metadata: authors: 0: author: Vagliasindi,Maria
count: World
docna: 0: docna: The role of policy driven incentives to
            attract PPPs in renewable-based energy in developing
            countries : a cross-country analysis
docty: Policy Research Working Paper
subtopic: Science of Climate Change,Climate Change and Health,Climate Change and Environment,Rural and Renewable Energy,Hydro Power,Energy Policies & Economics,Water and Energy,Energy Demand,Energy and Environment,Energy and Mining,Renewable Energy
teratopic: Environment,Private Sector Development,Energy,Finance and Financial Sector Development
abstracts: cdata!: This paper presents new global evidence
            on the key determinants of public-private partnership
            investment in electricity generated by renewable energy
            based on a panel data analysis for 105 developing countries
            over a period of 16 years from 1993 to 2008. It aims to
            identify the key factors affecting the private
            investor's decision to enter renewable-based energy
            generation, through a probit analysis and the amount of
            investment sunk in this market segment, based on
            Heckman's sample selection analysis. One of the key
            results of the paper is that the market for renewable-based
            energy is strongly driven by supportive policies. Support
            policies serve not only to attract the entry of private
            investors, but also to determine the level of investment. In
            the latter case, its impact is less significant, suggesting
            the need over time to revisit the power of the incentive
            schemes, as well as the implied allocation of risks between
            the public and private sector to ensure that feed-in tariffs
            produce the desired amount of investment. In contrast,
            broader economy-wide governance factors, including control
            for corruption and degree of political competition, are
            considered by private investors mainly for taking the
            decision to enter into renewable-based generation. This
            reinforces the expectation that private investors seem to be
            adequately protected against their risks, so that once they
            have entered the market, they can accommodate the governance
            environment. Private investors in renewable-based energy
            also require technical and regulatory certainty about the
            availability of renewable-ready transmission resources, if
            they are to finance investments. Private investors entering
            the market look more at the size of the market rather than
            the income level, whereas when determining the level of
            investment they assess both the size and
            "affordability" level. This raises some concerns
            on the sustainability of support mechanisms and their
            financing, particularly when the incremental costs implied
            by renewable-based generation are passed through to consumers.
repnme: repnme: The role of policy driven incentives to
            attract PPPs in renewable-based energy in developing
            countries : a cross-country analysis
display_title: The role of policy driven incentives
            to attract PPPs in renewable-based energy in developing
            countries : a cross-country analysis
listing_relative_url: /research/2012/07/16481342/role-policy-driven-incentives-attract-ppps-renewable-based-energy-developing-countries-cross-country-analysis
topicv3: Renewable Energy m1326170 525,Energy and Extractives m1326595 507,Climate Change m1326829 567,Power and Electricity Sector m1327094 515,Hydropower and Dams m1327326 527
publishtoextweb_dt: 2012-07-01T00:00:00Z
historic_topic: Environment,Private Sector Development,Energy,Finance and Financial Sector Development
no_of_pages: 27
author_keys: 0: author_key: 619680
model_extractions: WPS6120 Policy Research Working Paper 6120 The Role of Policy Driven Incentives to Attract Ppps in Renewable-Based Energy in Developing Countries A Cross-Country Analysis _Maria Vagliasindi_ The World Bank Sustainable Energy Department Energy Unit July 2012
Policy Research Working Paper 6120

# **Abstract**

This paper presents new global evidence on the key determinants of public-private partnership investment in electricity generated by renewable energy based on a panel data analysis for 105 developing countries over a period of 16 years from 1993 to 2008. It aims to identify the key factors affecting the private investor’s decision to enter renewable-based energy generation, through a probit analysis and the amount of investment sunk in this market segment, based on Heckman’s sample selection analysis. One of the key results of the paper is that the market for renewable-based energy is strongly driven by supportive policies. Support policies serve not only to attract the entry of private investors, but also to determine the level of investment. In the latter case, its impact is less significant, suggesting the need over time to revisit the power of the incentive schemes, as well as the implied allocation of risks between the public and private sector to ensure that feed-in tariffs produce the desired amount of investment. In contrast, broader economy-wide governance factors, including control for corruption and degree of political competition, are considered by private investors mainly for taking the decision to enter into renewable-based generation. This reinforces the expectation that private investors seem to be adequately protected against their risks, so that once they have entered the market, they can accommodate the governance environment. Private investors in renewablebased energy also require technical and regulatory certainty about the availability of renewable-ready transmission resources, if they are to finance investments. Private investors entering the market look more at the size of the market rather than the income level, whereas when determining the level of investment they assess both the size and “affordability” level. This raises some concerns on the sustainability of support mechanisms and their financing, particularly when the incremental costs implied by renewable-based generation are passed through to consumers.

This paper is a product of the Energy Unit, Sustainable Energy Department. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at mvagliasindi@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
**The role of policy driven incentives to attract PPPs in renewable-based energy in developing countries***

# **_A cross-country analysis**_**

## Maria Vagliasindi

### **JEL:** L1, L51, Q48

#### **Energy and Mining (EM) Sector Board**

* This paper is one of the papers developed in the context of the ESW “Public and Private Role in the Power Sector”, partially supported by ESMAP. The overall report results, which include detailed case studies,  are reported in Vagliasindi (2012a). I am very grateful to John Besant-Jones, Istvan Dobozi, Jose Luis Guasch, Karina Izaguirre, Jie Lie and Evgenia Shumilkina for their most helpful comments and suggestions.

