Accelerating Hydropower

Matching loan terms with useful life could help accelerate private financing for hydropower.

Hydropower has seen a resurgence over the past two decades, growing by over 500 GW since 1999 worldwide.[1] With the importance of a global transition to both modern and renewable power, it’s easy to see why. Large hydropower can help to drive economic development in places such as Southeast Asia and Africa. It can also serve as a backstop for more variable renewable energy sources, such as wind and solar. In fact, the ancillary services provided by hydropower such as black start capacity and frequency regulation, plus the ability to supply peaking power cheaply, make hydropower an essential component to a well-balanced energy system.

However, large scale hydropower projects bring unique risks, which has meant that private holders of finance have often been reluctant to invest. In Africa, the lack of available private financing for hydropower is a key constraint. This is unfortunate, because only about 8% of Africa’s hydropower potential has been tapped, leaving a huge unmet market need, and lots of ROI on the table. Further, when private finance is included, it often comes with restrictive terms that make projects less tenable.

As one key example, there is a disconnect between debt tenor and the useful life of most facilities. Hydropower plants can often produce for 50 years and more, but debt maturities from many institutions are rarely longer than 15-18 years, and sometimes shorter.[2] This arrangement forces tariffs unnecessarily high during the early years of operation in order to meet debt servicing obligations; it also has the effect of limiting debt-equity ratios to preserve higher debt coverage. For a large project with which I am very familiar, the difference between a 15-year and 30-year tenor drives the tariff up by nearly 15%, holding all else equal.

All of these effects make privately funded hydropower less competitive than many other power sources. So, most recent projects have been completed with public funds since public funds tend to come with longer maturities and concessional lending rates. But public funding introduces different problems. It can drive down the cost of electricity, distorting tariffs and skewing incentives, potentially discouraging other generation investments.

Today there is a growing consensus to increase private investment across all infrastructure types. One way to do this, as advocated by Africa50,[3] is for development finance institutions to help private lenders extend loan tenors toward 30 years for hydropower, by offering partial risk or credit guarantees. With the resulting higher credit rating, projects can look more attractive to institutional investors that have an appetite for long-term bonds. Governments can also help by offering longer-term power purchase agreements and pursuing policies that deepen local capital markets.
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Global hydropower generation is forecast to increase 9.5% by 2025, rising from 4,250 TWh to 4,650 TWh, not including pumped storage.[4] It will also likely remain the world’s largest source of renewable generation. But to fully realize a renewable transition, hydropower will need to play an even larger role. To realize this role will require flexibility by all stakeholders, and a renewed commitment to creative financial thinking.


[1] International Hydropower Association

[2] Brookings Institution. “Enhancing the Attractiveness of Private investment in Hydropower in Africa.” 2018.

[3] Africa50 is an “infrastructure investment platform that contributes to Africa's growth by developing and investing in bankable projects.” (From the company website.)
 
[4] International Energy Agency. 2020. “Renewable energy Market Update; Outlook for 2020 and 2021.”