The finance behind SA’s renewable energy development

By Janice Roberts, Deputy Editor of Intellidex Media Projects

Private sector appetite to finance South Africa's commitment to a future of net zero emissions is robust, despite the long delay between bid windows 4 and 5 of the Renewable Energy Independent Power Producer Procurement Programme.

Due to its transparency and efficiency as well as its government-backed power purchase agreements, South Africa's renewable energy programme (REIPPPP) continues to attract high levels of private funding and investment from commercial banks, development finance institutions and pension and insurance funds. Committed investments stood at R209.7bn, consisting of both debt and equity, after REIPPPP bid windows 1, 2, 3, 3.5, 4 and small bid windows 1 and 2, according to the Independent Power Producers Office (IPPO). This included R41.8bn from outside SA, improving the country's balance of payments. The 25 preferred bidders for bid window 5 were announced in October 2021, with the private sector collectively injecting about another R50bn into the economy.

Data from the IPP Office show that more equity has been put into bid window 5 than the last four bid windows, The debt margin is 2.5% on average, while the average internal rate of return (IRR) has come down from 17.27% in bid window 4 to 11.35% in bid window 5. The bid window sought to procure 2,600MW which includes 1,600MW from onshore wind and 1,000MW from Solar PV plants. A total of 102 bids were submitted with capacity of 9,644MW, making round five extremely competitive. Bid window 5 opened over six years after the previous bid window, yet investors remained interested, mainly because investments in REIPPPP are viewed as stable and predictable. "We've seen continued growth in appetite and interest from investors and sponsors alongside increased pressure to invest and fund renewable projects in line with climate change objectives," says Rentia van Tonder, Head: Power, Corporate & Investment Banking at Standard Bank.

The downward trend of the costs of renewable technology has led to a competitor driven decline in the tariffs bid in each bid window, with pressure being put on lenders to bring down the cost of finance. The average cost of renewable energy projects in bid window 5 is RO.473/kWh compared with the R3.12/kWh of bid window 1. "Bid window 5 featured some of the most competitive bidding between banks that I've ever seen," says Daniel Zinman: head of power and renewables in RMB's infrastructure sector solutions team. "It wouldn't be unfair to say that it was cut-throat — it was almost a race to the bottom." He says bid window 5 having been nearly four times oversubscribed illustrates the pent-up demand in the market. That in itself created such competition that equity returns and debt prices plummeted. Each aspect of these projects has been cut to the bone to the extent that South African renewable energy prices, while not necessarily at the absolute lowest in the world, are getting into that sort of realm."

Yet banks aren't losing interest in financing renewable energy, says Peter van Kerckhoven, co-head: debt finance at Nedbank CIB. "Through the rounds there's been more and more competition that's been driven by the success of the programme and the fact that the projects themselves have been relatively successful in terms of their completion and their operation. But at the same time, it's an efficient market. So, banks, including Nedbank, will bid terms that work for them and that are acceptable to them from a risk and pricing perspective. The market will settle at a certain level — you'll never have a situation whereby banks will step away and there'll no longer be REIPPPP financing, because an equilibrium will be reached in every round." Theuns Ehlers, Head of Resource & Project Finance at Absa Corporate and Investment Banking, agrees that debt funding terms have indeed become more competitive in bid window 5 than in prior rounds. "Demand from institutional investors to participate in green energy projects remains strong, which means that the bank's appetite to continue with its strategy to arrange, underwrite and distribute debt in the market is justified," he says.

Now that bid window 5's IRR stands at just 11.35%, some investors could be asking themselves if they're comfortable with the lower equity return given the illiquidity of these investments. Semple is expecting a consolidation in the sector in terms of the bigger developers and sponsor groups being more successful and dominating future REIPPPP bid windows. "In fact, we probably won't see the smaller developers that have participated in previous rounds actually winning again, because of the pressure on margins and on financial returns."

