NATURAL RESOURCES INSIGHTS | 02 - 03 FEBRUARY 2021

Why mining houses are
turning to IPPs to fund
their electricity needs

Theuns Ehlers Author

Theuns Ehlers

Head: Project Finance and Resources, Absa Corporate and Investment Banking

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Why mining houses are turning to IPPs to fund their electricity needs

Absa has always been committed to the growth of business and industry across Africa, which is why we are proud to sponsor this year’s Virtual Mining Indaba. Join our sector experts as we discuss non-traditional financing in a post-pandemic world, how to spot opportunities for your business, and how we can all contribute to the sustainable growth of mining on our continent. Because, for us, business without borders is a new normal we can all aspire to.

The resurgence in activity in the South African mining sector has been one of the few bright sparks in the local economy during the course of 2020 and with the power system facing capacity constraints in the new year, innovative financial solutions are being found to keep the lights on.

Over the last 12 months we as Absa have seen some exciting new projects being tabled by some of the major players in gold and platinum fields, who are all looking at green energy solutions – either established on-site or remotely.

The cost of renewable energy solutions is coming down sharply and is now on par with – or in some cases cheaper – than Eskom. This is a gamechanger for these organisations for two key reasons: Firstly, it reduces the dependence on the Eskom grid but it also shifts the discussion to using renewable energy as a cost-saving lever.

For those tasked with managing budgets during this challenging economic period, these factors makes a material difference as they can start to plan more efficiently and link generation and power costs to CPI-linked metrics rather than being a price-taker from Eskom where escalations over the past few years have exceeded inflation.

The clients we are working with in the mining sector are typically opting for one of two approaches to funding their renewable energy projects:

  • Using their own balance sheet, they look to acquire a renewable energy plant of their own to operate, raising financing on their balance sheets to pay for the equipment
  • The Independent Power Producer (IPP) model where the plant is owned by the IPP and power is sold to the mining house. The IPP raises the financing and this capital, as well as the cost to operate the plant, is recovered through selling electricity to the client in terms of a Power Producer Agreement (PPA)

With the resources sector moving into a higher gear, mining houses want to focus on running their core businesses rather than getting into the business of generating power and this is why we see a bigger focus on the IPP model. Key risks such as plant construction and ongoing operations of the power facility are all passed on to an experienced IPP.

The IPP route means that the project can be financed by potentially using longer-dated financing instruments, which assist to bring down the cost and result in a more competitive tariff. Some IPP partners also use a portfolio model to structure their offering, where they use the same vehicle to sign up multiple PPA’s, which reduces the credit risk for investors and financiers looking to deploy capital in such a structure.

In the eyes of the finance partner, the PPA model is well proven and forms the basis upon which the financing is structured. Payments for electricity under a PPA typically rank as an operating expense at the top of the creditor waterfall and before debt-servicing costs. This should result in a lower overall risk as the counterparty is in effect trading in one operating expense (Eskom) for another (IPP power).

Lastly, execution risk is a major consideration for banks and finance partners assessing green energy projects in South Africa. If your core business is extracting and processing minerals and resources, what expertise can you realistically bring to the table when it comes to managing an energy project? By partnering with experts in their fields, you can transfer construction and operating risk to the IPP who specialise in these activities.

At this point you might be thinking you have given all due consideration to building out your green energy project but one of the often-overlooked elements of these projects are the legal and contracting frameworks. The devil, as they say, is always in the detail.

These are some important commercial aspects of these agreements which directly impact the bank’s credit assessment of a specific opportunity:

  • Have you contemplated contact termination and how is this dealt with in the PPA? The debt provider wants certainty that the contract will remain in place for the long-term and there will be appropriate compensation in scenario’s where the contact gets terminated early for no fault of the IPP
  • Have all relevant licenses and approvals been obtained, including approvals required as a power generator, but also from the relevant authorities in respect of social and environmental standards? Most projects also require wheeling of power over the Eskom and municipal grid, and the legal and commercial arrangements relating to wheeling also need to be considered
  • Thirdly, South Africans became very familiar with the term “Force Majeure” in 2020 as the COVID-19 pandemic significantly disrupted business operations. While it is difficult to plan for a pandemic, it remains important that contracts provide a fair risk sharing between parties when it comes to dealing with unforeseen events, especially where insurance may not always be able to cover all risks.

Executive teams from mining houses across South Africa are facing some tough choices this year – the sector is booming and they have the opportunity to deploy capital, create jobs, attract foreign income and drive local supply chains. On the other side of the equation is unpredictable electricity supply which will hold back their ability to grow and the naysayers will be cautioning against investments in energy infrastructure.

As a bank, we believe that the pendulum is swinging toward the side of the optimists and we look forward to engaging with our clients around structuring appropriate funding for their projects.

Theuns Ehlers Author
Theuns Ehlers

Head: Project Finance and Resources, Absa Corporate and Investment Banking

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