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Evaluating the Need for Liquidity Instruments for IPPs

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By Obbie Banda – Underwriter

The African Trade Insurance Agency (ATI) issued the fifth policy under its Regional Liquidity Support Facility (RLSF) in support of the 7.8 MW Nyamwamba II Run-of-the-River hydropower plant in Uganda on 19 May 2022; closing Phase 1 of RLSF, a liquidity instrument jointly founded by ATI and the KfW Development Bank with grant funding from the German Federal Ministry of Economic Cooperation and Development (BMZ).

Under Phase 1, the five RLSF policies have been issued for the benefit of renewable energy projects in Burundi, Malawi and Uganda, enabling a total installed capacity of 116.3 MW and USD 172.5 million in total project financing.

The projects supported in Burundi and Malawi with RLSF cover were the very first solar Independent Power Projects (IPPs) within the two countries – reflecting not only the positive impact of the facility but the nascent nature of power markets across sub-Saharan Africa, in spite of notable progress having been made in recent years.

The launch of Phase 2 and a new RLSF structure

In February 2022, the Norwegian Agency for Development Cooperation (Norad) committed additional grant funding to ATI for the enhancement of RLSF and the development of additional guarantee instruments targeted towards similar renewable energy sector initiatives with distributed forms of renewable energy likely to be a key focus area going forward.

The adhesion of Norad, alongside the founding partners – ATI and KfW – further strengthens the technical capacity of the RLSF Steering Committee, the body that provides strategic guidance for this initiative.

The grant of NOK 500 million (around USD 56 million) from Norad, will go towards increasing the pool of first loss funding under RLSF – a key product feature that makes this unique instrument work – with the rest of the funding being directed towards technical assistance and first loss funding earmarked for similar guarantee initiatives.

Courtesy of this additional funding and lessons learnt as the first five policies were negotiated and issued, the product structure was revamped with ATI set to issue guarantees directly to IPPs without the involvement of an LC Issuing Bank as was the case under Phase 1.

This material change has been positively received by various stakeholders, including IPPs, African power utilities, lenders, and advisors, as it will greatly improve the efficiency of the policy issuance, and allow for greater flexibility in the nature of the contracts to be entered into, whilst also reducing costs.

Why RLSF and similar Liquidity Instruments matter

Between 2013 and 2018, structural reforms were undertaken in Malawi’s energy sector thanks to the financial support of the Millennium Challenge Corporation (MCC).

The reforms, which were undertaken under the USD 350.7 million Malawi Compact Program, resulted in the procurement of four solar power projects with JCM, Phanes and Voltalia being selected as the preferred bidders.

Whilst there was increased investor appetite in the sector, coupled with bankable project documents available to the developers and notable government support for the projects, there was a missing piece to enable the projects advance towards financial close – the requirement for the national power utility, Electricity Supply Corporation of Malawi Limited (ESCOM), to provide Buyer Payment Security for each of the projects.

ATI stepped in on behalf of ESCOM, providing liquidity cover amounting to a total of USD 8.9 million for the Salima, Golomoti and Nkhotakota projects – reducing the financial burden on ESCOM and providing the projects with a liquidity instrument from an A-rated financial institution that would not only provide assurance that liquidity will be available in the event of any payment delays but a commercially acceptable product that would provide additional comfort to project stakeholders such as international lenders.

In the absence of RLSF, alternative instruments would need to be explored to serve as the form of Buyer Payment Security – likely resulting in project delays, increased costs, and uncertainty on the availability of liquidity throughout the projects life.

The RLSF policies issued to the three projects were for tenors of 10 years, a much longer duration than most commercial instruments available to IPPs in many African countries.

A Brief Assessment of the African Power Market and what may follow next

The onset of the Covid-19 pandemic resulted in delays with project development, a deterioration in the financial standing of most power utilities, and an introduction of government policies meant to cushion the cost of buying electricity for end users – both commercial and at household levels.

This picture has slowly evolved as government policies shift to return power utilities to some form of financial competitiveness, and additional power generation projects are added to the grid.

Whilst wider sector trends have been well documented, what has become clearer – at least for ATI – is that there are notable cycles in the African power market.

Most countries are either in phases where they are looking to procure their very first renewable energy projects (understandably, developers and lenders will seek some form of government guarantees to make projects in these countries bankable), others are looking to transition from bilaterally negotiated contracts to some form of auction or Feed-in-Tariff, and lastly those that have gone through these first few phases and are more selective on the additional projects that need to come on board given a possible mismatch between current power supply and demand.

Why understanding each of these phases is important, particularly for newcomers to the market, is that it will undoubtedly guide the type of documentation each of the utilities and host governments will make available to you and the length of time it may take to negotiate and agree on a form of bankable documentation.

Whilst it may seem unfair to list countries in either of the first two categories – at least on record – markets such as Côte d’Ivoire, Kenya and Uganda firmly fit within the third and most advanced category of power markets.

North African countries and South Africa should be viewed and assessed in isolation given the unique factors faced by these countries – from high electrification rates (in part due to the dense nature of the North African populations around the Mediterranean Sea to Africa’s most industrialized country whose electricity needs far outstrip the type of planning and needs of its neighbours).

What can reasonably be expected is that country’s in the first phase of attracting renewable energy IPPs will have the greatest need to provide liquidity guarantees in addition to any government guarantees that address termination payments and other political risks.

This is duto the absence of any track record of making payments to IPPs and the need for additional comforts to be in place for investors to view this as an acceptable investment destination relative to other “safer” options in the region. Countries in the second and first phase may still need to make such guarantees available.

However (and increasingly), most investors no longer view this as being a deal breaker with an ever-growing number of projects closing without RLSF or similar market alternatives.

Closer to Home

In December 2022, I had the opportunity to drive through and spend some time in the eastern part of Zambia – along the shores of the Luangwa River – right in the middle of the country’s rainy season.

The timing of my visit coincided with an announcement that the country’s power utility – ZESCO – would start rolling blackouts of up to 6 hours (commonly referred to as load shedding) from 15 December 2022 following a notable reduction in water levels at the country’s Kariba Dam, the largest man-made lake in the world whose reservoir serves as the main electricity source for Zambia and Zimbabwe (the latter having announced even longer hours of load shedding given that country’s greater dependence on electricity from the lake).

As water levels in the Luangwa River continued to rise with each rainy day – with daily shifts that are visible to the eye, seasonal rivers begin to flow, and the savannah becomes greener, everyone starts to slowly forget about the dry months and challenges that preceded this period of relative abundance. Similarly short sided planning has guided the procurement of power generation projects in many African countries.

The dependence on huge hydro dams – whose short comings are immediately forgotten once there is abundant rainfall – has not waned with an imbalance in the generation mix that will likely continue beyond 2023.

If we are to make progress and move away from knee jerk reactions once faced with low water levels in our rivers and lakes, resulting in several hours of load shedding, the procurement processes need to be continuous, intentional and efficient.

Whether liquidity instruments such as RLSF will continue to play a role in such procurement should be a secondary consideration – what role each of the stakeholders (including ATI!) can play in supporting sustainable power generation efforts, coupled with additional investments in transmission and distribution infrastructure, should continue (or start to be) a real focus.

As ATI continues to stretch its underwriting pen, the adaptation of RLSF to address financing gaps for transmission infrastructure, could be our next big challenge.

Ensuring the availability of bright lights and sustainable electricity to meet growing demand across areas such as eastern Zambia – whether the Luangwa River runs full or dry.

The author is Acting RLSF Coordinator, African Trade Insurance Agency (ATI)

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