Blended finance is a structuring approach where concessional financing is used together with private finance in projects that were initially considered too novel and risky for private finance alone. The “blending” of concessional and commercial financing improves risk-return characteristics of investments and attracts private sector investors into RE and EE projects. Blended finance therefore offers a financial structure in which different investors with different investment priorities can participate.

Acceptable risk-return profile of the projects is achieved by:

• De-risking instruments, which may include (partial) risk guarantees, first-loss arrangements, grants, technical assistance, subordinated debt or junior equity, or
• Return enhancement, which can be created by giving investors priority rights to cash flows generated.

Many energy transition investments are more capital intensive than traditional infrastructure. For example, a renewable energy project may have a higher upfront cost but lower operating costs than a coal plant of equal size. This high capital requirement relative to non-climate-friendly infrastructure means that energy transition projects are disproportionately impacted by high costs of capital: small changes in interest rates have compounding effects on project costs over time, and lowering financing costs can, therefore, have significant price benefits for projects’ end beneficiaries (electricity consumers).

The issue of high costs of capital is the most pronounced in developing countries with high vulnerability to climate, non-financial and economic shocks. Blended finance offers the potential to create financing vehicles on a national or sub-regional level to break the persistent negative feedback loop between high perceived and actual risk, high cost of capital and limited investment in energy transition projects in developing countries.

Blended finance and concessional funding are therefore considered as key strategic tools for addressing market imbalances and mobilising private funding for energy transition investments in developing countries.