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Unlocking Energy Infrastructure Investment In Emerging Markets
Policy Solutions to Infrastructure Finance Constraints
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PELLEGRINO POT RAMOS SEKAR SHAN
Contents EXECUTIVE SUMMARY ....................................................................................................................................................................... 3
INTRODUCTION .................................................................................................................................................................................... 7
THE ENABLING ENVIRONMENT: CLEAR PROCESS AND RULES ....................................................................................... 9
The Decision to Tender ............................................................................................................................................................. 10
Approvals and Permitting ........................................................................................................................................................ 12
Local Content Requirements .................................................................................................................................................. 14
Evaluation Criteria and Forecasting Changes ................................................................................................................. 16
Dispute Mechanisms .................................................................................................................................................................. 20
RISK ALLOCATION ............................................................................................................................................................................ 22
PPA Structure ................................................................................................................................................................................ 23
Key Risk Mitigation Tools ......................................................................................................................................................... 25
PROJECT EXECUTION ..................................................................................................................................................................... 28
Early Stage Finance..................................................................................................................................................................... 29
Diversifying Financial Options................................................................................................................................................ 32
Availability of EPCs / Turnkey Solutions............................................................................................................................. 34
DIGITAL-INDUSTRIAL SOLUTIONS ............................................................................................................................................. 35
CONCLUSION ..................................................................................................................................................................................... 37
APPENDIX 1: Country Deep-Dive ............................................................................................................................................... 40
APPENDIX 2: Survey ......................................................................................................................................................................... 51
APPENDIX 3: Glossary ..................................................................................................................................................................... 53
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EXECUTIVE SUMMARY
Emerging market and developing countries are the fastest rising segment of the global economy. In 2015,
these countries accounted for over 70% of global growth, and in 2016 these countries’ collective annual
GDP growth is projected to have been 4.1% while their advanced economy counterparts are projected to
have grown by 1.8%.i Their economic growth has spurred a corresponding voracious appetite for energy,
and yet these countries are struggling to meet their energy infrastructure needs. GE sees this gap as a
tremendous opportunity, and is committed to working with emerging markets and their partners at
multilateral development banks (MDBs), development financial institutions (DFIs), and Export Credit
Agencies (ECAs) (collectively hereinafter referred to as “International Financial Institutions” or IFIs) to
meet the energy infrastructure challenges of the future. It is that commitment that motivates this
analysis of and recommended solutions to the policy obstacles to infrastructure finance in the developing
world. While we realize that much thought leadership has already been contributed to a robust
discussion of these policy issues, we believe our experience as one of the world’s largest infrastructure
technology companies, with a long history of working on and financing infrastructure projects in the
developing world, provides a unique perspective to further inform the discussion.
The policy issues we address in this paper were those
cited by GE’s finance, sales & marketing, and policy
personnel as the issues most frequently affecting the
financing of energy infrastructure public-private
partnerships (PPPs) – which we define in this paper as any
project in which we have a public or quasi-public entity as
a counter-party – that they are or have been working on.
These issues generally fall into three sequentially
dependent categories, as represented in the pyramid graphic
at Figure 1. The first of these three categories, depicted as the bottom layer in the pyramid and titled
“Rules”, reflects all the regulatory and process considerations a host country must address to create a
transparent and predictable framework for the private sector to propose and win the right to develop an
energy infrastructure project. The second category, depicted as the middle layer and titled “Risk”, is
Execution
Risk
Rules
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intended to capture the various categories of risk that must be allocated and accounted for prior to a
project becoming bankable, how a power purchase agreement must be structured to account for that
risk, and instruments that can be used to mitigate any residual risk. The last category, titled “Execution”
involves policies that must be addressed to unlock the financing required to fund the early stage of
projects, to diversify sources of financing and drive competition, and to encourage the participation of
experienced engineering, procurement, and construction contractors (EPCs). Each of these categories is
sequentially dependent: the rules – from regulatory approvals to evaluation criteria – are necessary
preconditions to assess a project’s risks, and having a clear assessment of the project’s risk profile is a
precondition to obtaining early stage financing and encouraging the participation of world class EPCs. We
lastly tackle a policy consideration that cuts across the categories and may have wide-ranging impacts on
infrastructure finance; and that is the potential of incorporating a digital-industrial solution to increase
visibility into the quality of projects in real time. We summarize our findings and recommendations as to
each of these categories in the subsections that follow, and provide greater detail later in the white paper.
The Enabling Environment: Clear Processes and Rules
A transparent and predictable regulatory environment and tendering process is a fundamental
consideration for any potential participant in the market. The most important of these regulatory and
process considerations, along with some of our recommendations include the following subcategories.
• Whether to Competitively Bid – while competitive bids have the advantage in many instances of driving down prices and improving quality for the host country, depending on how well the tendering process is structured, it can become a costly operation, discourage participation, and slow down implementation. Based on the sophistication and needs of the country, we recommend making an assessment as to whether to tender on a project by project basis.
• Approvals and Permitting – in many emerging markets, the rules for obtaining government approvals and permits are opaque, can shift, and require the engagement of multiple federal, local, and parastatal organizations. We recommend providing clear, bright-line rules; fixing the timeline and circumstances under which exceptions can be granted; and creating “one-stop shops” in which several approval functions are consolidated.
• Design Requirements – design criteria in tendering documentation can sometimes intentionally or inadvertently favor certain suppliers over others, and be inflexible to a point at which the ROI on a project is harmed. We recommend procuring countries to more consistently engage in a dialogue with technical experts in the private sector or through development organizations prior
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to drafting the tendering documents, and keeping flexibility in design criteria to drive down cost and encourage bids that provide designs with the best value to the country.
• Local Content Requirements – while host countries can derive development benefits by favoring bidders willing to source supply from within the country, countries must understand the trade-offs as it pertains to the higher cost of capital and the need for demand commitments, and development organizations must have a more clear-eyed understanding of what is feasible in terms of local content.
• Bid Evaluation Criteria and Project Lifecycle Cost – many countries are still procuring on a lowest
evaluated bid basis, and there are some markets where it is unclear what criteria they are using to select bid winners. We recommend that these countries procure on a Value-for-Money basis, ensure the publication and fixed nature of the rules, and where possible forecast to the private sector what changes to their current tendering systems they intend to make.
• Dispute Mechanisms – whether challenging the result of the tender or needing the resolution to
some dispute that occurs once under contract, many emerging markets have onerous venue stipulations or provide for after-the-fact relief that cannot make an aggrieved party whole. We recommend that countries make the necessary policy adjustments to conform to IFI dispute resolution standards and ensure that disputes can be triggered prior to any irreparable harm.
Risk Allocation
After addressing the transparency and predictability of the rules underpinning the approvals and bidding
processes, emerging market countries must consider how the foreseeable risks related to a project have
been allocated. The primary instrument to address these risks is the power purchase agreement (PPA),
and to the extent the PPA cannot adequately address all the risks, IFIs offer financial products that can
mitigate the residual risk. We have made detailed policy recommendations as to how both the PPA and
the IFI risk instruments can be optimized to achieve a bankable project, summarized as follows.
• Structuring the PPA – in our experience, many developing countries either accessing global markets for infrastructure solutions for the first time, or reopening to global markets make some common mistakes in structuring their PPA. We set out in this section to provide guidance with respect to the way in which many common risk categories such as design, construction, performance, and demand risk should be addressed in order to optimize project bankability.
• Risk Mitigation Instruments – IFIs provide a wide range of instruments aimed at mitigating risks that aren’t adequately addressed in the PPA. These include political risk insurance, export credit, and partial loan guarantees (collectively hereinafter referred to as “Partial Credit Guarantees” or PCGs and “Partial Risk Guarantees” or PRGs). We have found that these instruments aren’t used as frequently as either providers or recipients would prefer, and that standardizing these instruments across the various organizations that provide them, as well as engaging these organizations far earlier in the project structuring process could have a catalytic impact on PCG/PRG availability.
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Project Execution
The project execution category addresses policy issues at the government and IFI level that can obstruct
the development of a project – at any stage – despite the presence of a bankable PPA, risk mitigation
instruments, and a clear and predictable set of market rules. These obstacles can include everything from
the availability of EPC’s to construct the project, to the existence of deep capital markets that can provide
early stage development finance, facilitate local currency convertibility, and help developers otherwise
reach financial close. While the policy obstacles in this category can be many and varied, in our experience
there are three issues that typically evolve into bottlenecks in projects with which we are involved: the
gap in early stage development finance, maximizing the competitiveness of the financing options, and
encouraging the participation of experienced EPCs.
• Early Stage Finance – there is a persistent gap in the capital required to do everything from putting together the project technical concept and design to conducting the required feasibility studies and drafting and structuring the various deal documents. To close this gap, we recommend IFIs continue to shift their focus and resources from later stage finance and risk mitigation instruments and rebalance toward this early stage gap. We also recommend that IFIs improve local banks’ access to on-lending facilities, and that host countries enact aggressive pension sector reform – both measures we believe would increase local financial markets’ appetite for early stage infrastructure investments.
• Diversifying Financing Options – too often the presence of Chinese financing creates an assumption among IFIs, developers, and equipment manufacturers that the terms and rates offered by Chinese policy banks render Western financiers and products uncompetitive. In most cases, however, Chinese policy banks do not offer better terms, and instead it is Chinese manufacturers that offer better pricing. The resulting chilling effect creates reduced competition for a country’s tenders, which will ultimately result in lower quality. To combat this cycle, we recommend that countries procure on a value-for-pricing basis, IFIs collaborate more, and Western nation DFIs and ECAs offer more cohesive end-to-end support.
• Availability of EPCs / Turnkey Solutions – the ability to provide a turnkey solution is often a precondition for manufacturers such as GE to participate in the infrastructure growth of a developing country. The ability to deliver such a turnkey solution is, however, limited by the lack of skilled local EPCs and the willingness of international EPCs to participate in the market. To address this constraint countries can remove certain JV partner requirements, and enact reforms to encourage the growth of local EPCs.
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Digital-Industrial Solutions
What we hope in this white paper is our defining contribution to the ongoing conversation on developing
country policy bottlenecks to infrastructure finance is a discussion regarding the potential for IFIs and
countries to modernize how they approach the sector. Specifically, as digital-industrial software solutions
become more advanced, this technology presents a tremendous opportunity for IFIs and procurement
organizations within countries to benchmark projects, gain overall pipeline visibility at the geographic and
resource-specific level, and in so doing, the countries can rapidly address many of the issues outlined
above. GE’s unique perspective, gained from building and launching the Predix platform gives us insights
into the types of asset performance-based solutions that IFIs and countries may find beneficial. Moreover,
to the extent that these solutions already exist, Predix offers an opportunity to take them into the next
generation by basing them on an industrial internet operating system.
