Directing energy sector investment towards renewables means dissolving market barriers currently obstructing the development and financing of renewable energy projects. The technical aspects of renewable energy, lack of familiarity, limited knowledge and skills among project proponents and local financial institutions all reinforce a lack of track record and reliable investment data, especially in emerging markets. Investors find it hard to identify attractive projects, and project developers find it hard to identify investors. This often becomes a key barrier to renewable energy investment.
This chapter concentrates on enabling policies, debt-based finance instruments and hybrid structures that can overcome the barriers to developing and financing renewable energy projects. An overview of all the instruments that support project pipeline development and facilitate capital access, as well as their application, is displayed in Table 1.
2.1 Enabling policies
Lack of long-term policies and incentives and lack of clarity, consistency and visibility on policy measures supporting a renewable energy industry and market can also pose major obstacles to renewables deployment. They exist even in markets where the underlying economics are highly conducive to these technologies. A key component of any effort to scale up global investment in renewables must be policy commitment at the national level. A range of different tools and programmes developed and implemented by national or sub-national government acts as a set of enabling policies. These include regulatory tools as part of energy and finance policies. Targeted interventions that complement the regulations include public finance programmes and non-financial interventions.
Such policies are important not only in their own right, but also matter indirectly by affecting investment risk and in turn the cost of capital. Policy or regulatory risk is often associated with changes in legal or regulatory measures that have significant, adverse impacts on project development or implementation. These measures create the stable and predictable investment environment critical to ensure predictable project revenue streams. More direct public interventions include national or municipal targets, feed-in tariffs, competitive tendering or auction schemes, net-metering, quotas and tax incentives. These policy tools are discussed elsewhere: IRENA, 2015e; IRENA and CEM, 2015; REN21, 2015).
Public policy commitment can work as a critical factor to open up renewable energy investment opportunities, as case studies show (Box 2). While tools such as renewable energy targets provide a supportive and important signal to investors, dedicated finance policies can actually lower investment risks to reduce the cost of capital.
They can establish a sector-based funding mechanism to facilitate financing or provide regulations and guidelines for capital markets to increase deal flow liquidity and funding supply. Prominent examples include priority sector lending, differentiated interest rates, a funding mechanism dedicated to renewable energy and guidelines for green bonds issuance.
Other countries have also established finance policies dedicated to green or renewable energy projects. For instance, the Malaysian government has set up a USD 1 billion green technology financing scheme, which subsidises interest on loans by 2% for renewable energy projects. The People’s Bank of China – the central bank – established an institutional framework for green bond issuance in the interbank bond market in December 2015 (Kidney, Sonerud and Oliver, 2015).
2.2 Supporting project pipeline development
For many investors, the inability to find projects mature for investment is a significant constraint. This is sometimes due to lack of information about opportunities in a new market such as the renewable energy market. It may also be due to the capacity constraints affecting project sponsors wishing to move from project idea to a well-documented project. Developing renewable energy projects requires a comprehensive understanding of due diligence processes and applicable regulations, and the ability to prepare project proposals and financial documents covering all project development stages. In many developing countries – and for most newcomers in the renewable energy industry – it is not always easy to gain the necessary technical capacity, skills and resources for such tasks. Planning and zoning authorities may require special expertise to identify the social, economic and environmental criteria that renewable projects should satisfy.
Technical assistance and grant funding for project development and document preparation can increase the renewable energy deal flow and improve the pipeline of projects ready for investment. For example, Cabeólica (Box 7) received a technical support grant from the Private Infrastructure Development Group (PIDG) Technical Assistance Facility for resource assessments and technical studies. This included wind pattern and technical engineering studies. In addition, the grant facilitated access to high-quality and rigorous technical analysis, and attracted high-profile technology providers. A technical assistance grant to the Yap Renewable Energy Development project (Box 4) ensured that earlier delays caused by inadequacies in the bidding and procurement process were eliminated. Appropriately skilled engineering consultants were thus engaged as design and supervision consultants. The grant also covered technical feasibility studies for wind, solar and diesel generation, and funding for the environmental and social impact assessment study.
Several project preparation facilities help generate more deal flows by addressing the gap in early-stage financing, including the following:
» Clean Energy Finance Facility for the Caribbean and Central America is a collaborative financing mechanism pooling US government expertise6 and resources to catalyse greater public and private sector investment in clean energy infrastructure in the Caribbean and Central America. The facility provides support for essential project development costs to encourage investment in clean energy projects, including renewable energy. In particular, the US Trade and Development Agency leverages its project planning expertise and early-stage funding to support activities in eligible low- and middle-income countries (Overseas Private Investment Corporation, OPIC, n.d).
