Contributing elements to success of IPPs in sub-Saharan Africa

Only about 30 percent of the Sub-Saharan population has access to electricity1. It has been estimated that about 7,000 megawatts (MW) need to be added each year (2005-2015) to meet suppressed demand and provide additional capacity in the region. Such an investment would cost approximately USD 40 billion per year (Eberhard et al, 2011) out of which USD 27 billion would be for capital investment2. This latter figure is equivalent to 6.35 percent of Africa's GDP. Presently, funding for electricity capital expenditure is estimated at USD 4.6 billion a year, of which public sources contribute about 50 per cent, highlighting the urgent need for increased private investment, including public-private partnerships. Across sub-Saharan Africa (SSA), the push towards private investment in electrical generation dates back to the early 1990s when multilateral and bilateral development institutions, which largely withdrew from funding state-owned projects, urged a number of countries to adopt plans to unbundle their power systems and introduce private participation and competition. Independent power producers (IPPs), namely, privately financed, greenfield generation, supported by non-recourse or limited recourse loans, with long-term power purchase agreements (PPA) with the state utility or another off-taker, became a priority within overall power sector reform. IPPs were considered a solution to persistent supply constraints, and could also potentially serve to benchmark state-owned supply and gradually introduce competition. Since the 1990s, approximately 30 such medium- to large-scale projects3 have taken root across 11 countries. In total, approximately 4.7 gigawatts of IPP capacity have been added (Eberhard, A., 2013). However, the journey has not been smooth. The larger power sector reform programs were not far-reaching and IPPs represent only a fraction of the sector. A suite of country level and project level factors have emerged as playing a critical role in determining project success. Chief among them are: the manner in which planning, procurement and contracting are coherently linked and the role of development finance institutions along with the development origins of firms and credit enhancements. There are a number of notable success stories, including in Kenya, South Africa, and potentially Nigeria, where policy innovations have replication potential in other sub-Saharan African countries and beyond.

Investment climate and clear regulation

IPP projects were developed in a challenging investment climate in a number of sub-Saharan countries. Less than a handful of African countries have investment grade ratings. So as to attract private investors, countries had to develop tax incentives. Currency conversion was also provided for virtually all projects. It is noteworthy, however, that although one would expect the investment incentives to drastically increase with the perceived risk (in contrast to other regions), such a pattern is not apparent. With demand for IPPs outweighing supply, it is not surprising that those countries with a better investment profile attracted more investors and ultimately were able to cement deals on terms more favorable to the host country. The key take-away is that a risk-reward balance needs to be offered to attract investors/lenders; that balance starts with a stable and predictable investment environment. New policy frameworks and clear regulation also proved to be key elements for sustainable development of IPPs. Although most countries have introduced legislation to allow for private generation, few have actually realized a clear and coherent policy framework. Besides, the incumbent state-owned utility continues to play a key role in the sector. IPPs are gradually being introduced but nowhere in Africa is the standard reform model for power sector reform being adopted fully, namely, unbundling of generation, transmission and distribution, and the introduction of competition and private sector participation at all levels (UN-ECA/UNEP, 2007; Malgas et al., 2007; Gratwick, K.N., Eberhard, A., 2008). However, nearly all countries which have started implementing reforms have established independent regulators, which are intended to address some of the risk that IPPs face such as arbitrary changes to rules or too much regulatory discretion in price reviews. Independent regulators also contribute to increasing overall transparency in what is expected from the investors. The presence of a regulator is not in itself a defining factor in attracting IPPs but helps ensure positive outcomes for host country and investor alike.

