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Scaling up renewable energy investment in emerging markets

By: Emilia Samuelsson

The transformation of the world’s energy system in line with internationally established climate and development objectives will need a significant scaling up of energy investment. Yet renewable energy investments fell by 2.6% in the first quarter of 2020 compared to the same period in 20191. New commitments dropped further during April and May, two-thirds lower than the same period last year. The financial impact of Covid-19 is even greater in emerging markets. Increased risk aversion and a global liquidity crunch generated severe capital outflows from emerging markets2. Foreign capital flows to emerging markets are estimated to decrease by 53% during 2020.3

In addition, the crisis is likely to be accompanied by a wave of credit downgrades, making it even more challenging for borrowers from emerging markets and developing countries to access the international debt market. With reduced project financing options, emerging markets could see a decrease in new renewable energy projects. There are also concerns that developing countries will prioritise fossil fuels as a means to recover from Covid-19. For example, South-east Asia countries such as Vietnam and Indonesia, which have large coal deposits, may see the exploitation of these resources as a cost-effective option for boosting power generation and the economy.

Fatih Birol, executive director of the International Energy Agency (IEA) stated that “The historic plunge in global energy investment is deeply troubling for many reasons. The slowdown in spending on key clean energy technologies also risks undermining the much-needed transition to more resilient and sustainable energy systems.” Finding ways for emerging markets to create an environment for investment in renewable energy is of great importance.

That being said, there are factors that must be addressed to accelerate the development of renewable energy investments in emerging markets, but also ensure they are as sustainable as possible for the affected stakeholders. Risk-mitigation instruments will be essential, especially as the Covid-19 pandemic and its disruptions have made investors more risk averse.

Current trends in renewable energy development are already diversifying the investor base and decreasing funding costs. However, it is of vital importance that the right tools and policies are in place to enable these developments to effectively combine international and national goals with local implementation. The International Renewable Energy Agency (IRENA)  Coalition for Action has published a report which summarises the challenges, risks and solutions for scaling up renewable energy investments in emerging markets. The report highlights these factors in three main categories: Finance and Bankability Challenges, Administrative and Capacity Challenges and Policy and Regulatory Challenges.

Finance and Bankability Challenges

Renewable energy projects need to be seen as profitable and executed as proposed over the financing period. The risks must be minimised in every way possible. Off-taker risk parties, i.e. investor-owned, municipal or national utilities that buy electricity from independent power producers, may not have a balance sheet strong enough to satisfy investors.

A tool to mitigate this risk is an off-taker guarantee mechanism. If the off-taker is not creditworthy, a state guarantee can be used to mitigate the payment risk, and in some cases the regulatory risk, to make the contract bankable enough to be accepted by lenders and investors. In addition, if the state does not have a high enough credit rating, development banks or export credit agencies can step in and and provide the guarantees.

One successful example of this is the 25.5 MW Cabeólica wind farm project, the first commercial-scale wind farm in sub-Saharan Africa. It was commissioned in 2011 and developed by the private company InfraCo Africa with support from the government of Cabo Verde and its national utility, Electra. Electra had no credit rating and was loss-making at the time of signing the power purchase agreement (PPA). The PPA defines all the commercial terms for the sale between the two parties and defines the revenue and creditworthiness of a project. The off-taker guarantee mechanism was essential to develop the project. The government of Cabo Verde endorsed the Cabeólica wind farm by establishing a public-private partnership and issuing a government support agreement.4

Administrative and Capacity Challenges

Factors connected to administrative challenges and capacity, such as the project development’s timeliness and the transparency of the procedures and decision-making processes, are essential for a desirable investment environment. Land access is one of the most problematic concerns when it comes to renewable energy projects in emerging markets.

The renewable energy industry should not be put in a position of attempting to resolve old land disputes. The lack of jurisdictional guidance in these cases can create a terminal challenge for the project’s development. One risk mitigation measure is to centralise, strengthen and streamline administrative and permitting institutions. This could encourage investment as a concentrated framework to improve the coordination and permitting requirements processes. An example of this is Zambia’s Public Private Partnership Unit5.

Another important factor is the mitigation of land tenure issues. In many nations, land use and ownership records are incomplete, and arrangements of land ownership are complex, such as  post-colonial structures and unresolved indigenous land claims. The departments handling land reform and planning are often distant from energy policy departments. In such cases, introducing some level of government guarantee in the event of land disputes, or the definition by government of zones appropriate for renewable energy development, could have a tremendously positive impact on renewable energy development.

When it comes to the social acceptance of renewables and land tenure issues, proactive engagement and dialogue with landowners and communities is vital. In Mexico, following years of land disputes, the promoting of good relationships with stakeholders is a high priority for renewable energy developers. In the Oaxaca region, an annual socio-economic community study has been executed and the interests of the population and their views on the performance of the developers in environmental protection, business ethics and local economic development have been documented. This provides a guideline to reinforce the developer’s Social Management Plan and to address the risks and opportunities that arise.

Policy and Regulatory Challenges

The main regulatory risk for renewable energy investments in emerging markets is connected to unexpected changes in energy policies, procedures, market design, grid access and resource planning during the project development and plant operations phase. Rules for accessing grid connections, resource planning, curtailment compensation and payment mechanisms can generate regulatory issues.

To address regulatory challenges, an effective legal framework that forms long-term and comprehensive renewable energy policy is essential. A balance between predictability and flexibility is also crucial to adjust to a fast-evolving market environment and technology development. Three main principles should guide the strategies and policy implementations: environmental sustainability, security of supply and economic affordability.

Risk connected to policy exists in both mature and emerging markets. To mitigate policy risk it is important to establish and maintain clear policies and only gradually make changes when necessary, and to announce all changes early and concisely to keep stakeholders informed. This creates confidence in the market through a clear track record, instead of making “retroactive changes”, as has happened recently in some markets. In addition, international policy standards and comparability are crucial to deliver political and economic stability. International collaborations contribute to limiting the risk perception, which can be an obstacle to investment potential.

Emilia Samuelsson

Based on:

IRENA (2020), The post-COVID recovery: An agenda for resilience, development and equality, International Renewable Energy Agency, Abu Dhabi

IRENA Coalition for Action (2018) Scaling up Renewable Energy Investment in Emerging Markets, International Renewable Energy Agency, Abu Dhabi

1. BNEF (BloombergNEF) (2020), “Transactions” (database), BloombergNEF, Available at: www.bnef. com/fundscommitted/search.

2. IMF (International Monetary Fund) (2020), Regional Economic Outlook – Sub-Saharan Africa: COVID-19, An Unprecedented Threat to Development, Washington, DC.

3. IIF (Institute of International Finance) (2020), Capital Flows Report Sudden Stop in Emerging Markets, IIF, Washington, D.C.

4. ECREEE (2017), Case Study: CABEÓLICA WIND PROJECT Cabo Verde, ECOWAS Centre for Renewable Energy and Energy Efficiency ;IRENA (International Renewable Energy Agency) (2016a), Unlocking Renewable Energy Investment: The Role of Risk Mitigation and Structured Finance, IRENA, Abu Dhabi.

5. Zambia Development Agency (2014), Public-Private-Partnerships in Infrastructure Development in Zambia, Zambia Development Agency, Lusaka.

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