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LAGOS (Capital Markets in Africa) – Understanding the need for financing of projects in the African Energy Sector: The power sector is a fundamental building block for economic advancement in any country. Abundant, affordable and reliable energy is the cornerstone of growth in today’s world. The great efforts undertaken by the African States to supply sustainable energy to its people have been well documented in the last number of years, along with a shift from conventional fuels to cleaner energy sources. While the need is undeniable, the means, however, remain a point of contention amongst African states and their stakeholders alike.
Africa is undergoing a sustained period of economic growth and transformation with both an ever-growing population and diversifying economies, which undoubtedly requires a massive investment in energy. Consequently, providing greater and more reliable access to energy is one of Africa’s most pressing needs and greatest opportunities. The African continent is relatively underexplored and is today experiencing a modern-day renaissance across various sectors. It currently presents some of the best investment opportunities in the world, attributable to among others, its vast untapped energy resources which, if harnessed and processed efficiently, can provide energy at an affordable cost.
Accordingly, African governments, international organizations and private companies are actively promoting investment in energy projects to supply energy to underserved markets and remote territories in most African developing countries.
The prevalence of project finance continues to gain traction in Africa, but not without its share of challenges and complexity. In their quest to develop their economies and infrastructures, numerous African countries have engaged in various energy projects on their own and through other structures such as public-private partnerships.
Complexity in Financing Energy Projects in Africa
Projects financing is tending to diversify and move away from public lending, which was historically the major source of funding, towards more equity financing, or a balance of both. However, equity financing remains challenging in the absence of reliable power off takers and adequate, stable local regulation. The large funding gap for new energy projects cannot be met by the public finances of African countries alone, and governments are struggling to fund their power needs as they are unable to raise sufficient debt at affordable rates and most utilities have low investment grade ratings. The success of power projects depends on the ability of African governments to negotiate, implement and maintain them, yet, despite the enforcement of training of local employees in national content regulations, there is still a lack of local skills needed to ensure the sustainability of power plants built by private companies. As a result, more resources have to be spent on capacity building in the regions to develop stronger regulatory frameworks, including streamlining and speeding up the IPP and Power Purchase Agreement (PPA) processes, and most financial markets in African countries are newly established or non-existent.
It is widely acknowledged that the private sector can play an important role in tackling Africa’s energy crisis, and to meet its growing demand for power, African governments now need to attract greater levels of private investment to scale up generation capacity by providing a sound investment climate and enabling environment, including legal, fiscal and political stability. Fortunately, trends have shown that private investment in Africa is growing, especially with Independent Power Projects (IPPs) and investment from China, predominantly thermal and hydro, respectively, now being the fastest growing sources of funding for power projects in Africa. Despite evident private sector involvement, projects in Africa’s energy sector are still often difficult to finance and to reassure potential investors, their legal structures are generally rigid and tend to include more securities instruments than one would normally expect.
African state-owned companies in power supply are often drained of resources because of subsidised fuel prices and competition from other spending priorities, as in Nigeria and Mozambique by way of example, and face the challenge of financial participation in huge capital-intensive projects. In many parts of Africa, tariffs are either too high for consumers or too low in relation to the costs of supplying them with power. The risk is that this locks the power sector into a cycle of low revenues, high debts, inadequate maintenance, under-investment and poor quality of service.
African currencies and the risks in the global market economy
The cycle of economic and financing uncertainty concurrently with Africa Governments propensity to make unpredictable policy changes in respect of currency movements have elicited a sentiment of unreliability of African currencies among some investors, risk which some African states have sought to mitigate through measures such as the FCFA which is fixed to the Euro under the CEMAC regulations in order to accommodate currency fluctuation. In light of this, companies in the process of acquiring power facilities tend to include provisions in the protection of such risks drafted in the power purchase agreement.
Regulatory uncertainty and a lack of political commitment
One of the major barriers to investment in the African energy sector is the absence of certainty with regards to legal frameworks for investors, which make decisions on whether or not to invest in a particular jurisdiction difficult. The knowledge that the rule of law is being abided by all stakeholders is fundamental to investors, because in situations where investors live in fear of key legislation being consistently subject to review, proper decisions on investment cannot be taken. The prevalence of long lead times between the decision to invest and the granting of the authorisations impacts and enhances the uncertainty even further.
In Africa, as is elsewhere in the world, clear energy sector policies in combination with reliable, predictable regulations are the key to unlocking investment, improving efficiency and significantly increasing energy access. Having appropriate and updated regulations and a well-designed regulatory strategy is important for governments, companies and investors. The maturity level of the energy sector in Africa differs widely. Numerous countries have implemented regulatory change in recent years to improve overall sector performance, but many others have kept their energy sector regulations and market design unchanged. Concerns about regulatory uncertainty could include government implementing clear, conducive energy sector policies and structures, stable regulatory environments, framework which clearly specifies market structure as well as roles and terms for private/public sector investments, transparent, predictable licensing and tariff framework to improve investor confidence, and procurement/bidding practices which are transparent and competitive.
