Private sector acquires a taste for African power

Private sector investment in Africa’s power sector is growing in leaps and bounds, as James Gavin reports

Over recent years, private investors have started to scale up their involvement in the sector. Power Africa, an initiative backed by USAID, has more than $54bn of commitments from its more than 140 private sector partners. Private sector engagement is on the rise, energised by initiatives such as the New Deal on Energy for Africa and the US-led Power Africa Initiative.

Recent years have seen private sector involvement grow in leaps and bounds, starting out from the generation sector and now migrating into transmission and distribution. Power Africa’s Beyond the Grid initiative has for example seen over 40 private sector partners involved in developing mini-grid and distributed power services and infrastructure in Sub-Saharan Africa’s rural and peri-urban populations.

At country level, outliers such as Kenya have aggressively sought out private investment in the generation sector, and are now pivoting this towards the transmission sector. Nairobi’s robust focus on reforms has paid off.

South Africa has also led the way in private power provision. “If you look back 10 years ago, there were under 60 independent power projects,” says Bhavtik Vallabhjee, Head of Power, Utilities and Infrastructure at South Africa’s ABSA Group. “Now we’ve had 112 IPPs, which has been a staggering success story for the country in terms of foreign direct investment. And every single project had a contribution from a foreign developer. That has injected in excess of R200bn [$11.9bn] into the economy.”

Growing need

The need for private investment will grow even more acute in light of the coronavirus pandemic’s impact on the continent. From the perspective of Africa Infrastructure Investment Managers (AIIM), which manages $1.9bn of investments in 19 countries across the continent, the outlook for investment remains nuanced and varied between countries.

“We’re certainly going to see governments that are highly leveraged, essentially struggling from a debt service perspective,” says Olusola Lawson, Investment Director at AIIM. “And these governments are going to need multilateral interventions to keep the wheels spinning. This obviously has a second order effect in terms of the energy space, because in several countries across Africa, energy value chains continue to struggle and the utilities are backed by the sovereign. So, we’re going to see an impact in terms of continued sovereign support to credit enhance electric utilities.”

However, Lawson says there will also be an increase in commercial offtakers looking for alternatives to existing utility supplied power as they look for more reliable power sources and governments relax regulations to allow for self-generation or off-grid solutions in the face of public funding constraints.

Although more space is being created for private funding, one of the impacts of Covid-19 is that banks are likely to become much more selective about opportunities they pursue, looking at them primarily from the perspective of capital gains that are now under pressure.

“What’s even more important than normal, when you look at a project finance transaction is the bankability as this is long-tenor limited recourse financing – the robustness of the project, the track record of the developer that is behind it and the quality of the EPC and O&M contractors behind it, amongst others,” says Vallabhjee. “Banks will certainly to be looking at the larger developers and those with a substantial balance sheet and a track record to be able to execute these projects.”

If African economies are to make the most of the opportunities, they will need to continue to double down on reform, as a World Bank report released in September 2019, Rethinking Power Sector Reform in the Developing World, notes. 

Although the absolute amount of private investment in new generation capacity in Sub-Saharan Africa was small, at $30bn, it nonetheless represents around 40% of the region’s investment needs. However, for other developing regions, says the Bank, the private investment share was somewhat higher, at 40–60%.

Structural impediments

The World Bank report highlights structural failings that have hindered a faster uptake of private investment. For example, even when power contracts have been awarded to the private sector, African countries have faced challenges with the completion of these contracts. Private sector contracts in the power distribution sector have been cancelled at a much higher rate in Africa than in the rest of the world.

These cancellation rates were highest for divestitures (more than 60%) and management contracts (more than 30%), and averaged 22% of all distribution transactions. Most cancellations were initiated by governments or by the departure of private operators due to dissatisfaction over contractual terms.

The continent’s experience with utility management contracts in particular has been patchy, with an inability to recruit and train qualified managers and generally poor labour relations.

