NAMA Design Workshop Financial Mechanism Design

Rodrigo Violic

4th CCAP MAIN ASIA Regional Dialogue

Bali, Indonesia, January 20-22, 2015

Context

More than US$ 53 trillion in cumulative global investment in energy supply and in energy efficiency is required over the period to 2035 in order to get the world onto a 2° C emissions path (Source: IEA, World Energy Investment Outlook, 2014)

The “Investment and Financial Flows to Address Climate Change” report by UNFCCC (2007) recommended that long-term financing for mitigation and adaptation to climate change activities should be sourced 15% from the public sector (either directly or through bilateral or multilateral development banks) and 85% from the private sector

In 2012, annual overall global climate finance reached approximately US$ 359 billion, of which the private sector contributed with 62% of the total and the public sector the remaining 38%. Mitigation activities represented US$ 337 billion while adaptation only US$ 22 billion (Source: Climate Policy Initiative, CPI Report, 2013)

Private and public investors channel investments to low-carbon and climate-resilient projects via a range of economic and financial instruments, such as: Balance Sheet financing, Project-level debt (i.e. Project Finance and/or bond markets), Project-level equity, and Grants

Attract Financing Resources from the Private Sector

As a general rule, the private sector will only be willing to contribute with financing resources if there is an adequate balance between perceived risks and returns on its investment compared to other alternatives

Hence, the need to stimulate low-carbon investments and mobilize private sector resources at scale means first finding ways to increase returns and reduce risk to investors, as the key dimension of investment decisions is the trade-off between the risks of a project and the return on investment

Certain instruments may improve the risk-return ratio for investors either by increasing revenues and/or allocating risks more widely

Enabling environments are crucial for attracting private finance for scaled-up investment (e.g. policy, technology, finance, etc), as well as the technical quality of the projects

The GCF will provide an important toolbox to the private sector to help mitigate some of the risks associated with climate financing

Examples of Financial Instruments to Mitigate Key Risks/Barriers

Risk/Barriers Instrument

Perceived credit quality of borrowers or entering a new sector

Partial Credit Risk Guarantees or First Loss Guarantees

High transaction costs of smaller-scale projects

• SPEs to bundle projects for investment and implementation (eg ESCO model for EE)

• Concessional Loans (lower interest rate at extended maturities)

Lack of familiarity with technology Performance guarantees

High interest rate environments and/or lack of project revenues to cover market-terms of financing

Concessional Loans (lower interest rate at extended maturities)

Lack of capacity in local banks • Special Funds • Grants for technical assistance

Typical Project Finance Structure

Project

Company or

SPE

Financial

Institutions Sponsors

Off-Taker Regulatory

Authorities

Insurance /

Reinsurance Contractors

Completion Guarantee

Construction Contracts Premium payments for

Insurance Policies

Engineering &

Other

Service Contracts

Appointment as

Additional Beneficiaries

Dividends and other

Restricted Payments Equity

Local

Communities

Social

License

Local taxes,

other benefits

Payments

Payments Indemnity Payments

Innovative Financial Mechanisms: Bundling through SPEs (eg ESCO model for Energy Efficiency)

NIE

Project A

Project B

Project C

SPE or ESCO

Concessional loans

ESCO service

Guarantees, Concessional

Loans

End-user payment to ESCO based on savings

GCF approves the Project

Financial

Institution

Loan repayment

Guarantees, Concessional

Loans

Concessional loan A

Concessional loan B

Concessional loan C

Innovative Financial Mechanisms: End-consumer Loans for Distributed Generation Projects

NIE

Off-Grid

Project A

Off-Grid

Project B

Off-Grid

Project C

Micro Credit

Institutions

Project loans

GCF approves the Project

Loan repayment

Loan repayment

Concessional Loans, Guarantee

Concessional Loans, Guarantee

The Chilean Case

100% privately-owned Chilean bank

Rating: BBB+ (S&P, Fitch)

~ 3.0% loan market share (# 10 among 23 banks)

Total loan portfolio of ~ US$ 6.1 billion

CAGR ~ 17% for period 2003-2013

Climate Finance

The Chilean Case

The Chilean Economic Development Agency

Public-sector organization dedicated to promoting

entrepreneurship, innovation and growth

CORFO´s programs/financial instruments support and finance a

wide variety of initiatives in key industries of the Chilean economy

to improve their competitiveness on a global stage

In November 2008, CORFO launched a US$ 140 million program

(“CORFO NCRE Loan Program”) aimed at providing long-term,

low-cost USD funding to commercial banks in Chile for on-lending

to NCRE Projects

The program was financed by the German development bank,

kfW, and the Chilean Treasury and was operational until mid 2011

Climate Finance

Promote the development of clean energy projects in Chile, specifically NCRE and EE

