Futuregrowth Power Debt Fund portfolio manager Paul Semple says that following the devastating effect on economic activity of the lockdown and onset of the Covid-19 pandemic, for the first time in many years, State-owned power utility Eskom has a different challenge on its hands, that of managing up to 9 GW of excess power owing to plunging demand.

Semple indicates that drastic measures have been implemented to ensure the necessary balance between supply and demand is maintained in the transmission system.

“Eskom has been forced to run its power stations at minimum operating levels and is using this opportunity to undertake much-needed maintenance on some units taken off line,” he notes.

He indicates that independent power producers (IPPs) have not escaped the impact of the current climate, with wind farms having been issued with an energy curtailment notice from Eskom.

Using the reason of force majeure, Eskom has advised these IPPs that, during certain times, the power they produce will not be used nor paid for by the utility, until the energy demand returns to normalised levels. In exchange, Eskom has offered to extend the term of power purchase agreements (PPAs) with the IPPs, indicates Semple.

He avers that, at face value, the stance taken by Eskom is supported by the current events outside of its control, notwithstanding the President Cyril Ramaphosa’s appeal to big business to pay suppliers and not to opt for force majeure enactment in the interests of the country’s economy, when he announced the two-week extension to the national lockdown on April 9.

Semple says that while the risk to the transmission network from unbalanced demand and supply is real, he questions why Eskom’s coal-fired stations are not taken off line for maintenance and repairs.

“However, what could easily be overlooked is that very clear and detailed contractual commitments have been signed between Eskom and the IPPs. In short, the force majeure approach has been rejected by the IPPs as falling short of these contractual provisions,” he notes.

PENSION FUNDS IMPACT

Semple says that while IPPs have acknowledged the difficulty of the prevailing electricity oversupply, they are rightly claiming recourse in terms of the underlying contracts that underpin their operations and, ultimately, their viability.

“Billions of rands are invested in these wind farms, including the savings of pension funds, such as those managed by Futuregrowth. The ability of the IPPs to service their loan interest and capital repayments to investors depends completely on the revenue earned from the sale of electricity to Eskom.

"Each wind farm’s investment case is underpinned by a finely-tuned financial model that accounts for every cent of income and expenditure. In the same way, the over-arching financial covenants that govern our clients’ investment risk in these projects are highly sensitive to any resulting leakage of income that may come from Eskom’s force majeure notice. Any curtailment of electricity produced and nonpayment of the corresponding revenue will directly impair the financial returns of these renewable energy projects,” he notes.

He says that, arguably, Eskom’s proposed extension to the PPAs for a period equivalent to the curtailment is not an adequate quid-pro-quo.

“It is impossible to predict the wind performance on those additional days in future, in order to ensure a corresponding replacement of income, and thus would result in a binary win or lose outcome for the IPPs,” he explains.

RISK

Semple posits that the biggest risk of the proposed response by Eskom to managing the imbalance in its transmission system could be that it sets a precedent of circumventing legally binding agreements.

“The Renewable Energy Independent Power Producer Procurement Programme (REIPPPP) has achieved international acclaim as an outstanding public-private partnership model for renewable energy procurement.

"At the heart of this successful programme is the robust legal framework that governs the relationship, rights, obligations and recourse by the parties to each project. As the national energy utility and the sole buyer of all electricity produced by the IPPs, Eskom is a key party to each PPA.

"It is critical that investment confidence in the REIPPPP is not undermined by the current dispute between the wind farms and Eskom pertaining to the proposed force majeure energy curtailment,” he emphasises.

He highlights that the more than R200-billion of fixed investment into the REIPPPP sector to date has been underpinned by the trust that local and international investors have placed in its legal framework and, in turn, Eskom’s commitment to its obligations.

Semple warns that if the current deadlock between the IPPs and Eskom around energy curtailment is not resolved quickly and amicably, it is likely that the reputation of the REIPPPP will be compromised –  and higher risk adjusted returns will be required for future investment in the sector.
“This could translate to higher bid prices for new tenders under the next bid window of the REIPPP Programme. Sadly, this could arrest the strong downward trajectory in the cost of renewables, which, until now, has resulted in the cheapest (not to mention cleanest) form of new power for Eskom,” he notes.