**Maria Vagliasindi, Lead Economist, Energy Unit, Sustainable Energy Department, World Bank
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**Policies that support renewable energy use either price or quantity setting instruments. Of the different**

**options to support renewable energy, feed-in tariffs are increasingly seen as the “policy of choice” to attract private investment in renewable energy** (Menanteau et al.; 2003, Mitchell _et al._ ; 2006; Lipp, 2007; Lesser, 2008, Burer et al., 2009; REN 21, 2010, DB Climate Change Advisors, 2010). Under a feed-in tariff scheme, electric utilities are obliged to purchase renewable energy through long term contracts that guarantee access to the grid, at an enhanced price (the so called feed-in tariff).  Feed-in tariffs, where renewable energy delivered to the grid receives a pre-set tariff, have a clear track record of delivering significant volume increases in its deployment. The stable revenue stream across a pre-established timeframe reduces risk around cash-flow. IEA analysis indicates that cost of capital will be higher in support schemes with traded obligations given the lack of certainty over the revenue stream.<sup>1</sup> Feed-in tariffs can be applied consistently and transparently and can be readily adapted to different specific power market structures. For instance, the incentive can also be offered as a premium in addition to the spot-market electricity price (Cory et al. 2009, Couture et al. 2010).

# **_Box 1 Challenges for setting feed-in tariffs_**

Renewable energy support and incentive mechanisms are the most important factors that drive the growth of a market in renewable-based energy. Feed-in tariff (FIT), a price-based support, is in favor in majority of the European countries such as Germany and Spain. This system sets a guaranteed price for renewable energy generation or an addition to the prevailing market price. The feed-in tariff system is widely used in as well, and only few developing countries have implemented alternative solutions (see Box 2).

It is difficult to strike the right level of feed-in tariff. Low feed-in tariff may not trigger enough investment in renewable-based energy. High feed-in tariffs, though, also have a negative effect on cost reductions as they induce generators to choose high-cost sites and provide fewer incentives for cost cuts. This illustrates the importance of designing an efficient energy support system, which not only promotes diffusion but also provides continuous incentives for costreducing innovations. The rapid expansion of the Spanish solar PV and subsequent intervention to contract the market in 2008 (capping overall market size, alongside a 30% cut in the tariff) has been attributed as much to tariff design as to setting the tariffs at unsustainably high levels. In contrast, Germany prescribed stepped tariff reductions (degressions) and has produced steadier growth.

**The effectiveness of the feed-in tariff policy has been well documented in Europe.** A study comparing the effect of these policies to other policy mechanisms designed to support the spread of wind energy found that they resulted in 7-8 times as much installed wind capacity (European Commission, as reported by Thomas B. Johansson, Chair, Global Energy Assessment). The overall success of the German, Spanish, Danish and other national level feed-in programs has inspired similar initiatives in developing countries including China and, more recently, South Africa and India, as well as by regional and state governments in the UK, US, and Australia.

**The feed-in tariff policy has already been implemented in about 80 states and countries around the world, more than half of which are developing economies (see Fig. 5 below).** The most important element of these schemes is that they fully or partially remove the market risks of a project during a fixed period of time. The longer this period of guaranteed prices, the lower the cost of capital. Because of this, they are generally financed with a relatively large proportion of debt. In feed-in premium schemes, the risk of variations in electricity market prices is reflected by the tariff premium in the purchase power agreement (PPA). But private investors may struggle to acquire a PPA with a 15 to 20 year tenor at reasonable risk premium levels to cover this debt.   A strong government commitment towards the scheme is essential in this respect. Changes in the

> 1 IEA analysis indicates that a 2 to 30% cut in the cost of renewable energy can result from improved design of incentive or support schemes, with the higher end of this range linked to projects with higher project risk, such as offshore wind.

5
<!-- Start of picture text --> 90<br>Cumulative states and countries adopting feed-in tariffs<br>80<br>nnns 7 f<br>rs | 0<br>nn fff<br>nT 0 0 0<br>eT ltr lnn<br>eee0 gg a<br>oon~DaDDAAKDAAKEOcCCFCoOoGeGCDADAAAAAAEnenmnwtnwendc’ctrvtnmtnN UO RHR DODoS aSO<br>aA A At At A TT TOTO NONNONONONONONONONCSE SESCSCSCSESESOON<br>@ Emerging and developing M Advanced<br><!-- End of picture text -->
# **_Box 2  Quota systems for renewable generation: the case of Poland_**

The system of tradable certificates or the quota obligation framework, a quantity based system, has been adopted by Latvia, Poland and Romania. The Czech Republic adopted both systems. In 2000, the Polish government introduced a power purchase obligation for renewable energy sources, which was first amended in 2003, and again in August 2008. This requires energy suppliers to provide a certain minimum share of power generated by renewable sources (from 3.1% in 2005 up to 10.4% in 2010 and 12.9% in 2017). The electricity from renewable energy sources is purchased at a guaranteed price which is the median electricity price for the previous year. In 2010 this stood at 197.21 PLN/MWh. If a company does not fulfill its obligation according to the quota regulation, a penalty will apply that is equal to 248.46 PLN per MWh and an additional 30% fine cumulates to the initial fee if it is not duly paid. The European Commission‟s 2007 report found that fines were not enforced. In 2005, the Polish Law on Energy (1997) was amended to introduce an obligation for all renewable energy producers, regardless of the size of the installations, to obtain a license from the Energy Regulation Authority. Following this new requirement, more than 600 producers of renewable energy applied for and received licenses for producing electricity from renewable sources. The cumulative power installation moved from 83 in 2005 to about 1,000 in 2010.

|**Source**|**2005**|**2006**|**2007**|**2008**|**2009**|**2010**|
|---|---|---|---|---|---|---|
|**Biogas**|32.00|36.80|45.70|54.61|71.62|77.00|
|**Biomass**|189.80|238.80|255.40|232.00|252.49|252.49|
|**Wind**|83.30|152.00|287.90|451.00|724.68|1,005.00|
|**Hydro**|922.00|931.00|934.80|940.57|945.20|947.00|
|**Total**|**1,227.10**|**1,358.60**|**1,523.80**|**1 678.18**|**1 993.99**|**2 281.49**|

The rest of the paper is organized as follows. Section 2 will highlight the key objectives of the papers and the data that is used to carry out the analysis. Section 3 introduces the theoretical hypotheses that will guide the empirical analysis. Section 4 reports the results of the regressions. Section 5 concludes and presents new directions for future research.

