Outlook for energy in emerging markets following the Paris Agreement
February 2016 | 10QUESTIONS | SECTOR ANALYSIS
financierworldwide.com
FW speaks to Jonathan D. Cahn, Head of Emerging Markets Energy Strategies at Dentons, about the outlook for energy in emerging markets following the Paris Agreement.
FW: What is your view of the implications for emerging markets of the COP 21 agreement reached in Paris?
Cahn: The Paris Agreement represents an historic commitment by developed countries to underwrite the cost of transforming the energy economies of developing countries. The Agreement commits to an initial $100bn a year through 2020 and more thereafter. If developed countries honour these commitments, it can fundamentally transform the energy systems and the economies of developing countries. This would represent a major transfer of resources from the ‘North’ to the ‘South’. Deployed strategically and effectively, these resources could establish a new foundation for sustainable economic growth in developing countries, and may even position some developing countries to leapfrog their current levels of economic development into 21st century economies where growth is largely powered by renewable energy.
FW: Could you outline the practicality – or even feasibility – of spending $100bn a year, and where these funds are likely to be directed?
Cahn: We need to think creatively about how to deploy and supplement the resources committed in Paris. There already exist mechanisms, the Green Climate Fund and the Global Environment Facility, for financing activities to implement the UN Framework Convention on Climate Change. But far more is required. We need a ‘Plan B’. As the Paris Agreement itself acknowledges, $100bn a year is only the beginning given the magnitude of the global challenge. I would favour immediate and major increases in current funding through a new species of IMF facility that would deploy a minimum of $100bn per year in Special Drawing Rights (SDRs). Initially, that funding could be used to underwrite a global feed-in tariff to stimulate renewable energy electrification in developing countries. A global feed-in tariff, as designed by one UN research team, could be based on the difference between the costs of renewable technologies and the cost of conventional energy sources, with annual costs of $100bn ultimately increasing annually in order to target major increases in the share of renewables in new capacity. Funding annually deployed through this strategy could be used to leverage 10 times that amount in private capital to drive energy transformation in the developing world. It is also possible to design other IMF administered facilities targeted at climate change mitigation and adaptation, but in my estimation, a global feed-in tariff, providing 10 to 20 years of financeable payment streams to renewable generators, would be the most direct and should be the first intervention.
“We need to think creatively about how to deploy and supplement the resources committed in Paris.”
FW: How might the distribution of funds under the Paris Agreement affect poverty in emerging countries?
Cahn: There are over 1.3 billion people in the developing world today without access to electricity and 2.6 billion people without clean cooking facilities. More than 95 percent of these people are either in sub-Saharan African or developing Asia. Some of the first people to be helped through this transfer of resources must be those in greatest need, many of them living in rural areas in deep poverty. Bringing them access to inexpensive electrification using renewable energy resources will have a huge impact on poverty alleviation.
FW: Is development powered by renewable energy different from the current development path on which developing countries have currently embarked?
Cahn: Renewable energy – wind, solar, geothermal and hydroelectric – ultimately reduces the marginal cost of energy to nearly zero after the fixed costs for installation are paid back. Energy approaching zero marginal cost can underwrite new strategies to address poverty, food security and social services – you name it. Private enterprise is also transformed; developing country citizens would have the ability to create new models of enterprise powered by low or no-cost power generation. We potentially could see a global economic renaissance that is powered by renewable energy in which developing countries fully participate.
FW: Do you believe the energy systems in developing countries, as a practical matter, can absorb renewable energy at the level projected?
Cahn: It is true that energy ecosystems in developing economies are fragmented, access to capital is limited and regulatory systems are weak. Transmission grids, particularly in developing countries, are also fragile, and have limited storage. They are not designed to integrate intermittent renewable resources into available generating resources, not to speak of serving the large populations in these countries that are ‘off the grid’. Renewable energy, in this context, will be disruptive to existing energy systems for both technical and economic reasons, and progress, at times, will depend on advances in storage and grid technology. But if we can overcome these challenges, and I believe we can, citizens in developing economies will benefit enormously.
“We potentially could see a global economic renaissance that is powered by renewable energy in which developing countries fully participate.”
FW: What opportunities do you see arising from these potential energy reforms?
Cahn: To my mind, the most exciting opportunities – in terms of alleviating poverty and democratising ownership of power generation – derive from a ‘prosumer’ model of energy generation in which local communities and businesses in developing countries utilise a distributed model and are producing and consuming their own electricity. For instance, if developing countries were to model their energy economies after Germany’s, it could fundamentally change the development opportunities in those countries. In Germany, about 51 percent of the installed renewable energy is owned by small businesses and individuals while the nation’s giant utilities own a mere 7 percent of green energy production. This type of model would represent a major shift in economic power within developing countries as well as a wholly new platform for national economic development. Remember also that these developments in the energy sector are converging with other technology breakthroughs – in manufacturing, communications, computing power and the internet of things – offering developing countries an authentic alternative economic model – a counterpoint to investment by large, vertically integrated businesses which have dominated industrial development in the 20th century.
FW: Is there any evidence that developing countries can achieve such a model?
