Pool risks to push clean energy INFLEXION POINTS

For the past three years, much of the power sector investment in India and around the world has been in renewable energy. In 2016, renewable energy and power grids accounted for 80 per cent of the $718 billion invested globally in electricity. Yet, many investors remain wary of investing in renewable energy. This is particularly evident in developing countries, which have the largest potential for solar power and substantial potential for wind energy but are perceived as untenable markets for conservative investors. Why do clean energy investments remain risky, despite the trends? How could these risks be hedged, such that the quantum of investment increases, the sources of investment are diversified, and the cost of capital declines?

Investments in energy are lumpy, require long payback periods, and create assets that last a long time. These factors build in an inherent conservatism among investors. For renewable energy, this hesitation is compounded by the need for large upfront investments and the risks associated specifically with clean energy. At a systemic level, the challenge is both political and financial. Much premium is still placed on the political commitment to renewable energy and the overall low-carbon transition. If political support dissipates, or is perceived as uncertain, investors hold back from making long-term investments. The other systemic challenge is short-termism in finance. Despite a mandate to secure longterm returns, pension funds and other institutional investors also have been tempted by short-term gains in financial markets.

The willingness to invest is spurred by increasing competitiveness of renewable power tariffs, and a portfolio of operational and a pipeline of commissioned projects. Still, investors complain of limited availability of “bankable” projects, that is, projects of a size and risk profile that would be attractive to institutional investors. While the problem of investment size is particularly palpable for rooftop and decentralised energy projects, ticket size is not a major limiting factor for investments in utility scale renewables. There is a mammoth global pool of $300 trillion of international institutional capital. But these institutional sources have limited risk appetites. The modest credit ratings of most renewable energy projects make it harder for them to attract such investment.

At the project level, financiers perceive many risks for utilityscale clean-energy projects. These risks, which impact the credit rating, vary by country and technology. But they broadly include risks on receivables (defaulting or non-compliant offtakers), construction delays, regulatory uncertainties, technology and power evacuation challenges, and currency fluctuations. Off-taker risk itself comes in many forms: delays in signing power purchase agreements, forced backdown of power generated, or delays in making payments for the power purchased. As a result, once adjusted for risks, renewable energy projects lose their sheen for investors.

However, these risks are not insurmountable. There are attempts across the world to upgrade transmission networks, or strengthen the sanctity of contracts. But the pace at which renewable energy can be deployed exceeds the pace of broader reforms, thereby compounding long-terms risks for these assets. There is an urgent need to develop de-risking instruments.

The trouble is that the options for hedging against risks that are currently available are either narrow in scope or too expensive. An alternative route is possible. This is to combine various types of risks and spread them across several countries. The premise is that a multi-risk and multi-country approach reduces the exposure for any single country, investor or project developer. This premise is the basis of an alternative instrument, namely the Common Risk Mitigation Mechanism (CRMM). First designed by the Council on Energy, Environment and Water (CEEW), the Currency Exchange Fund (TCX) and the Terrawatt Initiative (TWI), the CRMM aims to use pooled public resources to crowd in more, new, and cheaper private investment into grid-connected solar assets around the world.

The CRMM would pool multiple risks (political, off-taker, and foreign exchange risks), and have many participating countries, capitalised through multiple sources of public money. The pooling of risks would reduce double counting of risk variables, providing a single guarantee cover at prices lower than the additive price of existing insurance products. If successful, it could leverage small amounts of public funds to crowd in billions of dollars of investment.

Additionally, the CRMM cover for projects could deepen markets by underwriting risks, lowering transaction costs (homogenous credit rating of aggregated assets), and, in turn, improved liquidity of assets. New investment flows from many sources would also make capital more competitive – and cheaper – for renewable energy. In the long run, the CRMM could create a sustainable market, making clean energy less reliant on public investment.

Even as renewable energy is on the upswing, it is still far from an obvious choice for investors. For the transition to cleaner energy systems to become sustainable, policymakers and markets need to turn their attention to the financing of renewables, rather than merely celebrate the lower costs of solar panels and wind turbines. The International Solar Alliance has an opportunity to demonstrate its value by helping its member countries adopt a common risk mitigation instrument. It is time to transform electricity markets, at scale.