The European Bank for Reconstruction and Development is a key institutional investor in Kazakhstan for the development of renewable energy sources. Aida Sitdikova, Director of the Eurasia Energy Department of the European Bank for Reconstruction and Development, tells about which projects are being implemented in Kazakhstan, what is the focus and what are the prospects for the development of renewable energy sources.

EBRD AND "GREEN" ECONOMY PROJECTS IN KAZAKHSTAN

— The European Bank for Reconstruction and Development is a key institutional investor in the development of renewable energy sources in Kazakhstan. What projects have been implemented during the financing period? What is the amount of investment made in renewable energy projects in Kazakhstan?

— Since 2008, the EBRD has supported Kazakhstan's transition to a low-carbon and climate-resilient economy ("green" economy), working closely with the Government to develop a regulatory framework for the renewable energy sector (RES).

In 2015, the Bank funded the first RES project in Kazakhstan, Burnoye-1, which was a pioneer in the field of renewable energy production in Kazakhstan and Central Asia. The EBRD team made significant efforts to develop the project and to ensure that it would fully meet both the client's needs and the Bank's requirements.

To date, the EBRD has allocated more than KZT 126 billion to the construction of 12 solar power plants with a total installed capacity of 572 MW in various regions of the country, as well as to the modernization of a 100 MW hydroelectric power station. Investors from Bulgaria, Great Britain, Germany, China, France and other countries were attracted to implement these projects. In addition, the EBRD attracted concessional finance from the Clean Technology Fund (CTF) and the Green Climate Fund (GCF), as well as co-financing from the Asian Development Bank for Baikonur Solar and M-KAT Green projects.

This year, the EBRD has approved funding for 5 renewable energy projects in Kazakhstan for the total amount of KZT 49 billion. These are Sholakkorgan Solar Power Plant (SPP) with a capacity of 50 MW, M-KAT Green SPP with a capacity of 100 MW, Zhangiz SPP with a capacity of 30 MW, Karaganda SPP with a capacity of 50 MW and Zhanakorgan SPP with a capacity of 10 MW. I would like to note that Zhanakorgan SPP is the first solar power plant funded by the EBRD as part of the auction mechanism.

This has been made possible thanks to a long-term cooperation between the EBRD and the Government of the Republic of Kazakhstan in improving the regulatory framework and carrying out preparatory work. Most of the projects were signed in accordance with the Kazakhstan Renewables Framework for the total amount of EUR 500 million and the Memorandum of Understanding signed in 2017 and in September 2019 with the Ministry of Energy of the Republic of Kazakhstan with the aim of developing renewable energy production and ensuring the transition to the auction mechanism in

Kazakhstan.

— Based on open data, the EBRD has invested EUR 8.3 billion in Kazakhstan's economy, of which more than EUR 2 billion has been allocated to “green” economy projects, that is, in fact a quarter of the total portfolio. What makes the EBRD so interested in the renewable energy sector in Kazakhstan and why are other international financial institutions not so active?

— Preserving and improving the environment is a central element of a modern, well¬functioning market economy and, therefore, the main goal of the transition process, which the EBRD is actively promoting. In Kazakhstan, the EBRD is actively supporting the Government in developing the “green” economy and the renewable energy sector, as well as in achieving the goals set in our Concept for Transition to Green Economy. Our long-term cooperation in this area began in 2008 when the Sustainable Development Plan for the energy sector was signed.

While Kazakhstan had for a long time had a poor reputation among foreign investors, especially in the energy sector, today the country, like other Central Asian countries, has a significant potential for attracting foreign direct investment. In recent years, the Government of the Republic of Kazakhstan has been actively initiating market reforms to attract more private and foreign investment.

As I noted earlier, the development of renewable energy potential in Kazakhstan through private investment was made possible thanks to many years of fruitful cooperation between the EBRD and the Government of the Republic of Kazakhstan in creating and improving the regulatory framework in the field of renewable energy and developing a mechanism for attracting investment. The EBRD mobilized more than EUR 9 million from its own and donor funds for the implementation of more than 60 technical cooperation projects aimed at introducing legislative reforms, carrying out energy audits and RES market research.

-- In order to develop renewable energy in Kazakhstan, it was highly important to implement a successful project which then could be replicated. In this sense, although our first project, Burnoye-1 SPP was carried out in a changing legislative framework in 2015, it played a crucial role.

Later, all projects financed by the Bank, demonstrated their economic viability and contributed to the emergence of new renewable energy projects, which are now actively developing throughout the country. To date, the EBRD has funded 572 MW of solar generation capacity in Kazakhstan.