Linking planning, procurement and contracting

Intricately connected to sound policy frameworks are coherent power sector plans, which are linked to procurement and contracting. Ideally, these includes a number of core components: setting a reliability standard for energy security; completion of detailed supply and demand forecasts; a least-cost plan with alternative scenarios; clarifying how new generation production will be split between the private and public sectors; and the requisite bidding and procurement processes for new builds. Among the most important aspects of coherent power sector planning is vesting planning and procurement in one empowered agency to ensure that implementation takes place with minimal mishaps (Malgas, I., Eberhard, A., 2011). Kenya provides a good example of how responsibility for these functions may be allocated and institutionalized (see Box). However, all too often, plans do not translate into timely initiation of competitive bid processes for new plants; and often there is insufficient capacity to negotiate with winning bidders or to conclude sustainable contracts. Transaction advisers may be appointed, but often there is little continuity over the long term. Hybrid power markets, with a mixed presence of private and public sector players, give rise to these new challenges and explicit policies, governance and institutional arrangements need to be developed to assign responsibility for planning, procurement and contracting of new power generation capacity. Effective linkages between these three functions also need to be established. In evidence are examples of demand and supply not being accurately forecast due partly to extended droughts, which in turn necessitated fast-tracking IPPs. Generally, the speed has been at a cost. Although it is easy in hindsight to accuse stakeholders of acting imprudently in the face of emergencies, the actual conditions of load-shedding and shortages appear to have provided few alternatives (Eberhard et al., 2011)4. However, better organization and planning upstream could have limited such situations.

Appropriate fuel supply and power purchase agreements (PPA)

The availability of competitively priced fuel supplies has also emerged as a key factor in how IPPs are perceived, in large part because fuel is generally a pass-through cost to the utility and in many cases to the final consumer as well. IPPs have helped countries to achieve greater fuel diversification; however, when their costs were compared with state-owned, generally amortized hydropower, they were seen to be largely more expensive, due partly to the fuel charge. The public perception is that IPPs drive prices up, which means that gaining public support for such projects is all the more challenging. When IPPs use fuel that is cheaper than the incumbent fuel, they have a greater chance of success. The other key contract is the PPA. All the projects evaluated had long-term PPAs with the incumbent state-owned utility to secure revenue flows for debt and equity providers. The PPA has been a central document5 and in certain cases, it has been the focal point of the discussions when deals have been considered out of balance.

Favorable debt and equity arrangements

Foreign firms have been the dominant players in SSA's IPPs. This should not be surprising, given the limited capital available. But a more revealing aspect than the nationality of the firm appears to be its prior experience in a country and the development origin of the investor. Globeleq, IPS and Aldwych International, for example, all emerged from agencies with strong commitments to social and economic development. Globeleq remains wholly owned by Actis, which originated from the private-sector promotion arm of the UK Department for International Development (DFID). IPS is the operating arm of the Aga Khan Fund for Economic Development (AKFED), investing only in projects with a high development impact. Aldwych International is an initiative of the Dutch development bank, FMO. Projects for these firms have to make commercial sense, but they must also serve a developmental function, helpful in the face of African risk. It is worth noting that almost none of the projects with involvement of firms with development origins have seen any changes in contract terms, which may signal a greater perceived balance by local stakeholders in the terms of the contracts as well as a better ability to withstand public pressure. With debt financing often covering more than 70 per cent of total project costs, competitively-priced financing has also emerged as a key factor in successful projects. Possible approaches in the African cases lie in the involvement of development financial institutions (DFIs), credit enhancements, and some flexibility in terms and conditions that may allow for possible refinancing. The recipe for sustainability appears to be that the risk premium demanded by financiers or capped by the off-taker matches the actual country and project risks and is not inflated, viz., the investment and development outcomes are largely in balance. DFIs funding has tended to take longer to reach financial closure but it also brings clear benefits; among others, development institutions help maintain contracts and resist renegotiation in the face of external challenges such as Kenya's droughts when developers were pressured to reduce tariffs. The main drawback of foreign financing is that it is usually denominated in strong currencies, which imposes PPAs in the same currency with negative impacts on tariffs as local currencies devalue.

