A large and persistent power deficit exists across the African continent; addressing this is key to achieving economic and social goals. There is significant potential for solar power, both at the utility and off-grid scale, to help close this deficit, particularly given high solar irradiation in many countries and the falling price of PV equipment in recent years. Governments increasingly see both forms of solar power as central to their electrification targets.
However, a range of challenges for both developers and lenders can constrain solar power financing. Whilst there are some shared challenges to financing both utility scale and off-grid solar (OGS), including the general absence of local commercial capital, the two sectors ultimately have very different financing requirements. We spoke with Holger Rothenbusch, Managing Director at CDC, the UK’s Development Finance Institution (DFI), to get his insights on the state of solar power financing in Africa.
Grid-scale solar: What are the key challenges?
When looking at utility-scale projects, key challenges include regulatory uncertainty and barriers to more commercial lending, according to CDC. Africa needs more bankable solar projects coming to market and greater regulatory certainty, transparency and consistency would very likely lead to an increase in the number of bankable transactions. CDC Managing Director, Holger Rothenbusch, observes that “the South African Renewable Programme, as well as the Egypt FIT programme are excellent examples of what a clear regulatory framework and predictable procurement processes can do to attract capital. We are also seeing improvement in regulatory frameworks on solar procurement in Nigeria, Ethiopia, and Zambia, which has attracted investors. We would recommend that other countries follow suit in introducing a clear procurement process, and clear, transparent criteria for awarding IPPs”.
CDC believes that well-structured utility scale projects will find finance, but DFIs have a critical role to play given the constraints that international and local commercial banks face in relation to both currency and tenor. Grid scale projects require significant hard currency debt due to imports and capex, and this debt must also be long tenor in order to keep electricity tariffs affordable. These factors make it difficult for commercial banks to provide the capital required. A number of international banks have hard currency liquidity and project finance expertise, but face growing regulatory constraints that make it unattractive to lend long term in many African markets. Local banks typically don’t have hard currency liquidity and struggle with long tenors, which limits their ability to participate in larger solar deals.
However, from CDC’s perspective there are clear and useful roles that can be played by commercial banks. “We tend to structure the documentation to pass the currency risk to the party best placed to bear it- which is the government of the host country in these instances. However, even governments have limited capacity to bear currency risk for an increasing number of power projects. Other solutions tend to be crowding in commercial banks that can provide a local currency tranche so that part of the loan repayment is in local currency. This has been done in African power deals that CDC has been involved in, including in Nigeria” said Rothenbusch. Commercial banks can also provide local currency working capital facilities and other important services such as agency, account management and sometimes hedging.
The challenges for commercial lenders mean that DFIs will continue to be a key source of capital for solar IPPs in Africa. Utility scale solar projects tend to be financed by organisations like CDC using proven and well-defined models. On the debt side, CDC typically provides long tenor, hard currency project finance to developers, leading or as part of club deals with other lenders, or being the sole lender. CDC adopts and deploys best practice developed over a long period of time working in project finance in emerging markets, partnering with strong developers and EPC contractors who have a proven track record of delivering projects in difficult operating environments. CDC looks to finance the lowest cost producers of power in any market, and thus incentivise the off-taker of the power to dispatch and pay for the power when it is available. Supporting the production of power at the lowest possible cost point is also beneficial for economic growth and development in these countries.
Off-grid solar: How can we scale up finance?
OGS covers a broad range of products and services from small solar lanterns to mini-grids and commercial and industrial applications. It is still a relatively nascent sector in Africa, meaning business models and financing models are both still being refined. CDC believes that the SHS segment shows great promise as a sustainable, commercially viable opportunity, and has developed an OGS debt initiative to support the growth of the sector.
One of the key challenges that must be overcome for pay-as-you-go (“PAYG”) businesses to scale, is the need for working capital. The PAYG model, which has unlocked a large segment of the market by allowing lower-income customers to buy SHS on credit, creates a significant need for receivables financing. But debt has generally been in short supply. This is commonly attributed to both a limited understanding of the emerging sector for many lenders, as well as low risk appetite for lending to early stage, pre-profit companies. With limited information on how this relatively new class of receivables will perform over time, it can be challenging for lenders to accurately assess the risk.
Access to debt for SHS companies has improved recently, but much of the debt has been in hard currency, creating a mismatch with the local currency receivables. Rothenbusch explains CDC’s view: “We believe it is critical to finance local currency receivables with local currency debt otherwise you are compounding the risks these young companies are already facing. Our new OGS debt initiative is explicitly designed to address the local currency issue, which we see as a key market need.” CDC’s approach includes partnering with local and regional commercial banks to mobilise local currency capital by sharing risk with banks and providing transaction advisory services if required. “We want to help fill the gap to allow SHS companies to continue to scale, develop track record and reach profitability. But we believe that local lenders are the natural providers of this financing in the near future, and we want to help catalyse that process.”
CDC has seen a number of different debt structures in the OGS market, including both on and off-balance sheet facilities. Rothenbusch explains that CDC is “looking at a number of structures, typically on balance sheet, linked to receivables growth, and mobilizing local banks through risk sharing or guarantee structures. We know a lot of companies want to go off-balance sheet, but our preference now is to start with simpler structures, where we are sure that interests are aligned, and then see how the market develops.” In addition to providing finance, CDC aims to work with OGS companies, other lenders and industry stakeholders to strengthen consumer protections, improve environmental and social management and promote data transparency, which it believes will enhance the long-term viability of the sector.
DFIs including CDC can continue to develop and improve the solar financing landscape in Africa. But what’s clear is that these efforts require close collaboration of all parties – including commercial lenders, governments and promoters – in order to overcome the challenges and meet electrification targets.
CDC Group is the UK’s Development Finance Institution (DFI). Energy is one of CDC’s core sectors and CDC supports grid scale and off-grid solar power through direct debt and equity investments, and through funds. CDC’s vision is to put sustainable megawatts on the ground in some of the hardest geographies, and to support access to affordable power for rural, base of pyramid customers via OGS
Globeleq, Africa’s leading IPP company with eight operational plants totalling 1,200+ MW, was founded by CDC in 2002 and was brought back under CDC’s direct control in 2015. CDC has also partnered with IPS, the industrial and infrastructure arm of AKFED, to launch a new power platform, which currently has 325MW of operational capacity. Through both platforms, CDC is pursuing additional projects, including solar, in Africa. On the debt side, CDC is a significant participant in the recent Egypt Feed-in-Tariff (FIT) solar programme, and is supporting other solar developers across the continent in, among others, Nigeria and Ethiopia.
In the OGS space, CDC has invested in a number of the largest solar home systems (SHS) players in the industry through investments in funds like Energy Access Ventures, Investec and Novastar. CDC has also invested directly - both debt and equity - in M-KOPA, one of the leading SHS companies in Africa. To further support the SHS industry, CDC recently launched an initiative to invest the equivalent of up to USD 150m of local currency debt into the OGS market, focusing on SHS companies using the PAYG consumer financing model.