Session 3: Planning and Financing Climate Change Actions

for Sustainable Cities

Thursday September 12, 2019

2019 Forum of Standing Committee on Finance

“Climate Finance and Sustainable Cities”

Vahakn Kabakian

Climate Change Advisor/Portfolio Manager

Ministry of Environment

Lebanon

De-risking: An Enabler for Unlocking Climate Finance

DREI - Derisking Renewable Energy Investment

Methodology and importance – global viewResults from the DREI Lebanon work

• DREI – Derisking Renewable Energy Investment – is at the heart of economic development

→capacity building towards policies in favor of clean technologies

→enabling cost-effective selection of public measures

→improving the climate finance readiness of governments, including local authorities

→leveraging public funds through private sector engagement

→more reliable, affordable and clean power for citizens

Derisking Renewable Energy Investment The issue with RE investments

2.5

2.0

1.5

0.5

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 1918 20

1.0

Capital expenditures Operating expenditures

Mill

ion

$ p

er M

W

Example:

CostsDiesel Power

(undiscounted)

years0

Operating expenditures

Example:

CostsWind Power

(undiscounted)

years

2.5

2.0

1.5

0.5

00 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 1918 20

1.0

Capital expenditures

Mill

ion $

per M

W

For RE investments: More up-front finance is needed (less cash-flow finance)

Risks and the associated costs of finance matter much more

Derisking Renewable Energy Investment The issue with RE investments (cont.)

• The objective: to make RE investment cost competitive with the business-as-usual investment, typically fossil-fuel based energy

• The challenge: the high financing cost (cost of capital) in developing countries

• A project’s specific risks drive the cost of capital:

Exp

ect

ed fin

anci

alr

etu

rn

Risk of investment

Unattractive

investment

Attractive

investment

Risk-return profile of an investment opportunity

2.

1.

For the policymaker there is a trade-off/interplay between these two approaches

Policymakers perspective: there are two ways to address this challenge:

1. Derisk RE by targeting investor risks that result in high financing costs

2. Compensate for risks via incentive mechanisms

DREI’s Theory of Change: policymakers to derisk as much as possible, before paying for the remaining incremental costs via incentive mechanisms

Derisking Renewable Energy Investment The issue with RE investments (cont.)

Source: Source: Derisking Renewable Energy Investment (UNDP, 2013), subsequently updated as of 2017. All assumptions (technology costs, capital structure etc.) except for financing costs are kept constant between the developed and developing country.

Low Financing Costs Envrionment

(Wind vs. Gas)

Capital Struc ture: 30% Equity, 70% Debt

Cost of Equity = 7%, Cost of Debt = 3%

Pre

-Tax L

CO

E (U

SD

cents

/kW

h)

Gas (CCGT)Wind (onshore)

2.9

1.4

0.5

1.4

6.2

0.7

5.0

0.20.46.3

Financing Cost(Equity)

Financing Cost(Debt )

Operating Cost(incl. fuel cost)

Investment Cost /

Depreciation

Capital Struc ture: 30% Equity, 70% Debt

Cost of Equity = 16%, Cost of Debt = 8%

Gas (CCGT)

0.7

4.4

0.7

0.9

6.7

High Financing Costs Envrionment

(Wind vs. Gas)

Wind (onshore)

2.9

1.3

1.9

3.0

9.2

Developed country: Developing country:High financing costs

reflecting a range of investor risks in developing countries

Public instruments can assist the private sector through reducing/transferring investor risk

Wind (onshore)

Developed

country

Developing c.

post derisking

$/kWh

Developing

country

$/kWh$/kWhDREI is quantitative: LCOEmodeling

DREI evaluates the public instruments w.r.t. performance metrics

Risks such as:1. Power market risks2. Permits risks3. Social acceptance risks… etc.

DREI measures: the perceivedprobability and impact of risks

DREI measures: the perceived effectiveness of public instruments Instruments such as:

1. Well-defined regulation

2. Streamlined permitting

3. Public loans… etc.

#1Risks

#3 etc.#2

#1

etc.#3

Best in Class developed country

%

Cost of equity/debt

Derisking instruments

Pre derisking

%

Post derisking

%

#2

Stakeholder interviews:

How does the private sector view the investment risks underlying RE?

