Concessional financing to encourage small scale renewable power initiatives

April 2024  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2024 Issue

This article looks at the vital role of concessional financing in helping to achieve climate change objectives in emerging markets, through helping to make small scale power initiatives economically viable for developers and their financiers in traditionally high-risk investment markets. In this discussion of small scale renewable power initiatives, we will examine two key types of project: solar home systems (SHS) and small commercial and industrial (C&I) solar plant developers that are rolling out easy to install renewable power systems and the developers of individual small, micro or mini-grids, both for national utilities and as off-grid generation and distribution facilities. In examining concessional financing solutions in the context of emerging market power initiatives, we mean primarily the deployment of subsidies, technical assistance and development grants and low-cost loans.

Electrification is a challenge in most emerging market jurisdictions. With grid connected power often unreliable, and power transmission and distribution systems not extending to all parts of the population, or able to support further power being made available to the national grid, customers and businesses are reliant on a poor performing grid and costly diesel generators. The move away from fossil fuel reliance in countries which not only have limited access to reliable power, but are often vulnerable to climate change impacts, requires a focus toward alternative power solutions. There has been a particular explosion of off-grid and small grid power solutions, and a proliferation of companies offering small scale alternatives to consumers – sub-Saharan Africa is a prime example of the competitive market for solar home systems and small-scale solar projects for C&I clients, particularly in east Africa and Nigeria.

Securing sufficient financing for necessary public infrastructure has always been a challenge for emerging markets, where attracting private sector development and funding requires significant government and external support to address inherent political and financial risks which the private sector is neither able nor willing to accept. Climate adaptability for emerging markets, through small scale renewable finance programmes, can help achieve net-zero emissions targets, reduce the impact of climate change and address significant infrastructure objectives. The challenge for these markets is that governments cannot fund the level of investment required to meet their climate change initiatives, but the full package of government support available for utility level power projects is not normally on offer to developers and their financiers. Consequently, as a starting point, an obvious question is: how can we structure the financing for small scale renewable projects in emerging markets?

With regard to renewables solutions platforms and small grids, financing is required to fund the construction of assets, albeit it small scale assets, but when you are looking at the creation of a platform for selling SHS or C&I solutions, or constructing a mini-grid, the risk allocation and project parties differ greatly from those in a typical utility scale project structure, and trying to recreate a typical non-recourse project financing will be impossible.

At a very basic level, while these types of initiatives often fall within the remit of project finance teams, these projects are small scale, and they will not be able to attract the level of interest, even from typical ‘project’ financiers – such as development finance institutions (DFIs) and multilateral finance institutions (MFIs) – for senior debt funding. In addition, the project counterparties will be unwilling and, in most cases, unable, to give the type of contractual protections which a typical project financier would expect as a condition to funding. Applying a typical lender project financing checklist makes small-scale projects unbankable.

The key for investment is to scale up. Looking at sub-Saharan Africa as an example, renewable solutions platforms, such as Daystar Group or Empower, have relied on grant funding and a mix of concessional and blended finance to start their operations. With small projects in their countries of operation, they plough the revenues from successful projects into expanding their presence in countries with more projects and investing in new markets, thus diversifying their risk and creating a scaled-up portfolio of operational assets across their regions of operations. Today, these groups can refinance and expand through procuring senior debt at parent or intermediate company level, or even by procuring local currency loans at the operational level, structured as a hybrid form of corporate finance.

To have evolved to the scale up required for this level of investment, initial equity support coupled with technical assistance loans and concessional grants (from specialist climate financing or emerging market electrification funds) were the key funding solutions to make the renewable solutions platform business model financially viable. Developers started with a mix of grant monies (both low-cost loans and grants) and equity to maintain cashflows during construction of their early projects to meet the high upfront costs. Procuring normal debt financing in politically high-risk markets, without investment grade or financially robust counterparties, is not an affordable or available option for small scale power developers.

