Shining light on the Power Sector in Sub-Saharan Africa

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By Ida Richter Gade

 
 

Introduction

Sub Saharan Africa (SSA) is home to some of the world’s fastest growing economies. Powering this growth is becoming a central focus for investors and presents a vital opportunity for companies in the power sector.

In 2015, infrastructure investments with private sector participation in SSA more than doubled to $6.3 billion compared to 2014. Almost all of these targeted the power sector, according to data from the World Bank. A 2017 World Bank report projects that SSA will consume 1,600 terawatt hours by 2040 which is four times that of 2010. While it is no surprise that companies from around the world are being drawn to the continent by the sheer number and scale of the opportunities, there is also increased interest because, with its abundant and varied natural resources, SSA is at the forefront of possibilities for innovation in generation, transmission and distribution technologies. And with scientific and technological advances lowering the costs to operate in the energy infrastructure market, the opportunities exist for companies of all sizes.

Demand is being driven by a number of factors including massive population growth, growing middle income groups and increasing urbanization, creating the need for reliable systems in order to maintain economic growth. Meanwhile, in addition to investment, new and better technologies, cheaper production and increasingly advanced business environments are enabling the supply side of this development.

In response to the challenge, policy reforms, including the unbundling of energy providers, are being enacted to promote innovation, technology and a healthy investment climate. This has led to increased cooperation between governments, finance institutions and the private sector on small and large scale projects with the help of new tools for financing and new deal structures.

The political will to address these challenges is also present. The African Union, a continent wide political union which includes all 55 African countries, has named energy as a top priority for the first decade of its 2063 agenda. In a similar show of ambition, the African Development Bank (AfDB), a multilateral development finance institution, has declared that its number one priority is to “light up and power Africa”. Similarly, in the US, this agenda has been embraced by Power Africa, a growth initiative implemented during the Obama administration with the goal of promoting the energy industry across the continent. Prior to this, the US launched the Millennium Challenge Corporation (MCC) in 2004, a US agency focused on results driven aid, such as successfully implemented energy programs. One of MCC’s core areas is the energy sector, and the agency has invested more than $13 billion since its inception.    

US based companies, particularly oil and gas majors, such as Exxon, have been operating in SSA’s energy and affiliated sectors successfully for decades. However, US presence extends beyond just the extractives sector to include both SME’s and major companies such as TetraTech, Louis Berger, Black & Veatch, Worley Parsons, APR Energy, GE and others. On the financing side, private equity firms, such as Blackstone, and Development Finance Institutions (DFIs), such as Overseas Private Investment Corporation (OPIC), are also heavily represented. However, the market is expanding and more investment and technological know-how is needed to fill the gap. Yet most US companies have been slow to approach SSA’s power sector. This is in large part due to a lack of information surrounding the opportunities, a lack of regional knowledge and an outsized perception of the risks involved in operating in SSA. These risks often relate to doing business in new political, cultural and corporate environments, which can present opaque business practices, incomplete or inefficient regulatory frameworks and complex regional relations. But the business climate in SSA presents a number of opportunities for US based companies and a sound investment climate exists - the main parameter for success in SSA, as in any foreign market, is market entry preparedness and sound risk mitigation.

Companies hoping to enter or expand their market presence in the SSA power sector need to look at a variety of factors, from commercial considerations such as identifying highest potential growth markets for their product or service in the medium and long term, to legal, political and regulatory environments in those markets as well as financial planning requirements. Unfortunately, most US businesses are not sufficiently familiar with SSA markets and SSA is notorious for its lack of widely available and reliable data sources. Therefore, US companies often rely on advisors with local knowledge and expertise to support them, as outlined in the chart below. While it is impossible to go into the specific informational needs of any one company here, this report aims to use this process to shed light on the general trends in energy generation, transmission and distribution projects, while assessing the main risks involved at the entry phase for most companies and identifying ways to mitigate these risks.

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Generation Trends

Of the 23 infrastructure projects to reach financial close across Africa in 2015, 22 were in the energy generation sector. In aggregate, these represented 98% of total investment with Rwanda, Nigeria, Zambia and South Africa featured in the top ten list, with deals ranging from $253 million to $900 million.

