Bankability of gas-to-power projects in South Africa

To this effect, the Honourable Minister of the Department of Energy (DoE), Ms Tina Joemat-Pettersson, has made two determinations under the Electricity Regulations Act and the Electricity Regulations on New Generation Capacity. The first determination is for 600MW of new generation capacity, which is needed to contribute towards energy security, to be generated from gas. This represents part of the 948MW of capacity allocated to ‘Gas CCGT’ (natural gas) for the year 2030. The second determination, and the main focus of this article, is for the procurement of 3,126MW of new generation capacity, which is needed to contribute towards energy security, to be generated from gas for the years 2019 – 2025.

To-date, South Africa has had a very successful Renewable Energy Independent Power Producer Procurement Programme (REIPPPP), which began in 2010. The programme has successfully procured 6.4GW from various renewable energy sources including solar, wind, hydro and biomass. The gas-to-power programme (G2P) will use a similar approach to the REIPPP programme including a government-backed long-term Power Purchase Agreement(s) (PPA), which necessitates the bankability required to attract investors. However, the G2P will involve the importation of liquefied natural gas (LNG) as a fuel source for 3,000MW of the 3,126MW determination. The remaining 126MW will be subject to a domestic G2P programme at a later stage.

Gas-fired power including the importation of LNG into the South African market will bring about some unique aspects that require careful consideration. The aspects provide a risk that can impact bankability and successful implementation of the programme in a manner that meets government objectives. Some of the aspects are summarised below.

1. Commodities: LNG price has some linkage to Brent Crude Oil and therefore a variation in fuel costs is expected. A pass-through and recovery mechanism of fuel costs will offer a solution to this risk; however, the mechanics will need to be addressed under the Multi-Year Price Determination (MYPD) methodology.
2. Foreign exchange: electricity in South Africa is Rand (ZAR) denominated while LNG is priced in US dollars (US$), and this too will vary the cost of fuel. In this case, one can look into options such as hedging, a US dollar-based electricity tariff and innovative LNG pricing mechanisms. Government, and potentially LNG suppliers, will decide how best to address this risk.
3. Commercial structure: G2P can be implemented based on a bundled or unbundled approach. A bundled approach entails the development, financing, construction, commissioning and operation of the entire valuechain (i.e. gas supply, marine infrastructure, LNG storage and regasification, gas pipelines and transmission infrastructure) of the project by a single entity/ consortium. This approach minimises interface risk but makes the projects too large for smaller players and financiers. An unbundled approach would require entities/ consortia to bid for parts of the value-chain and then enter into agreements with others in order to wrap the value-chain.
4. 3rd party access: the primary objective of South Africa’s G2P is to stimulate the creation of a downstream gas economy using power as an anchor. Therefore, it would be prudent for the DoE to enforce 3rd party access on import infrastructure to ensure that this objective can be met by promoting access to market and stimulating competition in the downstream sectors. However, investment in extra capacity on the infrastructure will be required to ensure 3rd party access. How these additional costs will be financed remains a discussion. Furthermore, the practicality and technicalities associated with 3rd party access will need to be addressed.
5. Power Purchase Agreement (PPA): the PPA is likely to be structured similarly to the one used successfully on the REIPPPP programme. However, inherent commodity and foreignexchange risk may require some adjustments on the PPA. Furthermore, the power plants are likely to operate on a mid-merit basis and therefore the PPA is expected to address minimum annual load-factor requirements including a potential upside if and when there is a requirement to run the power plants at baseload.
6. Role of State-Owned Entities (SOCs): South Africa has a number of SOCs whose mandates are aligned to the G2P. In order to boost local participation, skills transfer and maintaining government objectives, amongst others, the involvement of certain SOCs across the valuechain of the programme could be of strategic importance. However, if the role of SOCs are to be isolated from the commercial structure, where a SOC may be required to perform a certain function or provide a service to the project entities under a separate agreement(s), then this may pose interface risk to the projects. Therefore, one would expect SOCs to form part of the winning consortium post bid award to ensure alignment of interests and value addition.
7. Availability of finance: G2P will require a guesstimate of about ZAR50 billion ($3.6 billion) in total project costs, which is quite considerable from a South African perspective. Therefore, the capacity of local finance institutions will be tested. However, a programme of this nature should be able to attract international financiers provided the returns are attractive enough.Furthermore, with expected returns likely to be ZAR denominated, the ability to raise ZAR funding and/or to accept ZAR returns for some of the international investors will be critical.

In conclusion, none of the aspects discussed in this article will be fatal flaws to the programme. All these aspects are within the capability of government and its stakeholders to ensure the bankability and successful implementation of the G2P. So far, there has been wide interest from both the local and international communities in the South African G2P programme. The DoE has also recognised the complex nature of the programme and has proactively initiated studies to minimise the risk and timelines.

These include site identification at each of the proposed ports for the LNG import facilities and power plant including the appropriate servitudes. The DoE is also planning to prepare the sites in anticipation of the programme. This provides the comfort that the South African government will do what is necessary to ensure the successful implementation of the G2P; while the onus will be on investors to ensure that they can provide a viable integrated solution that allows for the creation of a downstream gas economy in the country and also minimises fiscal impact from a guarantees perspective. ESI