Seize the moment: Private finance for clean energy

Ingo Bordon, German Development Institute (DIE) and Leah Worrall Overseas Development Institute (ODI)

Through smart planning and allocation of investment, developing countries have an opportunity to ‘leapfrog’ developed countries in promoting clean energy systems, avoiding carbon-intensive lock-in and building on developed countries’ experience.

Thus far, financing models for climate-friendly technologies have focused on the role of international public funding in developing countries. Recent analysis however finds that Official Development Assistance (ODA) has not been catalytic in leveraging private investment, and may even crowd out private investors. ODA can be catalytic when applied to public sector reforms that create an enabling environment for private clean energy investment (e.g. Buntaine and Pizer, 2014, “Encouraging clean energy investment in developing countries: what role for aid?”)

The European Report on Development (ERD) 2014/15 focusing on financing and other means of implementation in the post-2015 context, presents evidence on the importance of governance and a conducive regulatory environment for clean energy investment. For example, Kenya’s achievements in scaling up clean energy technology to eight per cent of total energy use, were feasible thanks to Government efforts in creating decentralised energy bodies across the energy supply chain, and conducive policies including tax incentives and Feed-in-Tariffs (FiT). In Tanzania, stakeholders have argued that Tanesco – the centralised government energy agency responsible for generation, transmission and distribution across the energy supply chain – suffers from reduced effectiveness under conflicts of interest and bureaucratic delays. The Tanzanian Commissioner for Energy and Petroleum has outlined the Government’s development of a FiT policy, which will be an important factor in allowing clean energy technologies to compete with traditional fossil fuels. Despite this, recent energy sector corruption charges have stalled ODA from coming in to the country, which will in turn have a negative impact on energy investment, especially in the short-term until resolved. This risky investment environment has prevented Tanzania from scaling up its clean energy contribution in its energy mix.

These examples highlight the crucial importance of an appropriate institutional and regulatory framework set-up for clean energy. The ERD 2014/15 argues for the catalytic use of ODA in leveraging finance and promoting domestic reform, accompanying (non-financial) means of implementation – including well-functioning governance systems, effective policies and institutions that deliver a conducive enabling environment.

Based on risk-return valuations, private capital is directionally-selective and can completely bypass many poorer economies – a fact further exacerbated by the effects of the global economic downturn, which is still being felt through increased regulatory measures that impact on debt and equity providers. Bank lending will remain reduced until overall market conditions and bank liquidity recover. Private investors are hesitant to commit to long-term investments that require high upfront outlays – common of clean energy and infrastructure projects. Since the economies of scale for a large portion of green energy technologies have yet to be realised, financial institutions and private actors might overestimate the risk of operating in a policy-driven market. Therefore, it is particularly important for developing countries to put effective long-term policies and incentive mechanisms in place. Both national and international public finance has an important role to play, including in capacity building, to ease conditions for private investment and shift the risk-reward profile of clean energy projects that otherwise might have been shelved.

Within this context, urgent mitigation action remains essential to reduce the impacts from climate change. Why is the moment right? Firstly, the wide economic spill-overs of clean energy investments in productivity and growth bring about a social return in an effective policy environment. Moreover, under-valued market projects require the catalytic use of public funds for domestic reform. An ambitious international climate agenda in 2015 needs to push for a large-scale deployment of clean energy, and reduced international fossil fuel subsidies to level the playing field. A new financing for development framework in 2015 needs to promote long-term vision and effective, accountable institutions, as well as the use of public funds to leverage private investment, while recognising the role of complementary policies. Political and regulatory investment risk needs to be improved to facilitate market access, providing a safe environment for private actors to develop business continuity to scale up private clean energy technology investment. The time is right for catalytic use of ODA to for private investment in developing countries clean energy potential.