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Selling the Sun

Arman Galledri of Jones Day on financing renewable energy projects in the Middle East

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ANALYSIS

By Arman Galledri, Global Head of Project and Infrastructure at Jones Day in Dubai

The Middle East is a dynamic market for the energy industry. With contrasting challenges that range from dependency on fuel imports for power generation in Jordan, to global hydrocarbon powerhouses such as Qatar and the Kingdom of Saudi Arabia, the region paints a picture of energy diversity – and in some cases disparity.

Yet, a new frontier of power generation now unites the Middle East’s various economies, which share a mutual recognition of the opportunity renewable energy presents to long term economic and social development. This enormous energy transition is gathering pace, and its positive trajectory is being underpinned by two primary factors. Firstly, the critical need for energy security to support growing populations and expanding economies. And second, the falling cost of clean energy generation.

As we have seen with the recent Dubai Electricity and Water Authority (DEWA)/ACWA power deal, securing finance at favourable rates for utility scale renewables projects in the region is becoming a more straightforward process. For a number of years, the commitment shown by development banks – such as the World Bank to supply cheap capital for clean energy projects in developing nations, such as those across the African continent, has instilled a new sense of confidence in global financiers. Bloomberg New Energy Finance research revealed that in the six years from 2007 to 2012, 26 development banks had between them financed a total of $425bn in clean energy, breaking the $100bn barrier for the first time in 2012.

That funding has been critical. Africa is in dire need of renewable energy as its nations look to power themselves out of poverty and into sustainable economic development through clean, off grid electricity. The International Renewable Energy Agency’s (IRENA) Africa Clean Energy Corridor initiative calls for the accelerated deployment of renewable power across Africa, recognising that half of all electricity in Eastern and Southern Africa could come from clean, indigenous, cost-effective renewables by 2030.

The challenge has been a slightly different one in the Middle East. Financing renewables has been more a question of long-term commercial viability and return on investment, than having confidence in the political and regulatory system. And while technology costs have been high, it has been a challenge for a sponsor or government to offer up the kind of power purchase agreements that make clean energy cost competitive. But the energy market – like all global industries – is interconnected and the gathering pace of clean technology deployment in Africa, Europe and the Far East has driven down technology costs and allowed renewables in some nations to reach grid parity to electricity generated from fossil-fuels.

The UAE is one such country. Earlier this year, a report released by IRENA and the Masdar Institute of Science and Technology revealed that solar and wind are now the cheapest sources of new energy supply in the UAE. Realising full clean energy potential could result in energy system savings of almost $2bn annually by 2030. Energy projects such as the DEWA project signing with ACWA are a demonstration of this, with that deal in particular offering the lowest cost power from renewables anywhere in the world. The consortium led by Saudi Arabia’s ACWA and Spain’s TSK was selected based on an alternative proposal for 200MW with LCOE of $5.84869 cents/kWh. Clean energy at this cost has only been made possible by cheap and secure long term financing.

The new financing landscape is fuelling ambition. Dubai has tripled its target to increase the share of renewables to 15% in its energy mix by 2030. The emirate also increased its 2020 target by seven times to 7% – which by its own admission – was due to falling costs of solar energy. What’s more, part of that 7% may be from solar energy from rooftops of homes, something which Dubai has begun paving the way for through various regulatory framework adjustments.

This ambitious trend is not only evident in the UAE. Oil rich Saudi Arabia has promised to export several gigawatts of electric power instead of fossil fuels, with large-scale solar and wind projects in the pipeline. And Egypt’s re-emergence and redevelopment will be underpinned by a renewables program. The country is currently preparing a law that would allow for state-owned lands to be made available for renewable energy projects in exchange for 2% of the energy produced, and its Feed-In Tariff Program aims to generate up to 2.3 GW through solar power and 2 GW of wind energy.

This progress is indicative of a new confidence being shown by private financiers in clean energy’s viability across the Middle East. Even in a low oil price environment there is sufficient trust in the cost competitive nature of clean energy – and in its long term cost benefits – to make it a smart investment and a viable risk. According to the Oxford Institute for Energy Studies, renewable energy – especially solar power, given the GCC’s unique advantage – is set to be a cost-competitive alternative to conventional fossil fuels if the full opportunity cost of domestically consumed petroleum resources is fully priced into the regional energy system.

That said, the recent oil price volatility has to a small extent negatively affected the world’s appetite for renewable energy investment, but with the short to medium term oil trend being for increased oil demand, it may be that increase in demand that creates the capital to fund the renewables programme. According to the Organization of Petroleum Exporting Countries (OPEC), global daily demand for oil will rise from around 91 million barrels a day in 2014 to 111 million barrels a day by 2040. The quest for alternate energy is a transition after all and an argument for fossil fuels funding this transition may be a valid one.

The key to successfully financing utility scale clean energy projects in today’s landscape is about establishing the right set of regulatory frameworks that incentivise investment and breed confidence in financiers, and ensuring that that their capital investment is a smart and secure long term decision.

Understanding the elements of a deal that will keep the financiers up at night is an important part of this process and there are several aspects of the deal that fall into this category. They range from the credit rating of the country and its track record of fulfilling payment obligations to currency fluctuations – particularly because equipment and construction costs have historically always been in dollars.

Success – for the sponsors - is about building a strong enough case for investment that demonstrates viability. The development aid discussion is still a valid one but it is no longer enough to support the rapid scale up of renewables needed across the Middle East and Africa to make the transition possible.

It’s testament to the pathway laid down by multilateral development banks to engender confidence among private capitalists, that we are now in a position to demonstrate that renewable energy is not only the answer to a myriad of social and environmental challenges in various countries all over the world, but it is a long-term investment that pays.

Experience tells us that for international electrical utilities, independent power producers, electric transmission companies, developers and owners of wind, solar and other renewable energy sources, construction, engineering and environmental firms, the discussion is moving from what financiers can do for us, to what we can do for capital investors – and that is a healthy situation for a core industry like future energy.

In developing economies, while structuring a project of national relevance and seeking commercial bank support, there is a need for a degree of risk assurance and subsequent political risk insurance for the funding. Previous involvement of the likes of the World Bank usually offers a degree of relief to the lender or sponsor and before banks and lenders come on board, other structural parameters such as concessions offered by the host country, bankability, power purchase agreement, operation and management processes, must be built.

The significance of renewable energy progress in Africa and around the world is considerable and is making itself felt in the Middle East. As the market accelerates and matures it will continue to pave the way for dynamic activity that attracts smaller players who in turn help drive innovation and push down costs. This process further strengthens renewable energy’s viability and enables it to attract yet more commercial money. At that point, the scale of development will reach unprecedented levels.

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