7
# **2. Analytical Approach and Data**

**This paper presents new global evidence on the key determinants of** public-private partnership ( **PPP) investment in electricity generated by renewable energy** (including hydro, wind, waste and geothermal) based on a panel data analysis  for 105 developing countries over a 16 years period from 1993 to 2008.

**The paper aims at determining the evidence of the effectiveness of sectoral support mechanisms such as feed-in tariffs for attracting private investment in developing countries.** We divide the determinants of PPPs into three channels. These include (sectoral and economy-wide) governance variables and short and long run drivers, represented respectively by financial crises and climate change variables. We also control for macroeconomic, sectoral and regional variables.

**Our study aims to identify the key factors affecting the private investor’s decision to enter the renewable energy market and the amount of investment sunk in this market segment.**

**The analysis of the key determinants of the private investor’s decision to enter is done using the probit model** , where the dependent variable is a dummy equal to 1 if PPPs were introduced in the renewable energy market and 0 if not.

**The treatment of the modeling of the key factors affecting the private investor’s amount of investment sunk in the renewable energy market is based on Heckman’s approach to sample selection** . This distinguishes between (1) the decision on whether to enter the segment of the electricity market (selection equation), and (2) the decision on how much investment to commit to (investment equation).<sup>2</sup> Unlike the Tobit model, the factors that affect the two decisions need not be identical and, where identical, could even be different in the sign of their effect on the decisions. The selection equation relates the choice of whether to attract PPPs (via a zero/one dummy variable) as a function of the governance variables and the price of oil is estimated over the complete set of countries using a probit model. The second-stage equation, relating PPP investment to the full set of short run and long run variables described in Table 1, is estimated over the sub-set of countries. Because the group has been selected by the first-stage equation, the possibility of selection bias would be introduced if a standard regression were used at the second stage. This bias is related to the magnitude of the correlation between the errors (that include the omitted variables) in the selection and investment equations. Where there is no correlation between these errors, there is no selection bias. The direction of the bias depends on the sign of the inter-equation error correlation.

The condition for identification of the Heckman estimation procedure is that the selection equation contains a significant variable(s) not included in the investment equation. The significance of the Mills‟ ratio in the second stage indicates whether there would have been selection bias in its absence. If the Mills‟ ratio is insignificant, a simple regression of the quantity of investment on explanatory variables would be unbiased. The canonical Heckman model also assumes that the errors are jointly normal. If that assumption fails, the estimator is generally inconsistent and can provide misleading inference in small samples.

**Data used in this paper are composed of both micro and macro level data.** The micro, project-level data are from the Private Participation in Infrastructure (PPI)<sup>3</sup> database. The PPI database is managed by the World Bank and the Private-Public Infrastructure Advisory Facility (PPIAF). The data are collected at the project level for developing countries. The following information of each project recorded in the database is used in this

> 2 The data on the dependent variable consist of observations related to the investment. This would be zero for countries that had not attracted PPPs, and positive for those countries that had decided to use it. This observation is split into two components: a zero or one variable indicating the lack of entry or entry of PPPs, and a variable measuring investment for the subset of countries that attracted PPPs.

> 3 <u>http://www.ppiaf.org/ppiaf/page/private-participation-infrastructure-database</u>

8
paper: 1) country and region<sup>4</sup> , 2) year of financial closure and total life period of the project, 3) total investment (in both monetary value and physical capacity), 4) sector, subsector, segment, and technology (fuel) of each project.<sup>5</sup> The database includes observations for 105 developing countries from 16 years from 1993 to 2008.

**The macro data are collected from other central databases** , including i) the _World Development Indicators (WDI) 2009_ for macroeconomic variable and the _World Governance Indicators_ and Polity IV to select a few indicators of governance ii) the _Energy Balances and Statistics 2009_ of the International Energy Agency (IEA) to derive indicators of energy import dependence and per capita CO2 emissions and the electricity databases of the Energy Information Agency (EIA) of Department of Energy (DoE) of the US government (Annex 1) to countries‟ total installed capacity and their composition, total electricity generation, consumption, net import, and distribution losses. Finally, we also use REN21 to compile the list of countries adopting feed-in tariffs and for publicly available information on the list of countries with an autonomous electricity regulator.

**Fig. 6 PPP Investment in renewable-based energy, by region**

<!-- Start of picture text --> 3%<br>13%<br>27% EAP<br>5% ECA<br>LAC<br>MNA<br>SAR<br>16%<br>SSA<br>37%<br><!-- End of picture text --> _Source:_ World Bank/PPIAF PPI Database

**The key summary statistics show PPP investment highly concentrated in few regions.** As Figure 6 illustrates of all the PPP investment reported in the PPI data the large majority benefitted the LAC and EAP region (where investments are respectively just below 40% and above 30%). About 15% and 12% of investment in renewable took place respectively in the SAR and ECA region. Very little . investments have been recorded in the MNA and SSA regions

> 4 The six regions are East Asia Pacific (EAP), East Europe and Central Asia (ECA), Latin America (LAC), Middle East and North Africa (MNA), South Asia Region (SAR), and Sub-Sahara Africa (SSA).

> 5 The primary sector is energy, and the subsectors are electricity, natural gas, and other (road, telecom, or treatment plant). For the electricity subsector, the segment information tells whether it is a project for power generation, transmission, or distribution, or a combination of these. For power generation project, the technology (fuel) indicates what fuel (coal, oil, or natural gas etc.) or technology (hydro, wind, nuclear etc.) is used for the generation.

