Commentary: Energy investment in emerging economies: transforming Southeast Asia’s power sector



1 November 2019

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Whichever pathway the region takes, meeting Southeast Asia’s energy needs and priorities will require higher levels of investment, including enhanced efforts to attract private capital.

The financing gaps and opportunities differ starkly by scenario. Under today’s policy settings, the region’s investment needs over the next two decades total $2.5 trillion while under a more sustainable pathway (i.e. consistent with the Paris Agreement) they rise to near $3.3 trillion. Sizeable reallocation of capital from fuels towards power and efficiency will be needed, particularly under a sustainable pathway, where renewables spending quadruples. 

	Energy efficiency and end-use	Oil supply	Gas supply	Coal supply	Biofuels	Fossil fuel power	Renewable power	Electricity networks	Other power
SDS	40.80107002								
STEPS	17.61970044								
2018	4.05467793								
SDS		7.775718123	17.28581	0.379452408	1.027321955				
STEPS		12.79788759	23.08473136	1.618683614	0.439040909				
2018		13.1989573	12.546493	1.9942095	0.430921				
SDS						4	41	30	1
STEPS						10	15	32	1
2018						13	9	11	0
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Bridging investment gaps with more private finance

The energy investment situation is most acute in the power sector, where a number of systems are under financial strain. To date, public actors – including state-owned enterprises and public financial institutions – have provided the bulk of funding, particularly in thermal generation. By contrast, wind and solar PV projects have relied much more on private finance, spurred by specific policy incentives. In addition, funding for over three-quarters of generation investment has come from within the region. This landscape reflects prevailing decision-making frameworks, which have revolved around state-owned utilities and the distortionary impact of energy subsidies.

Sources of finance for power generation investment in Southeast Asia (by year of FID, 2014-2018)

	Public	Private
Coal and gas power	42.423	25.148
Hydropower and geothermal	9.893	5.800
Utility-scale solar PV and wind	0.629	10.515
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Notes: FID = final investment decision. Includes only utility-scale projects ≥ 25 megawatts. Public finance includes the participation of state-owned enterprises, development finance institutions, export-credit agencies and other public entities.

Public and regional sources alone cannot cover the sizeable investment needs ahead. Sustained and balanced access to international and domestic sources of private finance, complemented by limited public sources, would better help Southeast Asia fund its energy goals. This requires reforms and greater policy focus on tackling the risks facing investments, especially in renewables, flexibility assets and efficiency. With the dramatically improved economics of renewables in many parts of the world, the region now has a window of opportunity to transform its investment environment. The Outlook points to efforts needed across four priority areas, while recognizing that market conditions and underlying risks differ starkly by country:

  • enhancing the financial sustainability of the region’s utilities;
  • improving procurement frameworks and contracting mechanisms, especially for renewables;
  • creating a supportive financial system that brings in a range of financing sources and
  • promoting integrated approaches that take the demand-side into account.

 

Priority 1: Enhancing the financial sustainability of the region’s utilities

The region’s utilities, mostly state-owned, function as the primary counterparty to private generators and are the main investors across the power sector. Their financial sustainability depends on their ability to recover costs, which is influenced by customer connections, operational performance and regulatory frameworks. Cost-recovery varies across Southeast Asia markets, with particular challenges related to setting retail tariffs in a way that balances system needs and affordability for consumers. For example, despite improved borrowing conditions for Vietnam Electricity (EVN), financial performance is tenuous and tied to government decisions on electricity prices, which remain low by international standards. By contrast, in Malaysia, a combination of improved operations, better financing and regulations for cost-pass-through supports a relatively high level of per capita investment for grids.

