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The Financial Times

How Emerging Markets Can Attract Capital to Their Power Sectors

How Emerging Markets Can Attract Capital to Their Power Sectors

Policymakers can take four steps to make energy investment viable and profitable.

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How Emerging Markets Can Attract Capital to Their Power Sectors
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This article originally appeared in The Financial Times.

Emerging markets face a twofold challenge as they try to meet rising demands for electricity in their fast-growing economies.

First, they must invest in generation to keep up with their economic growth, as they connect some of their citizens to the power grid for the first time and as their already electrified populations grow richer and use more electricity.

Second, the energy and environmental policies of these countries will require much of the new power-generating capacity to come from renewable sources. Although these are becoming increasingly competitive with traditional thermal generation, they are still eight or nine times more capital-intensive, and much of that is required up front rather than as ongoing running costs. For example, wind farms may be expensive to install, but once they are in place, the fuel is free.

Meeting such demands will not come cheap: emerging markets will have to double their investments in electricity from the $240bn they spend each year to $495bn annually between 2015 and 2040—$13tn in total. Over that period, they will outspend more developed countries by two to one.

In the past, governments in such fast-growing economies have funded about 70 percent of their electricity investment, drawing in capital from international and private investors for the remaining 30 percent. But with the need for more capital, those percentages are likely to reverse. India, for example, aims to increase the private sector share of capacity from 13 percent in 2007 to 30 to 40 percent in 2017.

Unfortunately, many of these countries have a mixed record of attracting private capital, with many of the larger countries delivering poor and volatile returns on investment. Long-term investors have well-founded concerns about transparency and reliability of policies and regulations, particularly where policymakers have shorter-term political priorities.

To attract the necessary capital, governments will need to improve the viability of investment in their power sectors. Here are four things that policymakers should be thinking about.

First, develop policies that don’t burden the economy unnecessarily. Policymakers have an important role to play in encouraging the electricity sector to take the most efficient paths to achieve energy goals. For example, Mexico has historically relied on fuel oil for power generation, but this kept its industrial electricity prices about 77 percent higher than in the US. More recently, Mexico converted much of its power generation to gas, to take advantage of the low gas prices resulting from shale exploration across the border in Texas and elsewhere in North America. The country is also deploying ample solar to take advantage of its sunny location, and wind power along the Caribbean coast. These combined efforts have brought down Mexico’s wholesale electricity prices by 33 percent, providing a significant stimulus to the economy.

Develop integrated policies across the entire power value chain. Fast-growing markets must co-ordinate development, operations, planning rules and participation by international investors to make sure no part of the electrical system—power generation, transmission & distribution, retail delivery—develops too far ahead of the rest. China offers a good example of how to manage this. Before the recent slowdown, China’s demand for electricity grew at about 12 percent each year from 2002 to 2012, with per capita consumption of electricity almost tripling over this period. Its integrated strategy locked in agreements for fuel imports and added more than 900 gigawatt hours of new power generation (including nuclear, hydro and renewables). Meanwhile, it also made significant investments in its transmission and distribution grid, to ensure those power plants were able to deliver the electricity they generated.

Build in the implications of rapidly declining technology costs. Over the next 25 years, countries outside of the OECD will add about 1.7 terawatts of non-hydroelectric renewable capacity—mostly wind, solar and biomass. That amounts to 34 percent more renewable capacity than OECD countries will add. All this investment is expected to reduce the cost of solar-generated electricity by 4 to 5 percent each year and onshore wind costs by about 1 to 2 percent annually. Fast-growing economies can take these reductions into account as they plan. In Brazil, which has said it will invest up to $171bn in wind power through 2020, technology advances have made wind power nearly competitive with hydroelectric generation.

Build effective public-private partnerships. Governments around the world encourage public-private partnerships in infrastructure development, but the most effective ones structure these as true partnerships, with benefits for all parties. Since electricity prices are a highly visible and often politically sensitive political issue, they frequently attract intervention. Good governance and transparent contractual mechanisms can mitigate some of those risks and attract long-term, low-risk capital, such as pension, sovereign wealth and insurance funds. South Africa, for example, has recently made substantial progress in attracting private investment into its wind and solar sector. By carefully structuring public-private partnerships—defining a responsible independent government authority to manage auctions and providing government guarantees for signed public purchase agreements—the South African regulator attracted nearly $16bn in investment from 2012 to 2014 into these sectors.

There is no lack of capital out there to build out the electricity system in fast-growth markets. But it won’t flow unless the national electricity systems reform themselves. Economies that learn the lessons fastest will attract the private sector funds and have competitive, sustainable electricity systems that will support their economic growth. Those that remain stuck in the old paradigms will fall further behind, with their poorest citizens suffering from a power gap—a measure of inequality that will surely become an increasingly important political issue.

Julian Critchlow is a director at Bain & Company and head of the consultancy’s utility and alternative energy practice.

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