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The year 2015 was a turning point in the history of renewable energy: For the first time ever, the volume of investment in this sector was larger in emerging and developing countries than in industrialised countries. The reasons for this can be traced first of all to the short-term trend in total renewable energy investment on some key markets: While Europe's renewable energy investment dramatically fell by 21% in 2015 compared to 2014, a strong growth in this sector was reported in the corresponding period mainly in China, Brazil and India.
Figure 1: Total renewable energy investment by country category, in EUR bn1
(Click to enlarge)
When you look at this trend from the long-term perspective, you will notice that the annual renewable energy investment volume in emerging and developing countries had been almost constantly increasing between 2004 and 2015, resulting in a rise from USD 9 billion back then to USD 156 billion last year. However, many of the related investment risks are perceived to be relatively higher there, so capital providers receive higher risk premiums, which negatively affects the competitiveness or feasibility of RE projects.2, 3
The higher level of political and financial risks in emerging and developing countries poses a serious challenge to investors. Below we describe risks that are mentioned particularly often with regard to investing in emerging and developing countries. The description aims to give you an initial overview of the special aspects of the business environment there:
It has already been proven in many studies that renewable energy sources (RES) are competitive with conventional generation technologies in terms of Levelized Costs of Electricity (LCOE).8 Many factors influence LCOE. In addition to acquisition costs, site conditions, operating costs and the lifetime of power plants, it is the financing conditions that have a particularly significant impact on the market potential of RES.9
The additional types of risk present in emerging and developing countries (see Figure 2) put a particular strain on the costs of capital for RES projects. Due to the usually high initial investment costs, competitiveness of RES is impaired by the costs of capital; they are significantly higher in those countries, which reduces the level of acceptance of RES among local businesses and civil society. Thus, the bankability or financing of RES projects is one of the main obstacles to the success of RES in emerging and developing countries and requires strengthened risk management. In industrialised countries, special-purpose entities and power supply companies (PSC) normally use private-sector instruments to improve financeability, such as e.g. insurance products or comprehensive and clearly worded power purchase agreements (=PPA; also statutorily regulated as feed-in tariff, as the case may be). Due to the relatively far-reaching consequences of political and financial risks it can be stated, however, that insurance products covering the special aspects of the business environment in emerging and developing countries are either too expensive, not available or, simply, inadequate.10 Therefore, both risk categories require additional solutions.
When taking an investment decision, investors consider in particular the financial risks to which they will be exposed in target countries. Before describing in more detail the financial instruments available to that end, we should first point out some of the basic measures and recommendations relating not only to IFIs and commercial banks but also to project developers (engineering, procurement and construction = EPC) and investors.
Since RES projects have a long-term nature, inflation in emerging and developing countries, which is extreme in many cases, may seriously affect the cash flows of special-purpose entities. Inflation-related risks depend on various factors (e.g. on how the inflation allowance is regulated in a given PPA and in long-term agreements with third parties; on short-term and long-term correlations between inflation, exchange rates and interest rate changes etc.).7, 12 In order to avoid strong fluctuations in cash flows, a special-purpose entity (i.e. an Independent Power Producer = IPP) should, however, consider the following two principles:
Hedging instruments that are otherwise available to investors on other markets from third parties and enable them to achieve these objectives are not sufficiently accessible in emerging and developing countries.
Many investors often also avoid investing in emerging and developing countries because of low transaction volumes of individual projects and unreasonably high transaction costs.7 Now, however, various online platforms can give a good overview of prospective RES projects which involve reasonable transaction costs and help EPCs and capital providers connect. As regards financing by loans, emerging and developing countries are facing two big problems. Even if sufficient refinancing facilities exist, local banks are very reticent to lend money to the RES sector (“credit squeeze”). The reason for this is often the lack of know-how or experience.6 This problem is addressed in that IFIs provide technical assistance services in this area. Moreover, local long-term loans are often largely not available. The reasons for this are to be found, amongst others, in national and international regulation of financial markets.5 In order to overcome these obstacles, IFIs often grant different kinds of loans (e.g. subordinated loans or convertible loans) with longer tenures; they are granted via commercial banks to end borrowers on the basis of so-called on-lending.4
Figure 3: Basic measures addressing selected risks in RE projects (Click to enlarge)
In the context of bankability of RE projects, the urgent need for equity in emerging and developing countries should be pointed out. So, banks partly require a down payment of more than 40 percent.5 Instead of direct financing, IFIs, however, more and more often rely on e. g. guarantees or liquidity facilities that transfer the risks of special-purpose entities to IFIs but leave financing itself to local banks and private investors. In this way, the limited means of IFIs help mobilise additional capital and the lack of equity prevalent in emerging and developing countries is countervailed on a larger scale4 Figure 4 shows financial instruments that can be used in RES projects for risk management.
Figure 4: Financial instruments for risk management in emerging and developing countries4
In industrial countries, interest rate and currency risks can be basically hedged through derivatives, such as forwards or swaps. In emerging and developing countries, such products are often available only as short-term and low-liquidity products. Special-purpose funds, such as Currency Exchange Fund (TCX), aim to improve refinancing of local commercial banks by way of currency swaps.13 Whether the availability of long-term loans in local currency from these banks is indeed better (which, again, would be favourable to special-purpose entities) should be checked on a case-by-case basis.
Amongst products from the German speaking countries, product packages by DEG (Deutsche Investitions- und Entwicklungsgesellschaft) offer good opportunities to minimise the lack of capital that partly prevails on foreign markets. Apart from long-term loans with tenors of four to ten years, which are also offered in domestic currency, the KfW subsidiary offers various funding programmes:
The programme supports climate protection measures of German, European and domestic enterprises by taking over 50 percent of the costs for, e.g. the implementation of innovative climate-friendly technologies.