INTRODUCTION
Over the last fifteen years, emerging market and developing countries have made substantial economic
strides – shifting from agrarian to manufacturing economies, rapidly urbanizing, and becoming
increasingly wealthy as a result. This dramatic transformation over such a short time has stressed their
existing infrastructure, and has revealed the obstacle that a lack of basic infrastructure can present to
continued economic progress. There are, for instance, over 1 billion peopleii worldwide that lack access
to electricity – which impacts everything in an economy from food storage to access to information,
communication, and financial markets. Yet per the World Bank, there is a more than $1 trillion annual
funding gapiii in global infrastructure, which is a number that has not been shrinking and cannot be
shouldered entirely by those countries with limited balance sheets and limited access to sovereign bond
markets. It is this dynamic that is driving the need for an increase in infrastructure investment in emerging
markets – whether that be from the private sector or IFIs. Yet in the face this obvious demand for
investment, it is scarce in the developing countries that need it the most. Despite the current challenges,
however, we at GE believe that mutually beneficial policy changes can be made at the country and IFI level
to incentivize the deployment of the vast quantity of capital sitting idly on the sidelinesiv.
We will in this white paper provide our perspective on the systemic policy constraints to energy
infrastructure finance faced by emerging market countries throughout the world. While there no doubt
have been many experts that have contributed their insights and proposed solutions to the global
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conversation on these obstacles, we hope our distinctive contribution, as reflected in this paper, will bring
to bear on this discourse our extensive experience in project financing, project development, and
equipment sales in emerging markets in Latin America, Sub-Saharan Africa, the Middle East, North Africa,
and Southeast Asia. In so doing, we distill in this paper solutions that we believe will not only provide long
term benefits to emerging markets, but are implementable and will have the immediate impact of driving
near term energy infrastructure projects to completion.
We have compiled insights from business leaders from within GE and from external stakeholders that
have decades of experience within the public sector in these regions, in multi-lateral development banks,
and other development-focused non-governmental organizations. By doing so, we were able to merge
the top policy priorities of the development community, the public sector, and the private sector. In short,
we proceed in this paper to find areas of mutual interest with the sense that what benefits these
countries’ economies will benefit the private sector, and vice versa.
The scope of issues we will discuss centers exclusively on policy obstacles to the bankability of energy
infrastructure PPPs. We focus on PPPs, which we define as any legal arrangement in which the private
sector participates in a public-sector infrastructure project, because unlike our experience in more
economically advanced nations, we find that executing a project in emerging economies necessarily
entails our partnering with a public authority, a state-owned enterprise, or other quasi-public
organization. Moreover, IFIs provide a large pool of capital and PCGs/PRGs in emerging market
transactions, and they are motivated not just by their potential ROI, but by their economic development
mandate as well. We address both IFIs and the developing countries themselves insofar as they might
explore policy changes that could advance their mandates. These policy changes can generally be
grouped as they relate to three sequentially dependent phases of project delivery: the enabling
environment, risk allocation, and project execution. We describe each in further detail below, and
conclude with a discussion about modernizing the approach of IFIs and countries toward infrastructure
finance by implementing increasingly accessible digital-industrial solutions.
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THE ENABLING ENVIRONMENT: CLEAR PROCESS AND RULES
The primary consideration for infrastructure investors
and market participants like GE prior to entering a
developing country is whether the regulatory
environment and bidding and proposal process
guidelines – through a competitive tendering process or
otherwise – are clear, transparent, and predictable. The
processes and rules most important to GE and other
equipment manufacturers, financiers, and development
partners are those that create the framework of how to qualify, bid for, win, and execute projects in the
host country, and to make predictions on the economic returns and risk associated with them. This is of
vital importance for many reasons, but two of the most important of those reasons are: first, these rules
help set the parameters or outer bounds of the variety of risks that a project may encounter, and
unknowable risks are a predominant reason for non-participation by infrastructure investors in emerging
markets. Second, as a manufacturer, we often require years-long lead times for equipment delivery, and
as such we need certainty as to our potential customers’ competitiveness when bidding into the market
and the continuing validity of their project once they are awarded the right to proceed. Without this type
of certainty, the entire value chain in a market will begin to seize up, uncertain developers will not place
orders, uncertain suppliers will not begin production, and uncertain financiers will not provide capital. In
this section, we map out in sequential order the list of considerations that in our experience a country or
IFI needs to take into account in order to maximize investment participation in energy infrastructure
projects. These considerations include:
• The Decision to Tender – this is a threshold consideration for any developing country. While competitive tenders are preferred, there are trade-offs that must be considered, and occasions where a directly negotiated agreement is a best fit.
• Approvals and Permitting – obtaining licenses, permits, and approvals is at the core of infrastructure project development, and certainty around these items is key to encouraging
Execution
Risk
Rules
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market participation
• Local Content Requirements – developing countries have obvious economic reasons to seek local content concessions as part of their infrastructure deals, but there are trade-offs that the countries and their IFI partners need to weigh.
• Evaluation Criteria – from design criteria, to pricing and the decision of whether to implement an auction-based bid mechanism, countries have critical decisions to make regarding how to award project rights, and to whom to award PPAs
• Dispute Mechanisms – whether disputing the results of a bid or performance under a contract, in our experience the timing and venue choices of these mechanisms can often derail even the most beneficial of deals
It is helpful to think of each of these categories of risk as flowing from the category it immediately follows
in the order listed above. Specifically, the decision of whether to tender is a threshold consideration upon
which all other decisions turn, the rules regarding entitlement and local content will inform the bid
evaluation criteria, and those criteria form the basis of the type of disputes addressed by the governing
dispute mechanism. Each of these criteria are explored in detail below.
The Decision to Tender We define a competitive tender in this white paper as a process organized by a country or state-owned
utility to invite developers to submit expressions of interest (RFEIs), proposals (RFPs), or quotes (RFQs) in
response to the government’s need for a power production asset. A government may extend any one of
these invitations based on how well defined its criteria for the power is.
When considering whether or not to employ such a tendering process, the contracting country or state-
owned entity should be aware that tendering offers a host of benefits. The first and most often cited of
these benefits includes the likelihood of maximizing the value of the final product in terms of better price,
and higher quality service, driven through successive rounds of direct competition among a number of
suppliers and developers. Second, the tendering process offers a chance for the country or regulatory
organization to demonstrate transparency and compliance with international norms – an effort that can
encourage more participation in the market. Third, by widely publicizing the tender, countries can
maximize the number of bidders, which not only has the value-enhancing benefits noted above, but also
has the spillover benefit of giving local contractors opportunities to compete, learn, adapt, and grow.
Lastly, and perhaps one of the largest incentives for emerging markets to pursue competitive tendering,
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the World Bank Group and many other IFIs for these and many more reasons, make competitive tendering
a qualification criteria for obtaining financing. It is for these reasons that conventional wisdom suggests
that if a country has access to procurement expertise, and has a well-thought out and clearly defined
process, it should pursue competitive bids for power projects.
That being said, these benefits generally accrue only when the process is high functioning, the personnel
are experienced and committed, and as a result the transaction costs for bidders are limited. In a
developing country with high demand for energy and little to no experience executing a procurement for
a project valued in the hundreds of millions of US dollars (USD), attempting to execute a competitive bid
can sometimes have unintended consequences.v For instance, conducting a tender for the first time may
discourage the participation of larger, proven, multinational suppliers due to risk aversion – they may
believe that the opportunity presented may not be worth the transaction costs entailed in the bid and
new rules to which they will need to become acclimated. Similarly, a competitive tender may lead to
proposals that are too good to be true. Meaning, GE has witnessed on many occasions bidders that have
aggressively priced to win a contract, only to see them dramatically increase the price for any change
order the contracting entity may need to alter the design or other elements of the project. Countries
must moreover keep in mind the speed with which they need the project developed and its scale; the
quicker the schedule and smaller the scale, the less likely it is that more experienced suppliers and
developers, typically interested in very large projects, will incur the risk and cost to bid into the project. In
such circumstances, when these disadvantages outweigh the potential benefits of a competitive bidding
process, developing countries should consider unsolicited bids, sole-source tenders, and direct
negotiations.
It is worth noting that in many instances such unsolicited bids and direct negotiations may even present
an opportunity to DFIs and MDBs to achieve their development mandate. The prospect of developing
catalytic energy project in a country – of the type most reliably executed by experienced multinational
companies – often provides an incentive for host nations to make regulatory changes toward
transparency and predictability that they otherwise would not. In other words, there is perhaps a trade-
off to be explored by IFIs as to what types of economically beneficial actions could be taken by countries
in the absence of a hard-and-fast rule on competitive tenders.
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With a view to the preceding costs and benefits of a competitive tendering process, we make the following
recommendations with respect to competitive bidding:
Recommendations
• Countries should perform a cost benefit analysis on the value of conducting a competitive tender for a power production asset. Will the competition enhance pricing and reliability? Will the tender attract the best bidders? Will the value driven by the process more than offset the cost to conduct the tender?
• Countries should conduct a similar thought experiment from the perspective of its desired bidders. Is the opportunity being offered worth the transaction cost to participate in the tender? Does the size of the opportunity – to the degree it needs to – sufficiently compensate for any risk related to transparency and predictability? If only local developers participate, do they have a track record of delivering?
• IFIs, to the degree they have cemented their view on competitive tenders, should consider the development gains that may be leveraged through unsolicited bids and direct negotiations for large projects on which large multinationals can most reliably deliver. To the extent there are IFIs that allow for direct negotiations, they should work to harmonize those rules with other IFIs.
• IFIs and countries should partner to develop frameworks guiding when direct negotiations are appropriate and can be conducted transparently. Important considerations should include driving unanimity within the government for any contract awards, establishing safeguards against monopoly behavior, and publishing a “roadmap” of the negotiation process.
Approvals and Permitting Obtaining the licenses, permits, and approvals required by country, sub-national entity, or state-owned
organization prior to the construction and operation phase of a power project is at the core of the
development phase of a project – it is where developers incur the transaction costs of conducting a variety
of feasibility studies, liaising with numerous government and quasi-governmental entities, and compiling
and delivering compliance reports. The types of approvals and permits required on a project are many,
and vary from jurisdiction to jurisdiction, but at a minimum they include the following types:
• Interconnection Agreement – Determines how the project will connect to the country’s or locality’s grid system, and involves a variety of engineering studies.
• Land Leases – Determines the right to the land on which the project will sit, any easements that will allow for ingress and egress, and involves title searches and legal agreements with affected
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landowners.
• Environmental Permits – Involves getting approvals from agencies that cover everything from wildlife impacts to wetlands preservation and clean air and water.
• Construction – Formalizes the right to build to agreed-upon metes and bounds, as well as the right to road and equipment use during agreed-upon times, as the case my require.
• Taxes – Establishes the taxable basis for the project at the import, value add, and local level.
• Labor – Depending on the jurisdiction, compliance reporting as to wages and worker treatment can be required before construction and operation.
