Stockholm (NordSIP) – As part of our ongoing interest into how sustainable investors can navigate the opportunities and challenges of the Indian economy, we spoke to ThomasLloyd to hear about how they tackled ESG risks in India’s renewable energy market. While conglomerates such as the Adani Group do not seem to be a cause for concern in this market, a careful selective approach coupled with a strong presence on the ground seems to be crucial to navigate the complexities of this market.
The Appeal of Renewable Energy in Emerging Markets?
ThomasLloyd was founded in 2003 and entered the sustainable energy infrastructure market, including clean tech and renewables in 2005, advising project developers, corporates and others on M&A, corporate finance and how to raise project finance.
In 2011, the company set up its own asset management division. “Sectorally, we decided to focus on the energy sector because it is the largest carbon emitter globally, which brought us to the energy infrastructure sector across the value chain, including renewable energy power generation, storage, transmission and sustainable fuels,” says Michael Sieg, founder and CEO of ThomasLloyd.
“Our main focus is currently on the fast-growing economies of ASEAN (incl. Philippines, Vietnam and Indonesia) and the Indian subcontinent (India, Bangladesh and eventually Sri Lanka), which will be the main GHG emitters for the coming 20 to 30 years. Japan and South Korea offer limited growth prospects. The challenges presented by China are now well-established, and Pakistan’s risk-return profile is widely unsuitable for European investors. The same can be said of other regional pre-frontier markets like Laos, Cambodia and Myanmar, which at this point lack scale, liquidity and/or governance capacity and standards,” Sieg argues.
The focus was motivated by the fact that Asia is the fastest-growing major power generation markets in the world, which creates opportunities for impact. In 2021, the world emitted 37.12 billion tonnes of greenhouse gas. Asia was responsible for 58.43% of that amount. India alone represents 7.3% of the total. “Asia emits today 75% more CO2 than Europe and North America combined, which makes the continentthe heart and center of global efforts in the fight against global warming,” Sieg explains.
As growing populations and economic growth are expected to motivate a rural exodus and put increased pressure on urbanization, ThomasLloyd believes that this region will also see electricity consumption rise by another 200% in the next 25 to 30 years. “This massive energy demand will lead to a massive energy infrastructure funding requirement in all of our target jurisdictions, amounting to US$7.4 trillion over the next thirty years,” Sieg continues.
(Mis)Perceived Risks
A mismatch between perception and the reality adds to the appeal of Asian countries, including India. “There is a pervading expectation of higher risk in EMs that we just do not find in the renewable energy markets we operate in,” Sieg says.
“India’s renewable energy market has been on a very rapid learning curve in terms of improving private sector participation. But sometimes it feels like there’s a legacy issue where foreigners are holding on to an outdated view of a market informed by old events or the last scandal that received global media attention,” Smita Nakhooda, Head of Impact and ESG at ThomasLloyd says.
As is the case in other local markets, the commercial proposition for renewable energy infrastructure in India is commercially competitive and not particularly risky. “The markets we operate in passed grid parity five or six years ago. They don’t require subsidies. At 60%-65% the price of coal, the commercial case for solar energy is very compelling. Moreover despite the perception that EMs are risky, none of the states or countries we operate in has ever had a party default on a Power Purchase Agreement (PPA) since we entered these markets,” Sieg explains.
“The appeal is such that experienced and reputable international and Nordic names such as Norfund and KLP, Norway’s largest pension fund, have financed investment teams on the ground in India. In a country where 1.7 million people are dying of direct and indirect air pollution, renewable energy offers clean air electricity at less than half the price of our coal competitors. It’s a straight-forward proposition,” Sieg adds.
The Importance of Governance
“If investors leave their prejudices behind, they can find good opportunities. However, they have to be selective. Investor must choose markets carefully,” Sieg says. “The focus should be on institutions and their long-term effects. Governance issues are very important for us and contributed to keeping us so far out of some countries such as Pakistan, Cambodia, or Myanmar. We are a US-regulated investment manager. We are ultimately privately liable,” Sieg adds.
Using the example of Photovoltaic (PV) PPA agreement, Sieg argues that ThomasLloyd faces one main governance risk. “Corruption and bribery can occur either when services are sourced, or whenPPAs are negotiated,” he explains. A PPA defines the terms of a contract (normally the energy price) between an entity such as ThomasLloyd, which acts as a financier of the solar power plant. The energy produced by this PV power plant is then sold off to the other party of the PPA, an “offtaker”.
To tackle this risk, ThomasLloyd only participates in transparent PPA tender processes; interacts with reputable suppliers and off-takers and has the due diligence resources to monitor conditions on the ground effectively.