Predictions for energy generation sources indicate that SSA is on its way to creating a hybrid energy sector with a gradual increase in renewables. According to the International Energy Agency (IEA), more than 25% of total energy in 2040 is projected to come from geothermal, hydro, solar, and wind, compared with 21% today.

2016 was the fifth consecutive year where investments in renewables surpassed those in conventional energy sources in SSA on a year by year basis. But while costs of renewables have fallen and efficiencies have risen - a development that isn’t mirrored in thermal power sectors - upfront costs to solar and wind remain high and conventional energy still accounts for the top sector by total capital investments. Currently, generation from renewables is almost exclusively hydroelectric although solar, in particular, is on the rise.

●      Hydroelectric makes up the majority of current renewable energy generation, both globally and in SSA where it represented 84% in 2015. Hydroelectric is particularly prevalent in the Democratic Republic Congo, Mozambique, Zambia, Cameroon, Ethiopia, Sudan, and Nigeria. In Mozambique, the largest power generation plant is the Cahora Bassa dam, operated by the state owned Hidroelectrica de Cahora Bassa. This is the second largest dam in Africa with a capacity of 2,075 MW. Of current generation, 75% is sold to neighboring South Africa and Zimbabwe.

●      Gas discoveries in East Africa between 2010 and 2012 continue to attract investment. Both the West and East coasts sit on proven reserves, yet gas remains an underexplored resource. Gas is expected to account for more than 40% of the electricity generated from 2020. In Ghana, the Bridge Power project is expected to provide 400 MW, when it comes online. Bridge Power is structured as an independent power producer (IPP), with a 20 year power purchase agreement (PPA) with the state-owned utility, Electricity Company of Ghana, as the off-taker. Mozambique has commissioned several gas thermal plants, the latest of which is a 120 MW plant commissioned in 2015 under a PPA with Electricidade de Mocambique, the country’s utility. Gas based generation in the country is expected to increase by 18.1% annually through 2025.

●      Solar investment commitments in 2015 was $9.4 billion, globally. The two countries with the highest investments – and the largest percentage increase by 141% and 515%, respectively – were South Africa and Morocco. Solar photovoltaic (PV) hybrid technology is becoming more cost and energy efficient as the supporting technology becomes cheaper, allowing large scale industries, such as mining, to rely less on diesel generators in off-grid areas. Solar is expected to rise exponentially after 2030 and make up 8% of the generation mix by 2040. If this prediction comes to fruition, solar will account for more than 30% of capacity additions between 2030 and 2040. Mozambique’s first utility-scale solar power plant, a PV plant with a capacity of 40 MW, was commissioned in 2016. In neighboring Zambia, US solar manufacturer Solar First entered into an IPP consortium on a 54 MW project under a 25-year PPA. Solar First is contracted to deliver approximately 450,000 modules for the project. Also in Zambia, a tender was issued in April 2017 for a number of plants with the goal of producing a combined 500 MW under the government’s Scaling Solar initiative. Across the continent, in West Africa, Nigeria is also taking strides in solar activities. The Nigerian government has signed several power purchase agreements in recent years, including a 50 MW project in Kaduna state with the participation of a Houston based power producer and grants from the US Trade and Development Agency. In Jigawa state, also in Nigeria, a Canadian company recently signed a PPA with the government for 80 MW.

●      Coal capacities in southern Africa make up about 51% of the continent’s fuel mix and 91% of all of Africa’s coal reserves. South Africa alone has the sixth largest coal reserves on the planet. Coal is expected to continue as a staple source of power, tapering off around the middle of the century. However, global and regional demand for coal remain high, with regional industrial demand for thermal coal alone comfortably at 20 million tons per year. Although the vast majority of coal production in the region takes place in South Africa, neighboring Botswana, in south-central Africa, sits on over 4.5 billion tons in coal reserves in its Palapye region. US companies first became active there in the 1970’s and the country boasts a stable government as well as one of the healthiest business environments in the region.

