De-risking green power

Making the sustainable energy portfolio financially sustainable

Lebanon’s energy sector is characterized by a significant supply-demand imbalance, continuing growth in demand (5 percent per year), high generation costs (partly due to aging infrastructure), and a lack of financial sustainability. Electricité du Liban (EDL) cannot recover its operating costs and depends on the Lebanese government to subsidize operations. In 2013, EDL received transfers amounting to around $2 billion, corresponding to 4.5 percent of the GDP – creating a significant strain on the country’s budget and economy.

Lebanon’s baseline energy mix is dominated by oil, accounting for over 95 percent of generation. Renewable energy currently accounts for 4 percent of the electricity produced in Lebanon, predominantly hydropower, with less than 0.2 percent from solar photovoltaic (PV).

Renewable energy resources

The climate change case for investing in renewable energy is well known. A global and local shift to renewable energies, requiring both public and private resources, is essential to achieve the outcomes stipulated in the Paris Agreement.

Lebanon has significant wind and solar energy potential. The Ministry of Energy and Water (MoEW) started a wind energy procurement process in March 2013, requesting that wind farms be built and operated under a power purchase agreement (PPA). Three bids from local developers have been considered, and while the procurement process remains ongoing, there is optimism that agreements could be signed by mid-2017, which would bring with them a total of 180 megawatts (MW) worth of wind energy.

As for PV, most of the capacity installed to date is distributed on a small-scale (10 MW by the end of 2015), with an estimated 30 MW installed capacity by the end of 2016. Lebanon has two large-scale PV projects: the Beirut River Solar Snake (1.1 MW) and a second PV plant located within the Zahrani Oil Refinery Installation (1.1 MW), which are both connected to the EDL grid. The MoEW issued a call in January 2017 for parties interested in building solar PV farms in various regions of Lebanon, with the aim of installing an additional 120-180 MW of solar energy. The ministry received a total of 173 expressions of interest.

A risky matter still

A great deal of the recent advances in renewable energy can be attributed to increased political will and rapidly declining technology costs. However, financing costs for wind energy and solar PV in Lebanon today are estimated at 16 percent for the cost of equity (CoE), and 9 percent for the cost of debt (CoD).  These are substantially higher than in the best-in-class country, Germany, where they are estimated at 7 percent CoE, and 3 percent CoD. Given the longevity of energy assets and the capital intensity of renewable energy investments in particular, the impact of Lebanon’s higher financing costs on the competitiveness of wind energy and solar PV is significant compared to traditional fossil fuel powered technologies.

This means that high financing costs are a key factor hindering investment in renewable energy. Interviews with investors in Lebanon have shown that there is considerable interest today from domestic private sector actors, despite the slow pace of power sector reform and procurement activities to date. The high financing costs reflect a range of technical, regulatory, financial and institutional barriers, and their associated investment risks. The graph below shows how a range of investment risks currently contribute to higher financing costs in Lebanon. The risk categories with the largest impact on elevated financing costs are: 1) power market risk, which relates to accessing power markets and the price paid for renewable energy; 2) grid and transmission risk, which concerns the failure-free feed-in of the electricity produced; 3) counterparty risk, which concerns the credit-worthiness of the electricity off-taker (i.e., EDL); and 4) political risk, which concerns a country’s general intra and international stability.

By addressing these risks, Lebanon can create an environment conducive to investment and effectively address the concerns of private sector investors. This requires a targeted approach, which could include instruments such as: well-designed power market regulations, which reduce risk by removing the underlying barriers that create it; financial de-risking instruments, such as loan guarantees offered by development or central banks, which transfer risk from private to public sector; and financial incentives, such as direct subsidies for sustainable energy, which compensate investors for risk.

While challenging, these barriers are not insurmountable, especially if policymakers seeking to promote renewable energy assemble combinations of public measures to systematically address these underlying risks.

Public instrument selection

In order to specifically address the risk categories identified in the financing costs, a package of public instruments, containing both policy and financial de-risking instruments, needs to be developed and implemented (shown in Table 1). These measures would reduce the cost to the private sector, which in turn would be reflected in lower cost premiums quoted by the private sector when responding to government requests for wind and PV bids.

The ‘take or pay clause in PPA’ and ‘government guarantee for PPA’ are estimated to cost $55.1 million for wind and $25 million for PV. Taking a reserved approach, the ‘public loans’ and ‘political risk insurance’ are estimated to be $36.3 million for wind and $16 million for PV. This means that for financial de-risking of both wind and PV technologies, $91.4 million and $40.9 million are needed respectively. Policy de-risking instruments are estimated to cost $6.7 million for wind and $4.8 million for PV.

These represent costs (or expenditures) that would be incurred by the Lebanese government to de-risk (or uptake the risk) from the investors. This would allow for the further development of the sector and reduce the cost on future PPAs, as the investors would be bidding in a de-risked environment, and therefore, reduce the long-term cost on the government. This is obvious when the business-as-usual case (i.e., with the current risks) is compared to the post-de-risking environment (i.e., after implementing the policy and financial instruments mentioned above), where lower financing costs can be guaranteed.

In the business-as-usual scenario, wind energy and solar PV are more expensive than the baseline. The baseline technology mix consists primarily of combined cycle gas turbine (CCGT) plants, which Lebanon will likely use to increase its electricity generation capacity, and to a smaller extent the existing power generation fleet, which could be partly replaced by wind energy or solar PV. This approach results in baseline generation costs of $0.074 per kWh, assuming unsubsidized fuel cost for the CCGT technology. Therefore, the aim is to bring the cost of the wind and PV technologies closer to the CCGT technology.

To meet the 2030 National Renewable Energy Action Plan targets, the de-risking report estimates that $426 million and $140 million are required (in terms of price premium) for wind and PV technologies respectively.

However, the government could spend a total of $98 million and $46 million respectively to de-risk the wind and PV sectors. The de-risking would bring down the wind energy price premium to $205 million, thereby saving the government $221 million in generation costs over the next 20 years and resulting in a net savings of $123 million. The same holds true for PV energy, where the solar PV price premium is reduced to $43 million, thereby saving $97 million in generation costs over the next 20 years and achieving a net savings of $51 million. As such, following government interventions to de-risk the investment environment, and taking into account the resulting lower financing costs, the price premium for wind energy and solar PV would be reduced by roughly 50 percent and 70 percent respectively.

The above clearly demonstrates that investing in de-risking measures is good value for money when compared to paying a premium price for wind and solar PV energy. However, the majority of these measures could take time to implement. In the meantime, the government can offer subsidies to encourage immediate investments in the renewable energy sector. The ultimate risk, especially when generous subsidies are provided, is that the subsidy scheme itself might be vulnerable to a policy reversal. There are a great deal of complex trade-offs involved, and what seems to be of more importance is having continuous and consistent progress toward expanding the renewable energy portfolio. The thermal and renewable energy portfolios should  proceed in tandem by introducing renewable energy portfolio requirements for any future independent power producer (IPP) schemes in order to pursue the national 15 percent renewable energy target for 2030.

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Vahakn Kabakian is head of the climate change unit at UNDP Lebanon