Offtake risk — the pivotal energy finance barrier blocking Africa’s path to power
Sub-Saharan Africa’s electricity system is caught in a vicious cycle — the region urgently needs access to affordable electricity, but poor economic growth and low income all too often lead to the potential for bad debts, tariff-under-pricing and theft which in turn increase financing costs and delay the much-needed investment in power infrastructure.
Offtake risk — the risk of not getting paid for the power output– is borne of these conditions and it’s an investor’s worst nightmare. But in a continent with abundant energy resources, access to affordable electricity should not be an exception.
Over half of the world’s 1.1bn people without regular and reliable access to electricity live in the region. Electrification efforts are having an impact and outpaced population growth for the first time in 2014, leading to a decline in the number of people without access to electricity (see chart below). But that number is still higher than in 2000.
Overall, progress has been uneven and in 2016 the total electrification rate in Sub-Saharan Africa was just 43%. These increasingly youthful countries desperately need access to power if their economies are to grow and achieve prosperity and all the benefits associated with it.
If the energy transition is to be truly global, power investment needs to flow much more quickly and efficiently than it has in the past. However, the risks to power investment are sometimes so deeply buried in the economy that, despite the best efforts of the public and private sectors, providing solutions to address them has proven challenging.
In Sub-Saharan Africa, the standard investment route for private investors relies on a state-owned utility as the main project counterparty responsible for purchasing the power output at a pre-agreed price. Yet, the financial sustainability of electric utilities in many countries remains highly unstable. In a report from 2016, of the 39 countries studied, only two were fully recovering their costs of supply, with 20 countries not even covering operational expenses. The same analysis showed that fixing operational issues would solve the problem only in part, as in the absence of generation mix optimization, tariff under-pricing remains a key challenge. In this environment, it is hard to imagine how utilities can secure creditworthy status and maintain existing infrastructure let alone drive investment in the new power capacity that is so badly needed.
Given this ongoing financial instability, currency depreciation — as a result of falling commodity prices — or increasingly stretched government budgets can have significant impacts on power project bankability. Such negative shocks could lead to the implementation of retroactive tariff reductions or payment delays.
The risk that one of these outcomes may materialise means that debt investors in many countries will price the offtaker ability and willingness to pay in their returns, reducing the amount of debt that projects can attract and increasing the price charged to the consumers — an undesirable outcome particularly in a region where affordability is already a challenge. While riskier projects should be rewarded with higher returns, in theory, the current underinvestment in Sub-Saharan Africa suggests that there is a limit beyond which investors are willing to accept higher returns. This means that some useful projects remain unfunded.
Lowering the cost of capital can accelerate the energy system transition, but that can only happen by improving the efficiency of capital flows and capital allocation. In the CPI paper Financing clean power: a risk-based approach to choosing ownership models and policy/finance instruments we presented a framework with risk-allocation at its core, designed to determine the most appropriate ownership model for power projects. With the ownership model in place, financial vehicles and policies can then be used to fine-tune risk allocation and reduce cost of private capital for the project. We propose applying a similar approach to evaluate existing and new solutions to address the underlying sources of offtake risk.
Currently, risk mitigation instruments exist for investors who want to finance power projects in Sub-Saharan Africa. Both national government and development finance institutions offer project level instruments, without which many projects would not have been economically viable.
For example, the Government of Nigeria provided support to the Azura-Edo open cycle gas turbine project in the form of a put and call option agreement, allowing the project company to ‘put’ the plant, or put its shares to the government in nearly all circumstances where the PPA is terminated early, including in the case of a prolonged gas supply failure. It was also the first power generation project in Nigeria to receive a World Bank partial risk guarantee and political risk insurance from the Multilateral Investment Guarantee Agency.
Many variations and combinations of these instruments exist. On the other hand, risk mitigation which operates at the offtaker level can be supported by legislation. For example, in Cote D’Ivoire legislation was introduced to establish payment priority to independent power producers which meant that IPPs could receive payments even during a crisis situation. Finally, the introduction of an intermediary creditworthy counterparty has been discussed as a potential solution to address the issue at offtaker level.
The trade-off for the investor in choosing the appropriate mitigation instrument is often between effectiveness and simplicity. The investor may choose to shift all the risks to a single entity — this option is simple to arrange for the investor but may expose the project to more risks if, for example, the instrument is provided by an unstable sovereign and therefore this may limit the instrument’s effectiveness. Alternatively, the investor may choose to shift different risks to separate entities; this may be effective in addressing the individual issues but may be more complex and costly to arrange for the investor. The ideal solution is probably between the two. The research and evaluation of the range of options which make up this ideal solution is the subject of our current work in the area and will be analysed in the context of investment mobilisation.
Fixing the balance sheet of state-owned utilities won’t happen overnight, because it would require sustained economic growth and structural reforms. With the risk-framework allocation in mind, some of our ideas to speed the energy transition include widening the search for and creating new counterparties designed specifically to enhance creditworthiness with respect to power purchase agreements; developing new concepts for financial vehicles that allocate specific risks to different investors and limit reliance on single counterparties; and, refining policy, regulation and ownership models to reduce the cost of securing creditworthy status for potential counterparties.
The process of mitigating one or multiple risks can be standardised but given the technology, market and country context, the cost-effectiveness of the instruments will depend on the specifics of each project. However, the need becomes ever more urgent to accelerate power investment and break the cycle and enable the economy in Sub-Saharan Africa to flourish.
Gaia Stigliani is an analyst with CPI Energy Finance.