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NAMA Design Workshop Financial Mechanism Design
Rodrigo Violic
4th CCAP MAIN ASIA Regional Dialogue
Bali, Indonesia, January 20-22, 2015
Context
More than US$ 53 trillion in cumulative global investment in energy supply and in energy efficiency is required over the period to 2035 in order to get the world onto a 2° C emissions path (Source: IEA, World Energy Investment Outlook, 2014)
The “Investment and Financial Flows to Address Climate Change” report by UNFCCC (2007) recommended that long-term financing for mitigation and adaptation to climate change activities should be sourced 15% from the public sector (either directly or through bilateral or multilateral development banks) and 85% from the private sector
In 2012, annual overall global climate finance reached approximately US$ 359 billion, of which the private sector contributed with 62% of the total and the public sector the remaining 38%. Mitigation activities represented US$ 337 billion while adaptation only US$ 22 billion (Source: Climate Policy Initiative, CPI Report, 2013)
Private and public investors channel investments to low-carbon and climate-resilient projects via a range of economic and financial instruments, such as: Balance Sheet financing, Project-level debt (i.e. Project Finance and/or bond markets), Project-level equity, and Grants
Attract Financing Resources from the Private Sector
As a general rule, the private sector will only be willing to contribute with financing resources if there is an adequate balance between perceived risks and returns on its investment compared to other alternatives
Hence, the need to stimulate low-carbon investments and mobilize private sector resources at scale means first finding ways to increase returns and reduce risk to investors, as the key dimension of investment decisions is the trade-off between the risks of a project and the return on investment
Certain instruments may improve the risk-return ratio for investors either by increasing revenues and/or allocating risks more widely
Enabling environments are crucial for attracting private finance for scaled-up investment (e.g. policy, technology, finance, etc), as well as the technical quality of the projects
The GCF will provide an important toolbox to the private sector to help mitigate some of the risks associated with climate financing
Examples of Financial Instruments to Mitigate Key Risks/Barriers
Risk/Barriers Instrument
Perceived credit quality of borrowers or entering a new sector
Partial Credit Risk Guarantees or First Loss Guarantees
High transaction costs of smaller-scale projects
• SPEs to bundle projects for investment and implementation (eg ESCO model for EE)
• Concessional Loans (lower interest rate at extended maturities)
Lack of familiarity with technology Performance guarantees
High interest rate environments and/or lack of project revenues to cover market-terms of financing
Concessional Loans (lower interest rate at extended maturities)
Lack of capacity in local banks • Special Funds • Grants for technical assistance
Typical Project Finance Structure
Project
Company or
SPE
Financial
Institutions Sponsors
Off-Taker Regulatory
Authorities
Insurance /
Reinsurance Contractors
Completion Guarantee
Construction Contracts Premium payments for
Insurance Policies
Engineering &
Other
Service Contracts
Appointment as
Additional Beneficiaries
Dividends and other
Restricted Payments Equity
Local
Communities
Social
License
Local taxes,
other benefits
Payments
Payments Indemnity Payments
Innovative Financial Mechanisms: Bundling through SPEs (eg ESCO model for Energy Efficiency)
NIE
Project A
Project B
Project C
SPE or ESCO
Concessional loans
ESCO service
Guarantees, Concessional
Loans
End-user payment to ESCO based on savings
GCF approves the Project
Financial
Institution
Loan repayment
Guarantees, Concessional
Loans
Concessional loan A
Concessional loan B
Concessional loan C
Innovative Financial Mechanisms: End-consumer Loans for Distributed Generation Projects
NIE
Off-Grid
Project A
Off-Grid
Project B
Off-Grid
Project C
Micro Credit
Institutions
Project loans
GCF approves the Project
Loan repayment
Loan repayment
Concessional Loans, Guarantee
Concessional Loans, Guarantee
The Chilean Case
100% privately-owned Chilean bank
Rating: BBB+ (S&P, Fitch)
~ 3.0% loan market share (# 10 among 23 banks)
Total loan portfolio of ~ US$ 6.1 billion
CAGR ~ 17% for period 2003-2013
Climate Finance
The Chilean Case
The Chilean Economic Development Agency
Public-sector organization dedicated to promoting
entrepreneurship, innovation and growth
CORFO´s programs/financial instruments support and finance a
wide variety of initiatives in key industries of the Chilean economy
to improve their competitiveness on a global stage
In November 2008, CORFO launched a US$ 140 million program
(“CORFO NCRE Loan Program”) aimed at providing long-term,
low-cost USD funding to commercial banks in Chile for on-lending
to NCRE Projects
The program was financed by the German development bank,
kfW, and the Chilean Treasury and was operational until mid 2011
Climate Finance
Promote the development of clean energy projects in Chile, specifically NCRE and EE
Allow for a 20% reduction in GHG emissions below BAU by 2020, as pledged by Chile under the Copenhagen Accord
Reduce the cost of capital for low-carbon technologies through concessional loans (~ 250 bps differential with market rates for the same loan duration)
Engage local banks in climate finance by providing access to long-term, low-cost USD funding earmarked exclusively to finance NCRE and EE projects under PF structures
Reduce/remove barriers for deployment of a diversified portfolio of wind, photovoltaic, biomass and small hydro projects and allow the country to meet the goal of 10% NCRE injection in Chile´s electric grid by 2024, according to the then outstanding law (currently 20% by 2025)
CORFO NCRE & EE Loan Program
Aim and Rationale Access Modality
Project
Company or
SPE
Commercial
Banks
CORFO / kfW
approves credit risk, submits info
and requests access to Program
checks elegibility and approves loan
Submits info and loan request to
Commercial Bank
CORFO NCRE & EE Loan Program
Access Modality: Open Window
Type of Projects: NCRE, EE and transmission
lines
Loan Amount: up to US$ 15 million per project
D/E Ratio: maximum 85/15
Tenor: up to 15 years door-to-door, fully
amortizing
Grace Period: up to 36 months (principal only)
Currency: US$
Base Rate: fix in US$, informed by CORFO on
a quarterly basis (range between 2.0% and
3.75% p.a.)