» The Ukraine Sustainable Energy Lending Facility was established by the EBRD to foster renewable energy power generation projects in the Ukraine using a simplified and rapid approval process to reduce transaction costs. In addition to loans, the facility provides project developers with technical assistance from international and local experts. This includes improving feasibility studies and preparing documents required for project appraisal, permitting and licensing, commercial negotiations and loan applications (European Bank for Reconstruction and Development, EBRD, 2014a).
» The New Partnership for Africa’s Development Infrastructure Project Preparation Facility Special Fund is created by the AfDB. It is designed as a facility with a distinct role in financing regional/continental project preparatory activities through grants. These activities include advisory services, feasibility studies, environmental and social impact analysis, technical assistance, workshops and seminars. This fund is targeting support to the specific infrastructure needs of the member countries, including renewable energy projects (New Partnership for Africa’s Development Infrastructure Project Preparation Facility Special Fund, 2016).
Not all project preparation facilities target renewable energy projects (World Economic Forum, 2015). Furthermore, some facilities provide technical assistance along with grants, while others disburse grants without being directly involved in the preparation process. Either way, project preparation facilities represent a promising way to support the initiation phase of renewable energy projects. Consequently, more funding should be aimed at such facilities.
Other non-financial tools are also available to support project development and preparation. For example, IRENA’s Project Navigator is an online tool (https://navigator.irena.org) which provides project developers with a step by–step framework to develop high quality project proposals. It assists in the preparation of written project documentation and business proposals.
One of the biggest barriers affecting the release of renewable energy investment is the shortage of investment-ready or bankable projects with an attractive value proposition. These projects can secure financing and generate sustainable revenue streams with all the necessary components aligned so that investors feel confident in long-term project success (World Energy Council, 2014). In many developing countries, the pipeline of deals in renewable energy is not evident to investors. This makes them reluctant to build the internal capacity to evaluate renewables deals. Targeted nonfinancial interventions such as project initiation and facilitation tools thus make a big difference. They provide the necessary signal to investors that a pipeline of deals is becoming available in the near future, making it worth their while to develop internal capacity.
While grant funding and project preparation facilities can support the project development process, improving renewable energy market transparency and liquidity requires more interactive project facilitation support. Transparency has to encompass information on projects, investors, financing sources and mechanisms, legal and technical advisory services and regulatory procedures.
IRENA’s Sustainable Energy Marketplace (http://marketplace.irena.org/) is an online platform supplying this type of information to relevant stakeholders. The Marketplace aims to create a global virtual platform with regional hubs (Africa, the Caribbean and Latin America, and more), to connect project developers and owners with financiers, investors, and service and technology providers (Figure 7). Users can search for projects with specified investment criteria, financing sources or advisors. The platform allows users to find and connect with experts, as well as gain access to project development tools and data on markets, regulations and incentives. By providing timely access to renewable energy project information, the Marketplace can increase market transparency and significantly improve the visibility of renewable energy projects, helping them secure capital.
2.3 Facilitating access to capital
Limited availability of local debt finance is a key obstacle to investing in renewable energy, especially in developing countries (ADB and World Bank, 2015). A recent study conducted by the Climate Policy Initiative finds that limited availability of local debt is the biggest barrier to financing renewable energy projects in India. This manifests itself through less favourable lending terms such as high cost, short tenor and variable rates. It raises the cost of renewable energy in the country by 24%-32% compared with similar projects in the US (Nelson and Shrimali, 2014). Access to debt finance can be particularly difficult for small-scale projects such as off-grid solar PV systems (IRENA, 2015d). Due to the early-stage nature of the business and lack of track record, off-grid solar start-up companies often face difficulties securing working capital debt through bank loans and credit lines (Lighting Global, BNEF and the Global Off-Grid Lighting Association, 2016).
In order to improve the access to affordable capital, public finance institutions may provide concessional loans for renewable energy projects in developing countries. For example, the IRENA/Abu Dhabi Fund for Development (ADFD) Project Facility offers loans with a tenor of up to 20 years, a five-year grace period and interest rates of 1%-2% to cover 50% of total project cost.
