South Africa
Sector
Banking
State-owned utilities around the world are struggling to meet the increasing demand for electricity as countries become more industrialised and have an ever-increasing consumer base. High energy users are looking at alternative ways of either managing their current energy demands or considering alternative methods of securing the energy needed to keep their existing business functioning and expanding.
Outsourcing energy supply
While the security of energy supply is paramount to any business, businesses look to utilities, whether state-owned and controlled or privately owned, to meet these needs. High energy users have seemingly lost confidence in utilities and are investigating various options to ensure that their operations are not adversely affected by either interruptions in supply or the total lack of supply of the necessary energy requirements. While many companies have the financial and technical capability to meet these challenges, an alternative would be to outsource this non-core function to a third party.
A number of issues need to be addressed in structuring a solution to meet the requirements of such businesses. The first issue is whether the required power is to be a 'back-up' or the primary energy supply.
Primary vs 'back-up' supply
Where 'back-up' power is needed, the structure of the transaction needs to consider the uncertainty of the quantum and the duration of supply needed. As there is uncertainty regarding when and how much power is required, the design of the plant and the selection of the equipment is fundamental to ensuring that the cost of electricity is minimised. In addition, the selection of the type of fuel and a commitment to volume is difficult, as fuel suppliers tend to prefer contracts with committed minimum take-or-pay obligations. The overall cost per unit of energy generated will also be substantially higher than the business is accustomed to as the capital expenditure and fixed operational costs will be spread over a small number of generation hours.
Where the power is the primary source, it is easier to structure technology and fuel supply arrangements to ensure that the overall cost per unit of energy is relatively low. However, operations and contractual maintenance arrangements need to be well structured, as the full usage of the plant will require skilled personnel and regular overhauls. Typically, an operations and maintenance contract will be entered into with a third party provider, to ensure plant performance.
'Captive power' vs 'across the fence' supply
A second issue is whether the generation facility will be a 'captive power' facility, whereby power is supplied directly to the business or whether generation is located 'across the fence', supplied using the utility’s transmission and distribution infrastructure. The former affords many advantages as it allows generation to be established faster and at a lower cost, since there are no contractual arrangements with the state to be entered into, and the cost of transmission is lower due to the power plant being on site. The latter requires both grid connection and transmission contracts to be entered into with the state utility, increasing the time required to commercial operations, and incurring legal and ongoing operational costs, as the utility charges fees for connecting to and utilising its infrastructure.
Smaller initiatives = smaller risk
A third issue is the size of the generation facility. While project finance for power generation was formerly considered only for very large projects in South Africa, the current environment affords financiers the opportunity to participate in much smaller initiatives on a similar risk basis. This is because the quantum of each transaction is relatively small; the aggregation of power generation projects in different sectors potentially allows for good risk diversification; and the same risk mitigation principles used in large projects are brought to bear on smaller projects.
Investec has begun to explore this avenue of power project finance and is eager to speak to industry role-players requiring innovative power solutions. This would allow these companies to focus on their core business, and allocate their power generation functions and responsibilities to third parties.
For more information contact Fazel Moosa at Investec: Project and Infrastructure Finance, on +27 11 291 3571 fmoosa@investec.co.za
