Sparking a green recovery in developing countries

This article is taken from World Energy (WE) number 47 – The world to come

The coronavirus has unleashed the greatest global disruption in generations. The pandemic represents a deep and enduring human crisis, with reverberating impact on lives and livelihoods across the entire world. Coping with the crisis reminds us of the critical role that energy plays in our daily life and in our response to hardship. Reliable energy services lie at the core of preventing and fighting COVID-19 by powering healthcare facilities, supplying clean water for essential hygiene, and providing sufficient refrigeration for the maintenance of food and medicine. These services are also critical to power the digital infrastructure needed to fight the spread of the pandemic, cope with social distancing measures and ensure service continuity for the government and essential businesses. While many of us rely on access to electricity to connect virtually and continue to work, such access and options are not available in many parts of the world; nearly 790 million people live without access to electricity, mostly in Africa and South Asia. The interconnected nature of an effective health response explains our interest in a well-functioning energy sector and reliable access in even the most remote corners of the world.

In addition to its visceral impact on health and survival, the pandemic is also a historic political and economic turning point. COVID-19 severely impacts the energy landscape by causing supply and demand shocks across the sector, rattling commodity markets and threatening the viability of public utilities and private sector suppliers. Maintaining the sector’s viability will be important during the immediate crisis, but also for economic recovery, building resilience against future shocks and eventually achieving universal access. The policy decisions and investments that are taken in response to the immediate crisis will have a major impact on the trajectory of the energy economy in subsequent decades, particularly in terms of locking in lower-carbon pathways to growth.

The effects of COVID-19 on the energy economy in developing countries are dramatic. In April, the International Energy Agency (IEA) estimated that countries in full lockdown experienced an average 25 percent decline in energy demand, with electricity consumption patterns making every day look like Sunday. Activity slowed substantially in transport, trade, and commerce, and the deep reductions in energy consumption caused knock-on payment crises from customers to service providers, utilities, generators and governments. The slowdown also impacted both supply and demand in global commodity markets, and the effects are likely to persist for months to come. New investments in energy and extractive projects were delayed, suspended or cancelled, while existing operations have been confronted with new challenges to logistics, supply chains and personnel management.

Overall prices for industrial commodities like copper, zinc, and other metals are expected to fall this year, but the effects have been most dramatic for commodities related to transportation. Oil prices have plunged since January and reached a historic low in April with some benchmarks trading at negative levels. Declines reflect a sharp drop in demand and have been exacerbated by uncertainty around production levels among major oil producers. Oil demand is expected to fall by an unprecedented 9.3 million barrels per day this year from the 2019 level of 100 million barrels per day. Energy prices generally, including both natural gas and coal, are expected to average 40 percent lower in 2020 than in 2019—although a sizeable rebound is anticipated next year. These major disruptions to the extractive industry across the world are especially difficult for developing countries that lack essential fiscal revenues, forcing resource-dependent countries to assess and cope with the budgetary implications of commodity prices over the short and medium term.

Across regions at various stages of lockdown, the ongoing impact is uneven and dynamic, with consumer demand returning as restrictions are eased. In June, electricity demand (weather corrected) was still 10 percent below pre-crisis levels in most countries. While many countries reopened, successive waves of the pandemic threaten to return some jurisdictions to full lockdown. Overall, it is expected that the impact on energy demand in 2020 will be seven times greater than that of the 2008 financial crisis.

In the power sector, those demand shocks have led to liquidity crunches among both public utilities and off-grid electricity providers. Utilities are suffering from a sudden drop in sales to the most profitable industrial and commercial consumers (which can account for as much as 70 percent of revenues), as well as an affordability crisis among residential consumers facing unemployment and declining income. The result is the significant deterioration of the financial positions of power utilities across developing countries and potential bankruptcies. Utilities in developing countries are already under fiscal strain and may struggle to provide basic services or pay their own bills. If utilities are unable to fulfil purchasing contracts and default on payments, independent generators (which account for 40 percent of power in sub-Saharan Africa) are jeopardized in turn. Indeed, liquidity shortages can rapidly become a solvency issue both for public and private electricity providers, with negative fiscal impacts on the states that are forced to step in. The ultimate pressure on governments to fill the gaps comes just as public revenue is falling, particularly among oil, gas and mineral exporters that face low commodity prices.

