March 23, 2017

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Making hydropower bankable in Africa

hydropower-projects

By Vernon Joubert

Technically, Africa has significant potential for hydropower. There are, however, two constraints to realising this potential, commercial viability and lack of political structures.

The current demand for power in sub-Saharan Africa is about 100GW of which 22% is supplied by hydro, with future demand predicted at 385GW by 2040 of which 26% is projected to be provided by hydro. These projections imply that about 80GW of hydropower is to be added in the next 24 years, which amounts to about 3GW per year. This is a substantial rate of development, which will require significant investment to achieve.

African power pools

Considering the five major power pools on the continent – Central Africa (established 2003), Southern Africa (established 1995), West Africa (established 2001), East Africa (established 2005) and COMELEC (North Africa; established 1989) – 75% of the electricity mix resides in the northern and southern African power pool systems with South Africa being one of the largest contributors. Generation in these power pools is predominantly thermal (oil and coal) based. Much of the hydropower potential resides in the central, western and eastern power pools and remains undeveloped.

Old infrastructure

In addition, some of the power plants on the continent were built by former colonial powers and minimal upgrades have been conducted since then, reducing the effective power output to well below the potential initially installed. There are, however, major projects underway such as Inga 3 (4,500MW) in the Democratic Republic of Congo, but it has been subject to long delays as a result of logistical and funding issues.

Financial viability

Although there is technical potential to satisfy much of future planned demand, development prospects are limited by the financial viability of the projects. Many of Africa’s cash strapped governments turn to the private sector for some form of public-private partnership (PPP) arrangements for investment yet many do not have robust PPP frameworks in place. The private sector, however, makes decisions based on factors such as political stability, supportive legal framework and return on investment (ROI) and their implications for costs and tariffs. The private sector’s expectation of an acceptable ROI is often in conflict with governments’ desire to keep tariffs as low as possible. Projects are often financed with a combination of equity and debt funding and investment is made on the basis of proven bankability. Herein lies the major issue.

Bankable feasibility studies

Financiers require bankable feasibility studies, which consider the technical feasibility as well as the sustainability, including social impact and economic and financial viability of projects. Investors want the confidence that if they finance an expensive plant, there will be an acceptable return on their investment. This often means they need guarantees that they will be able to sell power generated by the plant for at least a 20-year period. Funders want assurance that the body signing the power purchase agreement is financially sound. In a number of instances however, the institution or parastatal that would have to buy the power is technically bankrupt, rendering the project unbankable without intervention of government in some acceptable form.

Social impact

While maintenance of hydropower plants and the average cost of producing hydropower is relatively low, the projects require high upfront capital to build dams, and power plants, and in some instances underground caverns and tunnels. Development times can be long, especially if a dam needs to be built. This has a social impact as dam building can mean inundating large areas with water and displacing communities, which has to be carefully handled to ensure sustainability of both the project and the displaced community.

Political stability

Another issue relates to political stability. Financiers do not want to invest in projects that are going to be compromised by political instability or even in extreme cases, appropriation, before the repayment period is complete. In addition, weak transmission systems mean several areas in Africa are not interconnected. In areas where there is great potential for power generation, including cross border sales, such as the DRC, limited infrastructure exists. Extensive transmission lines need to be built to evacuate power, which adds to the costs. Once again, political stability plays a role as financiers do not want the ability to sell power to be compromised by damage to transmission systems through theft or as a result of conflict. High initial costs against low certainty of sustainability means many projects that are identified as having technical potential may never come to fruition.

”Conduct a study”

As many governments do not have the funds to undertake feasibility studies and fund developments themselves, they may extend rights to developers to “conduct a study” on a specific scheme. In considering a project, developers usually start with a reconnaissance phase followed by a pre-feasibility study and eventually a bankability feasibility study – all at their own cost. The cost of such studies vary, depending on the amount of information available and the complexity of the project, but can be in the order of $2m or about 1% of the estimated capital cost of the project. This high cost represents a substantial risk to potential developers and in the face of high uncertainty of securing a bankable project, is a major barrier to development.

Robust PPP frameworks

A firm concession is required by financiers as part of proving project bankability, but there is often little assurance from authorities that the developer’s right to develop a scheme will be granted or protected through the entire process. In some instances, the process of undertaking studies is welcomed by the authorities, but issuance of a firm concession is then in conflict with tender based procurement policies, which causes downstream approval difficulties. This reinforces the need to have robust PPP frameworks with a fair mechanism for dealing with unsolicited bids.

Chinese model

Two models that have enjoyed some success include the Chinese model and the development agency model. China negotiates with governments in Africa to grant sovereign loans to develop assets, sometimes against security of other fixed assets. Because China has significant influence on the African continent and its government, lenders and contractors operate as a unified front, it has enough impact to effect this model.

Development agency model

Another model that enjoys a degree of success is the involvement of development agencies such as the World Bank or African-based development banks in funding the initial studies. This takes some weight off private developers and helps unlock projects on the continent. Investment at this level is, however, fairly limited and needs to be accelerated if the kind of growth agencies are projecting for hydropower development in Africa is going to be realised. Once a bankable feasibility study exists, private equity investors and operators are prepared to get involved, but it is the cost and process to get there that is a deterrent. This is where donor organisations and other funding bodies can play a greater part. While most of the identified projects are technically feasible, when the commercial aspect is considered, only a portion of them are commercially feasible. The many challenges faced by hydropower projects on the continent can be overcome if proper governance and frameworks are put into place and donor and other funding bodies get involved in bringing the projects to bankable feasibility stage.

Vernon Joubert is the general manager: dams, hydropower and underground works at Gibb

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