14 May 2019 | GET.invest has been linking renewable energy projects to finance opportunities and vice versa via its Finance Catalyst service. In this interview, Michael Feldner, a senior advisor of the GET.invest Finance Catalyst team, speaks about financing challenges, the situation of project developers, and how GET.invest can assist. The contents of this article are considered to be the personal opinion of the advisor and do not necessarily reflect the views of GET.invest’s donors.
What has been your most satisfying project and most satisfying task working for the GET.invest Finance Catalyst to date?
Michael Feldner (MF): A “large” mini-grid portfolio in Southern Africa.
MF: The project is grounded in a lot of sound technical data, for example load profiles for similar villages and ramp-up demand assumptions. So, the technical backdrop is sound, which makes building financial models and working on the remaining project development easier and more enjoyable. Second, the challenges of this project forced us to innovate in the financial modelling area and reach out to new contacts.
What was the main challenge on this project so far and why?
MF: The financial model. We had done financial models for single mini-grid projects before, but this was a model for a portfolio of mini-grids. The bundling adds complexity from a financial modelling viewpoint especially with regards to disbursement timing, but bundling makes these projects more attractive to finance, since it reduces transaction costs.
So, bundling is a way to solve the financing needs of projects too small to attract finance individually?
MF: Exactly. And you could use the concept to further reduce risk by diversifying income streams across regions, countries, currencies and so on, by including sufficiently diverse projects in your portfolio.
What other challenges did you face in building this financial model?
MF: The developer, who is an engineer, had previously built a financial model that was not in the right “language” – not in the language spoken by financiers and not aligned with their priorities. This was creating difficulties in his getting funding. An example of how we solved this was adding in a tariff-optimisation macro, which takes all Capex, Opex and funding variables into account to calculate the lowest possible tariff per kWh for the consumer at a given return profile. So equity investors, who have that “arbitrary” hurdle rate of 20% or 25%, can now go to their investment committee and say, “if we reduce this requirement, we can sell electricity at a more affordable rate”.
So, is this project now seeing financing commitments?
MF: Yes, and this is hugely satisfying. The process of fundraising for a project such as this one is a long and windy road. One funder would like to see a pilot working before committing, the other wants an affordability study and the third wants to have returns guaranteed. All these requests are reasonable. But combined they can easily add a year and a million dollars to the project. To some extent it’s the inflexible mandates of financiers that can drag the process out and make it expensive. At GET.invest, we are geared for that and we have made a point of not promising a financial close date. I think we are at an 80% commitment level now and with a bit of haggling this will get to 100% soon (soon being a relative term). That is satisfying, because this project was at 0% when we were asked to get involved.
Looking beyond this one example, what kind of people are developing the projects that you support?
MF: First, they are brave. It takes courage to want to become a renewable energy project developer in Africa. When I was involved with a venture capital fund where we supported a lot of mining projects, the mining developers were predominantly motivated by money. But in this sector, a developer who is primarily motivated by money will disappear quickly: there are easier ways to make a living. So, the people we work with usually want to make a contribution either toward mitigating climate change or alleviating poverty through energy access, or both. We need to respect their motives and treat these developers differently.
What do you mean by “treat developers differently”?
MF: Many of the smaller developers are struggling to stay afloat as the project development process drags on. Some have to juggle side-jobs and some exhaust their savings and can reach a frightening point of desperation. We should be supporting them as much as possible. At the moment investors and development-finance institutions have few instruments to help here. In fact, many early-stage funders even require an equity contribution from developers and don’t recognise sweat equity as such. Furthermore, most funds are not allowed to be used for salaries or developer expenses. We need to change this mentality and support developers more generously in this difficult early stage, if we want to see more high-quality projects being proposed.
But there are more and more programmes out there now to support early-stage project development.
MF: It’s true that there are now more programmes with more money than ever before, but there are also more projects. Also, they are extremely slow to disburse funds: it should not take a year to receive grant approval, it should not require the most archaic procurement processes to spend grant funds and it should not take a specialist to get through the process.
Isn’t there a risk of these funds going to weak developers or dishonest individuals if we lower the barriers to access these funds?
MF: Of course, support providers will still need to spend time on due diligence and on know-your-client, but it would help if they strengthened their assessment of individuals, scale-up potential, sustainability and so on. The dishonest individuals, as you call them, are not so difficult to spot; a face-to-face meeting usually reveals all. We don’t have enough face-to-face meetings. That is probably the root of many of our problems.
So, this leads to too much money chasing too few financially viable projects?
MF: Yes. But there’s more to it than that: we are also defining “viable projects” too narrowly. The rules of financing are not adapted to what we are trying to achieve. Indicators like payback periods, IRR and so on are designed to preserve capital, not for quick climate change action. The sustainable development goals and their associated measurements remain an afterthought: they are not currency, but they should be. So, prudence and profitability remain the highest priority and we prioritise financial returns over environmental or developmental priorities.
