[The Viewpoint] M&As and IPOs Taking Power Sector Global

Over the years a furor has been witnessed amongst the masses, condemning the rise in pollution due to emissions of carbon dioxide (CO2) caused by generation of electricity by burning fossil fuels, without factoring in the environmental consequences like global warming. However, a paradigm shift has been observed in the outlook of governments across the globe, more specifically post the adoption of the Paris Agreement and the agendas put forth at the 26^th UN Climate Change Conference held at Glasgow, United Kingdom (COP 26) which aims at reducing global warming. India, as a signatory to the Paris Treaty and a member of COP 26 has been proactive, in turning ambition into reality by introducing reformative measures in the power sector which aid in reduction of global warming.

In fact, on our 75^th Independence Day, Prime Minister Narendra Modi expressed the need for India to become an energy independent country by 2047. Pursuant thereto, the Government of India has commenced drafting a blue-print of Vision 2047.Embarking on this new movement, the Government of India aims to achieve energy independence, enhancing decarbonization of the energy sector, attaining self-sufficiency in manufacturing renewable energy technology and making the country a global hub for green hydrogen. Therefore, Vision 2047 aligns with COP 26 goals, agreed by India.All of this is empowering an increase in the pace of energy transition to clean energy along with the size of investment opportunities in India.

As of December 2021,India is the 3rd largest producer and consumer of electricity in the world with an installed power capacity of 395 GW. A surge of 2.2%. in the demand of electricity generation has been observed in July 2022 as compared to July 2021. The future of power generation in India seems bright, with an expected increase in the installed power capacity of 620 GW by the year 2026-2027, of which 38% will be from coal and 44 % from renewable energy sources. According to these statistics, there has been a rise in demand for power generation and a massive increase in the demand is expected in the future as well,this depicts existence of opportunities in power sector.

We understand that India’s installed renewable energy capacity is more than 160 GW and India has committed to a goal of increasing the installed power capacity to 500 GW by the year 2030. Therefore, these commitments would be a driving factor for the growth in production of, and opportunities in the renewable energy sector.

The Indian Central Electricity Authority has issued a report which indicates that the incremental renewable energy will be sourced primarily from solar and wind energy.In order to meet this vision and targets, investment is sought and Foreign Direct Investment (FDI) inflow in the power sector has reached USD 15.84 billion between April 2000 and December 2021. The boost of investment in the renewable energy sector in the financial year 2021-2022 in India, recorded a total investment of USD 14.5 billion i.e an increase of more than 125% compared to financial year 2020-2021. Further, according to a report by Moody’s, there is requirement of approximately around USD 225-250 billion to meet its 2030 renewable targets. The commitments made at COP 26 to achieve a non-fossil energy installed capacity of 500 GW and having 50% of its energy requirement fulfilled by renewable source, have acted as a catapult in making the renewable energy sector one of the promising sectors in terms of investments, mergers and acquisition and private equity.

Therefore, with the ever-increasing demand of power generation, availability of growth; solid cash flows and opportunities in the renewable energy, this sector has made a compelling case for new players to enter into the sector by investing and consolidating the business. A glimpse of this has been observed by the transactions made by subsidiaries of two of the largest conglomerates of India: the acquisition by Adani Green Energy Limited of SB Energy for an investment amount of USD 3.5 billion and the acquisition by Reliance New Energy Solar of REC Solar holdings for USD 771 million.

Identifying the growth and development in the Indian power sector the Government of India has introduced the following measures to provide ease of doing business leading to acceleration in global investments:\

A. Foreign Direct Investment:

As stated above,the statistical data shows a surge in demand for electricity generation, making India's energy sector a lucrative area for investments, to the foreign investors.

As per the extant FDI Policy, 100% FDI in the power sector in India is allowed for generation from all sources (except atomic energy), transmission and distribution of electric energy, and Power Trading under the automatic route. 49% FDI allowed in Power Exchanges registered under the Central Electricity Regulatory Commission (Power Market) Regulations, 2010 under automatic route.Up to 100% FDI is allowed under the automatic route for renewable energy generation and distribution projects subject to provisions of The Electricity Act, 2003.