9
<!-- Start of picture text --> 0%<br>3%<br>m@ Hydro<br>TM Geothermal<br>m= Waste<br>m= Wind<br>84% m SolSolar<br><!-- End of picture text --> <!-- Start of picture text --> 0%<br>= Geothermal<br>m Waste<br>= Wind<br>m Solar<br><!-- End of picture text --> <!-- Start of picture text --> 14000<br>12000<br>10000<br>8000<br>6000 = Other<br>Renewables<br>4000 m y Hydro<br>2000<br>0<br>ontNDNADAVDANmMTtTH ORAA WADGOAAMDTHAHDAGeCeeeeeseOR OW<br>SASRSARSASARRR RAR AAA<br><!-- End of picture text --> <!-- Start of picture text --> 2000<br>1800<br>1600<br>1400<br>1200 mSolar<br>1000 = Wind<br>800 m Waste<br>600<br>@ Geothermal<br>400<br>200<br>0<br>oerNDNADAAAAAVARHAOCCCCaCCC nmManNwUoRnRDAD OCH AMTHOR DW<br>ASASAAASASASAARRRRRRAAANSo<br><!-- End of picture text -->
<!-- Start of picture text --> 12000<br>m East Asia and<br>10000 Pacific<br>8000 mw EuropeCentral andAsia<br>6000 @ Latin; America;<br>and the<br>s000 Caribbean<br>South Asia<br>2000<br>TM Sub-Saharan<br>0 Africa<br>OF nmMmtTHNURDADOAaAwmMaTH HRW<br>NADA VAAVAAVAHA GCC CeCeeCeeec ge<br>DADAAAAAAAVAVODOVGVODCGDCOS<br>Ant A BP AP A AP AA ANNNNNNNN<br><!-- End of picture text --> <!-- Start of picture text --> 1800<br>1600 m East Asia and<br>1400 Pacific<br>1200 m CentralEurope Asiaand<br>1000 = Latin America and<br>800 the Caribbean<br>600 = MiddleNorth. Africa East and<br>400<br>m South Asia<br>200<br>0 lm Sub-Saharan<br>SCHANMTHOHRADOANMTtTHDADAAAAAAAGSGOCCCeCoCSeCSORD Aftica<br>DADAAAAAAAADWVODGCGDCSTSoS<br>Ae APA AAA AA ANNNNNNNN SS<br><!-- End of picture text --> <!-- Start of picture text --> 1000<br>900<br>800 East Asia and<br>700 Pacifici<br>600 s europe aneentral Asia<br>500<br>400 @ Latin America and<br>300 the Caribbean,<br>m South Asia<br>200<br>100<br>@ Sub-Saharan<br>0 Africa<br>oOoFnnmntunUOR ADAG srt aA wMaTHHURwW<br>DNaADADAVDAAVARAGCeOCeeeeeose<br>DADAADAAAAAGDOOCCSCOCCSCOCS<br>BAA BA BP BP BP AAA ANNNNNNNN NS<br><!-- End of picture text --> <!-- Start of picture text --> 600<br>500 m East Asia and<br>400 Pacific<br>@ Latin America<br>300 and the<br>Caribbean<br>200 @ South Asia.<br>100<br>@ Sub-Saharan<br>Africa<br>0<br>OQrnnmn stun vORDADOAtA MATH YR W<br>DADADAAGAAAAGIOOO0CCSC OCOD<br>DADDAAAADAAVADOVDIOODOCVCCDTOO<br>SAA KB ABA TBA TB A AA ANNNNNNNNS<br><!-- End of picture text -->
throughout the region have led to the continued development of Central America‟s geothermal resources. Costa Rica has been producing geothermal electricity from units located in the foothills of the Miravalles volcano since 1994. Studies of Guatemala‟s geothermal resource indicate that the country has up to 4,000 MW of geothermal potential, of which a small portion has already been developed for electricity production. Two geothermal power plants currently operate in Guatemala provide a combined 52 MW of geothermal energy to Guatemala‟s electricity grid. The majority state-owned company, LaGeo, operates the two plants which have a cumulative installed capacity of above 200 MW, making El Salvador the largest producer of geothermal energy in Central America. Investment in geothermal has significant upfront costs that must be spent prior to determining the viability of the resource basin. This investment requirement raises the upfront investment cost against (1) the short-term, up-front geological risk of exploration drilling, and/or (2) the long-term geological risk of developing and producing a geothermal reservoir with a lower-than-estimated temperature, higher than estimated mineralization, or difficulty with injection of geothermal fluids back into the subsurface.

**Wind** China alone attracted more than 50% of PPP investment in wind. Not surprisingly, China is listed as the top country in the world in terms of wind power added capacity in 2009, ahead of the United States, Spain, Germany, and India and the second country after the United States in terms of existing capacity.  Poland has been a fast mover, attracting since 2005 15% of the overall investment.  Bulgaria is following the lead by Poland attracting cumulatively more than 8% of the total investment. It is also worth noting the effort by Turkey and India in attracting private investment in wind which account for about 3% of the total PPP investment. The risk of lower revenue from a wind project due to lower than expected wind speeds is a major factor affecting the finance terms and conditions of wind farms.  For wind as for other grid-connected renewable-based energy, long lead times and administrative process may be needed to ensure grid reinforcements or additional investment necessary in the distribution or transmission system. Regulations requiring the project developer to pay the grid cost only up to the nearest grid connection point (the so called “shallow” grid connection charges) minimize the risks for the project developers, but they increase the burden on the network operator.

**Waste** Thailand alone accounts for 50% of the total PPP waste investment in developing countries. Biomass is by far the largest single contributor to power generation with most of the successful larger projects integrated into the rice and sugar mills. This is because of the large quantities of rice husk and bagasse produced by the mills that provide electricity for the milling process with additional electricity produced for export to the Electricity Generating Authority of Thailand (EGAT). Biomass from waste streams created during the processing of cassava and palm oil is the second largest source of renewable energy. Municipal solid waste projects have been proposed but only infrequently implemented. Privately owned renewable energy projects that produce electricity under the Small Power Producer (SPP) and Very Small Power Producers are eligible for special regulations and additional payment are available where the projects replace electricity generated from diesel fuel. Box 3 reports some of the challenges for SPP based from the pioneering experience in Thailand and Sri Lanka and the most recent experience in the first Sub Saharan country, Tanzania. Brazil has attracted more than 20% of the total PPP waste investment. Brazil has over 4.8 GW of biomass cogeneration plants at sugar mills, which generated more than 14 TWh of electricity in 2009; nearly 6 TWh of this total was excess that was fed into the grid. China accounted for 12% of total PPP investment in this subsegment of the market and its capacity rose further by 14 % in 2009 to 3.2 GW, and the country plans to install up to 30 GW by 2020. India generated 1.9 TWh of electricity with solid biomass in 2008. By the end of 2009, it had installed 835 MW of solid biomass capacity fueled by agricultural residues (up about 130 MW in 2009) and more than 1.5 GW of bagasse cogeneration plants (up nearly 300 MW in 2009, including off-grid and distributed systems); it aims for 1.7 GW of capacity by 2012.

