Jane Smith
Head of Energy & Power, Marsh Specialty Pacific
An increase in the current levels of investment is required to support clean energy transitions in both emerging and developed markets. Estimates suggest that trillions of dollars in renewable energy investment are needed to meet energy development and net-zero climate goals. Yet there remain obstacles to deploying capital to accelerate power projects due to credit related issues or macro dynamics such as economic or political instability.
Obstacles for energy investment in emerging markets
An International Energy Agency (IEA) report on the challenge of financing clean energy projects in emerging markets finds: “Many emerging and developing economies do not yet have a clear vision or the supportive policy and regulatory environment that can drive rapid energy transitions. Project-specific factors are compounded in many cases by broader cross-cutting issues, which undermine risk-adjusted returns for investors and the availability of bankable projects.”
The report highlights several challenges, including:
- The availability of commercial arrangements that support revenues for capital-intensive investments.
- The creditworthiness of counterparties.
- The availability of enabling infrastructure.
- Subsidies that skew the playing field against sustainable investments.
- Lengthy procedures for licensing and land acquisition.
- Restrictions on foreign direct investment (FDI).
- Currency risks and weaknesses in local banking and capital markets.
- Debt loads across developing economies (debt levels are at the highest levels in decades, reducing available resources for sustainability goals).
Insurance can be instrumental in addressing many of these obstacles and facilitating investment in proposed energy projects. By providing coverage, insurance can address the challenge of revenue predictability and creditworthiness of counterparties. These factors play a key role in establishing bankability and securing investment.
Providing a solution for power purchase agreements in emerging markets
Continued geopolitical turmoil, the highest inflation in decades, looming recession, and the worsening impacts of climate change have led to higher rates of negative country economic risk. Rising debt-to-GDP ratios look set to constrain expenditure in the coming years and lending rates are hindering the funding of power projects. One consequence, evident in Africa, is that many governments are reaching capacity in providing guarantees for power purchase agreements (PPAs) – which are the contracts that specify the amount of energy to be generated by an asset and purchased by a state offtaker(s).
To address the lack of government guarantees supporting PPAs, developers are turning to insurance as a solution. Political risk insurance (PRI) provided by private and/or multilateral financing institutions helps to mitigate risk for investors and potential lenders. By using insurers (rated A+ or better by S&P), revenue protection in the event of PPA termination can convince potential investors and lenders to deploy capital to support a project or potentially discount the cost of borrowing to a project.
PRI can also reduce timing challenges related to the financial closure of a project. This can take considerable time to negotiate and conclude if the developer has to seek other forms of security or payment support for the obligations of the offtaker, such as a parent company guarantee.
Early preparation is crucial
Key elements for developers to consider for any PPA cancellation coverage or offtaker credit risk are:
- Early engagement with a risk advisor to review prospective draft PPA agreements. This will highlight any potential deficiencies or impediment to coverage that may be negotiated by the insured and offtaker.
- Full oversight of all contractual parties, including any security providers to the offtaker payment obligations.
- Credit worthiness assessment (such as a review of a purchaser’s financial records).
Challenges in developed markets
In contrast to the challenges in emerging markets, the obstacles to investment in developed markets relate primarily to creditworthiness. Many project developers in developed markets may lack the required credit rating that would attract the interest of lenders.
However, if there is a contractual obligation between the developer and the offtaker through a separate PPA, the structured credit and political risk insurance markets can assess the situation and propose terms to bridge the financing gap.
PPA success requires alignment between various stakeholders
The involvement of insurance institutions, along with private finance, advisors, and multilateral organizations ensures the adherence to best practices and high standards. This support facilitates faster conversion and implementation of projects, and can enhance the project’s appeal to potential investors and encourage lender engagement.
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