NOVATIONS AND PRIORITIES

— Recently, the EBRD has approved €300 million extension of Kazakhstan Renewables Framework. How will this framework work? What are the changes and priorities? What are the conditions for obtaining financing from the EBRD for renewable energy investors?

— In September 2019, the EBRD approved €300 million extension of Kazakhstan Renewables Framework (second phase) to support solar, wind, hydro, and biogas energy projects, and electricity distribution and transmission projects. It should be noted that the first phase, approved by the Bank in 2016 for the amount of EUR 200 million, was successfully implemented.

The second phase meets the growing scale of the Kazakhstan renewable energy sector and is intended to become a catalyst for further development. The purpose of the second phase is, firstly, to support Kazakhstan in achieving its goals under the Paris Agreement, namely, increasing the share of renewables to 3% of total power generation by 2020; and, secondly, support for the transition to the RES auction mechanism. In addition to EBRD funding, the Framework provides for concessional financing from the Green Climate Fund (GCF) for the amount of USD 110 million. In addition, under the EBRD's Framework, Kazakhstan will be given comprehensive technical assistance, mainly aimed at supporting the preparation and holding of auctions for renewable energy projects (wind energy), developing carbon markets, and helping to expand women's economic opportunities in the RES sector.

It is expected that at least 400 MW of new renewable power generation capacities will be financed in the framework of the second phase, which will lead to a reduction in carbon emissions by at least 500,000 tons annually. It should be reminded that as part of the first phase of the Framework, RES projects are being implemented with a total installed capacity of 322 MW (out of a total of 572 MW) throughout the country, four private foreign investors have been attracted, and a project to upgrade and improve the energy efficiency of distribution networks is being implemented.

Regarding financing conditions, these are, first of all, project's stable economic indicators and reliable, financially stable shareholders (sponsors), with experience in implementing similar projects in other countries. Equity share should be at least 30% of the project cost. During the implementation of each project, our team conducts a comprehensive assessment of the project for compliance with EBRD standards, with independent technical, environmental, and legal review. Adequate equipment costs, construction costs and the total project cost, as well as confirmed renewable energy source potential (wind / solar radiation research) are among main requirements for all projects.

In addition to the project's financial and technical indicators, the EBRD, as a development institution, pays special attention to environmental and social aspects, namely, environmental conservation and supporting women in using economic opportunities. For example, a study of bird migration in the region where a WPP will be located is very important for the implementation of a wind energy project.

RECIPE AGAINST RISKS

— One of the factors affecting the cost of renewable energy projects is national currency volatility due to the dependence on imported equipment and components. How does the EBRD manage to minimize such risks? Is there a way out?

— As a rule, from the moment of signing the loan agreement, project implementation takes from three months to two years, which allows avoiding to some extent the risks of rising cost of imported equipment as a result of devaluation. A more serious risk associated with national currency volatility is dealt with by the attraction of financing in foreign currency.

In order to ensure a reliable project economy, it is necessary to compare a debt currency with an income currency under a power purchase agreement (PPA). For Kazakhstan, in particular, this means that debts should be in tenge. In this connection, one of the comparative advantages of the EBRD is the possibility of providing financing in local currency (KZT).

In order to further attract international investment, our Bank took steps to minimize the risk of currency devaluation, not only continuing to provide more funding in local currency for future projects, but also providing technical assistance to the Government of the Republic of Kazakhstan to introduce and improve a mechanism of fixed tariff indexation for changing exchange rate.

Starting from 2018, tariffs for electricity generated from renewable sources are indexed for the change in exchange rate of the national currency to convertible currencies by 70%, and to the consumer price index (CPI) by 30%.

We are confident that this is an important step towards increasing the investment attractiveness of renewable energy projects, as well as attracting cheaper loans, which in turn will help reduce the cost of renewable energy.

— As you said earlier, last year, the Government of Kazakhstan introduced amendments to the Rules for Indexation of Auction Prices. In particular, changes have been made to the current formula for auction prices indexation, which takes into account the change in the exchange rate of the national currency to convertible currencies by 70%, and to the consumer price index (CPI) by 30%. Do you think this is a working tool and will it help to avoid exchange rate risks?

