Irrational Exuberance About Africa?
The Obama administration hosted a commercial summit among heads of 50 African countries in Washington in early August. Interest in Africa is growing among private equity investors and developers as the region seems poised for a period of sustained economic growth. The World Bank projects a growth rate of 5.2% in 2014, up from 4.7% in 2013. There was a 16% increase in net foreign direct investment flowing into the region in 2013 with another increase expected in 2014. The United States launched a Power Africa initiative in 2013 with the goal of doubling access to electricity in sub-Saharan Africa by 2018.
However, developing projects in emerging markets is notoriously risky. Is there irrational exuberance about Africa? Does great need mean great opportunity? A panel discussed these questions at the 25th annual Chadbourne global energy and finance conference in late June. The panelists are Jennifer Cooke, director of the Africa program at the Center for Strategic and International Studies, Cheikh Gueye, mission chief in the Africa department at the International Monetary Fund, Maureen Harrington, head of the international development group at Standard Bank of South Africa, and Jerome Niessen, until recently principal investment officer for Africa infrastructure at the International Finance Corporation and currently managing director of NedPower, a project developer. The moderator is Ikenna Emehelu with Chadbourne in New York.
MR. EMEHELU: One of my mentors keeps telling me, “Africa has a lot of promise, and it always will.” Maureen Harrington, is the current exuberance about Africa misplaced?
MS. HARRINGTON: That is a huge question. Maybe I can start by telling you a bit about Standard Bank so that you will understand my perspective when I talk about potential opportunities for US companies in Africa.
We are Africa’s largest bank. We are headquartered in South Africa. We operate in 19 of the 54 countries in Africa. We have approximately $2 billion in market cap. I work from our office in New York where our focus is to look after our customers that are doing business in Africa. We focus on three main sectors in Africa: power infrastructure, mining and metals and oil and gas. We have underwritten about $2 billion worth of power deals in Africa in the last three years. It is a sector that we know quite well, and there is clear demand for more power in Africa.
Only about 30% of Africa’s population has access to power. The continent has the fuel sources: coal, gas, wind, sun, geothermal. The ingredients are all there. One of the biggest challenges has been developing a regulatory environment that facilitates private investment into utility-scale independent power projects. There are probably six or seven countries out of the 19 where we operate where the environment is in good shape to make those kinds of investment. Others are improving quickly.
There are also opportunities for distributed generation. Again, they vary by country based on local regulation.
MR. EMEHELU: Cheikh Gueye, are the companies and private equity funds rushing into Africa likely to be disappointed?
MR. GUEYE: I think the time is great for Africa. Growth is rising, and we have been experiencing a decade of strong market economic policies that are starting to bear fruit. Various countries are becoming more integrated into international markets. We believe this trend will continue in the future, although there are some risks. We think the larger countries have strong economic teams that will be able to manage through the tail wind that is starting to emerge in the international arena.
MR. EMEHELU: Jennifer Cooke, irrational exuberance? Too much risk still?
MS. COOKE: It is easy to fall into simple narratives on Africa. Ten years ago, it was a hopeless place. Now the simple narrative is the continent is about to take off.
There have been growth spurts in the past. The current growth is qualitatively different than some of the growth fueled by commodity booms in the past. We have seen a decade now of sustained growth coupled with high demand for commodities, particularly from China.
There is a diversification that we did not see in the past. Much of the growth in the last decade has been driven by construction, by telecommunications, by financial services and so forth.
You have a consuming class in Africa that generated less than $1 billion in consumer demand in 2008 that is expected to grow to $1.4 trillion in 2020.
There is something qualitatively different in the use of new technologies by more entrepreneurial globally-connected younger generations.
All of that said, one of the key features of Africa is something Maureen Harrington pointed out: divergence. Some countries will become important markets by virtue of their sheer size. Think of Nigeria with 170 million people or Ethiopia with 70 million verses a Malawi, Namibia or Sierra Leone, which are much smaller. Geography is another distinguishing factor: whether a country is landlocked, its ability to import and export products and the attitude of the government to a market economy. When we look at growth trends, we have to look at what drives that growth and whether it is sheer commodity export or whether the country is beginning to branch out into other areas.