Each of these approvals and permits, of which only a select few have been listed above, can take years to
obtain and the process of qualifying can cost hundreds of thousands in USD. As such, the risk entailed in
any uncertainty regarding the rules and cost for the government to issue such certification, delays in
granting the approvals, or outright administrative obstruction can have profound impacts on project
financing. This is because development costs balloon when the development team must engage a
multitude of government agencies each with their own set of byzantine rules. Moreover, when the rules
are unclear, or where such approvals are not a qualification criteria and are instead an item that may be
audited after winning the right to develop a project, the entire validity of a project can be called into
question at any time – even during construction or operation. This combination of a dramatic increase in
upfront cost and existential project risk reduces the appetite for investors to finance the early stage of a
project, and dissuades equipment suppliers from participating.
To combat this perception of risk, developing countries must prioritize making the permitting and
approval processes as transparent and streamlined as possible. Our primary recommendations to begin
doing so include the following:
Recommendations
• Emerging markets should consider centralizing or creating “one-stop shops” for permitting and approvals. Reducing the number of entities with whom a developer needs to engage reduces project costs and risk, and increases the attractiveness of the market to financiers. As an example, see the case study that follows titled “Chile’s One-Stop Shop.” Note also that in order to make such administrative mechanisms effective, these one-stop shops should maintain some level of independence from political actors by, for instance, subjecting the leaders of the institution to
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terms that are staggered from that of the national or local executive.
• While we have noted that there are some markets in which approvals or permits may be required as qualification criteria for a bid and there are other markets where permits may only be audited after the bid – and as such may call the project’s validity into question – we suggest a third approach. Specifically, we recommend developing countries adopt “deemed approval” standards, whereby requestors are automatically granted a permit or approval after the passage of a predetermined amount of time and the submission of threshold materials.
• Leasehold rights to the land on which the prospective project will be constructed must be granted for a term equal to the standard operating life of the energy project, (e.g., a current-day wind farm’s operating life is 20 years).
Local Content Requirements
Local content requirements (LCRs) defined in this paper as a mandate to prospective market participants
to purchase a certain percentage of domestic goods or to produce locally are a widespread form of
economic development initiative or trade protectionism, and the fact that they are widespread and
present a conflict between economic development and free trade make them a particularly thorny issue.
CASE STUDY: Chile’s One-Stop Shop
The Chilean environmental law enacted in January 2010 aims to simplify the process of obtaining and regulating environmental licenses in the country by:
• Bringing together the fragmented, sector-specific regulations into a single regulatory framework
• Creating one single environmental liability system • Introducing procedures for environmental impact
This new framework introduces the Environmental Superintendence which oversees rules and conditions set forth by new legislation as well as monitoring compliance. Project developers in Chile apply for environmental licenses using the “single window system” for which approvals are requested via a single RCA (Resolucion de Calificacion Ambiental) document. The Environmental Superintendence will then obtain the necessary approvals from all the country’s environmental sector-specific agencies and consolidate into a single approval. Having a unique procedure for approving environmental licensing in Chile regardless of industry-specific requirements makes a simpler, transparent, and faster framework more conducive to infrastructure financing.
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As of 2016, at least 39 countries had passed more than 340 LCR measuresvi. The measures are evidently
appealing to countries, and there are clear economic development justifications for them. Specifically,
countries look to LCR measures as a method to spur “infant industry” development and job creation –
GE’s own experience in Brazil bears this out. When expanding into the country, our Renewable Energy
business invested a significant amount of capital to develop onshore wind factories, to purchase multi-
million-dollar blade molds, and to qualify upstream suppliers throughout the country. By doing so, we
essentially set up an in-country supply chain for our onshore wind business, and helped employ thousands
of Brazilians.
These type of economic and employment-related benefits, however, come at the expense of what is likely
trade protectionism in violation of the WTO agreement. Like any import duty, an LCR creates a dead
weight loss – an overall loss in efficiency at the supplier level, an increased input cost to developers, and
when passed on, higher power prices for consumers. Due to this dynamic, LCRs reduce competition for
domestic suppliers and tend to drive up the cost of domestic supply, making those suppliers
uncompetitive as exporters. That inflated cost of supply, moreover, increases the cost of developing a
power asset, a cost that will likely cause the developer to bid a higher PPA price – i.e., a higher price for
the government or utility – which will ultimately get passed on to the retail power customer. Given these
dynamics, an industry built on the use of LCRs will necessarily be a fragile one, due to its excessive
dependence on the domestic market. Any abrupt change to long term demand in the country could lead
to the collapse of key suppliers and corresponding cost overruns in project execution. Moreover,
excessive LCR requirements could increase the cost of doing business in a country to a point where key
international developers and suppliers may not want to participate.
An important development on LCRs has been international trade bodies’ increasingly explicit invalidations
of LCRs as a matter of law. The World Trade Organization (WTO), for instance, recently struck down India’s
solar panel LCR and invalidated a number of innovative defenses in the process. The WTO has moreover
had a history of striking down LCR as restraints on trade in violation of the General Agreement on Tariffs
and Trade. That being said, there appear to be residual exceptions to the general proscription on LCRs
such as government procurement, and permutations of LCRs that have yet to be addressed by the WTO
(see the case study that follows titled “BNDES – Tying LCRs to Financing). While the ostensible benefits of
enacting LCR measures cannot be ignored, nor can the growing legal uncertainty surrounding the
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measures and the questionable long-term economic impact on the domestic industry. To account for
these drawbacks we recommend the following:
Recommendations
• Given the costs and benefits of imposing LCR requirements, countries should ensure they appreciate the trade-offs before executing any deal. Specifically, the higher the required levels of local content, the more commitment to volume a manufacturer like GE would like to see in exchange. Is that type of volume agreement better done in a competitive tender context or in an unsolicited bid context? Similarly, as LCR pushes up project cost and reduces margin, the cost of capital will likely increase for the project. As such, countries must make an assessment as to the ideal combination of local content and financing.
• The current cognitive dissonance between the development and trade communities regarding local content must be addressed. International trade bodies have been increasingly vocal in invalidating LCRs, whereas the World Bank and other IFIs continue to promote a floor of a 15% domestic preference in their competitive bidding guidelines. This appears to be an instance in which IFIs can take a progressive step forward.
Evaluation Criteria and Forecasting Changes
Evaluation criteria lie at the heart of what we term in this paper as the “enabling environment” –
essentially the rules and procedures that are set by a country that must be followed to effectively build
and operate a power project. The evaluation criteria specifically relate to how winners are chosen when
the country or procuring organization has solicited for proposals to build a power asset in the country, so
CASE STUDY: BNDES – Tying LCRs to Financing
Most wind projects in Brazil are financed by low cost Brazilian Development Bank (BNDES) financing. In exchange, BNDES requires participation local content-certified manufacturers – a designation which can be achieved by meeting minimum local content requirements of certain components and agreeing to phase the localization of other components over a four-year timeframe. GE, for instance, chose to incrementally localize towers, blades, and hubs from years 1-3 and added nacelles and machine heads in year 4 to comply with the required localization framework.
Penalties associated with the LCR rules are severe. If a turbine fails to meet any portion of the localization requirement BNDES will suspend the implicated OEM’s certification – this de-certification can often have a disastrous impact for an OEM. For example, one instance of Alstom non-compliance resulted in its certification being suspended for 6 months, during which period the company could apply for no new financing related to the affected product. Persistent non-compliance by a supplier could in the worst-case result in a permanent exclusion from the possibility of any financing from BNDES
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it is important to note that the observations and recommendations contained in this section are not
directly applicable to instances in which the country has chosen to accept unsolicited bids for a project.
Our views and recommendations in this area revolve around four bottlenecks: transparency, life-cycle
costing, design requirements, and providing advanced notice when dramatic overhauls of the bidding
process are likely to occur.
With respect to transparency in evaluation criteria, our view is straightforward – a country’s procurement
system is either transparent or it is not. When GE loses a bid, we typically engage the procuring
organization to learn where we were uncompetitive, whether that be on price, design requirements,
delivery schedule, or some other facet of the deal. We then, in response to the customer’s preferences,
adapt our approach in preparation for the next opportunity to bid. If this feedback mechanism is
interrupted, or the reasons for awarding a project are less than clear, then we will deem the process to
be arbitrary. Arbitrary bid processes not only dissuade manufacturers like GE from participating in bids,
but signal increased compliance risk, political risk, and reduced competition to capital markets and IFIs,
which in turn chills their participation as well. In this regard, it is an open secret for instance, that Thailand
has an opaque bid evaluation process, as has been confirmed by our experience in the country. At the
opposite end of the spectrum is South Africa, who is known for its exceptionally transparent process for
procuring renewable energy projects – the Renewable Energy Independent Power Producer (IPP)
Procurement Program (REIPPPP).
Life-cycle cost analysis, we have found, continues to be an elusive concept in much of the developing
world and in emerging markets. While we applaud the World Bank’s recent efforts to update its ICB
guidelines to acknowledge the notion of Value-for-Money as an acceptable alternative to awarding
contracts based on the lowest evaluated bid, our sense is that there is considerable work to be done to
socialize and implement the concept. The reason that procuring based on Value-for-Money or life-cycle
costing is so critical to unlocking project finance is that it has a dramatic mitigating impact on the
production risk of the project – by purchasing for value, the country or procuring entity optimizes up-time
(and therefore revenue-earning energy production), and reduces operating expenses due to the higher
quality asset over a 20 or more-year lifespan. As such, the Value-for-Money procurement model shouldn’t
be seen as a justifiable alternative to procuring based on the lowest evaluated bid, it should be seen as
the only option – if a country chooses the lowest evaluated bid and has not taken into account the
unstated costs over the course of the project then it is in effect trading current savings for much larger
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eventual expenses. Such a model should concern any development organization as much as it would a
business professor.
Further with respect to life-cycle cost analysis, while the World Bank has taken an important first step –
and is as yet the only IFI to take such a step – in updating its ICB guidelines to allow for Value-for-Money
as a bid evaluation criteria, it is worth noting that the update should be the first of several steps the Bank
needs to continue to take. Along with eventually transitioning to having Value-for-Money replace lowest
bid as the evaluation criteria, the World Bank and its contemporaries should make more of a concerted
effort to socialize and implement the concept in the developing world. Such efforts would essentially
involve capacity building such as developing key performance indicators, helping to stand up procurement
certifications, and familiarizing officials with approaches such as power curve guarantees and
corresponding liquidated damages – two contractual tools that help keep GE honest with respect to the
performance to which we commit.
As with price discovery criteria, design evaluation criteria can often be a roadblock to obtaining affordable
financing. This deterrence typically happens for two reasons – first, the design criteria in the solicitation
for bids may be written in a way that appears to uniquely favor one particular equipment manufacturer
over all others. Second, the solicitation may have unnecessarily inflexible design requirements. In either
event, competition is artificially limited and as a result bid prices will not be as competitive as they
otherwise might be – the increased expense reduces ROI and in turn limits options for financing. Similarly,
inflexible design requirements generally have the effect of increasing costs, which will also have act as a
deterrent to financing.
