Blog
Cost of Capital

4 July 2013

Carl-Gustav Lindén

In recent years the price of green energy technology has come down dramatically. This means that European investments in renewable energy can be very competitive. But in developing countries this price drop is not enough, as the cost of capital is so much higher than in Europe it becomes prohibitive to the spread of green technologies.

Yannick Glemarec, Executive Co-ordinator at the Multi-Partner Trust Fund Office in New York took up this crucial issue when he spoke about African energy challenges during the ReCom research results meeting 'Aid and Our Changing Environment', in Stockholm on 4 June 2013. In an interview with UNU-WIDER he develops his thoughts further and notes that there is no international consensus on how important it is to promote green technologies.

'Most people still think about green technologies as they were in the 1980s-1990s when the main problems were linked to engineering, reliability, etc. Today the renewable energy technology is extraordinary robust from an engineering view of point.'

At the same time, prices for equipment have come down, in some cases dramatically—the price for solar cells has dropped by close to 70 per cent over the last few years.

'The main issue for renewable energy is not so much the cost of the technology, but the cost of financing that technology. If you invest one million dollars at five per cent interest rate you have to reimburse 1.5 million dollars; if you invest one million dollars at twelve per cent you have to reinvest three million dollars.'

In Europe, and in other OECD countries, investors in renewable energy earn a five per cent interest rate, whereas in developing countries it is more than twelve per cent.

'The same technology that can be competitive in Europe suddenly is no more competitive vis-à-vis fossil fuels only because of the cost of financing the technology.'

So what is your proposal with regards to the cost of capital?

'First, we need to understand why we have such a big difference in the cost of capital.'

Glemarec says that most of the OECD countries have mature domestic capital markets. Developing countries need to rely on international capital markets where the money supply is tight.

'International capital markets are very, very cautious about investing in what seems to be new technologies in uncertain political environments, and they tend to be extremely cautious about any kind of institutional, technical, political, or administrative risk.'

If banks and funds are not so sure about the guarantee payment for a project they will insist on compensation in the form of higher interest for their additional risk.

'The way to reduce the cost of capital in developing countries is actually to address all these risks. And remove them.'

Glemarec notes that there is a big discussion about market transformation—should public money be used to compensate for risk, for example such as subsidies, increased tariffs, or should public money be used to remove risk? That can be done by removing or streamlining the licensing processes and investing in the local skills of people.

'We deeply believe—based on all the empirical evidence there is from the past twenty years—that it is much better to invest in removing risk than in compensating for risk.'

What is the ratio between money put in for removing risk and for dealing with the consequences?

'One can challenge the exact figures, but it is much more cost-effective to prevent than to cure. This is true for health; this is true for the planet; this is true for climate change.'

Yannick Glemarec has a solid background in the field, as a former executive director of UNDP's Global Environment Facility and director of environmental finance. He joined the UN in 1989 as a junior programme officer for the International Decade of Water Supply and Sanitation in Geneva. Glemarec has since held a number of progressively responsible positions within UNDP, including the country offices in Vietnam, China, and Bangladesh.

In Stockholm he talked about the need to focus more on renewable energy, but changing consumption behaviour and energy policies is not easy.

How shall we get rid of subsidies for fossil fuels?

'The first thing would be to try to figure out how much is the total amount of money being provided in the form of subsidies.'

Glemarec mentions that estimates go from US$500 billion to one trillion. Nobody knows exactly the total amount because there is no tracking system to figure out how much is given to whom and for what.

'Most of the subsidies, when they are put in place, are actually making sense. They are meeting special objectives, but the situation changes and the rationale for these subsidies disappear.'

Still, subsidies tend to stay because there are vested interests that make sure subsidies do not disappear. 'The first step is to try to figure out how much public money is being invested in subsidies, try to find out what is the exact impact of subsidies in terms of poverty reduction—do they truly meet their initial needs? And after that we need to come up with an alternative to subsidies in order to achieve the same impact. For instance, if the objective is poverty reduction, couldn't we achieve the same poverty reduction objective with universal social safety nets?'

Carl-Gustav Lindén is Senior Communications Specialist at UNU-WIDER