Allow for a 20% reduction in GHG emissions below BAU by 2020, as pledged by Chile under the Copenhagen Accord

Reduce the cost of capital for low-carbon technologies through concessional loans (~ 250 bps differential with market rates for the same loan duration)

Engage local banks in climate finance by providing access to long-term, low-cost USD funding earmarked exclusively to finance NCRE and EE projects under PF structures

Reduce/remove barriers for deployment of a diversified portfolio of wind, photovoltaic, biomass and small hydro projects and allow the country to meet the goal of 10% NCRE injection in Chile´s electric grid by 2024, according to the then outstanding law (currently 20% by 2025)

CORFO NCRE & EE Loan Program

Aim and Rationale Access Modality

Project

Company or

SPE

Commercial

Banks

CORFO / kfW

approves credit risk, submits info

and requests access to Program

checks elegibility and approves loan

Submits info and loan request to

Commercial Bank

CORFO NCRE & EE Loan Program

Access Modality: Open Window

Type of Projects: NCRE, EE and transmission

lines

Loan Amount: up to US$ 15 million per project

D/E Ratio: maximum 85/15

Tenor: up to 15 years door-to-door, fully

amortizing

Grace Period: up to 36 months (principal only)

Currency: US$

Base Rate: fix in US$, informed by CORFO on

a quarterly basis (range between 2.0% and

3.75% p.a.)

Beneficiaries: companies (SPVs) with

forecasted annual sales ≤ US$ 40 million

Other features: no breakage costs in case of

early repayment

15 NCRE projects financed for up to US$ 140 million; no EE project was financed

13 small-hydro, 1 biogas, 1 transmission line

Average tenor: 11.8 years (loan portfolio)

Average Interest Rate: 4.28% p.a. (range: 3.00% to 5.00% p.a. (Base Rate + Applicable Margin)

Summary of Terms & Conditions Results

BICE´s NCRE PROJECT PORTFOLIO (2007-2014)

Central Hidroeléctrica Puclaro

5.8 MW

2008

4.7 MW

2008

5.6 MW

2009

12 MW

2009

6 MW

2009

Central Hidroeléctrica El Manzano

Central Hidroeléctrica Trueno

Central Hidroeléctrica Guayacán

Central Hidroeléctrica Mariposa

4.5 MW

2009

6 MW

2010

3.3 MW

2010

6.8 MW

2010

Central Hidroeléctrica La Paloma

Central Hidroeléctrica Dongo

Central Hidroeléctrica Mallarauco

Central Hidroeléctrica La Arena

Planta Biogás Loma Los Colorados

14 MW

2010

4.3 MW

2011

8 MW

2011

3 MW

2011

Central Hidroeléctrica Río Huasco Central Hidroeléctrica

Nalcas Central Hidroeléctrica

Callao

2.6 MW

2011

6.1 MW

2011

Central Hidroeléctrica Allipén

Central Hidroeléctrica El Canelo

0.8 MW

2012

Central Hidroeléctrica Muchi

12 MW

2012

2 MW

2012

Complejo Hidroeléctrico Bonito

Central Hidroeléctrica Las Flores

HIDROELÉCTRICA LAS FLORES S.A.

36 MW

2013

46 MW

2013

Parque Eólico San Pedro

Parque Eólico Totoral

3.2 MW

2013

Central Hidroeléctrica El Diuto

9 MW

2014

6 MW

2014

Parque Eólico Raki

Parque Eólico Huajache

3 MW

2014

Central Hidroeléctrica Mulchén

3.2 MW

2014

Centrales Hidroeléctricas Munilque 1, Munilque 2

y Bureo

PMGD BIO BIO NEGRETE S.A.

>25 Projects

~ 210 MW Installed Capacity

Small Hydro, Wind & Biogas

>US$ 500 million committed

100% Project Finance

2% 2%

3% 3%

4%

5%

6%

9%

10%

-

500

1,000

1,500

2,000

2,500

2007 2008 2009 2010 2011 2012 2013 2014 2015

Small Hydro Biomass Wind Solar

The Chilean Case – Installed Capacity of Renewables

(in MWs)

The Chilean Case – Installed Capacity of Renewables

(in MWs)

Source: SEA, CER, CDEC-SIC and CDEC-SING, Chile, October 2014

Technology In Operation Under

Construction

With Environmental

Approval / Not

Constructed

Without

Environmental

Approval / Not

Constructed

Biomass/Biogas 504 0 95 48

Wind 737 160 5,195 2,197

Small Hydro 343 129 299 199

Solar 219 566 8,571 2,591

Geothermal 0 0 120 0

Total 1,803 855 14,280 5,035

9.3% of Total Installed Capacity

The Chilean Case - Lessons Learned

• Strong interest in the Program from Project Developers but limited engagement with

Commercial Banks: only 2 out of 23 banks participated in the Program.

