Energy reform in major emerging economies: new models for sustained growth:
Signalling market readiness
The transition to an energy system that is more secure, more affordable and more sustainable will require adequate levels of investment across the entire energy value chain. Energy systems need to keep up with growing energy demand by ensuring continuous sources of supply, increasing efficiency and enabling the transition to a low-carbon energy architecture while supporting economic growth.
Over the last three years, annual investment in global energy supply surpassed $1.6 trillion, supported by investment in renewables, the increase in global demand, and higher prices in many countries.65 This represents a substantial increase historically (50% since 2000). However, more capital is required to continue generating sufficient levels of energy to keep up with demand. In its New Policies Scenario, the 2014 World Energy Investment Outlook estimates that 25% more investment is required per year by the 2030s ($2 trillion annually), totalling $48 trillion between 2014 and 2035.66
Emerging economies are expected to account for nearly two thirds of this energy-supply investment ($25.2 trillion)67 – and 15% of global investment will take place in China. Investment in electricity in particular will need to be substantial in order to keep up with demand.68 This capital is likely to come from a variety of sources including state funding, energy investors, banks and capital markets.
Despite the promise of growing markets, the barriers to investment into emerging economies’ energy sectors are many, including weak institutions, political instability and deep-rooted market inefficiencies. Subsidies, in particular, create substantial price distortion – for both gasoline and diesel. Investors are looking to policy-makers to address these as “decisions to commit capital to the energy sector are increasingly shaped by government policy measures and incentives, rather than by signals coming from competitive markets”.69 Governments need to demonstrate to investors that their institutional frameworks are strong and stable, and that their energy policies are credible and consistent.
This is no easy task. On the one hand, governments in emerging markets are focused on deregulating and opening up markets by signalling market readiness to potential investors. This can take a number of forms, including rebalancing the risk-reward ratio of investments, and signalling commitment to long-term changes. Foreign Direct Investment (FDI) is attracted by working institutions, with inclusive institutions enabling smart policies.70 On the other hand, energy markets are imperfect, and have to be regulated to work for the public interest (e.g. internalization of externalities). Thus, governments need to implement the right signals to respond to challenges in the sector.
This section explores two case studies of reforms that have rebalanced the risk/reward ratio and signalled market readiness – one in the oil and gas sector, and one in power. The first case study is focused on changing incentives for oil and gas investors through amendments to the fiscal regime in Colombia. Reforms initiated more than a decade ago have yielded impressive results for its oil and gas sector, including increased flows of FDI into the sector. The second case study turns to Nigeria, where $10 billion in investment is required in the power sector for the government to meet its growth targets. So far, reforms have benefited from real momentum supported by a clear and consistent road map, as well as visible leadership from the Head of Government.