Moving from “billions to trillions;” tapping private-sector finance for climate-resilient, developing country infrastructure
The transition to a global, low carbon, and climate resilient energy future may require an investment of nearly $7 trillion per year, over the next 15 years. About $3.9 trillion of this total arises from developing countries, which are currently spending $1.4 trillion annually, leaving an “investment gap” of $2.5 trillion. Private sector financing is often touted as the only viable source of capital to fill that gap. As a result, development finance institutions (DFIs) are committed to increasing private sector financial participation to meet climate-related energy and infrastructure goals. The most likely sources at this scale are called institutional investors - insurance companies, pension funds and sovereign wealth funds. But these investors have been relatively disengaged from this type of investment.
One motive to engage these investors is their size. Institutional investors in OECD countries alone control about $92 trillion in assets. To put this in context, official development assistance (ODA) from traditional multilateral and bilateral sources is about $147 billion annually. This is less than 1% of the assets on the balance sheets of institutional funds, and just 5% of the developing country investment gap mentioned above. According to a recent OECD publication, Mobilizing Institutional Investor Capital for Climate Aligned Development, DFIs now face an excellent opportunity to engage institutional investors, if they take the right approach.
Institutional investors appear ready for partnerships with DFIs. Large investors are collaborating more with like-minded partners, and several priorities behind the collaboration fit DFI strengths: to get closer to investments (to better assess and manage risks), to increase deal flow, and to reduce expenses from intermediaries, due diligence and monitoring. These priorities could be met by DFIs, which would open the door to a mutually helpful arrangement. The big investors do not appear too exclusive about their partnerships, meaning synergies with DFIs are certainly possible.
According to the OECD authors, there is another group of investors, to whom the DFIs should pay attention, especially as a model. Green Investment Banks (GIBs) and Strategic Investment Funds (SIFs) have been the most effective at mobilizing private capital for climate-related purposes, including from institutional investors. Both are quasi-governmental entities that are embedded within a local community and have a strong private-sector mentality. GIBs are publicly capitalized entities with a mandate to facilitate privatesector investment for low carbon initiatives. SIFs are equity investment organizations, typically established to achieve a policy objective and often to target private finance partners.
One key to the success of GIBs and SIFs has been their “localness,” most importantly manifest in their ability to assess and manage local risk. Infrastructure investments are necessarily local, and it is famously difficult to understand local risks from afar. Both GIBs and SIFs are established and networked inside local business and political communities; and they possess an intimate understanding of market and regulatory frameworks that govern the energy sector in their neighborhoods. So, not only can they identify and assess project risks, but they also have a better ability to monitor and manage those risks through the stages of project development and service delivery, than someone overseeing the investment from a distance.
Further, GIBs and SIFs are governed by private sector financial principles and managed by private finance professionals. By contrast, DFIs are governed and managed from a public finance perspective. The differences can be felt in terms of investment decision making, the speed and agility by which decisions are made, and the viability of projects in the investment pipeline. The authors of the OECD article suggest several strategies for DFIs to more closely emulate these local organizations; I summarize them here:
 Halland, Dixon, In, Monk, and Sharma. 2021. OECD Development Center, “Mobilizing Institutional Investor Capital for Climate-Aligned Development.” Available at: https://www.oecd-ilibrary.org/finance-and-investment/mobilising-institutional-investor-capital-for-climate-aligned-development_e72d7e89-en.
 DFIs include the World Bank, the Asia, Africa and Inter America Development Banks, EBRD, their investment arms plus others; they also include climate finance organizations such as the Green Climate Fund, the Global Environmental Facility, and others.
 Halland, Dixon, In, Monk, and Sharma. 2021. OECD Development Center, “Mobilizing Institutional Investor Capital for Climate-Aligned Development.” Available at: https://www.oecd-ilibrary.org/finance-and-investment/mobilising-institutional-investor-capital-for-climate-aligned-development_e72d7e89-en.
