Financing Electricity Generation in Africa


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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.

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Financing Electricity Generation in Africa

  1. 1. Financing Electricity Generation in Africa Subtitle: The risks and realityBy Frost & Sullivan’s Energy and Power Systems Research Analyst, Rob SmithJust under half of Africa’s population of a billion people is entirely without access to electricity. Thisportion rises to an incredible 92% in rural populated areas. Flicking a light switch is taken for grantedby the developed world, while it is a luxury in many African countries. Demand appears to heavilyoutweigh supply across most of the African continent.The barrier to the expansion of electrification is, unfortunately, more complicated than simply anuntapped market. The real question is how many people in Africa can afford the costs associated withbasic electricity consumption? This challenge is unique to the developing world, and developingcountries 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 theeconomies afford to pay the interest on the debt that will be needed to build the infrastructure? Arethere 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 sufficientdemand will exist to fund plant construction, and that sufficient electricity is available to supportindustrial and economic growth. Further challenges that many African countries face include (amongstothers) politics, nepotism and corruption. Importantly, Africa is a continent of fifty four independentcountries, three disputed territories and eight international dependency states. And apart from severalmultinational trade agreements, each region is an entirely new prospect.The Complications of Mega-Project InvestmentsPower plants are hugely capital intensive, with construction costs (in 2011/2012) running in anapproximate range of $1.5 million to $7 million per megawatt constructed, depending on thetechnology 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. Thereality in Africa is that most financial institutions, let alone individuals, simply do not have a large orstrong enough balance sheet, or pool of funds, to absorb the risk associated with the enormousquantities of money required to finance power projects.Investment ParticipationThese 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 thirtysubcontractors supplying specialist services, each of which will have a unique contract structure andrisks. 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 tohave in-depth experience of all the variables and risks. Generally, the only organisations that have thehuman capital and financial resources to get involved have typically been large international
  2. 2. commercial banks, development finance organisations (DFIs) and national agencies. This leaves verylittle room for private investors.Lower risk usually means lower costs. Loans for large scale infrastructure projects are thereforesyndicated, 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 financeinstitutions (DFIs) also helps to reduce risk to financiers and, thus the cost of borrowing. Without suchstructures, many projects would never pass the feasibility phase.One of the few areas for private participation, or indeed for participation backed by a smaller balancesheet, can be found with independent power producer companies (IPPs). In some cases theseorganisations form collective investment schemes to allow private individuals to participate. Thepotential for such investments depends largely on power purchase agreements (PPAs) with nationalgrids or other electricity buyers (or off-takers). Developments in this regard have been very slow untilrecently and, as a result, private power makes up a very small portion of the African continent’sgeneration capacity.Participation in ImplementationEquity 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 companiesthat typically participate in the equity portion are the sponsors (sometimes IPP), developers or largescale Engineering, Procurement and Construction (EPC) companies.Most African utilities are state owned or directly influenced by government; however a general trendacross 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 forproject development.The size of EPC contracts, the financial capacity, and skills required to manage those contractseffectively prevents domestic firms from winning tenders for large scale projects. As domestic firmsgrow 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 normallydrawn from international sources, although local industries do participate in subcontracted work .Also,as governments acknowledge the importance of domestic development, policies such as localisationof content become more effective.At a minimum, local industries could expect to benefit via the supply of equipment and materials. Inmany cases, however, the support of export credit agencies ensures the procurement of products orservices from foreign countries. This is especially true for more complex equipment. This means thatfor the majority of African infrastructure projects, contract revenues are largely expropriated, anddepending 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 makingpowers has often led to mismanagement. This dire situation has left many countries with nationalinfrastructure in a state of disrepair, such as many South African Municipal systems, or dysfunctional.The Silver Lining
  3. 3. There is real potential for positive growth and development, and Africa as a continent is richlyendowed with mineral wealth. African countries have the chance to fast track learning, and developlocal 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 skillswhen fulfilling on a project contract.A major step in this direction has already taken place, where throughout Africa the trend is currentlytowards stabilisation of public private partnerships. In support of this, recent hydrocarbon discoveriesoff the East and Southern African coasts, as well as on land in East Africa, could provide a financialplatform 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 ofsuch 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 structureswill, however, take time to implement. The Kribi Power Development Company in Cameroon, throughthe cooperation of government, long term policy, technology selection and private capacity, wererecently successful in securing the first IDA partial risk guarantee for a local bank debt tranche indomestic currency.As local construction and EPC companies grow, their level of participation grows accordingly. TheAfrican 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, TataPower, YTL and Power, Aldwych International. Their alliances with leading international legal,advisory and financing agencies significantly enhance the ability of the multinational companies to wintenders. This, however, does not exclude domestic companies, but rather emphasises the need fordomestic 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 Africanbanks Standard Bank, Barclays ABSA, Nedbank, and Rand Merchant Bank have developed internaladvisory 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 bydevelopments in the South African REBID program.Some ExpectationsEnergy 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 aheadof newer renewable energy sources, where commercial viability and commercial scale technologystability are not as well understood. Notable recent exceptions include the South African andMoroccan renewable energy programs.Rising fossil fuel prices, and the reduced costs of installing and operating renewables, may bringrenewables closer to parity. The dollar per kilowatt cost of electricity generation from renewables isconstantly approaching that available from fossil fuels, and mechanisms that account for the negativeexternalities of fossil fuel consumption, such as carbon taxes, will bring the costs closer yet. As aresult, renewable power generation plants are certainly becoming more attractive from an investmentperspective. Unfortunately, higher prices of electricity and fossil fuels may have negative inflationaryimplications for economic development.
  4. 4. Regardless of the technology or financing methods utilised, electricity sales prices must reflect thelong run operation, maintenance and development costs, as well as account for capital requirementsto cater for growth in electricity demand from the consumer market. Without the stability that long runcost reflective revenues bring to electrical markets, sustainable development is seriouslycompromised. Fortunately, current policy developments (such as recent PPP legislature in Kenya)and recent PPA agreement, developments speak to an introduction of commercial feasibility and areduction in political exploitation of infrastructural development.The capacity for skills development and retention is different, depending on many country specificfactors. One thing that is certain is that a lack of technically skilled and capable personnel is heavilydetrimental to long term sustainability of development. We can only hope that governments willapproach the issue with the necessary sobriety.ConclusionThe 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 economiccapabilities. The levels of EPC skill and technical capability are constantly increasing, and aseconomies develop, the availability of funding from domestic sources is simultaneously increasing. Inthe interests of sustainability the transfer of experience, skills and education will be vital goingforward.Some requirements that have been identified include the ability of the population / industry to pay therelevant energy tariffs, the eradication of corruption, and the introduction of stability to legal systemsand national energy policies.Regardless of the technologies or methods utilised, the availability of finance is rarely a majorproblem. Feasibility, long term viability and expected returns depend on a vast number of idiosyncraticconditions and requirements. Successful investment is thus reliant on the ability to identify andunderstand 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. Infrastructureprojects are long term in nature and, for each nation, the precarious balancing act of energydevelopment will necessarily be a part of a much broader and infinitely more complex developmentprocess. This is a process where social, economic, political, institutional and environmental systemsmust develop simultaneously.Those who can afford to absorb the risk will be able to participate and undoubtedly many projects willfail. For those that manage, and time the development of projects correctly, success is analogouslyhigher, and the potential revenues are as impressive as the capital costs of the projects. There arehowever, no guarantees of success.Contact:Samantha JamesCorporate Communications – AfricaP: +27 21 680 3574F: +27 21 680 3296E: samantha.james@frost.com