Innovative structures for African projects
Africa will have to turn to innovative financing structures to reach a goal of financing the large number of power and other infrastructure projects needed to meet existing demand and satisfy the growing population.
This article discusses three such structures.
The energy deficit in Africa is both immense and well documented. Today, 620 million people in Africa do not have access to electricity, which represents nearly two thirds of the total population of the continent. According to the latest Africa Progress Panel report on electrification in Africa, the number of Africans without access to power is projected to increase by 45 million in 2030 if current trends remain unchanged. A detailed breakdown of the statistics paints an equally alarming picture: the average African (excluding South Africa) uses just 160 kilowatt hours of electricity per year whereas the average American consumes over 13,000 kilowatt hours per year.
Despite these enormous energy challenges, Africa boasts vast, untapped potential in power generation, in particular in its renewable energy potential. Africa has a staggering 10,000,000 megawatts of potential solar energy, 350 of hydroelectric power, 110,000 of wind power and 15,000 of geothermal energy. This vast energy potential, coupled with the continent’s rapid population growth as well as recent cost reductions in renewable power generation technologies, represents a promising investment opportunity.
A recent report by McKinsey & Company suggests that, in order to realize its full energy potential, Africa as a whole will require about US$490 billion of capital for new generation and another US$345 billion for transmission and distribution.
Innovative financing solutions involving both public and private sectors are key to unlocking Africa’s untapped energy potential and generating the investments required to secure the success of viable and sustainable energy projects.
Obstacles to investment
Risks accompany rewards, and Africa is no exception. There are multiple risks — financial, credit-related and political — that investors face whenever investing in energy projects on the continent.
In order to mitigate these risks, independent power producers typically request a sovereign guarantee from the host government to cover potential termination payments and offtake obligations under a power purchase agreement. However, a sovereign guarantee is only as good as the government issuing it. In accounting terms, a sovereign guarantee is a contingent liability on a sovereign’s balance sheet. Problems arise whenever a sovereign reneges on a sovereign guarantee or refuses to honor the contingent liabilities on its balance sheet.
A case in point is Tanzania’s state-owned utility, Tanzania Electricity Supply Company (TANESCO), which has been in arrears in its payments to SonGas Limited, an independent power company that runs a gas-powered plant in Dar es Salaam and contributes nearly 20 percent of Tanzania’s grid power. SonGas’s investment is backed-up by a sovereign guarantee from Tanzania, but when, in December 2016, SonGas threatened to suspend its operations due to long-standing arrears by TANESCO, the sovereign guarantee was of no avail and arrears continued to grow.
At the other end of the spectrum is Kenya, which refrains from granting sovereign guarantees in energy projects and has instead resorted to issuing “strong letters of government support.” One such letter of support was recently issued by the Government of Kenya to support the development of the US$144 million Kinangop wind farm in Nyandarua county in central Kenya, which has since been placed in receivership and is currently the subject of an International Chamber of Commerce arbitration. The outcome of this arbitration will help shed light on the value of letters of support, both practical and juridical and the protections they afford, if any, to their beneficiaries.
Development finance institutions (DFIs), including the World Bank Group and the African Development Bank (AfDB), provide important sources of funding through a combination of grants, equity investments, debt finance (oftentimes on concessional terms for low-income countries), guarantees and credit enhancement products on a project-by-project basis. Insurance products are also provided by certain DFIs, such as the Overseas Private Investment Corporation and the Multilateral Investment Guarantee Agency, export credit agencies and private insurers.
For its part, the World Bank recently announced that it would be investing US$57 billion to accelerate growth and development in sub-Saharan African countries over the next three years. By contrast, the AfDB launched the “New Deal on Energy for Africa,” which represents a commitment of US$12 billion on energy over the next five years with a goal of leveraging US$50 to US$60 billion from the private sector and other financial partners.