With longer loan tenors, lower interest rates or extended grace periods, concessional lending plays an important role in filling the gap in affordable debt financing. However, the positive impacts of concessional loans can only extend beyond the projects benefiting from the loans if supplemented by capacity building for local lending institutions to improve the country’s investment environment. On-lending structures and loan syndication can thus, through capacity building, reduce key financial barriers such as limited access to debt and lending experience in renewable energy.
Flexibility offered by hybrid structures can also facilitate the more active involvement of public finance institutions and investors into renewables, thereby improving the project developer access to capital. Hybrid structures combine key characteristics of two financial instruments and thereby allow projects to benefit from both instruments while reducing and transferring risks. These hybrid structures include, for instance, mezzanine finance, which is subordinated to senior debt but has priority over equity. Subordinated debt can attract private investors who are not familiar with renewable energy projects. Another option is convertible grants which can be applied so that public finance supports the risky stages of project development while providing a safety margin for failure. A third option is convertible loans, which help lower the cost of capital by providing contingent claims to capture the equity upside. Box 3 discusses how hybrid structures stack up in terms of risk and cash flow priority in capital structure.
Many local financial institutions lack the experience or information necessary to finance renewable energy projects. Structuring term sheets and developing screening criteria to assess the bankability of Power Purchase Agreements (PPAs) and credit risks requires an understanding of financial as well as technical aspects of renewables. The lack of track record and performance history (Climate Investment Funds, 2012) of certain renewable energy technologies further adds to the perception of high risk of renewables by local financial institutions. The absence of technology standards and comparable benchmarks for renewable energy projects has the same effect. In addition, financiers may not be familiar with market players and the industry structure in countries with nascent renewable energy markets.
On-lending, also known as financial intermediary lending, can increase the availability of local debt, improve access to local financing and help build local lending capacity. Many DFIs use their high credit quality and market access to borrow debt at low rates and on-lend them via credit lines to a government or other institution. While not necessarily cheaper than ordinary loans, the local lender may access consultancy services and training to develop feasible projects, thus building experience and a track record.
This practice reduces the local banks’ risk, making them more willing to lend, and improves the overall effectiveness of the investment. From a project developer standpoint, on-lending can increase the availability of financing, possibly on better terms than it might otherwise find in the local market. An example of a typical on-lending structure is illustrated in Figure 9.
On-lending facilities typically use credit lines. This is credit offered by banks which the borrower can draw upon if needed but is not obliged to. A credit line has a certain limit agreed between the lender and the borrower. When a credit line is used, the remaining limit is reduced accordingly. As the borrower repays the loan balance, the credit line is recovered and is thus of a revolving nature. Revolving, contingent credit lines are used for short-term financing needs. For example, they provide flexibility in the debt financing of businesses or act as buffer against short-term income volatility. Another use of credit lines is discussed in Section 3.3.
National governments and DFIs can develop on-lending structures targeted at small- to medium-scale renewable energy systems. Some prominent examples include the following:
» The World Bank and the GEF-funded TEDAP provide credit lines to eligible commercial banks in Tanzania to support small-scale rural renewable energy projects via on-lending. When a project developer requests a loan from any of the participating banks, the local bank (after a full appraisal of the project) requests a corresponding credit line from the TEDAP administrator, the Tanzania Rural Electrification Agency. As a result of TEDAP’s on-lending intervention, the interest rate was reduced from 6.24% to 5.61 % in 2011 (Rural Energy Agency, 2011).
» ARB Apex Bank, the implementing agency of the Ghana Energy Development and Access Project, acts as a mini-central bank by lending capital to a vast network of rural and community banks across Ghana. These in turn finance solar home systems to rural households lacking electricity. In order to facilitate on-lending schemes for off-grid renewable energy systems, the bank developed in-house technical expertise with technological knowhow (IRENA, 2015d).
» The EBRD’s Sustainable Energy Financing Facility in Turkey aims to address finance shortcomings by providing credit lines to local financial institutions for on-lending to small and medium-sized enterprises. This finances energy efficiency and renewable energy projects. This model combined concessional funding from the Clean Technology Fund, non concessional funding from the EBRD and technical assistance to banks and investors financed by EU and Clean Technology Fund resources. Facility funding of USD 289 million was channelled into 370 sustainable energy projects. This mobilised a total project value of USD 460 million between 2010 and 2012 (EBRD, 2014b).
