Scaling up private equity investments in renewableenergy in developing countries

Accessing greater finance and investment is essential to achieving higher levels of renewable energy (RE) in developing countries. The scale of capital flows required is significant, indicating that, together with domestic sources of capital, private finance from outside national boundaries will be required. There is already activity and interest for RE in many developing countries, but private investors need to deliver attractive commercial returns for risks taken. This article provides evidence for the views of private financiers and investors already engaged in RE from late 2008 to early 2010. They noted that to attract private equity, RE is still a low-return proposition, generating returns of 8-15%, whereas generally a 25% return would be expected. RE is rarely able to compete with conventional energy sources due to the high start-up costs, the higher perceived risk as technologies and project developers lack track records, and an existing policy environment that often favours or subsidises conventional energy. These and other challenges reinforce the central role of effective national policy in creating attractive investment conditions. A well-designed policy environment can be one of the most effective ways of reducing risk for investors. Although there is no ‘one size fits all' policy formula, the overall environment, including incentives such as feed-in tariffs and clarity and stability of energy policies, can contribute to attracting the private sector. Notwithstanding existing capital flows to emerging markets, and even in the context of strong national policies, developing countries present a range of risks. In this context, multilateral banks and public financing play key roles in enabling or accelerating commercial activity. Emerging private business models able to face existing constraints are also helping private finance to play a larger role. To help policymakers better understand the public policy side of scaling up RE in emerging markets, an evidence base of issues was sought2 as an important grounding for the next steps required.

Facilitating returns and reducing risk

Rising global investment in RE and strong exponential growth were experienced between 2004 and 2007. In 2008, for the first time, global investment in new RE power generation capacity (including large hydro) was greater than investment in fossil fuel generation. Financial investments reached USD 37.7 billion in 2008, a 27% increase from 2007, and the share of global investment in emerging markets increased to 31% in 2008 (UNEP et al., 2009). There was also significant annual growth in RE investment at a country level in 2008, with China growing by 18% (25% in Asia-Oceania in 2009), India by 12%, Brazil by 76%, and Africa by 10%, making emerging markets a clear growth sector for RE investment (Bloomberg New Energy Finance, 2010). Although the global financial crisis slowed growth in 2008/09, the decline was smaller than predicted. Statistics indicate that the market was upheld by strong growth in the Asia-Oceania region, with investment in Chinese wind and solar plants increasing by 27% and 97% respectively in 2009 over 2008, partly offsetting investment declines in the US and Europe (Bloomberg New Energy Finance, 2010). For the first time, Asia-Oceania investment had overtaken US investment. However, several challenges, particularly access to affordable debt, exist in new markets. Financial conditions affected bank deals, and severely constrained the availability of debt in many markets. Instances of this are expensive, slower processes and loans available for short periods (six or seven years compared to 15 years). A period of ‘nationalism' also followed as some international banks repatriated money back to home territories, particularly those recapitalised by governments. Although financial conditions had improved by mid-2009, the general view is that conditions have not normalised, and constraints may continue over the next two to three years. Similar to the role of public stimulus packages in OECD countries linked to RE, the role of public finance in emerging markets has increased in importance, as has clarity over the policy environment and its stability. Private financiers expect multilaterals and public finance entities, such as Export Credit Agencies (ECAs), to provide a scaled-up set of current products and facilities (loan guarantees, revolving credit facilities, etc.) to reduce risks and facilitate returns. Government-backed national banks, sub-national entities (e.g. local government) and private domestic financial institutions also play important roles in providing local currency–based lending. Significant additional public support will be required, with a clearer understanding of energy market development.