The co-financing instrument for projects that add a special value in terms of development policies and economy addresses enterprises from Germany and Europe and takes over 50 percent of the costs.
This programme supports innovative pioneer investments on the brink of commercialisation carried out by SMEs in developing countries (e.g. solar home systems). Up-Scaling takes over up to EUR 500,000 of the entire investment, which are to be repaid if the project is successful.
DEG can take over 50 percent of costs of feasibility studies conducted in preparation for further investment measures, such as wind measurement for wind farms. Although funding programmes impose various requirements on special-purpose entities, such as that to create the special value added in terms of development policies, the reward for all efforts expended in meeting these requirements is high – a grant of up to EUR 200,000.15
As regards international financial product providers, a further three programmes are worth mentioning, e.g.: GuarantCo, Global Climate Partnership Fund (GCPF) and Regional Liquidity Support Facility (RLSF).
The programme of FMO, a Dutch development bank, aims at providing local loans for infrastructure projects. Granting Partial Credit Guarantees to local banks should incentivise them to grant loans with sufficient quantum and of a sufficient tenor. The Partial Credit Guarantee protects the bank from possible defaults on the part of a special-purpose entity. Structuring is very flexible but requires comprehensive consultation between special-purpose entity, local bank and GuarantCo. Moreover, it is project developers who must initiate the involvement of GuarantCo by convincing the local bank to do so.
Global Climate Partnership Fund (GCPF) is a public private partnership (= PPP) and was founded, amongst others, by the KfW banking group. Financial management is handled by responsAbility Investments AG. On the one hand, the financial means of the fund help refinance Green lending programmes of local banks in emerging and developing countries; and depending on project structure, this might be also a benefit to project developers from Germany. On the other hand, GCPF also directly finances RES projects for which local long-term loans cannot be obtained due to their complexity.
Financing is normally provided in the form of loans of USD 5-10 million with a term of up to ten years; this directly addresses the lack of long-term loans. It is also possible to use equity and mezzanine financing. It is true that evidencing eligibility for funding and the subsequent reporting is an expenditure on the project financing level, nonetheless GCPF is a good alternative especially in high-risk countries.17
The Regional Liquidity Support Facility (RLSF) addresses liquidity problems of PSCs in emerging and developing countries. The liquidity problems are regarded to be the source of power off-taker’s risks and often hamper the financial closing of RES projects carried out by IPPs. Therefore, KfW partnered with Africa Trade Insurance Agency (ATI) and developed the RLSF targeting Ghana, Kenia, Zambia, Malawi and Rwanda. It will bridge possible short-term defaults on payments by PSCs in relation to IPPs and, thus, enable financial closing for the planned special-purpose entity. In addition, IPPs can take out political risk insurance with ATI. KfW has already applied to the Green Climate Fund for further funds under this regional liquidity facility in order to ensure that this initiative is continued.4
Figure 5: Functioning of the Regional Liquidity Support Facility (RLSF)
Financing of RES projects in emerging and developing countries remains complex. This is also attributable to the fact that risk management in these countries partly requires involving different solution providers and products. Nevertheless, smart selection and combination of instruments enables investors to conduct effective risk management.
Rödl & Partner has comprehensive expertise in handling risk management for renewable energy technologies, not least because we were the lead developers of the concept of the Geothermal Development Fund (GDF) and handled funds management under the Geothermal Risk Mitigation Facility (GRMF). Reliable legal, tax, and financial consulting as well as a thorough selection and combination of various grants can have a significant impact on the success of a project. In emerging and developing countries, there is still a lot of potential to unlock, such as medium-scale projects involving the supply of electricity to local enterprises or projects relating to decentralised systems (mini grids).
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1 UN Environment Programme & Bloomberg New Energy Finance, 2016: Global Trends in Renewable Energy Investment 2016.
2 UN Development Programme, 2013: Derisking Renewable Energy Investment.
3 U.S. Department of Commerce, 2014: Understanding Power Purchase Agreements.
4 IRENA, 2016: Unlocking Renewable Energy Investment: The Role of Risk Mitigation and Structured Finance.
5 IRENA, 2012: Financial Mechanisms and Investment Frameworks for Renewables in Developing Countries.
6 UN Environment Programme, 2010: Publicly Backed Guarantees as Policy Instruments to Promote Clean Energy.
7 UN Environment Programme, 2004: Scoping Study on Financial Risk Management Instruments for Renewable Energy Projects.
8 Agentur für Erneuerbare Energien, 2014: Stromgestehungskosten und die Kosten der Energiewende.
9 Fraunhofer ISE, 2013: Stromgestehungskosten Erneuerbare Energien.
10 Böttcher, Jörg, 2013: Projektfinanzierung – Risikomanagement und Finanzierung.
11 DiaCore, 2016: The impact of risks in renewable energy investments and the role of smart policies.
12 Böttcher, Jörg, 2009: Finanzierung von Erneuerbare-Energien-Vorhaben.
13 TCX, 2013: Local Currency Matters.
14 KfW, 2012: Ex-Post-Evaluierung – Kurzbericht Lokalwährungsfonds TCX.
15 DEG, 2014: Finanzierungsmöglichkeiten für EE-KMUs in Entwicklungs- und Schwellenländern.
16 GuarantCo, 2013: Local Currency Guarantees – Guarantee Policy and Operational Guidelines.
17 GCPF, 2015: Annual Report 2015.
Maria Ueltzen
Associate Partner
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The trendreport on renewable energies gives an overview of the opportunities and risks in selected fast-growing countries. Download