• Possible reasons: size of projects not attractive for larger banks; gaps in Project Finance skills and capacities within smaller banks; perceived complexity of working with public entities/MDBs; lack of confidence in developers who are newcomers to the energy sector, etc.

1

• Attracting interest from banks in financing non-hydro NCRE projects and energy efficiency projects proved to be extremely difficult.

• Possible reasons: in the case of non-hydro NCRE projects, risks associated with low-carbon technologies such as wind and solar relatively unknown; in the case of EE projects, cost-saving investments seemed less attractive to finance than cash flow generating assets; small transaction size/high transaction costs; difficulty to measure efficiency performance.

2

• First mover advantage allowed Banco BICE to be perceived as market leader in project financing to the renewable energy sector in Chile.

• Other commercial banks followed suit, reinforcing their PF teams and started to finance small-hydro projects in 2011.

• Currently, near one third of all banks operating in Chile are actively involved in the financing of NCRE projects, including wind, photovoltaic and small-hydro.

3

Applicability in Pakistan

Each country and region faces its own unique set of challenges: there is no “one size fits all” solution

However, there seems to be increasing evidence that political forces in most countries are focused on short-term

concerns rather than long-term imperatives

The situation of 60 million people in Pakistan without electricity calls for immediate action to deliver secure,

sustainable and affordable energy for its entire population

Distributed Generation (DG) appears to be a reasonable solution for rural areas of Pakistan where centralized

systems do not yet exist. SHS solutions have been implemented successfully in countries like Bangladesh (loan

amount of up to 80% of the SHS price, end-consumers pay a 15% deposit and the remaining by buy-down grants

provided by the Infrastructure Development Company Limited)

Given the size of the problem, it is likely that a balanced combination of both centralized and distributed systems,

with renewables at all levels and scale, would be the optimal solution (i.e. centralized grids will still be needed to

accommodate large scale-wind farms in the south western area of the country)

In countries like Chile, the government is strongly supporting the private sector in the construction of 740 kms of

new 550 kV transmission lines to support the penetration of large wind power and solar photovoltaics. As the

share of renewables on power grids have increased, electric utilities must respond to the challenge of balancing

large shares of variable renewables in order to maintain grid balance and stability according to local technical and

regulatory tolerances

Applicability in Pakistan (cont´d)

The risk-reward equation is at the center of any long-term investment decision in energy infrastructure projects

being made by the private sector

Hence the importance of policymakers and regulators clearly signposting the country´s future energy strategy and

set coherent, predictable, long-term and transparent policy and regulatory frameworks that are business-friendly

to the private sector

Also important for policymakers and regulators is to work with the financial and energy sectors to understand new

market models (such as DG) and how this can support national and international energy and climate goals

As well as in the case of Chile that imports 60% of its primary energy, Pakistan needs to take full advantage of its

available indigenous resources to avoid being vulnerable to supply shortages and instability/volatility of

international fossil fuel prices

Enabling Conditions

• The "rules" must be known and stable over time • Shorter duration of the policy cycle compared to the

recovery period of the investment requires public policy stability (e.g. Spain and withdrawal of feed-in-tariff)

Stability in Legal / Regulatory Framework

and Public Policy

• The title to the essential assets of the Project must be robust and ensure peaceful use by the developer

• Permissions and authorizations that have been duly given in adherence to current legislation must not be revoked without cause

Protection of Property Rights and Credibility of

institutions

• Energy projects have high capital costs and therefore require moderate interest rates over the long term

• Basel III will restrict the ability of banks to lend long-term so it is necessary to explore new models that combine different sources of funding (eg. Banks in the short term and Institutional Investors in the long term)

Access to Long Term Finance at reasonable

cost

Enabling Conditions

• Individual projects must achieve a certain scale to attract private sector financing on economic terms • Individual projects that do not meet this criterion should

be aggregated to reduce transaction costs

Reduction of transaction costs

• Countries with a well-trained workforce and adequate physical infrastructure (transmission networks, sub-transmission and distribution, roads, ports, etc.) will attract higher levels of investment

Suitable physical and operational infrastructure

• Renewable energy must be accepted as a reasonable cost solution to the energy problem competing on equal footing with conventional energy generation technologies (grid parity)

• The development of renewable energy projects must represent long-term benefits for the communities in which they are implemented (social license)

Social acceptance

The Challenge Ahead

Doing Business 2015 – World Bank

Rank Economy DTF Score

18 Malaysia 78.83

26 Thailand 75.27

41 Chile 71.24

78 Vietnam 64.42

95 Philippines 62.08

114 Indonesia 59.15

128 Pakistan 56.64

The Challenge Ahead

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Electric Power Consumption (kWh per capita)

Thank You