The last bid evaluation criteria to consider for countries and investors is how countries can make the
changes to their evaluation criteria more predictable and less costly for the energy industry. While feed-
in-tariffs (FiTs) or other subsidy models continue to be of critical importance in markets attempting to
attract investment, we have found that the most important phenomenon currently taking place in energy
markets in the developing world is a shift toward auction mechanisms from FiTs. Auctions are essentially
tendering mechanisms targeted toward a specific technology (e.g., renewable energy) and set for a
specific volume, for which the procuring organization will accept bids, and choose a number of bids in
order of price per volume, until it reaches its desired volume. These mechanisms are attractive to
countries because it maximizes competition between developers and OEMs, and drives down the cost of
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energy. In fact more than 60 countries, mostly in the developing world – including Brazil, Mexico,
Argentina, Morocco, and Peru – have shifted to auctions in the renewable energy sector alonevii. That said,
auctions are not monolithic, and minor differences between one auction system and another can lead to
major differences. Argentina and Mexico, for instance, both held recent auctions yet differed in terms of
design criteria and the fixed nature of the rules. While Mexico’s auction was largely seen as successful,
Argentina’s experienced was perceived as mixed (see the following case study entitled “Mexico vs
Argentina – A Tale of Two Auctions” for greater detail).
Yet, given the dramatic impact these changes are likely to have on project development and
manufacturing, we are often left in the dark as to what direction a country may take. The lack of clarity
we have experienced with respect to the auction transitions in Thailand and Indonesia for instance has
left us unable to develop a supply chain strategy, forecast demand, and begin partnering with developers
to engage the countries with a cohesive strategy. Due to the long lead times required for development,
information as to the direction the governments are taking would be extremely valuable.
Given that evaluation criteria are at the core of an attractive enabling environment, and the strategic
complications that even small changes can make, we recommend governments and IFIs take the following
steps to maximize investor interest in infrastructure projects:
Recommendations
• Countries should clearly publicize all bid evaluation criteria (South Africa’s REIPPPP is a useful benchmark) and include as part of the tendering process a bilateral debrief session in which losing bidders may seek information as to the competitiveness of their proposal.
• While the World Bank has taken an important first step in acknowledging life-cycle costing as an
alternative method for procuring organizations to price proposals, other IFIs must follow the lead and the IFI community must all transition away from lowest evaluated bid as the standard.
• The World Bank and IFIs should engage in procurement capacity building in the developing world, to socialize Value-for-Money concepts which may include, among other things, trainings on power curve guarantees and corresponding liquidated damages.
• With respect to design evaluation criteria, countries and procurement organizations should begin with the most flexible design criteria in order to maximize competition and discover best-fit technologies. The procurement process, as it progresses through successive rounds should narrow design criteria only as preferred technology is discovered through competition.
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• When considering wholesale changes to or overhauls of the bidding process, countries should engage IFIs, manufacturers, and developers to get a sense of what has worked in the past and what has not, and to also project for market participants the direction the country may be taking. By doing so, the country can maximize competition, and give the market an opportunity to provide the most competitive bids.
Dispute Mechanisms
In our experience, even when an opportunity in an emerging market is economically beneficial, the bid
evaluation criteria is straightforward, and the entitling procedures and administrative bodies have been
formally established, if a country has not adequately addressed the venue and protocol for disputing the
results of the bid, terms of the contract, or performance under the contract, that alone can deter investor
participation in a deal. Even when all parties are acting in good faith and the project instruments have
been written with an eye toward allocating risk, the complexities entailed in procuring, building, and
operating a power production asset with a new set of counter-parties – from both the developer and
supplier’s side and from the procuring country’s side – are bound to result in disagreements over terms,
conditions, and performance.
The World Economic Forum puts it this way: “the exposure of infrastructure investors to unexpected
circumstances, legal systems, government interference, complex contractual agreements, a broad range
of involved parties and regulatory regimes makes them prone to arising disputes. Initially, aligning the
interests of all involved parties provides the best protection against such risks. However, should a dispute
still evolve, a sensible resolution mechanism and transparent disclosure thereof is neededviii.”
CASE STUDY: Mexico vs Argentina – A Tale of Two Auctions
Mexico
Salient Features • Design requirements fixed at bid • Adhered to published capacity • Entitlement rules fixed pre-bid
Salient Results
• More int’l, experienced bidders • Diverse turbine supply • More award transparency • Avg. $55/MWh (Wind)
Argentina
Salient Features • Design requirements not fixed at bid • Diverged from published capacity • Post-bid shift in entitlement rules
Salient Results
• More local, inexperienced bidders • Greater quantity of Chinese turbines • Non-transparent awards • Avg. $70/MWh (Wind)
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A well architected dispute mechanism provides investors with a tertiary layer of risk guarantee outside
of those provided by IFIs and discussed later in this paper. Meaning that the mechanism provides an
assurance of an orderly transition in operation should any disruption in project operation occur, and of a
voice for all counterparties involved – from the country, to the developer, to the IFIs providing the PRGs.
Countries and procuring entities fail to adequately account for dispute resolution at their own risk, and
the negative consequences of failing to do so will unfortunately not be seen in the types of disputes that
are triggered under their prevailing guidance, but rather in the number of potential bidders that avoid the
market (see the case study that follows titled “Egypt – When Dispute Venues go Wrong”).
In our experience, countries and IFIs have a role to play in creating high-functioning and transparent
dispute mechanisms. Our recommendations are as follows:
Recommendations
• In crafting the dispute mechanisms countries or procuring entities must have three primary objectives in mind: establish a neutral venue, ensure flexibility so the type of resolution matches the type of dispute in terms of severity (e.g., mediation vs. arbitration)), and establish an effective (i.e., independent, well resourced, transparent, and speedy) judiciary.
• When providing for a mechanism for bidders to challenge the results of a competitive tender, countries and procuring organizations must provide for the ability to trigger the mechanism prior to awarding the project, otherwise an aggrieved party may not be made whole.
• IFIs are ideally situated to drive policy reforms in countries that can incentivize their adoption of best practices in dispute mechanisms. They should redouble their capacity building efforts in this regard, as in our experience such policy modernization can prevent otherwise mutually beneficial deals from collapsing.
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RISK ALLOCATION
If the enabling environment has been adequately
addressed by a country, and the rules as to entitlement,
bid evaluation, and dispute resolution have been
sufficiently cemented, then developers, suppliers, and
financiers should have a good sense as to the landscape
of risks that they are likely to encounter during the
development, construction, and operation of the project.
When that is the case, the country or procuring
organization together with IFIs must work to allocate
risks to the to the party best able to control and mitigate it. In this sense, risk allocation is best seen as
three successive lines of defense against project risk or risk of default by any party to the project. The
first line of defense is the deal documentation. Deal documents – of which the PPA is singular in
significance – should establish the sequence of events that takes place should any risk be triggered. For
instance, the PPA should indicate whether the off-taker must continue to make payments in the event of
an interruption in production, and what penalties the producer must pay during the period of interruption.
The second line of defense is access to IFI risk mitigation instruments such as PRGs and PCGs. Those
instruments typically cover particularly thorny residual risks unable to be captured adequately within the
PPA. A quintessential residual issue is political risk – which includes the threat of expropriation, terrorism,
CASE STUDY: Egypt – When Dispute Venues go Wrong
In September 2014, the Egyptian government set a 2GW solar target for the coming years attempting to target 20% Renewable Energy mix by 2020 and announced a Feed in Tariff associated with that PPA.
The Power Agreements negotiated with the Egyptian Electricity Transmission Company (EETC) included ambiguous wording for international arbitration opening the possibility of arbitration in Geneva in case of dispute. However, when it issued the final agreement issued, the document excluded the possibility of international arbitration outside of the Cairo courts arguing that the project SPVs are Egyptian and would therefore need to be subject to Egyptian law.
There is now law prohibiting Egyptian companies from setting international venues for dispute resolution provided necessary.
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or adverse shift in the political party in power. Many IFIs provide an instrument called political risk
insurance targeted at specifically these circumstances. The third and last line of defense is dispute
resolution, which we cover above. This section is dedicated to the first two lines of defense.
PPA Structure
As it pertains to energy infrastructure projects, the PPA is the most important document that must be
drafted; and especially when it comes to competitive tender or auction markets, it is a document that
cannot adequately be negotiated and must instead be drafted correctly, the first time, by a country or its
state-owned utility. The PPA dictates the terms and conditions of the cash flow on the project, and as
such, it is the primary document on which financiers – both private and IFIs – rely to assess project
bankability. As such, the importance of this document comprehensively addressing key areas of risk to
the project and its cash flows cannot be overstated. The global energy markets are replete with examples
of PPAs deemed unbankable by financial markets – our own experience in Argentina gave us first-hand
insight into what aspects of a PPA will cause the World Bank not to provide a guarantee. We learned from
the experience in Argentina, and are now working with the government of Vietnam to ensure its PPA
avoids the same fate. This experience has taught us that in order for a project to be bankable, the PPA in
conjunction with other deal documentation, as applicable, must cover the following areas of risk, and
adequately allocate the risk in a manner generally described as follows.
Recommendation / Key Risks and Allocation
• Construction and Completion Risk – this category of risk generally captures material and latent defects, subcontractor disputes, cost overruns, and commissioning the project on time. Generally, the PPA will provide that these risks are borne by the developer, who passes construction risk through to the EPC provider.
• Performance Risk – this category of risk captures the risk that the wind farm, power plant, or solar array can achieve the output to which the developer committed, and any corresponding health and safety risks as well. The developer will generally bear this risk, usually through some guaranteed minimum output delivery, which will ultimately be passed on to the supplier through the supply agreement.
• Input/Feedstock Risk – this category relates to the risk that the supply of feedstock (e.g., gas, coal,
etc.) or inputs to a project may be interrupted. Generally, the developer will bear the supply risk, but the government/contracting authority must take the pricing fluctuation risk. This is especially true in the LNG market, where costs can fluctuate, and the PPA must be flexible enough to pass cost increases through to retail power prices. While it is true that an increase in tariff rates can
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be politically problematic, ultimately economics necessitate tough decisions such as these. Publicizing such a trade-off to the public at the time of execution (rather than at the time of increase), and phasing-in rate increases may soften the political blow.
• Demand Risk – this category encompasses both the risk that there is insufficient demand for the electricity that the power asset produces, and that the off-taker is found by financial markets to not be creditworthy. In general, the PPA must be structured in a way that the off-taker or procuring entity must pay a set amount regardless of actual downstream demand for the electricity. This dynamic – where the utility must pay regardless of its ability to convert the electricity to sales – starkly brings into question the credit of the off-taker. In many instances the off-taker in developing countries, such as TANESCO in Tanzania, is not creditworthy because it cannot, for example, pass through cost increases to customers. As a result, the organization is typically underfunded. In these instances, developers have three options to preserve the bankability of a project: first, it can arrange for a sovereign guarantee, where the country agrees to put its balance sheet behind the off-taker. Second, the developer may attempt to circumvent the off-taker by dealing directly with some of the large commercial and industrial customers of the off-taker. Third, and something we will cover in greater detail in the following section, the developer can seek IFI PCGs/PRGs to cover the risk of non-payment of the off-taker. It is important to note, however, that PCG/PRG issuers typically require a sovereign guarantee as a precondition for issuance.