12
## **_Box 3 Small Power Producers and light handed regulation_**

Small Power Producer (SPP) regulations enable expansion of renewable generated electricity through model power purchase agreements, standardized tariffs, and streamlined interconnection and licensing requirements. The regulations provide the legal basis for customers to self-supply with small clean renewable energy or cogeneration generators, and to export excess power (up to 10 MW) to the national utility (either the national grid, or mini-grids). SPPs will only develop if the prices that they receive for their electrical output exceed their own costs of production. For example, where main grid connected SPPs can sell at an administratively set price of about US $.10/kwh, the only SPPs that are commercially viable are cogenerators, some biomass generators and some mini-hydro generators with well-endowed sites. Solar and wind generators are generally not viable at this price level. In Tanzania in some cases (as reported in Graecen, Kahyoza and Mbawala (2010), SPPs will replace some or all of the production of existing diesel generation of mini-grids operated by TANESCO (the national government-owned utility). In other cases, it will bring electricity to communities without electricity. EWURA, the Tanzanian electricity regulator, has made a conscious effort to employ "light handed regulation" in its regulation of SPPs. “L ight handed regulation” means first, minimizing the amount of information that is required; second, minimizing the number of different regulatory requirements and decisions; and third, relying to the extent possible on related reviews by other Tanzanian government entities. An example of the first is that annual reporting requirements for SPPs are a fraction of those required by TANESCO or larger IPPs. An example of the second is that projects under 1 MW are exempt from EWURA licensing, and the SPP program relies on standardized documents as much as possible to minimize the need for case-by-case negotiation. An example of the third is that EWURA has proposed to rely, to the maximum extent possible, on the economic and technical reviews undertaken in electrification grant reviews by the Tanzania Rural Energy Agency (REA). Tenenbaum and Graecen (2010) also provides a typology of SPPs, presents a more detailed and nuanced discussion of the different dimensions of regulation vis-a-via SPPs and, perhaps most importantly, concludes with a several page checklist of real world implementation issues for regulators and government officials who wish to promote SPPs, Thailand and Sri Lanka both have similar SPP regulations in place, and both have encountered – to a certain extent – problems in which companies apply for PPAs with the intention of selling these PPAs at a profit. For example, in Thailand one company accounts for 445 MW of signed PPAs for grid-connected solar PV. None of these projects have yet to be built. Similarly, in Sri Lanka companies have tied up key micro-hydro sites with PPAs that have failed to develop into projects even after a number of years. To discourage this form of „PPA speculation‟ EWURA‟s license approvals „expire‟ after two years, thus giving other developers the chance to move in and develop the site. _Source:_ Greacen Kahyoza and Mbawala (2010), Tenenbaum and Greacen (2010)

# **3. Theoretical hypotheses**

The key determinants of PPPs in renewable-based energy, measured as the existence and amount of investment, are divided into three channels, reported in Table 1. These include (sectoral and economy-wide) governance variables and short and long run drivers, represented respectively by financial crises and climate change variables. We also control for macroeconomic, sectoral and regional variables.

The hypotheses that we are going to test are reported below. Each of the hypothesis is divided in two parts (part A and B), taking into account respectively the key factors affecting the private investor‟s decision to enter the renewable energy market and the amount of investment sunk in renewable energy, because of the different modeling that will be used (as described in Section 3).

13
**Table 1 Dependent and Explanatory Variables Influencing Private Investment in Renewable-based Energy**

|**Vribl**|**Dfinitin**<br>**E Sin **|
|---|---|
|**aaes**|**eo**<br>**xp. g **|
|**Itdti f fdi**|**SECTORALGOVERNANCE VARIABLES**|
|**nroucon o ee-n**<br>**tariffs**<br>_FIT_|= 1 since the year of establishment of a feed-in tariff system<br>= 0 otherwise<br>**+**|
||**ECONOMYWIDEGOVERNANCE VARIABLES**|
|**Control of Corruption**|= measures the perceptions of the extent to which public power is<br>exercised for private gain, including both petty and grand forms of<br>corruption, as well as "capture" of the state by elites and private<br>interests.(Kaufmann and KrayWorld Governance Indicator)<br>**+**|
|**Degree of democracy**<br>**_Polity2_**|= Revised Combined Polity Score (Polity 2): This variable is a modified<br>version of the POLITY variable to facilitate the use of the POLITY<br>regime measure in time-series analyses. It ranges from +10 (strongly<br>democratic) to -10 (strongly autocratic) based on 6 indicators<br>**+**|
||, .<br>**SHORT RUN FINANCIALCRISES**|
|**East Asian and Russian**<br>**Crisis**<br>_d_FC1_|= 1 for the 3 years after 1997<br>= 0 otherwise<br>-|
|**Latin American Crisis**<br>_dFC2_|= 1 for the 3 years after 2001<br>= 0 otherwise<br>-|
|___<br>**LO**|**NG RUN ENVIRONMENTALSUSTAINABILITY FACTORS**<br>|
|**Price of oil**|= value of the internationalprice of oil<br>**+**|
|**Kyoto Protocol**|= 1 for the years after 2005<br>= 0 otherwise<br>**+**|
|**PPP Transmission**<br>**i**|= investment in transmission committed by the private sector in (US$)<br>**+**|
|**nvestment**<br>**GDP**<br>_ln_GDP_|**LONG RUN ECONOMIC FUNDAMENTALS**<br>= GDP, PPP terms (constant 2005 international $)<br>**+**|
|**Population**<br>_ln_Pop_|= total population<br>**+**|

# **_Sectoral and Economy-Wide Governance_**

**Hypothesis 1A** The likelihood of attracting private investors to provide electricity from renewables is higher in countries where support mechanisms, including feed-in tariff, have been put in place.