Beneficiaries: companies (SPVs) with
forecasted annual sales ≤ US$ 40 million
Other features: no breakage costs in case of
early repayment
15 NCRE projects financed for up to US$ 140 million; no EE project was financed
13 small-hydro, 1 biogas, 1 transmission line
Average tenor: 11.8 years (loan portfolio)
Average Interest Rate: 4.28% p.a. (range: 3.00% to 5.00% p.a. (Base Rate + Applicable Margin)
Summary of Terms & Conditions Results
BICE´s NCRE PROJECT PORTFOLIO (2007-2014)
Central Hidroeléctrica Puclaro
5.8 MW
2008
4.7 MW
2008
5.6 MW
2009
12 MW
2009
6 MW
2009
Central Hidroeléctrica El Manzano
Central Hidroeléctrica Trueno
Central Hidroeléctrica Guayacán
Central Hidroeléctrica Mariposa
4.5 MW
2009
6 MW
2010
3.3 MW
2010
6.8 MW
2010
Central Hidroeléctrica La Paloma
Central Hidroeléctrica Dongo
Central Hidroeléctrica Mallarauco
Central Hidroeléctrica La Arena
Planta Biogás Loma Los Colorados
14 MW
2010
4.3 MW
2011
8 MW
2011
3 MW
2011
Central Hidroeléctrica Río Huasco Central Hidroeléctrica
Nalcas Central Hidroeléctrica
Callao
2.6 MW
2011
6.1 MW
2011
Central Hidroeléctrica Allipén
Central Hidroeléctrica El Canelo
0.8 MW
2012
Central Hidroeléctrica Muchi
12 MW
2012
2 MW
2012
Complejo Hidroeléctrico Bonito
Central Hidroeléctrica Las Flores
HIDROELÉCTRICA LAS FLORES S.A.
36 MW
2013
46 MW
2013
Parque Eólico San Pedro
Parque Eólico Totoral
3.2 MW
2013
Central Hidroeléctrica El Diuto
9 MW
2014
6 MW
2014
Parque Eólico Raki
Parque Eólico Huajache
3 MW
2014
Central Hidroeléctrica Mulchén
3.2 MW
2014
Centrales Hidroeléctricas Munilque 1, Munilque 2
y Bureo
PMGD BIO BIO NEGRETE S.A.
>25 Projects
~ 210 MW Installed Capacity
Small Hydro, Wind & Biogas
>US$ 500 million committed
100% Project Finance
2% 2%
3% 3%
4%
5%
6%
9%
10%
-
500
1,000
1,500
2,000
2,500
2007 2008 2009 2010 2011 2012 2013 2014 2015
Small Hydro Biomass Wind Solar
The Chilean Case – Installed Capacity of Renewables
(in MWs)
The Chilean Case – Installed Capacity of Renewables
(in MWs)
Source: SEA, CER, CDEC-SIC and CDEC-SING, Chile, October 2014
Technology In Operation Under
Construction
With Environmental
Approval / Not
Constructed
Without
Environmental
Approval / Not
Constructed
Biomass/Biogas 504 0 95 48
Wind 737 160 5,195 2,197
Small Hydro 343 129 299 199
Solar 219 566 8,571 2,591
Geothermal 0 0 120 0
Total 1,803 855 14,280 5,035
9.3% of Total Installed Capacity
The Chilean Case - Lessons Learned
• Strong interest in the Program from Project Developers but limited engagement with
Commercial Banks: only 2 out of 23 banks participated in the Program.
