Arguably the most misleading narrative in global development today is that climate change adaptation and mitigation can be financed by de-risking and crowding in private capital. I have blogged earlier arguing that the idea that billions can be converted to trillions using blended finance is far-fetched.
Even if we keep aside adaptation, it's believed that mitigation can be largely financed with private, including foreign capital. This is a self-serving narrative perpetuated by MDBs like IFC and various influential global opinion makers on climate change and green transition.
Climate change mitigation investments include renewables power generation, transmission lines for its evacuation, green hydrogen and other clean fuels for industrial and automobiles use, electric vehicles and their charging infrastructure, electricity storage solutions like batteries and hydel pumped storage, carbon capture and sequestration etc.
Take the example of the simplest among these, solar and wind power generation. The conventional wisdom is that private capital can meet this requirement. I'm not sure.
In the bigger middle-income countries like India and Indonesia, renewables generation is already de-risked and will be mostly financed by the private sector. But it's difficult to believe that the same will apply to lower middle income and low income countries for a long time.
There are three important constraints. One, power generation is commercially viable only if the downstream distribution side is able to recover the cost of generation. But distribution is the weakest link in the power sector, including in countries like India. Operational inefficiencies of public sector distribution companies and the difficult political economy of tariff increases ensure high cost recovery gap.
Two, the cost of capital, both equity and debt, is prohibitive in low income countries. This arises from scarcity of equity, low domestic savings, limited depth of financial market intermediation, large commercial risks, and uncertain regulatory environment. In addition there are the macroeconomic risks of recurrent debt crises, high inflation episodes, currency devaluations, and capital flights.
Foreign capital will be more expensive given the country and currency risk premiums required. Besides, foreign capital faces the currency mismatch of local currency expenditure and revenues and foreign currency returns expectations.
Three, even if the utility is able to maximise operational efficiency and also collect tariffs, it's impossible for a highly politically sensitive regulated sector like electricity to be able to generate the returns that are required to cover various layers of risks and uncertainties faced by a domestic private investor (leave aside foreign investor) in addition to the cost of generation, transmission, and distribution.
In fact, the first group of countries themselves took several decades of iteration consisting of failures, defaults, and bankruptcies, apart from distribution side reforms for these kinds of projects to now be considered de-risked enough to attract private investors. The smaller middle-income and low income countries too will take a very long time before they fulfil these conditions.
Teal Emery, a research consultant and Adjunct faculty at Johns Hopkins University, has a new paper which examines why solar power generation has not scaled in Africa despite its costs having fallen steeply. He studied the World Bank Group's 100 MW (2X50) solar project in Zambia, Scaling Solar, that resulted in a low price of 6 cents per kWh in a 2016 auction. The tariffs were fixed and would not increase for 25 years, thereby making the average price in real terms an ultra-low 4.7 cents per unit. IFC was the transaction advisor.
Further, the Bank and IFC officials also claimed that there were no implicit or explicit subsidies and there were no complicated financial structures. It was a simple auction with a guarantee by WB's IDA to back-stop the national utility's obligation to pay for the electricity being supplied. In addition, MIGA offered political risk insurance to the project. The project was hyped, including by the WB President, as an illustration how public finance can derisk and attract private capital to invest in African solar projects.
Two private consortiums, Neon and First Solar, and Enel won the bids and were contracted to build and operate the project for 25 years. The entire debt of $81 million was supplied by WBG and some bilateral donors. The projects were commissioned in 2019 and are now operational.
But the project evaluation paper points to several troubling findings, which square with the two points raised earlier about why private capital flows into renewables generation will be difficult. One, low tariffs mean that the project is heavily subsidised with DFI debt, guarantees and insurance. The study estimates an annual subsidy of nearly $10 million.
Second, public finance has not been able to crowd-in significant amounts of private capital. Instead of the claims of crowding-in ten times private capital, every dollar of concessional finance catalysed just 28 cents of private financing in this instant case!
In this context, a joint report by multilateral development banks (MDBs) found that in 2019, far from leveraging private capital 10 or 20 times as is often claimed, the MDBs mobilized less than a dollar from the private sector for every dollar of MDB climate finance.
