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Analysis > Analysis and Strategy

Turning the lights on in Africa

Jens Thomassen, Director, Denham Capital
June 9, 2015, midnight
736

Word count: 1925

“Powering Africa” has been a hot topic for the past few years. As the continent experiences increased urbanization and GDP growth it is still constrained by a lack of access to reliable, affordable electricity. Both conventional and renewable technologies offer cost effective complementary power solutions, but building this infrastructure requires a significant amount of capital. Despite the sheer need, many investors find their real obstacles are not financial, but finding the right projects and management teams to deliver these projects.

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“Powering Africa” has been a hot topic for the past few years. As the continent experiences increased urbanization and GDP growth it is still constrained by a lack of access to reliable, affordable electricity. Both conventional and renewable technologies offer cost effective complementary power solutions, but building this infrastructure requires a significant amount of capital. Despite the sheer need, many investors find their real obstacles are not financial, but finding the right projects and management teams to deliver these projects.

Opportunity abounds

The Sub-Saharan African economy has doubled since 2000, reaching $2.7trn in 2013, yet 610 million people (approximately two thirds of the continent’s total population) remain without access to electricity. To put this in context, electricity consumption per capita is, on average, less than that needed to power a 50-watt light bulb continuously. Economic growth rates vary by country within Sub-Saharan Africa, although many countries have sustained 5-6% growth rates for more than a decade. The continent’s population is also expected to triple by 2050.

Even for those fortunate enough to have access to power, it is often unreliable and daily power outages are the norm. The cost of such “load shedding” is equivalent to 2.1% of GDP, on average. The current cost of the available generated power is high as many consumers rely on private diesel generation to supply their own electricity at costs above $200/MWh (4-5 times the cost of wholesale power in the United States and Europe). There is an undeniable need for new power generation in Africa, with more than 470GW of new capacity needed from 2014-2040. When building power plants in Africa, it is important for sponsors and developers to select a generation technology that is not only cost effective, but also suits the region’s social and environmental needs. In some instances, domestic natural resources in regions with an urbanized population work well or where there is industrial activity, conventional technologies, such as natural gas, are the logical solution. However, where there is a need for a more rapid power solution or decentralized generation, renewables can be a better option.


Role of renewables

Africa benefits from some of the best renewable energy resources in the world. Average daily solar insolation values are 4.5–6.5 kWh/m2/day, higher than Spain, Italy and Australia. In addition, wind capacity factors exceed 45% in the best regions, compared to the global average of around 30%. Combine this with the impressive drop in production costs for solar (85% cost reduction for solar panels over the last decade) and improved efficiency of wind turbines (14% over the last decade) and you can see that renewables have not only reached grid parity, are actually the cheapest available solution inmany cases.

Renewables are also modular. They can be deployed close to load centers and can be sized to match the local demand, alleviating the need for long transmission lines, with the ability to be constructed off-grid (an important aspect for a continent where transmission grids are not fully developed in many regions). Renewable power plants also provide power very quickly to the grid. For example, a 50MW wind or solar project can be built in 6-12 months, whereas a large fossil fuel power station would take 2-4 years to complete. As a result, renewables are often determined as the best and most cost effective power solution.

Significant capital required

Significant private and public investment is required to successfully build out the continent’s new capacity needs. The World Energy Outlook estimates approximately $775bn of investment in power generation is required over the next 25 years with annual African infrastructure spending anticipated to grow by 10% over the next decade. Private sector investment in energy infrastructure is ever increasing, although much of the capital will be required from the public sector since project development is often largely dependent on national governments and Development Finance Institutions. Global public-private partnerships can further drive investment to bring power to the grid. One key example is the US’s Power Africa initiative. Launched in July 2013, Power Africa is expected to combine $7bn in US government financial support with $9bn in private sector commitments over five years to develop and construct 8GW of new power generation capacity across Sub-Saharan Africa.

Execution is the key to avoiding failure

The need for new power generation and the sheer quantum of capital needed to finance power projects are obvious. However, the African power market requires both development expertise and equity capital to be successful. Raising capital for a shovel-ready project to start construction is not easy, but it can be done and investor appetite for such projects exists. The biggest challenge facing the African power opportunity is bringing together sponsors willing to invest pre-construction development capitalwith a management team that’s qualified, has relevant experience and the local knowledge necessary to bring such projects to financial close and, ultimately, through to final construction. There are only a limited number of qualified sponsors and management teams who exist with the capability and capital to invest across the entire development phases.

