Power project financing: The way forward for IPPs

While public and utility financing has traditionally been the largest source of investment in power generation in sub-Saharan Africa, independent power projects are now growing rapidly. In this article, the World Bank highlights the challenges that policymakers are facing and also the underlying factors that contribute to healthy investment climates

Renewables make up 18 per cent of sub-Saharan Africa’s independent power projects

Credit: Globaleq

The track record of sub-Saharan Africa‘s power sector is dismal. Two out of three households in sub-Saharan Africa, close to 600 million people, have no electricity connection.

Most countries in the region have pitifully low access rates, including rural areas that are the world’s most underserved. In some countries, less than 5 per cent of the rural population has access to electricity.

Chronic power shortages are a primary reason. The region simply does not generate enough electricity. The Republic of Korea alone generates as much electricity as all of sub-Saharan Africa. Across the region, per capita installed generation capacity is barely one-tenth that of Latin America.

The need for large investments in power generation capacity is obvious, especially in the face of robust economic growth on the continent, which has been the key driver of electricity demand over the last decade. The International Energy Agency predicts that the demand for electricity in sub-Saharan Africa will increase at a compound average annual growth rate of 4.6 per cent, and by 2030 it will be more than double the current electricity production.

The World Bank estimated in 2011 that sub-Saharan Africa needed to add approximately 8 GW of new generation capacity each year through 2015. But, in fact, over the last decade an average of only 1-2 GW has been added annually.

The cost of addressing the needs of sub-Saharan Africa’s power sector has been estimated at $40.8 billion a year, which is equivalent to 6.35 per cent of Africa’s gross domestic product. The existing funding is far below what is needed. This large funding gap cannot be bridged by the public sector alone. Private participation is critical.

Historically, most private sector financing has been channelled through independent power projects (IPPs). IPPs are defined as power projects that mainly are privately developed, constructed, operated, and owned; have a significant proportion of private finance; and have long-term power purchase agreements (PPAs) with a utility or another off-taker.

Like any other private investment, IPPs will not materialize in the absence of a suitable enabling environment.

Between 1990 and 2013, investments in new power generation capacity totalled approximately $45.6 billion ($31.3 billion, excluding South Africa), or far below what is required to meet Africa’s growth and development aspirations

Although public utilities have historically been the major sources of funding for new power generation capacity, that trend is changing. Most African governments are unable to fund their power needs, and most utilities do not have investment-grade ratings and so cannot raise sufficient debt at affordable rates.

Official development assistance (ODA) and development finance institutions (DFIs) have only partially filled the funding gap. ODA and concessional funding has fluctuated considerably over the past two decades and has recently been overshadowed by IPP and Chinese-supported investment.

Indeed, private investments in IPPs and Chineseà‚ funding are now the fastest-growing sources of finance for Africa’s power sector.

IPPs in sub-Saharan Africa date to 1994. Representing a minority of total generation capacity, IPPs have mainly complemented incumbent state-owned utilities.

Eskom’s 749 MW Medupi coal-fired power plant in South Africa

Credit: Ovivo

Nevertheless, IPPs are an important source of new investment in the power sector in a number of African countries.

IPPs are now present in 18 sub-Saharan countries – all with varying degrees of sector reform and private participation. Currently, 59 projects (greater than 5 MW) are in countries other than South Africa, totalling $11.1 million in investments and 6.8 GW of installed generation capacity. Including South Africa adds 67 more IPPs, bringing the total to 126, with an overall installed capacity of 11 GW and investments of $25.6 billion.

IPPs in sub-Saharan Africa range in size from a few megawatts to around 600 MW. The overwhelming majority of IPP capacity (82 per cent) is thermal; only 18 per cent is fuelled by renewables. However, there is important growth in renewables. For example, three windà‚ projects reached financial close between 2010 and 2014, and seven small hydropowerà‚ projects are on the horizon. South Africa procured 3.9 GW in private power between 2012 and 2014, all of which is renewable.

