Clearly the transition from carbon heavy energy to renewable energy is here to stay and will continue to gather momentum, including in emerging markets. There are many reasons for this shift towards renewable energy not least of all the fact that the global environment needs it. However, despite the global enthusiasm for green projects, the sector will not be sheltered from the usual political risks associated with foreign investments and in fact the risks may even be exacerbated given sensitivities around the right to power, the importance of power to fuel economies and growth, the cost of power and the continually widening gap between the haves and the have nots.
Renewable energy investors and the associated lenders need to be pragmatic about the political risks involved in their projects and be cautious of being swept away by the euphoria that tends to be linked to renewable energy. Fortunately, many of these risks can be managed, including being protected through wellstructured political risk insurance policies.
Energy is considered a key catalyst to economic growth and therefore when new power projects commence, a wave of optimism moves through the communities close to the projects. This optimism varies from the hope of employment to the impact that reliable electricity can have on the daily lives of communities. However, the employment contributions of renewable energy projects are sometimes limited and much of the available employment is short term. The establishment of local supply chains remains rare with most technologies being imported, further limiting the indirect job opportunities.
The onset of available electricity requires payment, something not always familiar or affordable to poor communities, highlighting the reality that there is a cost for energy. The initial optimism can quickly move towards frustration, social unrest and even political violence, either aimed at the government or the projects themselves. These tensions can often escalate through rumors of how foreign investors and international suppliers are benefiting from lucrative government contracts while the local community sees very little direct benefit.
Governments are investing heavily into renewable energy. Many renewable energy projects involve an independent power producer (IPP), often linked to international investors, and a power purchase agreement (PPA) with the state power utility. Most of these projects require international funding, which is generally structured in hard currencies such as the US$ or the Euro. Even though the PPA may be linked to a fixed amount in terms of the currency of the funding, this does not remove the financial pressures that an emerging market may have to settle international debt in hard currency especially when one considers that the majority of the utilities revenues are generated in local currency. Most utilities raise revenues by charging their citizens for the use of power. However, these revenues are in local currency and in the event of currency depreciation, the effective international cost of debt increases, with the utility having limited ability to simultaneously raise the local tariff charged to the general population.
Furthermore, governments are often required to invest in supporting infrastructure required to maximize the value of the power plant, for example expanding transmission lines in order to ensure the power reaches the required destinations. It is not uncommon for delays to occur in the development of this additional infrastructure either due to inefficiencies or financial constraints. This can add further pressure on utilities who may have to start paying for power that it is not fully utilized, having the combined effect of financial strain and a frustrated population.
As economic pressure and social tensions mount so will the risks of government intervention either through attempts to adjust license agreements, amend PPAs or revise feed-in-tariffs. In extreme cases, this government intervention could even be the nationalization of IPPs.
Most renewable energy investments are long term in nature with long term PPAs and long-term financing, increasing uncertainties. Political risks in the short to medium term are difficult enough to predict and the predicting of long-term political risks is near impossible. Governments and leaders will change during the duration of most projects and given the lack of democracy in some cases or the immaturity of democracies in many others, how emerging market governments will respond to foreign investors is often untested. The initial hype as to why the project was originally embarked on is long forgotten, especially if there are now financial and social challenges or if the original government that awarded the contract has a reputation of corruption.
Another unclear concern relates to the advancement of technology and the associated costs. In many rapidly changing environments, costs are generally written off over a relatively short period acknowledging that new technology will shortly replace the current technology. In the renewable energy sector technology is continually being developed and the cost of developing renewable energy continues to decline. However, PPAs and funding are often locked into 15 to 20-year PPAs and 15 to 20-year funding structures. Well before the expiry of these arrangements new projects will cost significantly less and far lower feed-in-tariffs will be negotiated. How relatively expensive and dated green plants will be viewed by governments and the populations adds to the political risk uncertainty.
Renewable energy is the future and should be welcomed by all. However, projects will not be without risks and certainly not without political risks. These risks need to be appropriately managed by investors and lenders. PPAs need to be well structured. In countries with weak utilities, some government backstop behind the PPA should be considered. A country’s legal and judicial structures are an important consideration for investors. Arbitration arrangements should be located in independent jurisdictions. Investors need to be sensitive towards the communities where the projects are located and should actively work on establishing good relations, have various social upliftment programs in place and maximize the involvement of the communities.
Procurement of political risk insurance by both investors and lenders needs to be seriously considered. The private political risk insurance market is actively looking to participate in the green revolution; developing green specific products, increasing the duration of their support and upscaling their project finance expertise. Most of the risks highlighted above can be managed through well-structured insurance policies. Political Violence and perils covered under the banner of Confiscation, Expropriation, Nationalization and Deprivation are standard covers under a political risk policy. While currency depreciation is not covered, Currency Inconvertibility / Exchange Transfer is covered. Protection against governments trying to change the agreed terms of an IPP or PPA can be covered by the inclusion of Breach of Contract and Arbitration Award Default. Willis Towers Watson is a specialist credit and political risk insurance broker able to advise clients on the appropriateness of insurance policies in place in a project or to assist clients purchasing the appropriate political risk insurance.