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The energy transition is more than just a buzzword; it represents a fundamental shift in how the world generates and consumes energy. 

Transitioning from traditional to renewable energy sources is crucial for combating climate change but will require immense capital investment. This is especially true for developing economies, given the scale and nature of investment needed to build the infrastructure that will ensure a just energy transition. 

Political risk and supply chain disruptions can affect the financing of energy transition projects. Higher perceived and actual risks push up the cost of capital, which can make projects uneconomic or more expensive for end users.  For example, as of July 2024, investors for a project in Ghana required an expected equity return that was 12.22% higher than the return expected by investors for a comparable project in the USA.

This difference is the so-called country risk premium, as demonstrated by Professor Aswath Damodaran of the Stern Business School at New York University (NYU).

A just energy transition is an area where the trade credit and political risk insurance market can help overcome hurdles to support such investments by mitigating risks, which may in turn lower the cost of capital, and provide the security needed to attract capital and support the successful delivery of energy transition projects. 

A just energy transition?

The shift from traditional energy to renewable and cleaner alternatives is driven by the urgent goals of reducing Greenhouse Gas (GHG) emissions by 40% to 60% between 2010 and 2030, and then to 100% by 2050, to mitigate the adverse effects of climate change. 

A just transition requires putting people and communities at the centre of the energy transition and ensuring that the benefits of the transition are widely shared, while also supporting those who stand to lose economically. It can support investors in identifying risks and opportunities that flow from the shift to a cleaner energy future and simultaneously integrating environmental and social aspects dimensions of ESG commitments. An abrupt transition away from traditional energy sources without needed support could result in significant economic hardship and energy poverty, so the idea is to balance the ecological urgency of green energy with the need to support vulnerable populations.

Multilateral development banks and other international financial institutions deliver the transition through their capital allocation and investment activities, as they can co-lend and crowd-in private capital to facilitate investments in the regions that need it the most.

However, socioeconomic and climate risks can make it harder for developing countries to secure capital and significantly, to raise the required funding for clean energy projects.

One particular paradox is that regions perceived as riskier for energy investors are often the ones where investment is most needed. This is where credit and political risk insurers can have important roles.

The role of credit insurance in mitigating investment risks

Credit insurance can play a central role in supporting the financing of the energy transition, particularly when it comes to mitigating risks that may otherwise deter investment in large-scale infrastructure projects. The presence of credit insurance can assist in attracting lenders and investors for long-term projects, especially in regions perceived to be riskier. 

For lenders, credit insurance can help to address issues such as exposure limits and concentration risks, for example, where a single borrower would represent a significant portion of the lender’s portfolio. 

At the project level, credit insurance can mitigate credit, political, and market risk, assisting in securing long-term supply contracts and offtake agreements: often essential for the bankability of projects like LNG facilities because they can contribute to increasing investor confidence and reducing the overall cost of capital.

Political risk insurance is another vital tool. In developing countries, where many critical minerals necessary for the energy transition are located (such as copper, lithium, or nickel), political instability can pose significant risks to investment. Political risk insurance can assist in mitigating the perceived risk, potentially making it easier and more profitable to finance projects in these regions, despite the additional cost of political risk insurance. 

This insurance not only protects against potential future losses but can also allow investors to consider opportunities that they might otherwise deem too risky. An S&P Global study, commissioned by Marsh, calculated how the purchase of political risk insurance positively impacts the net present value (NPV) and internal rate of return (IRR) of energy projects in emerging market countries. By mitigating the country risk premium and potentially lowering the cost of capital, political risk insurance can contribute to project viability. 

A case study on Ghana demonstrates how purchasing political risk insurance reduced its country risk premium (as measured in 2021) by 4.07%, from 6.30% to 2.23%. As such, the projected IRR for a utility-scale energy project tripled, and its NPV swung into positive territory, increasing by $169.2 million. On two different sovereign credit rating scales, Ghana’s adjusted gradation for country risk impacting the project improved by seven notches with the purchase of political risk insurance. 

These figures are indicative, but, alongside other similar studies, show a nuanced understanding of country risk and its relationship to project NPV and investment returns. (IRRs) They serve to illustrate the role political risk insurance can have in supporting energy investment for riskier countries. 

