In African countries, there’s a gap between the financing available for renewable energy and the projects its meant to reach. Funds are not reaching the right places and even as more funding is announced for clean energy, many projects don’t get off the ground because the financial tools available don’t fit their needs.
For example, credit rating rules designed decades ago place a limit on the amount of money a solar project can borrow. Another example is when loans have to be paid back within five years instead of over the 30 year life span of the project.
So it’s not only that emerging market and developing economies need more financing (they do); it’s also that funding isn’t reaching the places and projects where it would make the most difference.
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I’m a senior economics and finance researcher and I lead work on international climate finance with a focus on emerging markets. Over the past years, I have set out to study why financial instruments for green energy projects often fall short.
My findings draw on expert panels on local financing challenges in different parts of the world convened by Columbia’s Middle on Sustainable Investment and the UN Council of Engineers for the Energy Transition. I have also interviewed people working in green energy in the public and private sector across multiple continents.
Three compounding failures can explain most of the problem.
These are:
- outdated credit rating rules that penalise projects for their country’s risks
- guarantee instruments that underperform
- loans too short-lived for infrastructure built to last decades.
Fixing this requires that ratings agencies and development finance institutions change the way they do business.
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Applying the sovereign ceiling to green energy projects
One of the biggest barriers to clean energy investment in Africa is the way projects are rated.
Under what is called the “sovereign ceiling”, credit rating agencies cap or limit the rating of any domestic project at or below the rating of the country it operates in.
A green energy company that has always paid its loans on time and has 20 year commitments from buyers to purchase the power it generates won’t have a good credit rating if the country it’s based in doesn’t.
This limits the amount of money the project can borrow. Yet today’s green energy projects are often far less risky than the countries they are based in. This is because they have contracted revenues – payment for every unit of electricity produced has already been agreed. And many are co-financed by multilateral development banks or development finance institutions. These protect the projects from risks.
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Treating a well-structured solar project the same as a speculative corporate borrower with a poor track record raises the cost of borrowing money.
Because of this, African countries have paid out an estimated US$75 billion more in interest payments than they would have if their projects had been rated accurately. African countries have also missed out on financing equivalent to 80% of the continent’s annual infrastructure investment needs. Less capital is flowing where it is needed the most.
The promise and limits of guarantees
Several innovative financing mechanisms are available
- special purpose vehicles – where different funders put money in together so that no one company carries all the risk
- blended finance structures – partly funding projects with public money or development finance so that private investors are more willing to put money in.
- guarantees, where multilateral development banks and development finance institutions promise to cover investor losses if a project fails.
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However, my research has found that the picture is more complicated.
In practice, most guarantees protect private investors against the risk of not making a return on their money. But African green energy projects are still held back by other problems. Late payment by state owned utilities is one. Having to pay back loans in US dollars or pounds is another.
Basically, guarantees are promises (usually from a government or development bank) to cover a lender’s losses if a project fails. In theory, they unlock private investment in risky markets. However, some are are too complex and this puts investors off.
When debt terms don’t match the infrastructure
The debt instruments available to Africa’s clean energy projects are also too short term for the assets they are financing. Loans in emerging markets have to be paid back much faster than in advanced economies. Global financial stresses, like the COVID-19 pandemic, have caused lenders to pull back from emerging markets, and when lending resumed, it came with much shorter terms and tighter conditions. That has decreased average loan tenors from 12 to just five years.
Financing a solar plant on a five-year loan is extremely expensive as it creates the possibility that every five years, the borrower must refinance, meaning they have to find a new lender and accept whatever interest rates exist at that moment. If rates have risen, or if lenders are reluctant, the cost of that new loan can wipe out years of projected profit, making the whole project financially unviable.
Instead, development loans should span at least 30 years to support long-term economic growth and avoid the low-growth, high-debt cycle that Africa faces.
What needs to happen next
Africa has already put in place the frameworks for the whole continent to switch to green energy. Regional power pools are already sharing electricity across borders. The African Single Electricity Market sets out a vision for a connected continental grid. The African Continental Masterplan sets out how all 54 countries could be linked by shared energy generation and transmission infrastructure.
These plans exist because there’s an excellent case for regional integration of energy: larger grids reduce storage and operating costs and they can share power on still and rainy days when wind and solar don’t generate as much energy. They also allow economies that are better off to export surplus power to resource-poor neighbours.
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The three failures described in this article are not independent problems with independent fixes. They are symptoms of a single underlying mismatch: the tools available to African clean energy projects were not designed for them. The design failures are specific. So are the fixes.
Ana M. Camelo Vega does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
Night Magnet
Since the fall of Apartheid South Africa has experienced rapid economic growth, and in recent years South Africa’s black middleclass has expanded. This group’s purchasing power is increasing, and the high and middle-income groups are expected to rise with the country’s economic growth.