South Africa: understanding unique characteristics of this solar PV market | PV Insider

South Africa: understanding unique characteristics of this solar PV market

Any solar PV company interested in South Africa must evaluate its unique characteristics before making a commitment. We look at the issues of empowerment requirements, funding and how to make a public private partnership work here.

The South African government has shown its commitment to the development of a green economy. It is expected that the government will stay the course as long as its objectives of low cost energy, job creation, economic development and the establishment of a sustainable local renewable industry are being achieved.

Now that the ideological barrier to private sector participation has finally been crossed it is now up to IPPs to deliver and prove to government that the private sector is a worthy and capable partner. If at any time, now is not the time to fail.

Gareth Warner, Managing Director,  Momentous Energy, says, The solar PV market in South Africa is quite dynamic; the fundamentals are all there for sustainable growth; if we consider the government IPP programme for the next 20 years for renewable energy, the demand of electricity in the region and the increasing electricity prices. We believe the market is set to grow steadily over the next 10 years.”

He adds, “There are now a large number of European PV companies operating in this market, which has increased the competition in the sector as well. And hence the South Africa PV market has gone from an infant state to a mature state within 18 months, though the general knowledge and perception of solar PV is still at its early stages.”

The potential of this market is attractive, but entities focused on setting up new projects need to diligently evaluate opportunity for growth, and this includes assessing what’s working in the favour of the PV sector while equally sizing up the unique challenges.

Predictable cash flow

Of course, knowing the possibility of what can pave the way fora predictable cash flowis quite important for investors.

In this context, some key favourable factors include: A well developed and sophisticated banking and project finance market; clearly defined environmental approval process for projects; and support by Eskom for the renewable energy IPP programme.

The key enabling regulatory factor is obviously the REIPPPP (Renewable Energy Independent Power Producer Procurement Programme) which provided a bankable legal framework for renewable energy projects in South Africa. A key item in the programme is a government guaranteed 20-year inflation adjusted fixed-price PPA, with relatively generous caps on the per kWh price (although competition is driving the per kWh price needed to achieve “preferred bidder” status significantly down).

“This provides investors with a predictable cash flow enabling them to make the high-up front capital investment that is needed for solar PV,” says Bjørnar Baugerud, Investment Manager - Renewable Energy, Norfund.

“Furthermore, the 20-year inflation adjusted fixed-price PPA enables equity investors to raise a significant share of the capital in the form of long-term debt. Availability of this long-term local currency denominated debt in the South African market is a key factor in the local business environment making the solar PV investments attractive. However, the local currency denomination of the PPA could pose challenges in the future as local currency debt appetite is absorbed. Potential foreign lenders would require guaranteed cash flows in hard currency and long term secure foreign currency hedges are expensive or unavailable,” explains Baugerud.

What exactly do ‘unique’ challenges entail?

There are key aspects that exemplify the significance of understanding a market completely, before embarking on any project.

Empowerment Requirements and Funding

For instance, it is highlighted that one of the more challenging aspects of the project funding related to raising the empowerment equity funding, which is a unique characteristic of funding infrastructure projects in South Africa. “Under this funding mechanism the empowerment funder provides up to 90%-95% of the required empowerment equity,” says Coenraad Krige, managing director, Kensani Capital Advisory and Investments.

Warner acknowledges the significance of such requirement, and says companies should not under estimate this component.

“All the lenders are very familiar with this aspect and parties typically need to work together to structure the project deals accordingly,” he says. “Obviously the government is keen to develop a true empowerment equity market and not just have deals fronted. It definitely makes structuring a deal more complicated and involves more parties, which are not all necessary on the same page. However, we believeas the market matures further, it will become more competitive and the process will become smoother. It does ensure some degree of commitment to the market by companies in the sector.”

The intricacies of the empowerment funding revolved around developing an acceptable security structure that accommodated both the requirements of the empowerment funding and that of the project lenders. According to Warner, this is been done in a number of different ways in conjunction with the lenders in the sector.

“It seems to be deal specific and depends of the view of the parties involved, for example if it a long term investment or medium term investment. Some deals are using a blend of financial elements and hence structuring complex deals. It is very much project specific and in most cases confidential to that project,” he says.

Some other key aspects include:

Transactions

The agreements on these renewable energy projects are complex and multi-party, with implementation agreements signed by the South African government, PPAs by Eskom, economic development requirements and direct agreements turning what are, on the face of it, simple renewable energy deals into very complicated transactions, says Krige.

Understanding the interaction between these agreements, the requirements in each of the agreements, how and which risks are transferred, various protections, remedies and default and/or penalty scenarios – all proved to be critical in negotiations with lenders. “Given that competition for future bidding rounds will be fierce, understanding, managing and pricing risks like these could become a competitive advantage,” says Krige. 

Local Content and Economic Development Requirements

The programme requires a significant and growing requirement for local manufacturing content in the projects. This is a challenge to achieve given that the market is at an early stage of development. “(Also) local content requirements could result in increased costs, which has a direct impact on tariffs, which is counter productive to government’s aim of low tariffs. Finding the balance between these two factors is a challenge for most developers,” says Krige.

Making a public private partnership click

This journey , according to Krige, has revealed many challenges of a public private partnership rollout in South Africa as there are stakeholders involved at almost level of society. He explains:

Project level: Project developers have had to engage with concerned citizens in the environmental and land processes in order to address and make allowances for their concerns.

Regional and Municipal: There are high levels of local community involvement required in order to develop a project in a specific area. Thus obtaining their buy-in and endorsement is vital to achieve financial close from an approval and implementation perspective.

National: The programme has been developed by the Department of Energy and needs to be taken into account in the energy planning mix as well as the national budgets. As such, integrating the REIPPP programme has required approval at national level.

“In addition to the social hierarchy, the private sector has been extensively involved in the process, employing skills from the funding market, as well as the engineering, environmental, social and investment markets. These skills requirements have provided one of the many challenges of the programme as historically the South African market has not witnessed the levels of infrastructure interest it now enjoys. Thus sourcing experienced and reputable consultants, be it legal, technical, social, resource or other, was one of our key concerns when structuring our projects,” says Krige.

He adds, “To a large extent the experience gained over the last two years has seen the emergence of a cadre of specialists in these various fields that we have not witnessed in the past and that will go a long way to improving our project delivery in the future.”

All these factors clearly gain significance considering that this is a competitive tariff bidding market. So if on one hand, solar PV companies are buoyed by the growth potential, they also need to be cautious about what it takes to succeed here.