**Hypothesis 1B** The level of investment in renewable-based energy is expected to be higher in countries using such incentives.

Private investors are more likely to choose to invest in renewable energy if the country offers sufficient incentives from the regulatory side. This is because most renewable sources of energy produce electricity at a higher cost than electricity from conventional sources, and they also typically entail higher upfront capital costs. After recouping the capital cost, private investors can benefit from the lower operational costs of generation from renewables. This is because, for instance, producers of electricity from wind and solar do not have to manage fuel cost or fuel price volatility.

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<!-- Start of picture text --> feed-in-tariff***<br>governance (control of @ aboveavg<br>corruption)***<br>@ below avg<br>political competition<br>(polity 4)***<br>0 0.2 0.4 0.6<br><!-- End of picture text --> <!-- Start of picture text --> feed-in-tariff***<br>governance (control of<br>corruption)*** @ above avg<br>@ below avg<br>political competition<br>(polity 4)***<br>0 100 200 300<br><!-- End of picture text -->
<!-- Start of picture text --> East Asia Financial Crisis**<br>@ before<br>after<br>Latin America Financial Crisis<br>0 0.05 0.1 0.15 0.2<br><!-- End of picture text --> <!-- Start of picture text --> In_GDP***<br>above avg<br>@ belowbel ave<br>In_pop***<br>0 0.05 0.1 0.15 0.2 0.25<br><!-- End of picture text --> <!-- Start of picture text --> East Asia Financial Crisis*<br>@ before<br>@ after<br>Latin America Financial Crisis<br>0 10 20 30 40 50 60 70<br><!-- End of picture text --> <!-- Start of picture text --> In_GDP***<br>Maboveavg<br>@ below avg<br>In_pop***<br>ie} 50 100 150<br><!-- End of picture text -->
attract private investment in renewable-based energy. Countries with above average GDP and population growth are respectively seven and eight times more likely to attract more investment than countries whose population is increasing below the average.

# **_Long run Environmental Sustainability Drivers_**

**Hypothesis 5A** Developing countries are more likely to attract more investment in years following the entry into force of the Kyoto Protocol due to the rise of climate change up in the political agenda.

**Hypothesis 5B** Developing countries are more likely to retain more investment in years following the entry into force of the Kyoto Protocol due to the rise of climate change up in the political agenda.

**Hypothesis 6A** The likelihood of attracting and retaining private sector investment in renewable based generation is higher if the price of oil is increasing.

**Hypothesis 6B** The likelihood of attracting and retaining private sector investment in renewable based generation is higher if the price of oil is increasing.

**Hypothesis 7A** Countries that have attracted more private investment in transmission are also better prepared to integrate renewables in their system and hence more likely to attract private sector investors in renewables.

**Hypothesis 7B** Countries that have attracted more private investment in transmission are also better prepared to integrate renewables in their system and hence more likely to attract higher investment in renewables.

Fig. 13 shows that Hypotheses 5A and B are strongly reinforced by the data. After the entry into force of the Kyoto Protocol, developing countries became 30% more likely to attract PPPs in renewable-based energy. They also attracted more than twice the amount of investment in US$ terms in renewable generated energy.

Hypotheses 6A and B are also confirmed by the data. Countries with above average price of oil are 30% more likely to attract PPPs in renewable-based energy. They also attracted more than twice the amount of investment in US$ terms in renewable generated energy.

Hypotheses 7A and B found very strong confirmation in the data. Countries with above average private investment in transmission are 5 times more likely to attract private investment in renewable-based energy. They also attract almost 14 times the investment in US$. In other words, attracting additional private investment in renewable-based energy depends not only on policy and regulatory regimes, but also on several other factors including grid or infrastructure access and availability; the planning and approval process, given the potential for costly delays to construction which defer the point at which a project will start generating revenue; the power purchase agreements and so on – all aspects within the boundary of the project or that could affect the feasibility and profitability of PPPs in renewable-based energy (World Bank and E3 2010, Sovacool, 2009).

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<!-- Start of picture text --> Kyoto Protocol***<br>yes<br>Price of oil** mno<br>Transmission Investment***<br>0 0.2 0.4 0.6 0.8<br><!-- End of picture text --> <!-- Start of picture text --> Kyoto Protocol***<br>yes<br>Price of oil** Hino<br>Transmission Investment***<br>0 100 200 300 400 500 600 700<br><!-- End of picture text -->
**Table 2 Key Determinants of the Introduction of PPP in Electricity Renewable Generation**

||**(1)**|**(2)**|**(3)**|
|---|---|---|---|
|**GOVER**<br>**SECTORALG**|**NANCE VARIAB**<br>**OVERNANCE V**<br>***|**LES**<br>**ARIABLES**<br>***|**|
|**Introduction of feed-in tariffs**_FIT_|0.802<br>(0.146)|0.556<br>(0.158)|0.407<br>(0.175)|
|**ECONOMYWID**|**EGOVERNANCE **<br>|**VARIABLES**<br>||
|**Control of Corruption**_wgi_cc_|0.445***<br>(0.092)|0.452***<br>(0.104)|0.456***<br>(0.106)|
|**Degree of democracy****_Polity2_**|0.025***<br>(0.009)|0.021*<br>(0.011)|0.020*<br>(0.011)|
|**GDP**<br>_ln_GDP_||0.039<br>(0.068)|0.020<br>(0.076)|
|**Population**<br>_ln_Pop_||0.247***<br>(0.077)|0.271***<br>(0.035)|
|**LONG RUN ENVIRONM**|**ENTALSUSTAIN**|**ABILITY FACT**<br>|**ORS**<br>|
|**Price of oil**||<br>|-0.011<br> (0.007)|
|**Price of oil*Kyoto Protocol**||<br>|0.011*<br> (0.008)|
|**Transmission investment**|||0.002***<br>0001|
|**REGI**|**ONAL CONTRO**<br>|**LS**<br>|(.)<br>|
|**Regional Dummies**|Yes|Yes|Yes|
|**Constant**|-1.097***<br>(0.087)|-6.128***<br>(0.800)|-5. 570***<br>(0.838)|
|**N**|1185|1143|1143|
|**Log likelihood**|-444.67|-202.34|-391.75|
|**χ**<sup>**2**</sup>|130.52***|202.34***|218.66***|
|**Pseudo R**<sup>**2**</sup>|12.80|20.19|21.82|

