17 December 2018 – Following a recent roundtable discussion hosted by the University of Cambridge Institute for Sustainability Leadership (CISL) and the FutureDAMS consortium, Dr Judith Plummer Braeckman, CISL Senior Research Associate, discusses the risky reputation of hydropower projects and the potential solutions that could help to drive investment in this sector.
Building sustainable hydropower projects is key for achieving a net zero future by 2050. Yet, hydropower is known to be a risky business in construction and especially so in emerging market economies where much of the world’s unexploited hydropower remains. Getting a hydropower project to financial closure involves reaching agreement with locally affected families, agreeing environmental red lines, tunnelling long distances through some poor rock integrity and agreeing prices that balance risk and return with governments who need to secure low cost energy for development. These difficulties often prevent private financing from supporting viable hydropower projects. To address them, CISL has been working as part of the FutureDAMS consortium to improve the design, selection and operation of dams to support sustainable development. In particular, our objective has been to improve the flow of private finance into sustainable hydropower projects.
To understand the perspective of financiers, CISL held a roundtable discussion with industry experts on the key issues of how financiers view the risks of hydropower development to get more sustainable finance into hydropower for the future. Although the risks of hydropower are well documented, this is frequently done from the developers and government owners’ vantage point. Within the financial world, the participants agreed that some risks, such as security for both assets and staff, endemic corruption, and inadequately managed environmental and social impacts, were simply a matter of 'walking away'. Other risks could be managed: for example, the group saw an increasing risk of change of government leading to a renegotiation of contracts, reinforcing the need for government guarantees backed up by a partial risk guarantees from a multilateral agencies such as the World Bank or the Asian Development Bank.
A number of risk mitigation measures were discussed. These included geotechnical risk registers which define the risk sharing mechanism for difficult tunnelling of underground works or contractual terms which make risk allocation crystal clear. Interest was expressed in new insurance products and derivatives which can moderate the risk of hydrological issues such as drought or more hedging instruments which can mitigate the impact of foreign exchange risk. However, it was agreed that the overall cost of risk mitigation within the price of the project was significant.
One way of de-risking the project would be for governments to take some of the risks themselves so that they only pay if the risk crystallises rather than paying substantial risk premiums built into the contract price to mitigate risks which may not occur. This solution is clearly not appropriate in every situation, but it is worth considering for countries with capacity to understand the risk profile of the project and identify the risk premiums. An example of such an approach is 'FELT' – Finance, Engineer, Lease, Transfer in which a Government specifies the requirements of a project, sources the land and contracts a private company to deliver it on a low risk contract; this private company raises finance, completes the design, constructs and commissions the project, and then leases it to the public entity for an agreed term over which term is recovers its investment; at the end of the lease the operation of the plant is transferred back to the government.
The meeting also discussed the prospects for climate finance for hydropower development such as green bonds. To date, green finance flows have been limited in the sector as the technology is considered well developed and thus less in need of promotion than other more modern renewables. Some agencies only support small hydropower projects. The role of hydropower and particularly projects with storage capability to back up intermittent renewables and strengthen transmission grids is vital in the transition to a zero carbon economy. Discussion is ongoing as to whether it will be possible to issue Green Bonds for hydropower (Climate Bonds Initiative) and this decision is eagerly awaited.
The FutureDams project is ongoing and we are currently conducting research to assess the potential severity of risks inherent in sustainable hydropower and align them with risk mitigation measures, where possible. Within the progress to a zero carbon future, a clearer understanding of risks and risk mitigation measures could facilitate the flow of sustainable finance towards sophisticated and sustainable hydropower projects.