 The Green Bank Network. 2016. “Green and Resilient Banks; How the Green Investment Bank Model Can Play a Role in Scaling Up Climate Finance in Emerging Markets.
 To date, most GIBs have been established in OECD countries, but several developing and emerging economies are actively exploring opportunities to establish a GIB or a GIB-like entity.
 Lin, Halland and Wang. 2018. “A New Approach to Infrastructure Finance.” Project Syndicate. Available at: https://www.project-syndicate.org/commentary/attracting-private-infrastructure-investment-by-justin-yifu-lin-et-al-2018-03.
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. 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. 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, 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.
Global hydropower generation is forecast to increase 9.5% by 2025, rising from 4,250 TWh to 4,650 TWh, not including pumped storage. 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.
 International Hydropower Association
 Brookings Institution. “Enhancing the Attractiveness of Private investment in Hydropower in Africa.” 2018.
 Africa50 is an “infrastructure investment platform that contributes to Africa's growth by developing and investing in bankable projects.” (From the company website.)
 International Energy Agency. 2020. “Renewable energy Market Update; Outlook for 2020 and 2021.”
As the COVID-19 pandemic began to reveal its seriousness in early 2020, renewable energy market predictions for hydropower, solar and wind were dire; but the realities have turned out quite differently. The IEA’s 2020 Outlook, published in May, predicted: “…additions of renewable electricity capacity will decline by 13% in 2020 compared with 2019, the first downward trend since 2000.” However, a more recent “Renewables 2020” anticipates a year of
excellent growth, once all data has been compiled. “In sharp contrast to all other fuels, renewables used for generating electricity will grow by almost 7% in 2020.” Despite the pandemic, both 2020 and the future look positive for hydropower, solar and wind.
Hydropower additions grew by more than 18 GW in 2020, with significant large project installations in China, Lao PDR, India, Nepal, Viet Nam and Indonesia. In Europe, new projects in Portugal (pumped storage) and Turkey (large dams) helped to increase capacity additions. Over the next five years, global hydropower is expected to add about 10 GW to 13 GW annually, not including China. Asia will likely account for over 40% of that growth, led by India and Pakistan. Much of the remainder will occur in Southeast Asian countries where the private sector is becoming increasingly involved in hydropower development. China is expected to see the largest national increase, likely exceeding 107 TWh. Growth in Latin America is being led by Colombia, Argentina and Brazil. Overall, global hydropower generation (excluding pumped storage) is forecast to increase 9.5% by 2025, rising from 4,250 TWh to 4,650 TWh, and to remain the world’s largest source of renewable generation.
Solar PV additions are expected to have reached 107 GW in 2020, though progress across application segments has been uneven. For utility-scale projects, COVID-19 delayed construction activity in March and April but progress picked up in May. Initially, projections were for a drop in these large-scale installations, but instead both the U.S. and China saw growth (3% from the U.S. and 33% from China). Industrial installations fell as the global economy tightened, but a shift in demand toward residential load precipitated an increase in home installations. It is anticipated that 2021 will be another record year globally, with a 10% rise over 2020 and installations of about 117 GW.
Wind capacity additions are expected to have reached 65 GW by the end of 2020, 8% more than in 2019. Again, COVID-19 led to a slowdown in onshore construction between February and April because of global supply chain disruptions and logistical challenges. By contrast, the offshore sector was only mildly affected because longer project lead times mean short term disruptions have a smaller impact. For 2021, the forecast assumes a further acceleration of wind additions to 68 GW, 7.3 GW of which will be offshore.
What began as a seemingly devastating circumstance for the energy transition, has instead demonstrated a resiliency in the sector.
International Energy Agency. May 2020. “Renewable energy Market Update; Outlook for 2020 and 2021.”
International Energy Agency. November 2020. “Renewables 2020; Analysis and Forecast to 2025.”
International Energy Agency. July 2020. “World Energy investment 2020.”