●      Biomass, hereunder waste-to-energy, is underrepresented in the literature, despite examples of successful projects completed and more expected as urbanization in Africa increases. In Ethiopia’s capital, Addis Ababa, a waste-to-energy plant was completed this year as a turnkey project through an engineering, procurement and construction (EPC) consortium. Upon completion, ownership of the plant was taken over by Ethiopia’s power utility, Ethiopian Electric Power (EEP). The facility is expected to supply 50 MW of electricity to the national grid. The EPC consortium conducting the development includes China National Electric Engineering Co. Ltd and Denmark’s engineering company, Rambøll, which is acting on behalf of EEP.

●      Wind projects are still rare in the region overall. Partly because of up-front costs, and infrastructure complications - transporting turbine parts is costly, particularly over landlocked countries and where cabotage does not exist. Kenya, however, aims to generate 2,036 MW of wind power, or 9% of the country's total capacity, by 2030.

●      Geothermal is drawing attention, and estimates set potential for the East Africa region at more than 15,000 MW representing $40 billion in investment opportunities. The US is a world leader in geothermal technology and already has companies active in the SSA sector. Kenya, being the eighth largest producer of geothermal energy in the world, is a strategic target area. Kenya’s utility, KenGen, aims to add at least 3,000 MW capacity to the national grid by 2018. Geothermal sources currently account for one-third of Kenya’s installed capacity estimated at 2,150 MW. IPPs currently account for 10% of the country’s installed capacity generation, and the government is underway to eliminate its monopoly on transmission and distribution. Ethiopia, Kenya’s neighbor to the north, shows similar promise. The government has announced a 75 MW geothermal project at Aluto Langano, and the state utility, EEP, recently signed two power purchase agreements with private IPPs for the Corbetti project and the Tulu Moye project. The Corbetti project alone expects to develop up to 500 MW with an estimated investment volume of up to $2 billion.

Transmission Trends

Designing the optimal mix of power generation and grid capabilities is complicated when operating over vast geographical spread under politically variable conditions. Transmission and distribution are currently taking the shape of a system where the grid still plays a significant role, supported by off-grid households and mini-grid communities where appropriate, and supplemented by a cross-border supergrid.

Transmission is also subject to increasing regional integration, with more power being transmitted across state borders. Ethiopia, for example, is currently exporting to Sudan and Djibouti with MOUs signed for export to Tanzania, Rwanda, Burundi and others. Accelerating the process of regional integration is vital since natural resources do not respect political borders, and governments have long recognized that a reduction in energy poverty requires increased regional cooperation, for example through the existing Power Pools. To this end, all 55 countries of the African Union have been in talks to agree a continent-wide free trade area - Continental Free Trade Area (CFTA) - by the end of 2017 with the goal of creating a single integrated market with a combined GDP of $3.5 trillion. If CFTA comes to fruition it would speed up large scale, cross border transmission projects substantially. At the national level, current transmission capacity varies greatly as highlighted in the examples from neighboring South Africa and Mozambique, below.

South African ESKOM, the country’s public electricity utility, is modernizing existing power plants and transmission lines. To strengthen its grid, ESKOM has already spent $180 million upgrading its network of transmission stations and has strung high-voltage power lines to more than 40 private wind and solar plants, stretching hundreds of miles. Grid-connected wind and solar in South Africa is now among the cheapest in the world.

Mozambique, which stretches over 1500 miles along the southeast African coast, arguably has the largest power generation potential of all southern African Countries. Estimates show that Mozambique could generate 187 gigawatts of power from coal, hydro, gas and wind resources. At present, the vast majority of the country’s power derives from hydroelectric projects, however, the discovery of vast natural gas reserves is expected to provide 44% of total energy generation within a decade. Despite Mozambique’s potential capacity, only 34% of the population has access to electricity. This is, in large part, due to an underdeveloped power distribution network.

The Mozambican government has made rural electrification development a priority by establishing the Mozambique Energy Fund Institute (FUNAE), which focuses on small scale, off-grid projects of less than 10 MW. The aim of FUNAE is to mitigate the cost of expanding the grid to rural areas. But energy demand will be driven by industry and business, including energy allied sectors in the extractives industries, especially in the northern regions of the country.

