IEA Survey: Solar Investments Trump Gas in Emerging Economies Despite Rising Global Capital Costs

In a recent IEA survey on the cost of capital, clean energy investments in solar photovoltaic (PV) projects are revealed to be less risky than gas power ventures in emerging and developing economies. This revelation comes at a time when the cost of capital is escalating globally, with 2023 poised to witness a further increase.

The surge in borrowing costs worldwide, excluding China, follows 11 interest rate hikes by the US Federal Reserve since March 2022. This has led to a target rate exceeding five percent, a stark contrast to just over one percent in February 2022. As a consequence, financing costs have risen not only in advanced economies but also in emerging and developing ones, where such costs are at least twice as high.

Recognizing the critical role of the cost of capital in facilitating the energy transition, the International Energy Agency (IEA) launched the Cost of Capital Observatory in 2022. This initiative aimed to collect data, through surveys, on the cost of capital for clean energy projects in emerging and developing economies. In 2023, the IEA conducted a second survey, expanding its geographical reach to include countries such as Kenya, Peru, Senegal, and Vietnam, and incorporating new technologies like utility-scale batteries and offshore wind alongside solar PV and gas power projects.

The findings of the survey indicate that, in nearly two-thirds of cases, the weighted average cost of capital (WACC) for utility-scale solar power projects was either the same or lower than that for gas-fired projects. This trend suggests that utility-scale gas power projects are perceived as equal or riskier investments than their solar PV counterparts. The inclusion of utility-scale batteries in the survey, for projects taking a final investment decision in 2022, revealed that the WACC for batteries was higher or equal to that of solar PV projects.

However, the survey also points to a concerning trend: nine out of 10 respondents expect increases in the cost of capital in emerging and developing economies in 2023. Differentiating between underlying contractual structures, the results show that projects financed on a merchant basis present higher WACCs than those supported by revenue mechanisms such as power purchase agreements, feed-in tariffs, or contracts for differences.

Identified as the largest sector-specific risks, regulatory, off-taker, and transmission issues need addressing to reduce the cost of capital in emerging and developing economies. Investors and financiers highlight political, currency, regulatory, off-taker, and transmission risks as the top five risks to be tackled to achieve reductions in the cost of capital.

The persistently high cost of capital in these economies, coupled with anticipated increases, poses a worrisome trend, hindering affordable financing for clean energy projects. This challenge not only impedes economic progress but also deepens disparities between advanced and developing economies.

Recognizing the urgency of this issue, during the Summit for a New Global Financing Pact in Paris in June 2023, the IEA received a mandate to develop recommendations to reduce the cost of capital for clean energy projects in emerging and developing economies. These recommendations, expected to be presented at the IEA’s 50th-anniversary Ministerial Meeting in February 2024, aim to stimulate economic growth, enhance energy security, reduce carbon emissions, and foster technological innovation in these crucial global sectors.