How does the private sector view the ability of public instruments to mitigate risks?

The question: What is the most effective public instrument package?

Derisking Renewable Energy Investment DREI’s approach: 1) Quantify the risk environment

16%7%

0.1%1.7%0.4%

1.5%

1.8%0.5%0.5%1.0%

1.5%

Stu

dy C

ountr

y B

AU

CoE

Stu

dy c

ountr

y B

AU

CoD

Pow

er M

ark

et Ris

k

Perm

it R

isk

Soci

al A

ccepta

nce

Ris

k

Deve

loper Ris

k

Grid/T

ransm

issi

on

Ris

k

Counte

rpar

ty R

isk

Fin

anci

al S

ect

orRis

k

Polit

ical

Ris

k

Curr

ency

Ris

k

Pow

er M

ark

et Ris

k

Soci

al A

ccepta

nce

Ris

k

Deve

loper Ris

k

Grid/T

ransm

issi

on

Ris

k

Counte

rpar

ty R

isk

Polit

ical

Ris

k

Curr

ency

Ris

k

Best

-in-c

lass

countr

y C

oD

Best

-in-c

lass

countr

y C

oD

Cost of Equity (CoE)

3% 9%1.4%

0.5% 0.5% 1.6%1.2%

0.9% 0.0%

Cost of Debt (CoD)

• Reach out to investors active in the target country and perform structured interviews

• Aggregate perceived risk environment into Financing Cost Waterfalls

Derisking Renewable Energy Investment DREI’s approach: 2.1) Select public instrument package

Source: UNDP, Derisking Renewable Energy Investment (2013).

+

Reduce risks!«Policy derisking»

Transfer risks!«Financial derisking»

Compensate for risks!«Financial incentives»

Stud

y Co

untr

y BA

U C

oE

Post

-der

iski

ng C

oE

Post

-der

iski

ng C

oD

Stu

dy c

ount

ry B

AU

CoD

Pow

er M

arke

t Ris

k

Perm

it Ri

sk

Soci

al A

ccep

tanc

e Ri

sk

Dev

elop

er R

isk

Grid

/Tra

nsm

issio

n Ri

sk

Coun

terp

arty

Ris

k

Fina

ncia

l Sec

torR

isk

Polit

ical

Risk

Curr

ency

Risk

Pow

er M

arke

t Ris

k

Soci

al A

ccep

tanc

e Ri

sk

Dev

elop

er R

isk

Grid

/Tra

nsm

issio

n Ri

sk

Coun

terp

arty

Ris

k

Polit

ical

Risk

Curr

ency

Risk

Cost of Equity (CoE) Cost of Debt (CoD)

0%0.4%0.1%0.8%0.9%

0.5% 0.2%0.1%0.2%

12.8%16% 9% 6.6%

0.5% 0.2% 0.1%0.8%

0.6%0.2% 0%

Derisking Renewable Energy Investment DREI’s approach: 2.2) Quantify instruments’ effectiveness

• (Reach out to investors active in the target country and perform structured interviews)

• Aggregate perceived effectiveness of public instrument package into Post-Derisking Waterfalls

Financing cost waterfalls

10

#1Risks

#3 etc.#2

#1

etc.#3

Best in Class developed country

%

Cost of equity/debt

Derisking instruments

Pre derisking

%

Post derisking

%

#2

16.0%

0.5% 0.2% 0.2% 0.1%0.9%

0.8% 0.06% 0.4% 0.0%

12.8%Cost of Equity

Pow

er M

arke

t

Perm

its

Dev

elo

per

Gri

d/t

ran

smis

sio

n

Soci

al A

ccep

tan

ce

Co

unt

erp

arty

Fin

anci

al S

ecto

r

Polit

ical

Cu

rren

cy/M

acro

ec.

