Banking on clean power

Despite a lack of clarity from government on actioning SA’s renewable energy build programme, the appetite for investment in this sector is still healthy. But this could become subdued if government fails to ensure policy certainty, among other things, writes Jaco Visser.

While the government’s plans to restructure the sources of South Africa’s power generation over the next decade are ambitious, lack of funds can constrain any ambition. But is seems as though the appetite for funding renewable energy projects in SA remains intact – even as several risks stwill linger.

The sector, if the government’s policy on energy gets put into action and moves forward, may prove a much-needed light at the end of the local economic tunnel. It may even potentially boost Eskom’s cash

flow as well. But in order for this to materialise, the caveat remains: National Treasury must continue guaranteeing the power purchase (offtake) agreements signed with independent power producers (IPPs).

The appetite for renewables

Since 2012, funders forked out R192bn to invest in renewable energy, either through debt or equity investments over seven procurement bidding rounds (which included calls for large and small suppliers) until late 2016, according to an academic article by University of Cape Town Professor Anton Eberhard in the Journal of Energy in Southern Africa. Figures from the Renewable Energy Independent Producers Procurement Programme (REIPPP) show that financial commitments to these projects topped R209bn.

This investment that took place has seen 6 422MW of renewable energy procured from 92 large-scale IPPs and 99MW from 20 smaller projects, according to the latest quarterly report of the government’s Independent Power Producers Office, released in June. By the end of March, 4 201MW had been connected to the grid, the report states.

The department of mineral resources and energy aims to increase the country’s electricity supply by more than 37 000MW (excluding the extension of the Koeberg nuclear power station’s 2 000MW shelf life) between 2019 and 2030, according to the Integrated Resource Plan (IRP) released in October last year. This will necessitate billions more in funding.

“We have not witnessed a reduction of the appetite to fund renewable energy projects,” Vuyo Ntoi, investment director at African Infrastructure Investment Managers (AIIM), tells finweek. “If the procurement process and the underlying projects are well-designed, there should be sufficient long-term capital to fund the projects.”

And this “appetite” will be tested over the next decade. The IRP calls for an increase of 6 484MW of additional photovoltaic power to the grid from the 2018 supply level of 1 474MW. Of this, 814MW has already been committed or contracted. The contribution of concentrated solar energy would have doubled from 300MW in 2018 to 600MW by the end of last year, the plan shows. Wind power will see the largest megawatt jump from 1 980MW in 2018 to 11 442MW by 2030, the plan shows. Some 1 362MW of the planned 9 462MW increase has already been committed or contracted, according to the IRP. Interestingly, the plan makes provision for 2 500MW from the Quixotic Inga hydro scheme in the Democratic Republic of Congo, but only in the final year of the IRP’s long-term plan: 2030.

If all goes according to the IRP, SA’s installed capacity will increase to 78 344MW by the end of 2030 from a baseline of 54 177MW in 2018. The contribution of coal-fired power plants will decrease from 39 126MW in 2018 to 33 847MW as older power stations reach their end-of-life.

“The size of renewable energy generation will almost triple over the next 10 to 12 years,” Theuns Ehlers, Absa Investment Banking’s head of resource and project finance, tells finweek.

But procurement requires policy certainty. Reassuringly, government’s flip-flopping on deciding when the next independent power projects will be allocated hasn’t scared off those committed to seeing the rollout of renewable energy in SA speed up.

“We’re not seeing our clients pull out of the country,” says Ehlers. “They’re rather positioning themselves for the government’s emergency power procurement.”

Last year, as the lights went out in SA due to Eskom’s inability to meet businesses’ and consumers’ electricity demand, mineral resources and energy minister Gwede Mantashe used his emergency powers to call on independent suppliers to furnish proposals to supply the grid with power. No limits as to the source of power generation were set. This induced interest from those players that are already operating in the renewable sphere.

“There does seem an urgency to get the emergency power procurement programme going with a request for proposals expected during July,” says Ehlers.

But not all participants in the ramp-up of SA’s renewable energy build agree, and in the absence of policy certainty, the country stands to lose some dearly-acquired expertise and experience.

“The success of any government-sponsored programme is dependent on certainty and line of sight on the future,” says Dario Musso, co-head of RMB’s infrastructure team, and Daniel Zinman, infrastructure finance transactor at the bank. “A clear policy and programme, with timelines that are delivered upon, will be critical to ensuring the success of REIPPP and any other renewable energy programmes.”

The government’s energy policy decisions have led to a great deal of uncertainty for participants in the renewable energy value chain, says AIIM’s Ntoi. “We have seen various assemblers and manufacturers in the sector shut down their operations in SA due to uncertainty,” he says.

In addition, some project owners and sponsors have decided to exit the SA market, Ntoi explains. The impact of this is likely to be reduced competition in future procurement rounds, potentially resulting in higher tariffs, which will need to be covered by consumers, according to him.

Cost of debt

As these renewable projects are mainly funded through debt, the cost of these borrowings will play a significant role in the longevity of renewable power companies and the tariff at which the electricity is sold to Eskom. With long-term borrowing rates of the sovereign local issuer, the government, at elevated levels due to the investment grade of its debt, one needs to ask whether this will have an impact on long-term infrastructure projects such as renewable energy builds.

When the renewable energy build programme was launched around a decade ago, both the technology involved and the inherent risk of completion and operation were high. This increased the perceived risk of these projects’ ability to service and repay debt. As the projects rolled out successfully, and local financiers increased their understanding of the nascent industry, the risk premium on debt issued to these players started to decrease, albeit marginally.