The FDI in India will aid in satiating surge in demands by providing the foreign investors, a leeway to freely enter the thermal power and renewable energy sector via automatic route (RBI approval to invest is not required) and by allowing them to hold 100% equity capital in a company incorporated in the thermal power and renewable energy sector.

The government has strived to adopt a non-restrictive FDI policy, which ensures a free flow of foreign investment in the economy.

B. UN Climate Change Conference (COP 26):

India is the world's fourth biggest emitter of carbon dioxide after China, the United States of America and the European Union. On the 26th COP, India aimed to achieve the following:

a) Reach 500 GW Non-fossil energy capacity by 2030;

b) 50 per cent of its energy requirements from renewable energy by 2030;

c) Reduction of total projected carbon emissions by one billion tonnes from now to 2030;

d) Reduction of the carbon intensity of the economy by 45 per cent by 2030, over 2005 levels;

e) Achieving the target of net zero emissions by 2070.

We have seen above that these commitments have propelled the inflow of investments and opportunities in the Indian renewable energy sector. It has also opened doors for various other complementing businesses, one of the booming businesses is the manufacture of Electric Vehicles (EV) and their batteries.

The total private equity and venture capital investments in the EV segment in India have grown eight-fold from USD 181 million in 2020 to USD 1.7 billion in 2021.According to the report by Indospace and Colliers of 2021, EV segment is pegged to receive investments worth USD 12.6 billion across the automotive supply chain over the next five years. The report also provides that 64% of the investments will be made in automakers and rest in battery manufacturing.Therefore, COP26 has opened doors for funding startups in India in the EV sector such as Ather Energy and Ola Electric.

C. Electricity Amendment Bill:

The Government of India is making efforts to amend the Electricity Act, 2003 which regulates the power sector. A new Electricity Amendment Bill, 2022 has been tabled in the Lok Sabha on August 08, 2022 (Bill). This Bill introduces various reforms to the existing electricity Laws in India. These amendments aim to create a conducive environment and provide ease of doing business in India, leading to plethora of investments, mergers and acquisitions and Initial Public Offerings (IPOs) in the power sector.Few important segments of the Bill are discussed below:

1. Multiple Discoms in one area:

The Bill enables multiple Distribution Companies(Discoms) to get licensed for supplying and distributing electricity simultaneously in a particular area.The Bill would permit entry of various private players into distribution of electricity market, resulting in freedom to the consumers to choose from multiple Discoms, amplification of competition, building of a viable power system with economical pricing, enhancing in turn efficiency and ensuring sustainability. 

The Bill also provides for the licensed Discoms, to provide a non- discriminatory open access to its network, to all other licensees and to utilize the distribution systems of other licensees in the area of supply of electricity on payment of certain charges.

Therefore, the Bill attempts to legislatively put an end to monopolies of state Discoms and encourages competition by entry of new private companies. The flexibility provided by the Bill to the new Discoms, of using the infrastructure constructed by the existing Discom, will act as a driving force in making the power sector a fitting space to enter for new players such as startups, investors and new companies.

2. Tariffs:

The Bill provides for a ceiling or an upper limit for tariffs set by State Electricity Regulatory Commission (SERC) in areas consisting of multiple Discoms. The Bill provides SERC withthe power to initiate tariff revision proceedings on a suo motto basis, in the event the Discoms fail to file petitions for the same.

The Bill provides for multiple Discoms in the same area leading to a probability of discrepancy in tariffs by different Discoms. The concept of SERC setting up a threshold for tariffs introduces price parity throughout the sector and solves the problem.

Price parity smoothens the operation of business across the sector by reducing the losses caused due to imparity in tariffs and providing a sense of healthy competition. The ease in operation of business, healthy competition and reduction of losses would make it a lucrative sector for prospective investors, startups and other businesses.

3. License for distribution:

The Bill provides flexibility by granting multiple Discoms licenses, in multiple States by Central Electricity Regulatory Commission which facilitates in ease of doing business.