“What’s the difference between a financial and economic analysis?”
This question was posed during a presentation in which I was using both terms. It’s a good question and the distinction is important. Both are concerned with benefits and costs; and, both compare net benefits for scenarios with the project to scenarios without it. But the perspective of the analysis is different in each case, which alters the ways in which benefits and costs are counted.
The main distinction is that an economic analysis compares costs and benefits accruing to the entire economy, while the financial analysis makes that comparison from the perspective of an enterprise.
In a financial analysis, the viability of the project is based on its financial profitability – what remains from the revenues after all the bills are paid. Since the enterprise has owners, who are providing equity, a financial analysis seeks to identify the return on equity the project can provide. Benefits, therefore, are the year-on-year cash inflows received by the enterprise, in the market. For example, an electricity project would measure benefits as anticipated revenues from electricity sales (inflows). Costs are financial outflows. For a financial analysis these are called direct costs, and are reflected in market prices for debt financing, engineering, construction, inputs, operations, maintenance, etc. They are allocated to appropriate time periods of the project lifecycle and usually discounted at a weighted average cost of capital. Discount rates can also be nuanced to reflect differing risks for different stages of development. Before a capital structure has been formed, the financial analysis can be a market study that determines whether the enterprise’s services are price competitive. During later stage development, the financial analysis takes the perspective of a special purpose vehicle (SPV), for which a three-statement proforma model can be developed.
By contrast, an economic analysis considers the broader perspective of the public sector. Benefits in this case, are all social and economic benefits that accrue to the public welfare. These might include the avoided costs of less optimal project alternatives. They may also include health and public-use benefits, long-range climate benefits, and other advantages. For example, one benefit of a renewable energy facility is the avoided use of fuel. Therefore, a portion of the project benefits would be the cost of avoided fuel for a traditional energy source (i.e. fuel for gas-powered plant that will not be built). Additional benefits would include power capacity, avoided carbon output, etc. Costs are also different from a financial analysis; they consider what the project would cost monetarily, but also any additional burdens the project would impose on society.
For both benefits and costs, economic prices are used in place of market prices. The difference between economic and financial prices arise from two sources. First, financial prices are often subject to price distortions such as transfer payments, price controls, monopolistic pricing, etc. These contain elements that are paid or received by the firm but do not affect economic prices. Second, non-market effects are outputs or inputs that are not captured in the marketplace such as positive or negative externalities.
Finally, an economic analysis can also be a qualitative assessment if data for a quantitative study are not available. Often some type of proxy data can be found, but sometimes this is not the case. Furthermore, a quantitative assessment is not always required by the situation.
For a comprehensive view, the Asian Development Bank provides Guidelines for the Economic Analysis of Projects, one of the best resources on this topic.
Rich Swanson, PHD
Advising senior energy executives in realizing the full value of their investments through expert financial valuation, economic analysis and risk mitigation, to accelerate complex projects to financial close.In Africa and Asia energy development plans call for large investments in hydropower. But there is room to invest in this proven renewable energy source in the U.S. as well. And, the trends in the U.S. may be interesting for other countries as well. Late last year, the Department of Energy (DOE) awarded $24.9 million in funding to stimulate hydropower innovation in the U.S. This follows its significant “Hydropower Vision” report released in 2016.
Though advances in solar, wind and battery storage have been in the headlines, the US energy mix still features hydropower as its largest renewable energy source at 7% of total energy delivered (wind is not far behind at 6.5%). The DOE continues to promote hydropower innovation and envisions 48.3 GW of new capacity by 2050.  In fact, much of the DOE award money mentioned above appears to be clearing the way for new investments by promoting efficiency and environmental innovations.
Here are three areas in which hydropower investment in the U.S. may make the best sense…
• Augmenting capacity at existing sites. Refurbishment at existing sites takes the form of life extension, upgrades and expansions. Since the average age of the existing hydropower fleet is now approaching 50 years, the “re-commissioning” of these sunk costs can account for a significant increase in energy delivery.
