African governments are aware of the impact of energy insecurity on economic growth; however, they lack sufficient capital to invest in new power generation and grid capacity. However, there is room to plan ahead.
By Shamilah Grimwood-Norley, Head of Banking and Finance at Bowmans, South Africa
The article appeared in ESI Africa Issue 2-2021.
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According to the African Development Bank, between 2006 and 2016, almost 80% of businesses across Africa experienced up to nine interruptions to their power supply per month. Nearly half of businesses maintain production equipment to continue operating during outages, which occur on average 90 days a year, according to the World Bank.
Adding to their woes, the high cost of electricity for industries in Sub-Saharan Africa (SSA), at around $0.20 per kilowatt-hour, is four times higher than industrial tariffs in the developed world.
The Program for Infrastructure Development in Africa (PIDA) estimates that the electricity sector in Africa needs an annual investment of $42 billion across the supply chain, generation, transmission and distribution. As a result, governments are increasingly turning to private sector investment in Independent Power Producer (IPP) projects.
PPI vs. PPP
IPPs are often referred to as public-private partnerships (PPPs) given the off-take agreements between IPPs and the electric utility, which is usually state-owned or has a significant state stake.
Interestingly, recent large-scale IPP procurement programs have been passed outside of formal PPP regulatory frameworks, which typically involves handing over infrastructure assets built for PPP to the utility authority. Contracting State at the end of the duration of the PPP.
PPPs, which involve large private investments in fixed assets, are typically structured as Build Own Operate Transfer (BOOT), Build Operate Transfer (BOT) or Build Transfer Operate (BTO) type concessions (or variants thereof). types of concessions), with the compulsory transfer of these assets occurring at the expiration of the PPP term.
Structuring IPPs into PPPs where IPP assets are transferred to the state does not make much sense in countries where the electricity supply chain is still largely vertically integrated, and where the private sector is seeking a reform that will eventually lead to a generalized privatization of electricity production assets and the choice of the end consumer of the production offer,
Electricity generation is a naturally competitive business, and ownership should ideally be widely distributed, not monopolized by the state.
A missed opportunity
Electricity transmission and distribution is a natural monopoly. Private ownership of grid assets, especially in developing economies that require expansion and reinforcement of grid capacity and improved interconnection, is not optimal given that the interconnected grid system is a strategic national asset .
However, where public funds are limited, the government should consider private investment in the grid system undertaken on a PPP basis. Although many governments across sub-Saharan Africa have given considerable attention to the procurement of PPIs at scale over the past decade, governments in the region have not made any procurement of private sector investment. in national network systems.
To my knowledge, no African jurisdiction has pursued the acquisition of private sector investment in network services, through PPPs or otherwise, with the very recent exception of Kenya, and this appears to be a missed opportunity .
Although Kenya launched the first of its IPP procurement programs two decades ago, being the first African country in SSA to do so, it has only just started its first competitive procurement to upgrade its transmission system. If Kenya succeeds in financing the Kenya Transmission Project, it could be a game-changer for new investments in the power sector in Africa.
Bankability is key
Given the capital-intensive nature of utility-scale infrastructure investments, private developers will rely heavily on third-party debt financing from financial institutions.
It is clear from utility-scale IPP projects that have reached “commercial closure” in single-buyer markets (i.e. markets for utility-scale supply only to buyers public), that private investment in the form of equity and third-party debt can be used for new electricity generation.
The litmus test for investment is bankability, i.e. the ability of the project to raise debt from third parties.
Third-party lenders want to be sure that the cash flows generated by the project (in the case of an IPP, payments received for electricity delivered or available to be delivered by it) from the utility buyer will be sufficient to pay their costs, and that cash flows are adequately protected against all project risks.
In the case of a transmission PPP, the cash flows will primarily be the unit charges collected by the private transmission contractor for the network services it makes available to the transmission system owner.
In IPP projects with buyers of public utilities, a prerequisite for third-party indebtedness is that host governments protect IPPs against credit risk, in particular the risk of non-payment by the buyer. Credit risk is a challenge for many African jurisdictions, where utilities often have credit ratings below investment grade or close to sub-investment grade.
The importance of a structured approach
In addition to government credit support where there is apparent or potential credit risk, host governments must also pay attention to other factors critical to the success of an IPP or PPP procurement.
These include a properly structured planning process (which requires unequivocal state sponsorship), a well-managed and timely procurement process (adequately resourced), and a commercially reasonable pricing approach that enables cost recovery. investment costs plus a reasonable return.
The procurement process should incorporate strict discipline around timelines and evaluation criteria, consistent and open engagement with bidders, and well-developed procurement documentation.
Reasonable rate of return and risk allocation
Pricing is crucial to the successful implementation of IPPs or PPPs in single-buyer markets. Pricing parameters in the RFP document should be aligned with a pricing policy that supports rate of return or cost of service tariffs to enable investors to cover their costs and obtain a rate of reasonable performance. In these markets, an IPP or PPP only works if the regulator’s tariff methodology supports rate-of-return or cost-of-service tariffs.
More importantly, the regulator should not be allowed to reopen and review tariffs once the contract has been awarded. To be bankable, the off-take agreement must ensure a fixed duration, a fixed price and a fixed price increase, as well as a commercially balanced allocation of risk.
A general rule for governments, in my view, is that an IPP should not be required to assume risk that buyers of own-generating utilities do not bear in their own generation activities. IPPs should generally not be required to bear the costs that a public producer is entitled to recover from its customers. This is a key principle that African governments and investors should consider.
In summary, IPPs can be effectively operated in the power generation landscape in Africa, provided they are properly planned, well managed, transparent, properly priced and bankable. Governments should also consider exploring PPPs for transmission and distribution networks, which are currently a missed opportunity. ESI