Elsewhere, by way of demonstration, a solar and battery storage solution was required for a remote lithium mine in a West African country, rich in minerals crucial for the energy transition. A UK-based company was tasked with providing renewable energy infrastructure to the mine, which was essential due to its remote location and the country’s unreliable national grid. However, the nation’s political instability, marked by multiple coup attempts since 2012, posed significant challenges in attracting investment. 

Marsh helped the UK company obtain political risk insurance, covering potential risks like expropriation and political violence. This insurance was instrumental in securing the necessary funding and allowing the project to proceed.

Meeting the challenges of supply chain volatility and a high interest rate environment

One of the most significant challenges to financing large-scale infrastructure projects for the energy transition is supply chain disruption. Supply chain disruptions can be costly, with some shipping lines raising rates by up to 40% in the wake of recent unrest in the Red Sea. 

Rising expenses adversely impact emerging markets: delays in accessing critical components can lead to cost overruns and, in some cases, render projects financially unviable. Even in more stable markets, issues such as delays in obtaining key components like inverters for solar projects can create significant obstacles.

Interest rates further complicate the financing landscape. In recent years, interest rates globally have been generally high, raising the upfront capital costs of many investment projects, and making it more difficult for projects in emerging economies in these regions to secure the necessary financing. Also, that US interest rates remain near a 23-year high, does not help emerging markets, since it makes their debts, which are often priced in US dollars, more expensive due to depreciating local currencies.

The credit and political risk insurance market offers solutions to address these challenges. For example, trade disruption insurance can provide financial protection against loss of profit and additional costs resulting from delays or the non-arrival of supplies due to political or physical perils. Non-payment insurance aid negotiations with lenders,  potentially leading to more favourable financing terms despite the risks of supply chain delays or high interest rates in emerging markets. Similarly, risk transfer solutions facilitate the flow of capital and goods by providing balance sheet protection and increasing resilience against supply chain disruption. 

However, the availability of credit insurance is not limitless. Capacity constraints, particularly for large projects in high-risk regions, present a significant challenge. To overcome this, there is a growing need for collaboration with multilaterals and export credit agencies, which can provide additional capacity and support where the private market is unable to meet demand fully.

Industry and government initiatives to spur innovation

In recent years, a combination of global inflation, high interest rates, and increasing energy security needs has contributed to commodity price volatility, further exacerbating capital demands of the energy transition. The need for risk mitigation solutions among financial institutions and commodity traders to help manage credit and market risk exposures is now greater than ever.

For example, credit insurance and surety bond facilities can act as alternative forms of collateral, deployed to help manage liquidity and support higher internal counterparty limits during times of volatility. Credit insurance and surety market capacity is expanding to assist stakeholders across the commodity chain in managing price volatility and counterparty credit risk, and capturing trade opportunities. 

One development resulting from an increased focus on the transition is the growth of the voluntary carbon market. From developers and investors seeking to protect investment in assets which generate voluntary carbon credits (VCC) to commodity traders and exchanges looking to support the growth of VCC trading across global markets, the credit insurance industry is continuing to develop solutions to support the management of credit, political, and performance-related risks. Such solutions can support investment and trade in this rapidly evolving asset class.  

Insights and recommendations

The future of a just and successful energy transition lies in collaboration. Lenders, multilaterals, governments, and credit insurers all have a role in expanding financial capacity so that companies can have a tangible impact on the ground and make way for progress in the energy transition. 

Government intervention can be a driving force for investment in the energy transition. The 2022 US Inflation Reduction Act sought to encourage investment in domestic energy production and promote clean energy and has been a catalyst for similar incentives and regulatory frameworks internationally. 

In emerging markets, government policies should focus on creating a stable and predictable business environment. This might include strengthening legal frameworks, improving regulatory regimes, promoting market autonomy, developing infrastructure, facilitating trade, and offering tax incentives, as well as promoting good governance and transparency to mitigate risk for investors. However, the future effectiveness of these policies depends on political stability and continued government support. 

The escalating demand for critical minerals essential to the energy transition presents both challenges and opportunities, particularly in resource-rich regions like Africa and Latin America. Credit insurers play a crucial role in attracting investment and ensuring the successful implementation of these projects by providing the necessary tools and security. 

As the credit and political risk insurance industry evolves to meet the complex challenges of the energy transition, it must adapt its strategies and foster collaborations to ensure that this transition is not only achievable but also just and sustainable, offering significant opportunities for those willing to navigate the associated risks.