• Maintenance Risk – this risk covers the obligation to maintain the project pursuant to performance standards as provided for in the PPA for the life of the project. This is a risk that is borne by the developer and passed through to a service provider through an operations and maintenance contract.
• Force Majeure Risk – this subject covers the risk that unexpected events beyond the parties’ control interrupt performance. Typically, this risk is shared by both the developer and the government / contracting authority. These provisions generally include reasonable delays during the construction phase and suspensions of payments if operations are interrupted. There are also usually provisions requiring the developer to carry insurance to minimize reliance on force majeure.
• FX and Interest Rate Risk – FX and interest rate risk is typically allocated to the developer who will mitigate it through hedging instruments, whereas the current trend (see Argentina and Mexico) is to denominate the PPA in USD.
• Political Risk – the risk of government seizure or expropriation is allocated to the government or procuring organization, and the event of such risk being triggered constitutes a government default. In many circumstances, even though the PPA may address such a risk, political risk insurance will be required to make a project bankable.
• Change in Law Risk – with respect to any change in law that would materially and adversely impact the economic position of the developer, whether that be in the realm of taxes, regulation, or any other adverse policy, the government or procuring organization must bear the total risk, and ensure that the developer remains in the same overall economic position as it would have been but for the change in law.
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• Early Termination Risk – it is conceivable that either party to the PPA may cause the termination
of the project before the expiration of the contract duration. In the circumstance that the PPA is terminated due to reasons beyond the developers control, the government or procuring authority must make the developer whole.
Key Risk Mitigation Tools
The risk mitigation tools we cover in this section are exclusively those credit enhancement mechanisms
offered by IFIs aimed at covering the risks – among which several are mentioned in the preceding section
– insufficiently covered in the PPA and other deal documents, or what we term the “residual risks.” It is
these residual risks that make energy infrastructure projects in general less attractive of an investment
opportunity than other long-term projects in emerging markets. Specifically, the nature of engaging in
energy infrastructure projects in emerging markets entails having as counter-parties sovereign or sub-
sovereign entities that carry with them political, credit, environmental, and technical risks that would not
otherwise be present in strictly private transactions. Renewable energy projects are particularly exposed
to these risks because of their reliance on policy supports.
CASE STUDY: The Argentine PPA – Roadblocks to Bankability
For Argentina’s first wind auction for 600 MW to be implemented, it needed to set up a financing entity it termed FODER, which was a trust fund co-invested by it and the World Bank. FODER was to provide a 20-year guarantee on all PPAs issued by the utility – but the World Bank, upon review of Argentina’s first pass at the PPA deemed that corrections needed to be made before it could be guaranteed. Here are some of the facets Argentina missed:
Inadequate monetary relief for production shortfall for force majeure No penalties with interest for delays in construction Lack of clarity around underproduction penalties Non-standard definition for financial close No definition for force majeure Lack of clarity around how to measure wind resources PPA mostly in USD, but indicating that the seller is paid in pesos No change of law provision
Over the course of months, Argentina worked closely with World Bank officials to address these issues. Had government officials been more familiar with PPA structures and typical risk allocation methods, much time and effort could have been saved. Socializing these PPA best practices is an area in which IFIs have made a big impact, and in our view these efforts are extremely valuable in terms of encouraging infrastructure investment
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Since parties to the deal have been historically unable to shoulder the burden of all these risks, IFIs have
stepped in by developing several credit enhancement mechanisms that serve to mitigate the risks, and
make the project more appealing to investors. Broadly defined, these mechanisms include PRGs and
PCGs. PRGs are meant to cover risks such as currency inconvertibility, political force majeure (e.g.,
terrorism or war), regulatory risk, and government payment obligations. PCGs on the other hand are
intended to cover all or some of the debt service default risk irrespective of the cause of default. When a
government or contracting authority has sought and received a PRG or PCG for its proposed asset, it is
likely a project of primary importance to the government, has been vetted on a risk-basis by a reputable
IFI, and is an investment in which the government shows a high degree of confidence. As such, PRGs/PCGs
tend to enable the government to gain the interest of more investors for financing at better terms. While
there are some additional credit enhancement mechanisms such as first-loss provisions and contingency
loans, PRGs and PCGs are the primary, and most significant instruments.
Despite the presence and widely understood availability of PRGs and PCGs, from our experience they are
not used as often as IFIs expect, and they appear to be elusive to obtain for developers and countries
alike. Among the reasons for the limited use of PRG and PCG instruments our teams and IFI staff have
pointed to include the point at which IFIs are engaged to provide such mechanisms; the multiplicity of
issuing organizations, underwriting criteria, and options that must be navigated; the sometimes-onerous
prerequisite demanded by IFIs that a country provide a sovereign guarantee; and a lack of visibility into
the institutions that issue these instruments.
It is an all-too-common occurrence that IFIs are engaged by the developer and deal team at the last
possible moment for a deal that is not progressing. There are many issues with that scenario, but the
most pertinent includes the fact that if a deal is not progressing then there is likely a structural issue or a
major risk that no party has been able to adequately able to address – in short, it’s likely a bad deal, or the
PPA is flawed in some way. When IFIs are asked to salvage a bad deal in this way, it can take months to
modify a PPA and deal documentation only to recognize that the commercial finance never materializes
and it has been a wasted effort.
Similarly, the process for identifying the applicable instrument, engaging the issuing institution, and
understanding the variety of underwriting and qualification criteria for each instrument can be a
prohibitively time-consuming process for developers. This diversity of products, moreover, while
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theoretically beneficial to the prospective recipient, tends to add an opaque quality and inaccessibility to
PCGs and PRGs – and due to that inaccessibility, developers, operators, and off-takers tend to operate
through word of mouth regarding what credit enhancement mechanisms might be available to them, and
arbitrarily fixate on one or two sources. At the same time, many of these IFIs have stringent requirements
for sovereign guarantees before they participate in any way. While the motivation for requiring the
sovereign guarantee is well placed – determining whether a country will stand behind the off-taker for
any instance of default is a good measure of whether the country can afford a project – at times in
emerging markets their value can be questionable. For instance, requiring a sovereign guarantee from a
country whose credit rating is extremely poor seems to be an example of form over function. What is
more, many developing countries will likely be under strict balance sheet liability requirements if they are,
for example, recipients of an IMF loan. A sovereign guarantee would be an additional layer of inflexibility
on their budgets, and as such they are unable in these instances to provide the guarantee.
With respect to the visibility into the institutions that issue PRGs and PCGs and the types of vehicles
available, we provide a non-comprehensive list below in the cut-away box titled “PRGs and PCGs – The
Institutional Landscape”. In this same vein, we believe a worthwhile endeavor for all IFIs would be to
provide for the industry and all potential participants a readily accessible comprehensive list of
instruments available, their basic terms, and the corresponding issuing organization. The remainder of
our recommendations are as follows:
Recommendations
• Developers, suppliers, countries and their procurement organizations must get into the practice of engaging IFIs regarding their credit enhancement mechanisms much earlier in the deal process, and preferably when the PPA is being drafted. Doing so will help better identify the residual risk that the IFI is willing and able to cover and prevent any unnecessary waste of time. By doing so, it will also improve the project’s chances of receiving a PRG or PCG and attracting the lower rates and greater availability of private capital that follow.
• IFIs must begin and sustain an effort to standardize terms and qualification criteria for PRGs and PCGs across the multiple MDBs, DFIs, and Export Credit Agencies that offer them. Doing so will increase transparency and improve accessibility to these products.
• IFIs should consider under what circumstances – including cross-border and subnational projects – they would make an exception for requiring a sovereign guarantee, and make those exceptions as consistent and transparent as possible.
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PROJECT EXECUTION It is important for us at the outset of this section to explicitly define what we mean by “project execution”
constraints to infrastructure finance. For the purposes of this paper, we are not referring to or providing
guidance as it pertains to operational issues. Rather, this section focuses on the issues that must be
tackled to make a project happen, after it is agreed that the enabling environment in a market is
PRGs and PCGs – The Institutional Landscape
The landscape of different institutions providing credit enhancement instruments is diverse and numerous. To provide just a small example of the variety of institutions that provide this type of project assistance, we have included a non-comprehensive list of institutions and their current activities below.
• African Development Bank (AfDB): provides PCGs, PRGs, project bonds, and launched the Initiative for Risk Mitigation in Africa (IRMA) program in 2012 aimed at identifying projects in need of financing throughout Africa.
• Asian Development Bank (ADB): provides a variety of credit enhancement products including PCGs and PRGs. As an example, provided a backstop guarantee facility of up to 50% of the India Infrastructure Finance Corporation Limited (IIFCL)’s underlying project risk to cover four to five projects. Also provides loan syndications.
• European Bank for Reconstruction and Development (EBRD): EBRD provides many credit enhancement mechanisms including PRGs, PCGs, and loan syndications.
• European Investment Bank (EIB): EIB offers several innovative forms of PRGs and PCGs some
of the most notable of which are the project bond credit-enhancement scheme, and contingent loans.
• Inter-American Development Bank (IDB): not only offers standard PRGs and PCGs but also offers local currency guarantees and will ameliorate specific concerns such as construction risk.
• International Finance Corporation (IFC): unique insofar as the organization lends and interacts exclusively with the private sector, but continues to offer PCGs, along with more complex instruments such as partial swap guarantees and acting as the anchor investor.
• The World Bank Group (World Bank, MIGA, IBRD): These organizations provide many different PRGs and PCGs, including political risk insurance, and in many instances the qualification
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sufficiently transparent and predictable, and that the
“knowable” risks have been identified and allocated, and
where necessary mitigated using a PRG or PCG. These
big issues include the gap in available sources of early
stage finance, the risk that any one source of financing
my crowd out others and limit competition, and the lack
of an available stable of world-class EPCs that can
execute projects with the highest of quality, on-time,
and within budget. Each of these issues have proven to
be obstacles at each stage – even the conceptualization stage – of projects, and when left unaddressed
by policy or otherwise, becomes a systemic issue whose symptoms are reflected in a lack of indigenous
developers or Independent Power Producers (IPPs), a dearth of bidders during a procurement, and an
overall lack of interest by the international investment community.
