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Insight

Large-Scale Funding to Mitigate Climate Change

Wed, 02/19/2014 - 12:04

Created in 1959 to spur the development of Latin America and the Caribbean, the Inter-American Development Bank (IDB) is now the largest multilateral player in the region, according to Leandro Alves, the Head of its Energy Division. “We finance approximately US$1 billion a year just on the energy side, which accounts for between 14% and 20% of our portfolio. Since we have a mandate to finance up to US$3 billion per year, there is a lot of room for us to expand our financing to mitigation of climate change, which includes renewable energy,” he explains.

But despite being a leading development bank tasked with different responsibilities than its commercial rivals, the IDB’s lending criteria are not too distant from those of traditional lenders. The development bank looks for financial sustainability, for experienced and knowledgeable shareholders and for companies with a track record in the projects they are looking to have financed. “They also need to be able to backstop, to put in the equity requirements for a project, as well as certain guarantees,” says Alves. While the IDB has no specific guarantees that it looks for up front, its limited lending capability means it looks very closely to see if a project is bankable. For private sector projects in Mexico, the bank can only lend up to 25% of the total cost of the project. Typically, Alves explains, this means that another 30% is equity, and the other 45% has to come in some other form of lending. In essence, this means that projects have to be bankable under commercial terms in order for IDB to finance them. Where the IDB does stand apart is in its consideration of risk factors. Economic, social and environmental sustainability are far higher on IDB’s list of priorities than normal banks. “We want to make sure that the projects that we are working on are exemplary, not just for the shareholders but for the regional population directly affected by those projects and the country as a whole.”

In terms of which renewable sources it has worked with, the IDB has had most success in hydro projects, although wind projects are rapidly becoming a priority. Alves acknowledges that the application and execution of wind projects often involve social and environmental concerns that the IDB seeks to address. The scale of such projects can also be reflected in the proportions that these concerns can take. As such, Alves explains that it does not make sense for the IDB to finance very large infrastructure projects that have a negative impact on the local population.

The IDB’s work across Latin America seems equally spread across the region’s larger and smaller economies. While Brazil tops the list with the IDB involved in 1,105 projects there as of early 2014, Mexico has seen IDB participation in

666 projects, less than many Central American nations such as El Salvador, Honduras or Guatemala. Yet involvement in Mexico brings particular risks that the IDB has grown adept in adapting to. Alves sees two major issues that stand out in Mexico. The first difference is that social and environmental regulations vary from state to state and how they apply to local populations. “As in any large country, there is a difference in terms of project location and the way they are presented, which breeds either positive or negative reactions towards each project.”

The other aspect relates to off-takers. Alves outlines that should the IDB take on large renewable energy projects targetting private sector companies looking for self-supply, then Mexico would have a limited number of very large off- takers. “Mexican industry is mainly composed of relatively small and medium-sized companies as opposed to large conglomerates, a reality that is not reflected. That may be a limiting factor on the self-supply agreements that are currently being drawn up,” he outlines. That being said, climate change has made it essential for the energy mix to shift toward renewable sources in the IDB’s opinion. One aspect that could be of great benefit to non-conventional renewable energy sources, such as wind and solar, is smart grid technology, says Alves, while outlining its advantages. “The smart grid would provide more consistency and duality for transmission lines. This would be helpful in compensating for droughts in peers related with hydro systems. But more importantly, as more and more intermittent energy comes into play, the smart grid will be a key feature to bring new investment for non-conventional resources.”

The future of renewable energy projects, as well as the entire Mexican energy sector, has been changed by the approval of the Energy Reform. Alves, like many in the financial sector, is enthusiastic about the reform’s potential. However, he strongly advises Mexico to move ahead step by step. “The best approach to changing a sector is through incremental policy steps. Any drastic actions will end up causing a much tougher battle, both for internal political reasons and from a social point of view.” The other move that he advises Mexico to take, in order to shore up any lingering doubts about investment and financing in the energy sector, is to create an infrastructure bank similar to Brazil’s BNDES. Although Mexico already has Banobras and NAFINSA, a new bank could introduce specific lines of credit for public and private entities that have long-term financing needs for renewable sources. As Alves explains, 80% of the cost of these resources is return capital so, as that cost is amortized over longer terms, renewable energy projects can become more and more competitive.

 

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