Investors would do well to study the DFI’s terms and conditions for funding carefully to determine whether they meet a particular DFI’s eligibility requirements and strategic sector areas. Investors must also bear in mind that DFIs offer a limited range of products, which might not always respond to their particular needs.
More recently, in late March, French development agency, Agence Française de Développement (AFD), launched the “African Renewable Energy Scale-Up” facility at the Africa CEO forum in Geneva. This €24 million facility will help fund early-stage development of innovative on-grid and off-grid renewable energy projects, in particular solar energy projects, as well as other technologies like biomass, wind and mini-hydro.
In light of the uncertainty of sovereign guarantees and the limited product offerings of DFIs, investors will need to turn to more innovative financing solutions that better address their needs and mitigate the risks of their investments.
There are three recent financing solutions in particular that deserve to be highlighted and are explored further below. They are public-private partnerships (PPPs), green bonds and the put-and-call option agreement.
Traditionally, infrastructure projects in Africa are financed through the public sector, using tax revenues or public borrowing. Of late, however, African governments have become increasingly attuned to the advantages of using private sector capital for public services. With private sector investment in Africa’s public infrastructure growing, PPPs have emerged as the favored vehicle for infrastructure projects, particularly in the power and transport sectors.
The development of PPPs in Africa is still in its nascent stage, and there are countries that have yet to develop the necessary legal and regulatory framework for PPPs or that lack the technical skills to manage PPP projects.
Nonetheless, there are a number of initiatives that have been rolled out with the aim of supporting the deployment of PPP projects across Africa.
South Africa’s “Renewable Energy Independent Power Producer Programme” is one example of a successful partnership between the private sector and the government to promote renewable energy projects under a clear procurement structure with firm bidding deadlines.
Another is the World Bank Group’s “Scaling Solar” initiative, which provides a holistic, one-stop shop for investors and developers seeking to de-risk investment opportunities in emerging markets, by using the whole suite of World Bank Group products on a PPP basis. (For more information on Scaling Solar, see “Off the Grid in Africa” in the February 2017 Project Finance NewsWire).
Africa50 is an infrastructure fund established by the African Development Bank in 2012 and headquartered in Casablanca that is designed to accelerate infrastructure development and PPPs in Africa, particularly in the energy, transport, information and communication technology and water sectors. Africa50 mobilizes funds from African governments, DFIs and institutional investors, including pension and sovereign wealth funds. Its stated objective is to shorten the time period from project conception to financial close, bringing it down from an average of seven years to under three years. In December 2016, Africa50 signed a joint development agreement with Scatec Solar and Norfund to mobilize resources for the development phase of an 80-megawatt solar photovoltaic project in Nigeria. The electricity will be sold to state-owned offtaker, NBET, under a 20-year PPA.
Africa GreenCo is one of the latest innovative solutions geared towards de-risking projects in Africa. Africa GreenCo seeks to mitigate two main risks: lack of creditworthy offtakers and lack of a viable power market in which to sell the electricity.
Africa GreenCo is currently in the feasibility stage. It will involve setting up a PPP in the form of a single, creditworthy counterparty who will sit between buyers and sellers of electricity from independent power projects in sub-Saharan Africa. According to Africa GreenCo’s recently published feasibility report, Africa GreenCo will serve as an “independently managed, creditworthy (investment grade), intermediary offtaker and power trader” that would complement existing structures. Africa GreenCo proposes to operate as a member of the African regional power pools. In the event that a utility defaults on its electricity purchase obligation, Africa GreenCo would have the option to sell the power to other utilities or via the regional power pools.
This innovative structure brings many benefits, including creating a more favorable, certain investment environment for investors and, quite interestingly, allowing “open access” to DFI credit support for private investors. Africa GreenCo aims to replicate the success of PTC India Limited. PTC was similarly established as a credit risk mitigating intermediary offtaker for private power project developers and served as the catalyst to develop the Indian subcontinent’s regional power sector trading market.
