Centre for Sustainable Finance chairs discussion on the challenges facing hydropower in Africa

28 May 2019 – Last month, the Centre for Sustainable Finance chaired a panel discussion on attracting private finance into sustainable infrastructure, with the focus on hydropower, at the “Africa 2019” Water Storage and Hydropower Development for Africa conference in Windhoek, Namibia.

The panel brought together Cambridge University researchers with specialists from the World Bank, the Uganda Energy Company and Mott MacDonald. The discussion centred on managing risk and facilitating finance for sustainable infrastructure development. The session underscored the involvement of both private finance and host country governments to insure that infrastructure development is both sustainable and sustainably financed.

In her introductory note, Dr Judith Plummer Braeckman from the University of Cambridge Institute for Sustainability Leadership (CISL), highlighted the importance of considering issues of sustainable finance in hydropower development. African country governments and multi-lateral development banks (MDBs) have insufficient resources to meet their infrastructure development needs, making it necessary for these countries to secure more private sector finance, often through Public-Private-Partnerships (PPP). As the role of the public sector and MDBs is shifting to leveraging financing from private sector, risk is becoming more of a focus than before given its importance as a decision-making factor for the private sector financiers.  Facilitating finance and managing this risk was thus the key focus of the panel discussion.

Luciano Canale from the World Bank explained that in an ideal world a host country government would fund all studies to maximise the sustainability benefits of its natural resources - including economic benefits - before selling this optimised project to the private sector on a competitive basis. This approach would help emerging markets avoid a situation where preliminary studies fail to cover the full range of their economic, environmental and social costs and benefits.  

In reality, however, scoping studies for hydropower projects in developing countries are often carried out with limited funds and are of poor quality. This is the case especially when projects are financed without any MDB involvement, which would otherwise bring a focus on risk-mitigation, environmental and social impacts and safety.

Harrison Mutikanga from the Uganda Energy Company highlighted some of the challenges that the private sector is likely to face when investing in Uganda. Until recently, power purchase agreements (PPAs) for projects that were developed largely with private finance, such as Bujagali, have been capacity based, protecting the private operator from hydrological risk and the risk of low demand.  However, the Ugandan Government is now seeking to move away from capacity-based PPAs, thus unloading more of the supply and demand variability risk onto the private sector for future projects.  At the same time, the energy sector regulator is under pressure to keep tariffs low, meaning that legal contracts between the off-taker and the project developer are not always appreciated or respected.

Ajay Chaudhary from Mott MacDonald focussed on the need to categorise risks, highlighting three key areas:

• Capacity risk, caused by the lack of both availability of Government funding at scale and capacity within country institutions to understand how to best negotiate with the developer;
• Technological risk, such as risk associated with tunnelling,  which can be partially mitigated and managed by good preparatory studies;
• Market risk, which is borne from inadequate awareness of the national / regional market for energy, in particular whether there is sufficient demand for additional capacity at a price reflective of the cost of production. 

The developer may not have the ability to accept all these risks but, in some instances, may feel forced to do so, especially where risks are not easily predicted, such as flash floods.  Forcing the private sector to accept risk that they cannot manage can be a costly strategy for Governments as each investor will add a substantial risk premium to their required return on investment as compensation for accepting unknown risk. 

Dhruva Sahai from the World Bank discussed the challenges of attracting finance for projects in developing countries, where even well-prepared projects can fail to achieve financial closure. The key reasons, said Mr Sahai, are often associated with a perception of high risk related to the political context, regulatory framework and off-taker default. This, together with the magnitude of funding required for large hydropower projects, means that some form of credit enhancement will typically be required to attract private investment for projects in developing countries. However, short tenor of private sector debt finance can lead to higher tariffs in the early years of the project.  

The need for private sector finance does not apply to energy infrastructure projects alone. Developing countries have multiple competing needs for the use of (often limited) public funds (e.g. education / health / energy etc.). Even decisions affecting just one sector (such as energy) can be subject to multiple pressures and considerations (e.g. what kind of power station to build). To be able to maximise the potential benefits from private sector finance, governments in developing countries need to acquire more experience of dealing with the private sector.  The World Bank provides some support for governments to help improve their regulatory and financial frameworks to mobilise more private capital, while off-taker default risk can be controlled/ mitigated by a sovereign guarantee.