Utilities and grid-connected generators are not the only ones in trouble. In less developed regions, off-grid and mini-grid providers are particularly important for energy access, including at critical healthcare facilities. But some mini-grid and off-grid companies will struggle to survive the triple shock being dealt by the pandemic—they are unable to subscribe new customers due to lockdown; they face defaults from existing customers; and supply chain disruptions affect importation, inventory and in-country logistics. An April SEforALL questionnaire found that solar-home-system companies expected a 27 percent decline in revenues and mini-grid companies almost 40 percent. Most of these companies had less than two months of available OPEX.

In places like Africa that are still confronting the challenge of widening energy access, maintaining the solvency of private sector off-grid electricity providers is critical. A viable off-grid sector is key to keeping the lights on and also to growing the pie of sustainable energy access. Without them, many communities will rely on diesel generators that depend on an expensive and often unreliable fuel supply.

If these issues are not properly and swiftly addressed, they can ultimately pare back sustainability gains in the domestic energy sector and reverse critical economic reforms. The effect would be to undermine a decade of progress toward open competitiveness, energy security, affordability and de-carbonization. They also threaten the sector’s future trajectory, as planned energy investments are affected both by expected demand falls and the difficulty of raising equity in the current environment.

Immediate and collective action is needed to maintain the power sector’s viability, both in the context of the current crisis and the economic recovery to follow. Governments should fast track electricity connectivity to ensure business continuity of key government functions, especially health service delivery during the pandemic. Emergency financial support to both utilities and off-grid producers will also be necessary to ensure continuity of essential services and make sure that frontline workers can continue to lift their heavy burden during the crisis. It is crucial to fund contracts with local private sector producers (particularly small mini-grid and solar-home-systems) to deliver quality and reliable electricity in areas not connected to the main grid if those companies are to be kept solvent.

In the absence of long-term planning and effective policy, unreliability or service cut-offs will often be addressed by expensive and dirty rental power providers. Particularly in land-locked developing countries with weak institutional oversight and patchy exposure to energy supply chains, a flourishing temporary power generation and power rental market burns either diesel (at small scale) or heavy fuel oil (in larger plants) to deliver exorbitant electricity to some of the poorest consumers. Sector planning is a critical element for meeting growing demand in a coherent and sustainable manner, and it becomes especially important to adhere to positive and hard-won trajectories in the face of major disruptions.

Successes achieved through several years of reform should be maintained, so that efforts towards a de-carbonization of the economy can be sustained and quickly accelerated. In the longer term, the impacts of the pandemic are expected to reverberate, and it will be important to support investment in the clean energy transition as we emerge from the crisis. Depending on the fiscal space available to countries, investments contributing to clean energy and universal access goals valuable, particularly when they help create jobs and alleviate poverty.

For example, supporting labor-intensive energy investment programs, such as rural electrification or energy efficiency upgrades that could simultaneously contribute to fiscal stimulus and advance universal access goals while boosting employment is a no brainer. Another way to stimulate investment in clean energy would be to replace aging fuel plants with renewable-plus-battery combinations, which can be packaged with concessional debt or debt guarantees.

At the same time, direct support to utility-scale renewable energy projects is unlikely to be the most effective way to spend stimulus money, particularly as cost curves make them increasingly attractive to private sector investors under the right conditions. Instead, addressing structural issues such as interconnections, storage, smart charging and demand response technologies to compete in the flexibility markets—as well as accelerating the electrification of heating, transport and industry—will be crucial to stimulating investment.

