Third Way Opinion on the IPP Power Purchase Agreements

Third Way Opinion on the IPP Power Purchase Agreements

The Minister of Energy Ms. Mmamoloko Kubayi, made a formal announcement on Thursday, the 31st of August 2017 that the Power Purchase Agreements (“PPA”) will be signed by the end of October 2017. An additional announcement was made that a price ceiling would be imposed on the deals approved in Rounds 3.5 and 4 of 77c/kWH. The purpose of this communique to our stakeholders is to provide a view on the effects of this announcement and address the impact of the proposed price ceiling of 77c/kWh on the deals approved in round 3.5 and 4 of the Renewable Energy Independent Power Producer Procurement (‘REIPPP’) Programme. Third Way currently has exposure to 27 deals in Bid Window rounds 1,2 and 3, however, the deals in round 3.5 and 4 feature significantly in our pipeline of potential co-investment opportunities. As a result, Third Way has assessed the impact of this on the current proposition and growth prospects of the TWIP Core Plus Fund.

Announcement

Third Way views the announcement as a very positive step to alleviate any uncertainty that has tainted the landscape of the South African Renewable Energy Industry. The announcement signals to the market that the government is committed to implementing renewable energy in its resource plan.

The delayed projects represented a combined estimated value of R58-billion1 in investment and would create approximately 15 000 jobs1. The following table below shows that 2 CSP projects were contracted as preferred bigger in Bid Window round 3.5. A total of 26 projects were contracted from Bid Window 4.

IPP Overview June Table
Source: IPP Overview June 2017.

However, it is worth noting that the announcement came from the DOE and so there is a risk that Eskom repeats its refusal to sign the PPAs. It should be noted that existing projects still enjoy the DoE/Government guarantee of all Eskom’s obligations. The existing projects are appropriately protected from legal and regulatory risks and are a good investment vehicle for long term investors such as retirement funds.

The Minister of Energy has committed to meet with all IPP participants across all Bid Windows, to discuss issues of concern from IPPs and for government to give feedback on concerns raised before the date of signing. This will rebuild the trust between IPPs and the government which should bode well for the future of REIPPP.

Price Ceiling

A pricing decision to impose a price ceiling arose as a result of consultations, which had been under way since May 2017 between the Department of Energy (“DoE”), the National Treasury, the Department of Public Enterprises, and Eskom.

The 77c/kWh price ceiling does not take into account the inflationary impact on the project development costs over the last two years, therefore, it will place additional pressure on the deal sponsors to renegotiate.

Third Way feels that the wind and solar projects in Round 4 would be able to reach financial close with the price ceiling of 77c/kWh and comfortably break even. However, the other technologies such as CSP, biomass and hydro may be more challenging to achieve tariffs below the cap of 77c/kWH. This could lead to a potential decline in interest from some the CSP projects in the Third Way Pipeline. This does not pose a significant risk in Third Way’s ability to invest the funds raised, as the current pipeline of potential investments far exceeds the fund raised. In addition, there are significant opportunities for refinancing in earlier rounds of the REIPPP programme which are not affected by this announcement.

The selected project sponsors of the deals in Bid window round 3.5 and 4 will need to renegotiate the terms of the transactions given the price ceiling of 77c/kWH, and the increase in project development costs over the last two years since the original announcement of the preferred bidders. It is worth noting that the projects were aggressively structured with very little room for additional cost savings.

Future Rounds

All future procurement of Independent Power Producer deals has been placed on hold until the completion of the Integrated Energy Plan (“IEP”) and the Integrated Resource Plan 2016 (“IRP”). The Energy Minister has communicated that the Department of Energy has targeted to finalise the IEP and IRP by the end of February 2018. Any delay to this will place greater uncertainty to the South African Renewable Energy Industry.

Any further delays will detract multinational developers with the required expertise to grow the South African Renewable Industry and they, subsequently, may look to other jurisdictions. Third Way continues to believe that Renewable Energy will continue to feature in the energy mix in South Africa in the future given that is it the least cost option and it can contribute to achieve the optimal energy mix.

It is not certain at this stage if the price ceiling will be implemented in future rounds. If the same or similar price cap is instituted in future bidding rounds, it would result in Wind and Solar PV assets being the preferred technologies. Hydro, biomass, and CSPs were awarded above the 77c/kWH cap, due to these technologies being more focused on either delivering dispatch able base load or peaking power.

The signed contracts will not be impacted by the IRP 2016 since these contracts have been extensively negotiated and contain various protections to the projects which would trigger a termination and payout by National Treasury under the Purchasing Power Agreement.

( 1.  IPP Impasse to the Portfolio Committee on Energy: May 2017)

Suggestion readings:

Fin24: Kubayi: Eskom must sign IPP agreements by end of October
Engineering News: Kubayi sets 77c/kWh price cap and October deadline for signing of 26 renewables projects
IOL: Energy ministry confirms Power Purchase Agreements will be signed in October
Business Day: https://www.businesslive.co.za/bd/opinion/editorials/2017-09-07-editorial-kubayi-turns-off-energy-future/