The revolution will not be subsidised

“An energy revolution is under way. Globally, investments in renewables-based electricity capacity have beaten fossil fuels consecutively for the past two years. In India, too, renewables have dominated power sector investments since 2015. By some projections, global clean energy could grow by 1 terrawatt, or 46 per cent, during 2018-2023. What India is attempting in seven to 10 years took Germany more than two decades to achieve. This is nothing short of revolutionary. Like freedom, this energy transition will not come for free. It will need large sums of strategic investment.
 
As in any revolution, there are counter-revolutionaries. The first is structural inertia in energy systems. Electricity is only 20 per cent of global energy supply. Solid fuels in manufacturing, liquid fuels for transport, and gaseous fuels for cooking and heating buildings all rely (to the largest extent) on fossil fuels. Even with renewables winning at the margin in electricity, fossil fuels have stubbornly held on. Ten years ago, fossil fuels accounted for 81 per cent of global energy. Their share remains the same today. A structural shift in energy systems will happen with growing electrification and by substituting cleaner energy sources (biofuels, for instance) in non-electric energy applications. Capital investment has to be nudged away from locking into fossil fuels.

 
The second counter-revolutionary is embedded bias. Emerging economies are not getting their due share of capital. The sun shines the most between the tropics, yet the bulk of renewable energy investment continues to flow into temperate regions. Advanced economies are circulating capital amongst themselves. Institutional investors in OECD countries, alone, manage up to $84 trillion in assets, of which only 1 per cent is invested in infrastructure — and that too in developed countries.
 

The distortion can be attributed to the perception of risk. Institutional investors list a litany of risks when considering renewable energy projects in emerging economies. Research at the Council on Energy, Environment and Water (CEEW) has identified that the ranking of risks varies across countries such as India, Indonesia and South Africa. In some cases, these are project-specific and include delays in land acquisition or completing construction of a solar or wind farm. In many cases, the perceived risks are systemic: offtaker (whether utilities will pay for procured power); foreign exchange fluctuations; and political uncertainty.

 
Reality is less exciting than perception. On average, default rates are much lower for renewable energy projects than for thermal power. Returns on investment in clean energy markets have been higher for equity investors. This is not to say that there are no genuine concerns. Last week, Moody’s downgraded the Indian Renewable Energy Development Agency (IREDA) from stable to negative, courtesy the stress in general on non-banking financial corporations and the all-too-common problem assets in the power sector. Even as IREDA’s net non-performing assets remain under control, this downgrade could gravely impact investor mood. 
 
The response, thus far, has been inadequate and imprecise. In order to build investor confidence and tap into new sources of capital, as well as existing capital at improved terms, there is an urgent need to make clean energy investments more secure. Multilateral development banks (MDBs) have an expanding focus on climate financing. But there is limited focus on directing public money into initiatives that could make clean energy markets more attractive to private investors. Out of the record $27.9 billion that MDBs invested in climate mitigation projects in 2017, less than 20 per cent was directed to policy-based financing and guarantees.

 
Worse, the instruments currently deployed lack precision to solve specific problems. Instruments like credit enhancement mechanisms or partial credit guarantees may enhance the credit rating of individual projects, but do little to isolate individual risks and build investor comfort at the sectoral level. The perception of risk continues to be in excess of the real risk in such cases.
 
Bespoke solutions, which respond to specific impediments to investment flows, are needed. At CEEW, we have worked on two such solutions, the Common Risk Mitigation Mechanism (CRMM) and the Grid Integration Guarantee (GIG). The CRMM addresses political risk, forex risk, and offtaker risk for solar projects in solar resource-rich but finance-constrained economies. GIG is designed to address the risk of integrating a growing share of renewables in the electricity mix, whether due to the technical limitation of the grid or the commercial limitations of utilities.

 
In the same spirit, a dedicated facility is needed to design fit-for-purpose, market-ready instruments, which could help crowd in hundreds of billions of dollars into clean energy in emerging economies. The CEEW Centre for Energy Finance (CEF) aims to play the role of a non-partisan market observer and driver — to monitor, develop, test, and deploy financial solutions to advance the energy transition.
 
Inertia is more than a law of physics; it is a reality in financial markets. The bulk of energy subsidies continue to go to fossil fuels. Yet, we are witnessing a global energy revolution. Energy transitions in emerging economies are and will be distinct from those in more developed markets. They will need distinct interventions too. Existing efforts, neither by private investors nor by development banks, are adequate to accelerate financial flows. The revolutionaries need guerilla tactics to beat the incumbents. The tactics start with smart finance for smart energy. Ghosh is CEO, Council on Energy, Environment and Water (https://bsmedia.business-standard.comceew.in). Chawla leads CEEW’s Centre for Energy Finance. Follow @GhoshArunabha @CEEWIndia, @Kanikachawla8