1. Washington DC November 12, 2008 Financing Energy Investments in Developing Countries Jamal Saghir Director Energy, Transport and Water The World Bank World Bank Group-Finland-Norway Seminar

2. Outline and Key Messages Changing financial, commodities,and macroeconomic context – Recent global financial shake up has changed the outlook for energy financing – Volatility oil prices has forged close correlation with food prices – Deteriorating macroeconoic pictures have eased short-term energy demand growth Impacts this time around likely to be different than the 1990s crises, given stronger growth prospects in developing countries and energy sector reforms undertaken Policy challenges—managing the immediate crisis, while keeping sight on long-term needs

3. I.Financial Context  Recent developments have tightened credit conditions –Outlook depends on policy responses and financial consolidation  Emerging markets no longer sheltered, and private capital flows are set to decline from record levels of 2007  Financing of energy infrastructure will be affected as financial market consolidation continues

4. Financial turmoil has moved into a new and dramatic phase Source: Bloomberg. Stock market indices (June 2007=100) (June 2007=100) S&P 500 Financial index on Oct. 09,2008: 191.85 (lost 62% since June 01, 2007)

5. ……prompting significant changes in financial landscape  Massive market capitalization losses in global investment banking industry  Consolidation of the broker-dealer business with commercial banking  Deepening credit crunch,with significant widening of emerging market debt spreads  Financing of infrastructure energy projects would be affected

6. Bailouts and liquidity injections may have prevented bank collapse Basis points US Euro zone Source: Datastream. Spread between 3-month Libor and policy interest rates

7. Emerging market bond spreads have widened substantially Basis points Emerging-market bond spreads Jan 2007 – Oct 28, 2008 Source: JPMorgan

8. $ billions (12-month moving average) Bond issuance Private debt and portfolio equity flows to developing countries have been moderating… Bank lending, bond and equity issuance Jan. 2004 – Sep. 2008 Bank lending Equity issuance August 2007 Source: World Bank.

9. …but FDI inflows resilient FDI inflows to developing countries (US billion) China/Brazil/Russia * Based on data in 25 developing countries Other Developing

10. Number of foreign banks (left axis) Market share of assets (right axis) ……As Foreign banks play a dominant role in developing countries…scaling back would affect energy financing Percent Source: DEC Prospect Group based on data from Bankscope. Hungary 94% Mexico 82% Indonesia 28% Brazil 25% India 5% Thailand 5%

11. Risks from foreign banks’ transmission of financial shocks have heightened Number of countries with exposure Source: World Bank staff estimates based on data from Bankscope

12. $ billions Net private debt and equity flows 1990-2007, projected 2008-09 Percent Percent of GDP (right axis) Private capital flows expected to decline …Infrastructure and energy projects will be affected Source: DEC Prospect Group.

13. II. From Financial to Commodities Context  Most commodity prices have peaked and are expected to fall in response to improved supply and slowing demand  Oil prices have declined sharply in response to slower demand growth in the U.S. and OECD  Food prices are expected to fall on good supply prospects and weaker oil prices. However, prices will remain historically high and continue to be a major concern.  Metals prices have weakened as supplies have increased and are expected to increase further while demand weakens. China’s demand will be critical to prices.

14. The boom observed in recent years is unprecedented… Source: DEC Prospects Group.

15. …but most prices have begun to decline Source: DEC Prospects Group.

16. ……Growth in U.S. oil demand has slowed... kb/d 3-mo mov avg (y/y) Source: U.S. EIA and DEC Prospects Group.

17. … and global oil supplies have increased kb/d monthly (y/y) Source: U.S. EIA and DEC Prospects Group.

18. III.From Financial to Commodities to Economic Context  Developing countries face slower export growth, deterioration in financial conditions and higher inflation.  The ability of developing countries to play a stabilizing role in the global economy is diminishing.  These developments weigh on energy demand

19. Inflation now surging in emerging markets–on food / energy prices….. High-income OECD Developing countries Median inflation rates Jan 2000 to July 2008 Percentage change (12m/12m) Source: DEC Prospects Group.