Distribution Trends

In line with the trends in generation and transmission, distribution trends in SSA are constantly subject to new technologies. Grids must administer several types of power and will need to be adaptable to future technologies and demographic developments, including increasing urbanization (More on this topic).

East Africa, in particular, is ahead of the curve in terms of smart payment and metering systems. Kenya, for example, is a global leader in mobile payment systems according to data published by The Economist. Kenyan customers can pay for public services directly through mobile apps accessible anywhere in the country and now have access to financial services on par with other highly developed markets. Kenyan markets have leapfrogged card payment systems, which require the presence of ATMs and card machines that are not reliable in times of power outages, for example. Today, approximately half of all Kenyans use mobile banking systems exclusively. 

Sophisticated digital payment systems open up possibilities for advanced metering systems, allowing users to shift to smart, prepaid metering to purchase a fixed amount of power electronically. Studies show that metering not only helps customers but benefits utility companies and mini-grid providers by reducing the costs credit operations, making off-grid power sources more economically viable. Aside from being significantly safer and cheaper, the digital payment systems that come with the expansion of mini- and off-grid options circumvent the transaction costs of traditional cash payment options, such as time spent on transportation and standing in line. Mini-grids absorbing excess power generated by home solar panels, also makes solar a financially attractive option for homeowners, since any power they feed into the grid reduces their power bills. These factors allow for a broader customer base and reduces costs for utilities and power companies.

A conducive business environment is essential in attracting, and maintaining, private sector involvement and governments are taking steps to guarantee payments, a natural primary concern for foreign companies. An example is the introduction of feed-in-tariffs, which are a measure to encourage renewable energy investments. Acknowledging that solar and wind projects carry higher up-front investments than conventional source projects, these are awarded lower per-kWh prices than other forms of generation. The goal of feed-in tariffs is to offer cost-based compensation and price certainty to renewable energy producers.

Stored energy is still a vital part of the distribution system. Presently, households, businesses and off-grid plants rely on expensive diesel generators or battery storage when necessary. Battery technologies have seen substantial R&D investments from global leading companies in the past five years and technological leaps in efficient battery storage coupled with solar photovoltaic storage plants continue to drive down costs. Despite high cost of installation, the use of solar systems with battery storage has proven economical for producers and consumers in the long run.

Business environment in SSA

Doing business in SSA requires prior understanding of the region’s demographic developments and political landscape. Yet many companies underestimate the region’s latent opportunities for the power sector, or are wary of entering the market because of a lack of knowledge of the region (More on this topic).

Population growth and the emergence of a middle class

The total population of SSA is 1.2 billion, a figure that is set to double by 2050, according to the United Nations, with some countries, such as Nigeria, facing the largest population increase in their history.

Today, more than 600 million people - or half the population and two thirds of households - live without access to energy. However, SSA is also home to a growing middle class with access to capital and technology. SSA is home to some of the fastest growing economies in the world, and is home to the fastest growing middle-class. This means that energy demand is growing and changing rapidly.

Political backing for the private sector

The correlation between access to power and macroeconomic growth is evident, as experienced by advanced economies through the last century. SSA governments are acutely aware of this relationship, as are transregional bodies, such as the African Union and the AfDB mentioned earlier. Securing energy for their populations is a primary policy goal for governments in the region.

The establishment of independent regulators has been the most widespread power sector reform element in SSA and more than half of countries have established such agencies. Vertically integrated power utilities play a dominant role in most SSA countries and are often viewed as vehicles of political patronage and corruption. However, many countries are undergoing the restructuring, unbundling and, part or full privatization of utilities. Because the presence of an agency does not guarantee competitive procurement or competitive generation prices, understanding the regulations and the government’s ability to enforce them is essential to sustainable business practices and a key argument for conducting thorough due diligence.

Despite wide political backing however, most governments are unable to carry the cost of establishing and maintaining access to power. Often utilities do not carry the investment-grade ratings necessary to raise debt at affordable rates. This has led governments to take steps toward the democratization of the energy markets, by removing monopolies and opening up bidding or direct negotiation to private sector engagement in the sector.

