Article

Bankability in early stage African projects

Jade Palmer Jade Palmer

As institutional investors venture into emerging markets in search of yield, Africa is largely heralded as the new clean energy frontier given the abundance of solar, wind and geothermal resource that remains untapped.

In addition to significant natural resource, the demand for energy projects in Africa continues to exceed supply. The African continent requires around $70 billion of investment per year from 2015 to 2030 in order to meet its target of renewable energy providing 22% of Africa’s total energy consumption, according to the roadmap set out by the International Renewable Energy Agency (IRENA). 

And, while the opportunity is clearly there, actual deployment into the continent remains sluggish despite the large amount of capital pledged by funds for renewable energy investments. There is seemingly money to be spent, but a lack of projects. Or, in fact, not a lack of projects, but a lack of projects developed to a point where the large majority of the risk has been mitigated.

Apprehension by western investors looking to dip a toe into the African market often means their investment mandate is limited to investing in operational projects or, at the very least, a completely bankable solution.

Recent high-profile failures, such as Mobisol’s insolvency, have raised concerns for those investing in renewables across rural Africa, especially when considering its high-profile financial backers such as Investec, Dutch development bank FMO and the International Finance Corporation (IFC). 

But Mobisol successfully supplied more than 600,000 homes with electricity across Africa and business failures arose as a result of poor operational management, not project viability. Investors need to display a degree of resilience against headlines such as this because, without continued greenfield development on the continent, there will remain a limited pool of secondary market assets to choose from.

Attracting investment

The grand idea of capitalising on a first-mover advantage and reaping the development premia falls flat for many developers where substantial capital investment and time horizons are required to get a project to the point at which is considered to be bankable. Which is where the proverbial chicken or egg situation arises.

Without a bankable project, a developer is unlikely to attract capital investment. Without capital investment, a developer will struggle to create a bankable project.

The key to creating a positive investment climate in Africa will be to unlock the funding gap for feasibility stage projects. The first step will be to de-mystify and de-risk early stage projects, bringing investor expectations and reality closer together.

This requires the ability to realistically understand the risk-reward balance of the project and comprehensively outline and mitigate risks to the extent possible at such a stage of development. Projects at this stage do not often have the financial capacity to take on debt, with many sponsors initially funding the project themselves with cash equity. For many small developers, it’s not long before further capital investment is needed and additional equity investors are sought after. At this stage, equity investors are limited as they are required to take a longer-term view of the project, often requiring over 20% return on equity.

To make a project viable at this level of return, the focus is on the ability to foresee future costs and appropriately budget for these while remaining realistic about revenue forecasts. The most successful project developers ensure there is adequate contingency planning, with contingency costs reaching up to 20% of total project development costs. 

Diversifying risk

One way in which players can diversify risk is to tackle development using a multi-contract approach, though this makes it harder to maintain a good amount of control over the project. Project delays are often the main reason for development projects falling flat whether due to regulatory changes, contractor issues or otherwise. This is where larger and more diversified players have the upper hand, with many being able to wait-out project delays. Many smaller developers are required to partner with larger organisations or development funds in order to withstand the prolonged development phase. This is most effective where stakeholders have ‘skin in the game’, similar risk appetites and realistic time horizons.

However, partnering with larger stakeholders is typically at the expense of the project sponsor who, in return, will be required to part with a stake of project equity. Many sponsors are reluctant to do this until they have developed the project to a point where they may be able to realise some capital gain.

Early engagement with financiers and advisors will ensure the sponsor is aligning their efforts with the long-term view to raise future capital at bankable stage and helps to reduce the impact of unforeseen risks. Specialists such as InfraCo Africa combine a technical advisor and investor offering, which allows earlier stage projects the opportunity to be developed to the standard considered viable. Bringing the financiers along for the ride in the early days allows them to work together with the sponsor to mitigate key project risks and give the sponsor an indication of future project finance costs, terms and hurdles that should be considered as the project moves forward.

Assessing the obstacles

There are some risks, however, that an outside investor will just have to take a view on. Such risks include macroeconomic, political and regulatory risks. More specifically in renewable energy, the value of a power purchase agreement (PPA) rests in the security of the PPA, underwriting of it and the regulatory environment in which it is issued. For example, in some markets, the counterparty or utility is reluctant to issue bonds or warranties to secure payment in exchange for energy, but most international investors will be unwilling to look into a project without a warranty.

A recent example of how regulatory change can impact investment into renewable energy is the three year slow-down in South Africa’s renewable energy investment as a result of the state utility stalling PPA issuance to preferred bidders in the Renewable Energy Independent Power Procurement Programme (REIPPP).

What is clear is that governments seeking ambitious renewable energy and electrification targets need to do more to provide comfort for direct investors, by providing either incentives or guarantees that can enhance the credit quality of projects from an earlier stage without the need for third party intervention. While there are products that can help mitigate such political risk and provide project credit enhancement, such as Multilateral Investment Guarantee Agency (MIGA) guarantees, or the Regional Liquidity Support Facility (RSLF) offered by the African Trade Insurance Agency, these often have stringent requirements and are expensive for early-stage projects.

Reaping the rewards

On paper, the abundance of high-quality renewable resource and rapidly decreasing costs of technology suggest that the market in Africa could deliver energy at some of the lowest costs of energy worldwide1. But, in order to unlock this, something is going to have to give. Investors who wish to capitalise on a first-mover advantage are going to have to take that extra bit of risk for their reward, engage with project developers and jump the nest sooner if they are to have their pick of the projects.

For more information, please contact Jade Palmer

Footnotes

  1. Pre-construction projects: the battle to reduce uncertainty and improve business case bankability, K2 Management and JLT

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