• Non-powered dams and other existing infrastructure. There are over 80,000 non-powered dams in the US and thousands of miles of existing, man-made conduits that move water and wastewater. The abundance of existing infrastructure can limit cost, and environmental impact (due to using an existing structure) make this an attractive resource for hydropower development.
• Low-head hydro. These are small capacity facilities that use tidal flows or rivers with a head of 20 meters (66 ft) or less to produce energy. Often, no dam is needed. Using the drop in a river or even tidal flows to create electricity can provide a renewable energy source that will have a minimal impact on the environment.
Advising senior energy executives in realizing the full value of their investments through expert financial valuation, economic analysis and risk mitigation, to accelerate complex projects to financial close.
Real options analysis captures the value of flexibility in hydropower design that other decision-making processes may not.
The academic journal Renewable Energy Focus has recently published one of our collaborative research articles. The article highlights valuation techniques at hydropower plants when risks of climate change and other uncertainties are high. Here is part of the abstract, with a link to more.
Development strategies on the African continent include significant hydropower investment to meet a growing energy demand. However, long-lived assets, such as hydro facilities, face climate risks, among others, that shorter-term investments may not. Various tools for quantifying these risks and offering decision-makers some guidelines for investment strategies, particularly under climate uncertainty, are increasingly used to evaluate broad policy choices and specific investment decisions. Given uncertainties such as climate change, and the wide range of decision-making levels, all available tools have a role, depending on the need of the decision-maker. However, not all yield the same result under all circumstances.
This paper reviews three methods of analysis for decision making under uncertainty: Benefit-Cost analysis under uncertainty (BCA), Robust Decision Making (RDM), and Real Options Analysis (ROA). The paper then illustrates each within a project, the Batoka Gorge Hydropower Facility. We find that within the context of Batoka, the three analyses point to similar design choices with one important exception: Real Options offers values for the flexibilities embedded in projects or suites of projects, whereas the others do not incorporate these valuations. Furthermore, we find that flexibility, especially when integrating multiple risks into the project, creates value in smaller designs, such that the NPV exceeds that of inflexible, though larger designs.
To read the full article, follow this link: https://authors.elsevier.com/a/1a8Ha6F2kzMSYY.
In India, inefficiencies in the national power sector may be costing the nation 4% of GDP per year according to a new World Bank report.* Instead, with the right investment, universal connection to grid power could increase the income of rural households by $9.4 billion a year; and, eliminating power shortages may prevent an estimated $22.7 billion in business losses annually.*
According to the report, 178 million people still lacked access to grid-delivered electricity in 2017; and, many suffered from frequent power cuts, dragging down economic production. These present realities stand in the context of forecasts by which India may well triple its electricity demand over the next 20 years.
Still, India has not been idle regarding this sector. India’s electricity system has seen rapid growth in both supply and demand, over the last 5 years. In fact, over 130 million people have been connected since 2013, the result of new generation construction, and significant investment in both transmission and distribution.*
Despite progress, both capacity and energy remain at deficit levels, though the deficits are shrinking. The Table shows India’s capacity and energy demand and supply, deficits and shortages during the past 5 years. Figures are from India’s Ministry of Power Annual Report.**
India's national energy supply, demand and deficits (in million units, TWH)
Inefficiencies are found all along the power sector value chain. India’s electricity system is predominantly coal-based; the nation has the fourth largest coal reserves in the world. Despite the availability of fuel, India fails to meet demand (by 14% in 2016 according to the report) because of a lack of competition and inefficient mining methods. Only 10% of underground coal mines are mechanized, and the average output per labor shift is less than one twenty-fifth of that in the U.S. Further, the inefficient and over-use of coal is causing significant negative health effects on the population. Subsidies and inefficient generation, transmission, and distribution also play a role in shortages (75% of India’s generation capacity if from coal). Losses in transmission and distribution exceed 20% - a much higher rate than elsewhere in the world.
