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6 insights on financing clean energy projects in emerging economies

Financing the clean energy transition in emerging economies will be a key topic at COP27

By: EBR - Posted: Thursday, November 3, 2022

" We believe insights from a set of interviews we conducted in the lead-up to the launch of the Cost of Capital Observatory can help those seeking to raise capital in the clean energy and renewables sector."
" We believe insights from a set of interviews we conducted in the lead-up to the launch of the Cost of Capital Observatory can help those seeking to raise capital in the clean energy and renewables sector."

by Ogan Kose and Raj Gopalakrishnan*

As we head into COP27, during which financing the clean energy transition in developing economies is expected to be a key topic of focus in the negotiations, we believe insights from a set of interviews we conducted in the lead-up to the launch of the Cost of Capital Observatory can help those seeking to raise capital in the clean energy and renewables sector.

We spoke to practitioners from several institutions ranging across commercial banks, development finance institutions, utilities, private equity and infrastructure funds, and philanthropies.

Financing clean energy in emerging economies

Below we elaborate on six noteworthy insights from these interviews around clean energy financing and costs of capital in emerging economies:

1. Regulatory risks are top of mind for investors and financiers

Regulatory risks are a priority for investors and financiers as they determine the cost of capital (and, by extension, expected returns) required on clean energy projects they choose to invest in or finance, and even to decide if they should back clean energy projects in a region or not.

For example, a prominent commercial bank we interviewed had to stop financing clean energy projects in a certain market due to high regulatory unpredictability, while a philanthropy focusing efforts in another country felt the need to apply higher costs of capital due to changes every two years in renewable tariff schemes and inconsistencies across clean energy policies. Hence, regulatory clarity, stability and predictability are seen as critical for successful clean energy financing and project execution.

Another area we believe needs reworking is monetary regulations – policymakers and other stakeholders in emerging economies should especially consider ways to denominate Power Purchase Agreements (PPAs) in more liquid global currencies, simplify know-your-customer (KYC) processes on sources of funds and ease rules around overseas repatriation of earnings from local projects.

Changes to these monetary regulations are a must for accelerating investments in clean energy in some emerging economies.

2. Everyone wants a credit-worthy offtaker

A large global renewables developer we interviewed takes a stance that it only signs PPAs with off-takers that have a good credit rating. Another regional investment bank concurs with this view when it comes to choosing which clean energy projects it finances – it demands as a must-have either a guarantee from a government entity or state-owned enterprise, or a letter of credit facility from a commercial bank supporting the off-taker.

In the absence of such guarantees, many financiers we interviewed typically apply credit risk premia to projects with “newish” off-takers or might choose not to back such projects at all. In some cases, even projects with credit-worthy/investment grade off-takers get penalized if the sovereign credit rating of the government where the project is located is lower than that of the off-taker – as the norm is to always consider the former over the latter.

3. Developing strong relationships with local financiers can help lower costs of capital

Our interviewees suggested securing funding from local financiers as a good way to lower capital costs – as it can effectively mitigate foreign exchange risks, political risks and flight-to-safety global market conditions, which involve high-risk aversion to assets in emerging markets.

For example, a clean energy project developer we interviewed provided insights into the approach it uses to lower its costs of debt in the Brazilian market. First, it scouts for project finance provided by local Brazilian banks. If not, it approaches Spanish banks with branches in the country, as well as regional multilateral institutions. If these two local project financing options are not viable, it tries to tap into local capital markets.

It seeks international project finance only as a last resort if the other local financing options don’t work out. That said, there is a strong need to deepen local capital markets and their liquidity in many emerging economies, without which financing large-scale projects wholly locally could be quite challenging.

4. Clean energy technology risks remain a concern but mechanisms, such as blended finance, are emerging

Technologies such as battery storage, green hydrogen and carbon capture and storage generate a fair bit of enthusiasm in emerging economies, but investors and financiers willing to readily back these are limited, given the lack of established business models in these economies. However, our interviewees were hopeful about their prospects given the emergence of technology de-risking mechanisms, especially blended finance.

One interviewee gave an example of a blended finance facility tranche used to finance a new bifacial solar panel technology project. Bifacial solar panels, which at the time had a limited track record, had the ability to increase solar yields significantly and make land use more efficient. The institution structured blended finance facilities that allowed for deferred principal payments by taking into consideration the projected revenue gains from the increased yield, which helped improve the project economics and bring the financing to a close. This mechanism was then replicated in subsequent regional bifacial solar panel projects. Such innovative ideas could be considered for other projects and technologies as well.

5. Weighted Average Cost of Capital (WACC) evaluation methods are changing

Some of the changes described by our interviewees included: increasing the frequency of cost of capital forecast updates, incorporating the impact of rising input costs arising from disrupted supply chains, running multiple scenario-based models, and supplementing model forecast outputs with on-the-ground intelligence from local teams.

Currently, WACC is increasing for emerging economies in times of rising inflation and global recession expectations. Increased forex volatility and downward pressure on country credit ratings for emerging markets are increasing the risk profile of international investment opportunities. In such an environment, we can expect more such evolution in WACC evaluation methods.

6. Increased transparency on costs of capital could help with better understanding of risks

Our interviewees felt that the increased cost of capital data transparency could inform stakeholders more about the key inherent risks and help them develop commensurate risk-mitigating mechanisms. They also felt that this data could be supplemented by more transparency on the actual returns realized on projects versus their initial expected/projected returns. Armed with this information, policymakers could deploy targeted measures that would promote more private sector participation in the clean energy sector of these economies.

*Managing Director, Strategy, Trading & Risk Management, Accenture and Strategy Senior Manager, Accenture
**first published in: Weforum.org

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