• Possible reasons: size of projects not attractive for larger banks; gaps in Project Finance skills and capacities within smaller banks; perceived complexity of working with public entities/MDBs; lack of confidence in developers who are newcomers to the energy sector, etc.
1
• Attracting interest from banks in financing non-hydro NCRE projects and energy efficiency projects proved to be extremely difficult.
• Possible reasons: in the case of non-hydro NCRE projects, risks associated with low-carbon technologies such as wind and solar relatively unknown; in the case of EE projects, cost-saving investments seemed less attractive to finance than cash flow generating assets; small transaction size/high transaction costs; difficulty to measure efficiency performance.
2
• First mover advantage allowed Banco BICE to be perceived as market leader in project financing to the renewable energy sector in Chile.
• Other commercial banks followed suit, reinforcing their PF teams and started to finance small-hydro projects in 2011.
• Currently, near one third of all banks operating in Chile are actively involved in the financing of NCRE projects, including wind, photovoltaic and small-hydro.
3
Applicability in Pakistan
Each country and region faces its own unique set of challenges: there is no “one size fits all” solution
However, there seems to be increasing evidence that political forces in most countries are focused on short-term
concerns rather than long-term imperatives
The situation of 60 million people in Pakistan without electricity calls for immediate action to deliver secure,
sustainable and affordable energy for its entire population
Distributed Generation (DG) appears to be a reasonable solution for rural areas of Pakistan where centralized
systems do not yet exist. SHS solutions have been implemented successfully in countries like Bangladesh (loan
amount of up to 80% of the SHS price, end-consumers pay a 15% deposit and the remaining by buy-down grants
provided by the Infrastructure Development Company Limited)
Given the size of the problem, it is likely that a balanced combination of both centralized and distributed systems,
with renewables at all levels and scale, would be the optimal solution (i.e. centralized grids will still be needed to
accommodate large scale-wind farms in the south western area of the country)
In countries like Chile, the government is strongly supporting the private sector in the construction of 740 kms of
new 550 kV transmission lines to support the penetration of large wind power and solar photovoltaics. As the
share of renewables on power grids have increased, electric utilities must respond to the challenge of balancing
large shares of variable renewables in order to maintain grid balance and stability according to local technical and
regulatory tolerances
Applicability in Pakistan (cont´d)
The risk-reward equation is at the center of any long-term investment decision in energy infrastructure projects
being made by the private sector
Hence the importance of policymakers and regulators clearly signposting the country´s future energy strategy and
set coherent, predictable, long-term and transparent policy and regulatory frameworks that are business-friendly
to the private sector
Also important for policymakers and regulators is to work with the financial and energy sectors to understand new
market models (such as DG) and how this can support national and international energy and climate goals
As well as in the case of Chile that imports 60% of its primary energy, Pakistan needs to take full advantage of its
available indigenous resources to avoid being vulnerable to supply shortages and instability/volatility of
international fossil fuel prices
Enabling Conditions
• The "rules" must be known and stable over time • Shorter duration of the policy cycle compared to the
recovery period of the investment requires public policy stability (e.g. Spain and withdrawal of feed-in-tariff)
Stability in Legal / Regulatory Framework
and Public Policy
• The title to the essential assets of the Project must be robust and ensure peaceful use by the developer
• Permissions and authorizations that have been duly given in adherence to current legislation must not be revoked without cause
Protection of Property Rights and Credibility of
institutions
• Energy projects have high capital costs and therefore require moderate interest rates over the long term
• Basel III will restrict the ability of banks to lend long-term so it is necessary to explore new models that combine different sources of funding (eg. Banks in the short term and Institutional Investors in the long term)
Access to Long Term Finance at reasonable
cost
Enabling Conditions
• Individual projects must achieve a certain scale to attract private sector financing on economic terms • Individual projects that do not meet this criterion should
be aggregated to reduce transaction costs
Reduction of transaction costs
• Countries with a well-trained workforce and adequate physical infrastructure (transmission networks, sub-transmission and distribution, roads, ports, etc.) will attract higher levels of investment
Suitable physical and operational infrastructure
• Renewable energy must be accepted as a reasonable cost solution to the energy problem competing on equal footing with conventional energy generation technologies (grid parity)
• The development of renewable energy projects must represent long-term benefits for the communities in which they are implemented (social license)
Social acceptance
The Challenge Ahead
Doing Business 2015 – World Bank
Rank Economy DTF Score
18 Malaysia 78.83
26 Thailand 75.27
41 Chile 71.24
78 Vietnam 64.42
95 Philippines 62.08
114 Indonesia 59.15
128 Pakistan 56.64
The Challenge Ahead
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Electric Power Consumption (kWh per capita)
Thank You