Wednesday, July 18, 2012

POWER PROJECT FINANCING: Key Features & Areas of Concern



By John Peter Amewu

The power sector is the major index that drives business, manufacturing and transportation of goods and services to serve a competitive nation’s economy and the world at large. But the mechanism for financing of such projects is becoming tricky for emerging markets. According to the United Nations Environment Programme, the rising global demand for energy will require substantial capital investments in the coming decades. Sustainable energy development will play an important role in meeting this demand, particularly in emerging markets, but many mainstream financiers are averse to supporting what they consider a risky market.[1] While energy project developers face significant financial and regulatory barriers to market entry, a number of foreign governments are at various stages of implementing privatizing policies to allow private ownership of power projects with the assumptions that third party investors would fill the financing void. Promisingly, more financing opportunities are emerging across all sectors, from major corporations and private equity funds, to government and multilateral organizations.[2]

The current opening of Ghana’s energy sector to potential investors by UK government, particularly British nationals, to take advantage of opportunities available in the sector is clear indication for growth in the sector. According to the officials at the UK Trade and Investment (UKTI), an agency of the British government, Ghana is looking at ways of boosting its national electricity production. The demand for power in Ghana is currently at 1400MW and is growing at about 10% annually.[3]

Ghana, with its attractive emerging economy, will have to seek for more Independent Power Producers (IPPs) to boost up national electricity production. There is potential for electricity generation from renewable energy sources such as solar, wind, biomass and small hydro to connect communities off grid. In the renewable energy bill currently before parliament, the country aims to supply 10% of its domestic demand through modern renewable technologies by 2020.


Interestingly, the country currently gets about 70% of its electricity from hydro power stations. The current national access to electricity supply is about 43% of the population yet over 80 % of the domestic electricity supply is consumed in cities and towns. Subsequently, the provision of reliable and affordable power in sustaining the economic growth of the country can therefore not be a question for debate. In the mid-1990s, Ghana initiated a development agenda aimed at transforming the economy from a low-income level to a middle-income status by the year 2020.[4] Under the plan, a forecasted average real Gross Domestic Product (GDP) growth of 7-10 percent and a per capita income increase from about US $400 to US $1,000 for the period 2001 to 2015 have been targeted. The expected economic transformation is to drive the country away from the current subsistent agriculture base to industrialization based economy in an attempt to achieve the Millennium Development Goals (MDGs).[5]

To achieve these goals, adequate and reliable supply of power with high level of plant availability was identified as a necessary index to trigger the expected projections to reality. As a primary objective, Fellows at the Institute of Statistical Social and Economic Research (ISSER) have called for the deregulation of Ghana's energy sector to allow the private sector to engage in electricity production and distribution as well as pricing. As a result, the government of Ghana initiated a Liberalisation policy of the power sector in the mid-1980s by first corporatizing the state monopoly Electricity Company. The Country’s, policy framework on Energy is aimed at removing the entry barriers that have hampered financing of energy projects by encouraging investment in the sector. 

The Government in 1997 established the Energy Commission (EC) and the Public Utilities and Regulatory Commission (PURC). Under Act 541, the EC was mandated to design a regulatory framework for the sector[6] and Act 538 mandates the PURC to be responsible for issuing out generation licenses to new generators.[7] Energy Foundation a public –private institution was also established in 1997 to focus on the promotion of energy efficiency. Despite the establishments of these institutions, bankability of power projects has still not being encouraging. Power projects in Ghana are conventionally constructed as extensions of the existing assets of the company. Under this condition, funds are provided on the account of the entire company rather than on the account of the new plant. 

This approach only presents the lenders with the opportunity to have full recourse to the assets and revenues of the entire company, rather than recourse only to those funds related to the new power plant. For example during the construction of the T3 thermal power plant, the Government of Ghana had to enter into a credit agreement with Society Generale Canada with the Export Development Canada providing credit insurance for the construction of 132MW combined cycle thermal power plant[8]. Lenders of credit risks have generally expressed concern about financing of energy projects in the country. The rationale for this research paper is therefore to establish the systems through which power project financing can become bankable in Ghana by identifying the various roles and requirements by the parties and making suggestion as to how the related risks can be reduced. 

The research is focused mainly on power projects deals with private power projects that are financed on a limited recourse basis, in which the lender’s sources of security are exclusively on the cash flow and assets of the project company rather than on the balance sheet of the firm. 


WHAT ARE FEATURES OF POWER PROJECTS FINANCING?
Power Project financing means lending which is structured in such a way that the loan is extended to a project which the borrower has established. The loan is made for the sole purpose of financing and operating of that particular project. The subject of the repayment is directly on the project. There are no other assets or operation of the lender to look for the repayment. The lender must rely solely on the revenue of the investment and their security lies in the assets of the project.[9] Power projects are very capital intensive and require huge investments. Therefore, the financing of these projects is generally very complex –particularly in developing countries such as Ghana where traditional source of financing has been the government budget or government-sponsored borrowing. 

Equity and Debt Financing
Power projects are financed either through equity or through debt. The sources of equity financing may include; sponsors or owners contribution, equity funds or through strategic investors and sometimes through passive investors including the general public. The return on this kind of investment is mainly through the payment of dividends with no security of investment. Debt financing on the other hand is another source of funding power projects. Sources of debt under this consideration are likely to come from various agencies and institutions’ including; the Commercial banks, financial institutions, multilateral agencies, Suppliers credit and public borrowing. The return on investment is through interest payments with the security of investment mainly on the assets of the project or on the assignment of power purchase agreement (PPA).[10]

Level of interdependencies 
There is high level of interdependency among all the players involved in a power project financing. This is due basically to the contractual arrangement between the lenders and the borrowers. This arrangement is important because it sets out the commercial agreements and the roles and responsibilities of all the parties within the project arena. It also indicates the allocation of risks between the parties. The structure is likely to include the investors, the suppliers, the Host Government, Lenders and the Off-takers. (See appendix 1 for a typical structure of such arrangement)

Scale of the Capital Investment
The size of the capital expenditure (CAPEX) engagement in the financing of power projects is very high. Depending upon the output of the plant, the CAPEX can range from $300m upwards. Any consideration for lending to such a high investment project will have to take into consideration the commercial and financial links and the level of interdependencies of the players. For instance a power plant fired by gas needs a regular and constant supply of gas from a gas field through a pipeline to feed the plant. It is therefore important to conduct a due diligence of the availability of the supply throughout the project life span. The security of supply is therefore a key concern in lending to such an investment.[11]


NUTSHELL
This is the first instalment of an interesting article by J.P Amewu elaborating on Power Project Financing in Ghana.  This paper examines, from the point of view of project sponsors and the Government, the actions which they need to consider in making the power projects in Ghana bankable for a lender and he also examines what a lenders requirements are likely to be. Read, Learn and Discuss!!! Comments and questions on this issue are welcome. For more information about John-Peter's paper and to view his professional profile click here -->
[2] Ibid.
[4] Gboney. M. (2008) Policy and Regulatory Framework for Renewable Energy and Energy Efficiency Development in Ghana.
[5] Ibid

[6] Energy Commission Act of Ghana. Act 541.
[7] Public Utilities and Regulatory Commission of Ghana. Act 538.
[8]http://www.miga.org/documents/EIA_Takoradi.pdf (last date visited 15th Dec, 2011)
[9] Duval C. et al. International Petroleum Exploration and Exploitation Agreements: Legal Economic and Policy Aspect.
[11] Vinter, G., Project Finance: A Legal Guide, (3rd Edition), (London, United Kingdom: Sweet and Maxwell Limited, 2006).
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