Firm appointed as technical adviser

14th December 2012

Professional services firm Arup has been appointed by a number of financial services providers and the Industrial Development Corporation (IDC) as the lender’s technical adviser (LTA) to conduct due diligence for a portfolio of eight of the 28 projects that were selected as preferred bidders for the first round of the Department of Energy’s Renewable Energy Independent Power Producer Programme (REIPPP).

The eight projects, comprising solar, wind and hydro technologies, have a combined capacity of 300 MW.

Arup senior consultant Justin Wimbush points out that the range of individual project construction values for the REIPPP goes to billions of rands, with the value of round one alone being about R47-billion.

“Funding for the projects is predominantly made up of a combination of nonrecourse debt and private equity.

“From a debt perspective, South African lenders have adopted international advisory models, appointing specialist technical, legal and insurance advisers to assess investment risks and ensure mitigation by conducting preconstruction reviews and developing appropriate terms within finance, construction and operation contracts,” he points out.

Wimbush states that there was no particular standard for the technical due dilig-ence reviews for the eight bidders in the first round.

However, by learning from international LTA experience, Arup determined that the review scope should cover all technical risk areas relevant to permitting the lenders’ finan- cial models, as well as engineering, procurement and construction (EPC) contracts, operations and maintenance (O&M) contracts and any associated management agreements.

“During the LTA review process of the REIPPP projects, a number of challenges were faced, several of which were unique to South Africa,” he says.

Wimbush explains that the risks perceived by the South African investment community, associated with the limited local experience of the renewable-energy sector, required a high level of due diligence detail.

This is expected to be lower in subsequent bidding rounds, as South Africa becomes more comfortable and experienced in developing and implementing renewable-energy projects.

“Similarly, the LTA’s role in assisting the development of EPC and O&M contracts required far more input than would normally be expected. “This was linked to the level of complete- ness of the first drafts of the contracts.

“The LTA needed, in some cases, to drive aspects of the contracts and there have been instances where the LTA had to fill the role of owner’s engineer. “Both of these functions fall outside the normal LTA scope of work.

“Again, it is understandable that, given the relative maturity of the industry in South Africa, the first round of projects would require a higher level of input than is expected in the future,” he comments.

He adds that the bulk of due diligence work requires evaluating project documentation.

“The LTA is, therefore, dependent on the timely submission of permits, authorisations and design documents. A challenge that was experienced has been that documentation is often only received close to the lender’s submission deadline.

“This affects the LTA’s ability to provide a quality review of fundamental project concepts and considerations,” says Wimbush.

He points out that Arup has developed a comprehensive list of information required for each technology type and makes this available to project developers as early as possible to facilitate the timely submission of documentation.

Further, Wimbush notes that the reluctance of sponsors to spend money at the prebid stage, where risk levels are higher, often results in partially developed projects where feasibility studies are limited in their scope or have not been initiated.

“This results in limited information being available to the LTA for review, which, in turn, results in the LTA listing a number of risks associated with the project in the absence of completed studies, which ultimately impacts on the lender’s appraisal of the project,” he says.

He adds that the LTA is appointed and paid by the project developer, but has a duty of care to the lender, which can cause a potential conflict of interest. “This is a sensitive relationship to negotiate.”

Wimbush reiterates that the procurement of power from independent power producers is new to South Africa. “The requirements associated with being appointed as a preferred bidder are complicated and have required much effort to navigate and understand.

“The non-negotiable power purchase agreement (PPA) has had implications for the allocation of project risks. “This has largely resulted in risks being mitigated using measures in the EPC and O&M contracts.

“The implications of this transfer of risk have yet to be realised, and the appetite for contractors to absorb these risks may be differ- ent in future bidding rounds,” he points out.

Wimbush is confident that many of the challenges experienced during the first round of the REIPPP will become less common during future bidding rounds.

“This is particularly inevitable where experienced parties have repeat involvement in the programme. “With new parties engaging in the process, the challenge may remain for advisers to take more of a leading role than conventionally,” he says.