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Taurai Museka | The role of political risk insurance in mega energy projects

Taurai Museka | The role of political risk insurance in mega energy projects
08-09-23 / Taurai Craig Museka

Taurai Museka | The role of political risk insurance in mega energy projects

There’s been a call to accelerate the implementation of mega energy projects in African nations, particularly renewable energy projects such as solar and wind. Although there has been a lot of potential for private sector investment in the renewable energy, the power sector has been dominated by state owned utilities as these have been the largest off taker of power even from independent power producers.  Foreign investors in energy projects are therefore particularly keen on having protection against host country’s political risks.

Insurers play a pivotal role in attracting investment in mega energy projects, particularly through the use of Political risk insurance (PRI). PRI plays a crucial role in mitigating the risks associated with mega energy projects in both international and national markets. These projects often face uncertainties arising from the unpredictable political events, which can negatively impact the profitability of foreign investors. However, the distinction between political and commercial risks can be blurred, making it challenging to determine the exact nature of political risk. Despite this challenge, PRI policies are designed to protect insured investors or projects against  financial loses due to political events, acts of ill governance by host governments and their agents, as well as change in policy which can result in currency inconvertibility or revocation of licenses.

Understanding Political Risk in Mega Energy Projects

In the context of mega energy projects, political risk refers to the potential negative influence of a host government's actions or inactions on a foreign investor's business and profitability. This uncertainty arises from the host government's changing behavior towards private investments. However, it is essential to consider the reasons behind the government's change in behavior, as it may be justified as a regulatory intervention or a means to protect local communities' interests.  Most PRI providers are primarily concerned with the financial impact of governmental interventions on the insured projects. It is imperative that that PRI providers connect with local organizations who better understand the market and local political systems in the host country.

The Impact of PRI Policies on Mega Energy Projects

PRI policies have a significant influence on the behavior of both host governments and foreign investors in mega energy projects. National credit agencies and insurance providers can exercise leverage through their involvement in insurance contracts, which often require diplomatic support from the investor's home country and the project’s host country. This support, along with credit and investment insurance, helps secure better financing terms from international financial institutions and private banks. However, PRI policies also raise concerns about their impact on the design of investment projects and the relationships between insured investors and host governments. Insurers can shape the risks and responsibilities between the parties involved in the project as part of their policy conditions. They may indirectly influence host governments to secure better terms and treatment for their insured investors, but this may not always align with the interests of local communities.

In Zimbabwe, a lot of independent power producers have been licensed based on expected foreign investments into the projects. However, due to perceived political risk, many have failed to take off in the intended timelines due to the perceived political risks associated with Zimbabwe. PRI from private PRI providers can be a major boost into making these projects bankable. While developed nations have taken time to meet their promise to provide developing nations with investment into climate finance under the Paris Agreement,  it is important to use PRI as a means to attract these investments.

Responsible Investments and PRI Policy Implications

In response to criticisms regarding the environmental and social impact of insured projects, PRI providers have implemented policies for responsible investments. These policies require prospective policyholders to comply with social and environmental standards. For example NEXI, Japan’s Export Credit Agency who are the newest member of the African Trade and Investment Development Insurance, has issued guidelines on environmental and social considerations in trade insurance, which classify energy investment projects as Category A, subject to stricter standards. Monitoring mechanisms have been incorporated into PRI policies to assess the performance of insured projects and verify investors' compliance with social and environmental standards. Some PRI providers require insured investors to establish consultative methods with local communities and address grievances. These policies aim to integrate non-investment related factors, such as environmental protection and human rights, into international investment law.

PRI and Climate Action

Political risk insurance can play a crucial role in supporting climate action in African Countries. Private capital mobilization is crucial for achieving climate goals, but attracting private investment in low-income and developing countries can be challenging, especially without the use of PRI.

The Future of PRI in Mega Energy Projects

Political risk insurance will continue to play a crucial role in mitigating the risks associated with mega energy projects. As the world transitions to a low-carbon economy, the importance of climate action and responsible investments will only increase. PRI policies will need to evolve to address emerging risks and align with international standards for environmental and social considerations. They will play a vital role in attracting private capital and supporting the development of sustainable energy projects in emerging markets. With ongoing advancements in the field of PRI, private equity firms and investors can navigate the complexities of political risks and contribute to the achievement of global climate goals.

Conclusion

Political risk insurance is a valuable tool in mitigating the risks associated with mega energy projects. It helps protect foreign investors from unpredictable political events  and provides financial stability to projects in volatile political climates. PRI policies influence the behavior of both host governments and investors, shaping the relationships and outcomes of energy projects. Responsible investments and the integration of environmental and social considerations in PRI policies further contribute to sustainable development goals. In African nations, political risk insurance can plays  crucial role in supporting climate action and attracting private capital for renewable energy projects especially as fulfilment of the Paris Agreement pledeges. As the world continues to prioritize climate action, PRI will remain essential in navigating the complexities of political risks and fostering responsible investments in the energy sector.

**Taurai Craig Museka is a Zimbabwe-based

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