The study also points to the classic bane of infrastructure projects. One of the developers, Neoen deliberately bid aggressively and then renegotiated immediately to get tax incentives beyond that offered to others.
The report's findings are scathing and holds the WBG responsible.
This paper argues that IFC’s Scaling Solar is an ambitious and thoughtfully designed development finance program undermined by senior leaders’ desire to shield essential details and instead tell a magical story where a pinch of best practices and a dash of de-risking would catalyze the trillions of private sector dollars needed to fulfill the SDGs. Poor messaging and confidential contract terms kept solar developers and African governments in the dark about the drivers of Zambia’s low prices, hampering market development and contributing to governments canceling solar deals that could not reach the low prices advertised by IFC... official messaging undermined the program’s goals by denying or downplaying the critical role of explicit and implicit subsidies in Zambia’s success. This distorted price signals for African governments and solar developers. Poor messaging also undercut the case for the expansion of concessional lending vital in bringing down the cost of capital and making solar projects financially viable in lower-income countries...
It argues that the high risk premium demanded by private investors for financing utility-scale solar deals in poor countries results from genuine credit risk, not unfamiliarity with deal structures that will fade with time. Utility-scale solar is unviable at market interest rates in lower-income countries and is not being built. Projects that are unviable at market interest rates but have a high developmental impact are exactly where DFIs should be focused.
The misleading low tariffs created serious incentive distortions and policy consequences across Africa,
Multiple participants involved in the African solar market during this period report disappointment and consternation amongst African governments and project developers unable to match Scaling Solar’s purportedly unsubsidized low tariff rates. The deal economics no longer made sense for project developers compared to other investment opportunities. The low advertised tariffs caused some countries to back out of other existing deals with developers. In 2018, Nigeria’s Minister of Finance, Kemi Adeosun, cited Zambia’s lower tariffs as a reason for canceling 14 solar IPPs priced at 11.5 cents per kilowatt hour... If the actual price of developing solar power was higher than the low prices trumpeted by the IFC, this misperception might have restricted the supply of solar power in Sub-Saharan Africa by misaligning government and developer expectations. The empirical fact that only token additions to solar development have been made in much of the region in the seven years since the Zambia auction further supports participants’ claims.
The comments section in the World Bank blog post is a good pointer to how badly misleading was the claim and presentation of the project then.
Its recommendations
- Acknowledge that expanding clean power access will continue to rely heavily on concessional DFI lending and guarantees to reduce the cost of capital.
- Transparently report explicit and implicit subsidies.
- Innovate to enhance power contract transparency, empowering market participants to scrutinize pricing drivers and prevent the accumulation of large undisclosed public debts.
This is a tweet thread by Charles Kenny on the same project.
Given the three constraints discussed above - power sector political economy, high cost of capital, and low returns on regulated power supply - there are hard limits to de-risking and leveraging. It's therefore fair to say that the idea of de-risking climate mitigation and other infrastructure projects to attract large amounts of private capital in lower middle income and low income countries is a complete fantasy. The billions cannot be leveraged to get trillions.
Besides, by detracting from the need for much greater public finance and concessional funding, this discourse is a big obstacle to meaningful efforts at mobilising climate finance. By delaying serious engagement with the real issues, the damage to the climate change agenda has been enormous. Like with all narratives, the entire climate finance agenda is now captive to this completely unfounded belief.
Unfortunately, this de-risk projects and use the billions to leverage trillions agenda suits all concerned. This helps the developed countries, many of whom are reluctant to even meet their 0.7% UN commitment on development assistance, can palm off their climate finance responsibilities to the developing countries. The multilateral development banks, struggling to convince their members to replenish capital, can deflect the criticism they face of not doing enough to finance climate adaptation and mitigation. The theoretically and logically appealing concepts like de-risking, attracting patient capital, blending finance, outcomes financing, structuring financial closure, and so on, keep the researchers and development cosmopolitans busy on what they think are serious efforts.
No comments:
Post a Comment