I think there are opportunities, but there is no guarantee, and some are going to get it right and some are going to get it wrong.
MR. EMEHELU: You have been involved in high-level talks with African governments about access to energy resources.
MS. COOKE: Nigeria and Angola will continue to dominate in the oil sector, but there is a new producer, Ghana, and Uganda, Liberia and Sierra Leone have the potential to become smaller oil producers.
The big story is in the natural gas off the coasts of Mozambique and Tanzania and shale gas in South Africa. Mozambique and Tanzania have the kind of resources to meet real world class demand. This has led to huge expectations in those countries about what this might mean, but there are still significant uncertainties. Unlike oil, there is a lot of uncertainty about the global natural gas market going forward, and that makes it harder for investors who have to make massive upfront investments into infrastructure to produce and ship the natural gas. Put at the top of the list political risk, public expectations and governments that do not have the capacity to put complex deals together and who might change their minds about leaving key resources in private hands.
So there is a lot of exuberance, but I think you need on the natural gas side in particular to do a reality check.
MR. EMEHELU: And for a reality check, I want to get to Jerome Niessen. You were most recently on the Africa desk at the International Finance Corporation. It was your second tour at the IFC. Since then, you have been developing independent power projects. Is Africa a great opportunity for investors?
MR. NIESSEN: You know what they say about developers: they need to be optimists to survive. I did a short stint at the IFC about a year and half ago for a bit more than a year working on Africa infrastructure, but at heart I am a developer. And just to be clear: while I have spent years developing projects in emerging markets, my focus at the moment is in the US.
I remember 20 years ago when nobody wanted to touch Africa because it was a continent where nothing was happening and with wars and horrendous corruption. I was away from the IFC for 18 years. When I returned, lots of people wanted to work on Africa.
One hears from everyone that Africa has tremendous needs and there are lots of opportunities. I say that is indeed true, but let’s look closer. I worked in Tanzania and Uganda in particular. Only 4% of the people in both countries have power. So the government will come out with a report: we need 5,000 or 6,000 megawatts of additional generating capacity. I don’t know whether this is the right number, but it works for purposes of the point I want make. No one will contest the need.
Developers start to get dollar signs in their eyes. It reminds me of the early days in India with 27 fast-tracked projects. Everybody rushed into India talking about building thousands of megawatts.
Guess what? The utilities that are the potential offtakers are bankrupt. They are $150 million in the hole.
When you talk to your esteemed bankers at the IFC and Standard Bank about sovereign guarantees to support the power revenues, maybe the government can only afford to support 600 or 1,000 megawatts. You have to put these things into perspective.
Here is another point. I was trying to finance a solar power plant in Tanzania and the Spanish solar developer offered the government 12¢ a kilowatt hour. That is damn good for Tanzania because the project was in a remote area in which any other power would cost much more than 12¢. But you know, even though this developer was the lowest bidder, we did not get anywhere because the government wanted 4 1/2¢. The real handicap that I have noticed in Africa and, by the way, it is not unique to Africa, is you have governments with unrealistic expectations.
It is a recipe for frustration. I am not saying you should not go there as a developer, as the opportunities are vast, but know what you are getting into. It remains a tough place to do business.
MR. EMEHELU: Renewable energy projects have high upfront costs. Perhaps the governments need to take into account what they would otherwise pay for diesel when evaluating these types of projects?
MR. NIESSEN: True. Maureen Harrington mentioned distributed generation earlier. There are mining companies in remote areas that pay 35¢ to 40¢ a kilowatt hour for electricity. If you can produce solar power at 14¢, then there is clearly an opportunity. Choose your targets wisely. Make sure the project makes economic and common sense over the long term.
