February 2017
Sizable reductions in the cost of solar equipment have created countless opportunities for developers operating in the Middle East and Africa to enter into power purchase agreements with commercial and industrial enterprises and to provide electricity at a lower rate than the local utility.
Solar pricing on government tenders continues to hit record lows, raising questions about long-term market sustainability. This is causing some developers to try to secure deals with corporate offtakers directly.
However, developing a commercial or industrial solar project in any emerging market is challenging. PPA negotiations with C&I offtakers, who often have either limited or no experience in buying electricity, and maybe no project finance experience, can be extremely time consuming.
A group of energy executives actively involved in solar C&I development in the Middle East and Africa talked at a Solarplaza conference on “Unlocking Solar Capital” in Kenya in November about their experiences.
The group was Ira Green, managing partner of GG Energy, Jeremy Crane, CEO and founder of Yellow Door Energy, Raoul Ilahibaks, senior associate, renewable energy, at ResponsAbility, Roberto Martin, business development manager for East Africa at SolarCentury, and Matthew Tilleard, managing partner of Cross Boundary. The moderator is Marc Norman with Chadbourne in Dubai.
MR. NORMAN: Roberto Martin, as a business development executive working for a solar power plant developer, you are in close contact with C&I offtakers. I suspect one of the very first questions they ask you is, “Is solar actually going to work at my factory? I do not know the technology. Can I have confidence that the solar installation will not disrupt our company’s operations, and that the savings on electricity costs will be worthwhile?”
MR. MARTIN: Yes, in the initial stages, these are exactly the questions we get.
Another typical question is, “I see solar working in places like Europe and Latin America, but is it really working in Africa? There is no track record.” Over time as we build a track record, confidence in solar will increase and those questions should be less common.
The next stage is when customers start saying, “The technology is working. I see the numbers. How can you finance the solar system?” That is when we need to think about structuring a financing product. We see an increasing number of financing companies coming into the market, and we are seeing a lot of growth in this segment.
When we start looking into PPA terms, one of the key words for potential customers is “flexibility.” A corporate PPA is a different model. We are not talking to state-owned utilities with tried, tested and bankable PPA models and standardized processes for project procurement. We are talking to a wide array of customers from various sectors, often with very different profiles. So a solution that works for one customer may not work for another. In this context, flexibility is key.
Some customers only look at long-term savings, while others focus on short-term. This affects expectations on the PPA term. Customers that do not trust the technology tend to want very short PPAs — perhaps one, two or five years. The flexibility that we are able to offer is key to making this model work.
MR. NORMAN: If a developer wants to raise financing for these projects, the PPA must be long enough to support the debt. Ideally, you want a PPA with a term of at least 15 years. How do you get around this problem with potential customers who are only willing to commit for one to five years?
MR. CRANE: Commitment is always an issue in every aspect of life. [Laughter] Solar has a long-term payback, depending on the cost of power. In Jordan, where utility prices are high, we had the benefit of being able to generate high returns with a relatively short contract. The flexibility that an offtaker needs varies from one business to another.
For example, what flexibility does a shopping mall need that hopefully will be operating for a couple decades? Maybe the owner will want to add another floor? Then it is flexibility about removing and reinstalling the solar system. If you are dealing with a commercial enterprise, the flexibility could be something like a roof replacement, and that can be dealt with contractually. We will promise to remove the panels and put them back on the roof once over the life of the contract.
In a place like Kenya where electricity prices are fairly low, I cannot see a financed solution — a PPA, a lease, or whatever you call it — that does not require a customer to make a long-term commitment. The cost of the solar project takes time to pay back. The customer has to make a choice: “Do you want to save the maximum dollars in year one, and then take a long commitment, or are you willing to save very little, maybe nothing, and have a shorter-term commitment?”
MR. TILLEARD: People do not have problems with the length of the contract per se, but they have problems with the practical implications. What happens if I move site? What happens if the currency changes by 400 percent? What happens if the electricity tariff changes? These concerns do not rule out a long-term contract. We have to come up with the contractual structures that address these practical concerns.
We are fully focused on C&I solar. We are building and operating assets in Africa only. We spend all our time thinking about how can we structure these contracts to address these practical concerns.