PPA Tender Processes
“In some countries, government interactions are a source of governance risk. A simple solution to this risk is to avoid any type of contracts that require government officials to have a personal responsibility for handing out any type of licenses at any level. We have been very selective with Indian subnational state governments. We are in five states and are hoping to add another one or two this year,” Sieg explains. “The integrity with which you navigate any system ultimately determines the outcome. The way in which we choose to participate in a bidding process is also part of the terms that we seek to have control over,” Nakhooda adds.
The tender process via which PPAs are sourced is crucial. “The procedures in India are actually not that dissimilar from those we are accustomed to in Europe or the USA,” Sieg says. “These are reverse auction, public tender processes, conducted digitally and transparently with selected, sophisticated and technically qualified bidders. When we do utility-scale projects they are all conducted with the central government and very carefully selected subnational state governments. The authorities have to be reliable enough that nothing else is required of them other than to act as a clearing house and an administrator of the national grid,” Sieg continues.
“As part of that process we consider credit assessments, grid impact studies, payment track records and many other elements that are material for the commercial viability of the project. The contracts are all fixed price and long term in nature, normally lasting for 20 to 25 years. We negotiate with high credit worthy corporate and industrial offtakers to western standards. There’s a direct corporate offtaker buying the electricity on the other side that adheres to the same standards,” Sieg says.
The Developers
Governance risk is also important when interacting with project developers receiving financing from ThomasLloyd. “When looking for a construction company to build a plant, investors should look for counterparts that have proven that they have built those sort of assets successfully. Here too, we issue a Request for Proposals (RFP) and follow a tender process with three to five preferred bidders, after which we do our own complete supply chain check,” Sieg argues. “It’s very important to be able to understand local markets, which is why we have half of our workforce, is working in our investee countries. This is not a business where you can just fly in and out of. You have to be on the ground,” Sieg adds.
“Some of these things are simplified by the fact that our business model is to do direct investments in sustainable energy solutions through trusted counterpart investee companies that essentially work as our feet on the ground,” Nakhooda explains. “Due diligence on prospective partners in the countries where we are going to make these long term investments is the critical keystone of our approach. To someone sitting in Stockholm, events in Uttar Pradesh and Madhya Pradesh seem very far. But someone on the ground with the required understanding of the business and of the local players can make sense of events,” Nakhooda says.
“The capacity to understand local context and make responsible choices in that environment is a critical factor. Partnering with an investee company requires the fulfilment of an extensive set of due diligence requirements. ThomasLloyd group has implemented a set of ESG systems and principles that require investee companies to be able to adhere to best practices, such as the International Finance Corporation’s performance standards on health and safety standards, labour policies and environmental footprints,” Nakhooda continues.
Conglomerates, Coal and the Fair Transition
As is the case in many other countries, the Indian economy is prey to large and monopolistic conglomerates such as the Adani Group or the Tata Group. In most countries, such organisations tend to be well connected and a barrier to new market entrants. Although they profit from some of India’s biggest injustices, they are not problematic for renewable energy investors. “In the countries that we operate, the electricity transmission infrastructure is state-owned, not private conglomerate-owned,” Sieg argues.
This is in large part because India has removed restriction on foreign ownership in these markets. “While many countries in the region historically limited the energy sector as one of the restricted sectors where foreign ownership was limited to 40%, India did not. That decision allowed India to achieve 175 GW of installed renewable energy capacity. The experience of countries like the Philippines which held on to its restrictions longer and therefore failed to grow at its potential shows how beneficial breaking barriers to trade can be,” Sieg adds.
“Whether the energy transition is fair comes down to how it is managed. Whether we consider inequality across gender, caste or ethnic group, there are a multitude of inequalities that characterise Indian society today. Some of these are concentrated in pockets of the Indian economy that are dominated by coal, which is very unequal and dominated by very large conglomerates, which employ poor and marginalised people,” Nakhooda says
“Part of the just transition conversation in India is how to create opportunities for people who ekee out a livelihood in this industry that needs to be transitioned out of. Part of the solution will require grappling with the political economy of coal as an industry, and how to create jobs in clean energy alternatives,” Nakhooda continues.
“The availability of electricity for everyone is a crucial part of making a country fairer. On the other hand, lowering the price of electricity also improves living conditions. Asian markets have some of the highest energy prices in the world, but also some of the poorest people. We would hope the transition would help reduce the inequality in this manner and feed through to the rest of the country. Electricity is the baseline of any economic growth. If that part of the economy is healthy, the rest can flourish,” Sieg concludes.