MS. HARRINGTON: We are seeing quite of bit of that with solar developers proposing inside-the-fence projects for mining and cement companies and beer breweries who are all power producers in their own right and are trying to get out of that business. The governments like these kinds of projects because they take pressure off the grid.
It is possible to structure deals that make economic sense in Africa. South Africa is an interesting case study. South Africa embarked on a renewable energy drive. Three years ago, South Africa was a developing market for renewables. Three or four rounds later, it is a developed market for renewable energy, and that happens with the snap of a finger.
There are lessons to take away from the experience with renewables in South Africa. There are quite a few American companies that are involved in solar projects in South Africa and are having success in that market. The risk there is around the rand. The deals in South Africa are being financed in rands rather than dollars, which can create challenges for companies that do not have a lot of use for rands.
MR. EMEHELU: The two financing challenges that one hears about most frequently in Africa are foreign exchange risk and loan tenor. Many projects are financed with debt from domestic banks. In the first round of privatizations in Nigeria, Nigeria raised $2.4 billion. Almost all of it was sourced by domestic banks, but the banks do not lend longer than three years generally, maybe five if you are lucky. So there is an immediate refinancing risk.
How can you bring institutional money from US and European sources to help address the need?
MS. HARRINGTON: That’s a really interesting question.
The South Africa banks have a long track record of taking the upfront construction risks with five- to seven-year money. We would normally bring in the development finance institutions to do some of the longer-tenor aspects of the deal. Now with the constraints of Basel III, the South African banks — which are Basel III compliant already — do not get the benefit of their stronger balance sheets because our ratings are capped by the sovereign. We are Basel III compliant and we still have the rating issues to deal with, so our cost of capital is high.
So there is a lot of thinking being done today about how to bring in institutional investors in the US and Europe who are looking for high yields. A threshold impediment is a mismatch in the level of knowledge of risks. You have African banks and developers who understand how to structure deals and have done so with a very different set of investors in terms of risk appetite. We still do not understand well what key concerns American and European institutional investors have or what your hurdle rates are. If we were able to bridge that knowledge gap, then we could go a long way in terms of structuring something that makes sense for institutional investors. There are certainly deals that make sense for such investors, but we need a better understanding of your risk appetite so that we can structure accordingly.
MR. EMEHELU: Jennifer Cooke, we have not discussed the dragon in the room, which is China. American and European developers are finding that it is hard to put in a competitive bid when one of the competitors is supported by the Chinese government.
MS. COOKE: We have to have a little bit of humility when looking at the impact of China, particularly with the kind of resources that China has. The United States and US companies need to find where they can add the most value. It is also up to African governments to find the most competitive offer rather than the least costly. With this in mind, some US companies have been pressing African governments to look at the life cycle of projects rather than focus solely on the upfront cost.
There was an early kind of uncritical embrace of Chinese investment as an alternative to the West both for political and economic reasons. Many countries are taking a harder look at their relationships with China. They are not turning away from China, but they have become more sophisticated comparison shoppers.
MR. EMEHELU: The Chinese offer a 1% interest rate and they do all the work. Cheikh Gueye, those are tough numbers to beat, no?
MR. GUEYE: It is difficult for what I would call the other investor to match China. The way the Chinese package their offers is completely different. The criteria that they are using to evaluate investments is different also.
To bring US and European institutional investors to Africa, you have to address their fear of political risks. Do the Chinese really pay as much attention to political risk? The African governments have work to do to minimize these risks before they will attract large sums of institutional money.
From our standpoint, we think it is critical to continue the market-oriented, micro-economic policies that these countries are undertaking because that is the only way to mitigate this risk. You can use structuring, you can use unbundling, but in order to address the risk head on, you have to put forward strong micro-economic policies. That have been doing for almost 10 years. Over time, it will be an impressive enough track record to breed more confidence in the economy.
