Algeria will soon issue a massive 4-gigawatt tender for solar projects, but it can expect to see less interest from international developers than from nations like Saudi Arabia.

Algeria can also expect that the prices developers bid to win contracts will be higher than in Saudi Arabia. The reason? In large part, it has to do with the impact of currency depreciation. In Algeria, power-purchase agreements (PPAs) are denominated in dinars, a currency that has depreciated annually by an average of almost 12 percent since 2014. Saudi Arabia and other Gulf Cooperation Council Countries (GCC), like the United Arab Emirates, have currencies pegged to the U.S. dollar.

The potential perils of currency devaluation faced by solar developers active in markets outside of the U.S., China and the European Union is the subject of a new GTM Research report, Currency Risk: The Hidden Solar Project Deal Breaker, by senior solar analyst Tom Heggarty. Though global solar development has been fast-paced over the past few years, currency risk has dampened the potential of numerous emerging markets.

“I think it’s fair to say that without these issues, we could already have seen the emergence of several other large-scale markets in sub-Saharan Africa, where the need for solar is obvious and climactic conditions are ideal,” said Heggarty.

Different flavors of currency risk

In his report, Heggarty outlines a number of ways in which currency risk can impact solar markets and developer’s balance sheets. 

Local currency devaluation: In the majority of cases, the revenue a developer receives through a PPA will be in local currency. When that local currency loses value, the value of the PPAs also take a significant hit. How prevalent is this? According to Heggarty’s research, over 100 countries around the globe experienced average annual depreciation of their currency against the U.S. dollar of 5 percent over the past three years.

Equipment purchases: Unless a project is being built in China, modules, inverters and other components are generally purchased using U.S. dollars (some purchases are also made with euros). When a local currency devalues, it results in higher procurement costs. This is a risk that extends beyond emerging markets in Africa and Asia.

For example, when United Kingdom voters opted to leave the European Union last year, the British pound fell in value by nearly 20 percent in just 10 days. This caused a spike in the price of modules, which Heggarty said had a big impact on a 10-megawatt project in Cambridgeshire County. Because the project’s developers had not locked in the price of the Chinese modules they planned to use, Heggarty calculates they had to pay about 13 percent more after the pound tanked. By Heggarty’s accounting, that increased the price tag of the development by $645,000.

Availability of financing: In many emerging markets, developers have to find debt or equity in U.S. dollars because local banks don’t have the liquidity to back big projects. “There simply isn’t sufficient local currency financing available to support large-scale projects,” said Heggarty. “And when there is, local lenders often don’t have the understanding of solar PV as a technology to lend at lower cost. This is particularly true in markets where there isn’t a track record of projects being delivered as stated, and possibly where poor-quality technology has been used in the past.”

Convertibility: When PPAs are in local currency, there’s a risk in converting that money into U.S. dollars or some other currency when access to hard foreign currency is limited. This is the case in emerging markets like Nigeria. Concerns about currency fluctuation can motivate developers to pursue U.S. dollar PPAs. But even if that arrangement is possible, currency devaluation can still be a problem because it means that utilities and their customers are on the hook for suddenly more expensive solar.

This can erode political support for solar in emerging markets and erase its advantage against the fossil fuels that it displaces, whose costs fluctuate with the price of Brent crude oil. “One of the key benefits of solar to emerging markets is that beyond the upfront capital cost, the cost to offtakers and consumers is stable over the life of the project,” said Heggarty. “If consumers have to bear the cost of currency devaluation, this selling point no longer holds true. All told, local currency PPAs paired with local currency financing presents the most sustainable way ahead for all parties.”

A cautionary tale in Brazil

As the report makes clear, there are myriad examples from around the world to illustrate the harmful impact of currency risk and the steps developers and governments alike have taken to maintain the viability of their projects.

India’s promising and already substantial solar market is nevertheless stunted by a range of factors, including the high cost of borrowing Indian rupees (GTM Research estimates debt financing costs between 11 percent and 12 percent), limits on how much India’s banks can devote to individual sectors of the economy, and a disconnect between the duration of loans Indian banks can offer and the length of PPAs.

The report notes that these roadblocks have prompted developers to seek international financing. But to secure international financing often requires the purchase of a currency-hedging tool to protect against a potentially falling rupee. Add together the approximately 5 percent cost for U.S. dollar denominated borrowing, and another 5 to 6 percent for currency hedging, and suddenly project financing looks very expensive.

The most vivid cautionary tale about the impact of currency risk can be found in Brazil. Plummeting oil prices and political disarray have pummeled the nation’s economy and caused the real to drop from 2 to 4 BRL to the U.S. dollar between 2013 and the beginning of 2016. In the midst of that economic turmoil, Brazil held three reverse auctions for PV capacity, with 9 developers awarded PPAs for nearly 900 megawatts of capacity in the first round in October of 2014.

When the PPAs were first awarded, they had an average value of just over $86 per megawatt-hour. But as the real plunged, so too did the value of the PPAs. Just a year after they were issued, the PPAs were worth $55 per megawatt-hour. As a result, all but one of the projects -- Enel Green Power is the one exception -- were canceled because they were no longer economically viable.

“Agência Nacional de Energia Elétrica (the nation’s electricity regulatory agency) is now resorting to holding a competitive auction between developers who hold contracts for these projects to allow them to be canceled. The highest bidder will avoid a fine and not lose access to the Brazilian market in future auctions,” said Heggarty.

Long-term solutions

There is widespread awareness about currency risk among both developers and governments. In fact, when Heggarty was at a recent European solar conference, developers attending a session on dynamics in the sub-Saharan Africa market were polled on key challenges slowing development: financing and lack of trust in contract counterparties ranked second, behind only grid access.

While developers’ tools to lock in exchange rates and hedge currency risk are viable for some, the increased expense can spell the end of many projects. Over the long term, Heggarty argues that the key to eliminating currency risk in emerging markets is to provide local financial institutions with the tools and expertise needed to lend to solar developers. This can be facilitated by the involvement of development finance institutions that partner with local banks to provide technical expertise, as well as low-interest financing through tools like on-lending structures or loan guarantees.

The effectiveness of partnerships such as this are exemplified by the World Bank’s Scaling Solar program, currently active in Senegal, Zambia, Madagascar and Ethiopia.

“Scaling Solar provides all bidders with upfront technical and feasibility assessments and standard project documentation, as well as access to competitive financing and risk management tools,” said Heggarty. “The benefits are clear if we look at the $60.2 per megawatt-hour PPA signed in Zambia last year. This is very low for a new market, which would otherwise represent a substantial risk to investors. You can compare this to the $110 per megawatt-hour PPAs signed in Nigeria during the same timeframe.”

The report, Currency Risk: The Hidden Solar Project Deal Breaker, is available for purchase here or as part of GTM Research's Global Downstream Solar Service.