— This mechanism is indeed an important step towards increasing the investment attractiveness of renewable energy projects. If there is a high share of debt in foreign currency of renewable energy projects, small fluctuations in tenge exchange rate can have a significant impact on project's financial stability. Therefore, such a tool is especially important, as it will allow investors to use financing in foreign currency and, if properly structured, significantly reduce exchange rate risks. Currently, tariff is indexed once a year, which allows maintaining project financial stability in the conditions of moderate tenge fluctuations. It should be noted, however, that such a mechanism is unlikely to be effective in conditions of significant devaluation, which, for example, was observed in 2014-15. Therefore, further work should be aimed at improving the indexation mechanism, in particular, reducing the indexing delay and increasing the share of the tariff indexed to convertible currencies to 100%, which, together with other measures, will increase investors' confidence and, as a result, reduce the cost of renewable energy projects.

In turn, in order to achieve the goals set and to introduce best international practice, further work is needed to strengthen the investment climate. In particular, it is necessary to continue improving the power purchase agreement (PPA), and strengthening the credibility of a single purchaser - Financial Settlement Center of Renewable Energy LLP.

— It is known that one of the main issues for renewable energy projects to deal with is to gain access to long-term financing in national currency at affordable interest rates. According to experts, this should be financing for 15 years with a rate of no more than 10%. What steps need to be taken in order for such tools to work in our country?

— Historically, the project finance tool has been used for projects with stable cash flows and a long payback horizon. The 15-year period reflects the state of the sector at a given time, namely the low cost of the main energy sources in Kazakhstan (coal) compared to renewable energy sources. It should be noted that the renewable energy equipment is rapidly becoming cheaper, which could potentially shorten the required funding period in the medium term.

The finance rate reflects the required rate of return for a bank at a certain project risk. Currently, the refinance rate in Kazakhstan is 9%, determining the minimum short-term risk-free rate of return. It should be once again said that speaking of renewable energy sources, we mean 15-year projects with the presence of risks, so financing at 10% is currently difficult to achieve, although it is possible under conditions of long¬term macroeconomic stability in the country. The EBRD additionally supports renewable energy projects by attracting concessional financing from foreign donors aimed at reducing the average cost of a loan.

Developing project financing in emerging markets takes time and requires efforts from the government, development institutions and the private sector.

— There is no doubt that in foreign countries, second-tier banks play an important role in financing small and medium-sized businesses. All the renewable energy facilities in Kazakhstan are SMEs, but they are mostly supported by state financial institutions and development banks. Why do you think second-tier banks in Kazakhstan have not yet been involved in financing renewable energy projects?

— The full implementation of an average RES project takes more than 10 years, and this sector is not the main focus of banks financing SMEs. The reason is simple - such a period of uncertainty requires a different examination, access to capital markets and the development of financial infrastructure. In these conditions, the EBRD supports investors and the private sector (the principle called Additionality), taking on risks that second-tier banks are not ready to take.

At the same time, it should be noted that the sector of small-scale renewable energy projects, suitable for financing by second-tier banks is gradually developing. The EBRD supports such projects by providing credit lines to second-tier banks.

TOWARDS “GREEN” FINANCING OF RES PROJECTS

— According to international experience, the so-called “green” financing is an important tool for supporting renewable energy projects. These are “green” financing tools (loans, bonds, derivatives, etc.) and “green” infrastructure («green» funds, banks, relevant legislation, etc.). Global leaders in this market are China, USA, European countries. Kazakhstan is new in this area. What is necessary in order to develop these tools in our country? Does the EBRD have experience in this area and could the Bank as a development finance institution help interested institutions in Kazakhstan to develop “green” financing?

— As you noted earlier, the EBRD has invested more than EUR 8.3 billion in our economy, of which more than 2 billion has been allocated to “green” economy projects.

The EBRD also works closely with the Astana International Financial Centre (AIFC) to develop the concept of a “green” financial system. Kazakhstan seeks to become a regional center in «green» financing. Thus, the “green” financial system of Kazakhstan will provide additional support for investments in the “green” economy of the country.

In 2017, the EBRD provided technical assistance to the AIFC to determine the scope of work to create a “green” financial system for Kazakhstan. This was done thanks to a grant from the Ministry of Economic Affairs and Employment of Finland. As a result, recommendations were made in areas such as institutional development, governance, financial tools, and promoting further development of the emissions trading market. Currently, the results of this work are used by the AIFC to implement the “green” financial system. The AIFC promotes the development of “green” finance by providing a platform for issuing “green” bonds. After completion, the EBRD became a member of the AIFC Advisory Council on Green Finance. We also confirmed our intention to cooperate by signing a Memorandum of Understanding with the AIFC after the establishment of the AIFC Green Finance Centre.

In conclusion, I would like to once again note the readiness of the EBRD to continue supporting Kazakhstan in achieving its goals on the path to a sustainable, environmentally friendly future.