But investors remain satisfied that they have been provided with an adequate return on a risk-adjusted basis, says Vuyo Ntoi, Co-Managing Director of African Infrastructure Investment Managers (AIIM). "All the projects we've participated in pass muster from a risk-adjusted basis. We're still very happy with all the projects we've done in the REIPPPP, including the projects we are associated with in bid window 5," he says. Furthermore, there are potential scale benefits that are coming through from the existing fleet of projects that are already on the grid. Ntoi explains that AllM manages its renewable energy assets through Environmental Impact Management Services (EIMS) Africa, a company owned by the AllM IDEAS Fund. "This means that we're able to reduce overall project costs because we're splitting management activities over a wider set of projects. It's beneficial to the projects, to us and to end users because the economies of scale are recognised throughout the value chain and show up in the end tariff." There are nine projects under EIMS' management and work is being done to bring more on board in the near term. A large part of the success of the REIPPPP has been the sovereign guarantees that Treasury provides, but talks are under way on possible replacements.

"The IPPO has appointed consultants to investigate and research alternative options and there have been discussions with lenders and various stakeholders," Van Tonder says. "The key consideration will be the bankability of the offtaker and alternative structures and options that could be considered to provide comfort to stakeholders, including funders." Zinman believes there are both internal and external options around these sovereign guarantees. "An external alternative may involve agreeing some sort of credit enhancement with one of the political risk insurance providers or multilaterals like the World Bank or one of its agencies." While this could add complexity to the REIPPPP process, he doesn't view this as an insurmountable problem as RMB has done a significant number of deals in other jurisdictions where the sovereign's obligations are guaranteed by a political risk insurance provider. Paul Semple, head:unlisted credit at asset manager Futuregrowth and portfolio manager of the Power Debt Fund, emphasises that guarantees have been necessary to date in view of Eskom's weak balance sheet and heightened credit risk. "That's been the only requirement for those sovereign guarantees. It's not a reflection of the quality of the REIPPPP projects themselves or their credit risk, but rather the risk of Eskom not meeting its contractual obligations to these projects, to buy the electricity they produce and effectively underpin the cash flow generation of the projects. And because the REIPPPP is structured to only allow one power offtaker, which is Eskom, projects are inherently exposed to Eskom risk, but this is mitigated by the sovereign guarantee."

Without a guarantee, Semple believes there will have to be some changes to the structure of the REIPPPP, such as Eskom not being the only power offtaker to which projects can sell. This will mitigate the risk of the power utility failing to meet its commitments, thereby falling in line with the government's planned deregulation of the power sector. Ehlers sees the guarantees as an important bankability consideration for both debt and equity providers, but emphasises that elsewhere in Africa, governments have moved to different structures and still achieved the commercial position of sovereign support for their utilities. "In Ghana and Nigeria the PCOA (Put-Call Option Agreement) structure has been banked extensively. It remains unclear if the South African sovereign will change the current arrangement."

Martin Meyer, head of power and infrastructure at Investec says several factors are considered before an investment is made in a REIPPPP project. "We primarily look to bank projects with strong sponsors, engineering, procurement and construction contractors and original equipment manufacturers. Thereafter, the project will need to have robust cashflows and an appropriately structured risk transfer." When deciding whether to invest in a project, it's important to engage with developers that have had experience in the previous REIPPPP bid windows, says Semple. "They must have successful track records — that's probably first and foremost. The South African environment is different to Europe and America — we have our own specific development challenges. From a climatic point of view, SA is a country that has massive resources, but extreme temperatures in some areas that, for example, require solar panels and equipment that can withstand these climatic conditions in order to optimise the returns from the projects. So, we're looking for developers who have that experience."

He also stresses the importance of engaging with shareholders that have enough capital behind them to support the project if it comes under any form of stress. "We're looking for reputable shareholders who are aligned with the lenders. We've come across projects with operating challenges where the shareholders try to take money out of the project rather than inject additional capital to remediate the issues. We look very closely at 'skin in the game', including if the developer is also invested in the project as a shareholder." Semple's Power Debt Fund also focuses on what impact projects will have on job creation in communities. "It's one of the great features of the REIPPPP that the projects need to achieve criteria such as employment, local content and socioeconomic upliftment of the surrounding community and that is the biggest issue that we have with the Risk Mitigation Independent Power Purchase Procurement Programme (RMIPPPP)." Despite its intended urgency, Semple says the RMIPPPP implementation has been disappointing, particularly with the ongoing delays to the start of construction of the projects and the aspersions cast on the bid adjudication process.

