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Private sector

New energy for investors

by Katharina Latif
“At present, it is impossible to get full insurance coverage for relevant technologies such as offshore wind farms.” Danish infrastructure for offshore power generation

“At present, it is impossible to get full insurance coverage for relevant technologies such as offshore wind farms.” Danish infrastructure for offshore power generation

At international climate conferences, diplomats agree that the private sector must come up with a large share of the funding needed for climate protection. Indeed, the growth of renewable energy technologies offers institutional investors quite interesting opportunities. Nonetheless, the business environment must improve. By Katharina Latif

In 1997, 37 nations and the European Community signed the Kyoto Protocol, agreeing to reduce their greenhouse gas emissions to five percent below the level of 1990 by the years 2008 to 2012. What started out as an ambitious concerted campaign has increasingly become a sad affair in the past few years.

A number of signatory states will miss their targets by a long shot, and some of the consequences will be drastic. In 2011, Canada quit the Protocol to avoid impending penalties. Other countries say they will not accept any climate obligations beyond 2012. The Protocol only covered 33 % of global emissions for the year 1990. Today, it only covers about 15 %.

In view of the global economic crisis and the depressing debt levels of rich countries, diplomats in climate talks are now banking on the private sector. They have hardly engaged private-sector managers so far, but they took a step in the right direction at the Durban climate summit in December last year, when they agreed to set up the Green Climate Fund (see box on p. 286).

This Fund is meant to provide a set of tools to trigger financing and to hedge risks, facilitating climate finance for private donors and investors. One innovation will be the “private sector facility”. It will step up interaction with private-sector investors. This facility has been a topic of controversy, but it certainly is necessary.

Attractive investments

Renewable energy technology is one of the most important aspects of climate finance, and it is particularly capital intensive (see box on p. 284). In the past few years, the share of renewables in global power supply has risen rapidly. It will continue to grow in the course of climate protection. Global investments in the sector have similarly risen. In 2004, $ 54 billion was invested. By 2011, that figure had risen nearly fivefold (see chart). Bloomberg New Energy Finance (BNEF) expects investments to amount to $ 461 billion by 2030, forecasting this sector will grow by 30 % from 2015 to 2030.

Besides utility companies, municipal authorities and banks, the main financiers of renewables include institutional investors such as foundations, pension funds and insurance companies. Typically, institutional investors have long-term liabilities, so they prefer low-risk investments. In many cases, they opt for bonds issued by governments and corporations because such investments promise stable revenue over the long term. Germany’s Allianz insurance, for instance, invests roughly 90 % of its entire portfolio in bonds, six percent in stock, two percent in real estate and another two percent in other asset classes – 0.3 percent of which is renewables.

For an institutional investor like Allianz, investments in renewables technology are especially interesting because they:
– serve social and economic development, including in rural areas,
– ensure people’s access to energy, and
– mitigate detrimental impacts on the environment and health.
Moreover, the bottom line is promising. While upfront costs tend to be considerable – for instance, when a wind farm or solar plant is built – such infrastructure facilities promise solid returns in the long run, once they have become operational.

Investors are looking for such opportunities, especially in the current economic situation. Government bonds have recently become unattractive because of low interest rates. Investors also fear the possibility of inflation and are concerned about volatile stock markets. They are keen on investments that are indepen­dent of financial markets, carry higher interest rates than governmental bonds and promise stable returns. Clean energy projects make sense in this context.

Weighing the risks

Obviously, investors must assess a project’s feasibility before injecting capital. That applies to the energy sector too. The following issues matter in the context of renewables:
– Investors compare risk with expected yield, so renewables investments have to be competitive with mainstream investments.
– Any governmental support for projects must be reliable for the long term since such support has a ­bearing on success. This aspect matters especially because investors cannot back off from infrastructure investments when market conditions change. Infrastructure investments relate to hardware in a specific place.
– At present, it is impossible to get full insurance coverage for relevant technologies such as offshore wind farms, for example. Insurance policies, how­ever, are an important way in which institutional investors manage risks.
– A large share of climate finance will flow to emerging markets and developing countries, where risks are especially pronounced. Relevant challenges include political instability, underdeveloped infrastructure (including lack of grid connections and roads), poor access to suitable locations and, potentially, a lack of consumer demand for the power generated. More­over, customers either have to be creditworthy or able to provide guarantees.
– Investors need a safe regulatory environment. Ambiguous rules on use and valuation of capital scare off institutional investors. Examples include existing or planned caps for portfolios, rules on required risk capital (Solvency II), reporting standards (IFR) and asset structuring.
– In emerging markets and developing countries, government leaders, administrative bureaucracies and other project partners tend to lack expertise as well as experience. Risks are compounded when a wind farm investor cannot find a service crew for the planned site or when local officialdom complicates permission procedures.

Each project goes along with specific risks of its own. Many risks relate to technology. For instance, a biomass power plant must run close to full capacity to be economically efficient. A lack of feedstock can fast undermine efficiency. Wind farms depend on proper operations and diligent maintenance, and so do solar power facilities. Location matters a lot too. Solar energy, for example, cannot be generated in places with too much shade.

Cooperation of government and private sector

Private investors can make a difference in funding climate protection internationally. After all, renewables projects offer investors interesting investment opportunities. Nonetheless, such projects technologies remain comparatively risky. To change matters, all sides must cooperate:
– The international community has to adopt binding climate protection targets and create a stable regu­latory framework for investments in climate pro­tection.
– National governments have to reduce market risks and create favourable conditions. Moreover, the Green Climate Fund could provide investors with tools that serve international hedging and transfer of risks that arise in emerging markets and developing countries. Local authorities can also create such mechanisms.
– Private investors have to obtain the expertise they need to plan and implement renewables projects.

The money needed for climate protection will only be mobilised if all of these parties cooperate. Over the next few months, the Green Climate Fund will be fleshed out. Private investors hope that this Fund will build a bridge between states and the private sector.