Financing Electricity Generation in Africa

Subtitle: The risks and reality

By Frost & Sullivan’s Energy and Power Systems Research Analyst, Rob Smith

Just under half of Africa’s population of a billion people is entirely without access to electricity. This portion rises to an incredible 92% in rural populated areas. Flicking a light switch is taken for granted by the developed world, while it is a luxury in many African countries. Demand appears to heavily outweigh supply across most of the African continent.

The barrier to the expansion of electrification is, unfortunately, more complicated than simply an untapped market. The real question is how many people in Africa can afford the costs associated with basic electricity consumption? This challenge is unique to the developing world, and developing countries often overlook the lack of funding on a macro and micro scale in developing nations.

Certain questions associated with electricity generation arise, such as: when other basic services, (education and healthcare) are in short supply, can countries realistically afford electricity? Can the economies afford to pay the interest on the debt that will be needed to build the infrastructure? Are there enough skilled people in the country to construct and maintain the infrastructure in the long run? Is the population going to use enough power to make the construction worthwhile?

It is a precarious balancing act that energy planners must play in order to ensure that sufficient demand will exist to fund plant construction, and that sufficient electricity is available to support industrial and economic growth. Further challenges that many African countries face include (amongst others) politics, nepotism and corruption. Importantly, Africa is a continent of fifty four independent countries, three disputed territories and eight international dependency states. And apart from several multinational trade agreements, each region is an entirely new prospect.

The Complications of Mega-Project Investments

Power plants are hugely capital intensive, with construction costs (in 2011/2012) running in an approximate range of $1.5 million to $7 million per megawatt constructed, depending on the technology employed. Medupi is expected to cost around $3.4 billion.

Most financing companies would not be large enough to absorb such projects in their entirety. The reality in Africa is that most financial institutions, let alone individuals, simply do not have a large or strong enough balance sheet, or pool of funds, to absorb the risk associated with the enormous quantities of money required to finance power projects.

Investment Participation

These projects are also exceptionally complex. A project is likely to need specialist financial, technical, socio-economic, environmental and legal consultation. There can be twenty or thirty subcontractors supplying specialist services, each of which will have a unique contract structure and risks. These individual projects have to be managed and controlled in detail throughout the pre-feasibility, feasibility, financing, construction, operation and decommissioning phases.

What this translates to is that any company, or person, aiming to invest in a power project needs to have in-depth experience of all the variables and risks. Generally, the only organisations that have the human capital and financial resources to get involved have typically been large international

commercial banks, development finance organisations (DFIs) and national agencies. This leaves very little room for private investors.

Lower risk usually means lower costs. Loans for large scale infrastructure projects are therefore syndicated, with multiple lenders contributing. This process is aided by the syndication of loans, together with guarantees from export credit agencies (ECAs), and multilateral development agencies (such as the development arm of the World Bank, the IDA). Oversight by development finance institutions (DFIs) also helps to reduce risk to financiers and, thus the cost of borrowing. Without such structures, many projects would never pass the feasibility phase.

One of the few areas for private participation, or indeed for participation backed by a smaller balance sheet, can be found with independent power producer companies (IPPs). In some cases these organisations form collective investment schemes to allow private individuals to participate. The potential for such investments depends largely on power purchase agreements (PPAs) with national grids or other electricity buyers (or off-takers). Developments in this regard have been very slow until recently and, as a result, private power makes up a very small portion of the African continent’s generation capacity.

Participation in Implementation

Equity as a portion of capital in power projects in Africa very rarely goes higher than 10 or 15 per cent, and in most cases the equity stake is held by a national or parastatal organisation. Other companies that typically participate in the equity portion are the sponsors (sometimes IPP), developers or large scale Engineering, Procurement and Construction (EPC) companies.

Most African utilities are state owned or directly influenced by government; however a general trend across Africa is that the skills required to develop utility services are very rarely found in government. Unfortunately, a lack of domestic capacity has forced governments to utilise foreign private skills for project development.

The size of EPC contracts, the financial capacity, and skills required to manage those contracts effectively prevents domestic firms from winning tenders for large scale projects. As domestic firms grow in size and expertise, the chances of their inclusion in larger portions of tenders also increase. Due to the skill and experience required to be effective, the consultation expertise is also normally drawn from international sources, although local industries do participate in subcontracted work .Also, as governments acknowledge the importance of domestic development, policies such as localisation of content become more effective.

At a minimum, local industries could expect to benefit via the supply of equipment and materials. In many cases, however, the support of export credit agencies ensures the procurement of products or services from foreign countries. This is especially true for more complex equipment. This means that for the majority of African infrastructure projects, contract revenues are largely expropriated, and depending on the project, the materials, equipment, and even the labour could be outsourced.

From an operations and maintenance point of view, the misalignment of skills and decision making powers has often led to mismanagement. This dire situation has left many countries with national infrastructure in a state of disrepair, such as many South African Municipal systems, or dysfunctional.

