Financial Risk and Renewable Energy Financing
Analysts: Jonny Goldberg, Ryan Fitzgerald, Ryan McCabe, and Nick Agnew
Team Leader: Haliz Doskee
27/02/2017
Renewable Energy Financing Risks
Prior to evaluating the risk associated with the location of a renewable energy investment, investors need to construct a compelling financial model to determine what sort of returns they can expect to receive. Renewable energy projects require large upfront investments to develop a solar or wind farm, for example. Once the project is operational, there are minimal operating costs required to maintain the infrastructure. On the revenue side of the model, owners receive a steady monthly revenue payment that lasts the duration of the energy contract. Typically, power purchasing agreements span upwards of 15 years. The model is viable if the sum of the revenue inflows exceeds the operating costs, invested capital, and the investor's required rate of return.
The current state of the Guatemalan renewable energy industry is fraught with financial risk. Similar to other nations, the Guatemalan government has joined the global movement towards clean energy, setting lofty goals for their renewable energy sector. However, corruption and legislative gridlock draw the stated targets into question. The government aims for a nationwide goal of 60% renewable energy by 2022 — but the political culture of corruption is likely to persist. Even President Jimmy Morales, who ran on an anti-corruption platform, was recently embroiled in scandal. Prevailing corruption will force companies to increase their hurdle rates—also known as a rate of required return — the minimum return the firm must receive in order to proceed with project development. Higher costs of capital thereby dissuade future investment in the country, impeding government efforts to increase Guatemala’s reliance on renewables.
Political graft causes other headaches for the government. Guatemala’s revenue collection agency consistently struggles to collect adequate revenues, in part due to low-level corruption and bribery. In 2015, government revenues amounted to only 10.8% of GDP, the third lowest revenue-to-GDP ratio out of 131 countries surveyed. The uncertainty in revenue disrupts fiscal planning and threatens existing initiatives, namely renewable energy projects, from receiving necessary funding. Furthermore, widespread corruption does little to improve the perception of Guatemala on the global markets. Typically, companies do not want to invest in places where bribes are required in order to guarantee an adequate return.
Foreign firms’ determination of whether or not to invest in an emerging market such as Guatemala can often be thought of as a question of opportunity cost. If we assume that the average investor is achieving returns of 8-10% on their renewable investments in their respective domestic markets, the only reason they would choose to invest in a different, and foreign market, is if they believed they could realize greater returns. Due to the political, financial, and security risks in Guatemala, most companies would likely apply a risk premium ranging anywhere from 2-8%. Theoretically, if companies are not able to negotiate a financial model with local parties that ensures they receive a return on equity in the mid-teens, logically they would continue to invest their money elsewhere because it is simple, safer, and more financially feasible.
Governments actively try to incentivize foreign direct investment, however a poor credit rating from a trusted international ratings agency can often deal a fatal blow to governmental attempts to spur investment. As of June 2016, Moody’s, a prominent ratings institution, upgraded the outlook on Guatemala’s national credit from negative to stable and affirmed the Ba1 government bond rating. The economy demonstrated steady GDP growth of 4% in 2015, largely boosted by falling oil prices and increased remittances, translating into higher disposable incomes for the majority of Guatemalans. Additionally, the expenditure containment plan, enacted in 2014, began to show results,. In 2015, as the fiscal deficit fell to 1.4% of GDP. While local and national governments remains mired in corruption, significant efforts toward transparency and accountability have been made to strengthen traditionally weak institutions. Still, corruption in Guatemala’s highest office remains an issue, and will likely lead to further scandals and macroeconomic instability. Despite the likelihood of further political scandal, there has been no evidence of a negative economic effect due to political crisis — GDP remains on track for solid and predictable upward growth.
Guatemala’s Ba1 rating reflects the national government’s traditional commitment to conservative fiscal and monetary policy and moderate medium-term growth. However, weak institutional strength, and endemic poverty contributes to the rating as well. While budget deficits have been reasonable and debt ratios low, poor human development hinders foreign investment, particularly in industries that would rely upon existing electrical infrastructure, such as renewable energy. Moving forward, it would be prudent for the Guatemalan government to continue attempting to improve revenue collection agencies, strengthen the rule of law, and preserve their historically steady GDP growth. Factors that could increase financial risk include degradation of cautious fiscal and monetary policy, degradation of GDP growth, and further corruption and lawlessness.
International Investment: Threats and Opportunities
The 2015 Paris Climate Conference had a massive effect on Guatemala. Despite, only accounting for 0.1% of global emissions, the country entered negotiations promising to reduce by an additional 11% by 2030. Guatemala will be able to meet this target by reducing their dependency on fossil fuels from 40% to 20% by 2030. In 2013, the government of Guatemala passed a law to create the National Council for Climate Change, which seeks to develop a comprehensive plan to adapt to environmental changes and mitigate climate risk. The government also established a national fund for climate change, which will be seeded with $2 million in domestic funds. Initiatives will be vital for domestic job creation within the budding renewable energy sector. The government is actively looking to increase domestic production in this industry. Guatemala’s Ministry of Energy and Mines estimates that within 3 years, renewable energy sources will provide up to 12.5% of the country’s energy.
Domestic government turnover poses a serious threat to Guatemala obtaining their fair share of the new $100 billion global Green Climate Fund. A change in energy policy from administration to administration has the potential to disrupt the creation of the proper proposals to receive money from the Green Climate Fund. Environmental activists in the United States are currently coping with the consequences of a new administration, as Donald Trump has offered a drastically different environmental policy than his predecessor, Barack Obama. After an election, it takes time for the new administration to settle in and develop international climate proposals. Bureaucratic gridlock has the potential to disrupt the creation of critical legislation needed to receive funds from international organizations, which seek to help the renewable resource industry as a way to battle the general effects of climate change as a whole.
Guatemala will soon feel the ramifications of the recent election in the United States. As American climate change policy is poised to take an unprecedented turn. Given their close proximity to the equator, Guatemala will likely be harshly affected by climate change. Poor U.S. climate policy will amplify the consequences for Guatemalans. The largely impoverished and agrarian population is particularly vulnerable to unpredictable changes in climate.