Early Stage Finance When GE’s experts were surveyed in preparation for this white paper, an obstacle that they cited as being
one of the most problematic is the lack of availability of early stage financing. We define early stage
financing in this paper to be capital made available for all activities of a project from concept to
establishing project feasibility. That includes, among other activities, assessing and developing the
resources (e.g., gas/coal/other feedstock), technical concept and design, assembling the project
management office, conducting the feasibility study, spending on advisory costs, developing project
agreements, obtaining interconnect agreements, conducting environmental studies, and providing public
disclosures as necessary. The level of capital required for these activities is typically between 1-4% of the
total project cost and ranges in the hundreds of thousands in USDix. While that may seem like an
excessively modest investment, the risk entailed in financing this portion of the project is substantial – at
this stage, there simply is no certainty that the project is feasible and will reach financial close. Moreover,
these development costs are usually underreported because it is difficult for developers to account for
the cost of management time at this stage. Due to these risks, the return required for early stage capital
is typically in the 30-40% rangex, or well in excess of venture capital returns. It is also because of these
risks that early stage capital, especially in emerging markets where these risks are magnified, is so scarce.
In our view, several policy levers at the IFI and country level can be used to unlock more early stage finance,
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and among these include a more sustained pivot from IFIs to address early stage development, pension
sector reform within countries, and IFIs improving access to on-lending programs.
The early stage finance gap is reflected in the fact that the clear majority – 95% - of capital that is raised
by a project is concentrated for use for construction and operationsxi. Development, in general, is funded
by the developer itself and sometimes partially by a utility or other corporate business partner in the
project. Unfortunately, while this 95% includes the participation of IFIs, those same IFIs are for the most
part absent in the development phase of the project. We focus here on IFIs because while private sector
financiers like commercial banks and private equity share the same aversion to early stage financing, they
do not share the IFIs development imperative, and we believe that a sustained reallocation by IFIs toward
early stage development would reap large economic development rewards. Some of the most frequently
cited reasons that keep IFIs on the sideline during early stage development include the fact that such
financing is small and IFIs prefer large transactions that can scale an industrial sector, the risk that early
stage projects may never even reach financial close, the notion that intervening earlier in a project would
put the IFI in the position of having to pick winners, and the difficulty of measuring the economic impact
of the intervention.
Still, however, we believe there are many methods for IFIs to address these potential barriers and still
serve as a catalyst in the development phase. For instance, the method of measuring catalytic impact
should help assuage the concern that the small-scale investment would have a minimal impact. While it
may not be as easy as calculating that the 1% of the project in which the IFI facility invests catalyzes 99%
of the capital, some analyses suggest that $1 of early stage investment can mobilize between $50 and
$100 of total investmentxii. Moreover, the investment needn’t be direct, and in that way IFIs can avoid the
hazard of choosing winners – specifically, as ADB has done in the past, IFIs can stage a Venture Capital or
Private Equity Funds call, and limit the funds for early stage financing. Lastly, developers in emerging
markets need more than the modest cash infusion at the early stage, they need capacity building – the
coaching, mentoring, and advisory services that can yield sweeping development benefits in countries’
energy IPP sectors.
Outside of IFIs, the local financial markets should be a prime source for potential early stage financing,
but in many developing countries it is an industry that is rarely engaged in the energy infrastructure sector
due to policy constraints. Local institutional investors like pension funds, for example, often avoid the
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infrastructure asset class. Were countries to focus on pension sector reform, however, that dynamic
could easily shift. The reason for the lack of pension fund capital in emerging markets are many and varied,
but there are certain quirks in local law – such as early access to pension funds, government agency
management of portfolios, and regulatory obstacles to alternative investments – that can be addressed
in the near term by local policy makers. Chile’s success with pension reform efforts should serve as a
model for any country proceeding along this path (see the following case study titled “Chile – How Pension
Reform Catalyzed Access to Capital).
Unlike pension funds, local commercial banks have macroeconomic and currency headwinds that prevent
their participation in the infrastructure sector. Most of their absence is due to their lack of access to
international stable currencies like USD and the Euro. The need for developing countries to access
international currency is driven by twin constraints – local currency volatility and the corresponding
asset/liability mismatch between local banks and infrastructure investments. That inflation in many of
emerging markets is volatile is not exactly news: the pullback from emerging markets as an asset class
since the 2008 financial crisis, China’s economic slowdown driving down the demand for natural
resources, and the shale revolution in oil and gas and the corresponding oil price plunge have all wreaked
havoc with local currencies. As such, local banks can only borrow in their local currency at high cost and
short debt tenors, and that in turn disincentivizes those same banks from making steady but low pay-out,
long term investments in assets such as infrastructure, even in the early stage. Instead, local finance
typically flows to investments such as real estate and T-bills which are shorter term in nature. IFIs can,
and have started to, make an impact in fixing this mismatch by developing on-lending-type programs, of
the type spearheaded by ADB for instance, that increase the local banking community’s access to
international currencies.
Recommendations
• IFIs should continue to make adjustments in the allocation of their funds toward early stage financing, and set a similar threshold as that which they must try to meet for late stage deals – 39% of all financing that flows into developing countries. This will spur more energy infrastructure activity and private participation in emerging markets.
• Pension sector reform, including privatizing pensions, removing regulations that constrain too harshly portfolio allocations toward alternative investments, and limiting early access to pension savings can engage local pension funds in infrastructure.
32
• IFIs should expand and better publicize on-lending programs that expand local banking institutions’ access to international currencies, which will drive their participation in the infrastructure sector.
Diversifying Financial Options This subsection covers the circumspection among many market participants that the growing presence
of Chinese financing in certain developing countries – whether through the Export-Import Bank of China
(China Ex-Im) or through the China Development Bank (CDB) – offered at more generous terms and at
lower rates has crowded out financing by other IFIs in those markets and has therefore thinned
competition from other equipment manufacturers and EPCs. To a degree, there is some validity in this
sentiment, insofar as when Chinese firms and financing are active in a market western firms and financing
seem conspicuously less present. In our experience, however, this has less to do with China’s terms of
financing than it does the countries in which China chooses to operate, the price at which Chinese
manufacturing firms offer their equipment, and the level of state-led coordination of the Chinese policy
banks of China Ex-Im and CDB.
We have witnessed first-hand Chinese policy banks operating in countries in which other IFIs have
laggedxiii. In 2010 for instance, China’s loan commitments to Latin America of 37 billion USD were more
than those of the World Bank, IDB, and US Ex-Im Bank combined for that year. Also, in the five-year period
ending 2010, Chinese loans of 1 billion USD or more amounted to over 60 billion USD whereas the World
Bank’s billion-USD-plus loans amounted to just over 10 billion USD and the IDB’s amounted to just over 5
billion USD. In deploying this capital China targeted countries with poor sovereign ratings in which the
other IFIs were not as active, operated as a one-stop shop for CDB and China Ex-Im financing, and in our
view as is typically the case, offered the lowest price equipment and services. What is more, as research
has shown, the financing here was not offered at more lenient terms, but rather in many cases at more
stringent terms. However, one departure that Chinese policy banks make from Western IFIs is that they
CASE STUDY: Chile – How Pension Reform Catalyzed Access to Capital
In one of the most well-documented cases of pension reform, Chile reformed its pension system in 1981 by replacing its social security system with a mandatory individual account system run by privately managed pension fund administrators. Researchers have found that this move by Chile reduced the cost of capital, and had several other beneficial spill-over effects for the country. Among those spill-over effects include larger savings rates and economic growth, and a rise in total factor productivity and GDP overall.
33
do not condition financing on internal budgetary and policy changes; instead, they condition financing on
Chinese equipment purchases.
Ostensibly, this is not a bad outcome. Countries that have historically found financial markets and IFIs to
be inaccessible, thanks to Chinese financing, are able to acquire capital. Still, this financial dynamic does
create the downside effect of reduced competition. Due to the conditions of China’s financing, Chinese
equipment crowds out competitors, which can lead to a lack of quality delivery and technological options.
Similarly, a lack of competition among financing alternatives can lead to a higher cost of capital than might
otherwise be available. For Western developers, manufacturers, and IFIs to be more competitive in
markets where Chinese financing is so ubiquitous, we recommend the following approaches.
Recommendations:
• Chinese equipment manufacturers primarily win in emerging markets based on price rather than financing, and as such the policy method to drive equipment competition and a diversity of financing options is to – as mentioned earlier in this paper – socialize the notion of Value for Pricing, or project life-cycle costing by procurement organizations.
• IFIs must start getting better at cross-institutional collaboration. Chinese financing has a competitive advantage in that it operates as a one-stop shop, and this is the approach more western IFIs must take at the national level (e.g., US Ex-Im and the US Overseas Private Investment Corporation). At the global level (e.g., World Bank and IDB) we recommend that IFIs collaborate and seek to co-finance more – even with their Chinese counterparts. Furthermore, much like China, governments must more often advocate for their own businesses through close coordination with the private sector – an approach the US had tried to take by creating one-stop shops (see the following case study titled “The US Attempts to Maximize Policy Support”.)
• IFIs must have more appetite for making large commitments in countries whose sovereign credit ratings are far lower than investment grade; and when they do so, they should examine closely whether and to what extent their commitments should be conditioned upon budgetary restrictions and policy changes.
34
Availability of EPCs / Turnkey Solutions One consistent thread in our work in emerging markets is that host countries and the local development
community tend not to simply procure for equipment or maintenance services. The markets typically
require equipment manufacturers to deliver a complete and operational project. This is usually because
the local EPC sector is still nascent, and the countries or procurement officials lack access or familiarity
with global EPC providers. This can be an obstacle for equipment manufacturers – and consequently an
obstacle to the willingness of investors to finance a project – because EPC services, especially
construction, typically fall outside of the scope of equipment manufacturers like GE. We instead need to
find willing EPC partners to join an emerging market venture, but since construction risk is in many
instances prohibitively high in developing countries, many international EPC firms are unwilling to
participate. To combat these obstacles to EPC participation we recommend the following:
Recommendations
• Countries should enact reforms that encourage the growth of the local EPC sector. Reforms could include measures such as certification and training programs for EPCs, for which IFIs can continue to provide capacity building support; considering overhauls to the value-added tax (VAT) regime; and procurement code modernization (e.g., schedule for government payment of invoices and mandatory requirements for local subcontracting).
• Countries should consider loosening joint venture or local EPC equity participation conditions for projects that exceed a certain dollar threshold. Multinational EPCs are already hesitant to assume the construction risk in developing countries; stringent equity requirements for local contractors could make those risks prohibitive.