Green bonds are another alternative innovative method of raising funds domestically and internationally for projects that support environmentally-friendly and climate-focused projects.
The proceeds from green bonds are earmarked for environmentally-friendly projects. Moody’s, which launched a service aiming to standardize green bond issuances last year, predicted that green bond issuances in 2017 will reach a record US$206 billion, following an increase of 120 percent to US$93.4 billion in 2016.
In November 2016, the Morocco Agency for Solar Energy (Masen), a public-private venture established by Moroccan Law No. 57-09, issued Morocco’s first sovereign-guaranteed green bond to help finance three separate solar photovoltaic plants comprising the “NOOR PV 1” program. The proceeds of the 1.15 billion dirham (US$118 million) green bond will be used to fund two of the plants — the 80-megawatt NOOR Laâyoune and 20-megawatt NOOR Boujdour projects — and part of the cost of the third — the 70-megawatt NOOR Ouarzazate IV power plant. Additional funding in an amount of €60 million will be provided by German bank Kreditanstalt für Wiederaufbau (KfW) to cover the cost of the NOOR Ouarzazte IV project.
Last year, Masen signed a 20-year power purchase agreement with a consortium led by leading Saudi-based electricity company ACWA Power for the development and long-term operation of the three projects under a BOOT (build, own, operate and transfer) scheme. Masen will use the green bond proceeds to fund its obligations under the PPA.
In West Africa, Nigeria is gearing up to float a proposed N20 billion (US$64 million) sovereign green bond under the first tranche before the end of the first quarter of this year, the proceeds of which would fund a range of climate-related initiatives, including energy, transit and afforestation programs.
The challenge for African countries will be to attract enough funding through green bond issuances to meet project needs. The key will be to aggregate projects in order to create a more attractive value proposition to local and international investors.
DFIs, such as the World Bank, also issue green bonds. An innovative feature of these green bond issuances is that a host government can leverage a sponsor institution’s credit rating to issue a debt that is to be repaid through a loan to the host government. For example, the World Bank could issue a green bond to help finance an infrastructure project in an emerging market, Country X. Country X would then repay the World Bank on the bond. Country X would benefit from the higher credit rating derived from the World Bank’s financial standing, which in turn would result in cheaper capital than if Country X were to issue the bonds on its own. This model has been applied in World Bank’s green bond issuances. The diagram on this page shows how to leverage a sponsor institution’s credit rating through a green bond issuance.
Put-and-call option agreement
Yet another alternative innovative financial solution is the put-and-call option agreement (PCOA), which was first used in the 450-megawatt open-cycle gas-fired Azura-Edo project in Edo State, Nigeria, that reached financial close in 2015.
The PCOA establishes a direct contractual obligation between the host government and the project company. It in effect replaces a traditional sovereign guarantee or letter of support with a contingent real estate transaction. The PCOA provides both a “put” option in favor of the project company and a “call” option in favor of the Nigerian Finance Ministry, that are subject to certain conditions, which typically include the termination of the PPA after certain specified “trigger” events.
The “put” option, if exercised by the project company, requires the host government to purchase the plant or the assets of the project company by a date certain for a pre-agreed purchase price. Conversely, the “call” option is a discretionary right of the host government to require the project company and shareholders to sell the plant or the assets of the project company on a date certain for a defined purchase price, which may vary according to the circumstances (such as a seller default under the PPA) that triggered the government’s exercise of the call option.
The PCOA was key to the financing of the Azura-Edo project that is due to come online in 2018. In Azura, the federal government of Nigeria decided to adopt a PCOA structure rather than the traditional letter of support. The PCOA granted the government the option of purchasing the plant (or the project company’s shares) in the event of an early termination under the PPA after certain trigger events. This call option gave the government added comfort, in the event of an early termination under the PPA, by assuring the government that it would be able to recoup the physical assets of the project if certain conditions were met. The PCOA structure in Azura is now being considered in other projects across sub-Saharan Africa and beyond.