Markets and Finance
Alongside wider planning challenges, as a capital-intensive technology, hydropower projects can struggle to secure the finance needed to get over the Final Investment Decision (FID) line. As with many other types of large infrastructure projects, there is a risk that they will run over time and budget.
This is a particular challenge in Africa, though moving into construction is one of the most difficult parts of the hydropower development process everywhere. This is a barrier that needs addressing urgently. The delivery of new hydropower capacity needs to accelerate if we are to keep pace with global climate targets. This will only be achieved if larger quantities of capital are channelled into the sector.
Encouragingly, 2020 saw over US$75 billion put into the sector; however, investments have been on a downward trajectory since then, to US$54 billion in 2023 – lower than the 2010s average. Whilst these figures are comparable with investment in other dispatchable technologies such as nuclear, coal and gas, this trajectory needs to change in order to double hydropower capacity to meet net zero by 2050.
Building policy frameworks that attract investment
To double hydropower capacity by 2050, a cumulative investment of approximately US$3.7 trillion is required, or about US$130 billion annually. This equates to more than double the current level of funding. In some regions, the growth required is even higher: for Africa, the current annual investment of US$3.5 billion needs to grow to US$23 billion. Public and private financing are crucial to the growth of hydropower. Public funds are behind more than two-thirds of investment in hydropower, a higher proportion than other renewable technologies. Public funding is increasingly spread across other aspects of the energy transition or climate adaptation, so private investors will need to provide a larger proportion of the gap to meet the required US$130 billion annual investment. How can the sector attract more investment? By reducing risks and increasing returns. A bigger pipeline of quality projects, as outlined in this report, provides investors with the opportunity to deploy their capital profitably. If the opportunities are good, then investors will come to the table.
Governments need to focus on the following to encourage investment in this sector:
- Establish the financial and market mechanisms to reward reliability, flexibility and storage, as well as just generation.
- Signal to developers that the market is secure and long term, allowing investment in a bigger pipeline of quality projects.
- Provide the right supporting environment to enable developers to invest in de-risking projects during development and construction.
- Implement support mechanisms that secure finance at minimum cost.
- Mitigate off-taker and foreign exchange risks to ensure development can happen cost effectively in all countries
In addition, system operators and regulators should reward hydropower generators for all the services they provide, preferably under long-term contracts.
To induce investment at the lowest cost of capital, long term and meaningful policies are required:
- Projects need a mechanism that provides revenue certainty over the debt repayment period.
- Remuneration needs to be set at a sufficient level for asset owners to get a sufficient return.
- Policy is underpinned by a law with clear force, which cannot be changed at short notice and/or without due process, to ensure that investments are respected and kept whole.
Policy and market frameworks need to ensure that generators receive appropriate remuneration for the range of services that they provide to the system in addition to power generation. For Pumped Storage Hydropower, this includes the arbitrage income that is available from buying power cheaply when there is a surplus of variable renewables, and then sell it for a higher price when there is a deficit.
Market arrangements should include an ability to price for scarcity at the peak and acquire surplus power cheaply, including through use of pay-as-clear auctions for power to reflect the cost of the marginal generator on the market. Regulators should have a tolerance for high volatility in those prices. Storage operators will not be able to extract the value of being available at times of peak need if arbitrary limits are placed on the gap between peak and trough prices. There must also be a clear reward for the various ancillary services that hydropower can provide. In many markets, hydropower’s provision of inertia and other frequency control, as well as crucial black-start capabilities, border trade in these operations, giving hydropower operators more customers for their services. are not paid for. With clear payments for these services, they will be fully integrated into the design process, ensuring optimal capability. Services also need to be sold into the biggest pool of demand possible, improving liquidity and stabilising the revenue that can be secured. Regulators should facilitate the maximum possible cross border trade in these operations, giving hydropower operators more customers for their services.
For hydropower stations to provide these services while securing capital at low cost, the system operator should contract for system services on a long term basis. At the same time, there needs to be a balance between having multiple contracts for different services and keeping it simple to ensure revenue certainty. Otherwise, risk may be unnecessarily high. These and other recommendations for the promotion of modernisation and flexibility of hydropower were one of the key outputs of the XFLEX HYDRO project that concluded in 2024. In the developing world, there are also risks to revenue from unreliable off-takers which must be mitigated by widening the customer pool and/or guarantee mechanisms to underwrite income.
Alternative sources of revenue
Hydropower is among the best ways to mitigate for droughts. IHA estimates that through the water storage function of its reservoirs, the hydropower industry prevents over US$130bn in annual GDP losses from drought incidents. None of this is currently renumerated.
Sources of finance
Hydropower ESG fund During 2024, this fund will award a total of 250 thousand Swiss Francs (US$ 250k) to 10 or more hydropower projects across more than 40 countries in Africa, Asia, Europe and the Americas.
The initiative is funded by the Swiss government’s State Secretariat for Economic Affairs (SECO).
CBI certified climate bonds are widely regarded as the best way to direct investment to infrastructure that supports the Paris Agreement while reducing negative impacts on local environments and communities. Developers, banks, governments and other investors can issue certified climate bonds to finance or refinance hydropower projects that comply with strict social, environmental and climate criteria. Pumped storage, run-of-river and impoundment facilities of any size are eligible.
The Climate Bonds Standard criteria for hydropower stipulates use of two sustainability assessment tools supported by the International Hydropower Association (IHA) and a multistakeholder coalition of organisations. These tools are the ESG Gap Analysis Tool for identifying and addressing gaps against recognised good practice across 12 environmental, social and governance assessment topics; and the G-res Tool for reporting the estimated net greenhouse gas emissions of a reservoir.
Useful links:
HSA Hydropower sustainability standard assessment fund
State Secretariat for Economic Affairs (SECO).
IHA Pumped Storage Hydropower Capabilities and Costs
