By Aaron Daniels
Due to a variety of economic drivers, lack of deal flow, and declining returns, many renewable energy investors are being compelled to transition from mature markets like North America and Europe, to emerging market investments. This trend is well illustrated by Ernst & Young’s 2016 Renewable Energy Country Attractiveness Index, in which half of the markets listed represent emerging markets.
What are emerging markets?
Emerging markets evolve economically, and successful investments favor early (though not necessarily first) movers. There is a window between economic growth and incentives to sufficiently overcome market risk; as the market grows, investor competition naturally reduces project returns. The eventual entry of utilities further accelerates this decline in investor returns. As emerging markets mature through growth, returns typically decline faster than risk. Late movers into emerging markets may find deal flow, but returns at this point are typically less than the risk exposure.
For example, many Latin American renewable energy investment opportunities are too mature to yield sufficient investor returns. Southeast Asia, on the other hand, currently fits squarely in the window of an attractive risk/return ratio. Instead of relying on precedent, investors seeking emerging market opportunities often mistakenly turn to mature markets, because they either don’t understand their true nature, or don’t have the capacity to identify and manage emerging market risks.
Emerging market risks
Early mover investors looking to leverage that “sweet spot” in the risk-to-returns ratio face unique challenges due to their experience in more typical, mature market investments. In other words, these investors will not have a precedent to reference. The diversity of cultures, business practices and languages in these new markets, as well as shortfalls in the existing legal frameworks, can create a sense that risks are unidentifiable.
However, the rapid growth in emerging markets indicates these risks can and are being managed successfully by well-prepared investors. Successful investors in this market segment implement a robust, integrated risk management approach, leveraging advisors with emerging market experience and a comprehensive risk management strategy.
The risk management team
Investors prefer to see risks transferred, either to the contractor or project insurers. This requires a lawyer and insurance broker. However, the one person commonly overlooked is the project manager. The project manager uses his or her experience of building and operating renewable energy projects to bridge the gap between technical and commercial in identifying project risk, plans, and integrates risk strategies between project plan, contracting, and insurance, and manages the risk during project execution. Without a project manager experienced in emerging markets, legal and insurance risk strategies are developed in “silos”, presenting gaps that ultimately manifest themselves as cost and schedule overruns in construction, and revenue losses in operations.
In conclusion, the growth of renewable energy projects in emerging markets continues apace. Successful investors that leverage the high risk/return period of market evolution are those who move early and employ advanced risk management methodology. The key to risk management in emerging markets is a risk team with emerging market experience: a project manager, attorney, and insurance broker who work seamlessly to identify, plan and manage project risk comprehensively.
Aaron Daniels is managing director at Modern Energy Management PTE, Ltd. With experience in the construction of over 2400MW and the development of over 1000MW of wind energy projects globally, his specialties include de-risking projects and improving project financial returns.
Modern Energy Management (MEM) | http://www.modernenergy.co.th