New analysis finds that the average cost of capital for power projects in Africa is triple that of other parts of the world.
For Africa, the COP29 climate talks are set to be a critical moment for the future of global climate action. Starting today in Baku, Azerbaijan, the aptly dubbed "Finance COP" will see the establishment of the New Collective Quantified Goal (NCQG) on climate finance. This target will replace the 2009 pledge by developed countries to mobilise $100 billion per year for climate action in developing countries.
Ongoing negotiations for the NCQG have been slow and bogged down by numerous disagreements including over the fund's size, what kinds of funding are included, who should contribute, and how adaptation, mitigation, loss and damage, and accountability will be addressed. These questions are all critical to the future effectiveness of the goal.
Historically, the climate finance pledged has fallen far short of what is needed to meet the scale of the challenge. Moreover, even when funds are available, structural barriers have kept them from reaching the countries that need them most.
According to the Independent High-Level Expert Group on Climate Finance (IHLEG), emerging and developing countries - excluding China - need to mobilise $1 trillion per year through 2030 from international sources to support climate action. Half of this amount will need to come from the private sector, which currently provides 49% of climate finance.
One key factor in the ineffectiveness of climate finance for Africa thus far has been the high cost of capital. According to the International Energy Agency, over 70% of global clean energy investment will need to come from the private sector. This reliance may be even higher in Africa, where median public debt has reached 65% of GDP and 20 countries spend over 10% of their revenue on debt servicing.
For indebted countries, turning to the private sector offers a route out but with significant risks. Nothing comes free. Investors in energy projects require a return on their investments to make it worth their while (the cost of equity). Meanwhile, the interest on loans from creditors needs to be serviced (the cost of debt). These costs make up the cost of capital.
Studies on Africa's power sector typically used generalised figures for the cost of capital due to limited country-specific data, risking policy bias and inaccurate project cost estimates. That is why Clean Air Task Force undertook a comprehensive assessment of the weighted average cost of capital for 48 African countries. Our analysis reveals that, at 15.6%, the average cost of capital for power projects in Africa is over three times that of other parts of the world like Western Europe and the US. In fact, some countries in Africa see capital costs exceeding 25%. The study also finds that the cost of equity is twice the cost of debt in Africa.
What this means is that while the overall costs of clean energy technologies may be declining on a global level, it is still significantly more expensive to fund clean energy projects in Africa than elsewhere.
This country-specific data offers much needed insight as to why the transformation of energy systems in Africa has progressed at such a slow pace. Despite its abundance of renewable energy resources, the continent has received a meagre 2% of global clean energy investments and accounts for less than 2% of global renewable energy capacity. These trends point to the harsh reality that clean energy investments continue to be directed to countries where the cost of capital is lower, leaving countries with high capital costs behind.
Beyond targets at COP29
In Africa, over 600 million people - about 43% of the continent's population - lack access to electricity. 900 million people lack access to clean cooking solutions. Africa needs to rapidly deploy clean energy to address this deficit.
However, for this to happen, the discourse on climate finance needs to move beyond just target setting to ensure that the funds raised can catalyse solutions where they are most needed. This will require several structural shifts.
Firstly, it is essential to deploy more public finance as grants, concessional loans and guarantee instruments to lower the cost of capital in low-income counties. The predecessor to the NCQG was primarily disbursed as loans, some with interest rates as high as 18%. As a result, the lion's share of funds ended up in the hands of middle-income countries that could afford such rates. The NCQG must avoid replicating this inequality by intentionally deploying financing instruments that derisk markets in low-income countries. This will help attract private sector investments into regions like Africa, which would otherwise be considered too risky for investments in capital intensive clean energy projects.
Secondly, more granular data and insights into the factors that influence clean energy investment readiness across Africa is needed. Our research has shown that there are significant differences in the cost of capital across the continent's regions and between countries. With such country-specific data on the cost of capital, policy makers will be better equipped to design targeted policies to reduce capital costs and investors can make investment decisions with greater confidence. The application of uniform indices across Africa impedes a grounded understanding of the nuances at play and leads to ill-designed policy and finance interventions.
Finally, it is time to confront the fact that systemic poverty across Africa is limiting climate progress. Our analysis reveals a decline in the cost of capital as economies grow and thrive. For energy projects, improvements in living standards and thriving economic activity signal the existence of financially viable demand, making these markets more attractive for investments including in clean energy. With greater economic development and fiscal discipline, African governments can boost domestic revenues and increase the fiscal space for climate positive investments. A more prosperous Africa can only be better for our global climate. To be impactful, climate action in Africa must go hand-in-hand with targeted interventions to address poverty and underdevelopment on the African continent.
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COP29 is an opportunity to renegotiate a new climate finance goal, but the work must not end there. To get these funds into the hands of countries who need them, the climate community must nurture the right partnerships with national governments, the private sector, international development agencies and multilateral development banks to address critical barriers such as the high cost of capital, poor data, and underdevelopment in Africa.
Lily Odarno is the Director of Clean Air Task Force's Energy and Climate Innovation Program, Africa. She leads CATF's effort to address the dual need of expanding affordable energy in developing economies and building a global decarbonised energy system.
