Project financing (PF) is an innovative funding method used for large-scale projects, especially in sectors like clean energy and climate action. Different from traditional financing methods in several key ways, it is often structured as non-recourse debt, meaning lenders can only claim the project’s assets and cash flows, not the borrower’s other assets. The clean energy sector is experiencing a surge in PF, driven by global commitments to reduce carbon emissions. The International Energy Agency (IEA) reported that global investment in renewable energy will exceed over US $3 trillion in 2024 underscoring the growing trend towards financing sustainable projects. With the increased adoption of attracting investments through diverse funding sources, PF has been able to enable implementation of complex, capital-intensive projects which have been traditionally unfeasible through conventional financing.
PF allows for greater investments, better risk distribution, and the participation of foreign stakeholders via equity and debt financing without government guarantees, making it more appealing than traditional finance. One notable example is Vietnam’s renewable energy project, such as the Quang Tri wind farm (also known as Lotus Onshore Wind Farm Project) backed by the Asian Development Bank (ADB). This project was mobilized over time and received limited-recourse funding in US dollars from commercial banks and other development finance that was locally unavailable. However, even with the promise that PF provides, there are still existing deficiencies in design stage capacity and implementation gaps that need to be bridged. These existing deficiencies can be attributed to crowding out effect of private investments, and lack of innovative funding mechanisms.
With a significant shift in PF ventures in the last decade, there have been trends driven by environmental imperatives especially with renewable energy projects such as solar power plants, geothermal projects etc. According to ESFC Investment group, these PF global trends are dominated by renewable energy, followed by ESG and sustainability alongside the adoption of digital technologies such as blockchain, AI and advanced Fintech products. PF offers high financial flexibility and allows for tailored financial streams which are accommodative of capital-intensive projects. Going by the above-mentioned example of Vietnam’s Lotus Onshore Wind Power Project which is a capital-intensive project, the benefits of adopting this diversified-investing approach fuels sustainable energy development. It can be argued that opportunities do persist with the access of PFs especially when deployed to address intermittent challenges associated with renewable sources. However, scalability of undertaking such high infrastructural laden projects becomes crucial while securing substantial funding.
Challenges in project financing
With a a record 26% downturn in international PF in 2023, largely due to tight financing conditions, the landscape of PF presents several challenges, particularly in the context of sustainable development and infrastructure investments. There are three broader challenges which needs to be addressed:
- Geopolitical tensions and market volatility: Ongoing geopolitical issues and market fluctuations create uncertainty, complicating the landscape for infrastructure funding. The ongoing geopolitical tensions and market volatility have created an infrastructure funding gap, with an urgent need for climate-smart investments
- Financing gap: There is a significant gap between the required funding for sustainable initiatives and the available financial resources. By 2030, infrastructure investment of over US $90 trillion would be required globally, mostly in emerging nations, to meet projections for global growth. When linked with Sustainable Development Goals (SDGs), the World Bank emphasizes on addressing the annual expenditure of approximately US $5-7 trillion, with emerging economies bearing a substantial portion of this burden. The ADB projects an annual financing gap of US $ 1.7 trillion per year (climate-adjusted estimate) in Asia alone through 2030
- Rising default rates and risk exposure: The increasing default rates in PF structures poses challenges for banks and financiers. S&P Global’s analysis indicates rising default rates in PF structures due to exposure to various risks, including technology and counterparty risks
Opportunities in project financing
While the landscape of PF presents several challenges, it also has significant opportunities, particularly in the context of sustainable development and infrastructure investments.
- Developing PF schemes: Banks can better support the transition to sustainable energy, addressing both the financial and environmental challenges posed by climate change. PF is often a combination of equity and debt, even for capital-intensive clean energy projects. Sponsors typically contribute 30-40% of the project’s cost in stock, with the remaining 60-70% funded by debt. Such financial arrangements underscore the necessity for more banks to develop large-scale financing schemes for renewable energy project. Thus, opportunities persists for more banks to create and dedicate large-scale renewable energy PF schemes, similar to the approaches used by Rabobank International’s Project Financing Department and Barclay’s New Energy Transition Group. The development and availability of such customized PF schemes would help in three broad areas:
- It attracts more investments to green projects,
- It aligns the interests of the investors with sustainability goals, and
- It helps reduce the capital costs incurred while pursuing renewable energy projects
- Adoption of PF loans & other green financing instruments: In addition to developing customized PF schemes, there are also opportunities to adopt avenues of green funding, that advocates the inclusion of green bonds, carbon market instruments, project finance loans, etc. The recent growth in PF loans in Asia Pacific, highlighted by substantial deals like the US$5.9 billion HPCL Rajasthan Refinery transaction, demonstrates the opportunity for investment in renewable energy and sustainable infrastructure. It is important to emphasize that when financiers do increasingly turn to innovative loans instruments, they should be helping in tying up the financial gains to environmental and social outcomes. This has to be mapped as an overall opportunity since by structuring projects with sustainability at the core, there is a transformative impact on both the economy and the environment
Addressing implementation gaps
The future of PF for development hinges on addressing implementation gaps, which is crucial for ensuring the long-term viability and sustainability of projects. As the demand for low-carbon infrastructure grows, financiers must navigate these complexities while ensuring that investments align with sustainability principles and effectively address the pressing infrastructure needs of communities worldwide. Following can be some of the strategies to effectively address these challenges:
- Special purpose vehicles (SPVs): Developing and accommodating SPVs to isolate risks, adopting innovative financial instruments like green bonds (GBs) and sustainability-linked loans (SLLs), and engage communities to ensure project alignment with local needs
- Flexible financial schemes: Financial Institutions and MDBs should offer flexible financial schemes and comprehensive risk management frameworks that could enhance resilience against market volatility
- Innovative financial models: Lending-based crowdfunding can be considered as one of the innovative financial model for financing energy innovation. One noteworthy case is the “Renewable Choice” initiative of Enel Green Power, which debuted in Italy in 2021. Another innovative instrument could be “mini-perm structures” that would allow banks to provide shorter-term loans for project construction and initial operations. However, with a caveat of its success hinging on the investor sentiment, there is a potential of incentivizing banks to participate for energy transition and green financing opportunities
Markets are integral to the PF’s sustainability, and their rapid evolution due to technological advancements and regulatory shifts necessitates close monitoring of trends and changes to ensure project viability. Effective project design, emphasizing thorough feasibility studies, ecological impact assessments, and community engagement, is essential for aligning projects with sustainable development goals. This meticulous approach helps in mitigating risks and ensuring that projects are well-prepared for implementation. However, despite these efforts, funding gaps can still arise, particularly in major infrastructure and energy projects that often face significant cost overruns and delays.
In conclusion, while the PF landscape faces significant challenges, including geopolitical tensions and a substantial funding gap, it also presents critical opportunities for investment in sustainable infrastructure. Addressing implementation gaps in PF is vital for the success of sustainable development projects. As the demand for climate-smart projects grows, innovative financing models will be essential to bridge the financing gap and achieve the SDGs. There has to be more initiatives that could be explored and scaled to ensure that projects are not only financially viable but also contribute to long-term sustainable growth and development.
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