Credit enhancements and security arrangements

The underlying credit risk of the projects has been largely dealt with via a suite of credit enhancements such as escrow accounts, letters of comfort, partial or sovereign risk guarantees, political insurance, etc. Of the many different credit enhancements, it is sovereign guarantees that have been most commonly employed. Support from the government is still considered by developers and multilaterals as the first level of support (World Bank, 2010), even though, in no projects have the sovereign guarantees, political risk insurance (PRI) or partial risk guarantees (PRG) been invoked. Although the absence of sovereign guarantees usually hampers the ability to raise private finance, it is noteworthy that IPPs, which by their very definition imply private investment, have had such significant public involvement. On this, there has been very little evolution since the first set of IPPs, with all projects supported by a PPA and the credit risk largely carried by a government guarantee. In conclusion, it may be helpful to reflect on the overall application of security arrangements and credit enhancements. Efforts must continue to close the initial gap between investors and host-country governments' perceptions and treatment of risks, or contract unraveling will continue. The means of closing the gap may not be only, or mainly, via increasing the sort of new protections, including PRGs or PRIs, and may instead lie in systematic treatment of the numerous contributing elements to success.

1 As compared to one-half in South Asia and more than four-fifths in Latin America. 

2 The remainder is for operation and maintenance. 

3 This article deals with grid-connected projects, greater than 40 MW, with a long-term PPA with the utility, which have reached financial close and are under construction, operational, complete or concluded as of the end of 2Q2013. Although not included in this analysis, there are approximately 30 IPPs, each less than 40 MW, totaling 550 MW, also grid-connected, with long-term PPAs making a considerable contribution to the energy landscape across SSA. South Africa is also in the process of procuring 3.75 GW in renewable IPPs, over 3 tender rounds (with the first two rounds resulting in 2.5 GW), encompassing 47 discrete projects, totaling approximately USD 9 billion in investment, which represents Africa's largest renewable energy program, largest IPP development, and potentially, most complex public private procurement to date. Detailed discussion is, however, beyond the scope of this paper.

4 The cost of emergency supply is indeed still less than the cost of no power. In terms of assessing the overall impact, “the estimates of the value of lost load or, unserved energy, and power outages in the countries in Sub-Saharan Africa constitute an average of 2.1 percent of GDP”.

5 In addition to indicating who would buy the power, the PPA details how much power capacity would be available as well as capacity and energy charges. How plants will be dispatched, fuel metering, interconnection, insurance, force majeure, transfer, termination, change of legal provisions, refinancing arrangements and dispute resolution are generally all clearly laid out as well. Risk mitigation provisions in the PPA stipulate penalties when the plants do not produce, as well as the ultimate sanctions when the plants fail, together with buy-out provisions.

RÉFÉRENCES:

Eberhard, A., Rosnes, O., Shkaratan, M., and Haakon Vennemo, 2011. Africa's Power Infra- structure: Investment, Integration, Efficiency, The World Bank, Washington D.C. //

Eberhard, A., 2013. Feed-In Tariffs or Auctions, Procuring Renewable Energy Supply in South Africa, Viewpoint, The World Bank, Washington, D.C. //

Gratwick, K.N., Eberhard, A., 2008. Demise of the standard model for power sector reform and the emergence of hybrid power markets, Energy Policy 36. //

Gratwick, K.N., Eberhard, A., 2011. When the Power Comes, An analysis of IPPs in Africa. October 2011 and updated in July 2013. //

Malgas, I., Gratwick, K.N., Eberhard, A., 2007. Moroccan Independent Power Producers: African Pioneers. Journal of North African Studies 13 (1). //

Malgas, I., Eberhard, A., 2011. Hybrid Power Markets in Africa: Generation Planning, Procurement and Contracting Challenges. Energy Policy 39, forthcoming. //

UN-ECA/UNEP, 2007. Making Africa's power sector sustainable. An analysis of power sector reform in Africa. Addis Ababa, Ethiopia. September. //

World Bank, 2010. Personal communication, May 17 re: credit enhancements and security arrangements.