Success Factors

What does it take to develop a power project in Africa? The same skills and attributes required to develop a power plant in Europe or the US. A developer needs to secure land, permits, access to grid and a reliable and creditworthy off-taker. Commercial lending is not often available, so the project must be developed to a standard where the Development Finance Institutions, such as IFC, African Development Bank or the European Development Finance Institutions will finance the project. The earlier stages of project development prior to obtaining a PPA or financing represent the highest risk of not moving forward, so staging capital and spending the first (and smallest) dollars on the biggest risk is critical. This is where the experience of the management team can make a huge difference, but it is also important for the developer to be backed by an investor who understands the risk and is willing to accept and manage it. Such individuals must understand how to properly stage capital throughout the different de-risking events in development (e.g. permits, interconnection, PPA) as well as be familiarwith the political landscape and cultural sensitivities. Pushing forward a project that doesn’t have support from all regional and national stakeholders, from the local community to the minister of energy, is likely to translate into a long and costly development period.

Once a project is bankable, the rigors of project finance must be met before any substantial project equity is invested. While many may assume the default rates for projects in Africa to be comparativelyhigh, a study by Moody’s notes that the 30-year (1983-2012) average default rate in US power projects was 10.3% compared to 5.6% outside the region. Further, the average default rate for African project finance loans was even lower, at merely 2.2%. In many cases, the “halo effect” carried by the US as aninvestment region results in transactions being more aggressively structured than similar deals in less-developed markets where generally more risk-averse debt financing is available. These numbers provide evidence that sound structure rather than location is a better indicator of credit strength.

The failures perceived by many actually relate to development projects that never fully reached financial close and/or were put together in a “high risk” fashion. What was lacking in most of the larger faileddevelopments was the presence of an experienced and well-capitalized team who understood how to properly stage its development costs. Not all power developments (in Africa, the U.S. or any market) will reach financial close, but a significant factor contributing to success is minimizing the amount of equity capital at risk prior to material de-risking events, such as attaining a bankable PPA.

Additionally, there are unique measures sponsors and management teams can take to mitigate risks in emerging markets. These include taking advantage of “government-to-government” support mechanisms from multi-lateral organizations and development finance institutions including: the World Bank/IFC and the Overseas Private Investment Corporation; evaluating contracts against international standards; and, where appropriate, having contracts backstopped by governmental multi-lateral organizations, development finance institutions and export credit agencies. Third-party entities provide a variety of products, including project debt and equity, political risk insurance and partial risk guarantees.

When the objective is to deliver the lowest cost power solution, it is important to be technology-agnostic. That said, there can be much overlap. Endeavor Energy and BioTherm Energy, Denham Capital's two African IPPs, are examples of management teams that bring world class experience to deliver cost-effective power solutions across sub-Saharan Africa in partnership with local companies.

New Companies Meeting the Challenge

Seeking to fill the gap of experienced, well capitalized power developers on the continent, Endeavor Energy focuses on thermal and hydro-power development. The company is led by a seasoned management team with first hand development of more than 30 power projects in 16 countries with a capital investment in excess of $4 billion. Endeavor brings its global expertise to the local markets, using its deep network to gain access to the best projects and partners. In May 2014, Endeavor and GE announced a joint venture to develop more than 1,000MW of natural gas fired power generation in Ghana, capitalizing on recent domestic natural gas discoveries. The project will be built in two phases, with the first phase expected to come online in 2019. The PPA for Phase 1 (750MW) of the project has been initialed and is scheduled to go to Parliament for approval. The company is also in late stage development of a 375MW gas-fired project in Cote d’lvoire, a 200MW hydro expansion in Sierra Leone and has a broader 3GW pipeline in various stages of development across Sub-Saharan Africa.

While there are challenges to be met, the track record of project-financed power plants on the continent highlights the benefits for both investors and the people of Africa - Jens ThomassenSouth Africa-based BioTherm Energy is focused on wind and solar project development across the continent. BioTherm is truly an “African developer,” developing projects in Africa by Africans. The company has gained a leading market position in South Africa through the government’s Renewable Energy Independent Power Program (REIPP) and first mover advantage in the rest of the continent. The team’s management has more than 100 years of international power experience, with proven success in developing, financing and operating projects to international standards. The company developed, built and now operates 2 solar PV and 1 wind projects, totaling 49MW, which it was awarded in 2011 as part of Round 1 of the REIPP. In the latest Round of the REIPP (Round 4), BioTherm was awarded another 2 solar and 1 wind projects, totaling 251MW, or 25% of the total allocation. The company is well positioned for future rounds in South Africa as the government already announced an expansion to the program as a result of its success to date and the country’s power need. More than 5.1GW of renewable energy have been awarded since a formal renewables auction program was launched in 2011, with the government targeting renewable capacity of 17.4GW by 2030. BioTherm’s success across the rest of the continent includes winning 75MW of projects in regions such as Burkina Faso, Mozambique and Zambia. It currently has a project pipeline in various stages of development across the continent in excess of 2GW.

Untapped Opportunity

While there are challenges to be met, the track record of project-financed power plants on the continent highlights the benefits for both investors and the people of Africa in building low-cost power solutions in a region with a fundamental need for new capacity combined with the discipline of project finance.

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