The puzzle of China’s missing solar and wind finance along the Belt and Road (Part 1)

New paper sheds light on reasons behind the lack of renewable energy lending from China’s policy banks

By Tom Baxter

From 2000-2018 China’s two policy banks, the China Development Bank (CDB) and China Export Import Bank (CHEXIM), loaned over USD 251.3 billion to overseas energy sector projects. Of that finance, traditional energy sources such as coal and hydro dominated, occupying 45.2% and 33.7% of the total finacinging respectively. Just 2.3% went to wind and solar projects.

Given that China is the world’s leading manufacturer of wind and solar power generation equipment, given that the domestic renewables sector is experiencing overcapacity, given that Belt and Road actors have been tasked from the highest levels with expanding a “green BRI”, and given the enormous energy needs and renewable potential in BRI countries, why has so little of China’s two policy banks’ overseas finance go toward wind and solar projects?

CBDEXIMRE
Source: “Chinese Development Finance for Solar and Wind Power Abroad”, Bo Kong & Kevin P. Gallagher, Feb 2020

A recent paper by Boston University Global Development Policy Center’s Kevin Gallagher and Bo Kong labeled this reality a “counterfactual puzzle” and dug into the reasons for it. Why China’s Belt and Road Initiative has not led to large scale deployment of renewables as has been seen domestically in China is a question on the lips of many on the climate community, from NGOs to government staffers. Panda Paw Dragon Claw seeks to provide some insights on that critical question by digesting a few recently published papers and reports on that topic for our readers.

Is there potential for a renewable-powered Belt and Road?

In theory, both the supply and demand side for a large scale roll out of renewable energy projects along the Belt and Road are well aligned.

On the supply side, China has been a global leader in wind and solar power investment, manufacturing and deployment for most of a decade. Moreover, with the domestic market plagued with overcapacity, there is also a push factor from the supply side propelling Chinese companies to explore new markets. By as early as 2012 China’s solar PV production capacity exceeded total global demand by 33%. In fact, the overcapacity problem was in part driven by the two policy banks’ huge amounts of financing for the sector. By 2017, CBD and CHEXIM financing was behind about 40% of total installed wind and solar power in China, the paper points out.

In addition, both CDB and CHEXIM have an explicit mandate to promote the international expansion of China’s renewable energy sector. As early as 2015, a “guiding opinion” document from the State Council urged companies to “actively participate in investment and construction” of wind and solar PV projects overseas. In the same year, Deputy Director General of the New Energy Department of China’s National Energy Administration (NEA), Liang Zhipeng, publicly urged CDB and CHEXIM to assist China’s renewable energy companies’ exports, investments and expansion overseas.

This is backed up by a political vision for a “green Belt and Road” endorsed multiple times by President Xi Jinping himself. It also more broadly dovetails with China’s ambition to be seen as a key partner or even leader in global climate governance.

On the demand side, Belt and Road countries are projected to see large growth in power demand over the coming decades and an enormous market for solar and wind investment awaits, estimated at almost USD 800 billion globally. A report from Tsinghua University, Vivid Economics and Climateworks Foundation last year projected that keeping economic growth pathways across Belt and Road countries in line with the Paris Agreement’s 2 degree target could require investment to the tune of nearly USD 12 trillion up to 2030.

Banks’ caution 

In spite of the alignment of all these factors, the two banks’ appear to hold deep reservations about renewable energy projects. Via interviews with middle level staff at the banks, Gallagher and Bo are able to reveal some of these reservations.

“Not every government turns to us for financing. When they do, many of them are governments of Asian, African, and LAC countries. When they approach us for loans, they invariably prioritize financing for the development of their industrial economy,” a mid-level manager at CDB said, reflecting that the banks see themselves very much at the end of a decision making process, rather than steerers of energy project decisions.

The bankability of a project is another key concern for these policy bank insiders. With many of the country governments who seek loans for the power sector lacking the ability to subsidize and support renewable development, bankability of solar and wind projects becomes less tenable. The CDB mid-level manager noted that the bank ultimately accepts or rejects loans based on a series of indicators, including “profitability, future cash flows, and debt-paying ability, and technical indicators, such as grid connectivity and electricity transmission capacity.” Failure to meet thresholds on these indicators will decrease the likelihood of a project receiving finance.

Lastly, the banks are well aware of the difficulties experienced in China’s domestic solar and wind expansion, as well as the tumult in Europe after 2008, perhaps ingraining caution in their approach to renewables.

“Considering the amount of problems the renewable power expansion has experienced in China, it is natural these developing countries will have more problems in light of their stage of development,” said an interviewee at CHEXIM. “Because of these problems, renewable power for the moment will only remain at a demonstration stage in these countries.”

The projects

Between 2000 and 2018 CBD and CHEXIM financed a total of 11 wind and solar projects, in seven different countries. What do these experiences tell us about the nature of the banks’ renewables financing in practice?