Private sector investors will therefore want to see continued focus on developing and deepening the wider investment framework. The one thing that investors fear is an uncertain operating environment.

And here at least, there is some progress. Some of the region’s multi­lateral institutions are providing assistance in fleshing out the investment framework. The African Development Bank (AfDB) has launched its Facility for Energy Inclusion to close funding gaps in the small-scale energy infrastructure sector and catalyse last-mile energy access. Through a mix of commercial and concessional instruments, the facility provides low cost of capital, and mitigates key credit and currency risks.

The AfDB established in 2018 the Africa Energy Market Place (AEMP) as a platform for public-private dialogue, specifically to address barriers to mobilising and scaling up private investment into the energy sector. It reviews and prioritises transformative energy transactions, and accelerates reforms in order to attract private investments and create a pipeline of bankable projects.

Similarly, the World Bank’s Multilateral Investment Guarantee Agency (MIGA) has helped support Egypt’s government to introduce feed-in tariffs for renewable energy projects, enabling the country’s first wind farms around the Red Sea and solar parks in the desert to get off the ground. The Benban solar park now comprises dozens of private sector investors.

There are a number of guarantees already in place to support private investment in regional power projects. For example, many African IPPs enjoy take or pay clauses that guarantee the  purchase of power even in the absence of demand.

The European Investment Bank (EIB) has provided innovative structures like the Africa Energy Guarantee Facility, whereby it supports a leading reinsurer to boost its investment insurance capacity for private financiers of sustainable energy projects, while improving local insurer capacity to serve the energy sector with technical assistance. In this structure, a mezzanine portfolio guarantee of up to $50m allows Munich Re, the reinsurance provider, to offer up to $1bn in reinsurance exposure for local investment insurers.

Hedging against risks

According to the EIB, energy projects in Sub-Saharan Africa often face high real or perceived public counterparty risks that deter private sector investments. Insurance offers a way to hedge against such risks, making investments more attractive. The Africa Energy Guarantee Facility is an attempt to respond to this gap, as a form of guarantee initiative, and is expected to play a catalytic role in unlocking private sector investment. The EIB says it has been critical in attracting other partners and is on track to catalyse up to $1bn in reinsurance capacity to support the financing of green energy projects.

The African Trade Insurance Agency (ATI), a pan-African institution that provides risk mitigation solutions to companies, investors and lenders interested in doing business in Africa, is also doing its bit to help energy schemes attract investment.

“In the power sector we have built up capacity over the last few years largely in partnership with European DFIs such as EIB and KfW, offering our traditional political risk insurance for the benefit of equity and debt in projects as well as liquidity cover,” says Obbie.

Obbie says liquidity cover is a key requirement for investors looking at power projects in Africa, while PRI is also an essential component.

“Most on-grid power projects are structured in a way that they will exclusively deliver power to a state-owned utility. But most power utilities don’t have great credit profiles, so providing liquidity cover allows us to bridge that gap and cover some of the risk of non-payment.”

There is growing appetite for insurance products, with a major drive by investors looking to invest in power projects across the continent, including in renewables. Yet while markets such as Kenya, South Africa and Uganda have been operating IPPs for a long period, others are less developed and need insurance products to help render these projects more bankable (see case study opposite).

Countries with the most ambitious climate plans explicitly see an enhanced role for the private sector. For example, this year Rwanda submitted an ambitious 10-year climate action plan to the UN that requires an overall investment of $11bn to reduce the country’s carbon emissions and adapt to climate change.

The mismatch between supply and demand has been a running theme in Africa for a while. The story is more nuanced in some markets where there is oversupply – Ghana is an example here – or where there are significant long-running deficits such as Nigeria, where supply to the grid has peaked at around 4 GW.

“This is one of the markets which is structurally undersupplied, but that’s not a uniform story across the continent,” says Lawson. “There’s been just one new IPP project finance deal closed in Nigeria in the last 20 years so there hasn’t been a huge inflow of international capital into the power sector.”