The RMIPPP - announced to the market in August 2020 — is intended to alleviate the present electricity supply constraints as well as to reduce the use of diesel-base peaking electrical generators, and is being funded by the country's major banks, including Nedbank. "We're pleased that the projects we're financing have a large element of renewable energy embedded within them, obviously supported by a small amount of thermal just to enable them to meet the requirements of the round for the dispatchability of the power, but the base load is very much provided by renewable energy," says Van Kerckhoven.

"Investec is currently mandated on one RMIPPP project in the programme," says Meyer, "while Standard Bank is participating as a lender in a few RMIPPP projects." "We anticipate financial close during the first half of this year, depending on government processes", Van Tonder says.

Absa CIB "in general" supports the risk mitigation round. "We appreciate that Eskom and the DMRE need to find ways to address the current power supply deficit," says Ehlers. However, no firm or final decisions have been taken with regards to funding. "Final decisions around Absa's participation in the financing of any REIPPPP projects remain subject to relevant external due diligence and internal approvals, including a review of the projec€s compliance with the bank's internal lending policies and a review of social and environmental compliance," he adds.

The raising of the threshold for self-generation licence exemptions from IMW to 100MW in June last year could be bolstered by Eskom's decision to make land available in the grid-rich Mpumalanga province for these developments.

"RMB has been successful in this space where the mining houses are leading the private power revolution — but other energy-intensive user industries are following," says Zinman. He explains that companies have the same three priorities when it comes to these deals — albeit in differing orders of priority, depending on the entity. "They want security of supply, certainty of price and they also have a decarbonisation imperative. Consequently, this is a very exciting sector for us."

Semple says Futuregrowth is also eyeing self-generation projects and is engaged with several while putting term sheets together and assessing credit metrics. Investec is also a keen player in this space. "We've already funded a number of embedded generation portfolios," Meyer says. "We have a clearly defined strategy for embedded generation and will be a meaningful funder for these projects into the future."

Nedbank was a very early mover into the embedded generation space, setting up an embedded generation business alongside its utility scale energy business and developing a number of products that were designed to support this sector, Van Kerckhoven says. "At the time, this was premised on the IMW cap, so we built quite a significant portfolio of funding for embedded generation projects at the smaller end of the scale, and that's heading towards a billion rand book now; it’s made up of a raft of many small projects that our developer clients have built for their clients." He adds that the lifting of the cap to 100MW has obviously brought a new set of opportunities which stand between small-scale embedded projects and utility-scale projects. "These projects being undertaken by the mining companies and large industrial companies are big and they're funded very much on a project finance basis because of their size, whereas with smaller embedded transactions, financing needs to be much more fit for purpose, much more flexible and much easier to deploy."

Debt capital markets present an ideal mechanism of funding renewable energy, with Nedbank the first bank in the country to list a renewable energy bond in the green segment of the JSE in 2019 to finance new solar and wind projects, issuing R2.7bn in that year across two auctions, both of which were significantly oversubscribed. The bonds were developed in line with International Capital Market Association Green Bond Principles and the Climate Bonds Standard set by the Climate Bonds Initiative. Arvana Singh, head of sustainable finance solutions at Nedbank explains that there were several motivations for the issuance of the bonds.

"Firstly, we had a strategy to continue to finance green projects through our energy finance team and therefore to support lending into these projects in addition to servicing other clients; we need to constantly raise funding in the market to be able to on-lend this into the economy. While we could have approached the market to raise traditional vanilla funding, we identified the opportunity to raise green 'use of proceeds funding' as our market intelligence suggested that we would be able to unlock additional liquidity from investor mandates in addition to the traditional investment mandates through this mechanism — and there was an opportunity for us to potentially unlock value through pricing."

Singh adds that the country's banks are playing a key role in continuing to support high-impact opportunities in the economy which are aligned with the energy transition. "A green bond mechanism enabled us to attract funding flows from dedicated impact funds and infrastructure funds, which are looking for investment opportunities, and then channel this liquidity to support the financing of more green projects." "Foreign investors are participating, bringing foreign direct investment into SA. We pride ourselves on taking a leadership role in sustainability and using our financial expertise to do good."

