Cost of Capital Observatory

Case studies

Brazil: Using tailored regulatory changes to unlock private capital during a period of economic downturn and uncertainty


Risk addressed: Financing risk

The Tropicália project, a 245-kilometre transmission line in the state of Bahia, in the northeast of Brazil, is an example of how a trustworthy and dynamic regulatory environment can attract private capital from new players, even during a crisis. Costing around 370 million reals (around USD 112 million at the time)1, the project was developed to transmit excess wind power to cover power deficits in the southern regions. The bidding process took place at the end of 2016, a time of political and economic uncertainty, which dissuaded many traditional investors. Transmission line auctions around the time did not succeed in attracting the typical investors in the sector (e.g., large local and international energy or construction companies) because of an economic downturn, exchange rate depreciation, high inflation and high interest rates. At the same time, debt and equity markets were retreating, leading companies to pull back on investments.

To address this situation, the Brazilian energy regulator increased the maximum tariffs in auctions to attract new players. This resulted in financial investors, such as the Brazilian BTG Pactual, stepping in, along with other new strategic investors. Given higher perceived risks under the prevailing macroeconomic environment, the fund managed by BTG Pactual opted to finance construction with full equity, and third-party financing would be raised only post-completion. Ultimately, the project managed to raise long-term finance from a national development bank and from local capital markets and banks prior to completion. Apart from the tariff level, financing was secured by pre-defined inflation-indexed revenues, an objective cost of capital formula and the possibility for a payment extension in the event of delays due to licensing and land acquisition.

This case study was included in special report Financing clean energy transitions in emerging and developing economies.

Mozambique: Obtaining low-cost, long-term debt with support from development finance institutions

Risk addressed: Country risk

Mozambique aimed to develop its first utility-scale renewables project in the mid-2010s but the country’s macroeconomic environment was perceived as too risky for most private international investors. This case study describes how blending finance from various stakeholders – a development finance institution, a foreign renewable power project developer and a state-owned utility company – helped reduce risk perceptions for investors and lower financing costs, enabling Mozambique’s first large-scale solar power project. 

Central Solar de Mocuba (CESOM), a 40 MW solar PV plant, is Mozambique’s first utility-scale renewable energy project (excluding hydro). CESOM – an independent power producer (IPP) – is held by Scatec Solar, a Norwegian renewable power project developer (52.5%), Electricidade de Moçambique (EDM), the state-owned utility company in Mozambique (25%) and Norfund, the Norwegian development bank, through KLP Norfund Investments AS (22.5%). The investment is also supported by a 25-year Purchasing Power Agreement with EDM. CESOM aims to provide clean energy to over 170 000 households in Mozambique’s northern electricity grid system.

The project started around 2014, when a pre-feasibility study was undertaken to estimate the solar potential near Mocuba, in the northeast of Mozambique. Norad, the Norwegian Agency for Development Cooperation, funded the feasibility study with a grant. Once the project viability was established, Scatec Solar and Norfund committed USD 2.5 million in 2015 and the project was approved by Norfund’s Board in 2016. Norfund’s funding during the development stage was through a loan that is converted into equity if the project develops (an instrument that DFIs can offer in countries where early-stage financing risk is high and commercial finance is not available or too expensive).

The project also secured a syndicated loan of USD 55 million in 2017, from the International Finance Corporation (the “private arm” of the World Bank Group), the Climate Investment Funds and other debt financiers. Mozambique’s debt crisis created delays, but the financing for the project finally closed in 2018.

Norfund and other DFIs enhanced the bankability of the project by providing guarantees to cover excess construction costs and potential payment defaults by the off-taker (EDM). The project also includes a performance guarantee on behalf of CESOM that the project would produce a certain amount and quality of power.

The project created over 1 000 jobs during construction and will avoid approximately 79 000 tonnes of CO2 emissions a year once operating. 

India: Designing payment security mechanisms and foreign exchange facilities for renewable power projects

Risk addressed: Off-taker and currency risk

Investment in renewable energy projects in India – especially utility-scale solar PV and wind – has been impressive over the last years, driven by a combination of improved policies, better financing terms, technology developments and regulatory changes (e.g., innovation in tender design). Yet, off-taker risk (payment delays from power purchase agreements, also called counterparty risk) and currency risk are still critical concerns for both equity investors and debt financiers investing in renewables in India. This case study highlights how payment security mechanisms and foreign exchange hedging facilities were effective in addressing these risks in India. 

Off-taker risk can be addressed by using a Payment Security Mechanism (PSM). Two methods are suggested for appropriately sizing PSMs for solar projects:

  • Setting aside an amount to cover the expected loss from lack of payments from the off-taker. Findings concluded the size of the PSM to be less than 10% of the capital costs.
  • Direct credit enhancement to raise the underlying debt rating to the highest level possible. Findings suggest the size of the PSM to be 10–20% of capital costs of the solar power deployed.

Currency exchange rate risk can be mitigated by using Foreign Exchange Hedging Facilities (FXHF). Two different ways are proposed to size FXHFs:

  • Creating a contingency buffer to directly absorb tail foreign exchange risks (FX),
  • Absorbing certain tranches of FX risk through market available FX swaps.

Leverage – i.e., the amount of private capital deployed per unit of public capital committed – was found to vary between three and nine, with the lower number corresponding to the first scheme and the higher number corresponding to the second scheme.

These solutions are likely to be useful for other developing countries, given that they may face similar risks. The implications of these solutions are manifold. First, the results provide concrete recommendations for the size of funded facilities that could address key risks to renewable energy projects. Second, they suggest that policymakers utilise public money to fund these facilities, while appropriately structuring them in consultation with stakeholders, such as ministries and financial institutions.

