Cost of capital survey shows investments in solar PV can be less risky than gas power in emerging and developing economies, though values remain high

After years of low interest rates, particularly in advanced economies, borrowing costs are now high in most parts of the world aside from China. For instance, the US Federal Reserve – a global benchmark for financing costs – has increased interest rates 11 times since March 2022, reaching a target rate above 5%, compared to just over 1% in February 2022. Rising interest rates elevate financing costs, which not only impact advanced economies but also emerging and developing ones, where such costs are at least two times higher.

Clean energy technologies typically have higher upfront capital costs and lower operating expenditures, highlighting the importance that cost of capital as an enabler of the energy transition. Yet, collecting data on the cost of capital in emerging and developing economies is challenging given that capital markets are less developed, there are fewer projects, and a lack of transparency around risks. For this reason, the IEA launched the Cost of Capital Observatory in 2022, to gather – through surveys – data on cost of capital for clean energy projects in emerging and developing economies. In 2023, we conducted a second survey which includes more countries and technologies. 

This year, we broadened our scope both in terms of geographical reach and technology. In addition to the five countries we focused on last year – Brazil, India, Indonesia, Mexico and South Africa – we collected data from other countries, including Kenya, Peru, Senegal and Viet Nam. We also added two new technologies to the Observatory, utility-scale batteries and offshore wind, alongside the established domains of solar PV and gas power projects.

Our findings reveal that in almost two-thirds of cases, the weighted average cost of capital (WACC) for utility-scale solar power projects was either the same or lower than those for gas-fired projects. The finding was based on responses from institutions that answered both this and last year’s surveys, and covers WACC for projects reaching final investment decision (FID) over three years: 2019, 2021 and 2022. Assuming other parameters remain the same, the result is that utility-scale gas-power projects are perceived as an equal or riskier investment than utility-scale solar PV projects. This can be the result of higher climate-related risks associated with gas power projects, more uncertain demand or fuel prices, as well as more policy support for renewables in general and solar PV in particular. When comparing responses of utility-scale batteries, for projects taking FID in 2022, we found that the WACC for batteries was higher or equal to that of solar PV projects. This trend emerged primarily from the hybrid nature of the projects in the survey, with solar and storage projects increasingly in demand. This year’s survey also shows that nine out 10 respondents expect increases in the cost of capital in emerging and developing economies in 2023.

By differentiating the underlying contractual structure, our indicative results show that projects financed on a merchant basis (without any form of price guarantee outside the electricity wholesale markets) present higher WACCs than those financed through revenue-supported mechanisms such as power purchase agreements (PPAs), feed-in tariffs (FiTs) or contract for differences (CfD). These results are consistent with expectations as merchant projects have higher revenue-related risks due to less price certainty and less developed wholesale markets in emerging and developing economies, despite limited data for this comparison. Notably, approximately 90% of responses in our Observatory pertained to projects supported by PPAs, FiTs and CfDs.

Investors and financiers identify political, currency, regulatory, off-taker and transmission risks as the five key risks that should be addressed first to achieve reductions in the cost of capital in emerging and developing economies. The first two relate to country-wide issues, which apply for energy investments and beyond, while the latter three correspond to sector-specific risks. Other risks mentioned include sovereign risk and concerns around land rights. The ranking of top risks also varies a bit by country.

Persistently high cost of capital in emerging and developing economies, coupled with anticipated increases in 2023, presents a worrisome trend. It suggests ongoing challenges in accessing affordable financing for clean energy projects in the parts of the world that most need them. Such conditions not only impede economic progress but also exacerbate disparities between advanced and developing economies, amplifying the struggle to achieve sustainable growth and resilience in these vital global sectors.

Lowering the cost of capital in emerging and developing economies stands as a pivotal factor in facilitating the global energy transition. Local governments and international stakeholders (development finance institutions in particular) have an important role to play to help improve sector regulation, accelerate transmission investments and improve the creditworthiness of off-takers. By reducing the cost of capital, these economies can attract more investment and accelerate the implementation of clean energy projects at a larger scale. This reduction not only stimulates economic growth but also enhances energy security, reduces carbon emissions, and fosters technological innovation.

During the Summit for a New Global Financing Pact convened in Paris in June 2023, the IEA received a mandate to develop recommendations to reduce the cost of capital for clean energy projects in emerging and developing economies. We are currently working to develop these recommendations, which will be presented to Ministers from the IEA Family in at the IEA’s 50th anniversary Ministerial Meeting in February 2024. The report will provide indicators for a lower cost of capital in investments, flows of international capital and other metrics, as well as recommendations specific to the different sectors within the clean energy space. These range from policy suggestions to financial mechanisms needed to reduce risk perceptions in emerging and developing economies.