Opportunities
MR. NORMAN: Ira Green, you deal with private mining companies. Mining operations are sometimes unpredictable. For instance, work in a mine may be suspended when commodity prices fall. This is an issue from a financing perspective. How do you work around such challenges?
MR. GREEN: We focus on mines that have a long life ahead of them. In some cases, the projected remaining life is as long as 35 years. They are some of the deepest and richest mines in terms of mineral ore.
I just want to bring in another point here, because we talked about PPA pricing being important. It is important, but with many C&I customers, particularly in Africa, there are two other big issues. One is power quality. The other is availability and stability. If an offtaker in Africa is connected to the grid, power is often weak. If the customer is at the end of the grid, it will likely have issues with voltage fluctuations.
The integration of a solar photovoltaic system, if structured properly, can alleviate a lot of those issues and provide offtakers with a better quality of power at a competitive price. That is something that is very important for the mining industry. People need to take that into consideration when assessing the terms of these contracts.
MR. NORMAN: Raoul Ilahibaks, ResponsAbility helps developers explore investment opportunities in C&I solar. We often focus on how much customers can save against the price charged by the local utility for electricity, but where there is no grid, solar is often competing against diesel. The potential for C&I solar is likely to vary greatly from country-to-country, and from one site to another. Where do you see the most potential?
MR. ILAHIBAKS: It depends on the state of the local utility, electricity prices, and connectivity.
Take Rwanda, for example. You have a lot of diesel being imported into the country, and many large companies are still using diesel generators as a backup. It makes sense in Rwanda to displace some diesel with solar.
In Tanzania, where electricity prices are highly subsidized and the national utility is weak, solar photovoltaic systems are being offered as an off-grid solution: to mining companies, for example.
It depends on the country, and the reliability of the grid. It also depends on what the customer is really looking for. Is the customer looking for more reliable power or is it focused mainly on the cost?
MR. NORMAN: To what extent are offtakers willing to pay a premium for storage to have stability of electricity supply?
Rwanda is one of those markets where the grid tends to go off several times a day, not necessarily for very long, but between one and two hours a day.
Matt Tilleard, Cross Boundary has just signed a PPA for a fairly big solar C&I project in Rwanda. Was the offtaker on that project interested in storage, notwithstanding the cost? What is the market for storage?
MR. TILLEARD: I think storage is too expensive. Storage is a potential future technology, notwithstanding that we have two solar battery PPAs operating in Kenya. They are for a particular application. They are for remote, off-grid safari lodges where diesel fuel is trucked in across ecologically sensitive land, and people are paying US$1,500 a night for a tent. Customers who pay for this type of camping experience do not want to listen to a diesel generator. [Laughter] In that type of scenario, storage makes sense.
For our Rwanda project, storage does not make sense yet. The Rwanda project is for a large multinational company. The project is small at around 1.5 megawatts, but we will be adding close to 1 percent of the generating capacity of the whole Rwandan grid.
The nice thing about the PPA model is that when storage does make sense, we will be the first people there, and we will be able to go back to all of our existing customers and add storage to their existing solar systems. Storage will help increase reliability and power quality when the time comes.
Pricing
MR. NORMAN: We have talked about reliability as a selling point. However, the ultimate question is price. Roberto Martin, how much of a discount do you need to show from the local electricity price to have a sale?
MR. MARTIN: For perhaps 95 percent of customers in Kenya, the key motivation for looking at solar is cost savings.
If I could first, let me add to what was said earlier about battery storage. We are currently installing batteries on one of our solar photovoltaic systems. I agree that it is not economically viable if the goal is to compete with the grid, but it is probably competitive with diesel generators. At SolarCentury, we believe solar plus storage will be economic within fewer than five years. Once we integrate batteries, we will be solving more problems than we are now.
Another challenge we have with corporate offtakers in Africa is the take-or-pay clause in the PPA. They understand the concept, but the problem is how to make it workable from an operational standpoint. Sometimes a business may not operate on the weekend, meaning that there is little-to-no need for electricity during such time. A customer may also have seasonal operations. Without storage, the offtaker will have to pay for electricity that it does not need. That is a big challenge for many businesses. One solution is including batteries. Another solution would be for governments to implement net metering regulations: if an offtaker is permitted to feed excess power to the grid and then take it back when needed, this makes solar much more compelling.
