Examining more myths on energy transitions

Happy New Year!

I'll kick off the new year with a post questioning some principles of one of the most powerful enduring narratives, on energy transition. In an earlier post, I had shown using an economic model how economic transitions impose costs, whose allocation is always a problem. 

Consider these claims. There are trillions of private dollars waiting for opportunities in developing countries, especially in infrastructure sectors. There are hundreds of billions available for investment in green energy projects. There are tens of billions waiting to invest in businesses that help the poor. 

There are powerful proponents and supporters of these narratives that it's almost impossible to make a contrarian voice heard. These supporters are very rarely the capital providers themselves, but consultants, think-tanks, boosters, commentators, do-gooders, lobbyists, retired investors, philanthropists, and so on. 

For practitioners who engage from the other side of attracting these trillions and billions (like governments,  and green energy and impact entrepreneurs) and who have experienced the repeated frustrations from such engagements, nothing could be farther from the truth. I feel the same would apply to fund managers and investors who taken in by the hype trawl the market only to find little of substance. These are all pure ideological tropes at best, self-serving market making advocacy at worst. 

I have blogged on multiple occasions and written a long paper here questioning these narratives. The essence is this. The amount of foreign private capital available for infrastructure, green energy, and development in general for developing countries is much much smaller than is claimed. The risk appetite and returns expectations of the trillions of investment capital sloshing around is very different from that available (or even possible) in/from developing countries like India. After all, even theoretically these are different asset categories. Besides there are fundamental mismatches - foreign capital investment and local currency revenues.

For sure the regulatory environment can be improved and government policies can be made more predictable. And the envelope of investible projects can be expanded with support from development finance institutions. But these are all tinkering at the margins compared to the requirements. A continental economy like India can make large strides on its energy transition predominantly only with domestic capital, which includes significant concessional capital from its government. And it also requires demand-side acceptance of some of the costs associated with these transitions - see this for a model for economic transitions. 

A recent oped in Business Standard was effusive on the foreign capital supply-side of the climate financing problem, 

Climate financing for investment is a largely solved problem: The highway to near-infinite resourcing from foreign capital has been established in the form of ESG investment. This involves pensioners and insurance customers in DMs who get a sub-market rate of return for their investments in return for funding the Indian energy transition. Global ESG investment has reshaped the facts on the ground in investment finance in Mumbai.

The confidence - "largely solved problem", "near-infinite resourcing from foreign capital" etc - is mind-boggling. Such articulation does tremendous dis-service to the cause itself. It reinforces the already strong narrative of private and foreign capital being the solution to many complex development problems. It misleads the highest level decision-makers and forces policy makers into expending their efforts chasing chimeras. 

The oped then lays the blame for the lack of availability of demand side on the easiest target, governments.

The ESG world is quite able to support the Indian energy transition, subject to the limitations of present and future Indian financial regulation, capital controls, tax policy and rule of law. It is now hard to find financial closure for fossil fuel energy businesses in Mumbai. It is easy to find financial closure, at concessional rates, for economically sound clean energy businesses. 

The climate financing glass is thus half full for the Indian energy transition. On the one hand, infinite capital is available from the global financial system for sound projects. But on the other hand, there are limitations in the Indian electricity sector that limit what is possible. Our foundational problem is that we have an electricity sector that operates through state control instead of one which operates through the price system.

This is illustrative of a typical problem with armchair prescriptions. Such prescriptions are made on the assumption that there is a clean slate and governments have the agency to do whatever is technically right. 

Consider the problems with the above. India is what India is. Its financial market regulation, for sure, could and will improve. Its bond markets will deepen. Taxes will come down. But it's not at all clear that all this deregulation and lower taxation will lead to significant increases in capital inflows.   

On reforms to the electricity sector as a whole, it's easy enough to advocate cost-recovery pricing. In a country which is poorer than conventional wisdom appreciates, and where meaningful pricing reform on the farm power side is years away, the accounting reality is that aggregate cost recovery tariff schedule, even with cross-subsidisation, will require significant increases in tariff for the lowest category of consumers and large increases for middling consumers. Would our political economy, the shaping of which is a responsibility of the same commentators, allow any government to survive an electoral cycle after having raised tariffs as proposed? As Jean Claude Juncker famously said, we'll know what to do, but the problem is to win elections after having done that.

I have yet to see an oped by any esteemed commentator illustrating how less in purchasing power terms our higher category electricity consumers pay compared to similarly placed consumers in developed countries. Or a research work documenting the extent of farm power subsidy captured by undeserving large farmers, or a campaign exhorting governments to end free power subsidies to those large farmers. Most importantly, apart from articles blaming governments, I have not seen any oped or sustained efforts which seek to marshal hard facts to mobilise public awareness campaigns that creates the political space to undertake reforms.  

Take the example of privatisation of power sector assets, as a source to finance one-time expenditures. For a start, these are heavily regulated assets, whose upside potential is tightly capped. Further, almost all public sector generation and distribution companies have significant volumes of unregulated debt on their balance sheets. Besides, many also carry on their balance sheets debts raised on behalf of their state government to finance subsidies, debts which cannot be assumed by fiscally constrained governments. Finally, the political economy related uncertainties associated with the distribution sector also means that private investors will hedge and heavily discount any power sector asset purchased from the government. If all the liabilities are netted off and discounts applied, the likely returns from even the most competitive privatisation of power sector assets will be small, even negative. One should ask officials in any state where governments have seriously explored these options about the nature of these challenges. 

However, this is not to overlook the near certain improvements to efficiency and reduction in further bleeding from privatisations. But these are all in the future, and cannot make up for the legacy burdens. 

Commentators should acknowledge (as markets do) that developing countries like India, no matter what kinds of regulatory facilitators are put in place, are a different asset category from developed markets. It's fundamentally wrong to believe that even a significant proportion of the large volumes of private and public capital chasing infrastructure and green energy projects will flow into these markets. It's just as wrong to assume that the regulatory and political economy constraints that deter these investors can be addressed or alleviated significantly in quick enough time. 

The first requirement to create conditions for meaningful efforts at energy transition (or anything else) is to acknowledge the real extent of the problem/issue. Then, it's required to usher stability and predictability in policies, expand the envelope of investible projects, create enablers for effective intermediation of domestic risk capital into these projects, and of course create conditions to attract whatever foreign capital is available. All this has to be coupled with serious reforms on the power sector side in loss reduction, utilities performance improvements, and tariff increases. This will require a mix of regulatory oversight, state capability and governance improvements, and private participation where appropriate and possible. None of these are anywhere near close to being "solved problems".