Solar Power Plants : Can we term them as "Toll Bridge" functional equivalent ??

"In an inflationary world, a toll bridge would be a great thing to own because you've laid out the capital cost. You built it in old dollars and you don't have to keep replacing it"

-Warren E. Buffet

Above words are one of those excellent peice of advice, which Mr. Buffet has imparted to the fellow investors for better understanding of his business evaluation process. Though simple, but these words have profound meaning.

In Oct 2012, Prof. Sanjay Bakshi also posted a thought provoking on the functional equivalent of "Toll Bridge". In this post, I'll make an attempt to evaluate Solar Energy project from the "Toll Bridge Equivalent" perspective

Statutory Warning :

(a) The analysis might be suffering from "Confirmation bias" . Reader's discretion is expected.

(b) Since I am looking this analysis from the goggles of a "toll bridge" equivalent , so I might be lacking on variety of mental tool requisite for unbiased analysis. In words of Mr. Munger, " I am a man with hammer, and every thing to me look likes a nail"

Analysis :

Solar Energy project is a long term project whereby an entity setups solar panel today and generates electricity for future year (say 25- 30 years). So, going by the sacred words of Mr. Buffet , a solar panel's capital cost is laid down initially and the benefits are reaped in future years without any future incremental cost. In other words we built it in "old dollars" and we "don't haved to keep replacing it". So, prima facie it seems like a decent business model like a toll bridge, but unlike toll it has got several competition like non -conventional energy sources such as Wind based power plants, Hydro electric power plants. So we cant say that this business model has got a wide "moat". Though it has got some "moat" attached to it but it will converge within few years.

Now, coming to Prof. Bakshi's post on Functional equivalent for "Toll Bridge", the broad parameters laid out are as follows:

1. Pay the Toll
2. Mind of the user
3. Movement
4. Traffic
5. Gateway

Point wise analysis is as under :

1. Pay the Toll: Since electricity is one of the basic need for mankind and with the fact that still approx 60% of India is deprived of electricity, and rapid industrialisation has led to huge gap in demand-supply figures. So, in order to keep the country's growth momentum intact, the electricity demand will sustain and for the purpose Government is signing long term Power Purchase Agreement with the solar power project at high rate (As per Gujarat Solar Policy 2009, its Rs. 15/- for first 12 years and then Rs. 5/- for future years). So, Government is paying the toll to get access to the electricity. One can also sell the power through 3rd party sales, to enjoy the benefits of increase in revenue on y-o-y basis. 1^st point "Check".
2. Mind of the user: With this term " mind of the user" , professor meant that the product must not have any alternative. So, in a solar project, the underlying product is electricity and as we all would agree, there is no alternative to electricity. We cant imagine this world today without electricity. So , I guess, 2^nd Point "Check"
3. Movement : In a solar project, there is continuous movement of electricity or more specifically Electrons ( pardon me if I am wrong, and blame my commerce background for it) from solar panels to Grid and then to the end user. Also, since there are no viable technology available which can ensure the storage of power at large scale, so this makes the movement inevitable. Whatever energy generated, has to be transmitted. I agree that there are transmission losses, but still majority of current has movement. So, 3^rd point "check".
4. Traffic : As discussed above, since there is no viable source of large electricity storage, all the electric current has to be transmitted. So, therotically , there is no reduction in traffic movement as such over the period. There can be a fluctuation in Capacity Utillization but still it will generate electricity for atleast 10 hours a day generating healthy traffic of electric current over its useful life of say 30 years. So, 4^th point "Check"
5. Gateway : Gateway can be referred to as the junction point where two important ends meet. In effect, it is the passage which charges you to move from one point to other. Though I can't term solar project directly as a gateway like that of Internet, telecom companies or Power Dis-com, but indirectly it act as the reverse gateway between the buyer's demand for electricity and the suppliers urge to generate income. In order to source the electricity, the government is paying additional tarriff to solar projects for a considerable time frame. So, its upto one's own discretion whether to say, 5^th point "Check".

Other Aspects : Though prima facie, Solar project seems a good business model, but it has its own share of cons as well. Some of which i can think readily are :

• I guess the plant load factor in monsoon season should be less as compared to the normal scenario, hence reduced traffic/ movement in monsoon season.
• With involvement of Government, the project is subject to political risk. For states like gujarat where the government is stable and pro-active (personal view) , solar industry will be a good bet, but for other states (i won't name them) the tarrifs can change and dent the revenue for good
• Asset intensive industry. As per the latest information available to me, the cost per MW is somewhere near Rs. 8 Cr, which is on a higher side in comparison to its contemporaries.

Views invited.

--

Tony Stark

(CEO – Stark Capital)

(Note : The author has no intention to copy the ideas of other blogs/websites. If the person metioned above minds mentioning their name on this blog, author is ready to do so. Special thanks to Prof. Bakshi for his post)