4. Renewable Purchase Obligation:

Honoring the commitments made at COP 26, the Bill empowers SERC to set a threshold for Renewable Purchase Obligation (RPO) for Discoms to purchase electricity from renewable sources. The bill mandates that, RPO shall not be less than the minimum percentage prescribed by the central government. In the event of non compliance with the RPO threshold, a penalty between 25 paise and 50 paise per kilowatt of the shortfall will be levied.

The introduction of the concept of RPO, mandates Discoms to compulsorily purchase the electricity generated, using renewable energy resources like solar and wind energy. This would facilitate India in honoring the commitments made in the Cop 26 to increase the use of renewable energy for electricity generation.

5. Cross Subsidy Balance Fund:

The Bill makes provision for setting up cross subsidy balance fund managed by the State Government, where licenses are issued to multiple Discoms in the same area. The difference in power tariffs for various categories of consumers may result in profit or loss. In the event the Discom makes a profit, due to difference in power tariff of consumer categories then the profit making Discom will have to transfer the profit to the cross subsidy balance fund. However if there are losses caused to any Discoms, due to difference in power tariff of consumer categories they will be compensated from cross subsidy fund.

D. Green Bonds:

In addition to all of the above reforms and measures, Green Bonds have also been steadily gaining popularity.A Green Bond is like any other bond where a debt instrument is issued by an entity for raising funds from investors. What differentiates a Green Bond from other bonds however is that the proceeds of a Green Bond offering are 'ear-marked' for use towards financing ‘green’ projects. Green Bonds are an innovative way of aiding infrastructure financing, which in turn, leads to climate improvement and low carbon emission. Indian companies are becoming conscious of their carbon foot print and adopting various ways to commit themselves and contribute towards a clean energy India. Recently, India has emerged as the sixth largest country in the Asia-Pacific region to issue Green Bonds. As per statistics, Green Bonds worth USD 6.11 billion in 11 months of 2021 have been issued in India.These Green Bonds are also sure to grab the attention of the foreign investors, as these Bonds provide tax exemptions to the investors. This initiative will in turn accelerate more investment in the green sector in India.

The measures adopted by the Government of India, has pushed Indian companies to strive and generate clean and green energy, which in turn, has accelerated the capital infusion in power sector. A lot of activity in the renewable energy sector and the EV sector in the financial year 2021-2022 has been observed, specifically in terms of private equity investments, mergers and acquisition and IPOs.

A trend that is observed is that, the companies have been repositioning their portfolios from non-renewable energy to renewable energy. Repositioning of portfolios is being undertaken by acquisitions of renewable portfolios and by consolidation with renewable energy companies. These acquisitions are in the form of business transfer, asset transfer, acquisition of controlling stake in the renewable energy company.

The mergers, acquisitions and IPOs in the power sector have become an attractive prospect for investors since the last couple of years and majority of which has been seen in the renewable energy sector, thus creating a positive ripple effect and aiding in the smooth transformation to clean and green energy in India.Transformation to clean energy would help in curtailing global warming. Further, the initiatives by the government such as Vision 2047 to make India energy independent and the commitments by India at COP 26 to cut down on the usage of fossil fuels and increase the usage of renewable energy sources for power generation will increase the scope for more M&A and IPOs within the sector.

Considering the booming investments in the power sector, businesses have been reaching out to their legal and financial advisors to advise them on transactions involving either investments or mergers or acquisitions involving players in the power sector. It is imperative for businesses to consult legal experts for understanding the laws governing the power sector, to undertake the process of due diligence, structuring transactions and determining the documents that are to be entered.

While undertaking the process of due diligence, the Legal Advisors highlight the caution areas of the target company that will become detrimental in the future for the Acquirer or Investor. For instance, the existence of any encumbrance on the assets involved including in relation to its title or any preemptive right in favour of any third party and non-filing of forms or non-payment of fees with the statutory authority etc.would be identified as caution areas.

Depending on the structuring of the transaction and the due diligence undertaken, businesses may also be advised by the Legal Advisors to enter other definitive agreements. Therefore, consulting legal advisors is of paramount importance for highlighting the caution areas, providing solutions and safeguarding the businesses.

Purvi Kapadia is a Partner and Sakshi Sharma is an Associate at Rajani Associates.