-3.2%

Instruments addressing risks related to:

Post-Derisking

Data from DREI Lebanon (DREI 2018)

16.0%

1.5%1.0%

0.5% 0.5% 1.8%

1.5%

0.4% 1.7%

0.1%

7.0% Cost of Equity

Pow

er M

arke

t R

isks

Perm

its

Ris

ks

Dev

elo

per

Ris

ks

Gri

d/t

ran

smis

sio

n R

isks

Soci

al A

ccep

tan

ce R

isks

Co

unt

erp

arty

Ris

ks

Fin

anci

al S

ecto

r R

isks

Polit

ical

Ris

ks

Mac

roec

on

. Ris

ks

Best-in-Class Pre-Derisking

11

#2

#1

etc.#3

Derisking instruments

Pre derisking

%

Post derisking

%

16.0%

0.5% 0.2% 0.2% 0.1%0.9%

0.8% 0.06% 0.4% 0.0%

12.8%Cost of Equity

Pow

er M

arke

t

Perm

its

Dev

elo

per

Gri

d/t

ran

smis

sio

n

Soci

al A

ccep

tan

ce

Co

unt

erp

arty

Fin

anci

al S

ecto

r

Polit

ical

Cu

rren

cy/M

acro

ec.

-3.2%

Instruments addressing risks related to:

Post-DeriskingPre-Derisking

Risk Category Policy Derisking Instruments Financial Derisking

InstrumentsPower Market

Risk

•Long-term, legally-binding RE targets

•Enabling regulatory framework

•FIT/PPA tender (standardized PPA)

• Independent regulator for power sector

NA

Permits Risk •Streamlined process for RE permits

•Contract enforcement, recourse

mechanisms

NA

Social Accep-tance

Risk

•Awareness-raising campaigns

•Stakeholder outreach

NA

Developer Risk •Capacity building for resource assessment

Technology and O&M assistance

NA

Grid/Trans-mission

Risk

•Strengthen EDL’s grid management capacity

•Transparent, up-to-date grid code

•Policy support for grid infrastructure

development

•Take-or-pay clause in PPA

Counterparty Risk •Strengthen EDL’s management and

operational performance

•Government guarantee for PPA

payments

•Concessional public loans to IPPs

Financial Sector

Risk

•Fostering financial sector reform towards

green infrastructure investment

•Strengthening financial sector’s familiarity

with renewable energy and project finance

•Concessional public loans to IPPs

Political Risk NA •Political risk insurance for equity

investments

Currency/Macro-

economic Risk

NA NA

Public Instruments

Derisking Renewable Energy Investment DREI’s approach: 3) Levelised cost

• Perform LCOE modelling under transparent set of assumptions, incl. about RE target, operating parameters, country specifications, etc.

Remaining incremental cost

Effect of policy & financial derisking

7.5%

13

Risk Category Policy Derisking Instruments Financial Derisking

InstrumentsPower Market

Risk

•Long-term, legally-binding RE targets

•Enabling regulatory framework

•FIT/PPA tender (standardized PPA)

• Independent regulator for power sector

NA

Permits Risk •Streamlined process for RE permits

•Contract enforcement, recourse

mechanisms

NA

Social Accep-tance

Risk

•Awareness-raising campaigns

•Stakeholder outreach

NA

Developer Risk •Capacity building for resource assessment

Technology and O&M assistance

NA

Grid/Trans-mission

Risk

•Strengthen EDL’s grid management capacity

•Transparent, up-to-date grid code

•Policy support for grid infrastructure

development

•Take-or-pay clause in PPA

Counterparty Risk •Strengthen EDL’s management and

operational performance

•Government guarantee for PPA

payments

•Concessional public loans to IPPs

Financial Sector

Risk

•Fostering financial sector reform towards

green infrastructure investment

•Strengthening financial sector’s familiarity

with renewable energy and project finance

•Concessional public loans to IPPs

Political Risk NA •Political risk insurance for equity

investments

Currency/Macro-

economic Risk

NA NA

Theory of change: Policymakers to derisk as much as possible, before paying for the remaining incremental costs.

The question: What is the most efficient public instrument package?

Levelized cost of electricity

(usually fossil)

7.4 10.0 8.2

Baseline

Investment

Solar Investment

BAU

Solar Investment

Post-Derisking

LC

OE

[US

D c

en

ts/k

Wh

]

Source:DREI Lebanon

Public Instruments and LCOE Modeling

14

Theory of change: Policymakers to derisk as much as

possible, before paying for the

remaining incremental costs.