“Depending on the technology in the underlying project, the interest-rate margin on REIPPP projects has dropped from high-300 basis points in bid window 1 to mid-300 basis points in bid window 2 to low-300 basis points in bid window 3 and high-200 basis points in bid window 4,” Paul Semple, portfolio manager of the Futuregrowth Power Debt Fund, tells finweek.

“As the understanding of the various technologies and the programme has improved, coupled with the positive track record of projects being constructed on time and operating at or better than forecasts, the risk perception around renewable projects has reduced,” says RMB’s Musso and Zinman.

Consequently, the risk margins required by banks have decreased significantly, according to them. “More recently, however, the cost of longer-term rand funding has increased, as a result of, inter alia, the SA sovereign downgrade and market liquidity issues relating from Covid-19.”

A tangible reduction in the cost of funding for renewable projects may be on the cards, but this can only happen when these projects are refinanced. This entails substituting current debt for “new” debt.

“The ability to take advantage of reduced debt rates has also been limited by the slow progress on project refinancing,” says AIIM’s Ntoi. “There is an indication that project refinancing will soon be allowed, and this should result in more optimised debt funding, which recognises reduced risk in the projects, and allows for the sharing of the benefit with government or the consumer.”

Novel debt structures

Projects that rely heavily on debt for their completion, such as the renewable energy sector does, are faced with interest-rate risk. This risk is amplified in an environment where the outlook for inflation deteriorates. Given the easy cash splashing around the world in a bid to mitigate the effects of the coronavirus pandemic, this becomes a real risk for the future cash flows of renewable energy projects.

To bridge this risk, the offtake agreements, which are guaranteed by government, between the IPPs and Eskom were partially indexed to inflation. That means that the price which the producers receive will increase (even if only a proportion of the price was indexed) along with inflation.

Thus, theoretically, it means that even if the central bank tries to rein in inflation with higher interest rates, with the concomitant higher interest payments on debt at least the producers receive some form of inflation adjustment and subsequent higher revenue. One of the key risks facing renewable energy projects after their completion is low inflation.

This has led to funders benchmarking the cost of debt to inflation, rather than the general Johannesburg Interbank Acceptance Rate (Jibar), which banks use to lend to each other and some large corporates.

Absa’s Ehlers explains that this creates a natural hedge against inflation. This is important as between 70% and 80% of a renewable energy project’s initial cash flow is used to service debt. “If inflation declines, the project’s revenue line declines too,” Ehlers explains. “Inflation-linked debt instruments relieve pressure on a project's cashflow, especially in the early years of its life.” According to Prof Eberhard’s calculation of the completed bids through to round 4, R129.4bn of debt was issued to fund the renewable projects. If we use REIPPP figures – which may modify for currency movements, early revenue and VAT facilities – according to Ntoi, the debt funding rises to R132.8bn for these rounds of bidding. R69bn was funded through equity, according to him. Semple estimates that local investors provided around R30bn of this equity funding.

Future guarantee

Given these amounts of funding, it is evident that the appetite for renewable energy projects is alive in SA. That, however, doesn’t mean there are no risks involved going forward.

As government debt spirals out of control – as is evident from finance minister Tito Mboweni’s recent adjustment budget calling for a radical rethink of how the public purse is managed – the government’s ability to add to its stockpile of guarantees is being questioned. Remember that a guarantee remains a contingent liability for the government, even if it isn’t issued as cash.

This means that the financial malaise at Eskom doesn’t pose a direct risk to renewable power projects. The government’s ability to issue guarantees, however, does.

“Eskom has been in a financially precarious position for some time and the success of the REIPPP has been driven by the National Treasury guarantee underpinning Eskom’s obligations under the (power purchase agreements),” says Ntoi. “National Treasury’s ability to add to its contingent liability stock will be the big driver over whether there will be further renewable energy rollouts.”

Furthermore, the affordability of renewable energy as a source of electricity has been questioned. At the beginning of the REIPPP, on both a worldwide and a local level, putting up wind turbines and solar panels was extremely expensive. However, SA’s rollout of renewable energy came at the same time as similar builds across the world, leading to a substantial decline in the establishment costs of these technologies.

Absa’s Ehlers uses photovoltaic plants as an example, where the tariffs offered by IPPs reduced from between R3/kWh and R4/kWh in the first bidding rounds to its current level of around  R0.60/kWh.

Futuregrowth’s Semple shares the same view, but is also worried about the energy pricing efficiency at Eskom. “Renewable energy is the cheapest form of new energy development, but its contribution to Eskom’s cost mix can be lost within the inefficient operational structure of Eskom, including the vastly inflated costs incurred from its new-build coalpowered stations Medupi and Kusile.”

Ntoi agrees with this view: “It is our view that subsequent rounds of the renewable energy procurement programme will result in tariffs that are lower than the current Eskom charge to consumers. In fact, this procurement will create a revenue surplus in Eskom, which can be used to stabilise its overall financial position over time.”

And it is not only the reduced cost and subsequent lower tariffs to consumers that increases the allure of renewable energy.

“Renewables currently come out ahead of their competing technologies on many measures like cost, risk, delivery times and environmental sustainability – and that gap is set to keep widening,” says RMB’s Musso and Zinman.

While there may be a temporary decrease in demand for power due to the global pandemic, “there is no doubt that the future economic growth of the country will require more cost-effective, reliable and clean electricity in the medium to long term, particularly as Eskom’s ailing coal fleet is decommissioned,” they say.

One can only hope for two things. First, that the government’s ability to continue guaranteeing renewable power producers’ offtake agreements remains intact. This means the public purse should be strengthened through productive spending by government.

Second, that energy policy certainty somehow becomes the norm in the department of mineral resources and energy. This should entail a fixed  line-up of future rounds of bidding for renewable energy projects.

SA can’t afford to lose the experience and talents it gained through the REIPPP to inefficient government actions.