A program to help low-income countries adopt solar drove costs down but didn’t gain wide traction. The problem was baked into its design, an analyst says.
(Bloomberg) —
The late 2010s was an era of ever-cheaper solar power, thanks to falling equipment costs and near-zero interest rates. Every year, there were new record-low purchase prices for electricity from large solar projects. Many global records were set in the Middle East, but 2016 saw an important regional one in Zambia.
That record low was the result of the International Finance Corporation’s Scaling Solar program, designed to help the world’s least wealthy countries develop and build solar power without drawing on subsidies. Scaling Solar’s primary purpose was to lower the cost of capital for solar project builders in the world’s least developed countries and markets. While the costs of hardware might be relatively fungible across borders when adjusted for shipping, financial costs are not. The program has deployed a handful of mechanisms to lower these, such as advising governments on project due diligence; offering technical assistance for governments new to running competitive auctions; and providing both financing for winning bidders and guarantees to mitigate the credit risks of rickety state-owned power buyers.
In Zambia, this approach led to two projects but no more, even with low costs. And Zambia’s success did not lead to much wider deployment; only Senegal and Uzbekistan built additional assets under the program in its first eight years. Scaling Solar did not scale, so to speak.
A new paper by Teal Emery, a former emerging markets investment research analyst for Morgan Stanley Investment Management with experience in Africa and the Middle East, unpacks why and points to ways to achieve the scale that the initiative promised.
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Emery concludes that the program did not scale for key reasons. The IFC downplayed the essential role that subsidies played in enabling the very low solar prices achieved in Zambia. The resulting low prices in Zambia sent the wrong price signals to other African governments, which would be unable to match the economics of Scaling Solar’s Zambia projects without those subsidies. And a lack of transparency in the financing terms used in Zambia prevented other solar developers elsewhere from knowing how Scaling Solar’s Zambia projects were financed.
(In response to questions, the IFC refuted that it sent incorrect price signals and said term sheets were available to bidders, their advisors and lenders, the Zambian authorities and other project participants, calling that “standard practice.”)
In Zambia, Scaling Solar enabled bidders to renegotiate tax provisions after winning bids, and it provided hundreds of thousands of dollars of project preparation that did not factor into developers’ financial calculations. Developers in other markets will not generally expect that provisions can be negotiated after the fact in their favor. Finally, Scaling Solar’s lending bestowed a “halo effect,” because the IFC and other similar institutions have enjoyed preferred creditor status in financial restructurings, and defaulting on them carries high financial (and diplomatic) cost. Private sector lenders do not have that same preferred status, meaning that they are at greater risk of being defaulted on by government-owned or government-sponsored entities.
Considering all of these benefits together, Emery finds that no private-sector bidder could come close to the same pricing that the IFC’s participation enabled in Zambia.
In a statement, the IFC called Emery’s report “riddled with inaccuracies, flawed assumptions, and misleading facts” and said Scaling Solar is “replicable, transparent, and now proven.” The organization pointed to more than 400 megawatts of ongoing solar projects in five other countries.The best way to lower costs of capital and accelerate the energy transition in developing economies is a major issue among climate diplomats and will draw intense scrutiny later this year at the COP28 summit in Dubai. That’s why Bloomberg Green asked Emery to talk about his research over email. The exchange has been edited for length and clarity.
It’s striking that the IFC considers its financing terms to be “commercially sensitive.”
I come from the private sector, so I’m sympathetic to the argument that if the IFC wants to do deals in the real world, some level of commercial secrecy in line with industry norms is necessary. But I think there is an opportunity for the IFC to use its role to dramatically enhance transparency in power contracts. The Extractives Industry Transparency Initiative did this with mining and petroleum contracts. It created a disclosure standard that dramatically increased public transparency about extractives contracts while still being viable to investors. We can and should do the same for Power Purchase Agreements (PPAs) and related contracts.
The IFC’s stated mission is to create a viable market for utility-scale solar. Governments, project developers and financiers need to understand the deal terms in order to make informed investment decisions. When the key deal terms are secret, the industry is left in the dark.
Across the developing world, PPAs are a massive source of contingent liability for sovereigns. The World Bank Group itself has stepped up its efforts at improving debt transparency. The IFC should work to align itself with the recommendations from their World Bank Group colleagues to enhance the transparency of these contracts.
Can the private sector do anything to mimic the halo effect?
No, it can’t. Co-investing with multilateral and bilateral creditors will always be part of the toolkit for investments like this. There’s nothing wrong with this as a tool. We just need to be transparent that the halo effect is a large implicit subsidy that lowers the cost of capital for projects in developing countries.
You suggest a few steps the IFC can take to “reinvigorate momentum.” W hich do you see as being the most immediate in impact, and which do you see as the most scalable?
One of the most important takeaways from the paper is clarifying the source of high capital costs: credit risk, not unfamiliarity.
Building utility-scale solar in low-income countries generally involves signing multi-decade offtake agreements with financially unstable state-owned utilities. Investors need to be compensated for the genuine risk that they won’t be repaid. Zambia’s $1.4 billion in PPA arrears is testament to this.
Our number-one priority needs to be breaking the mythology that because solar power component prices have come down so rapidly, it means that building solar is cheap everywhere. If people continue to believe that we can have unsubsidized 6-cent solar in Sub-Saharan Africa if we just apply best practices, we’re going to get nowhere. The cost of capital is a binding constraint to building solar power in low and lower-middle-income countries.
Nat Bullard is a senior contributor to BloombergNEF and writes the Sparklines column for Bloomberg Green. He advises early-stage climate technology companies and climate investors.
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