Public funding: unlock untapped potential

Issues include ‘valley of death' projects – getting technology development from the R&D phase towards commercialisation. These projects are too capital-intensive for venture capital and too risky for private equity in that they require investors to bear technology and scale-up risks. The role of specialised public funding is to help create conditions that attract more private sector actors, make the process shorter and easier, and make capital more affordable for technology developers. Accessing debt and equity finance is difficult due to small or new developers having no track records. Concessionary equity financing to start developers on their first projects is identified as one means of opening up private equity finance to them, but attention to the smaller ‘enterprise level' deal with significant untapped potential is needed from multilaterals and other public finance entities. Investors highlight the importance of intermediation and aggregation at the enterprise level, and having the right range of products in place. This needs to be demand driven – getting recognition from governments and getting banks comfortable with smaller projects. In this area, a more targeted focus on public finance by multilaterals and public finance institutions is as important as efforts for larger projects. Greater engagement with local financial institutions, alongside international lending and private equity entities, is seen as key to arriving at solutions. Kenya, for example, has recently announced a ‘Green Energy Fund' that will provide low-interest loans to SMEs wanting to invest in RE. Another issue is driving technology costs down once technologies have a track record. One top-down approach involves working with a country with the right industrial and energy policy framework that has the right resources and conditions for financing, and has driven costs down through implementation. The case of concentrated solar power (CSP) was raised by financiers and investors with private sector, EU (the European Commission–linked Mediterranean Solar Plan) and multilateral (World Bank and European Investment Bank) interest in developing CSP – alongside wind in the Middle East and North Africa – with the possibility of transmission to European markets. Efforts at large-scale implementation are seen as a means to getting from ‘roadmap' to ‘road-test' stage, from where scale and experience can drive costs down. However, public financing instruments need to identify and tackle actual issues faced on the ground. Five main areas are highlighted by one international bank as challenges for new CSP technology: demand and price certainty; availability of debt and equity at the right scale; financial instruments (ideally local) that can bring this in (e.g. a guarantee facility on the debt side); managing technology risk; and attention to the later-energy nexus. The first area indicates the importance of clarity over the institution that power will be sold to. Laos was singled out as having one of the most attractive regimes, namely, the simplest off-take contract and tariff arrangements, and a state-guaranteed obligation from the Electricity Generating Authority of Thailand (EGAT) for the power off-take. However, even relatively mature markets, such as India, with a history in electricity and utility policy, can experience obstacles due to the complexity of contracts. There are methods of finding credit-worthy Power Purchase Agreements (PPAs)3 including with multilaterals such as the Multilateral Investment Guarantee Agency (MIGA)4 potentially able to cover contract revocation. To drive scale, systematic solutions are required through policy or national regulators.

Modern energy calls for new business models

With a stable policy environment and public finance, new business models are emerging from private investors to overcome existing constraints. Some examples were raised during the round-table, one being solar technology linked to infrastructure in the telecommunications sector, combining solar investment with the ‘soaring growth' in numbers of telecommunications towers installed as part of a high-growth mobile phone industry in India. Solar technology is installed as the solar infrastructure for the towers; the telecommunication companies pay for the towers, and the cost model for the infrastructure installer does not require income from charging local communities for energy use. This results in charges being cut by 50% or more at a community level, and provides a different model for providing energy via RE in areas where grid connection is not competitive. Another example raised was using a portfolio approach to reducing new technology risk.5 Linked to the ‘valley of death' discussion, technologies that are not commercially proven are finding it difficult to get finance, a situation exacerbated by the financial crisis. One private finance entity creates a portfolio of projects where a small segment is given over to a commercially unproven technology. This approach allows the risk to be spread across the entire portfolio. By taking this approach, the firm can still produce commercially viable returns while gaining experienc e and a track record in the unproven technology. The advantage is that for the next deal, a previous financing benchmark exists. Enterprise-scale financing has been pioneered by the company E+Co.6 With poor access to energy in developing countries, there is a ‘true market' for renewable electricity when sources are available locally. People may already pay significantly higher rates for their power through dry cell batteries, kerosene, etc; the higher up-front cost of RE is still competitive relative to those costs. The load levels are also lower, and this, coupled with higher transmission losses, leads to better economics for the more modular RE sources compared with large generation sources such as coal. The capital formation opportunity is as significant as micro finance, yet few institutions are seen to be tackling this. Financiers are looking for clearer signs from government regarding their intentions and commitment to RE and energy efficiency – the scale and timeframe policymakers want to achieve, the investment required and mechanisms for facilitating this – particularly given the scale associated with mitigating climate change and by fundamental energy demand. A shared agenda – rather than a single roadmap – is required between policymakers and financiers to enable investment plans to be made and capital to be mobilised. This will need to be at a national/regional level, particularly to develop an effective national energy policy and lay a foundation for international policy or public finance mechanisms. Regular direct exchange between policymakers and financiers will be an important part of delivery and a valuable method of getting feedback on, or anticipating factors that may impact capital flows.

1 The paper outlines perspectives of the financiers and investors involved.

2 This work was executed through three round-table conferences in India, Brazil and London in 2008 and 2009, involving leading, mainstream, transactions-focused financiers in infrastructure and RE (both in banking and private equity), as well as public financing organisations. Additional input and review from other regions and financiers also contributed to the final report.

3 A PPA is a legal contract between an electricity provider and purchaser, whereby the provider secures funding for a project, maintains and monitors energy production and sells electricity at a contractual price for the term of the contract.

4 As a member of the World Bank Group, MIGA's mission is to promote foreign direct investment (FDI) in developing countries by providing political risk insurance to the private sector.

5 See Adeline Lemaire and Christophe Scalbert's article in this issue of Private Sector and Development.

6 E+Co is a US-based NGO that invests services and capital in small clean energy businesses in developing countries through investment funds. See Susana Garcia-Robles's paper in this issue of Private Sector and Development.

RÉFÉRENCES :

Bloomberg New Energy Finance, 2010. Asia outstrips the Americas, press release, 7 January 

UNEP, SEFI, NEF, 2009. Global Trends in Sustainable Energy Investment – Analysis of Trends and Issues in the Financing of Renewable Energy and Energy Efficiency, report.