Building, owning and operating an independent power producer (IPP)
Independent power producers have a particularly relevant role to play in South Africa (and the rest of the continent), to both meet rising power demand and to do so in a way that has a minimal impact on the environment.
In this episode, our panellists discuss the IPP landscape, the role they play in meeting energy demand and the specific requirements and challenges of operating an IPP.
Our panel is made up of:
- Mike Meeser, chief investment officer, Revego Fund Managers
- Ziyaad Sarang, chief financial officer, Revego Fund Managers
- Mo Hoosen, head of power and gas, ENGIE Africa
- Chris Yelland, managing director EE Business Intelligence (moderator)
Meeser explains that an IPP needs to have a certain skill set to ensure success, including commercial acumen, environmental, operational, construction and other technical skills that allow them to shape a transaction that complies with the processes being run.
“Secondly, you need to have some form of funding to enable you to do this (which is not cheap) and thirdly, you need a proven track record,” he explains.
“That proven track record comes from taking a project from conception, through bid, successful bid, raise of financing, build it out and then start operating.”
Hoosen says there are a few things that come into play when a developer such as ENGIE looks at opportunities.
“There needs to be a fiscal, legal framework and contractual framework that allows for certainty in terms of making investments. These are often 20-year investments, so we need to be comfortable about the environment in which they happen,” he explains.
“Another thing that’s important to understand is that IPPs by their nature are embarking on an investment that is in direct competition with the host utility, so that acceptance of market competition and of private sector investment in the marketplace is also a necessary requirement.”
The operating and market environment is also important. “For example, to make it an attractive investment, the liquidity in the market should be there to enable financing of these type of investments,” Hoosen explains.
“Generally when we do an investment, we want to be there for the duration, but we also want to do it in collaboration with local partners and local participants. So if all those parameters exist, then yes, we will evaluate each opportunity on its own merits and accordingly make those investments.”
The regulatory environment needs to be an enabling one if IPPs are to thrive. Hoosen points out that the regulatory framework as it stands today does not allow for bilateral engagements between a developer and an off-taker, though progress is being made in that direction.
“At the moment they allow for up to 10 Megawatts behind the fence development of IPPs, but no environment currently exists to use the wires of Eskom. It would be fairly straightforward to agree a tariff that would compensate Eskom for the use of those wires,” says Hoosen.
“At the moment that regulatory environment does not exist and it is our hope that given the challenges that we face in the country and given the limitations that Eskom currently has, it can only be the private sector that would allow for this type of investment. I hope Eskom looks at this and sees the benefit of allowing power across the wires.”
What is involved in setting up and getting an IPP up and running? And how are these typically funded through the different phases of the development and finally the operation?
Meeser says in the first phase (development) one seeks out developers and shareholders who have the right risk appetite to take on the development. Various contracts would then need to be negotiated and then a financial agreement? reached with group of lenders.
As the project moves to construction phase, project management skills are needed to ensure the project is delivered on budget and within time.
“As you move towards a commercial operation date, which allows you to kick-start revenue under a public-private agreement (PPA) or whatever formal agreement you have, you would require a different skill set, and a different risk profile,” Meeser explains.
“Once you are into operations, you enter into a different type of potential risk profile because you now have operational risk rather than construction or development risk. And as you move along further, the risk profile drops and you get different sets of investors wanting to look at the project,” he adds.
“Post construction, you will take on the operational risk and look for a yield. Cash flows are based on a contract that has a tariff that is adjustable, so you have some certainty around the forecast revenues over the length of the PPA and beyond,” says Meeser.
Meeser says Revego as a fund is looking at the post construction period, where they look for yield. “We’re not willing to take a look at development or construction risk, we are looking at the future cash flows and those sort of returns are pretty good because they’re inflation-linked and also there’s some certainty around the off-take, and predicting the renewable space,” he says.
“[Revego as a fund] is basically a good investment for somebody looking for yield and certainty. It’s also inflation-linked, because a lot of tariffs are adjusted for inflation on an annual basis.”
Turning to the rest of Africa, Sarang says it’s important to bear in mind the differences in utility scales, in terms of off-grid and self-generation.
“Typically, the utility-scale projects are greater than five megawatts. Five megawatts are on the small side of things in South Africa – projects are typically greater than 10 megawatts – but in the rest of sub-Saharan Africa, greater than five megawatts would be viewed as utility scale,” he points out.
“For an off-grid application that can be anything, you know, between five and 20 megawatts, which would also include some mini-grid applications. Self-generation would only be for use typically in mines or industrial applications that would look to put in place a power plant and contract with an IPP for their own use.”
Sarang says that the utility scale application that we’ve seen successfully deployed in South Africa is the renewable energy IPP programme, with Eskom as the large off-taker.
Off-grid projects are attracting a lot of attention from developers, particularly in Sub-Saharan Africa, he notes.
Finally, there’s self-generation, where, Sarang notes, it’s really a question of what the off-take is.
“For example in terms of a large industrial project or large mine, will it make sense in terms of cost recovery and revenue for the IPP? We’re seeing a lot of interest in this area in South Africa, particularly because recent amendments will allow no limit to the amount of self-generation for those projects and this year I think we’ll see a few of those projects come to market,” he says.
Hoosen says it’s quite challenging to find opportunities in Southern Africa where there is a degree of comfort in terms of the duration that is required. He adds that the need for energy infrastructure in Sub-Saharan Africa has to also be aligned with bankability.
“If you want to make investments in these environments, you need to ensure that all parts of the project allow you to be able to raise debt financing, and for the likes of Revego to participate. That means that the yield needs to be certain and predictable,” he adds.
Finally, expanding on Sarang’s point, Hoosen says developers and investors in the rest of the continent need to bear in mind that the scale of these investments is relatively small compared to South Africa.
“You need to factor in the scale of these investments, to see whether there is merit in utility-type investments or in what we would call corporate PPAs, which may be more suited to the environment of southern Africa – for example to build the infrastructure, dedicated to large electricity consumers such as the mining industry,” Hoosen concludes.
The views expressed in this podcast or not necessarily those of Revego Africa Energy Fund or a Revego Africa Energy Limited and do not constitute financial or other advice. Revego Fund Managers (Pty) Ltd. is an authorised financial service provider (FSP number 47561).