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Power sector policy changes that will unlock significant value

28 July 2021 Theuns Ehlers, Head: Resource and Project Finance, Absa Corporate and Investment Banking

Seventy-five billion Rand.

This is the estimated value of construction sector related economic activity that could potentially be unlocked over the next few years following the recent announcements from President Cyril Ramaphosa to allow businesses to produce up to 100MW of power as the energy mix in South Africa changes…. And this is only the start of the potential value unlock.

For the last two decades, industrial businesses operating in South Africa have been hamstrung by irregular power supply, rolling blackouts and load-shedding. Local investors have declined to deploy capital expenditure as economic growth was benign at the best of times while multi-national firms eyeing the economic hub of Africa were struggling to justify investing in markets where consistent energy supply could not be guaranteed.

The announcement on 10 June 2021 was a gamechanger on many levels and our bank expects to commit funding to a number of exciting energy projects over the next 24 months.

Importantly, a number of businesses in the mining, property and industrial sectors have spent a lot of time laying the foundation for the roll out of energy initiatives and won’t be starting from scratch when it comes to their projects. We are aware of dozens of projects that are well advanced and this will fast-track their timelines for implementation.

These are a couple of trends that we expect to see emerge over the next few months as funding for these projects are unlocked.

New generation partnerships
As it stands, there are typically two models which are on the table for funding of energy projects. The first – and less common structure – is one where the business uses its own balance sheet to procure the required equipment to run a project. In this model, the business retains the risks associated with construction and operating of the power plant. Debt financing is typically limited to corporate-style covenants, with shorter funding tenors compared to the IPP model. Regardless of plant performance, the business remains on the hook for the debt financing.

The second model sees a business entering into a long-term power purchase agreement with an Independent Power Producer (IPP). This is emerging as the more common structure and allows the respective businesses to focus on their areas of core competence.

An interesting sub-trend emerging here is that organisations are actively seeking out IPPs with strong Black Economic Empowerment (B-BBEE) credentials and we believe through a combination of financing from banks and financing institutions plus incentives out of the Department of Trade, Industry and Competition (DTIC), we could see the emergence of a number of new Black Industrialists in the energy space over the next few years.

Quicker approval of project funding
One of the long-standing features related to the official Independent Power Producer (IPP) program has been that government was standing behind the Power Producer Agreements, which was a requirement for investors and financiers to achieve bankability.

These new captive power projects will be driven by private sector agreements without the requirement for Government support, hence reducing the level of contingent liabilities in National Treasury’s books. Banks will consider the credit quality of the private sector offtaker in its assessment, but in most cases banks are prepared to take a long term view on the financing as the projects are value-enhancing and typically result in cost savings compared to current electricity tariffs.

The added benefit is that these projects are procured outside of official Government-run programs, potentially getting to execution in a shorter timeframe.

Businesses and consumers can plan
South African electricity consumers were trapped in a cycle of double-digit tariff increases over the past decade with limited certainty around future increases. One of the benefits of captive power solutions is that tariffs are typically linked to CPI, which provides more certainty and can assist consumers in long term planning.

If the historical trend of double-digit electricity price increases is to continue, the captive power projects should result in very significant savings on companies’ electricity bills.

Momentum is a powerful force
For the better part of two decades, the South African economy has been stuck in a low-growth environment and much of this malaise has been blamed on restrictive economic policy by government, including lack of certainty around power supply.

What has not yet sunk in for many people is that this change in policy could translate into 5GW of additional renewable energy capacity – almost the entire renewable energy generation capacity added to the grid over the past decade.

This bold policy change is likely to drive construction activity, job creation and general economic confidence across the broader economy. Big step-changes like this can be a catalyst for additional Foreign Direct Investment (FDI) and help the country regain its standing in terms of global competitiveness.

As a bank specialising in the funding of energy projects and a proven track-record of supporting high-growth businesses, we look forward to entering this exciting new phase in the local economic development.

Quick Polls

QUESTION

South Africa’s Financial Sector Conduct Authority (FSCA) has the power to raise revenues by issuing administrative penalties and fines against non-compliant financial services providers, with this money flowing back to the Treasury… Does this, in your view, create a regulatory / government conflict of interest?

ANSWER

Absolutely, as conflicted as it gets
Maybe, I’m on the fence on this
No, the FSCA can do no wrong
The guilty must pay
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