Power generation in Zim and challenges for IPPs

Godknows Nyangwa

TO meet demand, it is estimated that Sub-Saharan Africa requires investment of at least US$40,8 billion a year. Approximately two-thirds of this is needed for capital investment, which is around US$27 billion a year, while the remainder is for operations and maintenance expenditure. Of that amount, about US$14,4 billion is required for new power generation each year, and the remainder is for refurbishments and networks (World Bank’s publication titled Africa’s Power Infrastructure: Investment, Integration and Efficency by Professor Anton Eberhard and Others 2011). The current investment falls short of the above requirements.

Closer to home, the Kariba Dam continues to be unreliable as water levels have receded to catastrophic levels especially during the period from the second half of the year 2019 to the present. Further, the coal-fired thermal power plants at Munyati, Bulawayo, Harare and Hwange are erratic and cannot meet the massive demand for capacity and are proving quite expensive to run. As a result, there is a huge power deficit which is threatening to cripple the economy because of the following factors:

There is a direct correlation between energy and socio-economic development of a country as the former drives the latter. For example, Zimbabwe requires about 2 000MW on a daily basis. The current demand outweighs supply.

Because this capacity cannot be met due to a myriad of factors, there is serious load shedding.Agriculture and mining form the mainstay of Zimbabwe’s economy. Approximately, more than 50% of the country’s electricity demand is driven by these sectors.

Due to the chronic power shortages, the harm that several sectors are suffering is debilitating to the economic fabric of nation as a whole.

Because of the huge financing gap in the power sector, it is a strategic area for long term investment especially in the climate-smart and cheaper renewable energy market. The heavy capital required for the construction of power projects cannot be provided by the government alone. This allows for independent power projects (IPPs) to invest in private construction of power stations to produce electricity which will be sold to the Zimbabwe Electricity Distribution Company (ZETDC). IPPs are privately sponsored power projects that are, in the main, privately developed, constructed, and operated and have long-term Power Purchase Agreements (PPAs) with the power utility (ZETDC).

In terms of the energy laws of Zimbabwe, ZETDC has a monopoly over the transmission and distribution of electricity. This means that electricity for mass production of electricity can only be done by the IPP under a licence issued by the regulator, Zimbabwe Energy Regulatory Authority (Zera). This electricity is then sold to ZETDC for public consumption through an agreement known as the PPA.

However, in order for the government to effectively attract investment in the sector; there is need for acknowledgment of the time-honoured tenet that investments will only flow where capital “feels safe” i.e. if the return on capital meets the necessary threshold and is easily redeemable or repatriated and where investment risks are adequately mitigated. Unless and until the above general criterion is met, increased investment not only on the power sector but also in general; will not materialise.

It is therefore in the government’s best interest to create a conducive environment as increased investment serves the public interest by achieving poverty reduction, economic stability and growth targets. Where public and private interests are well balanced, projects are more likely to have a positive impact across the board.

As at August 30, 2019, 43 IPPs had been accorded with power generation licences. Of that number only nine had their projects completed. On the other hand, Zera has commenced an exercise aimed at withdrawing licences for those IPPs found to have fallen behind their schedules. There is however need for Zera to take cognisance of the fact that the some of the challenges standing in the way of the projects are beyond their control.

Some of the challenges that hinder IPPs from reaching the consummate construction and commissioning stages include:administrative hamstrings in obtaining regulatory approvals;

sovereign issues;

currency changes;

land procurement issues;

policy uncertainty;

absence of a viable tariff; and
lack of funding etc.

The above issues are explained in detail below:

Administrative hamstrings

A typical IPP project is prone to be hamstrung by at least 18 to 24 months of paperwork in securing the necessary permits and agreements. For example, a solar photovoltaic (PV) project requires that there be several licences in place such as the power generation licence, land lease agreement, site access permit; building permits and Environmental Impact Assessment (EIA) certificate.

Obtaining a power generation licence has not been an issue for the majority of IPPs. However, it is no easy task to secure the bulk of the other licences and this can be a painstaking exercise.

Even after securing the licences, there is still need for the IPP to conclude contracts with the utility before commencement of commercial operations. These include PPA and the Grid Connection Agreement or Transmission Connection Agreement. This process involves a lot of back and forth which is time consuming.

After that, there is another wait for the tariff approval process by Zera. A lot of patience is required in negotiating and finalising the contracts.

Such administrative bottlenecks only increase the cycle time of concluding the IPP and may even jeopardise the whole project as the power generation licence is subject to timeframes which have to be complied. This may result in cancellation in the power generation licence.

Land challenges

Access to land is a basic requirement for a solar PV project to come to fruition. Typically, the land is state land and a Land Lease Agreement has to be signed with the Ministry of Lands.

The process of getting a land lease is an exasperating exercise. This part requires some illustration. For an energy project, the land is usually leased for a long period and this has to be longer than the debt coverage period and the PPA. A lease with a period ranging from 40–50 years is therefore desirable.

In addition to the project site, the developer needs to secure access to the land over which the grid connection will be laid out (this can be done by way of wayleaves).

Initial contact is usually made at district level before being forwarded to all the relevant stakeholder departments such as provincial offices up to the head office stage. At the head office, the director at the Ministry of Lands head office will vet the lease before onward transmission to the minister for approval. This exercise requires a lot of patience and chasing. Oftentimes, most projects suffer stillbirth because of the absence of a land lease.