The financing for the 11 projects total over USD 2 billion. 44% went to European countries Bulgaria, Romania and Italy, mostly in the form of M&As. 27% went to African countries, 17% to Latin America and 12% to South Asia. Finance to European countries dried up after 2013, however, after which the three other regions accounted for all solar and wind financing.

RE projects CBD-EXIM
Source: “Chinese Development Finance for Solar and Wind Power Abroad”, Bo Kong & Kevin P. Gallagher, Feb 2020

The seven countries which have received financing for wind and solar projects share a few similarities. Firstly, all are endowed with rich renewable power resources. Secondly, all have rolled out some sort of support for renewables development, aiding project bankability. For example, all seven countries have renewable installation targets and tax incentives. Only Kenya however implements a feed in tariff (FiT) system, wherein the government subsidizes a premium price for renewable power. Lastly, all seven of the countries have good relations with China and all except Argentina are official members of the Belt and Road Initiative.

The countries and their power sector investment environments also have some obvious differences, however. Gallagher and Bo divide them into two distinct categories. The first consists of the three European countries, who are primarily expanding renewables for environmental considerations, not least that the EU’s 2020 Energy Strategy obliges all countries to expand the percentage of renewables in their energy mix. The second category consists of Kenya, Ethiopia, Pakistan and Argentina. These four countries see renewables as part of the answer to power shortages, rapidly growing energy demand and energy security.

Finance for renewable projects in European countries

CDB financed all three of the solar projects in Europe. One notable aspect of these three projects is that the financing mechanism bore strong similarities to how Chinese PV companies would approach CDB for loans domestically. All four of the companies engaging in European projects, who all had existing strong relationships with CDB, sought to mortgage their project loans on fixed assets, such as the solar PV stations themselves, corporate bonds or future revenues. This is almost identical to how firms secure CDB loans in China, Gallagher and Bo note, with the major difference that in the European market there was no local government to act as guarantor, greatly increasing the riskiness of the project.

Indeed, the rollback of subsidies for renewables in all three of these European countries created major problems for the Chinese companies involved in solar PV projects there. This contributed to the bankruptcy of three of the companies, Europe Suntech, Chaori Solar and Hairun Solar, between 2013 and 2016.

“It is hard for us not to conclude that CDB may have gotten burned in all three cases,” conclude Gallagher and Bo. This early negative experience of overseas solar financing is likely to have contributed to the banks’ caution and reservation about loans for renewables projects.

Finance for renewable projects in the South

Financing for projects in Africa, South Asia (Pakistan) and Latin America (Argentina) have taken on a very different, and overall more reliable, mechanism. Most fundamentally, financing for projects sees significant government involvement, providing far greater security. In many cases, governments themselves are the borrowers.

Loans to these countries tend to take the form of preferential export seller’s credit (Argentina, Ethiopia) or concessional loan (Kenya), making up a total of 90% of all the loans to this group of countries from 2000 to 2018. At 2-3%, their interest rates are low, and repayment periods of 10 to 15 years come with significant flexibility. The authors cite the case of CHEXIM’s loan to the Cauchari Solar Park I, II, and III in Argentina, with an interest rate of 3% and a repayment period of 180 months, with a grace period of 60 months.

CHEXIM is by far the biggest lender to these “global south” countries, having issued more than USD 1.2 billion between 2013 and 2017, compared to USD 341 million to date from the CDB.

As well as a high level of government involvement, the financing deals with these countries are almost always conditional on the use of Chinese EPC in the project, emphasizing the export expansion incentives of the two policy banks.

The government-to-government loan making model in Argentina, Ethiopia, Kenya and Ethiopia has proven reliable and provided “unambiguous wins” for the two banks, Gallagher and Bo write. The problem with this mechanism, however, is that the heavy involvement of bilateral government deal making means that a rapid scale up of the mechanism is unlikely.

Cracking the puzzle

With the world off track on the global Sustainable Development Goals and Paris Agreement climate commitments, where support for the large scale deployment of solar and wind power will come from is a critical question for the world. China, as the world’s solar and wind power leader and a country hungry for overseas markets for its industrial output, must be a key partner in meeting those goals. Just as they did in the rapid expansion of wind and solar domestically, China’s two policy banks could play a critical role, especially in energy generation capacity hungry Belt and Road countries. To date, however, that finance has been largely missing.

Gallagher and Bo’s exploration of the puzzle helps to explain some of the reasons why overseas financing for renewables from the CBD and CHEXIM has been in such short supply. Though they believe we are unlikely to see a major change in these financing dynamics any time soon, based on their understanding of the puzzle they do offer advice for those seeking to promote and attract Chinese policy banks’ support for renewable energy projects on the Belt and Road:

“For countries that want to turn to China for help with their solar and/or wind power expansion,…they will have a better shot if their governments step up to the plate and play a more proactive role in engaging the two Chinese policy banks and working out an arrangement in their favor.”

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