Investors are attracted to a track record of settling bills and invoices on time. I would say that on the back of Covid-19 and the ensuing sovereign fiscal crises, the long-term trend in certain markets will continue to move towards distributed models and captive commercial/industrial solutions, and potentially away from on-grid projects where reliance needs to be placed on multilateral instruments and guarantees. “In certain large markets in Africa today, these are often the projects with the greater line of sight to sustainable cashflows,” says Lawson.

The key question facing financiers is how to get wider savings pools, pension funds, insurance companies, government bonds and other securities, into the power space. Those conversations will need to continue. In most markets, the current trend is for a migration of cash into the captive space.

Investing for the long term

Above all, patience will be key as investors scout the continent for energy investment opportunities. According to Lisa Pinsley, Director of Energy at Actis, the Africa power sector continues to prove a solid investment: “The fundamentals are strong, as there’s clearly a huge demand for new power generation capacity. Africans need more power – cheap power – to grow their economies. But energy deals are complex and take time to complete. Some people come in starry-eyed seeing the unmet demand, thinking they’re going to do deal after deal. It’s not like that. An investor needs savviness and on the ground presence to know how and where to spend time and money.”

The positive development is that groups such as Actis attract investors like pension funds and sovereign wealth funds that may until recently have been sceptical of Africa. “African energy investments are good, long-term stable investments that make strong returns, not such outsize returns that hurt local economies, but better returns than you find in Western markets. They’re highly structured deals, as you have to mitigate risk by bringing in multilateral organisations around the project, and while this provides investment stability, it does also mean it takes time to complete them,” says Pinsley. 

Case study: ATI renewable energy facility backs Burundi’s largest private investment

In January 2020, the African Trade Insurance Agency (ATI), in partnership with Gigawatt Global, announced the launch of the first energy project under its Regional Liquidity Support Facility (RLSF). The project is the first private grid-connected solar field in Burundi and the country’s first permanent power station in three decades. It will provide electricity to 87,000 people and businesses in a community where less than 5% of the population has access to reliable and clean energy.

ATI provided an innovative solution to cover the project’s payment risk in support of partners that included the UK government-funded Renewable Energy Performance Platform, the United States International Development Finance Corporation and the Inspired Evolution II Fund.

The 7.5 MW solar project will add nearly 15% to Burundi’s total energy generation capacity. It will provide electricity to 87,000 people and businesses, making a significant dent in the country’s energy deficit.

In addition to the positive impact on the climate, this project will also demonstrate that green energy is a bankable proposition.

The RLSF has an initial capacity of €63.2m ($73.1m) and it supports small and mid-scale renewable energy projects with an installed capacity of up to 50 MW (and in exceptional cases up to 100 MW) by protecting the developers against the risk of delayed payments by public offtakers to ensure more projects reach financial close.

The facility can be accessed by IPPs located in countries that sign on to the RLSF Memorandum of Understanding (MoU). To date, seven countries have done so – Benin, Burundi, Côte d’Ivoire, Madagascar, Malawi, Uganda and Zambia, with several others in the pipeline including Ethiopia and Ghana. ATI is actively encouraging other countries to sign on as a way of providing more cost-effective and clean energy solutions.

“The RLSF addresses the issue of non-payment risk for power utilities,” says Obbie Banda, Underwriter at the ATI. “We offer this product in a number of member countries that have signed an MoU with us. A good example of the value of RLSF is in Burundi where we recently supported our first project under the facility. The country has low installed capacity and by partnering with the developer, Gigawatt Global, and mitigating some of the concerns that the developer and its lenders had, we as an institution were able to help that project reach financial close.”

John Lentaigne, CEO of ATI, said the RLSF enables countries to attract quality IPPs, who are in turn able to efficiently implement renewable energy projects in their countries. “This solar-project in Burundi is the first of what we expect to be many more green projects in our countries that will benefit from ATI’s de-risking solutions.”

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