	Revenues	Government subsidy	Purchased power (IPPs)	Fuel costs	Other costs	Op. income (subsidised)
2013	12.20	7.68	-0.80	-11.21	-4.77	3.11
2014	14.4137839	7.400221398	-3.988179817	-11.41198516	-4.37121064	2.042629673
2015	16.02572502	4.169808503	-0.920662892	-10.20531086	-5.50636201	3.563197766
2016	16.25158713	4.233403185	-4.833751105	-7.985860253	-5.738762335	1.926616618
2017	18.27272478	3.273706962	-5.655760774	-8.370525734	-5.690736981	1.82940825
2018	19.16828795	5.006358399	-6.219011995	-9.641586593	-5.786533138	2.527514627
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	No tariff rises + thermal capacity expansion in STEPS	2.6% annual tariff rise + thermal capacity expansion in STEPS	1.8% annual tariff rise + higher thermal utilisation, less expansion
2019	4.039118699	3.556914122	3.492372198
2020	4.454472982	3.376092711	3.221254939
2021	4.667830935	2.938512029	2.725718936
2022.00	5.24	2.79	2.21
2023.00	5.18	1.92	1.61
2024.00	5.23	1.10	0.90
2025.00	5.12	0.00	0.00
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Underperformance can put pressure on government budgets, as in the case of Indonesia. Following several years of improvement, increased financial pressure on PLN, due to rising power purchase and fuel costs in the face of frozen retail tariffs, prompted a year-on-year boost in government subsidies in 2018 (equivalent to 3.2% of total state spending). Looking ahead, PLN’s subsidy burden could be reduced through more cost reflective electricity tariffs, but changes to retail prices could be tempered through better utilisation of existing generation, more focus on slowing demand growth and less dramatic expansion of capacity with contractually onerous terms.

Priority 2: Improving the bankability of projects, especially for renewables

Investment frameworks for power generation have evolved considerably, but further reform could help improve bankability. While independent power producer (IPP) investments are playing an increased role, these have come mostly through administrative mechanisms, such as direct negotiation with utilities, which are often not transparent in terms of price formulation. Price incentives (e.g. feed-in tariffs) under licensing schemes have driven most investment in renewables, but their design is not always effective; in some cases (e.g. Indonesia) tariffs have been set too low to attract investment at current project costs. Competitive auctions, which can provide transparent price discovery and clear risk allocation through contracts, have helped drive down renewable purchase prices around the world, but most Southeast Asian countries have been slow to adopt this mechanism.

	Utility developed project	IPP - Direct negotiation	IPP - Competitive bidding	IPP - License scheme	IPP - Corporate buyer
2014	65.14	31.39	0.00	18.92	0
2015	59.60	39.01	21.63	1.99	0.03296
2016	67.13	11.02	42.00	17.98	0
2017	70.42	23.00	3.55	58.03	0.1538
2018	29.74	29.95	37.75	51.59	0.66
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Notes: LCOE = levelised cost of electricity and is expressed on a nominal, unsubsidised basis. Assumed capital costs = $1 090/kilowatt (kW) for solar PV and $2 080/kW for onshore wind. Assumed capacity factors = 17% for solar PV and 30% for onshore wind (South central Coast). Projects reflect capital structure of 70% debt/30% equity. Higher financing assumptions assume before-tax cost of debt of 6% and required return on equity of 16%. Low financing costs correspond to 3% for debt and 7% for equity.

The case of Viet Nam illustrates challenges and opportunities in terms of policy design and bankability. Despite attractive feed-in tariffs – which spurred a boom in solar PV deployment (mostly by local developers) in the first half of 2019 – financing costs are relatively high and international banks remain reluctant to lend to renewables projects. This stems from risks associated with the power purchase agreements, including areas related to dispatch and payments, as well as concerns the adequacy of local grids to accommodate a rapid increase in variable generation. Better policy design, system integration and contractual measures could help to improve the affordability of investments. With financing terms equivalent to those found in more mature markets, generation costs for solar PV and onshore wind could be around one-third lower.

Priority 3: A supportive financial system to reduce the cost of capital for clean energy

As changing financing conditions make investment in some legacy parts of the power system more difficult, more effort is needed to cultivate a supportive financing environment for newer technologies that would support capital reallocation—while ensuring security of supply Final investment decisions for coal power in the region fell to their lowest level in over a decade in 2019 (reflecting a mixture of increased financial scrutiny by banks and overcapacity concerns). There has been a reduction in the number of financiers involved in transactions in the past three years, while IPP projects that have gone ahead continue to rely on a high share of international public finance.