In recent years, the World Bank and other bilateral and multilateral lenders and donors have also encouraged the private sector to play a larger role in achieving access to reliable energy. The Organization for Economic Cooperation and Development (OECD) calls the private sector “the missing piece” of the economic growth puzzle. This common agenda - to prioritize energy to Africans across the continent as a vital step to economic prosperity - is a key part of the broad effort to create an enabling environment for viable and accessible opportunities for investors. For US companies in the wider energy sector, this agenda presents a number of opportunities.

IPPs

Independent Power Producer (IPP) projects represent good opportunities for US company involvement. An IPP is an entity which is not a public utility, but owns facilities to generate electric power for sale to utilities and end users under a PPA, and is contracted to deliver a specified amount of electrical power within a specific timeframe. Private investments in IPPs are now the fastest-growing sources of finance for Africa's power sector. In 2016, 126 IPPs accounted for 13% of the region’s output.

IPPs vary in financing structures, size and risk mitigation. Common for most of them is that they are long-term agreements with contracts typically extending from 15 to 30 years. During years of volatility in the power markets and technological reform, fixed long-term take-or-pay contracts can face issues if underlying parameters change, but predictable revenue streams allow equity risk capital to be rewarded.

Excluding South Africa, total IPP investment for projects in SSA between 1990 and 2013 was $8.7 billion, and another $2.3 billion was added in 2014 alone. Currently, 59 IPP projects are ongoing in 18 countries in the region, excluding South Africa. These total $11.1 million in investments and 6.8 GW of installed generation capacity. South Africa alone has 67 IPPs, bringing the total investments for the region to $25.6 billion. IPPs range in size, up to 600 MW and 82% of capacity is conventional while 18% is renewable. Renewables overall appear to be increasing gradually, in line with global trends.

Two flagship IPPs in SSA today are Azura-Edo in Nigeria and Cenpower in Ghana. The Azura-Edo IPP is a 450 MW open cycle gas power station, developed by Azura Power Holdings. The construction costs for the power station are budgeted at $900 million, financed by loans from a consortium of twenty international banks and more than nine equity finance institutions. The project is expected to start generating power before the end of 2018. Cenpower in Ghana is a 350 MW combined cycle gas plant, scheduled to come online in early 2018. The plant will be among the largest private IPPs in the country, accounting for approximately 10% of Ghana’s total installed capacity and approximately 15% of its available thermal generation capacity. Finally, Bridge Power in Ghana, mentioned earlier, is another large scale example of current developments with an aim of 400 MW dual-fueled LPG and natural gas.

Other investors

Power project financing and deal structuring is changing in ways that lower risks to foreign investors. The opportunity to crowd in private investors to the energy agenda presents an opportunity to maximize impact. Private investments from FDI (Foreign Direct Investment), philanthropic investments and remittances in aggregate dwarf the government and donor funds that previously made up the sum of capital investments.

This means that areas which were traditionally donor-reliant are increasingly open to mixing different types of finance capital. Evidence shows that the inclusion/engagement of these parties in energy related projects strengthens their viability, partly because of rigorous due diligence and partly because of the weight they bring to honoring investment contracts.

The US based OPIC, has supported more than $1 billion in power projects across Africa in the past decade, and currently has more than $4 billion in investments across the region. In 2014, for example, the large-scale Lake Turkana Wind Power project in Northern Kenya was financed by OPIC. The plant, which will be the single largest wind power project in Africa, is projected to boost the country’s installed energy capacity by 20%. Other DFIs engaged in the region include CDC and Norfund, from the UK and Norway, respectively, who with Globeleq Africa are in a partnership. Globeleq Africa is currently the largest IPP in the region, with the goal of adding 5000 MW of generating capacity over a decade. Globeleq Africa’s current projects include a plant in Cameroon, Kribi Power, which sells electricity to ENEO, the national transmission and distribution company through a 20 year PPA. On the private equity side, US companies, like Blackstone, are heavily invested in the region as are Nigeria based Helios Investment Partners, which manages a portfolio of funds totaling $3 billion.