MR. TILLEARD: Returning to pricing, when we first did the model for our fund, we thought we would tell customers you are paying 12 US dollar cents in Kenya for your electricity, which is the price for most large industrial customers, but you are running on diesel 20 percent of the time, and diesel costs this much, so your weighted average cost of electricity is X. But by that stage, the potential customer is already bored.
Our customers are not really interested in the weighted average cost of the grid versus diesel. It has been very difficult to make the case on this. What we have found is that we generally need to be 20 percent cheaper than the grid. Until that point, you are just wasting a lot of sales time and effort.
MR. NORMAN: Jeremy Crane, customers ideally want to set a fixed tariff throughout the term of the offtake agreement, but this may not always be workable. To what extent are you managing to build some escalation into your PPA tariffs, and how is it structured?
MR. CRANE: These are very interesting questions. On savings, I agree: 20 percent is a good number. If you can hit that, customers get interested. If you are talking 10 percent, is it worth their time? Depending on the size of the customer, you may be talking about US$1,000 a month. An important CEO probably does not worry about such small amounts.
With regards to price escalation, the power industry is in a price compression phase. I am talking globally. In our backyard in Dubai, we are seeing ridiculously low prices coming in for power generation. The cost of power generation will continue to fall during our lifetimes. There will always be a premium paid for grid interconnection, and we will pay that as long as it is less than the cost of batteries.
As soon as batteries become economical, then maybe the grid is no longer relevant to us and our industry. In the meantime, we pay. As a consumer at my house, I pay for the generation that happens a long way away, and I pay for the transmission to my house. If I was to price to a consumer today at, say, 20 percent off 12 US dollar cents a kilowatt hour and I was to put an escalator in there, expecting the customer to follow inflation, I am going to be moving that customer out of the market of economic benefit as I move forward, and that will put my contract with that customer at risk. So I do not think that is a viable scenario. In fact, in many situations, we price relative to the grid. In case grid prices go up or down, we will follow the grid pricing.
MR. NORMAN: Raoul Ilahibaks, another price-related issue that worries offtakers in the Middle East and Africa is currency risk. If an offtaker is being asked to sign up to, say, a US dollar tariff payable in a non-pegged local currency, then its key concern is a scenario where the local currency plunges against the US dollar thereby increasing its solar energy charges to a level that may be no longer viable.
Some of the offtakers you and your clients deal with are local enterprises. They will be getting their revenues in local currency, and so they will want to deal exclusively in local currency. When you are dealing with big multinational companies, perhaps mining companies, they may be getting some of their revenues in US dollars and will be happy to pay you in US dollars. Do you have any thoughts on currency-related issues that one typically encounters in these deals?
MR. ILAHIBAKS: Offtakers can be separated into three different buckets: the big multinationals, the local companies that have hard currency revenues, and the local companies that only have local currency revenues.
The multinationals are part of a larger organization and can absorb currency risk. For these companies, agreeing to a hard currency-denominated tariff is less likely to be an issue.
But if you look at the other two buckets, currency is a big issue. And this is problematic because that is where the majority of the market is. In order to unlock the potential of these two buckets, we need to find a solution to the currency issue.
We are looking at local currency lending. We need more participation from local lenders in the market, whether from local banks or entities like GuarantCo, to provide local debt financing.
The low-hanging fruit is the multinationals, but to capture the bigger part of the C&I market, we need to find a solution for currency risk. I believe institutions like TCX can help with these currency issues, but local banks need also to play an active role.
MR. GREEN: I agree. There is another complexity that affects all three of your buckets and that is the regulatory framework for payments.
In certain countries you cannot be paid in foreign currency. For example, if you have a project in Tanzania, you are not permitted to be paid in any currency other than Tanzanian shillings. So you would have to seek a currency hedge — which the local banks or your lender can provide — but that adds to the cost.
Check out part two (here) to learn about the panel’s experiences in working around single buyer model regulations, designing off balance sheet structures and making the sale.
This article was originally published in Chadbourne & Parke’s Project Finance NewsWire and was republished with permission.
