Renewable Energy Financing: Understanding the Risks
Increasing investment in renewable energy will bring substantial opportunities to the global economy and is an essential element to the decarbonisation of the electricity generation sector necessary to reach the targets set by the Paris Agreement. As mentioned previously, the current level should be scaled up to reach at least the double by 2030.
According to the International Renewable Energy Agency (2016), the private sector is supposed to provide the highest share of this financing as the share of public financing is not likely to increase above the current level of 15%.
The involvement of the private sector is necessary to scaling up the financing for renewable energy. When mentioning the private sector, the literature is generally referring to institutional investors: insurance companies, pension funds and sovereign wealth funds that can more than USD 90 trillion in the real economy (OECD, 2016).
The narrative behind contribution of institutional investors is based on the fact that the liability profile of these investors matches the characteristics of renewable energy as an asset. The fact that revenues from renewable energy projects can be stable over a long term period is particularly attractive. At the same time, renewable energy projects need long-term financing.
Corporations are also important players in the financing of renewable energy projects. More and more companies around the world are voluntarily and actively investing in self-generation of renewable energy. This trend is driven by both the decrease in renewable energy generation prices as well as the demand for corporate sustainability among investors and consumers (IRENA, 2018).
Figure 1.
Risks faced by investors in renewable energy projects
Developing markets have the fastest growing energy demand and will require the largest increase in investment (IRENA, 2016). Development Financial Institutions (DFIs), such as the World Bank, historically played a very important role in scaling up renewable energy investment in developing countries. Multilateral Development Banks are banking institutions owned by governments and whose aim is to help the financing of projects in the developing economies. In 2017, Multilateral Development Banks (MDBs) alone financed USD 9.2 billion in renewable energy projects. Beyond direct financing, MDBs are increasingly positioning themselves as “private sector mobilisation engines”, institutions that act as corner stone investors taking some of the most important risks in a project, using blended finance structures, and therefore facilitating the investment from private financing sources in difficult contexts.
Figure 1 presents in detail the risks associated with renewable energy financing. The better these risks are mitigated and protected against, the more attractive renewable energy projects become for investors.
Figure 2 describes the various levels at which risks can be mitigated in renewable energy projects (i) the enabling policies and tools, (ii) the financial risk mitigation instruments, (iii) and the structured finance mechanisms and tools. The next section is going to explore further all these elements with a focus on the structured finance mechanisms and tools.
Figure 2.
Policies, tools, and instruments that reduce barriers and mitigate risks in renewable energy projects
The Lake Turkana case study discussed in the case study section will dive further into the risk mitigation instruments and the way the various stakeholders mentioned earlier can collaborate to finance a renewable energy project in a developing country.