Energy Financing and Trading

*Biased towards RE investments

 Financing RE & EE Projects
Reasons behind relatively limited financing
Market-related issues
 RE and EE potential is often only roughly
estimated
 A limited number of feasibility studies are
available
 There are few RE/EE project developers active
in the market
 Market information is still largely unavailable.
Political and policy-related issues
 Most African country’s policy documents do
not prioritize RE/EE
 Undeveloped regulatory and operational
frameworks
 Operational risks and regulatory uncertainty.
Technology
 High up-front costs of RE/EE projects
compared to conventional energy sources
 Inadequate access to finance for research,
development and manufacturing
 Perception of high investment risks by financiers.
Inherent nature of projects:
 Governments have traditionally been the main
investors in energy and have tended to focus on
centralized power projects, whereas the
greatest potential for RE and EE is in decentralized
projects
 Small-scale nature of the projects.
Lending and investment decisions
Overall, financial institutions will aim to create a package that
includes the total finance amount;

 The repayment terms

 The interest rate
 The repayment schedule and
 Any guarantees or securities.

For any given project, financial institutions will estimate

both the risks and returns of the project.
Risk assessment & management
 Different risk categories include business risk, country risk, market risk, money or
interest rate risk, project risk, and foreign exchange risks.
 Business risk includes the risks incurred in operating a business:- raw material costs, sales volumes,
fluctuating prices, affected by demand disruption, strikes, natural disasters, etc.
 Country risk includes the risk of regional economic recession, national economic mismanagement,
and political unrest.
 Foreign exchange risk includes the possibility that exchange rates may fluctuate during the course
of the loan.
 The risk finally depends on the design of the project or programme, e.g. the business model, time
frame, location, etc.
 The likelihood of a risk-event is generally assessed by examining similar programmes in similar
countries that have already been completed.
 If no similar projects are available for comparison, financiers will consider the risk to be
“uncertain”.
 Many commercial financiers are usually unwilling to loan to projects with “uncertain” risks, except
by applying higher interest rates.
 Distinct types of financiers look at renewable energy projects in distinct ways;
 Investment bankers expect to earn a fee,
 Lenders expect to receive long-term and fixed payments
 Equity investors expect to earn a shorter-term payback and return.

 Each of the players will do their own due diligence or examination of the
project before committing money to the project.
 The analysis may include a review of:
o The business plan
o Projected cash flows, margins, IRR, NPV;
o Reliability of technology involved;
o Creditworthiness of all parties involved;
o Likelihood of changes in regulatory and policy environment;
o Permits and environmental approval (required for project to begin
construction and operation)
Risk insurance
 Even after the analysis, a risk never actually disappears but rather, it is simply
transferred (allocated) to somebody else’s balance sheet.
 Once a structure for risk sharing is identified and agreed upon, each of the
key risks involved can be allocated and priced under contractually binding
arrangements.
 For projects in developing countries, governments (often backed by bilateral or
multilateral agencies) partially or fully assume the risks that result from their own
actions including policy, regulatory and country risks.
 Risks due to events beyond governments nor project sponsors are covered by
insurance or other contracts/solutions from private sources.
 Where such insurance is unavailable or premiums are too expensive, then
public assistance is required to mitigate the risk.
 In World Bank, the Multilateral Investment Guarantee Association (MIGA) was
formed by the Bank specifically to provide guarantees to development work.
Returns
 After assessing the risks, financial organizations are willing to lend or
invest money when they expect to make a profit, e.g. a return on investment
(ROI) or a return on equity (ROE).
 The return is generally earned in the form of interest (in the case of loans)
and dividends (in the case of equity investment).
 The higher the perceived risk of a programme or project, the higher the
required return in order to attract investors to it.
Basic types of financing
Debt - Debt financing involves taking a loan or issuing a bond to provide capital
and require repayment of both the amount of money borrowed and the interest
charged on that amount.
Equity - Equity investors provide capital in a project in return for a share of the equity
of the project. It entails sharing ownership and/or revenues with the investment
partner(s) through ordinary or preferential shareholding, including that equity
investors maintain the right to get involved in the decision-making process of the
project or company in order to protect their investment.
Grants and guarantees - Grants do not require repayment, they are essentially “gift”
money with specific requirements or terms for use. Governmental and international
organizations offer grants to promote environmental and development policies.
Types of financing models
 Government-led model - Most of the financing programmes are managed by a
government body or donor organization, although the actual model can take on
several different forms and include different market players.

o For example, the overall management and allocation of funds may remain under
federal government control, but then involve some form of private sector
participation, as a vendor of goods and services (not as the owner-operator) and a
high degree of participation from the communities.

