Julian Jackson of Norton Rose Fulbright takes an in-depth look at current and future financing trends in Africa.
"The story of African IPPs is one of slow progress and some false starts: the aggregate installed capacity in Africa resulting from IPPs remains small and comparatively few IPPs have been financed on a project finance basis."
Governments, sponsors and financiers are showing increasing appetites for developing independent power projects (IPPs) in Africa on a limited recourse finance basis. Governments are trying to close large infrastructure development gaps while avoiding the enormous CapEx costs associated with building new generation capacity. At the same time, project sponsors are looking for new opportunities. And yet, the story of African IPPs is one of slow progress and some false starts: the aggregate installed capacity in Africa resulting from IPPs remains small and comparatively few IPPs have been financed on a project finance basis. Are there financing solutions to reduce the bottleneck?
Traditionally, the bankability of IPP projects for limited recourse finance has been enhanced through a number of mechanisms:
• Off-taker escrow arrangements: to mitigate the risk of a public off-taker experiencing cash shortages resulting in cash constraints for the IPP, one sometimes sees several months’ worth of expected revenues put in escrow, either in cash or through a letter of credit facility.
• Sovereign guarantees: in the case of some IPPs, the off-taker’s obligation to pay is guaranteed by the state. This is in line with the World Bank’s thinking that the first level of support for IPPs must come from the government. However, for obvious reasons, guarantees are not attractive to host governments, and depending on the balance sheet of the relevant government, they may be of limited value for the financiers. In some cases, governments simply do not give guarantees; in others, “softer” support such as comfort letters may be considered.
• Other government support: some IPPs are supported by other government support in various guises, for example tax reductions or tax payment grace periods offered to the project, reduced or waived import tariffs in relation to certain products, etc.
• Partial risk guarantee: the World Bank Group offers partial risk guarantees that are designed to cover commercial lenders (or investors through shareholder loans) against the risk of government or quasi-governmental entities failing to perform contractual obligations. The World Bank issues the guarantee to the commercial lenders, and the host government indemnifies the World Bank. While a good number of such guarantees have been provided by the World Bank in Africa, they are only suitable for large infrastructure projects in qualifying countries, and they must be requested by the host government.
• Political risk insurance: political risk insurance can be purchased on commercial terms from commercial insurers, the Overseas Private Investment Corporation (OPIC) and the Multilateral Investment Guarantee Agency (MIGA). Typically, they cover risks that include currency inconvertibility, expropriation, political violence and breach of political sovereign financial institutions.
• Carbon finance: IPPs relating to renewable technologies may theoretically be able to benefit from carbon finance. In practice, such financing has been of disappointingly little significance, since the only significant carbon trading market now is Europe – the US refused to ratify the Kyoto protocol and emerging economies like China, India and Mexico do not have emissions-cutting obligations under the treaty. The current phase of the Kyoto protocol ended in 2012 and its future is uncertain, which has contributed to a collapse in the price of carbon credits. However, renewables projects may benefit from other sources of “green” finance and find support from other emission reduction initiatives. This may mean, for example, that qualifying IPPs may be recognised as part of low carbon development plans and then potentially access climate funds to support the development of the project.
Despite these “enhancements”, Western project finance techniques are increasingly competing with Chinese financing options. Chinese investment in Africa has risen by, on average, 30 per cent per annum for the last 10 years and is continuing to rise. China’s Africa policy is long term and secures the long-term supply of a significant percentage of China’s resources needs (oil, iron, copper, etc) from Africa. What makes Chinese financing solutions particularly effective is that the viability of a project is not measured solely on the basis of that project’s ability to repay the loan (based on its contractual structure), but also the ability of Chinese industry to supply labour and technology, to develop relationships that will assist future Chinese businesses, and to give China access to markets. The total benefit of a project to “China Inc” can thus be aggregated. In addition, default risk may be mitigated through influence at government-to-government level.
In some cases, repayment of loans is made not in cash but in commodities. For example, in the past decade, China Exim Bank has lent Angola several billion dollars, and further loans are being negotiated. A large proportion of this is used to finance infrastructure projects built by Chinese contractors. Repayment is made in oil rather than in cash. In addition, these loans are on attractive terms, including grace periods and grant elements. In a similar vein, China Exim Bank has granted a commercial loan and a concessional loan to the Ghanaian government for the Bui Hydro-Electric Project, and repayment of the loans will in effect be made in cocoa.
What are the future trends for the financing of African IPPs? Two dominant themes arise. First, conditions in Africa are consistently improving for IPPs and, as project-financed IPPs develop a track record, and governments and investors learn from experiences, the prospects for IPPs improve. At the same time, governments’ commitments to creating frameworks for IPPs are increasing. This is in part a function of the African growth story in which urbanisation and growing consumer bases (and therefore revenue bases) are improving. Western countries’ funding and associated export credit agency support remain significant – and will continue to be. At the same time, new Western sources of capital are emerging and there are funds and financiers who are willing to take high risks and hold assets on a long-term basis. Secondly, there are new emerging financiers, such as China and India, who can support projects with a different profile, supported by a long-term investment strategy at government level that allows these financiers to offset and balance different risks. This combination means that African IPPs are expected to be on a growth trajectory.