There have been three major IPP investment spikes: 1999-2002, 2008, and 2011-2014. The first two spikes were due to the financial close of a small number of comparatively large projects. In 2011, IPP investments began taking off. Excluding South Africa, total IPP investment for projects in sub-Saharan Africa between 1990 and 2013 was $8.7 billion, whereas in 2014 alone another $2.3 billion was added. Previously, IPP investments in South Africa had lagged those in other sub-Saharan countries, but between 2012 and 2014 that country closed $14 billion in renewable energy IPPs.

Although the conditions were varied in the countries where IPPs and other private participation took root, certain themes were common. With the exception of South Africa and Mauritius, none of the sub-Saharan African countries with IPPs had an investment-grade rating. The possibility of a traditional project-financed IPP deal in this climate was limited. DFIs that invest in the private sector have made a significant contribution to funding.

Chinese funding

In addition to IPPs, significant increases in generation capacity have stemmed from Chinese-funded projects. Chinese-funded generation projects can be found in 19 countries in sub-Saharan Africa. Eight of these countries have IPPs as well as Chinese-funded projects.

Between 1990 and 2014, there were 34 such projects in sub-Saharan Africa, totalling 7.5 GW. Chinese-funded projects far exceed IPPs in terms of total megawatts, especially for the years 2010-14, with an average size of 226 MW, in contrast to the IPP average of 98 MW.

As of 2014, Chinese-funded projects exceeded IPPs in total megawatts and in total dollars invested. The majority of Chinese-funded projects are large hydropower projects, for which Chinese engineering, procurement, and construction contractors have become renowned worldwide. The typical project structure involves a contractor plus a financing contract. The majority of these projects received funding from the China ExIm Bank (responsible for soft loans and export credit) on behalf of the Chinese government.

Additional finance has been provided by other banks owned in whole or part by the Chinese government.

Independent regulation

By definition, IPPs are investment transactions regulated by the underlying contracts.

Regulations at the sector level, although they do not directly influence the details of these contracts, are important in defining the rules of the game and ultimately shaping the enabling environment for IPPs.

The establishment of independent regulators has been the most widespread power sector reform element in sub-Saharan Africa. As of 2014, more than half of all sub-Saharan African countries had established such agencies, and the countries with the most IPPs all have electricity regulators. The mere presence of such an agency, however, is not sufficient. The quality of regulation is critical.

Transparent, fair and accountable regulators that produce credible and predictable regulatory decisions are necessary for creating the certainty around market access, tariffs, and revenues that encourages investment. Ideally, an independent regulator should enforce best practices in investment transactions and notably competitive procurement. In sub-Saharan Africa, the presence of a regulator is not necessarily associated with more competitive procurement practices, and regulators have not always ensured that captive electricity consumers benefit from the pass-through of competitive generation prices.

The independence of regulators may be compromised by overreaching and competing government agencies. In many countries, the independence and professional capacity of regulators need to be strengthened so that they can discourage directly negotiated generation contracts and instead enforce the rules for the competitive procurement of IPPs.

IPPs: Types and outcomes

IPPs differ in their ownership and financing structures, in technology choices and risk profiles, in how they are procured and contracted, and in risk mitigation mechanisms.

South Africa has embarked on the most ambitious renewable energy IPP programme, which will soon be followed by thermal IPPs. Nigeria is undergoing the most extensive power sector reforms on the continent. Although other countries may not be able to replicate the experiences of these two major economies, many lessons from them can be adapted and applied. Tanzania and Kenya provide a fascinating opportunity to contrast the experiences and outcomes of solicited versus unsolicited bids.

Tanzania is also about to start more ambitious reforms and will expand its gas-to-power investments, while Kenya is encouraging a diversified set of power investments, including in renewable energy. Uganda has overhauled its electricity supply industry and has numerous small IPPs and the largest hydropower IPP in sub-Saharan Africa.

