24 May 2023
Power Sector Project Risks in Sub-Saharan Africa
Sub-Saharan Africa has seen a marked increase in the number of IPP’s building and operating renewable energy projects as demand for new grid connected capacity soars.
Along with the previous development, construction, and upgrade of gas generation and HFO plants, it is solar PV, BESS, wind, geothermal and hydro projects which are right now playing a key role in sub-Saharan Africa, mirroring the rapid rise of renewables across the Middle East.
Development risks often mean project lead-in times can take longer in emerging markets than those in countries with well-established renewable energy legislation and frameworks. Risks posed by land permitting, power offtake, government policy, currency fluctuation and conversion can present volatility in Africa and therefore perceived project risk is greater.
The Challenges
Power Purchase Agreement (PPA) and political risk
The Power Purchase Agreement (PPA) is the most crucial element of a project as it is the revenue mechanism of the project, the risk is long term and is influenced by multiple factors. A project may secure a partial risk guarantee (PRG) through a credit risk agency or development bank, however, only lenders will be covered and only if the offtaker is state-owned. The offtaker issuing the PPA must be financially sound. However, due to the credit rating of many African countries being non rated, even when an offtaker holds a strong balance sheet a project can need political risk insurance or a partial risk guarantee. These can be considered by export credit agencies or development banks such as MIGA and AfDB. The Political Risk insurance market can be accessed to provide an insurance solution for PPA risk particularly for currency inconvertibility and non-payment due to contract frustration.
Expertise for Lender Insurance Requirements and Bankability
One of the key conditions precedent to financial close is for a specialist broker to arrange appropriate construction and operational (re)insurance policies in which local insurance law and legislation is adhered to. Typically, local insurance legislation will require an insurance policy to be issued by a local insurer through a domiciled broker. The insurance package is then completed with a reinsurance programme which is lender approved and meets lender requirements. Lenders require a certain minimum level of reinsurance participation with a security rating of at least ‘A-’ Standard & Poor’s. This level is typically designated at 90% minimum, with the remaining balance being accepted as compulsory local (re)insurer participation or retention. The mandatory reinsurance retentions are different dependent on each country’s legislation but ultimately as the majority of (re)insurers in sub-Sahara Africa have low or no security rating, the participation needs to be minimised to the extent allowed by law, otherwise lenders cannot commit funds to a project.
Working with a specialist international broker and experienced country domiciled brokers allows the maximum level of bankable cover to be arranged and with the optimal (re)insurer structure for lenders. Partnering with local insurers and brokers that are experienced in project finance is crucial due to the lender requirements for back-to-back policies, lender driven endorsements to the policies, as well as notice of assignments and broker letters of undertaking for the locally issued insurance policy, and the package reinsurances.
LAND AND PERMITTING
The acquisition of land required for site development and long term usage can pose great challenges, a number of sub-Saharan African projects have been cancelled at various stages due to disputes. In addition to land lease and purchase costs being equitable for landowners, relocation and displacement protocols including all usage permits being attained within timescales — an evident risk exposure is lack of community engagement. Lack of wider community engagement has in the past caused protest, demonstration and riots resulting in project delay and/or cancellation. Considerable reputational damage can also result. Whilst a strike, riot and civil commotion policy will cover the damage reinstatement costs to property insured, the recurrence of such protests can lead to violence and unrest which can place a barrier to workers being granted permission to continue to work safely. In these cases a project can be ‘in limbo’ until an ongoing community engagement or land dispute is resolved.
CONSTRUCTION RISK
Two important features of construction phase risk for emerging markets are grid infrastructure and the transit of project equipment. In developing countries there is often a need to build new grid infrastructure specifically to support the capability of the project to export power. Several projects which have completed in recent years have been unable to reach operational stage because grid infrastructure required to export to the grid has not been completed. The financial cash-flow model and repayment of debt service and fixed costs rely on commercial operations being achieved by a certain date. Therefore ambitious grid infrastructure plans with responsibility falling to a third party, such as a utility or government, can pose a severe risk in spite of project completion being on time. Due to the long distances inland which need to be travelled to deliver project equipment, transit in Africa is a particular focus for insurers. Beyond main highways, it is often likely that access roads and side roads require works to level and strengthen the surface. The combination of heavy rains and inadequate drainage channels can cause issues with the integrity of the roads when multiple heavy trucks are due to pass so pre-emptively (re)insurers expect a route survey and any recommendations or requirements to be adhered to prior to the first equipment arriving to site.
OPERATIONAL RISK
Once projects reach the operational stage, a majority rely on connecting into existing transmission and distribution infrastructure, which helps minimise the project risk profile. In respect of protecting ‘contingent’ revenues i.e. indemnifying for lost revenue following damage to network owned infrastructure (substations and transmission lines) careful review of mitigation and the ability to re-route is key. This ensures the contingent revenue cover reflects a sufficient estimated time period for reinstatement of network infrastructure outside of the project’s control. Comprehensive Political Violence & Terrorism insurance policies for both the construction and operation of a project will cover damage perils which can be typically excluded from the main ‘All Risks’ material damage policies. In addition Political Violence cover will protect against damage to the project arising from sabotage, terrorism and war which are otherwise main exclusions from the ‘All Risks’ material damage policy and is required due to unpredictable political and conflict landscape over a projects 20 year lifespan.
MANAGING THE RISKS
As each project has its own nuances to consider in respect of power type, location and ownership structure, it is important to utilise a specialist broker with experience of providing tailored coverage across all stages of the project lifecycle, and with specific sub-Saharan African expertise. In sub-Saharan Africa, Gallagher actively work on behalf of IPPs in South Africa, Kenya, Ethiopia, Uganda, Rwanda, Botswana, Tanzania, Mozambique, Zambia, Senegal, Ghana, Chad, Mauritania, Sierra Leone, Ivory Coast, Cameroon, Mauritania, Nigeria and Togo. With risk comes reward. Given the equity development risk is supported by average internal rate of returns (IRRs) of around 10% across renewables in Africa, lenders are increasingly attracted to these high project finance margins, particularly since comparable IRRs average 4%-6% in Europe. We recommend IPPs and project stakeholders engage Gallagher Renewables at the earliest possible stage of a project in order for us to provide the best advice on potential project risks and ways to mitigate them.
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