Recommendations of the report go beyond the simple liberalization of energy prices; without solving other issues, prices would merely reflect all inefficiencies and be unreasonably high. Instead reforms should prioritize efficient coal allocation and delivery, promote competition in both fuel and electricity supply, and then allow electricity prices to reflect the true cost of supply. In this way the right incentives will be present to promote investment. Social assistance can then be targeted to help those in need to cope with higher prices.
To see the report, click here.
To watch a short video about India’s power sector, click here.
* Zhang, F. “In the Dark; how much to power sector distortions cost South Asia?” World Bank, 2019, Washington DC.
** India’s Ministry of Power, 2018-2019 Annual Report, 2019, p. 18-19.
The Nam Theun 2 Hydropower (NT2) energy export project in Lao PDR, illustrates a unique blend of financing vehicles for a large power project. It closed in 2005 and began operations in 2010, allowing several years of retrospect for lessons to be learned. According to a World Bank review, “Nam Theun 2 demonstrates that it is possible to privately finance a large and complex project in a small and economically weak country. It also demonstrates how a single project can dramatically improve economic growth and contribute to poverty reduction and environmental protection (Head, 2006).”
The project was large with power production of 1,075 MW; 95% of is sold to Thailand, and the remaining 5% to Lao PDR. When the NT2 closed its financing, it was the largest ever foreign investment in Lao PDR, the world’s largest private sector cross-border power project financing deal, and the largest hydroelectric project ever to use private sector financing (World Bank, 2005).
The financing structure of NT2 was as follows:
The capital structure features a debt to equity ratio of 72/28, and the private sector supplied about 85% of the total cost. It was developed as a BOOT (Build, Own, Operate, Transfer), with the concessionaire as a locally registered SPV, the Nam Theun 2 Power Company (NTPC), of which the Government of Laos owns 25%. NTPC contracted to finance and develop the project, and then to operate it for 25 years. After that, it will revert to the State free of charge. During the concession period, the Government will receive dividends, royalties and taxes amounting to $80m/year (Head, 2012).
To make the project bankable, and secure financing, a power purchase agreement (PPA) was established between NTPC and the Electricity Generating Authority of Thailand (EGAT), to guarantee sales. This was a 25-year agreement for NTPC to supply 5,636 GWh/year to EGAT on a take-or-pay basis. The tariff was predetermined and denominated half in US$ and half in Thai Baht, to avoid exposure to local currency devaluation (Head, 2012).
Funds for the 25% equity portion of NTPC, amounted to $87 M. This was raised through concessionary loans and grants. However, money was made available to the Lao Holding State Enterprise (the Government holding company) as a loan at commercial rates. This difference in rates created an additional revenue stream for the government (Head, 2012).
International debt totaling $350m was raised from export credit agencies (ECAs), with multilateral banks insuring the debt against political risk through guarantees. (Debt coming from Thai commercial banks was uncovered for political risk.) A total of nine commercial banks participated including BNP Paribas, Societe General, Fortis Bank and Bank of Tokyo-Mitsubishi.
The project showcases the benefits of credit enhancement mechanisms now offered by the MDBs. Though, guarantees only covered $126 M (10% of the total cost), they provided sufficient confidence to leverage a much larger sum from international sources. The public sector provided only 15% of the total project cost, and much of this was concessionary lending for the purchase of the Laos government equity shares (Head, 2012).
Source: Head, “Hydro Finance Handbook,” HCI Publications, 2009.
The US still has a significant amount of hydropower potential; the question is how to develop it. The US Department of Energy (DOE) finds that hydropower could grow from its present capacity of 101 gigawatts (GW) to nearly 150 GW by 2050, with the right investment. The scenario explored, was a combination of 13 GW of new generation capacity, and 36 GW of new pumped storage capacity. The new capacity would result from upgrades to existing plants, adding power at existing dams and canals, and a limited number of new facilities on undeveloped stream-reaches.