MS. COOKE: Another big area is on the regional integration front. I wonder if you could say something about East Africa? There are so many small markets. Half of sub-Saharan economies are under $10 billion. Without regional integration, it will be tough for really tiny economies to draw serious investment. East Africa appears to be getting it right. Kenya has had a 15-year process of trying to reform the power sector to make it attractive and is also driving regional integration in East Africa. It strikes me that there are pockets of opportunities that are worth investigating.
MR. GUEYE: I think you are right. Integration is key, whether it is East Africa or West Africa, and there has been progress in both places. For instance, take Benin and Niger. They are starting to build communications links between the two countries. The same thing is happening between Niger and Cameroon. We have to move in this direction. Developers should not write off small markets without exploring what steps are being taken toward regional integration.
MS. COOKE: It also makes the deals much more complicated to put together.
MS. HARRINGTON: Correct. The regulatory environments are not consistent across borders, so it can become very challenging.
Returning to the issue of China, if you are competing on price, most American companies will lose. However, if you look at our pipeline of infrastructure deals and the ones we have closed, most are driven by western sponsors or there is western equipment involved because the kind of initiative required to put these projects together is something at which our culture is very good. There is plenty of room for an American or western approach to building power and infrastructure on the continent. There is also room for an eastern approach. The demands are so enormous that there is room for both.
It may be more difficult for American companies that are trying to compete for government procurement deals because pricing ends up being so important, but when it comes to more complicated projects, there is plenty of room for a western-style approach.
MR. NIESSEN: What I have observed about Africa and China is the following. China often finances projects in the public sector. We are talking here about having our private sector compete with its public sector.
You will not see many Chinese developers. I know of none that is working on an independent power project in Africa.
China comes in with cheap money and Chinese labor, and the latter is leading to a backlash. China comes in with 2,000 Chinese laborers to build a project. There is little or no local labor involved. People are not going to like it. The quality is not always there. Numerous Chinese projects have had quality issues.
So I do not want to minimize what the Chinese are doing, but there are plenty of opportunities for quality developers from the US and Europe to do their own thing.
Let’s also give the Chinese credit. They woke us up. We all have been sleeping on the wheel in terms of opportunities in Africa, and it was the Chinese who first spotted the opportunities based on minerals. They moved in a big way, and that is one reason why I think we are now interested in Africa. Another reason is returns are better than in competing markets. The returns have been falling across Latin America and Asia.
MR. EMEHELU: Are there any audience questions before we move to the next topic? Keith Martin?
MR. MARTIN: Some people think that rooftop solar has great potential in Africa because you do not have to rely on building transmission lines. However, rooftop solar does not take hold in markets where electricity prices are subsidized. Is there an opportunity?
MS. HARRINGTON: The opportunity is just starting to appear in parts of Africa, particularly East Africa. Some companies are trying to adapt a SolarCity model — and, in fact, SolarCity just made an investment in a Tanzanian company that is mimicking the approach in the US where the solar company puts the solar equipment on the customer’s roof for free and the customer signs a long-term contract to lease the equipment or buy the electricity. But then the customers have to prepay part of what they are expected to owe over time, and that is a critical issue in most parts of Africa.
One of our key challenges as a bank when making consumer loans is people do not have credit histories. It is impossible to make credit decisions on an individual basis in many parts of the continent.
So what you see a lot of these distributed solar companies doing is trying to adapt the same technology that has blossomed across Africa around prepaid mobile phone cards where you have to pay for the power upfront and you get a code that you type into the machine in your home to buy a fixed quantity of electricity. All of sudden, it has become the model of choice for dealing with payment risk.
It is too early to say how the model will work. It worked in the telephone market, but the capital investments are much smaller. Many people thought cell phones would not develop into much of a market because most Africans cannot afford to make phone calls. Maybe they can’t, but it is a service they really need, and you will probably find the same thing with electricity. My gut feeling is it is a huge opportunity.
MR. EMEHELU: Jerome Niessen, you have developed projects in India, Europe and the US. What would make you go to Africa?
MR. NIESSEN: I would not go to Africa, but only because I am a small developer. I am a strong believer. There are great opportunities for some. However, the only way I would do business in Africa is if I could diversify. When you are big enough to diversify your risk by placing more than one bet at a time, then absolutely. It is still risky.
