Since the demand for electricity in Africa will likely triple by 2030 due to rising living standards, industrialisation and growing electrification rates, there is an urgent need to fuel the economic growth with sufficient energy to power the continent.
Renewable energy sources are favoured to meet this demand but they can’t succeed on public funding alone.
In order to increase the proportion of renewable energy sources in the energy mix, private investors will have to play a bigger role in financing new investments as public funding is unlikely to increase. In comparison to Europe and North America, financing renewable energy projects across most parts of Africa is challenging due to uncertain energy policies and higher financing costs amongst other factors. The following de-risking tools can be considered to ease the burden on investors.
Public de-risking instruments
Institutional capacity building, renewable energy resource assessments, grid connection and its proper management, skills development for local operations and maintenance are some of the primary public sector measures that help attract investors. In addition, organised power procurement methods coupled with consistent long-term renewable energy policies, streamlined permit processes and standardised project documentation can also help entice international developers. Given their impressive track records and access to vast internal expertise, such developers are able to access funding at lower costs. The success of initiatives such as the World Bank’s Scaling Solar and KfW’s GET FiT programme have shown that a transparent process puts investors at ease and encourages global investments in developing countries with relatively new or underdeveloped renewable energy sectors. By directly targeting barriers that create investment risks, public institutions can play a major role through policy de-risking of both on-grid and off-grid sectors. Improvements in the technical capacity and financial stability of energy regulators, public utilities and rural electrification agencies can also have a positive impact. For the latter, financial incentives and targeted subsidies may also be considered to encourage the development of mini-grids.
Financial risk mitigation instruments
The options available to improve the risk profile of the energy sector in developing countries differ from country to country with more options available in markets with a developed, open, and stable political system. The following three instruments have helped in directly addressing investment risks in several countries:
Guarantee instruments can improve the structure and quality of renewable energy investments, making projects more attractive to private investors. These are usually issued by public entities to address political, policy, credit and currency risks. Under exceptional circumstances, guarantees can be issued to mitigate a technology specific risk such as geothermal resource risk guarantees.
Most governments are increasingly reluctant to issue such guarantees due to financial constraints, obligations under the International Monetary Fund and a lack of capacity to support smaller projects. National bank guarantees, corporate guarantees and risk guarantees issued by Development Finance Institutions (DFIs) or export credit agencies are viable alternatives.
Political risk insurance (PRI): Renewable energy investors often face the risk of unstable political systems as well as inadequate rule of law. PRI provides tremendous value to investors by allowing them to transfer risks to international institutions with the capacity, expertise and local market information to better mitigate them.
The most popular type of cover for potential lenders and equity holders is the Four Point PRI, which insures against Breach of Contract (almost always via Arbitral Award default), Transfer Restrictions/ Currency Inconvertibility, Expropriation along with the risk of War & Civil Disturbance.
Several institutions such as the Multilateral Investment Guarantee Agency, the African Trade Insurance Agency (ATI), the Islamic Corporation for the Insurance of Investment and Export Credit, along with multilaterals and private insurers, are able to provide such policies with varying eligibility criteria.
Partial risk guarantee (PRG): This is a financial guarantee extended to commercial lenders covering payment defaults that result from the non-performance of a government or government-owned entity on its obligations with respect to the specific project (e.g. the risk of non-payment by state-owned enterprises, change in law/regulatory risk, expropriation risk, etc.).
Two key features of PRGs are their cover, which includes the debt portion of a project, and the stipulation that the host government must sign a counter indemnity in favour of the issuer. PRGs have traditionally been issued by the World Bank with the African Development Bank having recently issued its very first in support of the Lake Turkana wind farm in Kenya.
For projects that involve an element of trade, access to export credit guarantees may be helpful in covering the risk of default on any debt service as well as reducing the financing costs and perceived risk of local lenders.
Mitigation of currency risk
Currency risk arises in situations where the project has revenue in a local currency and loan payments in hard currency: a mismatch that arises often for renewable energy projects. An additional risk is that of currency inconvertibility, where payments have been made but a lack of hard currency means repayments to foreign investors are not met. In addition to PRI cover, the following may be considered:
Currency hedging instruments: The use of forward contracts and swaps as hedging instruments. One key consideration for investors will be the cost in comparison to local debt.
Local currency lending: DFIs can address high hedging costs by investing capital in funds that provide local currency lending through portfolio diversification. The TCX currency fund, which offers local currency loans in emerging countries as well as GuarantCo, which provides flexible guarantees over local currency loans, are market leaders in this space.
Liquidity risk mitigation instruments
In addition to the internal tools that could be considered by investors (i.e. Debt Service Reserve Accounts, Over Collateralisation, Excess Spread Accounts, Contingent Equity), additional external options exist which can help better manage this risk in order to see more projects reach financial close. For instance, the Regional Liquidity Support facility (RLSF), an initiative of KfW and ATI, covers up to six months of the Independent Power Producer’s revenue via a Stand-By Letter of Credit. KfW and ATI provide the collateral for the Letters of Credit, lessening the burden on power utilities and enabling more projects to reach financial close. PRGs can also be used to mitigate this risk. Liquidity guarantees and options provided or backed by DFIs are also a way to ensure long-term lending for borrowers.
The availability of grant or public funding would make developing markets more attractive to investors looking to roll out renewable energy products in developing countries. Investors should also look into the possibility of standardising and aggregating their projects. This has been proven to mitigate key risks and increase a project’s appeal to both commercial and development banks.
Stable and predictable energy sector policies along with the availability of risk mitigation instruments would make Africa more attractive to investors. Making more projects bankable and increasing the continent’s share of the over $250 billion invested globally in renewable energy per year. This would also contribute towards the attainment of the UN’s 2030 Sustainable Development Goal 7: to increase substantially the share of renewable energy in the global mix. ESI
About the author
Samuel Obbie Banda is a Bilingual Assistant
Underwriter with the African Trade Insurance Agency (ATI) based in Kenya. He is part of the ATI team responsible for RLSF and other initiatives in the energy sector.
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