Fast developing markets across the globe need an unprecedented level of capital investment in order to meet the rising demands for electricity in their growing economies. According to Bain & Company’s Plugging into Emerging Markets, electricity demand and greater capital intensity means that fast-growing economies will have to double their investments in electricity from about US$240 billion annually to US$495 billion annually between 2015 and 2040—US$13 trillion in total—outspending OECD countries by 2-to-1.
The need for this level of investment comes from the fact that electricity demand is rising along with economic growth, per capita consumption of electricity is rising along with consumer wealth and many customers are connecting to the central grid for the first time. In addition, the energy and environmental policies of these countries call for the development of renewable energy which are more capital intensive than conventional power generation technologies.
In the past, governments of these fast-growing economies have ploughed 60% to 70% of investment into electricity but as the need for investment grows, an increase in private capital will be required to meet needs. The focus will shift from importing fossil fuels to importing capital, says the report.
Unfortunately, many of these countries have a mixed record of attracting private capital, with many of the larger countries delivering poor returns on investment. Long-term investors have well-founded concerns about transparency and reliability of policies and regulations, particularly where policymakers have shorter-term political priorities.
Improving viability of investment in the power sectors
But to attract this capital, fast-growing economies have to improve the viability of investment in their power sectors. This involves a combined effort on the part of policymakers, regulators and the business and investment communities to improve viability.
According to the report, companies and investors looking at global expansion should go through a two-stage process that first helps them assess the most promising markets to enter and then determines how to enter these markets while balancing risk against potential opportunity.
Companies evaluating opportunities in the power sectors of fast-growing economies need to think along two dimensions: market-specific risks (including currency risk, depth of debt and equity markets, openness to foreign investment and transparency of business practices) and sector-specific risks.
Risks in the first category apply across sectors, and they are well captured in a range of indices, including that of the Economist Intelligence Unit. The nature of investments in the power sector— capital-intensive and long-life assets—underscore the importance of some of these risks more than others. For example, the implications of regulatory and planning approvals make investors particularly sensitive to the transparency and openness of governance processes for these approvals.
The second set of risks deals directly with the stability and robustness of the policy, regulatory and investment options within the power sector. Investors must determine whether policies are sufficiently integrated to ensure parallel development along the full value chain. Without such integrated policies, assets may become stranded due to obstacles in other parts of the value chain. This occurred in China and South Africa when wind farms sat idle because they were not yet connected to the transmission and distribution grid. Since then, China has made substantial investments in its transmission and distribution system to match its progress in power generation and South Africa’s Eskom will be working more closely alongside the IPP programme to ensure that networks can support new renewable power integration. [China’s Transmission Grid To Support Growing Economy] [World Bank Helps China Clean Up Its Act] [South Africa’s IPP Challenges Renewables.]
Investors should also investigate whether the local government supports effective public–private partnerships. For example, in Brazil, where electricity demand has grown with the economy at about 4%, the government adopted new rules in 2004 that encouraged public–private partnerships by clearly defining the rules for competitive bidding and contracting and by providing financing support through the Brazilian Development Bank. These changes attracted US$118 billion for over 172 public–private partnerships across industries and added new power generation capacity. This changed when the government introduced new policies in 2012.
The report suggests that companies find the best fit among their capabilities and the opportunities and risks in new fast-growth markets. Companies and investors must make an honest assessment of their technical and operational capabilities and the strengths and weaknesses of their operating model and culture. The characteristics of individual markets can then be assessed for fit with these capabilities.
Evaluating the market
Utility companies looking at longer-term and operational investments in emerging markets (that is, 10 years or more) have at least three options for entry: purchasing an existing company, creating a joint venture, or making a greenfield investment, a form of foreign direct investment where a parent company initiates a new venture in a foreign country by constructing new operational facilities from the ground up.
Because of the high fixed costs of entry, utilities are advised to select only a few new markets to enter and invest in learning the rules and developing relationships there. The capabilities that they develop will prepare them for subsequent expansion in those markets and beyond. Finally, energy companies entering the electricity sectors in fast growing markets should keep in mind some basic principles that apply to companies entering new markets across all industries:
Localize at every level. Local or homegrown competitors enjoy a number of advantages, including consumer loyalty, lower costs and sympathetic government regulators. By taking the time to master local complexities, multinationals can begin to regain a competitive edge.
Think global, hire local. Market leaders cultivate strong local management teams with market insights that give them an edge in product design, promotion, and distribution. Empowering local teams fosters loyalty and develops a talent pool to tap into when entering other emerging markets.
Build dedicated emerging-markets capabilities. Leaders approach each emerging market with strategies developed to distinguish the characteristics they find there from established practices they pursue in developed economies. One UK multinational has a formal emerging-markets organization separate from its other international operations. Putting the emerging-markets operation under one tent sharpens focus and improves managers’ ability to evaluate the relative risk–return trade-offs across its emerging-markets portfolio.
Over the next couple of decades, the power sector in growth markets will offer many opportunities for investment and growth. Policymakers and regulators in the most successful markets will learn from the past to attract the necessary capital domestically and from international investors. Successful investors will have a clear understanding of their capabilities and appetite for risk, which will help them evaluate markets and design winning strategies. With a robust approach, the returns are likely to far exceed the risks of fast-growing markets.