Captive power projects
kick into higher gear

Theuns Ehlers Author

Theuns Ehlers

Head: Resource and Project
Finance, Absa CIB

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The latest power blackouts have once again highlighted the urgent need to diversify South Africa’s sources of energy amidst the country’s ongoing capacity challenges. While the urgent challenge is to keep the lights on and minimise disruptions caused by power outages that have been part of our lives for the past 15 years, the country has been presented with a unique opportunity to transition into cleaner energy sources.

As one of the leading funders of energy projects in South Africa, we are encouraged by the number of power projects coming to the market. We are, of course, mindful that these projects take time – usually years – to come on-stream. We are, however, encouraged by the efforts of the public and private sectors in working together to resolve the country’s lingering energy challenges, especially in the commercial and industrial space where a number of utility scale projects are currently being finalised.

Absa acted as  joint mandated lead arranger and lender for South Africa’s first utility scale renewable energy captive power project which closed last month, comprising 200MW’s of solar power, which will be built in the North-West province in South Africa at an estimated cost of approximately R4.1bn. The 200MW project (comprising of two projects of 100MW’s each), developed by Sola Group of South Africa, will supply power to Tronox SA, under a long term power purchase agreement. It will assist Tronox to reduce its reliance on fossil fuel power and – in line with its strategy – to reduce carbon emissions. The project is expected to reduce Tronox’s global carbon emissions by approximately 13%. This agreement comes at a time when South Africa is in dire need of capacity to be added to the electricity grid.

Encouraging policy developments

One of the catalyst for this has been a shift in government policy to drive green and renewable energy project activity. Last year, President Cyril Ramaphosa announced an increase in the private energy generation licensing threshold to 100MW. This announcement unlocked a pipeline of more than 80 confirmed private sector projects with a combined capacity of over 6,000MW. In July this year, Ramaphosa announced the removal of the licensing threshold for embedded generation completely ensuring that captive power projects can be pursued with a new level of urgency. This will assist businesses over the next 12 months as load-shedding continues.

With the pipeline of captive power projects growing, financiers are very focused on setting market precedents for bankability of key project agreements underpinning these projects, including power purchase agreements between the IPP’s and private off-takers. Unlike the Government-backed programs where the main project agreements are pre-agreed, these agreements have to be negotiated for every new captive project. We expect some level of market standard to develop over time, hence the importance of setting the right tone and standards for the first few projects.

Where is the back-stop?

When assessing the credit quality of a government-backed renewable energy project, the Government (National Treasury) is the “back-stop” and guarantor for power off-take agreements. But we must consider what happens in the instance where the buyer is a business from the private sector. Financiers are very focused on the off-taker’s credit quality, as well as the sustainability of the business over the longer term. In some cases additional credit support may be required, for example in the form of parent company support (for a local subsidiary’s commitments) and/or liquid security to support payments under the agreement.

With the captive power market opening up in South Africa, banks are now starting to take a longer term view on the power market, with the expectation that even if an initial power off-taker defaults, the project should be able to find an alternative buyer. We expect a merchant-style market to develop over time with more flexibility to trade power between producers and users. This view does help in getting financiers comfortable to take a longer term view on the financing, beyond where banks will normally lend money to corporates directly.

Price is what you pay, value is what you get

The ability to reach financial close is now in focus for green captive energy projects. The explosion of captive energy projects which we are seeing at the moment in South Africa can provide much needed additional generation capacity to the grid, without the need for Government guarantees backing these commitments.

The benefits to power users are really two-fold – firstly it supports their ambitions to transition to green energy and achieve net zero targets, and secondly the procurement of green energy now also results in significant cost savings to these typical heavy power users. Going green is no longer a grudge purchase, but a critical commercial imperative, even more so on the African continent with its power supply challenges.

We look forward to continue our support for green energy entrepreneurs in 2022 and beyond, and build on our portfolio of over 3GW’s of project finance in the sector!

Theuns Ehlers Author
Theuns Ehlers

Head: Resource and Project Finance, Absa CIB

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