POWER, UTILITIES AND INFRASTRUCTURE | 05 NOVEMBER 2021

Power sector policy changes will
unlock significant value

Absa-CIB-Author

Theuns Ehlers/Bhavtik Vallabhjee

Head: Resource and Project Finance, Absa Corporate and Investment Banking
Head: Power and Renewables, Absa Corporate and Investment Banking

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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.

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 recent announcements from President Cyril Ramaphosa to allow businesses to produce up to 100MW of power  without the need for a generation license from NERSA (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 almost sole reliance on Eskom for power generation.

For the last two decades, industrial businesses operating in South Africa have been hamstrung by irregular power supply, rolling blackouts and load-shedding. Local & international investors have been reluctant to deploy capital for new investment in the country as economic growth has been benign at the best of times - multi-national firms eyeing the economic hub of Africa were struggling to justify investing in markets where reliable and affordable energy supply could not be guaranteed.

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.

Importantly, a number of businesses in the mining, property and industrial sectors have already spent a lot of time on their project development activities and won’t be starting from scratch now. We are aware of dozens of projects that are well advanced and this will fast-track their timelines for implementation.

These are a couple of trends that we expect to see emerge over the next few months as funding for these projects is unlocked.

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. Debt financing is typically limited to corporate-style covenants, with shorter funding tenors compared to the IPP model. Regardless of plant performance, the balance sheet strength of the business is looked to for debt service.

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 (B-BBEE) 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 (DTIC), 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.

The added benefit is that these projects are procured outside of official Government-run programs, potentially achieving execution in a shorter timeframe.

Businesses and consumers can plan

South African electricity consumers were trapped in a cycle of double-digit tariff increases over the past decade with limited certainty around future increases. 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 and can assist wholesale consumers in long term planning. 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 (like many other countries) electricity grid was designed for centralized electricity generation. In the case of SA, most of our (coal) power plants are situated in the coal-belts of Limpopo and Mpumalanga in SA.

With the advent of renewable energy, this has changed. Decentralized 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.

In order to receive rollout at scale of captive power (i.e. decentralized generation), 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.

In the case of Germany, “Netmetering” is permitted. Individual homes can essentially be generators of power for self-consumption. Excess capacity generated can be sold back into the grid, which the utility purchases. This does not currently occur in South Africa. This is another initiative that could alleviate the pressure on Eskom’s grid.

Momentum is a powerful force

For the better part of two decades, the South African economy has been stuck in a low-growth environment and much of this malaise has been blamed on restrictive economic policy by government, including lack of certainty around power supply.

What has not yet sunk in for many people is that this change in policy could translate into 5GW of additional renewable energy capacity – almost the entire renewable energy generation capacity added to the grid over the past decade.

This bold policy change is likely to drive construction activity, job creation and general economic confidence across the broader economy. Big step-changes like this can be a catalyst for additional Foreign Direct Investment (FDI) and help the country regain its standing in terms of global competitiveness.

The future of electricity generation in SA is indeed bright. With COP26 around the corner, clean energy is the direction the world is moving towards. Green is the new Gold. The current Eskom CEO is supportive of the ‘green agenda’. Time will tell how this unravels in South Africa.

As a bank with extensive experience in the funding of energy projects and a proven track-record of supporting high-growth businesses, we look forward to entering this exciting new phase in supporting local economic development.

Absa-CIB-Author
Theuns Ehlers/Bhavtik Vallabhjee

Head: Resource and Project Finance, Absa Corporate and Investment Banking
Head: Power and Renewables, Absa Corporate and Investment Banking

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