Hydropower Potential Unleashed: Strategies for Private Sector-Driven Energy Transition

The World Bank report highlights the potential for large hydropower projects to meet global energy goals, emphasizing the need for private sector investment through de-risking mechanisms, early developer involvement, and innovative financing like YieldCos and green bonds. DFIs are positioned to play a critical role in addressing investment barriers and fostering sustainable development partnerships.

The World Bank's Energy and Extractives Global Knowledge unit recently released a report on hydropower development, analyzing the potential for private sector engagement in large hydropower projects to achieve sustainable energy goals. Hydropower, a primary low-cost and low-carbon electricity source, is vital in the global transition toward net-zero emissions and universal energy access. In 2020, it supplied most electricity for 28 emerging economies and remains central to least-cost energy expansion plans in numerous countries. However, expanding this capacity will require significant investment; the International Energy Agency (IEA) estimates that 2,500 gigawatts (GW) of new hydropower capacity must be added by 2050 to meet net-zero targets, with annual investments of 138 billion dollars. Despite these demands, recent hydropower investments average only 9.7 billion dollars annually, emphasizing the need for a financial boost and more extensive private sector participation. Historically, private investment has primarily supported small greenfield projects in middle-income countries, where the economic and policy environments are more favorable. Large-scale projects have lagged due to barriers like political and regulatory risks, high costs, lengthy project timelines, and environmental challenges.

Survey of Stakeholders Reveals Investment Barriers

The World Bank's report is based on a survey of 23 stakeholders developers, lenders, government officials, and development finance institutions (DFIs) to understand the private sector's perception of large hydropower projects. While there is clear interest in developing hydropower, participants expressed concerns over key challenges, especially in low-income countries, where regulatory uncertainty, project costs, and technical risks are significant. Key obstacles include government policy shifts, regulatory unpredictability, environmental impacts (like resettlement and biodiversity), and financial issues, including off-taker risk (reliability of buyers) and foreign exchange instability. The extended timelines typical of hydropower projects often exceeding eight to ten years from conception to operation complicate matters further by increasing exposure to these risks. In countries where governments or public utilities lack a track record of successful large-scale projects, private investors are particularly hesitant, as they face heightened exposure to these issues. Regulatory and policy uncertainties around brownfield projects have historically restricted private sector involvement, limiting successful examples in this segment of the market. Respondents also noted interest in non-traditional hydropower forms like pumped storage hydropower, which can stabilize grids and provide ancillary services. However, this approach faces obstacles such as high initial costs and uncertain market conditions in low-income areas, affecting potential returns.

Early Project Preparation Key for Reducing Risks

The report emphasizes that DFIs could play a transformative role by facilitating private sector involvement through de-risking mechanisms and financial innovations. Early project preparation, including feasibility studies and environmental assessments, is essential to boost developer confidence and mitigate technical risks. However, these studies are costly, and without project certainty, private developers are often reluctant to fund them. DFIs can provide financial support at this stage, ensuring comprehensive and reliable early-stage assessments. Such support also extends to public infrastructure essential for hydropower projects, like transmission lines. Additionally, financial guarantees and risk mitigation tools offered by DFIs, such as liquidity extension guarantees (LEGS), can manage off-taker risk and support long-term loans. The report advocates a shift in development approaches, suggesting that involving developers earlier in the project design phase could significantly reduce project costs and enhance alignment among stakeholders. This early engagement could integrate environmental and social considerations into project plans, reduce future expenses, and enhance project acceptance. Survey participants further suggested capital recycling as a crucial mechanism for scaling up hydropower investments. Yield Companies (YieldCos) and green bonds could facilitate reinvestment by allowing capital from operational projects to be redeployed for new projects. YieldCos, which own operational assets with predictable cash flows, appeal to investors interested in stable returns and reduce the need for public funding. Green bonds, targeted for sustainable projects, align well with hydropower assets, which have long operational lifespans and stable revenue. Yet, the use of green bonds in hydropower remains limited due to environmental concerns, and DFIs could help by promoting standards that encourage their broader application.

Addressing Regional Differences and Financing Challenges

The report highlights that regional differences affect project financing, with DFIs channeling much of their funding toward low- and lower-middle-income countries, where private investment remains insufficient. Stakeholders suggested that DFIs should increase awareness about available financing tools, especially as the World Bank recently introduced the Unified Guarantee Platform (UGP), a streamlined platform to help private players and governments navigate financing and risk mitigation options. Another recommendation is for DFIs to support the development of independent platforms to oversee project preparation. These platforms would work with governments as technical and commercial partners, with DFIs pooling resources to ensure robust, bankable project designs. This approach would enable a portfolio of projects to be developed and quickly tendered, accelerating private investment in large hydropower. In countries with policy limitations or in contexts where private investment is challenging, DFIs can act as primary financiers for early project stages and help transition to private refinancing within a few years. DFIs could also encourage the use of local financing to address foreign exchange risks in lower-income countries, where revenue generated is in local currency, while most investments are in hard currency. Through these measures, DFIs can attract more private capital and encourage innovative financial mechanisms, making hydropower projects more attractive.

Capital Recycling and Financial Innovations for Scaling Investment

Survey participants highlighted capital recycling as a promising approach to scaling hydropower projects. Mechanisms such as Yield Companies (YieldCos) and green bonds can enable private capital to be reinvested into new projects more quickly. YieldCos, which own operating assets that generate stable cash flows, allow investors to earn predictable returns without facing the uncertainties of project construction, thus attracting a broader pool of investors. Green bonds, dedicated to funding climate-friendly projects, align well with hydropower assets, which have extended operational lifespans and consistent revenue streams. Despite the benefits, green bond issuance in the hydropower sector has been limited, mainly due to environmental concerns and variability in regulatory criteria. DFIs could bridge this gap by advocating for more inclusive green bond standards that accommodate large hydropower projects, allowing for a diversified financing approach that appeals to socially responsible investors.

Collaborative Framework for Sustainable Hydropower Development

Ultimately, the World Bank report outlines a collaborative framework that leverages public and private resources to accelerate hydropower development, which will be vital for the sustainable energy transition. DFIs, with their experience and tools, can help overcome the barriers that have kept private sector participation limited, particularly in high-risk regions. Through effective partnerships, large-scale hydropower could play a transformative role in delivering clean and resilient energy systems, contributing to global climate and energy targets while offering investors an opportunity to support sustainable infrastructure.