Risk mitigation and bottlenecks

When working in foreign jurisdictions, entry phase strategy mapping and rigorous due diligence is central to securing successful outcomes. Yet, insufficient risk mitigation remains not only a key barrier to entry for foreign companies, but also a major cause of project failure. Some of the most common challenges facing foreign companies operating in SSA are described in this section. Risk management is a wide topic which can be broken down into subcategories, as seen in the example flowchart below, however it is important to emphasize that each project comes with its own set of risks and it is vital for companies to map these for every project.

US based companies typically hire established market entry advisory companies with on-the-ground experience and expertise in navigating the relevant jurisdictions. Market entry experts can supply information on a variety of topics that can shield foreign companies from unnecessary sunk costs down the line. This includes pre-entry support on scoping for opportunities, contacting relevant key persons on the ground, as well as contract-phase tax and regulatory insights.

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Risk mitigation can be subdivided into three main categories: political risk, which addresses issues of stability and institutional strength; regulatory risk, which examines compliance issues in foreign jurisdictions, particularly pertaining to the Foreign Corrupt Practices Act (FCPA, 1977) and the United Kingdom’s Bribery Act (UKBA, 2011), but should also extend to broader understanding of the regulatory environment in the host country; and, financial risk, which assesses the financial viability of projects and is often the area of most concern to companies.

Some of the primary topics that arise during scoping typically concern financial aspects, such as payment methods and payment sources. Naturally, the first question from companies is: how will we get paid? In the case of service sector contracts, this issue can be addressed with advance payments, for example, or by establishing regular payment milestones for the project and, in some cases, escrow accounts to insulate and secure payments. Contracts pertaining to the production sector, meanwhile, might contain insurance terms, fail terms and letters of credit where relevant. Under both types of commodities, contracts should contain clear exit terms and, moreover, foreign companies should identify methods for repatriation in advance.

The assumptions about the risks of doing business in SSA are often oversimplified, and in some cases they draw attention away from pertinent issues. The presumption that regulations and tax laws do not exist or are not enforced can lead companies to underestimate the importance of understanding local regulatory environments, eventually exposing them to potential violation of international or national laws. In reality, almost every SSA country has set in place local content requirement laws, land rights, distribution laws and tax laws, all of which require prior understanding. Therefore, in line with financial oversight and planning, foreign companies should always seek to establish sufficient oversight of local regulatory and tax requirements.

Further, US based companies are legally required to comply with the United States’ FCPA and, more often than not, the UKBA. These legal frameworks address specific issues of coercion, collusion, corruption and fraud, and require companies to conduct due diligence on potential partners abroad.

Political risk assessment overlaps with regulatory risk assessment in establishing a picture of the accountability and stability of local governments and institutions. Political risk assessment is particularly important in less stable nations, or where local or regional cooperation is weak. While a measure of political change does not necessarily impede business in a country, it presents a set of issues that foreign companies need to be aware of. This includes, for example, increased security costs, particularly around elections or where local conflict exists, or unforeseen shifts in governments and changing government agents.

With each locale come a variation of issues, for example land transportation and cabotage, security and local staff know-how. Each issue might be planned and budgeted for in advance. As an example, many SSA countries have a deficit of technically trained individuals, however many US companies in SSA have gained a positive reputation for active knowledge transfer, which grants them a strategic advantage against companies who import trained staff from abroad.    

Each of the parameters outlined above - political, regulatory and financial - can be clarified through meticulous market entry preparation. Different project types and categories present different risks, and the parameters around each project, such as geography and project partners, also present their own variables. Addressing risks at an early stage can save money and time down the line, which is why a sound market entry strategy is essential to successful project completion.

ISI Consultants assists U.S. companies to enter or further expand their business in Middle East and African markets. From small projects to longer-term engagements, we put our knowledge and experience to work for you, saving you time and money and minimizing your risk. And our results-oriented approach means we don’t just advise you on what to do to be successful – we work with you to get it done.


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