CASE STUDY: The US Attempts to Maximize Policy Support
The US has recently engaged in multiple efforts to streamline federal finance and other policy support mechanisms to assist the private sector in establishing a presence in emerging markets. Among those efforts have included an Interagency Task Force on Commercial Advocacy established by the White House in 2012 tying together support services offered by the Departments of State, Treasury, and Energy, USAID, US Ex-IM Bank, and OPIC among other agencies. In 2013 the President also began an initiative termed Power Africa to increase sub-Saharan Africa’s access to electricity by providing expertise from US Ex-IM, USAID, and OPIC to increase deal flow. Lastly the US has had the long-standing Advocacy Center at the Department of Commerce intended to mobilize on-the-ground diplomatic assets to facilitate projects. While GE has successfully partnered with the Advocacy Center on a number of deals, we feel that these endeavors have so far fallen short of streamlining, or creating a similar one-stop shop for the policy finance (e.g., OPIC, US Ex-Im, USAID) that could unlock countless opportunities
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DIGITAL-INDUSTRIAL SOLUTIONS Throughout this white paper we have discussed various policy obstacles to infrastructure finance in the
developing world and within the IFIs that support them, but have not yet touched on what appears to be
a unifying issue among the IFIs and developing countries attempting to address glaring needs for energy
infrastructure. That common thread is that these organizations, whether financial, procurement, or
government based, appear to be using obsolete tools, disconnected from the real-time information that
most other industries take for granted – in effect, they are fighting the last battle.
IFIs operate, for instance, on a “push” rather than a “pull”
basis. Developers propose a project, and apply for
funding, or a country does the same thing. The IFI reviews
the proposal, and makes an assessment as to risks, and
decides whether to provide the applied-for levels of
financing. In an ideal world, however, were the IFIs to
have real time information into the early stages of all
energy infrastructure projects within a country or region,
or information as to similar projects across countries and
regions, the IFIs instead of the self-selected applicants could make a sharper determination as to which
developers it should invite to apply. The IFI could also benchmark its portfolio investments against similar
projects that aren’t within its portfolio. The gap in the state of IFI information systems – and the
importance of closing that gap – has been acknowledged by the World Bank itself. In November 2016, the
World Bank hosted a panel on the issue and came away with the following findings:
• Project Risk Profiles are Not Adequately Captured – while current commercial databases track thousands of deal announcements, they do not provide adequate follow-up information on those projects.
• Lack of Visibility into Project Comparables – the participants acknowledged the difficulty in using databases to compare project data because information is not populated in a standardized fashion or in comparable ways (e.g., deal terms).
• Lack of Project Prioritization Within a Country’s Development Program – one of the core missions of IFIs like the World Bank is to ensure that countries are tracking to their economic development program, and in the case of energy infrastructure projects, whether the project fits within the
Execution
Risk
Rules
36
country’s overall infrastructure modernization program. Yet current databases do not provide this type of tracking functionality.
The preceding gaps are just some of the many issues that could be resolved and opportunities that could
be captured were IFIs and developing countries to aggressively pursue information technology
modernization. There is moreover an enormous potential of these digital-industrial solutions to
dramatically simplify some of the policy changes we have presented in this paper. We name just a few of
those potential simplifications below.
• The Decision to Tender – one of the most salient reasons to conduct competitive tenders is that tendering is a tool for price discovery. The use of a digital product to gain visibility into comparable projects in the region, however, can simulate that price discovering mechanism and may allow a country to forgo what may be a costly and time consuming competitive bid.
• Project Life-Cycle Costing – we have discussed in multiple sections of this paper the need to shift from a lowest-evaluated bid model, and how it can drive interest in long term investment and a diversity of financial options. Procurement organizations can now use digital products to track the value they are receiving over the life of the product, and even require such analysis from bidders.
• Increasing Access to Risk Mitigation Instruments – earlier in this paper we discussed the less than expected use of PRGs and PCGs by developing countries, recommended that IFIs standardize the instruments, and that procurement organizations engage these IFIs at earlier stages of structuring the bid and PPA. Digital products could facilitate these recommendations by creating the “pull” process discussed earlier in this section. In short, the IFIs should have a constant and up-to-the minute view of projects at every stage of development, and should be able to provide real time feedback as to PRG or PCG suitability.
• Early Stage Finance – as it pertains to the gap in early stage finance, IT modernization can assist IFIs in receiving the pipeline and comparative project visibility at earlier and earlier stages of a project. By having that visibility IFIs will be better equipped to make early stage financing decisions or to communicate such opportunities to the private sector.
These opportunities are just a few of what are likely to be innumerable opportunities presented by
modernizing IFI and country approaches to infrastructure investment. Over the past couple of years GE
has worked hard to develop and launch Predix, an operating system on which many of the solutions we’ve
mentioned can be based. Our experience in that effort has taught us that many of the opportunities
presented by such a digital transformation don’t emerge until beginning the implementation. As such,
37
our recommendation to IFIs and procurement organizations is to not delay in pursuing these new
technologies.
CONCLUSION GE endeavored in this white paper to provide our unique perspective on the systemic policy constraints
to infrastructure finance in emerging markets. Our dual goals were to not only provide what we deem to
be priority policy measures that resonate with the IFI and development communities, but also to provide
new thought leadership to an area of ongoing discussion. In our view, there are policy opportunities at
the enabling environment level, the risk allocation level, the execution level, and through digital
modernization can help pull through investments and finance in emerging markets. We summarize those
opportunities and recommendations in the below matrix.
Section Subsection Recommendation
THE
ENA
BLI
NG
EN
VIR
ON
MEN
T: C
LEA
R P
RO
CES
S A
ND
RU
LES
The Decision to Tender
Cost-benefit analysis on the value of conducting a competitive tender Cost-benefit analysis from the perspective of its desired bidders Consider potential development gains via unsolicited bids and direct negotiations
Entitlement Requirements
“One-stop shops” for permitting and approvals Developing countries adopt “deemed approval” standards Leasehold rights to the land equal to the life of project
Local Content Requirements
Countries should ensure they appreciate the trade-offs before executing any deal Reconcile dissonance between the development and trade communities regarding local content
Evaluation Criteria and Forecasting Changes
Clearly publicize all bid evaluation criteria and include a bilateral debrief session Incorporate life-cycle costing to price proposals Procurement capacity building/socializing Value-for-Money concepts Begin with the most flexible design criteria to maximize competition and discover best-fit technologies Project for market participants the direction the country may be taking
38
Dispute Mechanisms
Neutral venue, ensuring flexibility and transparent judiciary. Provide for the ability to trigger the mechanism prior to awarding the project
IFIs are ideally situated to drive standardization in dispute mechanisms
Section Subsection Recommendation/Key Risks and Allocation
RIS
K A
LLO
CA
TIO
N
PPA Structure
Construction and Completion Risk Performance Risk Input/Feedstock Risk Demand Risk Maintenance Risk Force Majeure Risk FX and Interest Rate Risk Political Risk Change in Law Risk Early Termination Risk
Key Risk Mitigation Tools
Engage IFIs for credit enhancement mechanisms early in the process, preferably when the PPA is being drafted Standardize terms and qualification criteria for PRGs and PCGs IFIs should consider when to require a sovereign guarantee
PR
OJE
CT
EXEC
UTI
ON
Early Stage Finance
IFIs should make a minor adjustment in the allocation of their funds toward early stage financing Pension sector reform can engage local pension funds in infrastructure
IFIs should expand and better publicize on-lending programs
Diversifying Financial Options
Socialize the notion of Value for Pricing, or project life-cycle costing IFIs must start getting better at cross-institutional collaboration and explore co-finance opportunities More appetite for making large commitments in countries with lower sovereign credit ratings
39
Availability of EPCs / Turnkey Solutions
Countries should enact reforms that encourage the growth of the local EPC sector Countries should consider loosening joint venture or local EPC equity participation conditions for projects that exceed a certain dollar threshold
DIGITAL-INDUSTRIAL SOLUTIONS
Facilitating the decision to tender Accurate predictions of project life-cycle costs Increasing access to risk mitigation instruments Incentivizing early stage finance
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APPENDIX 1: Country Deep-Dive
To support the analysis presented in this white paper, we provide below a deep-dive analysis on several emerging markets relevant to GE. For each country, we present a case study alongside main policy impediments we identified during our research. We provide the primary macro-economic and regional electricity context for each country as well. Finally, we provide a proposed ranking for these countries based on the impediments to infrastructure investment discussed in this paper. We established for each ranking a maximum score of ten and a minimum score of zero per indicator. We compute the weighted average of each indicator per category: rules, risk and execution.
Please not that when were not able to locate an indicator value for a country, we attributed to that missing value the minimum value among all the other countries.
The “Rules” category is composed of:
- CPIA business regulatory environment rating (1=low to 6=high) from the World Bank data base: Business regulatory environment assesses the extent to which the legal, regulatory, and policy environments help or hinder private businesses in investing, creating jobs, and becoming more productive. http://data.worldbank.org/indicator/IQ.CPA.BREG.XQ
- CPIA policy and institutions for environmental sustainability rating (1=low to 6=high) from the World Bank data base: Policy and institutions for environmental sustainability assess the extent to which environmental policies foster the protection and sustainable use of natural resources and the management of pollution. http://data.worldbank.org/indicator/IQ.CPA.ENVR.XQ
- CPIA property rights and rule-based governance rating (1=low to 6=high) from the World Bank data base: Property rights and rule-based governance assess the extent to which private economic activity is facilitated by an effective legal system and rule-based governance structure in which property and contract rights are reliably respected and enforced. http://data.worldbank.org/indicator/IQ.CPA.PROP.XQ
- CPIA quality of public administration rating (1=low to 6=high) from the World Bank database: Quality of public administration assesses the extent to which civilian central government staff is structured to design and implement government policy and deliver services effectively. http://data.worldbank.org/indicator/IQ.CPA.PADM.XQ
- Ease of doing business index (1=most business-friendly regulations) from the World Bank data base: Ease of doing business ranks economies from 1 to 190, with first place being the best. A high ranking (a low numerical rank) means that the regulatory environment is conducive to business operation. The index averages the country's percentile rankings on 10 topics covered in the World Bank's Doing Business. The ranking on each topic is the simple average of the percentile rankings on its component indicators. http://data.worldbank.org/indicator/IC.BUS.EASE.XQ
The “Risk” category is composed of:
- Sovereign debt (% of GDP) from Trading Economics
41
http://www.tradingeconomics.com/country-list/government-debt-to-gdp - CPIA debt policy rating (1=low to 6=high) from the World Bank database: Debt policy assesses
whether the debt management strategy is conducive to minimizing budgetary risks and ensuring long-term debt sustainability. http://data.worldbank.org/indicator/IQ.CPA.DEBT.XQ
- CPIA financial sector rating (1=low to 6=high) from the World Bank database: Financial sector assesses the structure of the financial sector and the policies and regulations that affect it. http://data.worldbank.org/indicator/IQ.CPA.FINS.XQ
- Energy imports, net (% of energy use) from the World Bank database: Net energy imports are estimated as energy use less production, both measured in oil equivalents. A negative value indicates that the country is a net exporter. Energy use refers to use of primary energy before transformation to other end-use fuels, which is equal to indigenous production plus imports and stock changes, minus exports and fuels supplied to ships and aircraft engaged in international transport. http://data.worldbank.org/indicator/EG.IMP.CONS.ZS
- GDP growth (annual %) from the World Bank database: Annual percentage growth rate of GDP at market prices based on constant local currency. Aggregates are based on constant 2010 U.S. dollars. GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG
The “Execution” category is composed of:
- Bank capital to assets ratio (%) from the World Bank data base: Bank capital to assets is the ratio of bank capital and reserves to total assets. Capital and reserves include funds contributed by owners, retained earnings, general and special reserves, provisions, and valuation adjustments. Capital includes tier 1 capital (paid-up shares and common stock), which is a common feature in all countries' banking systems, and total regulatory capital, which includes several specified types of subordinated debt instruments that need not be repaid if the funds are required to maintain minimum capital levels (these comprise tier 2 and tier 3 capital). Total assets include all nonfinancial and financial assets. http://data.worldbank.org/indicator/FB.BNK.CAPA.ZS
- Depth of credit information index (0=low to 8=high) from the World Bank database: Depth of credit information index measures rules affecting the scope, accessibility, and quality of credit information available through public or private credit registries. The index ranges from 0 to 8, with higher values indicating the availability of more credit information, from either a public registry or a private bureau, to facilitate lending decisions. http://data.worldbank.org/indicator/IC.CRD.INFO.XQ
- Firms using banks to finance investment (% of firms) from the World Bank database: Firms using banks to finance investment are the percentage of firms using banks to finance investments. http://data.worldbank.org/indicator/IC.FRM.BNKS.ZS
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Angola
Kenya
43
Tanzania
Mozambique
44
Namibia
Botswana
45
Zambia
Uganda
46
Turkey
Algeria
47
Pakistan
Egypt
48
Thailand
Vietnam
49
Argentina
Mexico
50
Brazil
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APPENDIX 2: Survey
In the spirit of tailoring this white paper to the insights of GE’s leaders, we designed a survey and circulated it among the executives of the following GE businesses: Energy Financial Services, Global Growth Operations, and the Commercial Operations functions among the industrial segments of GE Renewable Energy.