For those of you who have never done a project in an emerging market, the problem I find is you can have all of your ducks lined up nicely in a row. You do everything according to the book. Then there is one thing that can kill you, and it may be totally irrational. For example, I was developing a wind farm in India and had to get approval from the foreign investment approval board for 100% foreign ownership. Guess what? Never came through. Why? Presumably because somebody was holding out his hand. That is why I am saying that, as a developer in Africa, you had better be big enough to diversify.
MR. EMEHELU: Ken Hansen?
MR. HANSEN: Cheikh Gueye, I know a number of developers that are taking African opportunities really seriously right now. They recognize the problem that was flagged, which is that outside of South Africa, there basically is not a solidly creditworthy offtaker utility anywhere in the neighborhood, so they are looking for credit support from finance ministries. If you speak to the finance ministries, some are sympathetic and say, “We would provide the support, we are willing to bet on the development of our country, we recognize the need and the relevancy of this project, but we can’t act because the International Monetary Fund says that we are stretched too thin.”
They identify you and your colleagues as a major impediment to these deals getting done. I guess what I am looking for is not your defense, but your analysis of how to get over the IMF standing in the way.
MR. GUEYE: It boils down to the credibility of the project. If your project is credible, if your project is bankable, then why do you need the support of the government?
MR. HANSEN: Because we need to be able to persuade the banks or the IFC that we will get paid for the power the project generates.
MR. GUEYE: If a project is credible, then the IMF would not advise policies that would go against it. What we consider is the welfare impact of the project in the long term. The welfare of the project should be sustained by the market because if it depends solely on the support of the government long term, then we could conceive of a situation where the government has helped launch the project, but the economic burden causes it to lose interest over time.
MR. NIESSEN: If I may, since I have been working for one of the sister organizations, I look at it a little differently. You cannot expect the IMF or anybody else simply to say all right. Government X may be keen to have the power, but it can only afford so much in guarantees. Any commercial bank would reach the same conclusion.
Having said that, these are development institutions after all, and we have to find a way to help the continent develop. There is political risk even in South Africa that the government will say no tariff increases for the next five years. That is why these projects ultimately need guarantees from the World Bank and so on. I do not think anybody in this room would do a project in an emerging market without those kind of guarantees in place.
MR. EMEHELU: It is time to wrap up. Let me go across the panel and ask for final thoughts.
MR. GUEYE: I encourage developers to look at where Africa is headed rather than where it has been. If we look at economic policies 20 years ago, we can see that things are moving.
These are markets where the pace of development is accelerating.
MR. NIESSEN: I have a simple analysis. It is Africa’s turn. There are many opportunities. Having said that, do not go with dollar signs in your eyes, and do not think it is a gold rush. If you go in with that attitude, for sure you are going to get hurt.
MS. HARRINGTON: The US is behind. Africa is not a frontier market for other companies and countries that have been active in Africa, and the Africans themselves are starting to drive a lot of the opportunities. If you are thinking long term for your company and trying to figure out where the next growth opportunity is, then you have to start looking at the continent and, even if you start by looking slowly, find a good local partner and realize that people are already there well ahead of us trying to harness the opportunities. If we can help you, we would be delighted.
MS. COOKE: There has been a qualitative change in the mindsets of many African governments who see an opportunity for long-term growth in jobs and manufacturing. The US government and US companies in power and other sectors are just waking up to the opportunities. President Obama has scheduled a summit this summer in Washington with the African heads of state. We have the Power Africa initiative, but the US is beginning to realize that it has to bring institutional players as well into the mix on Africa policies and not limit our efforts to conflict analysis and health development. We are coming late to the game, but what President Bush and now President Obama and probably the next administration are starting to do is think more strategically on the commercial front, informing US investors of the opportunities and putting the Commerce Department, OPIC and the US Export-Import Bank on the ground to help.