_Note:_ *, **, *** indicate significance of the coefficient respectively at 10%, 5% and 1% confidence level.

In what follows the key results are highlighted, focusing on the specific hypotheses tested in each of the regressions.

**Regression 1 confirms Hypothesis 1.A, namely the introduction of a feed-in tariff is positively and highly significantly associated to the introduction of PPPs in renewable electricity generation.**

**Hypothesis 2A is also confirmed, that a higher standard of economy wide governance is more likely to attract PPPs in renewable electricity generation.** The result extends more broadly to all form of (price and quantity based) support to renewable-based energy. The results are presented only for feed-in tariff, as they represent the predominant support mechanism used in the developing countries sampled in our study.

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**Hypotheses 3A, related to short run crises, is not confirmed** . Despite after the East Asian and Latin American crises PPPs declined substantially, the likelihood of attracting investor did not decrease substantially following periods of crises which go beyond the initially impacted region.

**Hypothesis 4A is partly confirmed.** Interestingly, countries characterized by higher income have a higher probability of attracting PPPs, but not significantly so. The size of the market instead has both a positive and highly significant relationship with the introduction of PPPs.

**Hypotheses 5A and 6A are partly confirmed.** Regression 3 shows that higher international prices of oil do not significantly affect likelihood of attracting PPPs in renewable electricity generation, even not significantly so. Controlling for the interaction between the price of oil and the Kyoto protocol, environmental sustainable considerations affect the choice of introducing PPPs in renewable based generation.  The positive sign of the interacted terms however implies that after the introduction of the Kyoto protocol countries became more likely to introduce PPPs in renewable based generation, also driven by the higher price of oil.

**Regression 3 introduces an additional variable for the level of committed private investment in transmission.  Hypothesis 7A is confirmed.** Countries with higher private investment in transmission are positively and significantly associated with the introduction of renewable-based energy. This confirms the importance of including considerations related to access to the grid and development of the network so as to integrate renewable-based energy into the power system. Because of the potential concerns with endogeneity due to the fact that private investment in both segments of the power sector can be driven by similar factors, we also used instrumental variables, including the lagged variable of the transmission variables. The results are robust to the introduction of instrumental variables. In sum, Hypothesis 1.b on the links between better readiness of the transmission resources for renewables and higher investment in renewable generated energy is strongly confirmed by the regressions.

Regression 3 confirms the robustness of the previous results, controlling for regional dummies and for the interaction between the emission per capita and the GDP per capita of the country.

**We can now move to determine which of the previous factors affect the private investor’s decision to enter the market of renewable-based energy and the amount of investment sunk in the sector.** Regressions (1) and (2) in Table 3 report the results of the two step Heckman model, introducing in the first stage as a dependent variable (reported in red) the likelihood of attracting private investment in renewable-based energy and as explanatory variables the key sectoral and economy wide governance variables. The second step of the model uses the logarithm of amount of private investment in renewable-based energy as the dependent variable, conditional on the decision to enter the renewable market, and as explanatory variables the broader model including the short run and long run variables described above. The final two regressions report the GLS model using as a dependent variable the logarithm of amount of private investment in renewable-based energy, which restrict the number of observations only to countries with a non-negative level of private investment in renewable-based energy.

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# **Table 3 Key Determinants of PPP Investment in Electricity Renewable Generation**

||**Two step (1)**|**Two step (2)**|**(3)**|**(4)**|
|---|---|---|---|---|
|**SECTO**|**RALGOVERNA**<br>|**NCE VARIAB**<br>|**LES**||
|**Introduction of feed-in tariffs**_FIT_<br>_First step inred_|0.803***<br>(0.143)|0.681***<br>(0.150)||0.509*<br>(0.318)|
|**ECONOM **|**YWIDEGOVER**<br>***|**NANCE VARI**<br>***|**ABLES**||
|**Control of Corruption**_wgi_cc_<br>_First step inred_|0.386<br>(0.088)|0.372<br>(0.088)|||
|**Degree of democracy****_Polity2_**<br>|0.023***<br>(0.008)|0.020**<br>(0.009)|||
|_First step inred_<br>**ENVIRONM**<br>|<br>**ENTALSUSTA**|<br>**INABILITY F**|**ACTORS**<br>*||
|**Price of oil**|||0.011<br>(0.006)||
|**Kyoto Protocol**||0.003***<br>(0001)|||
|**MA**|**CROECONOM**<br>|.<br>**IC CONTROL **<br>|<br>||
|**GDP**<br>_ln_GDP_|0.627***<br> (0.173)|0.541***<br>(0.174)|0.586***<br>(0.197)|0.628***<br>(0.192)|
|**Population**<br>_ln_Pop_|0.345***<br>(0.171)|0.196<br>(0.170)<br>|0.312<br>(0.213)|0.373*<br>(0.209)|
|**Constant**|-6.998***<br>(2.412)|-5.466**<br>(2.397)<br>|-5.370**<br>(2.345)|-5.109**<br>(2.378)|
|**N**|1184|1184|189|189|
|**Censored N**|1002|1002|||
|**Wald χ**<sup>**2**</sup>|32.85***|27.32***<br>|23.80***|22.87***|
|**Within R**<sup>**2**</sup>|||7.88|7.20|
|**Between R**<sup>**2**</sup>|||17.92|20.29|
|**Overall R**<sup>**2**</sup>|||16.72|15.85|

_Note:_ *, **, *** indicate significance of the coefficient respectively at 10%, 5% and 1% confidence level.