Since the inaugural green bond issuance in 2019, Nedbank has had various multilateral institutions and commercial investors reaching out and expressing interest in partnering with it to drive the development of the green economy. "These institutions are looking for a transparent mechanism and framework to channel investment that will enable strategic unlocking of developmental priorities on the African continent," Singh says. "This led to us issuing a further R2bn of green bonds in 2020 in partnership with the African Development Bank and a further R2.1bn of green bonds in 2021 that will also serve to orientate capital flows, in addition to energy finance projects, towards financing green residential developments. This brings our total green bond issuance listed on the sustainability segment of the JSE to R6.78bn." Nedbank also entered into a USD climate loan with the International Finance Corporation (IFC) in December 2020, thereby bringing its total green "use of proceeds" funding lines across bonds and loans to R 9.8bn.

Standard Bank issued its first local Tier 2 capital qualifying green bond in December last year. The 10-year, RI.4bn bond is listed on the JSE's sustainability segment and is the third bond issue under the group's Sustainable Bond Framework that was established in February 2020. "We are consistently broadening our issue base under the Sustainable Bond Framework," says Ann Hunter, head of group strategic funding at Standard Bank Group. "Sustainable finance markets and products are evolving quickly and, as an issuer, we recognise the urgency and the opportunities as well as the responsibilities." The group's first green bond listed on the London Stock Exchange in March 2020 and was placed via private placement with the IFC. The $200m bond, a 10year facility, funds eligible green assets in South Africa.

The Development Bank of Southern Africa (DBSA) developed its Green Bond Framework in 2021. "This reiterates the bank's commitment to playing a role in the just transition to a low carbon economy with the framework being aligned to the International Capital Market Association Green Bond Principles," says the DBSA's head of energy, Lucy Chege.

In February last year, the DBSA launched its first green bond structured in alignment with the framework. The €200m bond was issued through a private placement with the French development finance institution, the Agence Franqaise de Développement. "This inaugural issue under the framework was intended primarily to refinance select renewable projects under SA's REIPPPP," Chege says. The DBSA has made a sizeable contribution to the REIPPPP, assisting what was then known as the department of energy with programme management as well as providing support in setting up the IPPO. The development institution has invested around R20bn in 34 projects, of which approximately R3bn went towards funding black economic empowerment parties and community trusts. 0This critical DBSA funding enabled these parties to secure equity participation in the projects, as well as ownership by local communities. Such local involvement ensures inclusion and has contributed to the long-term sustainability of the projects, " Chege says.

More pension funds are looking to invest in renewable energy now that Regulation 28 of the Pension Funds Act is in the process of being adjusted. Phathutshedzo Mabogo, acting joint chief investment officer at the Eskom Pension & Provident Fund (EPPF), says the fund's ideal investment is long-dated, predictable and indexed to inflation — and renewables offer all three. "Our vision is to become a sustainable and trusted retirement savings provider, positively impacting a change in society," he says. 'Accordingly, we believe that renewable energy not only presents us with an attractive investment opportunity, but also enables us to leverage our investments in addressing the challenge of climate change and environmental sustainability as well as creating jobs and enabling economic growth in countries we invest in.

The EPPF's investment in renewables, particularly through the REIPPPP, has always been premised on risk, return, the ability of cash flows to match the fund's pension liabilities and positive social impact generated by the projects, Mabogo adds. In addition, the EPPF committed R350m of the total R2bn raised by renewable project investor Revego Africa Energy in 2020, alongside co-investors Investec and the UKCI. "The vehicle will build a renewable energy portfolio that is geographically diversified including diversification in the generation source, technology and income streams, giving the EPPF an indirect footprint into the sub-Saharan Africa energy sector," Mabogo says.

The release of the request for proposals for bid window 6 is expected towards the end of March.

Zinman hopes that the country will see rolling rounds of REIPPPP. "You don't need to have one every six months although that would be great but maybe one every year. This will keep people interested because we really need to get local manufacturing going, for example, panel assemblies. There's a push down from the Department of Trade, Industry and Competition specifically to use local panels — but it's a bit of a chicken and egg situation. Manufacturers need to know that there'll be another REIPPPP round every 12 months and if those timelines are adhered to, the development of local industry and consequent job creation will be successful."

Disclaimer: This article was originally published on 1 March 2022 in a supplement that Intellidex produced together with Business Day entitled ‘Shaping SA’s energy sector for the future’.