o The state may offer subsidy to cover the initial investment costs in a joint financing
with the electricity companies and the users. This makes the projects affordable to
the consumer.
 Market-based models - Due to the perceived high risk and low return on investment
for RE and EE projects, few success stories using a market-based model are available.
However, international aid agencies have been developing several market-based
business models, especially for rural electrification programmes.

o Consumer finance – The consumer financing (CF) approach implies consumers purchase their system
from a dealer on credit by making a down payment and financing the balance with a loan,
making periodic payments of capital and interest. The customer gets (gradual) ownership of the
system.
o Leasing - In the leasing model, the leasing company procures systems on a wholesale basis, and
then offers them to households through retail lease agreements. In contrast to the CF approach, the
leasing company retains ownership of the system, although it is often gradually transferred to the
customer.
o Fee-for-service or ESCO - A fee-for-service approach, also known as an Energy Service Company
(ESCO) model, offer rural households the best prospect for widespread access to sustainable energy
services. ESCOs intervene in two aspects of the financing structure: 1) in downsizing the high initial
costs of systems by offering a staggered payment and fee for service models; 2), in serving as financial
intermediaries in consumer bank loan procurements and guarantees for securing loans.
List of potential donors and funds
A) International multilateral funding
 Funding is available through multilateral development banks such as the World
Bank, the Global Environment Facility (GEF) or the European Commission.
 This type of formal funding in general is only accessible for governments and not
for private developers and most often consists of loans at an interest rate or pay-
back periods below commercial averages, and sometimes grants are applied.
 The large development banks also offer guarantees to mitigate the risk of the
project and facilitate other forms of financing (such as loans from commercial
sources).
 Examples include the International Bank for Reconstruction and Development
(IBRD) and the International Finance Corporation (IFC).
 For CDM (Clean Development Mechanism) and low carbon projects, several
“Carbon Funds” have been established, including the Prototype Carbon Fund, the
Community Development Carbon Fund and the Carbon Fund for Europe.
B) Regional development banks

 Regional development banks act in much the same way as multilateral

development banks, and focus on a specific continent or region.

 Examples of formal regional development banks include the Asian Development

Bank (ADB), the African Development Bank (AfDB), the European Bank for
Reconstruction and Development (EBRD), the Inter-American Development Bank
(IADB), the Islamic Development Bank (IDB), the East Africa Development Bank
(EADB), and the Development Bank of South Africa.

 Examples of private regional development banks are the Atlantic Development

Group for Latin America (ADELA) and the Private Investment Company of Asia
(PICA).
C) Bilateral agencies
 Apart from multilateral organizations, developed countries through their
development programmes often provide funding to developing countries.

 Examples include the Department for International Development (DFID, UK),

the Bundesministerium für wirtschaftliche Zusammenarbeit und Entwicklung and
the Gesellschaft für Technische Zusammenarbeit (BMZ and GIZ, Germany), the
Agency for International Development (USAID, USA), the International
Cooperation Agency (JICA, Japan), and the Agency for International Development
(AusAID, Australia).

 This type of funding is generally only accessible for governments, and, due
to political priorities or historical relations, often specifies preferred target regions
or countries.
D) Government finance
 In many developed countries, public funding is still the most important source of
financing for RE and EE.
 This funding is usually provided in the form of loans or grants, and is combined
with financing from multilateral and bilateral organizations.

E) Private sector finance

 Commercial banks - Provided that a proper business plan, acceptable risks and
returns on investment can be presented, commercial sources can be interested in
financing RE and EE projects through loans and equity investment.
 Ethical banks - Some banks provide funding for sustainable projects in both
industrialized and developing countries. Examples include Triodos Bank and
Cooperative Bank. Most of the classic commercial banks have recently developed
specific ethical products.
 Microfinance banks - Local communities, both in urban and rural areas, are emerging
actors in the financing of clean energy, especially for the low-scale application of RE
products and technologies. This trend takes the form of microfinance or community-
based “green funds” as mechanisms of consumer financing.

F) Private foundations and charities

 Private foundations include for example the Shell Foundation, an independent,
grant-making charity created by Royal Dutch/Shell in June 2000, providing capital in
the form of grants or soft loans for a range of socially responsible projects.
 Part of the Shell Foundation is the Breath Easy Kenya Fund, aiming to develop
market-based solutions that get smoke out of kitchens.
 Concepts being tested include consumer credit and enterprise financing for
cleaner fuels and more efficient stoves.
Matrix of financing instruments
Energy Trading
Introduction
 Energy trading refers to the transaction between power generators, who
produce electricity or any other form of energy and suppliers who sell it on to
consumers
 Energy trading involves products like crude oil, electricity, natural gas, wind
power, etc. Since these commodities often fluctuate abruptly they can be
attractive to speculators.
 Energy prices affect the cost of virtually everything we consume including our
groceries, the clothes we wear, the electronic devices we use, and the gasoline
we put in our cars.
 Several long-term trends could create trading opportunities in energy in future:
Emerging Market Growth, Energy Efficiency Revolution, Population Growth,
Electricity Penetration, Climate change, Industrialization in Developing
Economies.
 There are many parties in the power market and include generators, consumers
and suppliers in the middle.
Why is Energy Trading Important

