The world has continued to experience adverse changes in climatic conditions over recent years. Ramifications of the ever-increasing climate change effects are dire for the land, infrastructure and general economic ecosystem – including people, especially the poor and vulnerable in society. This growing adverse ecological disparity is created due to excessive emissions of carbon dioxide into the environment, leading to global warming.
These emissions are due to an increase in market activities, largely underpinned by the drive to satisfy modern consumption requirements without due consideration of their impact on the environment. A study conducted by the International Energy Agency (IEA) on energy-oriented CO2 emissions worldwide revealed that fossil fuel-based energy and climate security challenges are regarded as serious issues influencing sustainable economic development globally (IEA, 2010).
Consequently, there has been a consistent policy focus, particularly in the developed economies, on green financing as a driver of sustainable development. The World Bank estimates that the yearly green project financing will reach US$40trillion between 2012 and 2030 in developing or emerging economies. In sub-Saharan Africa, an estimated amount of US$100bn is required annually to finance green infrastructure.
The Africa Green Finance Coalition (AGFC) is formed with the aim of bringing African countries together to pool resources, share learning and create a pathway for increased flows of green investment capital to the continent. According to the Partnership for Action on Green Economy (PAGE) baseline report (2021), the government of Ghana has recognised the Green Economy (GE) and is poised to implement measures that ensure sustainability and scale-up green financing in Ghana.
Green project finance can be explained as a combination of financial instruments that can be utilised to make green investment affordable and lower risk for private individuals, financial markets and governments. It is the process of promoting projects that involve low carbon, renewable or clean energy, resource efficiency, clean production, improved waste management and other initiatives which contribute to sustainable growth and development. Sustainable development is the type of development that improves people’s lives in a progressive and sustained way.
The United Nations Environmental Programme (UNEP) (2014) described green project financing as the financial engagements which enhance the livelihood and well-being of people in a consistent and sustained manner. It engenders social protection and ensures social equity, thereby significantly reducing environmental risks and ecological scarcities. Despite the strengthened focus on green project financing as a critical variable in the sustainable growth and development equation, it still requires more attention. This is because the green project finance market is still shrouded in a number of challenges, from both the supply side and demand side.
Supply-side Challenges of Green Project Financing in Ghana
Commercial banks, Development Finance Institutions (DFIs) and other private sponsors are faced with peculiar challenges that inhibit their potential to drive the expected green growth target. Some of these challenges include, but are not limited to, the following:
Risky nature of green projects’ cash flow profiles: Most green projects exhibit peculiar cash flow streams juxtaposed with traditional, less eco-friendly projects which generally tend to be more upfront loaded with lower operational costs. This is particularly true with green projects such as renewable energy and energy-efficiency projects, whose upfront cost is offset by the savings in operational costs post-implementation. The apparent upfront cost differential presents a burden in the initial financing decision, even though the project may be deemed viable through a stream of positive cash flow in the operational years. Also, risk factors associated with green technologies require careful consideration. Such risks are often treated by adding risk premiums – which increase the interest on green project loans. Given the upfront nature of the cash flow, the higher the rate, the more expensive the project – hence rendering it less profitable.
Technology Risks: While it may be true that unproven technologies for both green and non-green projects may present similar cost and revenue characteristics, the former comes with substantial technology risks that most lenders are unwilling to take. These risks require a different funding approach involving technology commercialisation, viability and validation by reports from research and development (R&D). The other options for risk mitigation in this regard include incubation and demonstration, among others. While some investors may be willing to assume these types of risks with the support of venture capital funding, some actors in the financial services industry may not find these projects attractive until the risk return profiles are stabilised at certain levels.
Information and knowledge gaps: Most green projects, especially low-carbon ones, require a certain level of technical expertise and experience to be able to appraise them. Most lenders have limited technical capacity and little awareness of the green projects’ viability. Consequently, they tend to overestimate the technical risks associated with them; leading to higher interest charges and thereby making some of these projects unattractive.
Policy Distortions: A certain level of policy distortion in the economy may be inimical to achieving the desired speed of green growth. For instance, subsidies for fossil fuels and general tariffs (electricity, urban transport, water supply and sanitation), depending on their magnitude, may jeopardise the viability considerations of some green projects – or extend the required payback periods beyond levels that financiers or investors are willing to accept. According to the IEA report for 2022, worldwide subsidies for fossil fuel consumption have skyrocketed to more than US$1trillion. These distortions do not favour the drive for green growth.
Demand-side challenges of green project financing in Ghana
High initial cost and long payback period: The sunk cost of most green projects is high at the beginning, but the payback period is usually long. This makes financial decisions difficult, especially for companies or individuals with limited cash flows. This has the potential to render green projects unattractive to individuals and corporate organisations.
High interest on loans: This is probably one of the key challenges on the demand-side. There are several reasons why the price of loans for green projects may be high. The current macroeconomic environment is characterised by the volatility of macroeconomic indicators – particularly exchange rates, which directly impact inflation and bank lending rates. Also, some of these projects are fronted by private individuals whose assessment sometimes raises issues of succession and what has come to be known in credit appraisal circles as ‘key man’ risk. These factors affect the loan’s pricing, making these green investments expensive and unattractive.
The Way Forward
To surmount these challenges, collective efforts by all stakeholders is required to address them. Sean Kidney puts it aptly: “We have the solutions and there is no shortage of capital that needs to be invested in the new low-carbon economy. We need to design the future sustainable world in which to invest that capital”.
Firstly, for financiers or sponsors, there is a need for partnerships involving banks, investors, micro-credit entities, insurance companies along with the public sector in the form of syndication to create a pool of funds sufficient to finance these green projects. This will helps raise enough capital for these projects, as well as diversify their loan portfolio and thereby minimise risk.
Secondly, insurance is another great option to transfer the inherent risks within green projects, which are often an anticipated uncertainty. The insurance companies should be capitalised enough to underwrite such green projects. A well-capitalised insurance industry is a viable prerequisite and a sound support for green project financing.
Thirdly, the bond or capital market presents a viable avenue to access a pool of funds. The capital markets provide an avenue to access funds that are long-term in order to meet the long-term green finance requirements.
Finally, from a policy perspective, the state has a stake in ensuring a conducive macroeconomic environment with a favourable lending rate regime to reduce the cumulative interest on loans for green projects. Instead of offering subsidies for fossil fuels and other general tariffs, those subsidies should rather be channeled toward supporting green projects financing.
Abraham works with the Banking and Finance Think-Tank, Project Management Institute, Ghana Chapter