The drawbacks and benefits of the bidding process
Competitive biddings are particularly noteworthy in the energy sector as they guarantee that power projects are carried out at the lowest possible cost while promoting the development of bankable projects in the renewable energy sector. Nonetheless, one of the main issues of this intricate process is the fact that most African governments fail to provide project developers and funders with strict standardized long-term contracts and reliable timelines. In this regard, the process is marked by negotiated deals. These factors are detrimental to the energy sector as it pressurizes investors and lenders to withdraw from deals due to the uncertainty and unfairness of the process. Pre-selection may, to some extent, deny opportunities for several sources of investment which reinforces the need for the implementation of a clear regulatory framework.
Sovereign Guarantees and Power Purchase Agreements
It is often the case that IPPs require the host government to issue a sovereign guarantee, however, with the current trend of increasing public debt of African governments, the challenge is always whether or not a government should accept the obligations imposed by the investors.
On one side, a sovereign guarantee is an attractive tool for the government to reassure potential investors because, unlike conventional public spending, it does not require immediate payment or explicit budgetary constraints. Sovereign guarantees are usually issued to guarantee buyer obligations under the power purchase agreement.
On the other, a sovereign guarantee is a contingent liability to be recorded in the host government’s balance sheet. In other words, it constitutes a future and conditional financial obligation which realisation depends on the occurrence (or absence) of one or more future events potentially not under the control of the government. The risk associated with contingent liabilities is therefore not easily identifiable or quantifiable. This complexity has created significant uncertainty about the sustainability of the public debt of several countries which have contingent liabilities and has led investors to reverse the credit rating of certain countries in the recent global financial crisis. It is on this account that certain African countries such as Kenya are no longer issuing sovereign guarantees in their energy projects.
Few would argue the importance of having an enabling environment with clear and precise legal and fiscal regulation frameworks, within which both the government and the private sector will be able to reach breaking ground on financing energy projects and increasing participation in such energy projects in pursuit of the continent’s economic growth.
It is imperative that African government find the political will to make a number of critical decisions rapidly and transparently on developing clearer legislative and fiscal frameworks, standardising power purchase agreement model, more effective rating systems and so forth. Here, generation, distribution, and pricing models could be handed to more private sector players to make vital energy supplies more competitive, and the government’s role will be to regulate the energy sector effectively, while creating and maintaining an enabling legislative environment conducive to investments which will enable African countries to tap into their rich reserves. Dialogue and collaboration between all stakeholders in this instance is an essential prerequisite.
This article is featured in the April 2017 edition of INTO AFRICA Magazine, Powering Africa’s Energy Projects.
Adaku Ufere heads the Energy practice at Centurion Law Group; managing legal teams across; Equatorial Guinea, Ghana, Cameroon, and South Africa and directly developing and managing multiple strategic partnerships across the globe for the firm. Adaku has extensive experience in the Oil & Gas and broader energy industries, and is an expert, deeply familiar with the legal and commercial aspects of international contracts, international corporate framework, contractual management clauses and key contract risks. Adaku advises several clients on matters including; Hydrocarbons, Mining, National Content, State Assets, Oil and Gas Infrastructure and Power, and has negotiated multiple Joint Operating Agreements, Memorandum of Agreement/Understanding, Master Service Agreements, Production Sharing Contracts, and Service Contracts, for African and International Oil & Gas companies, with global Exploration and Production interests. Adaku has an LLB from the University of Nigeria, a BL from the Nigerian Law School, and an LLM in Oil and Gas from the University of Aberdeen. She is a member of the Nigerian Bar Association, the International Bar Association, and the Young Women in Energy Association. She is also a certified Chartered Arbitrator and an Associate Member of the Chartered Institute of Arbitrators (United Kingdom). She was recently named one of the 40 Under 40 Leading Lawyers in Nigeria at the Nigerian Legal Awards 2016.
Keseena Chengadu is an Associate Attorney at one of the largest Oil & Gas Law firm in Africa. She dutifully advise clients who wish to set up companies in Equatorial Guinea with regards to the Oil and Gas sector by addressing to due diligences and reviewing of contracts. The main components of her work include drafting contracts, advising on oil and gas matters, working on due diligence reports, reviewing legal agreement, documents, laws and regulations, advising clients on OHADA and CEMAC regulations. With more than 6 years of experience in corporate and business law, her skills were harnessed in light of the different aspect of the legal industry. Prior to joining Centurion she practiced law in a French law firm in Mauritius, worked as a corporate Law lecturer at the University and was part of the Board of Directors of a few companies, some of which she still sits on. Her experience allowed her to be fully proficient in undertaking a plethora of legal task with dexterity and tact as she got a whole-some insight in the legal business world though many challenging situations.
Cynthia Yav is an associate at our Johannesburg office. She has experience in project, structured and corporate finance, commercial law, energy and resources, litigation, cross-border infrastructure related project and public sector procurement (PPP and project finance). Prior to joining Centurion Law Group, she was a Legal Consultant at Dlamini Attorneys, a law firm based in Johannesburg. Cynthia completed her LLB at the University of the Witwatersrand, South Africa, and holds training certification in inter alia, advanced company law, private-public partnerships, the National Credit Act and Consumer Protection Act.
Leslie Mamouaka is an intern at the Johannesburg office of Centurion Law group. She has just completed her B.S in International relations and Women and Gender studies at the University of California, Davis. Prior to joining Centurion Law Group, Leslie joined the Tanzania Women Lawyer Association as well as Fairtrade USA to help the social and economic development of local communities”.