20. …..Current account stress has risen substantially for oil importers Current account balance / GDP oil-importing developing countries ( ex. China), 2000-07, projected 2008-10 Percent Source: DEC Prospects Group.

21. IV. From Financial to Commodities to Economic to Energy Context

22. World Bank estimates that power sector investment in developing economies would be of the order of $165 billion per year until 2010, rising to $185 billion per year during 2011–20. Power Sector Investment Gap Cumulative Power-Sector Investment by Region 2005-2030 (IEA)

23. High bank borrowing renders the energy sector vulnerable to global credit crunch Capital market financing for developing-country energy sector $ billions Source: Dealogic

24. Bank lending to energy-sector and total bank lending to emerging markets Energy sector borrowing Total bank lending $ billions * As of September Bank lending for energy accounts for one- third of total international bank financing

25. Lending for in oil & gas dominates energy financing Industry breakdown of developing-country energy financing, 1997-2008* (percent) * As of September

26. International debt flows to the energy sector is highly concentrated in a few countries Top 5 recipients in energy-sector financing: aggregate 2004-2008 $ billions * As of September

27. Past financial crises in developing countries …..With the origin of 1990s crises residing in developing countries, impact on energy was severe  East Asia In 1998: –GDP in the region declined by an average of about 8 percent –Primary energy demand declined at a rate comparable to GDP –Electricity consumption declined at a much lower rate (2,4% in Thailand; 2% in Korea) or even continued growing (4% in Indonesia) – Sharp currency devaluations against the US dollar pushed up the cost of energy in local currencies –Deterioration in financial markets disrupted normal operations of energy sector –Reduction of investment on the supply side, price adjustment (limited) and renegotiation of specific contracts –Further steps in the reform (regulation, PPP, privatization) postponed or cancelled

28. …1990s crises : impacts on energy sector  Latin America –Significant progress had been achieved in restructuring and privatization of existing utilities until 1997 –The crisis disrupted reform programs (privatization and creation of competitive markets) –In some countries (e.g.Brazil) reforms were restarted several years later  Eastern Europe and Central Asia –Russia and Former Soviet Union (FSU) countries experienced loss of access to commercial funding for project financing –Institutional and regulatory reform were affected

29. This time around, the macroeconomic and sector profile is different Different Macroeconomic conditions in the majority of middle-income developing countries, particularly in the large BRICs (Brazil, Russia, India and China) Energy sector worldwide: high prices of oil and other primary resources expected for the next two decades – Russian financial crisis in 1998 was partly due to the fall in oil prices-- to USD 11 per barrel. Food prices There is a Financial + Energy + Food crisis

30. Private Investments in energy peaked in 1997. The recent surge is likely to be reversed …

31. Consequences on energy would vary across countries  Most affected would be countries with high dependence on foreign capital -- Mexico, Ukraine  Limited in countries with developed institutional investors --.. Chile  Local and regional investors expected to consolidate their lead -- Brazil, Russia, India, China  “Energy rich” countries -- Gulf States, Norway, Brazil and Russia could become bigger financiers of energy projects in other regions  Brazilian and Russian companies likely to expand their role as direct foreign investors in other regions

32. Policy Challenges Medium income countries Short-term : safeguarding existing projects involving foreign investors Medium-term : maintaining strong investment climate to attract future FDI flows –Enhancement of sector’s institutional development –Design and implementation of mechanisms for allocation of risks (project, macroeconomic, currency) between project developers and governments Low-Income Countries Increasing Use of renewable energies to expand access Maximizing energy efficiency Designing better institutional, technical, procurement procedures

33. Need to: Develop better tools and mechanisms to distinguish energy cycles from business and credit cycle –procyclical with credit cycle, counter cyclical with business cycle Highlight the fact that public sector cannot afford to finance all required energy investments in developing countries In dealing with crisis, the state’s role has changed to “ guardian of last resort” –-- implications for fiscal deficit, interest rtaes, and PPI model One thing is sure: Private sector participation remains essential and likely to revive once markets find their footings But keep in mind: Energy investments are for the long haul and need robust rules-of-the-game Concluding Remarks

34. Thank you