Partner James Simpson, counsel Katharine Sonneborn, and associate Giulia De Michelis at Winston and Strawn examine how Africa can benefit from experience gathered in the Middle East on infrastructure and power projects
Over the last decade, Africa has, for the most part, demonstrated resilient economic performance. But, by most measures and in most regions, sustainable and affordable energy development has not kept pace with economic growth. With the rising demand for power, Africa could witness a continued infrastructure gap which presents a genuine risk to its growth.
According to the World Bank, 25 of the 54 African countries are in an energy crisis. In Sub-Saharan Africa, only seven countries have electricity access rates greater than 50%, which means more than 600 million people (approximately two-thirds of the continent’s population) lack access to electricity. African governments have responded with conventional and renewable energy investment growth initiatives. Such initiatives include an opening of markets to private investors, the adoption of regulations to enhance transparency and legal certainty, and feed-in-tariff schemes to promote the deployment of renewables.
While many government initiatives have been met with great success, such as South Africa’s Renewable Energy Independent Power Producer Procurement Programme, others have not been as well received. The experience and lessons of successful Independent Power Projects (IPPs) and Independent Power and Water Projects (IWPPs) in Arabian Gulf countries and the wider Middle East over the last two decades can serve as guidance for Africa. The parallels are important – many parts of Africa have the same opportunities as Middle East countries had when developing their IPP/IWPP programmes, including significant economic growth, increasing consumer demand and an abundance of natural resources against a backdrop of strong interest from the international investor community. However, Africa faces a number of challenges – as the Middle East has faced and overcome – such as scepticism related to political risk and perceptions of inefficiency.
Clearly one model will not fit all and the variety and complexity of economic and political considerations across the African continent cannot be underestimated. Drawing on the Middle Eastern experience can make a vital contribution to the successful development of power projects in Africa. Project participants should feel confident that with the establishment of a process which follows generally acceptable procurement standards, Africa will continue to represent a significant and exciting opportunity for the power project market.
In this article we examine and consider six key lessons from our Middle Eastern experience and how they may contribute to the effective development of power projects in Africa.
The Middle East: A (very) brief history of IPPs and IWPPs
The Middle East took on the challenge of the infrastructure gap in part by developing IPPs and IWPPs. Both have played a major role in the electricity and water sector in the Middle East providing for significant additional generation and water production capacity in the region. Abu Dhabi alone has procured one IPP and nine IWPPs, the most recent being the Mirfa IWPP, which closed in October 2014, resulting in an aggregate of approximately $14bn of finance raised and over 14,500MW of contracted capacity. The Abu Dhabi model has also been successfully adopted, with certain variations, by other countries across the region, including Qatar, Bahrain, Saudi Arabia and, more recently, Kuwait.
What lessons can be applied in Africa based on the Middle East experience?
A clear, fair and consistent independent regulatory regime
The Middle East experience demonstrates the benefit of having a clear and consistent independent regulatory regime which is built to respect political realities but at the same time facilitates private investment and ensures fair regulatory oversight from both the public and private sectors.
For example, in 1998, Abu Dhabi issued comprehensive legislative framework, governing its power and water sectors, including a coherent regulatory regime, the provision of guidelines for the development of IPPs and IWPPs and, critically, the establishment of an independent regulator.
A transparent procurement process
A thorough, transparent procurement process is essential and project procurement should be by reference to specific non-discriminatory criteria and open to appropriate public scrutiny. For example, the opening of financial bids should take place on the bid submission date and in public.
A well-structured and consistent contractual template
It is also important for projects to be well structured and follow a contractual template that delivers bankable projects while not requiring extensive reworking for each new development. In the Middle East, the legal contractual matrix, with the power purchase agreement (PPA) at its heart, has rigidly followed precedent through the IPPs and IWPPs across the region, regardless of changes in commercial terms or market conditions.
Bankability: Stability and strength of supply and off-take arrangements
In particular, the key to success is ensuring there is a bankable contractual structure. The PPA should ensure a source of revenue over a tenor which is sufficient to ensure the repayment of the project finance loan and provide a return to investors. In this respect, the careful selection of creditworthy counterparties is one of a number of critical factors which will determine the bankability of the project. Similarly, the adequacy of the fuel supply arrangements, preferably by way of a fixed price long-term supply agreement, is a key factor in determining bankability.
In Abu Dhabi, the Abu Dhabi Water and Electricity Company (ADWEC) is responsible for the fuel supply as well as being the single off-taker of electricity produced by all the emirate’s IPPs. No government guarantee is issued in respect of ADWEC’s payment obligations; however, the Abu Dhabi government guarantees termination payments under the PPA.
Where the creditworthiness of an off-taker presents a concern, a higher level of government support is typically required.
Bankability: Tariffs and revenue generation
The tariff that the power producer can charge for the power it generates is fundamental to the bankability and ultimate success of a project. When setting a tariff, consideration should be given to realistic and comprehensive calculations of the costs of generating power and to the price which end-users are paying for the power.
In Abu Dhabi, payments by ADWEC to power producers have followed a take-or-pay structure comprising a capacity payment and an output payment. ADWEC also takes the fuel supply risk by paying fuel suppliers directly for the fuel consumed by the power producers.
Making use of the multitude of financing sources
Projects in the Middle East have been able to mobilise and leverage a wide range of financing resources. These have included export credit agencies, multilateral financing institutions, development finance institutions (DFIs) and political risk insurance providers.
All these sources, and in particular DFIs, who can supply due diligence, influence with host governments, and/or partial risk guarantees, which are likely to be essential in strengthening sovereign guarantees in countries with low credit ratings, will almost certainly be vital for the development of projects in Africa as well.