 Running a power station is an expensive process and demand for energy never
stops.
 The energy market ensures the country’s energy demand are met while also aiming
to keep energy businesses sustainable, through balancing the price of buying raw
materials with the at which energy is sold.
 For electricity for example, trading ensures the grid remains balanced and meets
demand where the system operator also makes deals with generators for ancillary
services far in advance or last-minute.
 This ensures elements such as frequency, voltage and reserve capacity are kept
stable across the country and that the grid remains safe and efficient.
 Energy trading therefore ensures there is always a supply of energy and that the
market for energy operates in a stable way.
Speculating on Energy Prices
 In theory, then, trading energy company shares is a way to make a leveraged bet on the
price of energy commodities. As the commodity’s price rises, more revenues should
flow to the bottom line in the form of profits.
 However, many factors other than commodity prices can affect the performance of
energy company share prices:
o Production costs: A rise or fall in the cost of wages or equipment, for example, affects
profits.
o Competition: The strength of competitors can affect the profitability of energy
companies.
o Interest rates: Changes in interest rates can affect the cost of debt servicing. This factor
is especially important to utility companies with huge infrastructure financing costs.
o Local Economies: The relative strength of the economy where a company sells its
products can impact its profits.
o Multiple Contraction or Expansion: The market assigns price/earnings multiples to
companies based on perceptions of future prospects. Changes to these multiples can
cause fluctuations in share prices.
Markets
 Power is traded on different marketplaces.
 In general, the power delivery timeframe and the form of the transaction
characterize how the marketplaces are defined.
 Since power cannot be stored in large quantities, power trading is conducted using
either short-term trades or long-term agreements, in which the power has yet to
be produced.

A) OTC
o In Over The Counter (OTC) trading, power is directly traded between two parties
which prices and trading volume are agreed in bilateral negotiations.
o OTC trading is the most common form of power trading, especially in the
conventional power industry.
o It is less common in the renewable energy industry.
B) Power Purchase Agreements
o A power purchase agreement (PPA) often refers to a long-term electricity supply
agreement between two parties usually a power producer and a customer (such as
an electricity consumer or trader).
o A power producer is usually seeking long-term income with a PPA, while the a
power consumer is seeking long-term power provision.

C) Short-term power trading

o In today’s power trading, power exchanges are common especially in Europe.
o While participants on the exchanges trade anonymously, the exchanges general
framework provides a transparent system for multilateral trading.
o Power exchanges operate in a similar ways to regular stock exchanges.
o These exchanges are used to buy and sell power on short notice to meet demand.
o Usually, these transactions are needed to level out forecast deviations in both
consumption and production
D) Renewable power trading – Feed-in Premiums

o Renewable power producers are usually too small, in terms of installed power
and trading expertise, to directly trade their produced power on energy markets.
o To enable renewable energy resources to integrate into the market, various
subsidy schemes or Feed-in Premiums (FIP) are used.
o A FIP is different from a FIT. A FIT refers to a subsidy that is paid for feeding-in RE,
this power is traded by the TSO or the DSO and effectively means that the FITs
socialize the risk. A FIP on the other hand refers to a subsidy that is paid when
power is sold on power exchanges either by the asset owners directly or by a
third –party aggregator.
Energy Trading Reporting
 Energy trading is subjected to regulations that originally applied to financial markets,
including the market abuse regulations (MAD and MAR), the European Market
Infrastructure Regulation (EMIR), as well as rules specifically designed for the energy
market, such as the Regulation on wholesale Energy Market Integrity and Transparency
(REMIT).
 The objective of REMIT is to increase integrity and transparency in the wholesale
energy market and to foster competition for the benefit of final consumers of energy,
whilst EMIR aims to reduce systemic risk by increasing market transparency and to mitigate
counterparty risks.
 The purpose of reporting energy derivatives is to efficiently and effectively monitor energy
trading and to detect and prevent suspected market abuse.
 Monitoring is essential to ensure that end consumers and other market participants have
confidence in the integrity of electricity and gas markets, that prices set on wholesale
energy markets reflect a fair and competitive interplay between supply and demand
and that no profits can be drawn from market abuse.
 Also, insight into activities of parties that may entail a systemic risk is mentioned as a goal of
transaction reporting.
 PPP Arrangements/Types of PPP Agreements
 Public-private partnerships (PPPs) take a wide range of forms varying in the extent of
involvement of and risk taken by the private party.
 The terms of a PPP are typically set out in a contract or agreement to outline the
responsibilities of each party and clearly allocate risk.
 Most PPP projects present a contractual term between 20 and 30 years; others have
shorter terms; and a few last longer than 30 years.