DFIs can co-lend senior debt with commercial banks and distribute the risks among a broader group of lenders, thereby limiting each bank’s risk-taking. This applies especially to larger and riskier projects such as offshore wind power. While no single commercial bank could extend the large loans needed, many banks participate in a syndicate to finance such large-scale projects.
When a DFI participates in loan syndication, this can facilitate local bank participation because local banks can piggyback on the development bank’s experience of renewable energy project finance. Foreign banks find the participation of development banks in project finance politically reassuring (Wang et al., 2013). For example, DFIs with experience in a particular renewable energy technology could lead the early rounds of financing with soft loans.
Local banks in syndication with other banks then take the lead for later rounds (Lavine, 2013). In this way, local banks can enhance their capacity and interest in lending to renewables through the knowledge gained from the early rounds. Meanwhile, borrowers benefit from the lower cost of local financing. Through this experience, local financial institutions can build a track record and capacity in consultancy services to finance renewable energy projects on their own.
B-loan structures led by a public finance institution in syndicated loans can benefit both participants (lenders) and borrowers. In this type of scheme, a DFI retains a portion of the loan for its own account (the ‘A-Loan’) and sells the remaining portion to participants (the ‘B-loan’) (International Finance Corporation, IFC, 2016). By contracting with a DFI instead of lending directly to the projects, commercial banks and other financial institutions can lend to DFI-financed projects. This means they benefit from the DFI’s high credit rating, strong relationship with governments and ability to provide risk mitigation.
Borrowers can achieve financing with longer tenors by signing a single loan agreement with the DFI. They then benefit from lower financing and transaction costs as well as a more simplified administration and documentation process than if signing with multiple lenders. The effectiveness of B-loan structures is further discussed in the Jordanian solar case study in Section 5.3.
Subordinated debt can help to insulate senior debt investors from unacceptable risks and reduces the cost of capital in cases where equity is too expensive. This can be especially important where senior debt investors are unfamiliar with the risks inherent in renewable energy projects. As a form of mezzanine financing, subordinated debt can be provided by public investors to attract private investors. For example, the UK Green Investment Bank (GIB) invested GBP 70 million in a biomass plant together with the Irish utility Electricity Supply Board. The GIB and the utility invested the capital in the form of equity and a shareholder loan, which is a type of subordinated loan. Through this structure, the equity investors were able to raise GBP 120 million from an export credit agency and two commercial banks (GIB, 2015). Such subordinated debt supported by public institutions can also work as a type of credit enhancement for senior debt (see Box 12).
Convertible grants provide the ability to shift funding from grant to loan. This instrument offers public finance institutions a useful way to support early stage project development and high risk renewable energy technologies with the potential to benefit from loan interest. At the same time, they leave a safety buffer for project developers (the beneficiaries of public finance support) should the desired outcome not materialise.
Convertible grants have been proposed in the European Union’s Electrification Financing Initiative (ElectriFI) to support renewable energy and energy access projects in developing countries. Under this initiative, private sector equity investors at the early investment stage can enjoy a safety buffer from convertible grants. These convert into subordinated debt once they reach particular milestones (such as the completion of a feasibility study, financial closure, or project completion).
Subordinated debt (up to 30% of total project cost) can be made available in cases where equity availability is low or comprises in-kind contributions (5%- 15% of total project cost) (European Union, 2014). Convertible grants can be also used to lower geothermal resource risk during exploratory drilling (Section 3.4).
Convertible loans are like convertible grants, in that they can be converted, at certain points and at certain pre-agreed terms, into another instrument with a higher risk and return profile, in this case equity. They can support early stage project development by mitigating risks while allowing for potential upside returns to lenders. This structure can be used by public finance institutions to finance project development activities or new renewable energy technology deployment.
On the one hand, convertible loans can provide the borrower with the option to repay the loan instead of equity conversion and tailor the repayment schedule according to the project schedule. On the other hand, they allow the public finance institution to fund projects at reasonable terms compared with the high risk of the investment. The embedded opportunity and related upside potential to convert the debt into equity can result in lower cost of the debt to the borrower.
For example, project development cost could be financed by a convertible loan (project development loan) to be repaid by refinancing it at the construction stage using construction stage senior debt. If the project is implemented on schedule, the project owners are able to repay the loan and avoid the dilution. If the project is delayed or cancelled, the project company avoids going bankrupt since the loan will be converted to equity, although the project owners’ equity stake would then be diluted.
Source: IRENA (© IRENA 2016)