Large investors make the running in emerging markets

"My mama always said, investing in emerging markets is like a box of chocolates. You never know what you’re gonna get."

Okay, so Forrest Gump never said that in the 1994 movie of the same name. To be honest, if I was to level any criticism at that film, it’s that there was too much running and not enough discussion about investing in wind farms in emerging markets.

It’s a shame as, if he had said that, he’d have been absolutely right. Investors in emerging markets do so for higher returns because they don’t know exactly what they’re gonna get.

This was one of the key warnings in a report by JLT Realty and K2 Management last week about pre-construction projects, and how companies could improve the bankability of their schemes. This includes well-established ideas like the use of insurance to manage the impact of fluctuating wind speeds, and using computational fluid dynamics to more accurately predict the energy yield from wind developments.

However, one warning stood out: “Key emerging markets, like South Africa, are at risk of stagnating investment if long development phases continue as some smaller investors can’t afford to wait prolonged periods for returns,” it said. Well, sort of.

It’s no secret why investors are looking at emerging markets in Africa, Asia, South America and eastern Europe. They want higher returns than they could access in established markets, where the legal systems are more established and wind is a more established asset class.

There's also no shortage of investors that want to get into emerging markets: this report said there are five investors for each project.

But if that's the case, is investment really at risk of stagnating? I'm not so sure. There seems no reason why investors would stop looking to put their money into these projects, and they are all looking to invest in the knowledge that emerging markets are risky. Sure, some losing bidders might end up having to put their money in sectors other than renewables instead or wait around for the next wind deal, but that’s just business.

The report also alludes to the fact that there are greater challenges for the smaller investors, which can find it tough to compete with larger and better-capitalised rivals. It argues that long development cycles bias the system against those smaller investors, as they cannot afford to wait around to receive their returns. We understand that.

The system is arguably weighted in favour of larger investors too because they can afford to spread their risk by investing in projects in multiple emerging markets.

But, and this may sound callous, is that such a problem? If smaller investors can’t afford to take those risks then there's an argument they shouldn't be investing in emerging markets. Long development cycles are as much a part of these markets as underdeveloped legal systems, lack of an established supply chains, and higher-than-average political risks. If you can’t find a way to make your business model work then it probably isn’t the market for you.

In our view, this fierce competition for opportunities in emerging markets is a good thing. In Africa, there's a great opportunity for renewables including wind and solar to help get more people onto the electricity grid, with the social benefits that brings. It's even better if those developers can fund projects with a very low cost of capital. Not great for investor returns – but it helps companies to roll out cheap energy where it’s needed.

Yes, we would like to see more developers bringing forward projects in emerging markets. That will help the rollout of electricity to happen faster, and we expect to see more of them once the pioneering developers in these markets have shown that they can make projects happen, and that they can be profitable. As long as that happens, there’ll be no shortage of well-capitalised investors with which they can partner.

That will be key to making sure wind projects happen in emerging markets, whether they come with long development cycles or not. And surely that is the point.