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Impact Investing

IPE special report May 2018

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Emerging green markets

Will declining costs and changing policy priorities lead to investment opportunities in green energy in emerging markets? Elisabeth Jeffries poses the questions

At a glance

• India’s targets are deemed unrealistic but solar is still set to grow substantially.
• China has announced a large target for concentrating solar power, an emerging technology.
• Mexico has introduced a carbon tax and a plan to phase out fossil-fuel subsidies.

The Indian prime minister, Narendra Modi, caused a stir when he announced a major solar power target at the 2015 Paris climate change negotiations. For the first time it seemed, the government was seriously rolling out a photovoltaic (PV) programme of substantial proportions – 100 gigawatts (GW) by 2022. But as the months pass, some question the rhetoric. “The 2022 target is unrealistic under the current regime,” says Gurpreet Gujral, renewables equity analyst at Macquarie Group. “Our 2020 forecast for India is 36GW, two years short of target and not at that rate. In 2020 9GW will be added and in 2021 another 10 GW and so on, but by 2022 the country will be only just over half way there.”

Macquarie’s experience indicates that one of the principal deterrents to speedy investment is the incentive system set up by the government, a reverse auction process favouring the lowest bidder. Gujral suggests this is not attractive enough. “At the level we’ve seen, it’s too aggressive. Developers win the allocation to build out solar. They end up waiting until costs are down to a level which makes sense, and this slows down the installation. Bidding is on the price of the electricity they will be paid. So they bid lower and work out how they could build the asset at a lower cost.”

However, the market is on an upward curve given the change in direction. Despite the favourable weather conditions, “only two years ago hardly any solar had been deployed in India,” points out Gujral. Most low carbon investors in India are based locally. Lenders include Yes Bank, Infrastructure Leasing & Financial Services Limited (IL&FS) and the Indian Renewable Energy Development Agency. 

However, as more microgrids are built and smaller solar projects grow in number, a greater role may emerge for overseas investors. Of particular relevance is the UN Green Climate Fund (GCF), founded in 2013. The fund has thus far only disbursed modest amounts. However, the SRI investment coalition Ceres believes this may change. With new economic instruments emerging, major foreign investors may be more attracted to India as well as similar countries with an undeveloped transmission grid and dispersed projects.

“One GCF tool anticipated to be of great interest in terms of pairing GCF resources with institutional investor capital is the Private Sector Facility. This is intended to be used, in part, for the creation of large-scale investment opportunities and the mobilisation of capital markets, for instance by aggregating groups of projects into single investment vehicles,” says Sue Reid, Ceres vice president for climate and clean energy programmes. 

Through prospective clean energy project aggregation advanced via the facility, the GCF can be deployed to kick-start clean energy investment in developing countries, including India. “Given the GCF’s newness, however, the overwhelming majority of its potential has yet to be realised,” she says. In India in particular, high cost of capital and currency risks still put off investors. 

“More SRI investment is on the way. The government is looking to policies to make game-changing investments, focusing on de-risking to draw in more institutional investment. There is a collective effort to attract institutional investors,” says Reid.

It is tempting to draw connections between the Paris agreement and a surge in cleantech activity in emerging economies. However, the shift was perceptible beyond China and India some time before that. “It’s less to do with Paris and more to do with declining wind and solar costs. Governments are interested in energy security angle and hedging against fossil fuels. It is also an area of key interest for donors, who provide support for capacity building,” says Dana Younger, chief renewable energy specialist of the International Finance Corporation (IFC).

Morocco has attracted attention for deploying a major new $8bn (€7bn) Concentrating Solar Power (CSP) installation in Ouarzazate Noor. The technology differs from solar PV in using arrays of mirrors to concentrate the sun’s rays, heat fluid and produce steam, which drives a turbine to generate power. In addition, Younger sees exciting new CSP potential in China. “The Chinese government has set a CSP target of 10GW in the latest five-year plan. It’s still a draft target but set in the context of a global installed capacity of 5GW, that is considerable,” he says.

Younger believes major original equipment manufacturers such as Siemens and Dow, already involved in renewable energy investment in China, may find a further role in CSP. “There are lots of opportunities in the industry if it is going to scale and develop a supply chain,” he says. The Chinese commitment could transform this previously very specialised sector. However, installations are only viable in areas of high insolation, so the market is still likely to remain niche. “A most significant dimension is that once China becomes active in CSP, prices drop and solar costs get cheaper. It will start making basic materials more cheaply. This has a broader implication, just as it has had in solar PV markets,” he says.

Apart from suitable locations in remote parts of western China, CSP has the advantage of being a fully dispatchable renewable source, unlike wind and solar. China’s plan to diversify energy is another major motivation. Innovation and competition also play a role. “This industry can absorb skilled people coming out of China’s universities, and is a focus of scientific expertise. They can produce breakthroughs and innovate,” says Younger.

In India, Younger, sees change in wind as well as solar. “The government has moved from accelerated depreciation to a generation-based incentive similar to the US production tax credit. That isn’t sufficient to drive growth, but the accelerated depreciation has been reinstalled, albeit at a less generous level.” The hybrid scheme, he predicts, will alter market sentiment: “Foreign companies have been doing very well. A lot of production is going from Spain to other markets. People have been coming back into the Indian market and getting more interested fairly recently,” he says.

Carbon pricing commonly accompanies new cleantech drives in emerging economies. Reid notes significant initiatives in Mexico, Chile, South Africa and Morocco. “In Mexico, there has been really visible leadership and a new framework and carbon tax, as well as efforts to phase out fossil fuel subsidies,” she observes. Hence, Mexico increased investment in renewable energy by 105% in 2015 to $4bn. Reid points to a greater interest from institutional investors: “We’re seeing more starting to follow the lead of Pension Danmark,” she says.

Policy improvements hold out equal promise for the sector in another Latin country, Argentina, after a new renewable energy law was passed last autumn aiming for 20% renewable energy by 2025 from a very low base now.

“There’s been a lot of interest in the last six months in Argentina, a country which previously did not have cost-reflective tariffs, and whose energy sector was in distress but has now been rationalised. They provided a subsidy but the rate was kept artificially low. Patagonia has among the best resources in the world and Argentina has the potential to easily develop 10-12 GW in the next 7-10 years,” says the IFC’s Younger.

In addition to new directions on the part of pension funds, Reid sees more opportunities for insurance companies in emerging economies as low carbon policies make their imprint. “Insurers are showing interest. Some investors have been shifting their portfolios from high carbon into cleantech and are looking for infrastructure investment, and that is often a good match with insurance,” she says.

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