ANALYSIS - Renewable power shines bright in emerging markets but mind the traps as well
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The growth prospects for the renewable power industry shine particularly bright in emerging markets but investors should carefully consider the many roadblocks that may trip profitability of projects there.
There are three key drivers of renewables development in emerging markets - energy demand to power industrial development and provide access to electricity for increasing share of population; promotion of national resources; and the cost advantages of renewables.
Some developing countries, such as Kenya, want to promote renewables as many locals still do not have access to the energy grids. It is far quicker to ensure power using small-scale renewables projects than to build connections to large-scale transmission and distribution networks.
Distributed photovoltaics (PV), for example, is constantly gaining popularity in emerging markets, especially India and Africa.
The potential market for off-grid renewables is considerable. At present, 1.3 billion people across the globe still have no access to electricity, according to the International Energy Agency. Of these, 621 million live in the emerging economies of sub-Saharan Africa and another 620 million live in Asia.
Others, like Brazil and China, more or less have the grid infrastructure in place but want to address domestic power demand by promoting national resources and cutting dependence on imported oil and gas.
Yet, the single most important driver behind the steep increase of renewable energy investment in emerging markets is the price of energy. Renewable sources, especially wind and solar, are now very competitive with fossil fuels.
According to findings of the Climatescope 2014 report, put up by research firm Bloomberg New Energy Finance (BNEF), solar panels can provide electricity at about half the cost of the wholesale power price in Jamaica. Wind power enjoys a similar price advantage in Nicaragua.
SOUNDS GOOD, RIGHT? The truth is growth statistics and market rankings may appear attractive reading for potential investors, but investing in emerging markets carries additional risks. Every market has its own specifics but the following are most common problems that investors face when investing in a renewable energy project in emerging markets.
Political swings can bring renewable energy projects, and supporting policies, to a halt. Investors may be attracted to new incentive schemes, but a change of leadership could quickly reverse these incentives. It is generally common sense to avoid overly generous incentives schemes as they are usually not lasting.
Renewable energy projects usually generate most of their revenue from a long-term power purchase agreement (PPA). In emerging markets even state-owned companies may not be creditworthy. Investors shall make sure that the offtaker can pay for power over the term of the contract.
Finding the right funding option
Traditionally, renewable energy investment has been limited to project finance structures or bank debt that greatly limits the supply and raises the overall cost of capital, especially in emerging markets.
Since there is a higher perceived risk, many projects will benefit from the support of multilateral banks and public finance entities, including export credit agencies, World Bank institutions, the Asian Development Bank, Brazilian Economic Development Bank and other similar entities.
If financing can be sourced through “impact investing” funds or helped by local development banks, the cost of finance can be lowered enough to make the investment profitable.
There may be barriers to investment, including laws to prevent or restrict foreign ownership of certain assets, such as land or energy generation assets, or at least require a percentage of domestic ownership. Investors will need to determine the cost and process of repatriating their investment returns.
TODAY, over 130 countries across the globe have some sort of government support for the development of renewable energy and the key to a positive investment outlook is to minimise the sources of risk wherever possible, thus reducing the cost of capital and improving the project economics.