have cut down heavily on profits to help realize the dream of a green-energy powered nation. This fool-proofing was required to allow the generators and IPPs to function profitably and also to ensure that the citizens can benefit from lower-priced energy sources in the long run.”

When asked how the DISCOMs be dealt with if they are not procuring even after getting into the contract, the official said, “Regarding the matter of DISCOMs which have contracted with a generator but are not making payment and approaching the exchange, the load despatch centers have been directed to ensure that the DISCOMs do not access short-term open access or the power exchanges to procure power in the contract period.”

Another positive news for renewable energy generators is the move by the Central Electricity Authority (CEA) to maintain a database of all outstanding dues by the DISCOMS to renewable energy generators. Recently, the CEA found that renewable energy projects aggregating 5,981.67 MW have dues totaling ₹30.1187 (~$0.42) billion from the distribution companies across India.

The CEA list will show the states in which the DISCOMs are delaying repeatedly and over what duration. Thus, the investors will know which are high-risk states, and even the SLDC and RLDC will know which DISCOMs are most likely to default.

This move to make the database of outstanding payments transparent is already paying dividends in some instances. After Mercom recently reported on CEA data of outstanding dues, an agency executive told us that they received a call right after our article was published assuring them that past dues would be taken care of immediately.

In Andhra Pradesh, the erring DISCOM that has been delaying payments for over a year has led to a situation where future investments are under threat as the state is seeking unilateral revision of power purchase agreements (PPAs). The situation has turned unpleasant with developers opposing the state’s move and seeking legal remedy. The power minister recently said that the non-payment of dues to developers might cause them to default on their borrowings from government institutions like Indian Renewable Energy Development Association (IREDA), adding to non-performing assets in the sector and the developers could further drag DISCOMs to the National Company Law Tribunal.

When contacted, Manoj Gupta of Fortum said, “It is a great move by the MNRE. However, let’s wait and watch for its practicability as it has just become effective on August 1, 2019.

Talking about how it will help the project developers and owners, Gupta said, “If it really becomes effective, then it will be a great support to the industry to avoid non-performing assets in power and renewable sector. The balance will become healthier, and the creditworthiness of DISCOMs will improve and in the future, we can see the revival of the power sector and regaining of the faith of bankers in financing power projects.”

Gupta added that it would change the outlook of lenders towards financing solar projects in India for sure, but it will take some time, at least 12-14 months. “They (lenders, investors) would like to see at least one year cycle of payment collection before deciding,” he added.

Is there a way for DISCOM to find a way around this mechanism? To this, Gupta said, “The DISCOMs that don’t have a healthy balance sheet would still like to avoid opening of the letter of credit, and in case the SLDC or NLDC does not supply power then when will the compensation happen? What will be the mechanism? A lot more questions will arise. I wish to see the success of this mechanism, so that more healthy investment comes into the power sector.”

The industry wishes these mechanisms were put in place much earlier to prevent payment issues instead of reacting to it after the situation turned grave. However, most agree that it is better late than never.

Image credit: Azure Power