The puzzle of China’s missing solar and wind finance along the Belt and Road (Part 2)

Despite strong domestic performance, the Chinese renewable energy sector’s lack of financial support overseas is multifaceted.

By Ma Tianjie

In Part 1 of this blog series, we looked at why China’s two major policy banks, China Development Bank and China Exim Bank, whose overseas energy sector lending totaled 251.3 billion between 2000-18, lend only grudgingly to Chinese renewable companies going overseas. The difficulty for Chinese renewable energy projects along the Belt and Road to raise funds is not limited to the arena of policy bank financing, however. A March report from Chinese NGO Greenovation Hub and the Center for Finance and Development at Tsinghua University paints a broader picture of the obstacles to renewable energy financing along the Belt and Road, with key and often poorly understood players including commercial banks, multilateral banks and insurers. The study gives us another perspective on the puzzle of the Belt and Road’s missing renewable energy finance and suggests some financing mechanisms which could break through some of the obstacles.  

One of the report’s main conclusions is that there are a number of financial factors that make the overseas expansion of Chinese renewable energy firms less competitive vis a vis their international peers. Factors such as interest rates offered by Chinese banks and higher financial costs become disadvantages for Chinese solar and wind firms when bidding in a cost-sensitive developing country market. It is understandable why some Chinese renewable industry players express grievance over such issues and question the wisdom of host country markets in adopting more competitive price mechanisms. 

The main focus of this blog, however, is the financing constraints that disadvantage Chinese renewable projects vis a vis traditional fossil fuel projects, particularly coal power. For the global transition towards a low-carbon energy structure, this second competition is more critical. 

Conflicting preferences between project developer and project financier

Based on interviews with a dozen industry insiders, including finance directors from large Chinese energy companies, the report authors came up with the diagram below illustrating the typical financial arrangement for a renewable energy project overseas, financed by a Chinese bank and with Sinosure overseas investment insurance.

REfinance
A typical “limited recourse” financing model for Chinese renewable energy projects overseas, by Greenovation Hub/Tsinghua report authors, recreated by Panda Paw Dragon Claw

A key concept that is embedded in this diagram is that of neibao waidai” (内保外贷), a practice of using assets inside China as collateral for loans supporting projects overseas. According to the industry insiders interviewed, this is still the most common way for Chinese companies to find financing for renewable energy projects overseas. In other words, even though Chinese companies are developing projects all over the world, from developed markets such as Canada and West Europe to Belt and Road countries such as Indonesia and Ethiopia, they continue to rely on their home market assets and Chinese banks for financing. It is relatively rare for a Chinese developer of renewable energy to tap into the financing pool of host country banks, international banks or multilateral banks, or to go beyond debt financing and make use of capital market, bond market or institutional investors.

The heavy reliance on neibao waidai indicates Chinese companies’ lack of access to alternative funding sources. It is also a sign of risk aversion from Chinese banks. In essence, it’s a form of recourse loan that favors the lender in providing extra assets (other than the project in question) to go after in case the borrower does not fulfil their obligations. For the borrower, the recourse loan will reflect on its corporate balance sheet as potential liability, reducing the amount of assets that it can underwrite other loans. 

Naturally, borrowers would want to go for non-recourse loans to keep such liabilities off corporate balance sheets. In the case of overseas energy projects, this means using only project assets, including its future revenues, to secure financing, with the investor’s other assets off-limit. Usually this would mean higher charges as the lender takes on more risks, but Chinese renewable energy developers nonetheless prefer this option. These differing preferences create barriers to finance as risk-averse lenders would prefer to provide asset-backed recourse loans, while developers are keen to secure non-recourse loans.

The ups and downs of China’s domestic renewables policy

Interviews with industry insiders in China also show the overstretched condition of Chinese renewable energy firms that are already “highly leveraged” and can barely allocate more assets to underwrite new loans. One factor that is particularly burdening them is the severely delayed payment of renewable energy subsidies in China, which has proved a huge drag on their cash flow. China set up feed-in tariff for wind and solar in 2011, a favorable policy framework that propelled spectacular growth of renewable energy installation. A renewable energy development fund was set up with money coming from a renewable energy surcharge on industrial and commercial electricity users. The fund is used to pay for the difference between the subsidized solar and wind tariff and the benchmark coal power price.  

But with exponential growth of installations aiming to take advantage of the subsidy, the fund’s pool has been unable to keep pace with the number of eligible entities drawing from it. Rationing was installed and payments became slow, leaving many renewables companies surviving on very tight revenue streams.

A large portion of China’s renewable energy sector (solar in particular) is private-owned and does not control large assets compared to their rival state-owned energy companies. This pushes private solar and wind firms to pursue more project financing (non-recourse) that does not eat into their corporate balance sheets.

Systemic biases

While “liberating” for some Chinese renewable companies, breaking away from the neibao waidai model is easier said than done. For a financier of renewable energy, to offer project financing requires a confident grasp of local market conditions and risks that many Chinese banks simply do not have. Moreover, Chinese renewable energy projects along the Belt and Road are generally disconnected from multilateral and international banks’ financing, which tend to be more attuned to host country markets.