Funding and other sovereign issues

Financing of power projects generally involves two key components. The first one is by way of injection of equity into the project by one or a number of investors, directly or via a special purpose vehicle (SPV or “project company”) or by getting finance through debt. The second avenue is via non — or limited — recourse debt from one or more lenders, secured against the assets owned by the SPV (“project finance”).

Before injecting capital or extending debt, investors and creditors consider issues such as the ease with which they can repatriate dividends or debt repayments from the host country. The currency uncertainties in Zimbabwe, policy inconsistencies around that area as well as the stringent exchange control regime together with the general shortage of foreign currency are the Achilles heels for capital injection into IPPs in Zimbabwe.

For example, in engineering, procurement and construction (EPC) contracts and PPAs form power projects in the country, liquidated damages and other monetary obligations are supposed to be stipulated in local currency (see Finance Act Number 2 of 2019). Funders are usually reluctant to accept such arrangements).

Investors and lenders will also consider a number of risks before channelling capital in the local energy sector. These include political risk i.e. events resulting from adverse actions by the government or from politically motivated violence; regulatory risk i.e. any change in law or regulation that may have a negative impact on a project; and credit/payment risk which entails deficiencies in the credit quality and the payment capacity of the off-taker.

It is public knowledge that the Zimbabwean economy is not performing well. Investors in an IPP power project will therefore consider the risks when evaluating the overall attractiveness of a project and will be less inclined to invest without mitigation of such risks in the form of sovereign guarantees. These are preferred especially by the Abu Dhabi funders.

In a well-performing economy, the government can provide sovereign guarantees or arrange other risk mitigation measures where their capability to deliver on IPP commitments may remain in doubt. In terms of the Public Debt Management Act (Chapter 22:21), the Minister of Finance is the one who can issue sovereign guarantees.

With the current Finance minister’s chest of austerity measures that are in place, sovereign guarantees will not be easy to come by in the near future. From an economist’s standpoint, the minister is probably right in this regard as a matter of fiscal prudence because guarantees create what is called a contingent liability on the part of government.

Fritz Bachmair of the World Bank Treasury says that, “Sovereign credit guarantees and government on-lending can catalyse public and private sector investment and fulfil specific policy objectives. However, contingent liabilities stemming from guarantees and on-lending expose governments to risk.”

A contingent liability is a fiscal obligation which is dependent upon a specific but uncertain event that may or may not materialise in the future. They can be explicit i.e. defined by a legal contract, or implicit i.e. with no legal obligation but severe social or economic repercussions if not serviced. The more contingency liabilities a country has, the more its credit rating is adversely affected. Further, the materialisation of the risks creates a fiscal cost for the government thereby causing a strain on the sovereign balance sheet.

In South Africa, the government has bailed Eskom on a number of occasions on the basis of sovereign guarantees following default by the utility and the resultant cost has caused a lot of furore.

According to the indices from top rating agencies such as Standard and Poor’s Financial Services LLC, Fitch Ratings Inc and Moody’s Corporation, Zimbabwe has a very poor credit rating because of its unhealthy sovereign debt portfolio.

In general, a credit rating is used by sovereign wealth funds, pension funds and other investors to gauge the credit worthiness of a country thus having a big impact on the country’s borrowing costs. This means that even if the government issues the Sovereign guarantees, these may not be enough to assuage concerns by some investors as they may consider these to be of no consequence. Overall; the cost of debt, if it comes by; is therefore very high and unsustainable.

Macro-economic volatility

Local IPPs have failed to realise full potential because of a myriad financial and macro-economic challenges. Solving the problem associated with convertibility of currency, repatriation of dividends and liquidity is key to unravelling investment in the energy sector in Zimbabwe. Further, the quicksand shifts in exchange rates pose a serious threat to capital.

The tariff conundrum

While Zera sets the tariff, the actual cost of electricity is determined by forces beyond its control and in line with foreign exchange rate movement which is in turn influenced by macro-economic fundamentals obtaining in the economy. The balancing is always delicate and there is no certainty for the IPPs.

In an ideal environment, the tariff is supposed to be cost-reflective for the IPP investor (which might mean higher prices of electricity for the consumers). At the same time, any modern government would strive to provide affordable and reliable electricity to its citizens. This makes it imperative for the government to manage the twin challenges of investor confidence and consumer confidence. Where there are populist policies, the governments strive to ensure that consumers pay for electricity at a cost which is much lower than the actual cost of purchasing or generating, distributing and retailing electricity.
The difference between the tariffs most customers pay and the actual cost is then subsidised by the government. What investors look for is a tariff which is cost reflective i.e. one which reflects the true cost of supplying electricity and removes the reliance on state subsidies to cover the variance between the current tariff and the true cost of supply of electricity.

When negotiating the financial model for the PPA, it is impossible to assuage the funders because the laws that are currently in place provide that the currency of denomination should be the local currency. This is viewed as pone of the foremost deal breakers for funders who typically seek energy markets with a high return on investment.

Nyangwa is an energy and commercial litigation lawyer at MawereSibanda Commercial Lawyers where he is a partner. This article is part of a series focussing on the legal, economic and other areas around the energy sector in Zimbabwe.

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