We have spoken about project developers and financiers. What about your experiences with the other key actors like regulators and local banks?
MF: Despite all the policy support that has been provided, I still see huge gaps in policy, regulation and local financial sector capacity. Take policy for example: business models for energy projects are evolving continuously; consider “net metering”, “concessions” and “feed-in-tariffs” as examples. These are all relatively novel concepts which have not yet been fully incorporated in energy policies. Similarly, financial institutions often have difficulty keeping up with organisational, legal and institutional developments in the sector. We need more hands-on training and practically relevant capacity building for all of these: policy-makers, regulators, bankers and pension fund managers. It’s an ecosystem and should be treated as such.
You have mentioned one example of a project where support from the GET.invest Finance Catalyst was particularly rewarding. What about failures?
MF: There have been a few; usually these are due to structural problems that are beyond our influence, for example a utility scale project in a country where sovereign guarantees are worthless. If the sovereign guarantee issue cannot be fixed, the project is stuck. We need special teams of experts working on such issues, rather than a collective shrugging of shoulders.
Has the inadequacy of the framework conditions been a recurring problem?
MF: The problem affects large projects primarily: the regulatory, technical and legal setup in most of sub-Saharan Africa is not conducive to big projects. Small projects are more easily viable as they don’t require large grid infrastructure, co-ordination between government departments and so on. It is not helpful that many funds say “we fund 50MW upward projects”, when there are only a handful of those on the whole continent and those are all oversubscribed. Ten 5MW projects, more widely disbursed are easier on the grid than a single 50MW plant, and fit more easily into the budget of a severely indebted country. This shift requires a change in mindset by development finance institutions: looking to what makes sense from the demand side rather than disbursement priorities.
Returning to the project developers themselves, what are their greatest needs in terms of support services from the Finance Catalyst and similar programmes?
MF: This can be answered easily: financial modelling, contract law and transaction advice.
Let’s take those one at a time: financial modelling.
MF: Every project needs a financial forecast. The more of a standardised product we can offer there the better. Recently a financial modelling code has been adopted by some key players and I am a real fan of the concept. A financial modelling code defines the “grammar” of financial models. It keeps people calculating the same indicators in the same way and being transparent about their figures.
And contract law?
MF: Contracts are a big part of project development and legal expertise is expensive. This is compounded by the sheer number and volume of contracts required by energy projects: land leases, joint development agreements, PPAs, loan agreements, EPC contracts, just to name a few. Large developers have the resources to have contract lawyers at their disposal, but smaller developers and projects need sound contracts just as much. Contract law advice should be a free service offered by the donor community and governments.
And finally, transaction advisory services…
MF: In most projects, at one point you need to understand corporate and project finance principles. That means speaking financing language, as I mentioned before, but knowing what needs to be included in financing agreements, term sheets and so on. The inexperienced developer judges a contract by what he reads and not by what was left out. An experienced advisor can see both what is there and what is not, and say for example, “There should be a penalty clause here, I don’t see one, let’s add it in”.
So how do you see the future? Is universal energy access by 2030 within reach?
MF: The additional attention that the energy access sector has received is welcome, as is the introduction of more financial instruments, albeit that it makes the space more confusing as well. Many of the resources currently available are aimed at pulling private sector players into the space. This is an important element in facilitating scaling up, but it is not the only area that needs increased attention. I suspect that we have moved a little too far towards commercial financing and that in order to reach the ambitious SDGs, we need to more aggressively scale-up our existing efforts in capacity development, partial subsidy schemes and the provision of policy support.
💡 The greatest hurdles in the project development cycle to overcome are proper financial modelling, negotiating contracts and conducting financing negotiations. Project developers should be provided with financial and in-kind support targeting these activities.
💡 Bundling is a key mechanism for making rural electrification projects bankable by increasing size and diversifying risks. Larger portfolios can be created through project redesign and partnerships.
💡 Support facilities such as the GET.invest Finance Catalyst provide a “translation service” between project developers and financiers. This requires close relationships and partnerships with both groups.
💡 Financiers should minimise their demands on project developers’ time and resources, in conducting project analysis and due diligence. Required information should be made clear and transparent at the outset of discussions.
💡 Support programmes need to become more flexible in funding all early stage project development activities and be less bureaucratic in their fund application processes.
💡 Size thresholds of development finance funds and institutions and support programmes should be aligned with development priorities rather than aimed at minimising transaction costs.
💡 Project developer support needs to be coupled with capacity-building for policy-makers and the financial sector.
💡 More face-to-face meetings are required for all financing decision processes and project development support.
💡 The definitions of project viability should be broadened to include and value sustainable development goals.