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Hydropower largely excluded from burgeoning green bond market

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Hydropower largely excluded from burgeoning green bond market

Hydropower projects are largely excluded from the green bond market due to environmental and sustainability concerns, but hydropower advocates hope things will change once a standard-setting organization creates new qualification criteria.

A task force of the Climate Bonds Initiative, or CBI, could soon release for public comment sustainability and environmental criteria that investors, utilities and others could use to issue green bonds for hydropower, Sean Kidney, CEO of CBI, a green bond certification and voluntary standards-setting organization, said in early October.

Green bond experts have reported that many green bond issuers and investors are shying away from hydropower altogether due to environmental, reputational and other concerns. The green bond market has been growing since it was initiated in 2007, and in 2017 a record $173 billion in green bonds were issued. But only about 2% of those 2017 green bonds included hydropower compared with about 7% in 2016, International Hydropower Association Senior Analyst Nick Troja said.

Bonds are a form of debt securities used to finance or refinance projects in which an issuer such as a corporation, municipality or a sovereign government borrows money from investors for a defined amount of time at a variable or fixed interest rate. A "green" labeled bond means that the issuer has earmarked the proceeds to go to new or existing projects that meet specific environmental objectives such as offsetting carbon dioxide emissions. But that also means parties to bonds are sometimes cautious about including technologies that may leave them susceptible to being accused of greenwashing.

"No one wants to [experience] getting a green bond raised in the market and having someone else in the market coming along and saying I don't think that should be a green bond," International Hydropower Association Chief Executive Richard Taylor said.

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Leaving hydropower, which supplies more than two-thirds of the world's renewable electricity, out of the green bond financing and refinancing mix could make meeting global decarbonization goals more difficult. The Intergovernmental Panel on Climate Change recently reported that to limit global warming to 1.5 degrees C from pre-industrial levels — an aspirational target under the Paris Agreement on climate change — renewables would need to supply 70% to 85% of electricity globally by 2050. Kidney and others have suggested hydropower could play a key role in that transition if the projects are developed correctly.

"If we're to make the transition [to a] low carbon economy to avoid serious climate change, we need hydro, we need everything and anything that is clean energy," Kidney said. "So the question has to be, is it clean energy, and secondly, is it going to last?"

Hydropower advocates hope the CBI criteria, once finalized, will give issuers and investors the confidence to use green bonds for hydropower.

"At the moment, it's been down the market to decide who ... wants to include hydro and who wants to exclude it," which creates a lot of unpredictability, Taylor said. "That's the last thing a bond market, investors or developers want."

Despite being a zero carbon-dioxide emitting resource, hydropower projects sometimes draw opposition from environmental advocates over concerns new projects may damage local ecosystems, displace indigenous communities, and emit methane into the air. The concerns tend to center around projects of 25 MW or larger that operate using major upstream reservoirs, particularly those in warmer climates.

"There have been some hydropower projects that have been absolutely horrendous in terms of impacts on native peoples and the environment," said Josh Olazabal, a senior ESG analyst with CreditSights. That said, some projects can be "done in a smart way that has very little negative impacts and that clearly have environmentally positive impacts. The more folks look at that and make that distinction and differentiation, the better off it's going to be," he said.

Hydropower already receives more scrutiny than other renewables

Hydropower projects often face more scrutiny than other renewables, and that trend is likely to continue even under the CBI's draft criteria, experts said.

The CBI's hydropower technical working group that is working on the criteria, as of early October, was still debating what future climate scenario hydropower developers should be required to design their projects to withstand, Kidney said. Investors are concerned about the ability for hydropower to operate over the long term if climate change diminishes water supplies and impacts weather patterns, Kidney and others said. In particular, a recent scientific paper found that climate change could pose new challenges to hydropower in the U.S. Pacific Northwest.

IHA's Taylor also worries that the CBI's draft criteria, which has expanded in scope over the past two years, could set a higher bar for hydropower than for wind and solar, which could make hydropower costlier and dampen developer interest. The CBI criteria "is a way forward, but we do think that the transaction cost of complying with that will be quite the deterrent to some parts of the sector," Taylor said.

To help address sustainability concerns, the IHA under the mandate of the Hydropower Sustainability Assessment Council in July launched an Environmental, Social and Governance Gap Analysis Tool aimed at identifying unaddressed sustainability issues at each stage of a hydropower project’s development, from early planning to operation.

Organizations and several analysts who provide second party reviews of the greenness of the bonds in interviews also said they tend to give hydropower more scrutiny than they pay to other renewables.

For example, Cicero, one of the largest green bond second party opinion providers globally, examines how a large hydropower project could impact biodiversity both in the water and along the shoreline. And it reviews whether the use of construction materials and transportation of those materials could create greenhouse gas emissions, Cicero Research Director Christa Clapp said.

Why green bonds matter to hydropower

Because bonds tend to have longer terms, bonds can align with the lifespan of hydropower projects, which in the U.S. can be federally licensed to operate for an initial term of up to 50 years. Outside of the green bond market, CBI reported in September that hydropower projects hold $54 billion in outstanding bonds largely in emerging markets. Moreover, many existing hydropower projects are nearing the end of their normal lifespan and will soon need to be updated and refinanced, Troja said.

As for new builds, about 21.9 GW of hydropower capacity was added globally in 2017, most of which was in East Asia and the Pacific region followed by South America, according to the IHA. And about 75 GW of new capacity for pumped-storage projects that store and release water from massive reservoirs is expected to be added globally by 2030, IHA said.

The hydropower sector appears to have a strong interest in using green bonds going forward, IHA said. In a recent survey by the association, more than 100 heads of organizations and senior decisionmakers in the hydropower sector said they expect to finance or refinance a hydropower project through the green bond market over the next five years. However, more than three-quarters of respondents also said they need greater clarity on the eligibility criteria for hydropower.

While hydropower projects are sometimes included in regular bonds, green bonds add publicity value, provide an indication that the technology is viewed as publicly acceptable, and help attract additional financing for hydropower and green bonds, Taylor said.

From a broad perspective, Eric Glass, portfolio manager of fixed income impact strategies at the global investment management firm AllianceBernstein LP, said green bonds are one of many financing tools that the world will need to address climate change.

"However you want to do it, whether it's through a green bond" or another model, "these are all arrows in the quiver of our society to move us closer to a more equal society and a more environmentally friendly society, which is very important form an overall sustainability perspective," Glass said.

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