Drought having a big impact on hydropower investments

July 2017 - Hydropower is a critical energy source that should not be rejected but retooled in the face of increasing droughts, writes Tusekile Kibonde, Resident Underwriter at Africa Trade Insurance Agency (ATI).

There was a time, in the not too distant past, when the word hydro in relation to electricity generation and large hydropower projects such as dams was taboo. Large hydropower projects, particularly in developing regions, fell out of favour due to several factors – the financial crises in the second half of the 1990s and reduced lending from development banks due to pressures from groups concerned about the environmental and social impacts.

Today investments in hydropower are still under pressure due to, lack of strong regulatory environments, large upfront costs and long project development times. The average project takes 2 to 10 years to develop and 6–48 months to construct. To compound the situation further, environmental and social impact still plays a pivotal role in the viability of a project – chief among them is drought.

Hydropower bankability perspective

From a bankability perspective, in terms of the ability to get hydro projects financed by private banks, the main issues that we see in getting projects to financial close are environmental risks and risks relating to so-called ‘country’ risks. The environmental risks are easier to manage on smaller-scale projects with a well-thought out rationale and solid environmental and social due diligence studies. It is important, for example, that efforts are made to minimise the ecological impact of any dam on the river where it is situated.

It is also important to fully consider the impact of climate change on the likely hydrology patterns. Larger-scale hydro is generally much harder to get financed via commercial lenders. The country risks are the real or perceived risks around the risk of regulatory change, retroactive tariff adjustment and the risk of payment by the power off-taker, as the financial health of many state-owned electrical off-takers isn’t ideal.

Although this scenario does not sound very encouraging, it does have a flip side. Hydropower is the largest global source of affordable renewable energy. This form of energy is not susceptible to oil price shocks that have created hardships in so many developing countries in the last five years. In Africa, hydropower is an under-exploited asset with seven major rivers – the Nile, Niger, Congo, Senegal, Orange, Limpopo and Zambezi. Africa has the potential to develop much more than the existing 23% of energy potential currently being used. This compares to 72% in Organisation for Economic Co-operation and Development (OECD) countries.

Africa is lagging behind the rest of the world in its ability to produce enough electricity for its growing population. The continent is producing a mere 129GW for a population of just over 1 billion compared to regions such as South America, which produces 250GW for a population of 480 million and Asia which produces 1,748GW for 3.7 billion. (Source: www.eia.gov)

Drought increasing hydrological risks

For all its challenges, governments and experts have come to realise that hydropower should not be a zero sum solution – meaning all hydro or nothing. This in the past resulted in projects with questionable results where dams were built without proper rainfall data leading to rolling blackouts.

With climate change and global warming seen as constant risks that are negatively impacting rainfall patterns and amounts across the continent, these risks, known as hydrological risks, simply cannot be ignored.

According to an April 2017 report produced by OXFAM on the impacts of climate change in Africa, the prolonged drought in East Africa over the past three years is part of a three-decade trend. For instance, 7 of the past 10 years have seen chronic droughts in East Africa due to poor or failed rains, and temperatures across East Africa are rising, and have been much higher in recent years compared with historic averages.

So what does all this mean for the future of Africa’s development - because clearly, the continent’s continued development relies on its ability to produce power for industries, homes and institutions? I would argue that Africa needs to focus on affordable, accessible and green energy options. A mix of different sources will be crucial to providing reliable and sustainable power.

As an important energy source, hydro capacity can be harnessed more effectively with a focus on smaller scale hydropower projects that will be easier to realise than large-scale mega projects such as the $80 billion Grand Inga project in the Democratic Republic of Congo. This project aims to supply cumulative output capacity of 42,000MW, which could conceivably power all of sub-Saharan Africa by itself.

Attracting investments

With obvious resources and demand, it is financial and political — as distinct from technical — challenges that have presented the biggest obstacles to bankability of African hydropower projects. Transparent financial structures and independent regulatory authorities are also a fundamental requirement to attracting investment, as is energy sector reform in many cases.

Ultimately, the goal of African governments is to attract investments to the sector. To do this, investors must have confidence in the policies, laws and regulations governing the sector. This confidence is supplied in large measure by the involvement of development finance institutions such as the World Bank because their involvement is tied to a requirement to adhere to environmental and social safeguards as well as raising the bar on financial integrity and transparency of the project.

Kenya provides a good case study in terms of the lessons learned. Hydro still represents a healthy component of the country’s energy mix ranging anywhere from 37 to 52% but the difference is that hydro is not providing a baseload. This important feature is provided by geothermal energy sources, which is much more reliable.

In addition, for many years, Kenya has been laying the groundwork for a stronger legal and regulatory framework. For instance, in 2015 the government passed a public–private partnership law to facilitate such structures. They also provided clarity around Letters of Support provisions and its inclusion as part of the Independent Power Producer framework to ease the process of closing transactions. There is also a forthcoming mini-grid framework to support this emerging sector and Kenya’s state-owned enterprises within the energy sector have a reputation for sound financial management and corporate governance practices that help them attract private sector capital.

This openness to private capital structures has led to the creation of Africa’s largest wind farm – Lake Turkana which was tied to a $700 million investment, the largest single investment in Kenya’s history.

However, despite all these reforms, without adequate rainfall or water conditions the hydropower plan will not have sufficient water to produce power at the designed capacity.

Inadequate water levels

While rainfall data has become more reliable, data alone cannot solve the problem of inadequate water levels. As a countermeasure, some African governments are not only changing the available mix of generation sources to be less dependent on hydroelectric power, but they are also increasing dam storage capacities to provide a larger cushion against fluctuations in water supply.

Looking more broadly, countries could protect themselves against the impacts of drought on hydro and other forms of power generation by investing in more regional transmission infrastructure to allow hydropower facilities in non-drought affected countries to make up generation shortfalls in times of drought in a neighbouring country.

It’s clear that Africa, like many other developing regions, is faced with no good options when it comes to the impact of climate change on producing efficient and accessible green energy such as hydropower. Taking a multi-pronged approach that is aimed at creating greater openness and confidence by prospective investors seems a sensible step in the right direction in ensuring the continent’s continued progress.

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