Solar energy prices are crashing through the floor in India.

In the last three months, solar tariffs have dropped by over 25%, with much of the recent action focused around Rajasthan’s Bhadla solar park, a 10,000-hectare facility on the edge of the Thar desert.

At an auction for 500 megawatt (MW) of capacity at the park on May 12, the state-run Solar Energy Corporation of India (SECI) managed to discover a record-low tariff of Rs2.44 per kilowatt-hour (kWh). The previous low was two days before that when tariffs hit Rs2.62 per kWh during auctions for another phase of Bhadla solar park.

At such rock-bottom prices, solar power is even cheaper than India’s coal-based thermal power plants. The country’s largest power company, NTPC, sells electricity from its coal-based generation units at a princely Rs3.20 per kWh.

Moreover, India’s solar-generation capacity is expected to touch 8.8 gigawatts (GW) this year (a jump of 76% over 2016) to become the third-largest solar market in the world, according to renewable energy consultancy Bridge To India (BTI). And, on the back of prolific growth in non-conventional power, consulting giant Ernst & Young reckons that India is the world’s second best market for investing in renewable energy.

So, it really should be party time for India’s solar sector—except that it isn’t.

Instead, there is real fear that, with such low tariffs, many of the country’s solar projects could turn unviable.

Nuts and bolts

There are a bunch of factors behind the dramatic drop in solar prices in India.

First, the price of photovoltaic panels, which account for a major chunk of a solar power plant’s cost, have plunged by 30% in the last year. Developers are betting that the downward trend will continue, and factoring that into their overall cost estimates, which, in turn, is helping lower tariffs. “To that extent, they (developers) are taking a forward punt on this (drop),” said Anish De, a partner with infrastructure and government services at KPMG. “Whether they (the bets) are hedged or covered, we don’t know.”

Second, the Narendra Modi government has moved decisively to assure private renewables developers by backing a payment security mechanism. Last year, SECI, the country’s largest solar power purchaser, was included in a tripartite agreement (pdf) between the central government, state governments and the Reserve Bank of India (RBI), which safeguards it against payment defaults. India’s state government-owned power distribution companies are notorious for delayed payment to renewable energy producers, which are increasingly under pressure because of falling tariffs.

Who dares lose

But the main driver for this sharp reduction in tariffs is cut-throat competition, which is leading to overtly aggressive bidding. For an auction of 750MW of capacity at Bhadla solar park in April, some 33 developers are estimated to have lined up. Competition is rife, BTI reckons, because a slowdown in new tenders is pushing global and domestic solar developers to fight harder for whatever is on the block.

Moreover, the reverse auction process—where sellers typically underbid each other to win business from a buyer—that has been employed for projects like Bhadla has helped push tariffs lower, according to KPMG’s De. “If you’re having a regular tender, you would’ve taken your final calls and given your bid,” he explained. “In a reverse auction… it’s a very, very visible competitive process, and makes you take even sharper calls egged on by competition.”

Solar arithmetic

The basic math for setting up a solar plant is that 1MW costs around Rs6 crore, according to Rupesh Sankhe, senior analyst at Reliance Securities, a brokerage. His estimate is that if a developer wants a return on investment of around 14%, then the tariff needs to be in the range of between Rs4.5 and Rs5 per kWh. “If they come below Rs3 (per kWh), then the return will be zero,” Sankhe said. “No matter what they do, they won’t make profits.”

KMPG’s De estimates that some players are settling for “very low returns” as a result of aggressive bidding. At the same time, these companies are not completely factoring in all the risks—including sticky issues like grid curtailment. Simply put, curtailment refers to incidents where a power-generating unit is not allowed to despatch electricity to the grid and ceases production for a certain period. This especially impacts renewable energy producers, like solar power plants, because they typically function only during certain hours, and there may not be enough demand on the grid at those times. Or, there may be cheaper power available elsewhere. Hence, the curtailment.

“In some projects, you’ll be paid if production is curtailed,” De said. In other cases, producers may not be compensated, which’ll hurt given how thin margins are likely to be on the back of such depressed tariffs. And as India pushes to create 100GW of solar power by 2022, the danger of financial damage from curtailment will only get bigger. “…the future risk of curtailment of power due to grid congestion, especially in high renewable penetration areas, can upset project cash flows and return expectations,” BTI said in a May 2016 report.

With such risks persisting, and tariffs dropping in an increasingly overheated Indian solar market, it’s only a matter of time till someone ends up burning their fingers.