BOT – Build-Operate-Transfer; DBO – Design-Build-Operate

PPP contract
o A PPP contract is the contractual documents that govern the relationship between the
public and private parties to a PPP.
o In practice, the PPP contract may comprise more than one document. For example, a PPP
to design, build, finance, operate, and maintain a new power plant, with power supplied in
bulk to a government-owned transmission company may be governed by a power purchase
agreement (PPA) between the transmission company and the PPP company, as well as an
implementation agreement between the responsible government ministry and the PPP
company.
o Each agreement may, in turn, refer to schedules or annexes to set out particular details, for
example, detailed performance requirements and measures.
o In addition to the PPP contract, there will also be numerous contracts between the SPV and
its suppliers and financiers. Chief among them would be financing agreements between
the SPV and its lenders, and shareholder agreements between equity investors.
PPP contract design
In designing a PPP contract, the following areas must feature;
o Performance requirements—defining the required quality and quantity of assets
and services, along with monitoring and enforcement mechanisms, including
penalties.
o Payment mechanisms—defining how the private party will be paid, through user
charges, government payments based on usage or availability, or a combination, and
how bonuses and penalties can be built in.
o Adjustment mechanisms—building into the contract mechanisms for handling
changes, such as extraordinary reviews of tariffs, or changing service requirements.
o Dispute resolution procedures—defining institutional mechanisms for how
contractual disputes will be resolved, such as the role of the regulator and courts, or
the use of expert panels or international arbitration.
o Termination provisions—defining the contract term, handover provisions, and
circumstances and implications of early termination
Carbon Pricing
 There are several paths governments can take to price carbon, all leading to the same
result.
 That is, the external costs of carbon emissions (costs that the public pays for in other
ways), such as damage to crops and health care costs from heat waves and droughts
or to property from flooding and sea level rise and tie them to their sources through a
price on carbon.
 A price on carbon helps shift the burden for the damage back to those who are
responsible for it, and who can reduce it.
 Instead of dictating who should reduce emissions where and how, a carbon price gives
an economic signal and polluters decide for themselves whether to discontinue their
polluting activity, reduce emissions, or continue polluting and pay for it.
 In this way, the overall environmental goal is achieved in the most flexible and least-
cost way to society.
 The carbon price also stimulates clean technology and market innovation, fuelling
new, low-carbon drivers of economic growth.
There are two main types of carbon pricing: emissions trading systems (ETS) and
carbon taxes.

Emissions Trading Systems

 An ETS – sometimes referred to as a cap-and-trade system, caps the total level of
greenhouse gas emissions and allows those industries with low emissions to sell their extra
allowances to larger emitters.
 By creating supply and demand for emissions allowances, an ETS establishes a market price
for greenhouse gas emissions.
 The cap helps ensure that the required emission reductions will take place to keep the
emitters (in aggregate) within their pre-allocated carbon budget.
 For example, Clean Development Mechanism (CDM), defined in Article 12 of the Kyoto
Protocol, allows a country with an emission-reduction or emission-limitation commitment
under the Protocol (Annex B Party) to implement an emission-reduction project in
developing countries. Such projects can earn saleable certified emission reduction (CER)
credits, each equivalent to one tonne of CO2, which can be counted towards meeting Kyoto
targets.
Carbon Taxes
 A carbon tax directly sets a price on carbon by defining a tax rate on greenhouse gas
emissions or, more commonly, on the carbon content of fossil fuels.
 It is different from an ETS in that the emission reduction outcome of a carbon tax is not
pre-defined but the carbon price is.

 The choice of the instrument will depend on national and economic circumstances.
 There are also more indirect ways of more accurately pricing carbon, such as through fuel
taxes, the removal of fossil fuel subsidies, and regulations that may incorporate a “social cost
of carbon.”
 Greenhouse gas emissions can also be priced through payments for emission reductions.
Private entities or sovereigns can purchase emission reductions to compensate for their own
emissions (so-called offsets) or to support mitigation activities through results-based finance.
 Some 40 countries and more than 20 cities, states and provinces already use carbon pricing
mechanisms, with more planning to implement them in the future.
 Together the carbon pricing schemes now in place cover about half their emissions, which
translates to about 13% of annual global greenhouse gas emissions.
Thank you