Enabling clean energy also means ensuring the supply of critical resources, yet the crises associated with COVID-19 could represent a risk to sustainable mining for the many minerals and metals used in renewable energy technologies. As economies start to reopen, governments and companies will need to strengthen their commitment to climate-smart mining principles and mitigate negative impacts, including through the increased deployment of renewables in the mining sector itself.

In both the renewable energy sector and those that support it, there is a need for enhanced international cooperation that includes stronger public and private engagement in order to drive increased financial flow to those most in need.

With public sector funding stretched, the role of the private sector becomes increasingly important. In recent years, private sector investment in developing countries has grown rapidly, thanks to new financing mechanisms as well as meaningful progress on policy and institutional reform. Fostering private participation by nurturing enabling conditions and creating attractive investment opportunities has played a major role in addressing near-term development needs such as energy access, infrastructure and public transport and has also supported the longer-term financial viability of low-carbon projects.

However, with the onset of the pandemic, the move of capital toward less risky markets has limited the availability of private sector financing in developing countries. In late April, Devex reported nearly USD 100 billion in private investment retreating from Africa. In the world of highly constrained public budgets that will persist for years after the heavy toll of COVID-19 emergency spending, it is crucially important to retain existing investors as a first step to attracting new ones. Yet retaining the private sector in higher-risk countries poses a challenge when global uncertainty feeds the temptation to revert to safer havens. Adjusting incentives and risk sharing will be key to maintaining private capital for innovation and effective management.

The World Bank is working to bridge the gap between governments and the private sector, helping to maintain payment schedules or, where necessary, to restructure deals to accommodate exceptional circumstances. The aim is to avert a downward spiral of defaults, legal disputes over credit and further inability to service debt. In some cases, that means providing necessary liquidity by extending concessions or access to new credit in order to alleviate the near-term pressure on public entities struggling to provide service to populations under crisis conditions. For example, in Guinea-Bissau the World Bank Group restructured a regional access project for USD 6 million to enable the Government to pay arrears and fuel, thus allowing the utility to cover its costs and avoid power cut-offs by the sole independent power producer.

However, support also entails fostering dialogue between the parties to promote rational flexibility, so that lending arrangements can survive the discrete shock of COVID-19 and ultimately deliver better outcomes for both borrower and creditor. Every possible action should be taken to avoid defaults and the emergence of costly legal claims due to force majeure clauses. Costly disputes between public utilities and suppliers ultimately serve little purpose beyond ruining the credit rating of the state-owned entity or even the sovereign, and finally hindering the long-term return to investors on generation assets.

While short term mismatches may be resolved through dialogue and some supplementary liquidity, the most important component to maintaining investor confidence is still a strong commitment to sector reform and a conducive enabling environment. Engaging the private sector as a financier, operator, service provider or innovator in the pursuit of Sustainable Development Goals requires efficiently functioning and competitive markets, as well as effective governments. Such markets only emerge when there is a framework that addresses market failures through policy reform, and also improves underperforming markets through demonstration effects - enhancing competition, innovation, integration and better skills through investments and advisory services.

That is why, in conjunction with concessionary financing, the World Bank also helps to provide enabling conditions such as sector reforms, regional trade, planning, regulatory transparency and demand creation through income-generating appliances. Such enabling conditions should address affordability, inclusion and poverty reduction.

The necessary market-driven reforms to de-risk the energy sector require a forward-looking vision that recognizes the increasing attractiveness to capital of resilience, sustainability, social stability and thoughtful governance. Getting the generation mix right in terms of affordability and sustainability, while ensuring energy security and reliable service delivery, is a critical factor. That mix is increasingly tilted towards renewable energy, and requires significant investments in network technologies, grid management and storage to manage variability and integrate renewable energy at scale.

Investment opportunities at the intersection of energy and development are immense. Before the COVID-19 outbreak, the World Bank estimated that the off-grid solar energy industry presented a USD 1.7 billion annual market and would have to grow at an accelerated rate of 13 percent to reach the goal of universal energy access by 2030. This meant that up to USD 7.7 billion in private investment and up to USD 3.4 billion in public funding would be required to bridge the affordability gap.