REbankability
Solar project bankability from the perspective of a major Chinese solar developer, recreated by Panda Paw Dragon Claw

Beyond passing the “project bankability” test, Chinese renewable projects on the Belt and Road also need to overcome biases in the system that is built for supporting large fossil fuel projects overseas. A large part of the bias originates from the state financial institution’s perception of risks. For example, the neibao waidai model has a built-in element requiring overseas energy project developers to purchase Sinosure insurance, which provides an extra level of protection for Chinese banks. According to the report authors, this is very much a residual model of overseas fossil fuel financing where large amounts of funding is usually at stake with long project development cycles. Renewable energy projects, in contrast, are nimbler, with much smaller per project investment and shorter development time. Chinese renewable developers cannot, however, be exempted from insurance requirements that invariably increase their development costs. The report authors also highlighted the fact that at Sinosure, there are quotas for mid-long term export credit insurance, a product that is required of developers whose overseas projects involve export buyer’s credit or export seller’s credit. A large portion of that quota is reserved for overseas coal power projects, however. When renewable energy projects do need to tap into that quota, they often find themselves facing the left-over share from coal. 

Another bias is that Chinese state financial institutions consider risk at overall country level, rather than sector level or project level. This results in renewable projects in “high risk” countries that are otherwise healthy from a project point of view incapable of securing financing from Chinese banks. In addition, Chinese financial institutions, many of them with fresh memories of cash flow troubles experienced by the domestic renewable energy sector in recent years due to energy curtailment and unpaid subsidies, tend to project these worries onto their assessment of overseas renewable projects, even though market conditions such as pricing and subsidy mechanisms are different from those in China. In short, these biases lead Chinese public banks to take an over-cautious approach to solar and wind projects according to the authors. 

Lastly, the report also sheds light on different sets of incentives for Chinese banks when it comes to funding domestic and overseas projects. Inside China, the People’s Bank of China (PBoC, China’s central bank) has included key green financing indicators in its Macro Prudential Assessment (MPA) of commercial banks. First introduced by the PBoC in 2015, after a stock market meltdown almost triggered a financial crisis, the MPA is a powerful rein on Chinese financial institutions. Although a bank’s financial health and risk control are the focus of the assessment (with emphasis on indicators such as capital, leverage and liquidity), green performances were included in the MPA starting from 2018, with quantitative indicators such as the percentage of outstanding green loans in a bank’s overall lending. The domestic renewable energy sector has long been a beneficiary of green finance. Unfortunately, the greenness of a bank’s overseas lending is not part of the MPA, stripping Chinese financing institutions of a key incentive to take Belt and Road renewable energy projects more seriously. 

A road through the obstacles – blended financing

In light of these constraints in debt financing from both policy and commercial banks for Chinese renewable energy projects overseas, the report authors advocate for the mobilization of capital markets, institutional investors and utilization of blended financing to overcome the obstacles facing such projects. The report lists two types of arrangements commonly understood as blended financing:

  1. Blending of development financing and commercial financing
  2. Blending of corporate financing and project financing at different stages of a project’s life-cycle

Under the first type of blended financing, a development finance institution, usually a multilateral development bank, leads a consortium of commercial lenders to provide what is known as A/B loans to a borrower. The multilateral bank, serving as the Lender of Record for the loan, provides the A portion of the loan while other lenders chip in with the B portion. The blended financing model benefits renewable energy projects for its lower financing costs, as multilateral banks, with their Prefered Creditor Status, are better positioned in risk mitigation. This allows for non-recourse project financing with no sovereign guarantee and a long tenor. Critically, in the case of Chinese borrowers, such arrangements also waive the need to secure Sinosure insurance, further lowering costs. Jinko Solar’s San Juan project in Argentina is one of the few Chinese-invested renewable projects financed through an A/B loan led by the Inter-American Development Bank with participation from Bank of China.

The second type of blended financing takes into account the temporal differences in risks throughout a project’s life cycle and addresses them using different financial arrangements. What is commonly seen in Chinese overseas renewables projects is a combination of short-term corporate financing (raised by the EPC contractor) at the construction phase of a project and project financing after the project goes into operation. This allows projects to speedily go online and reduces the risks in the construction of projects for later financiers who would feel more comfortable taking on project financing of the solar or wind farm.

Authors also pointed to the fact that it is still a relatively recent phenomenon for Chinese companies to take up the role of developer in overseas energy projects. Up to now, they have more commonly been seen under the EPC contractor hat. It takes time for them to develop and cultivate relationships with host country financial institutions and multilateral development banks. Educating domestic market financiers also takes patience.

As Ma Jun, chair of China’s Green Finance Commission and former Chief Economist for the People’s Bank of China, put it at a March 27 webinar, Chinese financial institutions should honor the Party leadership’s Green BRI vision “through their portfolios” by financing less coal projects and more renewable projects. 

Understanding the financing challenges of renewable projects along the Belt and Road is the first step towards unlocking and mobilizing the massive financial resources needed to steer the BRI along the green path the Chinese leadership propounds, and to secure a form of development for BRI countries that does not lock them into carbon intensive energy systems. Given the scale of energy sector growth expected in these countries in the medium to long term, many of whom are in stages of rapid development, unlocking renewable energy financing would also significantly help to steer the world away from catastrophic climate change.

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

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.”