The question: What is the most efficient public

instrument package?

Levelized cost of electricity

(usually fossil)

7.4 10.0 8.2

Baseline

Investment

Solar Investment

BAU

Solar Investment

Post-Derisking

LC

OE

[US

D c

en

ts/k

Wh

]

Premium price

Source: DREI Lebanon

88

279140 4341

5

Cost of BAU

Instruments

Cost of

Post-Derisking

Instruments

Solar PV

Investments

Mil

lio

ns

US

D

INVESTMENT LEVERAGE RATIO

Policy derisking instruments

Financial derisking instrumentsPrice premium (FIT, PPA)

Present valueof costs over 20 years

3.2x2.0x

Key performance metrics

Source:

DREI Lebanon

Derisking Renewable Energy Investment DREI’s approach: 4) Evaluation

Use DREI’s financial modelling tools to evaluate four key performance metrics

How does the deployment of the selected public instrument package

1. … catalyse private sector investment ?

2. … generate economy-wide savings?

3. … increase the affordability of RE for end-users?

4. … benefit the environment?

• On top: Perform sensitivity analyses on key inputs and assumptions

• to explore robustness of the modelling exercise

• to explore scenarios, e.g. alternative sets of public instruments

16

140 43

4697

415

Cost of

Post-Derisking

Instruments

Incremental

Cost

BAU

Savings Incremental

Cost

Post-Derisking

Mil

lio

ns

US

D

SAVINGS RATIO

Policy derisking instruments

Financial derisking instruments

Present valueof costs over 20 years

2.1x

27.0 17.1

Solar PV

Abatement Cost

BAU

Solar PV

Abatement Cost

Post-Derisking

US

D/t

CO

2e

CARBON ABATEMENT

5.2 Mt CO2 (20 years)

-37%

Data from DREI Lebanon

88

279140 4341

5

Cost of BAU

Instruments

Cost of

Post-Derisking

Instruments

Solar PV

Investments

Mil

lio

ns

US

D

INVESTMENT LEVERAGE RATIO

Policy derisking instruments

Financial derisking instrumentsPrice premium (FIT, PPA)

Present valueof costs over 20 years

3.2x2.0x

derisking is more effective in catalyzing private sector funding

explore how different instrument packages affect economy wide saving and other metrics

compare carbon prices and use e.g. for NDC design

Key performance metrics

DREI Lebanon studyForeshadowing some results

Wind PV Total

2030 Targets (MW) 450 300 750

Cost of Public Instruments (USD) 98 million 46 million 144 million

Private sector investment (USD) 635 million 279 million 914 million

Economy-wide savings (USD 20 yrs) - 221 million - 97 million - 318 million

Affordability (LCOE) US¢/kWh From 11.4 to 9.4 From 10 to 8.2

CO2 (million t 20 yrs) - 10 - 5.2 -15.2

CONTACT: MoE Lebanon:

Vahakn KabakianClimate Change Advisor/portfolio manager

Ministry of EnvironmentBeirut Central District, Lazarieh CenterPO Box 11-2727, Beirut, Lebanon

Phone: +961 1 97 65 55 ext. 475vahakn@moe.gov.lb

UNDP DREI New York:

Oliver WaissbeinLeader UNDP DREI work

UNDPBureau for Policy and Programme Support 304 E 45th Street, FF-924New York, NY 10017, USA

Phone: +1 212 906 3637oliver.waissbein@undp.org

www.undp.org/DREI

Solar power

Local authorities

Bus Rapid Transit

Public transport

Wind power

Waste strategy

Fuel-efficient fleetReforestation and afforestation

Derisking

Paris Agreement

1.5 degree goal

Political Risk

Energy efficiency

Sustainable cities

Decoupled economic growth

Counterparty risk

Combatting climate change

Greenhouse gas emission reduction

Climate Finance Sustainable mobility

Integrated Solid Waste Management

Sustainable agriculture

Job creation

Sustainable use of resources

Capital Expenditure

Private sector

Climate leadership

Clean industrialization

Nationally Determined Contribution