5 ways to boost renewable energy investment in developing economies

Originally posted on World Economic Forum’s website on 29 June 2021
By: Brad Handler, Morgan Bazilian, Michael Hayes

  • Achieving a net-zero energy future in developing economies is going to require trillions of dollars of private investment.
  • Many obstacles remain in the way of this much-needed renewable energy investment, however.
  • Here are 5 ways policy-makers can smooth over these obstacles and get things moving.

For emerging and developing economies to meet their energy development and net-zero climate goals, tens of trillions of dollars in renewable energy investment will be required. This is significantly more than can be expected to be raised from public funds alone, and thus private capital must provide the difference. Yet there remain many obstacles to the deployment of private capital in clean energy projects in emerging economies, as they can impose additional risk and cost and thus dampen investor interest.

A new International Energy Agency report, written in collaboration with the World Bank and the World Economic Forum, puts this point starkly: “The world’s energy and climate future increasingly hinges on whether emerging and developing economies are able to successfully transition to cleaner energy systems, calling for a step change in global efforts to mobilise and channel the massive surge in investment that is required.”

Image: IEA

Best practises for renewable energy investment

We have identified five broad areas that can be addressed to lower these obstacles, and thus help stimulate renewable energy investment.

1. Regulated, transparent power arrangements. Broadly, policies must establish transparency and predictability, which provides confidence for investors in the ability to recover investments in power generation. Examples of such policy include allowing independent power producers (IPPs); having bankable, standardized power purchase agreement (PPA) templates; holding transparent auctions; and having transparent and fair rate adjustments and public participation. One example is a recent transmission line auction in Brazil, which failed to attract investors when it was first launched in 2016. Revised terms, which included higher maximum tariffs and a transparent tariff revision formula that was based on inflation and long-term interest rates, encouraged BTG Pactual and other investors to participate.

2. Specific clean energy/climate incentives. Having an integrated, multi-year energy strategy with short-term targets for retiring fossil fuel plants, if applicable, and building renewable energy helps lay the foundation for conducive policies. Establishing a carbon market or other carbon-pricing mechanism, as well as governance/legislation around carbon removal, is also of value. Chile offers an example: it passed a binding decommissioning schedule for coal-fired power plants; engaged with private power plant owners to develop coal phase-out schedules; and implemented a tax on carbon for larger coal-fired power plants.

3. General business-friendly measures. There exist several general (that is, not necessarily specific to energy) policies that can facilitate renewable energy investment. These include tax policy (such as not withholding taxes on profits, and no VAT on clean power sales), allowing foreign direct investment (FDI), improved permitting processes, and foreign currency/ability to repatriate profits.

4. Innovative financing mechanisms. Financing mechanisms of different types can be useful in mitigating risk, offering additional return potential, or creating more investment opportunities. Masala bonds, which are Indian Rupee-denominated bonds issued in foreign countries for investment in India, offer an example of risk mitigation (in this case providing a currency hedge). Separately, the cost of financing, and therefore a project’s financial return, can be conditioned on achieving decarbonization targets. For example, the European Bank for Reconstruction and Development’s €56 million bond investment in a €233 million offering by Tauron Polska Energia includes lower financing costs if Tauron meets its 2030 decarbonization objectives.

Other financial innovations being considered seek to create more renewable energy investment opportunity. Examples include 1) synthetic corporate power purchase agreements (CPPAs), which can offer a hedge against a corporate buyer’s fluctuations in power cost while providing demand for renewable energy; and 2) an energy transition mechanism (ETM), which gives investors the opportunity to buy high carbon-emitting assets, retire them and replace them with renewable energy (financial returns in an ETM investment come from operating the high carbon and renewable-energy assets supplemented by, for example, carbon credits for accelerated retirement). The World Economic Forum’s Taskforce on Mobilizing Investment for Clean Energy in Emerging and Developing Economies is working to flesh out operational details on several of these innovations.

5. Early risk assumption. Several successful projects have included an early sponsor that was willing to assume various risks. Once certain risks in the project had been ameliorated, the sponsor was able to attract additional, or less expensive, capital. BTG Pactual in the aforementioned transmission project in Brazil was one such example. The company assumed full equity risk initially, but was able to find debt financing once construction was completed. This role can also be fulfilled, or at least supplemented by, international development organizations. For example, InfraCo Asia’s early-stage equity in a smart solar network in the Philippines supported the initial 4,000 homes of a 200,000 home pre-paid mobile-based metering clean energy project and only later found another investor.

Much of the responsibility associated with these five areas falls to government. Governments in emerging economies must enact supportive legislation to ameliorate some of the risk and improve financial return prospects on energy projects. They should request multilateral development banks and other international financial institutions raise their risk instrument offerings and financing capacity. They must also work with the private sector to set the parameters and goals for renewable energy investment opportunities. And they should be receptive to financial innovations that can increase the flow of private foreign capital for clean energy projects. Meanwhile, governments in developed economies must commit to mobilize more funds to climate finance as well as to provide greater technical advisory assistance.

Given the pressing need to invest in the near term to expand low-carbon energy access globally, the key is that governments across both the developed and developing economies must act quickly. Actions taken this decade can threaten to lock in emissions for decades to come — or they can set the stage for fulfilling the world’s sustainable development goals.