Considering political risks when investing in renewable energy

• As the global economy recovers from the pandemic, a combination of growing energy demand and increasingly more ambitious (and enforced) emissions reduction targets are encouraging renewable investments in advanced, emerging and even more frontier markets.
• Significant technological improvements have resulted in a dramatic reduction in the costs associated with green electricity. Further technological breakthroughs are expected in transportation and heating technologies and in the production of green hydrogen, thus improving the prospect of good investment returns. In many regions the cost of renewable energy is now below its fossil fuel-based alternatives.
• Public support for more decisive climate change mitigation action is changing consumer behaviour and increasing pressure on investors – including limited partners and public investment funds – to make the funds they invest in and their own portfolios greener and more sustainable.

• Volatile regulatory environments: Governments around the world are upgrading their climate change mitigation targets and rolling out new incentives (and constraints) for attracting FDI in RES projects.
• Public procurement processes: Governments increasingly rely on competitive auctions for distributing additional renewable energy capacity to foreign investors. In countries with less developed – and at times corrupt – public procurement systems, investors need to navigate complex decision-making processes while managing financial crime and reputational risks.
• Community relations: Investors need to take into consideration local residents’ concerns about the social and environmental impacts of large-scale RES projects. There is also potential for such projects (and local concerns) to become politicised at the regional and national levels, posing new risks to investors.

Subsidies start to subside

The most significant regulatory risk for investors relates to the stability of subsidy regimes. For many years, European governments subsidised RES projects to ensure their financial viability and attractiveness to private investors. However, growing financial burdens from these subsidies and technological advances that made renewable generation cheaper are compelling governments to abandon subsidy schemes – such as feed-in-tariffs (FITs). They are being replaced with other market-based competitive schemes where investors face greater risk exposure to wholesale electricity prices. In China, the government has phased out wind and solar PV subsidies and from 2021 new projects will be subject to long-term tariffs, which are fixed at provincial benchmark electricity prices set by the government.

As these changes are often driven by national and local politics, investors need to understand governments’ track records in supporting and implementing subsidy policies and the outlook for future policy changes in this area as a result of election outcomes or changes in fiscal and environmental policies.

Broadening compliance challenges

Changing regulations also impact operational and compliance strategies for renewables investments. European and US investors increasingly have to comply with new ESG requirements covering not only their projects, but their global supply chains. Renewable energy investors may soon face new sanctions risks, as the US administration has threatened to target some equipment suppliers for solar PV projects. Other countries are taking steps to regulate the production and export of rare earths and minerals that are important components in renewable infrastructure and supply chains. Finally, renewable energy investments are increasingly subject to foreign investment screening laws in the US and Europe, particularly if these investments originate from non-Western jurisdictions.

Beyond one country or one sector

All these developments indicate that in order to mitigate risks effectively, investors need to analyse their exposure to regulatory changes beyond a single country jurisdiction, as well as across a range of sectors.

Hydrogen is an example of how risks and rewards in renewables are indirectly affected by regulations in a range of other sectors. Policymakers will set thresholds for CO2 emissions when defining what constitutes “clean (green) hydrogen” under the EU taxonomy, which in turn will impact renewable energy required for its production. Such thresholds may change or vary country to country. Other examples of sector regulations indirectly affecting renewables include electric vehicle (EV) subsidies and energy efficiency requirements for buildings.

Investors can mitigate regulatory risks by conducting policy-focused due diligence and country-specific scenario planning at the early stages in the investment cycle. In addition to understanding the existing regulations (and comparing them across different regions), it is important to assess how these are likely to be impacted by elections, high fiscal deficits in the wake of COVID-related recessions, and the potential for political instability.

Auction action

Auctions to procure a particular capacity of solar PV- or wind-generated electricity have become the preferred option to provide incentives to investors. After evaluating price bids, a government signs a long-term power purchase agreement with the successful bidder. According to the International Renewable Energy Agency (IRENA) the number of countries that have adopted renewable energy auctions increased from five in 2005 to more than 100 in 2019. The European Bank for Reconstruction and Development (EBRD) has issued guidelines for such auctions that offer a summary of best practices.

However, these auctions could be challenging for investors with little on-the-ground experience in a particular country, or when their ability to travel is limited. In many emerging markets with weak public procurement legislation, practices and oversight, decisions can be politicised or prone to corruption due to nepotism, poorly enforced property rights, and the lack of a functioning competitive market in the energy sector. Although auctions often award long-term contracts to investors, some investors may still face pressure to renegotiate their contract conditions or may encounter difficulties in securing land and other permits to effectively implement their projects.

Know your stakeholders

It is important that investors understand the dynamics around who is making decisions over contracts and how they compare to their competition. Sector-specific stakeholder mapping can help to understand networks of influence around specific procurement decisions, which often involve relationships between governments, landowners, and powerful energy sector lobbies.

Local influence also a factor

Local governments can also have a considerable influence over projects – both positive and negative. While they often offer additional incentives to investors and a good overall investment climate, they can put up barriers that pose significant challenges to project implementation. In India, power producers, including renewable companies, in states such as Andhra Pradesh and Punjab have suffered significant payment delays and tariff rate renegotiations because of changes in government at the state level.

Wild ones

And it’s not just human residents that create challenges for project implementation. The Supreme Court of India in April 2021 passed what is perceived as a landmark judgement asking wind and solar companies to take their power lines underground to avoid potential danger to wildlife in the vicinity of power plants. Activists across the country are coming together to underscore the serious threat the renewable sector can cause to the environment. Koyna Wildlife Sanctuary in Maharashtra, for instance, has one of the largest wind farms, which has impacted biodiversity. Wind farms in the Gulf of Khambhat in Gujarat threaten to impact marine biodiversity. Andhra Lake Wind Farm, close to Bhimashankar Wildlife Sanctuary in Maharashtra, has led to the felling of trees and diversion of forest land.

Wildlife welfare concerns – including behavioural changes, impact on habitats and direct mortality – are also increasingly causing delays to RES projects in European countries. Planning permission for solar projects, which commonly need large plots of land, and for offshore wind projects, which impact bird migration and habitat, often require complex and lengthy assessments. Onshore wind projects have attracted considerable public backlash in many European countries, including Germany, because of some residents’ perceptions about the noise they generate or their negative impact on the countryside landscape and tourism.

Who holds the power?

In order to manage community relations effectively, project developers need to understand local power dynamics to assess which groups are likely to be most affected by the project and which groups exert most influence with local governments and regulators. It is also important to start community engagement early to avoid potential conflicts, which can leave a lasting legacy.

An overall strategy required

These at-first-glance local issues are increasingly being politicised at the regional and national level, which means renewable energy investors and operators need to start to think about how to manage these issues not just in relation to individual projects, but in developing their overall market and ESG strategies for individual countries, and in conducting and resourcing their government relations.