Cahn: There are a number of examples that provide confidence that not only are these innovative models feasible, they are happening. For instance, in Africa ‘off-grid’ solar systems have for the first time been aggregated and sold on the bond market and new securitisation models are now being pioneered to bring to scale distributed solar power to off-grid households and businesses. Small, decentralised mini-grid businesses are also emerging – the IFC calls them ‘mini-utilities’ – with available power from 30 kW to 500 kW. Using a range of technologies, from simple diesel generators to hydropower, biomass, photovoltaic, and hybrid systems, these mini-utilities serve a mix of household and SME customers. Although diesel remains a preferred fuel in some cases given its availability, these mini-utilities are increasingly relying upon renewables to keep costs down and to make pricing more predictably stable. In the near future, we will see many more examples, such as these, which promise to bring to scale new service models.
FW: What are the options for developed countries financing the transformation of developing economies?
Cahn: Developed countries, in the Agreement, have committed to underwrite $100bn a year of support to developing countries through 2020 and thereafter to use the $100bn as a floor. In reality, the financial requirements are far greater, and developed countries are facing their own budget constraints. Implicitly, many industrialised countries hope that much of the investment will flow from the private sector, from multilateral institutions, and from cap and trade. I respectfully submit that private enterprise cannot do the job alone in developing countries – private enterprise faces a ‘trifecta of risk’ as one energy developer has described: impoverished customers, emerging markets and new technology models. Only if governments and international institutions act to mitigate these risks, can the private sector response achieve the scale of investment that is required. Our best strategy, in my view, is to begin by calling upon our international ‘first responders’ – the IMF and World Bank. The IMF can play a distinctive role as I have described earlier, although it may require amendment of its Articles of Agreement to do so. Yet only the IMF, of the multilateral institutions, can issue its own virtual currency, the SDR. Only the IMF has the ability to rapidly mobilise the scale of monetary resources required to effect the type of macroeconomic intervention envisioned in Paris – and only the IMF can establish the monetary and fiscal support that is required while imposing the requisite conditionality to ensure climate policy and climate targets are aligned. The World Bank, by contrast, has the ability to fund on both a project and programmatic basis. Through the World Bank’s Multilateral Investment Guarantee Agency (MIGA) and technical assistance, the Bank can substantially mitigate investment risk, catalyse investment, and multiply the effect of the IMF’s initial financing by opening markets to energy investments. We also need the Bank to explore new models for climate finance that channel investment from both the public and private sectors. Acting in concert, the Fund and Bank have the requisite institutional competencies to supplement the Green Climate Fund and the Global Environment Facility. The IMF and Bank need to be our point of the lance.
“Only the IMF has the ability to rapidly mobilise the scale of monetary resources required to effect the type of macroeconomic intervention envisioned in Paris.”
FW: To what extent would this be a major departure – both in scale and mission – from the IMF’s conventional monetary role? Why not rely principally upon the World Bank and other multilateral development banks instead?
Cahn: Among the purposes of the IMF is the maintenance of global stability. The world is arguably confronting the greatest liquidity crisis and its greatest challenge to species’ survival since World War II – and that is precisely why in the aftermath of WWII we had established the Bretton Woods institutions – to save us from ourselves. In particular, the SDR was created by amendment of the Fund’s Articles of Agreement specifically to address a feared global liquidity crisis. Although some would argue for leadership of the multilateral development banks – the World Bank and its regional counterparts – I believe that we require the support of both financial institutions, and in my view, the IMF is the better positioned to use SDRs combined with new quota subscriptions to underwrite the cost of the transformation and through its ability to use macroeconomic and monetary tools and conditionality. The magnitude of change simply exceeds the microeconomic focus which is the typical ambit of the multilateral development banks.
FW: In your view, are there any drawbacks to using the IMF?
Cahn: There are several. Neither the IMF nor the other international financial institutions provide adequate assurance of accountability to affected populations. The question is therefore: how do we institutionalise the voice of ordinary citizens in this global process of transformation? Citizens in developing and transforming economies – in particular women and children – are always the first victims of climate change, and possibly the victims of our intended response. The change envisioned is fundamental, and citizen participation, direction and accountability will be essential. The world is at a strategic inflection point in its response both to climate change and global poverty. The Paris Agreement reflects a commitment to change our global environmental, economic and governance trajectory. We ignore the linkages between climate change and development at our peril. That trajectory – for industrialised and developing countries – must lead to the transformation of energy systems in developing countries. Failure to achieve this means collective failure, and threatens ‘mutually assured destruction’, a future of devastating consequences for both industrialised and developing countries.
Jonathan Cahn is an international energy lawyer with broad experience in cross-border transactions, international trade and trade litigation, public international law, compliance and international arbitration. He is qualified to practice in the US and as a solicitor in the United Kingdom. He is a member of Dentons’ Energy sector and Transportation sector teams and is the head of the US region’s Emerging Markets Energy Strategies (EMES) group. For more than 20 years, Jonathan has represented some of the world’s leading investors making cross-border investments in the Middle East, Africa, Latin America, North America, Russia and Central Asia. He can be contacted on +1 (202) 408 9134 or by email: energy.strategies@dentons.com.
© Financier Worldwide