Financial Mail - Investors Monthly
POWER PLAY
Renewable energy will need innovative funding
The government’s landmark decision to increase the embedded generation threshold from 1MW to 100MW effectively lowers the last hurdle to mass private sector investment in renewable energy production.
“To date, the single largest stumbling block to private power proliferation has been the licensing constraints. With this removed, we expect the renewable energy sector will see rapid and sustained growth,” says Martin Meyer, head of power and infrastructure finance at Investec.
Amid unreliable electricity supply and load-shedding due to capacity constraints, coupled with Eskom’s runaway electricity costs, the value proposition for independently produced energy through renewable generation has become extremely compelling.
“Many companies have been desperate to secure more reliable and cost-effective energy supply for a long time but were unable to get these projects over the line,” says Meyer.
Many businesses, particularly intensive users in the mining, manufacturing and agricultural sectors, welcomed the announcement and plan to embrace renewable energy projects to supplement their power sources or even end their reliance on Eskom.
“These businesses will also benefit from increased productivity and cost-efficiencies due to less reliance on diesel and other back-up generation methods,” adds Meyer.
Meyer expects that a combination of solar, wind and hydroelectric power generation will dominate renewable energy projects once the government finalises amendments to schedule 2 of the Electricity Regulation Act.
From a financial perspective, return on investment from renewable energy is generally immediate, but implementing large-scale generation projects requires significant upfront capital or intelligently structured funding models.
“Innovative funding will be key to get these projects off the ground and make them viable with the large capital outlays required, especially for projects that approach the 100MW threshold.”
In this regard, projects require the right combination of equity and debt. “Cheaper, longer-tenor debt delivers better returns for the investor and lowers the tariff,” Meyer says.
Some companies with available resources may opt for self-provision.
Nadia Rawjee, director at development funding consultancy Uzenzele Holdings, says:
“Established private commercial and industrial power users typically utilise a combination of property and asset finance to finance on-balance-sheet renewable energy projects, which generate power for their own consumption. This is among the simpler and quicker options to raising capital.
“Industrial users such as manufacturers and mineral beneficiators that require energy supply can also utilise structured project finance through a combination of debt, mezzanine finance, equity, already capitalised 12J venture capital funds and cash grants or incentives.”
Rawjee says these grants can contribute up to R50m in a cost-sharing structure ranging from 10%-50% of the renewable energy project based on eligibility and other criteria.
However, most intensive users don’t have the sites or the resources to efficiently provide renewable energy for themselves.
Meyer expects that independent power producers (IPPs) will account for the bulk of generation via off-take agreements with corporates.
“Typically, IPPs rely on project finance as there is no balance sheet behind them to fund transactions. This comes with the need to allocate risk appropriately, especially if there is only one off-taker.”
In these instances, it is imperative to find the institutions best placed to manage the transaction risks, which in smaller deals can make project financing prohibitive.
“Smaller projects require ‘bulletproof’ technology and proven engineering capabilities from implementers, and applicants need solid balance sheets — most small projects are selffunded or funded through commercial lenders or alternative lenders on balance sheet,” says Rawjee.
Bigger deals bring economies of scale and are typically funded using traditional structures.
Meyer says: “For smaller deals, equity typically funds the construction phase and debt comes in when plants are operational. If projects are installed correctly and operating to spec, IPPs can refinance equity and roll the debt.”
While government support has enabled existing projects to secure 18-year debt, corporate balance sheets don’t typically allow for such long amortisation periods.
“In these instances, IPPs need tenor extensions, especially if they only have one offtaker. Development finance institutions are gearing up to fill this gap,” says Meyer.
For instance, the Development Bank of Southern Africa and the Green Climate Fund recently announced a $200m facility to support the construction of private sector wind and solar plants ranging in size from 10MW to 75MW. ●