Attracting private investment through NAMAs: the role of risk, return ...
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Attracting private investment through NAMAs: the role of risk, return and policy design
Part1: why and how private investment matters
UNFCCC Asia Pacific Regional Workshop on NAMAs
Vientiane/Lao PDR, April 24, 2014 Speaker: Tobias Schmidt, ETH Zurich
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Agenda
The role of finance in low carbon development 1
2 Sources of finance
3 Basics of private investor investment decisions
5 Summary
4 Policy measures to tap private funds
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USD37tn by 2035 in energy infrastructure
additional USD17tn to reach 450ppm scenario
• Higher emission reduction potentials compared to baseline are in non-OECD countries
• Most investments in non-OECD countries • Not only additional finance needed, but re-direction of existing
and planned capital flows from traditional high-carbon to low-emission, climate-resilient investments
• Additional investment does not mean additional cost! (often these investments can save costs)
Low carbon development necessitates tapping additional, and redirecting existing, investment flows
Sources: IEA, 2012; UNDP, 2011/2013
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Source: ETH Zurich, UNDP
Upfront finance is more important in low carbon investments than in high-carbon investments
Reve
nues
Co
st
Upfront
Time
Cost
Time
Reve
nues
Running cash-flows (cost and revenues)
Typical high-carbon cost-revenue structure
Typical low-carbon cost-revenue structure
• Cost can be lower • But upfront finance is more important!
Investment costs (upfront)
Finance (upfront)
Operating costs (fuel, maintenance ,etc) Revenues
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Agenda
The role of finance in low carbon development 1
2 Sources of finance
3 Basics of private investor investment decisions
5 Summary
4 Policy measures to tap private funds
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Already today most climate finance is provided by the private sector
Source: Climate Policy Initiative, 2011
Private sources
CDM revenues
Public sources
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Private funds represent by far the largest source of Climate/NAMA finance
Domestic International
Public funds mostly limited limited
Carbon markets limited limited
Private funds varying large
Challenge: How to leverage private funds using public funds/carbon markets?
Source: ETH Zurich, UNDP
Public funds
Private funds Carbon markets
NAMA Finance
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Agenda
The role of finance in low carbon development 1
2 Sources of finance
3 Basics of private investor investment decisions
5 Summary
4 Policy measures to tap private funds
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Expe
cted
fina
ncia
l ret
urn
Risk of investment
Attractive Investment
Risk premium
Source: ETH Zurich, UNDP
⇒ Investment Risk is an essential part of private sector’s investment considerations
Risk free rate Unattractive
Investment
Private investors’ decisions are mainly guided by the risk-return profile of an investment opportunity
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Downside investment risk is defined by the combination of the probability of a negative event and its potential financial impact
Source: UNDP
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Different risk levels result in different cost of capital
• The cost of capital reflects the risk involved in an investment • The cost of debt represents a bank loan’s interest rate • The cost of equity represents the hurdle rate for equity
investors • Due to seniority, debt has lower cost than equity
Source: UNDP
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As investment risks in developing counties are typically higher financing costs are increased • More barriers increase the risks perceived by investors • The financing costs increase with perceived risks • A project feasible in one country might be infeasible in another due to
higher perceived risks
Cost of Equity Cost of Debt
Source: UNDP
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Financing costs heavily affect the competitiveness of renewables (more than of fossil fuel-based technologies)
Source: UNDP
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Agenda
The role of finance in low carbon development 1
2 Sources of finance
3 Basics of private investor investment decisions
5 Summary
4 Policy measures to tap private funds
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Policy makers need to create a favorable investment environment to attract low-carbon investors
Source: UNDP
Fina
ncia
l Ret
urn
Risk of Investment
Infeasible renewable
energy project Price Premium
Feasible renewable energy
project
Guaranteed Access to the Grid
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The policy mix should address both the risk and the return aspect
Source: UNDP
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Four-step process for selecting the appropriate combination of policy and financial instruments
Source: UNDP
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Addressing risks can therefore strongly reduce financing costs
Source: UNDP, Derisking Renewable Energy Investment (2013). Data obtained from interviews with wind investors and developers. See Annex A of the report for full assumptions. The post-derisking cost of debt and equity show the average impacts over a 20 year modelling period, assuming linear timing effects.
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Financing costs heavily affect the competitiveness of renewables (more than of fossil fuel-based technologies)
Source: UNDP
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Source: UNDP, Derisking Renewable Energy Investment (2013). See Chapter 3 and Annex A of the report for full assumptions.
LEVELISED COST OF ELECTRICITY
Reduced capital costs can strongly decrease the costs of electricity generation and thereby the NAMA costs
Compare the NAMA case study
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Current practical applications (full DREI) Utility-scale renewable energy
BUDGET
TIMELINE
CORNERSTONE INSTRUMENT
DERISKING AREAS
FINANICIAL INCENTIVE
FIT/PPA bidding process
TBD Yes
2015-2019
Utility-scale solar PV & wind Utility-scale solar PV and wind TARGET SECTOR
FIT/PPA bidding process
Tunisia Nigeria
2015-2019
GEF: $3.5 m Co-financing: $63.8m
GEF: $4.4m Co-financing: $167m
• Power market risk • Permits risk • Resource/technology risk • Grid/transmission risk • Financial sector risk
• Power market risk • Permits risk • Resource/technology risk • Grid/transmission risk • Financial sector risk
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Agenda
The role of finance in low carbon development 1
2 Sources of finance
3 Basics of private investor investment decisions
5 Summary
4 Policy measures to tap private funds
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Summarizing the 4 key messages
Upfront finance is essential to enable low-emission development I
Important to use scarcer public funds in order to leverage private funds II
For private investors, the risk-return profile of an investment opportunity needs to be attractive III
NAMAs & LEDS should provide a policy mix that provides attractive returns and reduces risks IV
Source: ETH Zurich, UNDP
Private funds
LEDS Finance
Expe
cted
fina
ncia
l ret
urn
Risk of investment
AttractiveInvestment
UnattractiveInvestment
Cost
Time
Reve
nues
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Two UNDP reports on promoting renewable energy in developing countries
(October 2012) (March 2013)
www.undp.org/DREI