Risk perspective plays an integral and sensitive role in climate-related issues and the energy sector in Africa. Indeed, the continent is currently facing the alarming challenge of climate change, combined with important concerns regarding its energy trilemma, exacerbated by price fluctuations due to the current international instability. While its population has been experiencing the growing impacts of a changing climate, millions of people still lack access to clean and reliable energy, a situation preventing economies from prospering and being in stark contrast with the region’s rich endowment in natural resources.
Even though several technical solutions exist to reach SDG 7 (Ensure access to affordable, reliable, sustainable and modern energy) in both rural and urban areas, significant additional investments are required for their implementation. Whereas there is no capital shortage at a global level, it is imperative to reallocate (mainly) private savings to bridge the financing gap associated with the energy sector in Africa.
Private capital providers tend to limit investments or cover risk premiums due to higher perceived risks in the region. This reduces the availability of affordable capital for (clean) energy-related projects, while increasing the cost of financing, despite ongoing reliability and technological improvement in the sector.
Certain risks are directly associated with technical characteristics and financial structures of the selected investment opportunities. Others echo broader concerns from macroeconomic contexts, which may significantly vary from one place to another. Classifying such investment risks into categories may help public and private stakeholders to better address them, by formulating tailored risk mitigation strategies.
A first group of risks may include economic and financial factors, encompassing currency and liquidity risks, as well as other macroeconomic considerations, such as fluctuations in global interest rates and inflation. Moreover, the political, legal and regulatory situation within a country can alter business prospects and practices, thus forming a second category of investment barriers. Additional investment hurdles associated with the business environment and customer risks (due to the sadly numerous low-income households across the continent) may be included in a third category, as unstable socioeconomic and political circumstances may thwart commercial operations. Finally, environmental and other social considerations (e.g. social acceptance) should not be forgotten.
The role of energy and climate policies
Accordingly, there is an urgent need to improve risk perception of projects and companies active in Africa addressing climate change. This is especially true with regard to the energy sector, due to its important role in the economy and for human well-being, as well as its contribution to negative social and environmental externalities. In this context, the public sphere is crucial, mainly by enacting policies and regulations aimed at addressing market failures and socioeconomic issues, as well as mobilising capital at scale.
Government actions and policies properly designed imply a complex, long-term political commitment, besides leadership and effective planning, to steer a process of reforms and ensure adequate resource allocation. Regarding the African energy sector, the current landscape usually tends to be fragmented and neglect often some of the above-mentioned barriers. From a business perspective, deployed instruments and mechanisms frequently cover only certain phases of project life cycles, generally early development stages, and focus mainly on medium- and large-scale projects. Thus, such gap should be filled through a comprehensive, end-to-end strategy to tackle climate change and develop reliable and modern energy systems for all.
Across Africa, plenty of interesting examples have been observed regarding the energy sector and the fight against climate change, including at macro level (e.g. national planning, improvement of governance practices, decentralised specialised public agencies). For instance, due to the difficulty to reach certain rural zones and considering their huge gap in energy access compared to urban areas, Mali decided to create the Agency for Rural Electrification, AMADER, to foster the completion of certain procedures and support rural development. Since its establishment in 2000, rural electrification in the country has risen from 1% to around 17% in 2020.
Fiscal incentives are another example of policy, designed to change behaviour, by reducing or exempting some tax burdens to support the development of specific activities, without involving direct public spending but implying tax revenue forgone. Zimbabwe introduced different fiscal incentives to support clean energy projects, such as import duty exemptions for solar panels and income tax holiday for investments in renewable energies. Such public initiatives improve the risk-return profile of energy projects, fostering the reallocation of capital towards solutions aimed at increasing well-being and addressing climate change.
The role of public and private actors in the financial sector
Concerning Africa, the lack of capital flowing towards the continent stands as one of the main obstacles to address climate change and adapt to its consequences, as well as to implement energy systems capable to deliver clean and reliable services to its entire population. However, several initiatives and mechanisms have recently emerged involving public and private actors, with the aim to boost investment in the region.
Public financial institutions, either national or international, have a crucial role to play in capital mobilisation and reallocation, especially by paying the way for the private sector and creating enabling investment climates. Public funding sources include government spending, multilateral agencies, public export agencies and climate finance institutions. Apart from their function in the development and implementation of supportive government policies and programmes, public financial resources can be used to directly invests in sustainable activities and underinvested sectors generating positive social, economic and environmental impacts. They usually offer funds on concessional terms, mainly through grants and concessional lending, thus reducing the overall cost of capital. Furthermore, the presence of public money decreases the risk perception and therefore catalyse private investment. Also, the last decades have witnessed the deployment of innovative financial structures and mechanisms, such as guarantees, liquidity facilities and derivative instruments, aimed at addressing specific investors’ concerns and leveraging private capital. Even though some projects may still require direct public funding, the increasing use of mobilisation tools is essential considering the limited availability of public money and the pressure linked to debt to GDP ratios.
Yet, the private sector is also of high importance to bridge the financing gap associated with the energy sector and climate change initiatives in Africa. In regions considered as risky, traditional financing solutions (equity, debt) may not be adequate in several cases. Private financial actors can thus increase their use of alternative instruments, tailored to financing needs and cash flows of projects and companies. Examples include revenue-based investment, shareholder loans, convertible instruments and redeemable loans.
Beyond alternative financial instruments, private capital providers are increasingly using innovative financing structures, such as special purpose vehicles, crowdfunding or off-balance sheet financing (e.g. project finance). Moreover, some encouraging examples of blended finance have started to emerge across Africa. For instance, the Rwandan government collaborated with several private companies to deploy off-grid solar systems in remote locations, providing access to affordable electricity to approximately 600,000 rural households. Still in Rwanda, a securitisation project led by the Development Bank of Rwanda is supporting the financing of several solar initiatives. By pooling loans associated with multiple solar stand-alone systems into tradable asset-backed security, the project allows to free up capital for market expansion and to provide project developers access to more liquid financing. This initiative should enable the deployment of around 175,000 solar home systems, involving both public and private investors thanks to two investment tranches, with the second serving as subordinated, being financed by development finance institutions and providing first loss credit enhancement and downside protection for senior tranche investors. Yet, to reach wide adoption, such financing mechanisms must strike the right balance between necessary innovation and familiarity to capital providers, as well as be supported by public policies and regulations.
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