	Indonesia	Viet Nam	Philippines	Rest of Southeast Asia
2010	1.34	4.30	0.02	2.00
2011	1.02	1.24	0.02	1.13
2012	1.76	2.36	0.08	1.10
2013	0.87	0.00	1.50	1.07
2014	0.31	4.52	1.79	2.67
2015	1.39	4.20	1.0985	0.834
2016	3.54	0.63	1.775	0.026
2017	2.60	1.32	0.74	0.16
2018	0.13	1.43	0.00	0.00
2019 1H	0.45	0.00	0.00	0.04
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	International commercial	International public	Regional commercial	Regional public	Lenders (right axis)
2015	1138	0	3245.788889	308.1111111	26
2016	1217	5323	1719	225.4	24
2017	2407.6	4999	802	73	21
2018	653	724	492	0	9
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Notes: GW = gigawatts; 2019 1H = first half of 2019. Regional sources of finance include domestic financiers and those in other Southeast Asian countries. Sources: IEA analysis with calculations based on McCoy Power Reports (2019) and World Bank (2019).

Sources: IEA analysis with calculations based on McCoy Power Reports (2019) and World Bank (2019).

At the same time, mobilising capital in newer areas requires improving the cost and availability of finance. The average loan duration in Southeast Asia is just over six years, far less than the lifetimes of energy and infrastructure assets. The cost of capital for an indicative IPP varies widely – with estimates in Singapore, Thailand and Malaysia at 3-5% (nominal, after-tax), while those for Philippines, Viet Nam and Indonesia are much higher (7-10%). Investors cite limited availability of early stage project development equity and long-term construction debt for renewables and storage, though some dedicated funds, such as the Southeast Asia Clean Energy Facility, are emerging to fill the gap.

Priority 4: Integrated approaches to investment that address the demand side

Integrated approaches to investment, which take into account the demand side, could help to address rising consumption needs more cost-effectively. This is particularly true in fast growing areas, such as demand for cooling, which is a major driver of supply requirements during peak periods. But there are barriers to financing efficiency due to the small transaction sizes and challenges in evaluating the creditworthiness of consumers. Low and subsidised retail power tariffs can also distort the investment case.

Addressing information barriers, enhancing financing models and reducing subsidies would better support investment. For example, energy service companies are addressing the scale challenge of investment and have become well established in markets with long-term savings targets and supporting regulations, such as in Malaysia, Thailand and Singapore. Targeted use of public funds, insurance and capacity building can help reduce performance-related risks, as in Indonesia’s Energy Efficiency Project Finance Program. Progress in aggregating and securitising projects, through green bonds for example, could also help attract lower cost finance from a bigger pool of investors. Despite picking up in 2018, with over 40% targeting low-carbon buildings, Southeast Asia accounts for only 1% of global green bonds issuance to date.

Higher investments can be compensated with multiple benefits

Overall, achieving Southeast Asia’s energy goals will call upon stronger policy ambitions across a range of energy sources and significant new capital commitments in the years ahead. These efforts would also yield multiple benefits – in the Sustainable Development Scenario, average annual capital spending of around $150 billion over 2019-40 (higher than the $120 billion under the State Policies Scenario), is offset by the nearly $200 billion that Southeast Asian economies save annually on fossil fuel imports by 2040. Such financial savings would come in addition to improved local air quality and universal energy access, as well as a reduced contribution to global climate change.

There is now an opportunity for investors and companies in Southeast Asian countries to engage with governments in order to encourage financial decisions and policy making that are better aligned with sustainability goals. This includes not just traditional utilities, developers and banks, but also the crucial perspectives of development finance institutions and the institutional investors, whose participation will be critical to funding the region’s energy goals.

As the world’s “All-fuels and All-technologies” energy authority, the IEA will continue to assist ASEAN Member States to tackle their energy policy challenges, including through good data and analysis, training and capacity building and engagement with such communities.