How is hydropower financing changing, and how is risk managed in the sector? In this interview, Morgan Landy, director of transaction risk solutions at the International Finance Corporation (IFC), sheds some light. He will also speak at a session on project and financial structuring at the 2015 World Hydropower Congress.
How has the landscape of hydropower financing changed in recent years?
Hydropower financing can be challenging. While it is a low-cost source of power with low operational costs, it is capital intensive, meaning that a great deal of investment takes place upfront.
Investors who consider these projects need to understand what they are getting into, and once they make an investment decision they’re generally locked in for 10, 15 or 20 years.
The investors most able to get involved in this sector are the ones that have patient capital: hydropower projects can last 100 years. There is a need to put together a group of people that can de-risk these projects and then have the capital to stay through the natural cycle of the investment.
The reality of today’s capital markets is that most lenders and investors don’t have that long-term of an outlook, so we have to bring together the technical aspects and optimise the financing. We will see more and more creative kinds of financing, especially with some of the larger multi-lateral development banks returning to hydropower after having reduced their involvement.
Long-term capital is coming back into the sector, which is a key piece that unlocks the puzzle. I think from IFC’s perspective, hydropower can have a fantastic development outcome, and it can really lead to low-cost and clean power – but you need to really understand the risks you’re taking upfront, and have capital that’s long enough to make it work.
At the end of the day hydropower plants are not like airlines – if you make a loan and something goes wrong, you just can’t pick up that plant and take it somewhere else."
How is risk managed in financing hydropower projects?
I would put the risks into four big buckets. If it’s financial risk you need the right sponsor or lender; for construction risk you need the right EPC contractor; for environmental and social risk you need to make sure you’re looking at issues such as resettlement or impact on communities; and there is also regulatory and political risk, because at the end of the day hydropower plants are not like airlines – if you make a loan to a hydropower plant and something goes wrong, you just can’t pick up that plant and take it somewhere else.
We see the key to making a project successful is to have the right people involved who can manage the various risks. If things don’t go well, you often look in retrospect and realize that you were missing one of those key ingredients, whether you didn’t have the right kind of long-tenor financing, or you had a contractor without the right expertise, or maybe a sponsor who is trying to get in and out quickly.
From our view, the real litmus test is to do your upfront analysis, site selection and ethical work, and then before you start investing, make sure you have the right team to take it forward.
What factors have the biggest effect on the finance model that is used for a project?
I think the technical aspect is key. For example, is it a small run-of-river project that is relatively straightforward, or is it a large project with tunnelling? If you have large tunnels, it always increases the technical complexity dramatically. With a smaller project without a major tunnel, perhaps you can do it with a relatively small company and financing from vendors, but once you get into large tunnelling the risk profile changes.
The key to successful projects in the hydropower sector is having a good understanding of the risks and the rewards."
From our experience, tunnelling is the major factor when it comes to cost over-runs and delays. Once you start tunnelling you’re not sure what you are going to find, no matter how good your studies may have been, so the key factor is what kind of contractor do you bring in, and does that contractor have experience in dealing with that kind of situation? Then, how do you allocate the risk between the contractor, the company and the lenders?
With the typical EPC contract that the market has developed, there are challenges when you talk about such unquantifiable risks – it’s really difficult to allocate that risk to any one person. The key trick for the larger projects is to have clear decisions and agreements upfront about who takes that risk. Does the contractor build it into their price? Does the sponsor or the lender take it on? This is a key challenge in hydropower, more so than other kinds of infrastructure.
What do you hope will be the outcome of the session on ‘project and financial structuring’ at the 2015 World Hydropower Congress?
The key to successful projects in the hydropower sector in our view is having a good understanding of the risks and the rewards, and to do that you need to have not just the sponsors and the contractors but also the lenders, the regulators and the environmental people all willing to think through the opportunities and who is best positioned to manage the various risks.
So what I am hoping for is to have a good robust discussion with a wide range of stakeholders giving their different angles and perspectives, so we can come out of the congress with a better view of where the real opportunities are, and who is needed to make these deals get done.
Morgan Landy is speaking at a session on Project and financial structuring: what are the new options? at the 2015 World Hydropower Congress. Find out more here.