There is a clear correlation between emerging market economies and climate change vulnerability. This is particularly acute for Indian and Pacific island nations threatened by rising sea levels. We have seen governments in the Seychelles, the Maldives and Papua New Guinea launch renewable power initiatives as an alternative to reliance on expensive and polluting diesel power generation. An additional challenge for small island nations is that they are often remote, their populations and project areas are spread across wide areas separated by large bodies of water, they require a mix of technologies (floating solar is ideal but is more complex than ground-mounted solar), and importation, exportation and dismantling is expensive. The overall costs of renewable projects in these jurisdictions are therefore often significantly higher than in non-island nations, while the size of the projects (even on-grid) is often small, notwithstanding all these additional challenges.

The Asian Development Bank (ADB) is currently financing significant investment into new transmission and distribution networks across the Maldives, including battery storage facilities which will be owned by Fenaka, the national utility. This initial investment is a precursor to the launch of renewable power auctions for ground mounted, rooftop and floating solar across the islands, requiring the development and financing of multiple facilities by private developers, which will be able to connect to the newly constructed transmission and distribution network, with battery storage able to secure delivery by Fenaka during periods when the solar facilities are not generating. This will be a significant project in terms of reducing the islands’ reliance on fossil fuels, and the integration of battery storage is a key element in helping the utility maintain power supplies in communities which will be relying on solar. While this programme will be supported by government, the project size is significantly smaller than usual grid-connected projects, and is essentially the development, construction and operation of a number of renewable small grids across multiple islands. The project has been scaled up – to create a size that will be attractive to developers and attract financing – but there will still be a requirement for developers to balance the high initial development costs with the government expectation of the lowest possible pricing. To help developers achieve this, the structuring of concessional financing subsidies is a key component of the project’s contractual package, through the availability of grants from the government. The Maldives’ government will offer this funding through the Asia Pacific Climate Finance Fund, an ADB-managed, multi-donor trust fund established with the German government as its first financing partner.

The World Bank Group recently launched the Scaling Mini-Grids Programme as a significant tool in providing low-cost, reliable and clean energy to emerging markets communities that are out of reach of the existing power grid. The mini-grid systems identified by the programme are primarily powered by renewable energy sources. The World Bank Group predicts that by 2030 nearly half a billion people around the world could be using electricity from mini-grids, and it is crucial in the fight against climate change that this new generation of mini-grids utilise clean technologies. The Scaling Mini-Grids programme seeks to increase private investment in mini-grid services by working with governments, private sector investors and donors to find solutions to the remaining challenges in the sector. The programme addresses the key bankability challenges to deploying mini-grids at scale – legal and regulatory uncertainty, creation of PPP frameworks, demand, currency and political risks, and crucially, offers risk mitigation instruments for governments and the private sector. Among the risk mitigants offered to the private sector is grant funding. The expectation is that government subsidies will be dispersed to developers upon the achievement of certain construction and connection milestones. This will incentivise developers, help lower tariffs, and ensure developers can maintain project cash flow to meet construction costs which cannot be fully financed upfront by equity. The expectation is that debt financing will only be available once the mini-grid has a proven operational and payment track record – the point at which lenders will likely consider the project sufficiently de-risked for funding.

A number of significant DFIs and MFIs have identified working with vulnerable governments to design climate change resilient power programmes as a key factor in helping to adapt emerging nations away from fossil fuel reliance and reduce emissions. In most circumstances, these programmes acknowledge that small-scale power does not provide the same financial incentives as large scale utility projects, and that the high upfront and development costs make it difficult to attract private sector developers and financiers. Concessional financing, particularly through the reward of grants and subsidies, is being deployed as a key part of the financing toolkit to enable these projects. Without concessional funding, these initiatives would not find participants.

Where the public sector is unable to finance initiatives itself, concessional finance can bridge the gap to private sector capital. It is the essential element required to create the financial viability necessary for the private sector to be involved in small scale power projects which contribute to emerging market climate change initiatives.

 

Fiona Gulliford is a partner at Trinity International LLP. She can be contacted on +44 (0)20 7997 7058 or by email: fiona.gulliford@trinityllp.com.

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BY

Fiona Gulliford

Trinity International LLP

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