In the DOE’s assessment, entitled “Hydropower Vision,” this level of investment would achieve several benefits, including a $24 billion savings from avoided greenhouse gas emissions, attributable directly to new development. Pumped storage schemes can also provide a backstop to more variable renewable energy sources such as wind and solar.
In order to realize much of the potential, the industry will need to rely on private investment for a significant portion of the development. Today, federal agencies own about 49% of all installed capacity; these agencies include the U.S. Army Corps of Engineers, the U.S. Bureau of Reclamation, and the Tennessee Valley Authority. An additional 24% of the existing capacity is publicly owned through utilities, irrigation districts, and cooperatives. The remaining 27% of installed capacity is privately owned.
The global total of renewable energy installations plateaued for the first time in nearly 20 years, in 2018 (IEA), prompting calls for improved policies and financing solutions. Global renewable energy installation in 2018 was 177 GW, roughly the same amount of capacity as was added in 2017. This marks the first year since at least 2001 that year on year growth has not occurred. Figure 1 shows overall growth in renewable development since 2001, segmented by technology.
Figure 1 (Data Source: IEA)
The primary reason for the growth rate slowdown was a change in incentives for solar PV development in China. Last year, China sought to curb costs and focus on grid integration in an effort to sustain long-term solar PV expansion. In 2018 China added 44 GW of solar PV, compared with 53 GW the year before. After China, lower wind additions in the E.U. and in India also contributed to the slowdown. The U.S. increased net capacity marginally, from 17 GW to 18 GW, mainly through the addition of onshore wind. Figure 2 shows global renewable net capacity additions, segmented by country. (IEA 2019)
Figure 2 (Data Source: IEA)
Policy instruments can be employed to reinvigorate the upward trend in capacity, but financing availability and incentives can also play a big role. Financial and fiscal incentives can be used to improve access to capital, lower financing costs, and reduce construction costs. The incentives can take the form of tax breaks, rebates, grants, performance-based incentives, concessional loans, guarantees, and risk mitigation. Tax credits and capital subsidies have been applied with especially helpful results.
Of the available tax credits, a production or energy credit is often seen as the most effective. This is in contrast to the most popular tax tool which is a reduction in sales or energy taxes. However, a drawback to this type approach is the difficulty in designing mechanisms that specifically promote renewable energy. Instead, production tax credits, based on energy produced, and investment credits, based on up-front costs, are often seen as a more effective alternative. Production and investment tax credits have been especially instrumental in both wind and solar development in the U.S. The allowance of accelerated depreciation, whereby the cost of the facility is counted against taxable income more heavily during early years of operation, has also been beneficially applied. (IRENA 2019)
Capital subsidies can be helpful in creating a level playing field with incumbent technologies. The subsidies can target specific technologies and work best when the qualifications are highly specific. This approach is most often used in countries at early stages of new-technology integration, after which performance-based subsidies might take over. As an interesting case study, Nepal offered capital subsidies in 2013 for projects up to 1 MW depending on the technology and location of facility (as an incentive to supply remote areas). The subsidy covered 40% of the capital cost, a soft loan covered an additional 40% and the developer was responsible for the final 20%. (IRENA 2019)
More financial incentives will be required to achieve long-term climate goals; current power additions are only 60% of what’s required. According to the IEA, renewable capacity growth should be more than 300 GW annually, through 2030, to reach international goals. Currently, the energy industry is losing ground; last year, energy-related CO2 emissions rose by 1.7%, despite growth of 7% in generation from renewables. (Utility Dive) Increased availability of flexible financing (from both government and the private sector), along with fiscal incentives may be critical, to re-energize growth.
Richard Swanson, Ph.D.
Asset valuation and project finance expert, specializing in financial and economic analysis of civil infrastructure assets.