This week we publish a working paper setting out a framework for: (i) determining how risks for power investments should be allocated so that costs are minimised; and (ii) how a blend of ownership models and policy/finance instruments can be used to achieve this allocation.
Over the last three decades, there has been a general trend towards privatization of the energy sector, particularly in developed countries. This trend has brought a corresponding transfer of risks towards private investors, particularly in parts of the market where competition is possible such as electricity generation.
This growing preference for private investment is understandable given large pressures on public sector budgets, and evidence that competitive private investors can deliver cost efficiencies. But some risks are still better managed by governments or development banks, or best transferred to consumers. In particular, if we ask private investors to manage risks they are not well-placed to manage or understand (eg, policy or curtailment risks), the investment may only be financeable at a high cost of capital, or may not happen at all.
In this report, we argue this debate is not simply about choosing between public or private finance. Rather policymakers and investors should ensure each different investment risk (eg, construction, price) is allocated according to whether private investors, public entities or consumers are best placed to manage, understand and bear it. This allocation of risks can be achieved through a blend of ownership models, policy, regulation and specific finance instruments.
This working paper establishes an approach for choosing the right ownership models and policy/finance instruments which has “risk allocation” at its core. It is aimed at policymakers (eg, energy and finance ministries, regulators) and development banks, who play an active role in setting policies and deploying public finance. It is also aimed at private investors with an interest in where public finance and policy should (and shouldn’t) play a role in transferring some of the risks for their investments. Specifically, in this paper we show how for different energy technologies and country contexts we can:
- assess the ideal allocation of each risk; and
- choose a blend of ownership models and finance/policy instruments to achieve this allocation.
A strategic approach to selecting which risks are financed by the private sector versus the public sector could lead to large savings in the overall costs of the energy transition. In two case studies we analyse in this report, we find that cost savings of 10-40% could be achieved. In particular, we find that significant savings could be achieved from reallocating development, price, offtake and curtailment risks. This suggests that these risks, and the instruments that can be used to transfer them, should be a focus for future work.
CPI Energy Finance’s report, Financing clean power: a risk-based approach to choosing ownership models & policy/finance instruments is part of a programme of work for the Advisory Finance Group (AFG). The AFG is a network of individuals who have served as senior level officials in both the public and private sectors, and is designed to analyse and shape policy and investment choices presented by climate risk.