There has been a wide variety of African IPP sponsors and debt providers. State institutions have invested in some IPPs, but private sponsors are prominent, including private African partners, European entities such as Globeleq, Aldwych and Wärtsilä, and numerous European bilateral DFIs. A smaller number of sponsors are from North America, Asia, and the Middle East.à‚ A few multilateral agencies also hold some equity.

In addition to equity investments, DFIs are prominent in the debt financing of IPPs. The African reality is one in which most IPPs carry substantial risks.

Without DFI financing, key projects would not have reached financial close and commercial operation. DFIs have also reduced the chances of investments and contracts unravelling – in part because of rigourous due diligence practices, but also because of the pressure governments or multilateral institutions might bring to bear around honouring investment contracts.

Technology options

The last decade has witnessed a revolution in renewable energy technologies such as wind and solarà‚ energy, especially in the past five years as costs have fallen and efficiencies improved. The same has generally not occurred in fuel-to-power plants.

Accordingly, for IPPs in the sub-Saharan African power sector, grid-connected renewable energy is gaining traction.

The most dramatic example has been South Africa’s recent large Renewable Energy Independent Power Project Procurement Programme (REIPPPP).

Grid-connected wind and solar in South Africa is now among the cheapest in the world

Credit: Mott MacDonald

Grid-connected wind and solar renewable energy in South Africa is now among the cheapest in the world. Outside South Africa, the wind story has been centred around a few projects in Kenya, which are marginally more expensive than Kenya’s private geothermalà‚ capacity but beat any of the country’s existing thermal plants on price.

Because both solar- and wind-based generation entail higher up-front costs and different risk profiles than those of traditional technologies, countries interested in renewables have experimented with methods to incentivize private investment.

Until recently, the most widely adopted procurement strategy for attracting renewable energy IPPs involved feed-in tariffs (FiTs), which have primarily been promoted by European bilateral aid programs. FiTs are beginning to face criticism, however, because prices have not come down as fast as those associated with competitive tenders. In Africa, the experience with this instrument has been disappointing, and relatively few projects have materialized.

However, two solar projects have been developed in Uganda under the global energy transfer feed-in tariff (GETFiT) programme. This programme was designed as a temporary facility to stimulate the small-scale renewable energy market, initially through a premium payment but also through firming up the contractual framework, providing investors with confidence, and extending institutional assistance to the host government. By early 2015, GETFiT had confirmed support for 15 projects with a total of 128 MW capacity.

Although the results achieved to date in Uganda are less impressive than those in South Africa, these projects are still cheaper than the imported fuel-to-power alternative in Uganda.

Independent power projects make a significant contribution to meeting Africa’s power needs. There is no doubt that IPPs are worth the effort. But it is not only the quantum of private investment in IPPs that is relevant; equally important are investment outcomes and, especially, the price and reliability of the electricity produced. The challenge ahead is for African countries to create the conditions to attract more and better IPPs and thus help overcome the continent’s power deficit.

About the authors:

Anton Eberhard is a professor at the University of Cape Town’s Graduate School of Business in South Africa. In his research and teaching, he focuses on the restructuring and regulation of the electricity sector, investment challenges, and links to sustainable development.

Katharine Gratwick is an independent energy consultant based in Houston, Texas. Her area of research is largely independent power projects across sub-Saharan Africa.

Elvira Morella is a senior energy specialist in the Global Energy and Extractives Practice at the World Bank, where she leads energy sector investment operations and major analytical work in the sub-Saharan region.

Pedro Antmann is a lead energy specialist at the World Bank, working in the areas of institutional restructuring, regulation, tariffs, and management of utilities, including incorporation of information technology applications.

Eberhard, Anton, Katharine Gratwick, Elvira Morella, and Pedro Antmann. 2016. Independent Power Projects in Sub-Saharan Africa: Lessons from Five Key Countries. Directions in Development. Washington, DC: World Bank. doi:10.1596/978-1-4648-0800-5. License: Creative Commons Attribution CC BY 3.0 IGO

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