The Silver Lining

There is real potential for positive growth and development, and Africa as a continent is richly endowed with mineral wealth. African countries have the chance to fast track learning, and develop local skill and capacity for the future. This can only be achieved if the right systems are implemented, where learnings are documented and developed nations are contractually forced to transfer skills when fulfilling on a project contract.

A major step in this direction has already taken place, where throughout Africa the trend is currently towards stabilisation of public private partnerships. In support of this, recent hydrocarbon discoveries off the East and Southern African coasts, as well as on land in East Africa, could provide a financial platform for further PPP collaboration. The Republic of Mozambique Pipeline Investment Company (ROMPCO), development of the Mozambican Temane and Pande gas fields is a perfect example of such a development.

In terms of local capabilities for financing and project management, multinationals such as the EIB, are actively working to develop domestic banking and lending structures in Africa. These structures will, however, take time to implement. The Kribi Power Development Company in Cameroon, through the cooperation of government, long term policy, technology selection and private capacity, were recently successful in securing the first IDA partial risk guarantee for a local bank debt tranche in domestic currency.

As local construction and EPC companies grow, their level of participation grows accordingly. The African development scene always has a sprinkling of multinationals, such as GDF Suez, AEI, AES, Alstom, Edison Corp, ESB, Globaleq, Harbin Power, Marbueni, Mitsubishi, Shell, Sumitomo, Tata Power, YTL and Power, Aldwych International. Their alliances with leading international legal, advisory and financing agencies significantly enhance the ability of the multinational companies to win tenders. This, however, does not exclude domestic companies, but rather emphasises the need for domestic utilisation of skills and the requirement of local content, albeit on a progressive basis.

Domestic financing capacity is also under development, and some local banks, such as South African banks Standard Bank, Barclays ABSA, Nedbank, and Rand Merchant Bank have developed internal advisory and capital project financing divisions that support activities of subsidiaries throughout Africa. Their skill in risk assessment and project selection is growing, and will undoubtedly be tested by developments in the South African REBID program.

Some Expectations

Energy projects with more history and higher success rates usually have a reduced risk profile. Traditionally, fossil fuel based generation and large scale hydro electric projects are favoured ahead of newer renewable energy sources, where commercial viability and commercial scale technology stability are not as well understood. Notable recent exceptions include the South African and Moroccan renewable energy programs.

Rising fossil fuel prices, and the reduced costs of installing and operating renewables, may bring renewables closer to parity. The dollar per kilowatt cost of electricity generation from renewables is constantly approaching that available from fossil fuels, and mechanisms that account for the negative externalities of fossil fuel consumption, such as carbon taxes, will bring the costs closer yet. As a result, renewable power generation plants are certainly becoming more attractive from an investment perspective. Unfortunately, higher prices of electricity and fossil fuels may have negative inflationary implications for economic development.

Regardless of the technology or financing methods utilised, electricity sales prices must reflect the long run operation, maintenance and development costs, as well as account for capital requirements to cater for growth in electricity demand from the consumer market. Without the stability that long run cost reflective revenues bring to electrical markets, sustainable development is seriously compromised. Fortunately, current policy developments (such as recent PPP legislature in Kenya) and recent PPA agreement, developments speak to an introduction of commercial feasibility and a reduction in political exploitation of infrastructural development.

The capacity for skills development and retention is different, depending on many country specific factors. One thing that is certain is that a lack of technically skilled and capable personnel is heavily detrimental to long term sustainability of development. We can only hope that governments will approach the issue with the necessary sobriety.

Conclusion

The need for expansion of electricity generation, transmission and distribution in Africa is undeniable. It is important, however, that the investment matches the country’s financial and economic capabilities. The levels of EPC skill and technical capability are constantly increasing, and as economies develop, the availability of funding from domestic sources is simultaneously increasing. In the interests of sustainability the transfer of experience, skills and education will be vital going forward.

Some requirements that have been identified include the ability of the population / industry to pay the relevant energy tariffs, the eradication of corruption, and the introduction of stability to legal systems and national energy policies.

Regardless of the technologies or methods utilised, the availability of finance is rarely a major problem. Feasibility, long term viability and expected returns depend on a vast number of idiosyncratic conditions and requirements. Successful investment is thus reliant on the ability to identify and understand these determinants, and where possible, mitigate the risks involved.

There is not a simple solution to any of the questions posed at the start of the article. Infrastructure projects are long term in nature and, for each nation, the precarious balancing act of energy development will necessarily be a part of a much broader and infinitely more complex development process. This is a process where social, economic, political, institutional and environmental systems must develop simultaneously.

Those who can afford to absorb the risk will be able to participate and undoubtedly many projects will fail. For those that manage, and time the development of projects correctly, success is analogously higher, and the potential revenues are as impressive as the capital costs of the projects. There are however, no guarantees of success.

Contact:Samantha JamesCorporate Communications – AfricaP: +27 21 680 3574F: +27 21 680 3296E: samantha.james@frost.com

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