NATURAL RESOURCES AND ENERGY Power sector policy changes will unlock significant value Absa | Corporate and Investment Banking > Insights and Events > Power sector policy changes will unlock significant value Theuns Ehlersa and Bhavtik Vallabhjee Head: Resource and Project FinanceHead: Power and Renewables, at Absa Corporate and Investment Banking SHARE Seventy-five billion Rands! This is the estimated value of construction sector related economic activity that could potentially be unlocked over the next few years following the announcements by President Cyril Ramaphosa to allow businesses to produce up to 100MW of power without the need for a generation license from the National Energy Regulator of SA. And this is only the start of the potential value unlock. These embedded generation projects will unlock a new era in electricity generation in SA with gradual diversification away from reliance on Eskom for power generation. The announcement on 10 June 2021 was a gamechanger on many levels and our bank expects to commit funding to a number of exciting energy projects over the next 24 months. These are a couple of trends that we expect to see emerge over the next few months. New generation partnerships As it stands, there are typically two models which are on the table for funding of energy projects. The first – and less common structure – is one where the business uses its own balance sheet to procure the required equipment to develop and operate a project. In this model, the business retains the risks associated with construction and operating of the power plant. The second model entails a business entering into a long-term Power Purchase Agreement (PPA) with an Independent Power Producer (IPP). This is emerging as the more common structure and allows the respective businesses to focus on their areas of core competence. An interesting sub-trend emerging here is that organisations are actively seeking out IPPs with strong Black Economic Empowerment credentials and we believe through a combination of financing from banks and financing institutions plus incentives out of the Department of Trade, Industry and Competition, we could see the emergence of a number of new entrants in the energy space over the next few years. Quicker approval of project funding One of the long-standing features related to the official IPP program has been that national government has been standing behind the offtake & termination payments due by Eskom under the PPA, which was a requirement for investors and financiers to achieve bankability. The difference here is that these new captive power projects will be driven by private sector agreements without Government support, hence reducing the level of contingent liabilities in National Treasury’s books. Banks will evaluate the credit quality of the private sector off taker in their assessment, but in most cases banks are prepared to take a long-term view on the financing as the projects are value-enhancing and typically result in cost savings compared to current electricity tariffs of power procured from Eskom. Self-generation would displace expensive power procured from the utility and help ensure energy security. Businesses and consumers can plan Whilst wholesale consumers of power such as mines procured power on a ‘preferential tariff’ basis (“megaflex tariff”), one of the benefits of captive power solutions is that tariffs are typically linked to CPI, which provides more certainty. Mines and smelters are heavy energy intensives users of power. Captive, secure power also ensures that they do not need to curtail their operations due to power cuts and load-shedding – helping them to take advantage of the high commodity prices during the current ‘commodities super-cycle’. If the historical trend of double-digit electricity price increases is to continue, the captive power projects should result in very significant savings on companies’ electricity bills. Procuring power from renewable energy is already at ‘grid parity’ and very competitive. Even if hybrid power plants are developed, the benefit of favourable tariffs compared to the upward trajectory of the Eskom tariff path makes captive power a very attractive proposition. Add to this the sustainability & ‘green’ aspect, which helps companies decarbonize. The changing electricity model globally South Africa’s electricity grid was designed for centralised electricity generation. Most of our (coal) power plants are situated in the coal-belts of Limpopo and Mpumalanga. With the advent of renewable energy, this has changed. Decentralised power is now being generated by plants at the load centres where they are required. This is a global phenomenon. This calls for a redesign of the transmission grid to accommodate this facet. And clarity needs to be obtained around the wheeling arrangements and the cost thereof. No doubt, Eskom is the custodian of the transmission infrastructure in SA. There can be no “free lunch”. Self-generation and “wheeling outside the fence” must entail a wheeling charge. Although the Electricity Act in SA permits “wheeling”, the exact cost of wheeling is not widely clear and clarity needs to be obtained in this regard. Theuns Ehlersa and Bhavtik VallabhjeeHead: Resource and Project Finance Head: Power and Renewables, at Absa Corporate and Investment Banking https://cib.absa.africa/wp-content/uploads/2020/07/file_example_MP3_700KB.mp3 Related Articles Environmental, Social and Governance Exciting times in African debt markets Are South Africans too pessimistic and are they missing some positive signals from the Debt markets? 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