Although falling renewable energy technology costs have significantly lowered the capital needed to invest in new systems, and even if renewable energy represents the cheapest option for 2/3 of the global population, financing renewable energy projects is still difficult in many parts of the world. Underlying market barriers and a perception of high risk constrain the development and financing of renewable energy projects. Identifying attractive projects and gaining access to capital often presents a major hurdle to realizing renewable energy investments. Project risk can take multiple forms. These include political and regulatory risk; counterparty, grid and transmission link risk; currency, liquidity and refinancing risk; as well as resource risk.

Policy makers, financial institutions and investors can draw from a strong toolkit to help overcome such barriers, mitigate investment risk, and improve access to capital for renewables projects. Development finance institutions (DFIs) such as the World Bank can help countries implement enabling policies for stable and predictable investment environments and ensure predictable project revenue streams. Technical assistance and grant funding can be critical early on in the project lifecycle when preparing the ground for investment. We can also foster project development and strengthen documentation with the Energy Sector Management Assistance Program (ESMAP). Targeted non-financial interventions can play a facilitating role and help take projects forward to full investment maturity.

While non-financial interventions can create a better enabling conditions for private investment, commercial banks and development finance institutions can also provide critical support with the long-term financing necessary for infrastructure (due to particularly enduring liabilities), as well as effective risk mitigation instruments. These include guarantees, currency hedging instruments and liquidity reserve facilities. Debt-based instruments, such as on-lending and co-lending structures, can help local finance institutions overcome key barriers, including limited access to capital and weak experience in lending to renewable energy projects.

Credit enhancement instruments can play an important role in de-risking projects and making them replicable. Credit enhancements aim to mitigate the specific risks of a project that either weigh on its overall credit profile or decrease its appeal to the private sector. They can take various forms. Cash flow stabilization can prevent or delay potential distress and default; recovery enhancement can reduce losses in the event of default. Combined instruments provide both. Credit substitution is a guarantee that serves to fully transfer the risk of timely debt repayments from the project finance issuer to a guarantee provider. Partial guarantees for recovery can be an attractive feature for investors as they give enhanced visibility on recovery, while the experience and influence of a multilateral lending institution can be another significant draw. This is sometimes referred to as “the halo effect.” 

The World Bank’s Mobilizing Finance for Development (MFD) strategy aims to deliver infrastructure projects by reducing the reliance on public funds (i.e., taxpayers’ money) and mobilizing greater amounts of commercial financing. One key metric of success is the MFD multiplier, defined as the ratio of commercial finance to public funds in the context of infrastructure finance. 

To significantly scale up investment capital, renewable energy projects must become more accessible to mainstream investors. Structured finance can help increase investment volumes by reducing due diligence costs. Standardization of project documents and aggregation are important mechanisms allowing smaller projects to be pooled together. These mechanisms can also help securitize renewable energy assets for the purpose of trading in capital markets.

To build resilient, equitable and sustainable economies in a post COVID-19 world, sustainable energy must be placed at the heart of economic stimulus and recovery measures. Mobilizing capital, optimizing technologies and adopting the enabling conditions for private sector investment will be crucial to the recovery phase, particularly in countries with limited fiscal headroom and existing energy access shortfalls. DFIs such as the World Bank can support with technical assistance as well as credit instruments that are important to de-risking particular projects.

However, the real de-risking must be a functional energy sector that is underpinned by efficient markets, dependable institutions and ongoing reform. Protecting progress to date, and establishing the right path forward, can ensure greener growth and a healthy recovery as the world emerges from this pivotal moment.

He joined the World Bank Group as Senior Director, Head of the Energy and Extractives Global Practice in November 2016. On 1st July 2020 Puliti has been appointed Regional Director and assumed responsibility for all operations in energy and infrastructures in Africa.