Renewables bring far-reaching benefits in terms of human health, energy access, environmental protection, and the response to climate change, along with the potential of creating new jobs around the world. Yet global investment in renewables has remained far below its potential, according to the Unlocking Renewable Energy Investment: The role of risk mitigation and structured finance report from the International Renewable Energy Agency (IRENA). According to IRENA, although the falling renewable energy technology costs have significantly lowered the capital needed to invest in new systems, financing renewable energy projects is challenging globally. This is due to the high cost of capital elevated by risks and underlying market barriers. Identifying attractive projects and gaining access to capital often present a key barrier to renewable energy investments. What is more, 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, which is particularly significant for geothermal energy.
Barriers to Unlocking Renewable Energy Investment
A range of barriers can obstruct the development and financing of renewable energy projects. An important factor to explain this is the front-loaded cost structure of most renewable energy projects. The limited experience and capacity of policymakers and national financial systems is also a fundamental obstacle to increasing renewable energy investment, even where this would be economically and commercially efficient. Lack of experience and capacity gaps in local financial sectors also translate into higher capital costs for renewable projects. In practice, this means that risk-adjusted capital, such as capital that accounts for the risk-return profile, is still not sufficiently available in potential growth markets for renewable energy projects. This is despite the dramatic decline in the capital cost of renewable energy projects as technology costs.
To realize the aspirations of Sustainable Development Goal no. 7, enduring market barriers and perceptions of high risk that deters private investors and finance ought to be addressed.
Investors often perceive risks as high. Such risks include political, regulatory, counterparty, currency, and liquidity risk, as well as the grid interconnection and transmission-line delay risk. The high-risk perception adds a risk premium to the cost of capital, which limits access to affordable capital. Risk mitigation instruments and structures provided by public finance institutions can mobilize capital in renewable energy investment by addressing investment risks. Nonetheless, they are underutilized if implemented at all, contributing to the high cost of capital for renewables projects.
Some barriers can also be particularly difficult for large-scale investors, especially institutional investors. They consist of insufficient investment deal size and high transaction costs, and financial regulations restraining illiquid and riskier investments. This can contribute to problems in going beyond small-scale investment. Lack of long-term policies and incentives and lack of clarity, consistency, and visibility on policy measures supporting a renewable energy industry and market can also pose major obstacles to renewables deployment.
Enduring Market Barriers
To realize the aspirations of Sustainable Development Goal no. 7, enduring market barriers and perceptions of high risk that deters private investors and finance ought to be addressed. This necessitates the implementation of a renewable energy investment ecosystem, not only to meet the growing energy demand and reduce climate concerns but also to enable sustainable development and growth with significant socioeconomic, environmental, and health benefits.
Although renewable energy technology costs have significantly lowered the upfront capital needed, financing renewable energy projects remains a challenge globally. This is due to the high cost of capital elevated by risks and underlying market barriers. Mobilizing private capital is central to rapidly scaling up investment in renewable energy. Therefore, the role of public finance in this regard is to address investment constraints faced by the private sector. Mechanisms to effectively leverage private finance include, for example, risk mitigation instruments and structured finance mechanisms.
Historically, the adoption of renewable energy has been driven by investment from the private sector. By virtue that the private sector is perceived as a key project implementer with the capacity and capability to act as a central driving force of renewable energy deployment. Consequently, institutional investors such as pension funds, insurance companies, endowments, and sovereign wealth funds could play an important role in scaling up renewable energy investment in the future as the largest potential source of private capital. Additionally, institutional investors tend to have a stronger appetite for sustainable and responsible investment due to their fiduciary duties. Given their growing interest in renewable energy, it is thus possible to attract institutional and other large-scale investors now and in the future.
Fundamentally, the scale-up of renewables will play a central role in meeting the world’s future energy supply amid a number of concerns. They include rising energy demand, the need to cut costs, air pollution reduction to save millions of lives, increasing economic growth and employment. Last but not least, the world needs to minimize the mean temperature increase to below 2o Celsius, which a scale-up of renewables combined with increased energy efficiency can help achieve. If public finance institutions focus on risk mitigation rather than crowding out private investors; if public and private financial institutions join forces to standardize contract templates and other project documents to allow for aggregation of smaller projects; if local financial institutions are engaged to leverage local networks and knowhow to build strong project pipelines; and if policymakers support these actions through dedicated financial risk-mitigation facilities, investment levels that may now sound unrealistic can be reached.
Scaling up Global Investment in Renewables
A key component of any effort to scale up global investment in renewables must be policy commitment at the national level. A range of different tools and programs developed and implemented by national or sub-national government acts as a set of enabling policies. These include regulatory tools as part of energy and finance policies. Targeted interventions that complement the regulations include public finance programs and non-financial interventions. Such policies are important, not only in their own right but also matter indirectly by affecting investment risk and in turn the cost of capital. Policy or regulatory risk is often associated with changes in legal or regulatory measures that have significant, adverse impacts on project development or implementation. These measures create a stable and predictable investment environment critical to ensure predictable project revenue streams. More direct public interventions include national or municipal targets, feed-in tariffs, competitive tendering or auction schemes, net-metering, quotas, and tax incentives.
Conclusively, to scale up renewable energy to fulfill its promise for a sustainable energy future and wider socio-economic benefits, investment has to increase significantly above current levels. Essentially, public policy and finance have an important role in creating an enabling environment for renewable energy investment using public funds in a way that releases additional investment. Policymakers and public finance institutions will have to work out how to make the best of limited public funding sources to increase the overall capital for renewables. This means public finance institutions should pay increasing attention to helping mitigate the risks and barriers affecting private finance aimed at scaling up renewable energy investment.
