Neshwin Rodrigues and Duttatreya Das are energy analysts at Ember

High cost of capital is a major barrier to the rollout of renewable energy across the Global South. The Alliance of Small Island States has highlighted this repeatedly, and last year the International Energy Agency (IEA) concluded that across a range of developing and emerging economies, raising capital to build utility-scale solar projects costs twice as much as in the Global North.  

Capital costs more when investors perceive risks to be higher: the riskier the investment, the bigger return they demand. So the key to making renewable energy investment cheaper is to reduce the perceived risks.  

But to reduce them, we must first understand them. 

A league table for decision-makers

At Ember, we have developed what we believe to be the first model-based approach that quantitatively assesses the importance of various factors affecting a solar energy project’s overall risk.

As an example, in many countries the time it will take to get your solar farm connected to the grid is uncertain. This means missing out on revenue and presenting a clear risk to investors. We calculate the importance of this uncertainty relative to other risk factors. In this way we can build a ‘league table’ of factors that raise the cost of capital, giving policymakers the information they need to tackle the biggest first and bring costs down effectively.  

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We can also show investors where they are being too risk-averse for their own good, encouraging them to worry less and loosen the purse-strings a little.

In the report that we publish today, we focus on India. But, in principle, our approach could be used in any country in the Global South where enough data is available to calibrate the model.

The Indian case is especially interesting at the moment because in 2023 the government introduced tenders for Firm and Dispatchable Renewable Energy (FDRE) generating capacity which require generators to supply electricity in non-solar hours. This can be approached by adding technologies like wind generation and battery storage.  

Range of uncertainties

Among the risks that Indian utility-scale solar investments face, we show that the biggest is exposure to market price volatility for FDRE projects.

Electricity prices have become a lot more volatile since 2020, with events such as the Covid-19 pandemic contributing alongside more variable weather and changes to the electricity system and markets. This, we estimate, can reduce a facility’s overall revenue by 7-13%, sending a clear risk signal to investors. 

Second in our league table come the penalty payments that FDRE projects face if they fail to provide power when they are contracted to.

Next come delays in commissioning solar farms (due to issues such as grid connection queues), and then the perception that solar panels may perform less well than they’re claimed to. Uncertainties in the future cost of batteries, and the risk of other penalty payments, sit at the bottom end of the table. 

Cost escalation, delayed benefits

In principle, we calculate that a solar farm in India would see investors needing up to a 4% higher return on investment to offset the risks associated with FDRE and project delays.

Leaving these risks unaddressed would have major consequences. Renewables and batteries would be deployed more slowly, delaying the benefits of clean energy for citizens. It would keep energy bills higher than necessary, given that the cost of capital accounts for about half of the price of renewable energy in India (and many other developing countries).

And it would exacerbate climate change. India’s target is to build 500 GW of renewable energy capacity by 2030. We find that adding four percentage points to the cost of capital would likely mean falling short by 100 GW, entailing more use of coal.   

Taking action

The good news is that understanding these numbers makes life much easier for policymakers.

For example, Contracts for Difference (CfDs) are used in other countries, offering a long-term agreement that guarantees a price for renewable electricity, which lowers the exposure of renewable developments to market volatility, and could be used in India too.

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Commissioning delays can be addressed by, for example, increasing the number of solar parks where grid connections are pre-built, offering generators a ‘plug and play’ facility.

Concern over solar panel performance shortfalls can be addressed by enhancing product testing and by encouraging Indian manufacturers to adopt advanced designs.

During our analysis, we discovered that investors are over-estimating some risks, notably that solar farms produce less electricity than forecast. A full 75% are generating above prediction – a fact which should help make investors a little less risk-averse without any policy intervention needed. 

Concepts into costs

The approach that we developed has been around in conceptual form for at least a decade. But now we have turned concepts into cost elevations.

This approach does not address macroscopic factors affecting the cost of capital, such as a country’s credit rating. But it can contribute to a meaningful reduction in other factors, making renewables development faster and cheaper.  

We look forward to exploring the application of our methodology in other countries of the Global South, and helping their citizens realise the full benefits of the clean energy transition as soon as possible. 

The post Can a different approach to risk accelerate the energy transition in the Global South? appeared first on Climate Home News.

Can a different approach to risk accelerate the energy transition in the Global South?