The survey participants were asked to rank a set of criteria from 1 to 5, 1 representing a very low importance and 5 a very high.
Some criteria where used to consolidate the three categories discussed in this white paper: Rules, Risk Allocation and Execution:
Rules:
- Clear tendering and execution rules, tollgates, and timelines for a finalized PPA
Risk allocation:
- Access to partial risk guarantees or risk insurance (e.g., was the cost of the instrument appropriately valued?)
- Availability of local credit-worthy off0takers
Execution:
- Access to early stage capital and/or expertise - Access to a reliable EPC contractor or turnkey solution - Sufficient access to and participation from local IPPs - The investment expertise of local financial institutions in long-term assets - Lack of local institutional investors – e.g., pension funds and insurance companies
The initial results outline the importance of rules versus the execution and risk allocation impediments. These responses were consistent with the insights we received during one-on-one interviews with business leaders.
52
The detailed responses reflect that our respondents view, laws, regulations, and the enabling environment are the primary obstacle to energy infrastructure investment. In addition, it is worth noting that access to early stage capital/expertise is ranked at of highest importance with a significant gap from the second criterion, the process and rules. This might be attributed to the fact that almost half of our respondents (7 – see below) are from our Hydro Business. Due to its nature and potential impact on its environment, a Hydro project requires particularly extensive and sometime complex preliminary studies for its development. Thus, accessing early stage capital and expertise is key to support this process. Similarly, due to the importance of civil work activity in Hydro project, EPC project organization is widely used and explains the importance of this criterion in the ranking. Removing answers from Hydro business leaders, “access to early stage capital/expertise” and “access to a reliable turnkey solution or EPC” drop down, respectively, from 3,8 to 3,3 and from 3,3 to 2,7 while “clear process and rules” criterion remain at the same level.
Hereafter, the list of the survey participants:
1
2
3
4
5
Rules Risk Allocation Execution
Impo
rtan
ce (5
=Hig
h, 1
=Low
)
Key Impediments - Overview
1.0 1.5 2.0 2.5 3.0 3.5 4.0
Restrictions on alternative investmentsLack of local institutional investorsAccess to international currencies
Access to risk coveringlocal investment expertise
Same processes across the regionAvailability of local offtakers
Sufficient access to local IPPsAccess to a reliable turnkey solution or EPC
Clear process and rulesAccess to early stage capital/expertise
Importance (5=High, 1=Low)
Key Impediments - Details
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- Bob Psaradellis, EFS Global Capital Markets Leader - Aijun Xu, Commops leader of Hydro China - Jérôme Pecresse, President & CEO, GE Renewable Energy - Tim Richards, Senior Executive, Government Affairs and Policy, GGO - Krikor Nigoghosian - Sales Director for Hydro Business in Europe & CIS - Derek Kongsawat, Regional Sales Leader, Hydro APAC - Fabio Nossaes, General Manager, Hydro China - Erik Granskog, MD, Deal Execution Leader - SSA, EFS Global Markets - Jorge Casana, Deal Execution Leader, O&G, Power, REN, GGO - Yves Rannou, CEO, GE Hydro - Francois Berthiaume, North America Sales Leader for GE Renewable Hydro Solutions - Godin Bruno, business leader Hydro India - Mary Ann Ring, VP, Global Capital Markets; Relationship Mgr for World Bank Group - Leo Kirby, MD EFS Capital Markets Asia - Paul Hennemeyer, raising capital for GE projects, EFS, GGO, GE REN, GE Power
APPENDIX 3: Glossary
Availability (of equipment) - Amount of time that the equipment can produce electricity over a certain period, divided by the amount of the time in the period. Conventional energy – Production of energy with fuels not classified as renewables (nuclear, gas, coal, diesel…) Early stage development – First phase of a project, generally until the end of feasibility studies ECA – Export Credit Agency - Financial institution that offers financing to domestic companies for international export operations and other activities. ECAs offer loans and insurance to such companies to help remove the risk of uncertainty of exporting to other countries and underwrite political risks and commercial risks of overseas investments, thus encouraging exportation and international trade. There is not a mold for a typical export credit agency; some operate from government departments, and others operate as private companies. Electricity generation mix – Distribution of electricity being produced in the country per source (Coal, Gas, Solar, Wind, Hydro, …) Energy consumption net of imports – Quantity of energy consumed in the country minus quantity of energy imports of the country Entitlement – we define entitlement as the activities involved in siting, permitting, and providing approvals for a project. In many emerging markets, these rules are opaque, can shift, and require the engagement of multiple federal, local, and parastatal organizations. We recommend providing clear,
54
bright rules; fixing the timeline and circumstances under which exceptions can be granted; and creating “one-stop shops” in which several approval functions are consolidated. EPC - Engineering Procurement and Construction – is a particular form of contracting arrangement used in some industries where the EPC Contractor is made responsible for all the activities from design, procurement, construction, to commissioning and handover of the project to the End-User or Owner. Externality - Consequence of an economic activity experienced by unrelated third parties; it can be either positive or negative. Pollution emitted by a factory that spoils the surrounding environment and affects the health of nearby residents is an example of a negative externality. The effect of a well-educated labor force on the productivity of a company is an example of a positive externality. Financial Market Constraints – Constraints linked to the local financial ecosystem that can limit the financial attractiveness of the infrastructure project (for example access to international currency, local institutional investors, local business regulations…) FDI - Foreign Direct Investment – investment made by a company or individual in one country in business interests in another country, in the form of either establishing business operations or acquiring business assets in the other country. Force Majeure - French term literally translated as "greater force", this clause is included in contracts to remove liability for natural and unavoidable catastrophes that interrupt the expected course of events and restrict participants from fulfilling obligations. IFI – International financial institutions - financial institution that has been established (or chartered) by more than one country. (World Bank, European Development Bank, African Development Bank, …) Institutional investor - Nonbank person or organization that trades securities in large enough share quantities or dollar amounts that it qualifies for preferential treatment and lower commissions. Institutional investors face fewer protective regulations because it is assumed they are more knowledgeable and better able to protect themselves. Examples of institutional investors include pension funds and life insurance companies. MDB – Multi Lateral Development Bank - financial institution that provides financing for national development. The bank is formed by a group of countries, consisting of both donor and borrowing nations. Furthermore, an MDB offers financial advice regarding development projects. Partial Risk Guarantee - also known as political risk guarantees, cover private lenders and investors against the risk of the government (or a government owned agency) failing to perform its obligations vis-à-vis a private undertaking Per capita GDP – (gross domestic product) This is the value of all final goods and services produced within a nation in a given year, converted at market exchange rates to current U.S. dollars, divided by the average (or mid-year) population for the same year.
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PPA – Power Purchase Agreement - contract between two parties, one which generates electricity (the seller) and one which is looking to purchase electricity (the buyer/off-taker). The PPA defines all the commercial terms for the sale of electricity between the two parties, including when the project will begin commercial operation, schedule for delivery of electricity, penalties for under delivery, payment terms, and termination. MEFMI - Macroeconomic and Financial Management Institute of Eastern and Southern Africa, Zimbabwe, co-operative venture among ten southern African countries (Angola, Botswana, Lesotho, Malawi, Namibia, Swaziland, Tanzania, Uganda, Zambia and Zimbabwe) MWh- Unit of production of electricity (one megawatt produced during one hour) Policy framework - Set of principles and long-term goals that form the basis of making rules and guidelines, and to give overall direction to planning and development of the organization. PPP – Private-public partnership Renewable energy - Production of energy from renewable sources (wind, solar, hydro, biomass, …) Sovereign guarantees - given by host governments to assure project lenders that the government will take certain actions or refrain from taking certain actions affecting the project. Although a blanket sovereign guarantee of all project risks is impossible to obtain in any project finance transaction, many of the legal and political risk categories typically encountered in an infrastructure project will be well within the host government’s ability to control and may therefore be fairly allocated to such host government.
i https://www.imf.org/external/pubs/ft/weo/2016/update/02/ ii http://data.worldbank.org/indicator/EG.ELC.ACCS.ZS?end=2012&start=2012&view=bar iii http://www.worldbank.org/en/news/press-release/2014/10/09/world-bank-group-launches-new-global-infrastructure-facility iv http://www.cnbc.com/2014/10/15/beyond-piketty-putting-todays-capital-to-work-to-benefit-allinfrastructurecommentary.html v https://openknowledge.worldbank.org/bitstream/handle/10986/11305/263990PAPER0VP0no10257.pdf? sequence=1 vi https://piie.com/blogs/trade-investment-policy-watch/local-content-requirements-backdoor-protectionism-spreading vii https://irenanewsroom.org/2015/08/25/auctions-emerge-as-key-instrument-to-promote-renewable-energy/ viii http://www3.weforum.org/docs/WEF_Risk_Mitigation_Instruments_in_Infrastructure.pdf ix https://www.scaf-energy.org/sites/default/files/public/downloads/files/Catalysing_Early_Stage_Investment.pdf x Ibid. xi Ibid. xii Ibid. xiii http://ase.tufts.edu/gdae/Pubs/rp/GallagherChineseFinanceLatinAmerica.pdf