Mexico: Bundling projects to address credit risk in the residential solar PV sector

Risk addressed: Credit risk

Lack of access to affordable financing, and the ability to pay high upfront costs, is a major impediment to improving energy end-use and efficiency across the developing world. This case study highlights how bundling projects helped address credit risk in the residential solar PV sector in Mexico, enabling households to access to low-emissions solar PV solutions. The project was one of the first debt financings of a portfolio of distributed residential solar assets in Latin America. 

Investment in residential solar PV solutions in Mexico was limited in 2015 as the enabling regulation was only a few years old and the developer ecosystem was small and fragmented. It was hard for households to cover the upfront investment costs, or to access financings, as they sometimes had low or inexistent credit histories.

To address this barrier, IDB Invest (the “private arm” of the Inter-American Development Bank) provided a 13-year local currency credit facility of approximately USD 15 million, including a MXN 228.4 million (Mexican pesos) IDB loan (approximately USD 12 million at the time)2 and an MXN 114.2 million (approximately USD 6 million) equivalent USD loan from the Canadian Climate Fund for the Private Sector in the Americas (C2F). The funds were intended to finance both the existing portfolio and origination of new residential subprojects, supported by a partial liquidity and credit guarantee from the Clean Technology Fund (CTF).

The CTF guarantee and the concessional pricing of the C2F loan provided the credit enhancement necessary to close the financing at a volume and terms not available in the commercial market at the time, with the expectation that the portfolio would develop into a performance benchmark eventually leading to issuances of aggregated residential solar portfolios in the local capital markets. The final portfolio is expected to comprise of approximately 9 MW of generation
capacity, inject 178 GWh of clean energy into the grid, abate approximately 5 700 tCO2/year, and to shave 20% to 27% off the energy bills of residential customers.

Furthermore, the C2F loan includes a gender performance-based incentive mechanism to encourage the participation of women in non-traditional roles. It also included incentives for recruitment objectives for female undergraduates in technical roles with the project sponsor company, which led to a significant increase in the employment, retention, and promotion of women in a fast-growing firm.

At closing, the project was one of the first debt financings of a portfolio of distributed residential solar assets in Latin America, and the first for IDB Invest, helping to support a new asset class.    


Zambia: Developing bankable project pipelines to address multiple risks and unlock financing for a new clean energy sector

Risk addressed: Off-taker risk, transmission risk, currency risk and lack of project pipeline

Investors generally highlight off-taker and currency risk when financing renewable power projects in emerging and developing economies. Another prominent barrier to increased investment in these markets is a pipeline of large, predictable and bankable projects, which are a critical signal to attract investors, especially large and international ones who generally enter markets only if there is enough expected growth to cover for the transaction costs.

A coordinated, generally centralised, project preparation and project development facility has proven successful to accelerate deployment of renewable projects in developing countries. This case study describes how Scaling Solar – “a one-stop shop program[me] [that] aims to make privately funded grid-connected solar projects operational within two years and at competitive tariffs”3 – addressed off-taker risk and helped the Zambian government successfully negotiate requests for solar power.

The Government of Zambia in 2015 announced a plan to install 600 MW of solar PV in an effort to diversify and increase its power supply capacity. That same year it decided to start by tendering up to 100 MW of capacity using the World Bank Group’s “Scaling Solar” programme. Scaling Solar applied a package of payment and loan guarantees, public debt financing and pre-negotiated template documents (e.g., for a Power Purchase Agreement [PPA] and Government Support Agreement) to encourage equity participation and competitively priced offers for power provision.4

Zambia’s first tender in 2016 under the Scaling Solar programme was a success, attracting two bids for a combined 75 MW, including at the lowest tariff for solar power in sub-Sahara Africa at the time (the West Lunga project at USD 0.0615/kWh). The power is being provided at a fixed rate for the duration of the 25-year PPAs. The timeline was also fast: the competitive tender was carried out in nine months and financing was finalised within 18 months.


Brazil: Innovative debt financing to reduce technology risk

Risk addressed: Technology risk

Under the right conditions, bifacial solar technology can be a step change in solar plant yields and efficiency, including land-use efficiency. This project was only the second in Brazil to employ bifacial technology, and one of the first in Latin America, and this small track record deterred private investors. To address this barrier, IDB Invest (the “private arm” of the Inter-American Development Bank), along with other development finance institutions, structured a transaction that included features to directly mitigate the project’s financial risk of incorporating this new technology, reducing risk perceptions and mobilising private capital to the project. 

To finance the design, construction, commissioning and operation of four bifacial PV plants with a combined capacity of 157 MW, IDB Invest arranged financing of up to USD 69 million in senior loans composed of USD 54 million of IDB Invest’s own funds and a USD 15 million blended finance tranche, with USD 7.5 million each from the Canadian Climate Fund for the Private Sector in the Americas and the Clean Investment Fund.

IDB Invest structured the blended finance tranche to defer principal payments in the case of significant underperformance, provided a solution that allowed the revenue from the expected yield gain to be credited in the financing of the project, thereby improving the overall project economics. The blended finance tranche also included incentives for gender and diversity outcomes in construction.

The IDB Invest repeated the structure in the next bifacial solar PV project it financed, but after that it became sufficiently comfortable so as to no longer require credit enhancement.

References

  1. Exchange rate: 1 Brazilian Real (BRL) = USD 0.302 (as of 29 June 2016).

  2. Exchange rate: 1 Mexican Peso (MXN) = USD 0.0519 (as of 9 December 2019, date when project was approved).

  3. https://www.scalingsolar.org/

  4. More information on the forms of World Bank support, as well as the overall project finance structure can be found here BriefsGuaranteesZambiaScalingSolar.pdf (worldbank.org)