Financing Challenges and Opportunities in Africa
Lion’s Head Global Partners Managing Director James Doree speaks to Bill Lumley about progress in funding Africa’s energy transition.
How do Lion’s Head funds play a role in Africa’s energy transition?
It comes down partly to what we mean by energy transition. Our funds all have the ethos of targeting an issue and being able to bring capital into emerging or new sectors. Specifically as it relates to energy transition, our newest fund, AfricaGoGreen, is there to finance through debt for industrial energy efficiency, e-mobility, green buildings, or anything that involves displacing fuel or emissions. The fund is set up with a technical assistance facility that allows it to build knowledge and determine the technical and market feasibility of some of these new areas.
No single finance initiative alone can run energy transition, but this sort of capital is able to enter these new sectors and scale up emerging technologies, while at the same time attracting institutional capital where it can play a crucial role.
How important are local currency tranches in the context of renewable energy financing structures?
In many countries they have been non-existent. Those countries that have had the ability to finance projects in local currency have achieved the most scale, for example South Africa. In many markets, the chicken-and-egg scenario to resolve is the need for long-dated funding to fund this long-dated infrastructure, but often long-dated fixed-rate funding isn’t available in some of these local currencies. That doesn’t however mean that hard currency funding from DFIs is a free option, as it leaves participants open to currency risks.
Using local currency in these projects is really around efficient risk management and developing the financial expertise and ecosystem onshore. In many markets, the main feasible source of long term fixed-rate finance comes from institutional investors like pension funds and insurance companies. They are not necessarily expert in lending to infrastructure, so this is one area where support is needed.
The motivation is clear: people paying the bills in these markets are usually consumers earning local currency, so it is particularly important for households and small enterprises. Obviously there are a number of commercial exporters who can afford to pay in hard currency, but that doesn’t mean it is technically straightforward for projects to be structured this way. We’ve done some work looking at what would be involved for projects that have existing dollar tariffs to be partly redenominated in local currency and essentially the lower the domestic interest rates and the deeper the local funding market, the more feasible it is.
But these things will happen incrementally. If you are going to explore introducing local currency then you need to figure out how to make sponsors at least neutral to the extent to which the equity is still covered by hard currency, or you may have some form of compensation mechanism. So, if you are trying to introduce local currency options into PPAs and tariffs, then you have to figure out how to get the support of sponsors, who tend to be foreign investors. Perhaps this could involve extension mechanisms for the PPA (in response for tariff amendments).
Yes, you can have some local equity, but ultimately international sponsors will want to know that they will be able to get currency out in order to pay their dividends.
Smaller projects tend to be more feasible for local currency finance. Our “Facility for Energy Inclusion” was recently able to refinance the 20MW Sakal Solar project in Senegal with a local currency tariff, with proceeds being redeployed into new projects. In Nigeria the African Local Currency Bond Fund participated in the first corporate green bond a few years ago, allowing North South Power to refurbish hydropower turbines (with the support of Infracredit). In general, guarantors like Infracredit and GuarantCo can play a crucial role in developing local currency markets.
What needs to be done to develop domestic African capital markets?
First of all, you need to understand what’s in these markets. Many will have commercial banks with limited experience of infrastructure project finance. Even if they did have interest, there’s not really market for them to then hedge interest rates to provide long-term fixed rates to finance these projects in the private sector.
Therefore, there’s a need to develop interbank lending, liquidity and interest rate derivatives. Otherwise, the only source of long term funding tends to be pension funds and insurance companies.
I think there needs to be a bit more willingness on the part of DFIs to let the local market take the lead. There are no DFIs lending in the South Africa renewables programs, purely domestic banks, for instance.
In another example, one thing helping in Nigeria is that none of the DFIs are lending because they’re scared of the currency getting trapped, which is in turn giving space to people like Infracredit and the pension funds to finance it (notwithstanding other bankability concerns!). Obviously it would be better if the DFIs were able to operate in Nigeria, but it’s interesting their inability to participate in the market more is getting done in local currency, the naira.
Are energy sector offtaker creditworthiness issues still a major challenge?
Yes, they are. Most projects are set up with fixed offtake from utilities. Utilities tend to be in financial difficulty or insolvent in most markets in Africa and therefore the whole financing ecosystem is set up to mitigate the fact that the buyer of the power is not bankable. That leads to demands for sovereign guarantees in these projects. If you look at the current trend of rising insurance rates and costs for various players, the political response in many markets is not to raise tariffs to end users because that’s bad politics, but this again exacerbates the problem of these uptakers not being financially stable. This is a long term problem.
AfricaGreenCo is an entity set up to provide support in the Southern Africa power pool intermediating between generator and buyer of power, which is more bankable as an optic but also with the ability to sell power to different buyers within the SAPP.
What other key energy-related projects are you currently advising on?
We’re seeing a lot of M&A activity, for example, we’re currently in the market with JCM Power which has solar and battery assets in Malawi.
We’re also working with Decentral, one of the existing players in the South African C&I market, to source equity for its expansion.
