Tread lightly and think deeply – keys to unlocking opportunities in Africa’s energy sector
Commentary by Jef Vincent, Chief Underwriting Officer, ATI
The energy sector in Africa presents a vast amount of untapped opportunities. If you were to peel back the layers of severe infrastructure deficits, lack of effective regulations and dispute mechanisms, corruption and political risks, the potential is enormous. The key to working successfully in this sector is to enter the market fully equipped with the tools to protect yourself against risks that, if not managed well, could turn into pitfalls.
The first step for any investor is to understand the opportunities and challenges.
The demand for energy in Africa is huge while the supply is limited. This shortfall results in multiple issues and the cost, in terms of lost investments, higher production costs and overall productivity is higher than the cost of producing the power itself. What is needed is investment in new energy but this has stumbled due to a host of challenges.
On a micro level, lack of power affects a majority of households in Africa, which has the lowest electrification rates of all regions at just 26% of households. This translates into about 550 million people who do not have access to electricity. Without access, basic necessities such as proper refrigeration, safety after dark and the ability to work are denied to a majority of the population – which ultimately impacts on economic and social development.
For energy dependent industries such as mines and manufacturers, expensive fuel generators are not an option. This has a direct impact on economic productivity in many regions. For example, there are millions of cattle in Kenya’s Maasai Mara, a vast territory that relies on cattle rearing and tourism, but the lodges and hotels in this area choose to fly their meat in from Nairobi simply because they lack access to the power required to refrigerate meat. This translates into lower prices for the cattle owners, higher prices for processed meat, and lost employment for the region.
One additional problem hampers investment in new power generation. Government agencies are not always able to collect all the revenues generated from consumers. The typical causes are illegal wire-tapping and clients who simply refuse to pay their bill. Without the capital generated from daily consumption, these agencies are not able to invest in additional capacity.
To make the leap from a situation where a majority of the population in most African countries do not have access to modern energy services to a scenario where they will by 2030, the World Bank estimates that new capital investment of about $48 billion will be needed every year just to sustain energy services at current levels.
The solution is to invest massively in new power plants and in better distribution networks. But the reality is that most African governments, who are saddled with high debt ratios, just don’t have the money and expertise to do this.
Instead many countries have turned to a more practical alternative. This can be summarized by 2 acronyms: IPP and PPA.
IPP stands for Independent Power Producer (IPP). Under this scheme, governments encourage national or international investors to set up power production facilities and then sell the electricity to the national grid. These arrangements can take many different forms. Sugar plantations, for instance, can make electricity out of bio-waste or independent entrepreneurs can set up low cost solar power farms, which they could then supply to the local grid.
For governments, this can be the silver bullet to an issue that for many borders on a crisis. For investors, this can also be a lucrative proposition provided they have access to international finance, expertise and co-investors in the case of larger projects. All this can typically be done on a private basis without upfront government investment.
Regardless of the size of the project, no investor will provide financing without a reasonable return on their investment. To protect their capital, most investors will get a Power Purchase Agreement, or PPA. This is essentially a commitment by the government agency to buy all the power produced by the IPP at a given price during a certain period – usually more than 10 years and up to 20.
While the PPA does provide a certain level of security, there are other important risks to consider. Ten or twenty years is a long time – a lot can happen. Take the case of Zambia in 2011 for example, after President Sata won the elections the new government challenged decisions and commitments taken by the previous administration alleging corrupt practices and unfair advantages given to investors.
During this ten or twenty year period, countries can also split into two, such as Sudan – a country could also go bankrupt or become isolated by the international community. These and other potential scenarios can leave the investor in a no-man’s land.
There is also an obvious economic risk to the investor. When a country is desperate for power it will look for solutions that are available at short notice. It takes years to construct a dam or find the exact location for a geothermal power plant and generators that use fossil fuels are much easier to set up. Even though these are environmentally unfriendly options that pollute, drain foreign currency out of the country and come with a higher production cost, they offer governments a more immediate solution.
Investors involved in these “quick-fix” operations should be aware that in five or ten years there will likely be cheaper and cleaner alternatives in operation and governments may be tempted to switch off these old installations, or at the very least adjust the purchasing price to the level of the newer installations.
While the challenges may seem daunting, the opportunities in the African energy sector far out-weigh the risks – as long as investors come armed with the right type of protection. This is where ATI comes in. The African Trade Insurance Agency (ATI) was set up specifically to help African governments attract investments. By acting as the guarantor for governments, ATI insures investors and holds countries accountable to honour their contractual commitments.
ATI is exceptional because member governments are shareholders and they are bound by a special agreement to ATI. This accord binds governments to honour contractual obligations undertaken on all ATI backed projects. Under this scheme, if ATI has to pay a claim due to a member government’s actions, the government will fully reimburse ATI as part of the terms of their membership. Failure to do this will trigger a series of measures that act as a powerful deterrent. This set up has been designed with the aim to motivate investors to invest in ATI member countries while also giving the countries the power to unlock all the resources that it has, above and under the ground.
In terms of building adequate infrastructure, the energy sector is key to moving African countries to the next level of development. If effective, this could be a game changer for everyone. For governments this could potentially shoot them to middle-income status and higher FDI inflows. And for investors, this level of economic development could help to create transparent and regulated business climates making it much easier to uncover more opportunities within the sector. If you add risk mitigation to the arsenal, then companies entering this sector will have a much greater chance of success in Africa.