As the energy transition gathers pace, renewable energy projects are on the rise, with investors and project owners alike keen to take advantage of lucrative incentives offered by governments. While government incentives create interesting investment opportunities, they can also make investors vulnerable when faced with unexpected regulatory and/or government changes. This post explores some of these risks as well as the steps project owners and investors can take to mitigate them.
Striving to comply with their Paris Agreement targets (under which 196 signatories have committed to limiting global warming to below 2°C), governments have promised tax credits, preferential loan opportunities, and direct subsidies to investors engaging in renewable energies. The incentives on offer are far-reaching: for example, Sweden recently proposed the allocation of EUR 19.2 million per year from 2021 to 2023 to cover a tax reduction on the installation of renewable technologies, and Colombia reinforced its offer of VAT exclusion and exemption of tariff duties for renewable energy projects.
But investors should tread carefully when relying on such incentives. A change in government or an economic crisis may be all that is needed to trigger the retraction of economic incentives to invest in renewable projects.
In Europe, Spain, Italy, and the Czech Republic are the most striking examples of this. In the early 2000s, all three countries first adopted legislation promising investors in renewable energies certain levels of profitability through feed-in tariffs (i.e., a guarantee of fixed and above market prices for a period of time). When the financial crisis hit, all three either reduced or eventually abolished the feed-in tariffs.
Similarly, in Latin America, Mexico adopted a number of different measures to promote investment in renewable energies. For example, in 2014, the Electricity Industry Law created green certificates that could only be awarded to private investors complying with rigorous criteria and guaranteed a steady purchase from the national energy supplier. Yet, with a change in government in 2018, successive reforms have loosened the requirements to obtain green certificates, thereby reducing their value, and prioritized the use of local fossil fuel resources.
To mitigate the risk of states retracting incentives, prospective investors would do well to understand the exact legal implications of promises made by a state—preferably before making substantial investment decisions based on them. From a mere political speech to a firm commitment, not all state actions carry the same legal effects.
Importantly, investors should consider whether the prospective host state is a signatory to favourable international investment treaties. Such treaties have been invoked against Spain, Italy and the Czech Republic and have allowed investors to be compensated for the frustration of their legitimate expectations through arbitration. Two similar proceedings against Ukraine have also been very recently commenced in relation to the revocation of its feed-in tariff regime in 2020.
If not already covered by such treaties, investors may seek to restructure their investment so as to benefit from their protections. Different risk mitigation strategies may also be put in place ranging from keeping good records of all communications with states to negotiating with governments to ensure that investors’ rights under international law and applicable treaties are protected.
Please do not hesitate to contact us if you have any questions about how you can mitigate risk and take advantage of investment treaties to protect your investments in renewable energy projects.
This is part of a series of blog posts exploring the potential impacts of energy transition and climate change on global projects disputes. Click here to see other posts in the series.