**Some interesting results are worth highlighting. In what follows we focus on the different factors that affect entry and the level of investment in renewables.**

**First, better control of corruption and higher degree of political competition are crucial in attracting the entry of private investors, but they do not affect the extent of investment in the presence of substantial sharing of risks between the public and private sector.** The economy wide governance factors affect only the first step of the Heckman model, confirming the results of the probit model analyzed before. In other words, This suggest that the first generations of private investment in renewable-based energy have been developed on the basis of attractive feed-in tariffs and long term PPAs guaranteeing a fixed rate of return, through takeor-pay clauses and/or government guarantees, shifting most of the risks to the public sector.

**Second, the sectoral support scheme, provided by feed-in tariffs, instead, affect both the entry and the level of investment in renewable-based energy, though they become much less significant when it comes to**

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**determine the amount of investment.** The result is easily explained, as investments in renewable-based energy depend crucially on the presence of support mechanisms. We found confirmation of an important result as before. Higher investment in transmission can be often an important prerequisite for attracting private investment in renewable-based energy.

**Third, investment in renewable-based energy has been significantly affected by the signing of the Kyoto Protocol, proving also the importance of legal international commitment to further generate confidence and foster investment in the sector.**

**Other differences in results are more a question of nuances.** In terms of economic fundamentals, whereas the level of entry was mainly affected by the market size (in terms of population), both income and population size affect the level of investment, highlighting the importance of affordability and sustainability of the support for renewable-based energy.  Investment in transmission does not affect significantly the level of investment in electricity renewable generation.

# **5. Conclusions and Future Directions**

**Strong evidence is found in this analysis of the effectiveness of support mechanisms such as feed-in tariffs to attract private investment in renewable-based energy in developing countries, after controlling for several short and long run factors related to the presence of financial crises and trends in economic fundamentals.  The key results of the paper are summarized below:**

- **The market for renewable-based energy is strongly driven by supportive policies. Support policies serve not only to attract the entry of private investor but also to determine the level of investment** . In the latter case, its impact is less significant, suggesting the need over time to revisit the power of the incentive schemes, as well as the implied allocation of risks between the public and private sector to ensure that feed-in tariffs produce the desired amount of investment.

- **In contrast, broader economy-wide governance factors, including control for corruption and degree of political competition, are considered by private investor mainly for taking the decision to enter into renewable-based generation.** This reinforces our earlier suggestions that private investors seem to be adequately protected against their risks, so that once they have entered the market, they can accommodate the governance environment.

- **Private investors in renewable-based energy also require technical and regulatory certainty about the availability of renewable-ready transmission resources** , **if they are to finance investments.** The traditional reactive model of transmission regulation that has been used in the past, where transmission has been developed on a first-come, first-served is not conducive for renewable-based energy, as it introduces extensive regulatory and technical uncertainty about whether adequate transmission will be available once the resource is generated, and transmission distances for renewable-based energy can be large. Also in this case such factors do not affect the level of investment but only the decision to enter the market.

- **Private investors entering the market looks more at the size of the market rather than the income level, whereas when determining the level of investment they assess both the size and “affordability” level** . This raises some concerns on the sustainability of support mechanisms and their financing, particularly when the incremental costs implied by renewable-based generation are passed through to consumers.

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- **Short run financial crises do affect neither the decision to enter the renewable market nor than the level of investment, proving the resilience of renewable-based energy to such shocks.**

In a nutshell, the policy and regulatory regime will be assessed across all aspects of the project, not just the support or incentive mechanism. This would include: the planning and approval process, given the potential for costly delays to construction which defer the point at which a project will start generating revenue; grid or infrastructure access and availability; power purchase agreements and so on – all aspects within the boundary of the project or that could affect company activity.

Moving this analysis forward, our future research aims to look at a more detailed analysis and policy recommendation on specific factors that could contribute to successfully attract investment in developing countries, by looking at the two issues reported below:

- **Incentive schemes.** What types of incentive schemes proved to be the most successful in attracting private investment in renewable generated electricity? The importance of details of feed-in tariff system design, which may include capping (government-established limit on installation); tariffs differentiated by technology; tariff inflation-indexation; duration. All of these design factors will make the business environment for renewable-based energy, or less, attractive to private investors. Further work is planned to look at to what extent the level of feed-in tariff vis-à-vis other characteristics (including the time duration and those mentioned above) affect private investment in renewable-based generation.

- **Financing and affordability issues:** Ultimately, financing choice rests between (today and tomorrow) users and (developing and developed countries‟) taxpayer (tomorrow‟s users, if financed through borrowing, developed countries‟ taxpayers if financed through ODA). Where feed-in tariffs have been employed in developing countries, they often have to be met by government budgetary allocations to cover the differential between the guaranteed price that the utility pays to the renewable energy suppliers, and the average rate that it is allowed to charge consumers for each kilowatt hour of electricity. This dependence on national budgets to cover the difference places a cap on the total expansion of renewable energy that can take place in a developing country, and thus creates a disincentive for expanded renewable energy investment. Within this context, alternative support schemes, including through a “global feed-in tariff”, a payment-on-delivery mechanism, whereby funds flow only when electricity comes on line; that is, when real and tangible benefits are being provided. Whereas they have been cases where costs has been borne by the taxpayers, in most cases will be passed through consumers, raising formidable affordability issues. There are ways to protect poor consumers, but at the same time allowing for some partial pass through of feed-in tariffs. The incremental cost associated with renewable based generation can be, for instance, recovered for instance only through large customers.

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