By Richard Doyle and Berrie de Jager

The Renewable Energy Independent Power Producer Procurement Programme (REIPPPP) has seen South Africa leapfrog from renewable energy zero to hero in a few short years. This progress has contributed significantly to acceleration of growth in the commercial, industrial and residential spaces as well. The latter has been assisted by the development of technical, financial and legal skills, the importation and local manufacturing of components in volume and a general acceptance of the technology, thus lowering the risks and cost of capital.

Initial activities in the commercial and industrial space have been characterised largely by self-funded systems, as has happened in other territories. It is a feature of business that product-based offerings evolve into services in due course. Currently, however, an estimated 99% of the perhaps 200 MW of non-REIPPPP projects installed in South Africa are self-funded and owned by the user of electricity. A small number of companies are making slow but steady progress in the background in developing solar leases, and a number of recent tenders have appeared seeking to buy solar electricity rather than solar electrical generating systems.

Common features of the recent advertised power purchase agreement (PPA) tenders include, not surprisingly, a need to match or beat grid tariffs and escalation. This stated ambition is, one suspects, a direct result of published data on the rates at which REIPPPP tariffs have plunged to below even large power user rates in the recent bid windows. What is missed in this assumption – frequently made in technical management teams in large companies – is that the tariff reflects the cost of capital.

Such cost (and debt, in particular) depends on the risks. The very low risks associated with sovereign guarantees for the REIPPPP are simply not attainable in commercial projects, even with formal parent company guarantees (PCGs). REIPPPP projects are able to attract debt for tenors of 15 to 16 years and at rates of Jibar plus 300 points. Commercial debt, even for listed and large established companies, is more unlikely to be longer than eight to ten years and can be as short as five years for volatile industries, such as mining and manufacturing concerns. The cost of debt is also higher by as much as 200 points in some cases. Banks will charge a risk premium to compensate for the degree of default risk inherent in the loan request. In determining this risk and corresponding risk premium, they will consider the financial strength of both the borrowing entity and the ultimate offtaker of electricity.

Finally, the requirements from equity investors are closer to 18% to 20%, higher than the numbers for REIPPPP, which are banded closer to 13%.

Next we briefly discuss two other key features of solar performance contracts. The first is deemed energy and the second is termination. In the REIPPPP – provided energy can be produced – Eskom has to pay for it even if it cannot take it. This is a standard feature of a PPA. The investor in the capital must assume that his or her asset is allowed to work as well as possible, and the financial models depend on long-term probability-based meteorological data sets. If the off-taker is not able to buy power on a Sunday, for example, when his or her factory is closed, there needs to be an adjustment in the model and tariff. This is complicated, so the usual approach is to ‘short’ the energy needs of the offtaker, designing a system that should produce just below the minimum requirement and then oblige the offtaker to enter into a take-or-pay agreement. The generator takes the capital risk and the offtaker takes the risk of downtime. The model is easy.

The associated and perhaps more important issue of termination is next. The investor and lenders take the long-term capital risk for an assumed contract or lease period that is agreed and usually assumed to be 20 to 25 years (at least to offer tariffs that are comparable with the utility in South Africa). The investor will either want guarantees that the production will not be affected materially in the period (by moving premises, ceasing operations owing to contrary market conditions, and so on), or will want a return that covers these risks. Lenders will typically require formal guarantees that all debt is immediately payable on default, and equity investors will seek guarantees not just for the asset value, but for lost revenue for at least part of the full contract period.

Some of these requirements can be managed down in part. Equity investors can cover construction risk and then refinance the cash flows at better rates. Offtakers can seek short-term alternatives to lay-off electricity that they are not able to use by signing Eskom’s wholesale electricity pricing system agreements. It is less likely that a spot market will appear in South Africa in the foreseeable future, so some work has to be done in order to equitably share the risks between investors and counterparties. Companies wishing to explore solar performance contracts need to ensure that the right mixture of technical and corporate/project finance and commercial/legal skills is engaged at an early stage to avoid disappointment when it turns out that the cost of solar electricity is not, at least yet, as cheap as the REIPPPP.

Doyle is GM of the commercial and industrial division of Mulilo, a leading South African independent power producer, while De Jager is head of natural resources at Standard Bank Commercial & Business Banking.