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Africa could provide cheap energy with gas-to-power

Gas-to-power projects offer an opportunity for nations in sub-Saharan Africa to provide cheap electricity from domestic resources. But there are difficulties as well

It is not uncommon to hear oil company executives say – half jokingly – that their order of preference, when it comes to hydrocarbon exploration in certain frontier markets, is the following: oil, then a dry hole, then gas. Indeed, the development of gas resources, without the access to a readily available gas grid, does not come without headaches. 

As distance from energy demand centres increases, gas monetisation options become constrained by infrastructure requirements and shipping costs, but most of all by size. Many gas fields are simply not large enough to justify certain monetisation strategies.

Liquefied natural gas (LNG) is, for example, viable only with large gas reserves – generally in the order of at least 5-10 trillion cubic feet (cf) – which are required to justify the investment. Similarly, gas-to-liquids (GTL) or petrochemical projects require gas fields in excess of 1-2 trillion cf. With the number of existing and newly discovered small to medium size fields far exceeding the number of large ones, it is easy to conclude that these types of gas monetisation schemes are the preserve of the owners of the very few, large gas fields. 

Other monetisation schemes, such as using gas as feedstock for fertiliser or methanol production, may work with a smaller resource base. Nonetheless, these alternatives are capital intensive and the price volatility inherent to these businesses makes them very challenging to finance.

However, gas-fired power generation may provide a natural monetisation strategy for several medium-size gas fields in sub-Saharan Africa. As a result of the population and double digit economic growth on the continent in the last 10 years, there is an ever increasing demand for power. Couple this demand with an abundance of international capital seeking yield, the development of indigenous gas-fired power facilities is garnering increased interest as a means to meet this demand. Nonetheless, the development of gas-to-power projects in emerging markets comes with unique risks and challenges (some of them unique when compared to many other monetisation schemes) that need to be adequately addressed in order to attract the capital required. 

Growing demand

Power generation in Africa represents less than 50% of the peak demand requirement, which is estimated at 74,000 megawatts (MW). Total installed capacity in sub-Saharan Africa (excluding South Africa) is estimated at 28 gigawatts (GW), the same as the country of Argentina, which has a population of almost 40 million, or 5% of that of sub-Saharan Africa (excluding South Africa). 

According to the International Energy Agency (IEA), almost 57% of sub-Saharan Africa’s population – about 600 million people – do not have access to electricity. Patchy electricity supply has proved to be the major constraint to businesses in Africa and has contributed to the low productivity and poor competitiveness of the manufacturing sector on the continent. More than 50% of sub-Sahara African firms identify problems with electricity access as a major constraint to their businesses. 

Lack of power hinders economic as well as human development. School children doing their evening homework in the lit up halls of airports is unfortunately a common scene throughout the lesser developed African countries. 

In many sub-Saharan countries power demand is either unmet or is partially met through expensive, inefficient and dirty liquid fuels. According to the World Bank, the result is an average electricity tariff across sub-Saharan countries of $0.13 cents per kilowatt hour (kWh), compared to US $0.04-$0.09/kWh in other developing economies. The World Bank also estimates that the cost to the economy of load-shedding is equivalent to 2.1% of GDP on average. These shortcomings in the power sector threaten Africa’s long term economic growth and global competitiveness.

Against this backdrop, governments as well as investors have been looking with increased interest at the “pockets” of gas, once considered stranded due to the lack of monetisation schemes. Tanzania, for example hosts onshore gas discoveries totaling 8 trillion cf, while neighbouring Uganda recently declared its natural gas resources to stand at 500 billion cf.

These resource, combined with current and pent-up power demand has sparked proposals for a number of gas-to-power projects across sub-Saharan Africa. Some have been in development for some time and are advancing towards completion. 

For example, in Namibia, the Kudu field, which has reserves of 1.3 trillion cf, was discovered in 1974, and the license has been held by numerous companies over time without activity. A gas-to-power project is being developed, which may add more than 400 MW to the country’s installed capacity.

The development of the Banda gas field, offshore Mauritania, is also a case in point. Discovered in 2002, its development was stalled due to lack of monetisation options, until declared commercially viable in 2011. Gas from Banda will supply fuel for 310 MW of new generating capacity, more than doubling the country’s installed capacity to almost 500 MW. This gas-to-power project will not only meet domestic electricity demand, it will also allow Mauritania’s power-constrained neighbouring countries, Senegal and Mali, to import lower-cost electricity. For Mauritania, gas development also means replacing fuel imports with domestically produced gas, with clear budgetary benefits for the country.

Credit dilemma

Turning gas molecules into electrons appears to be a logical and natural solution to the gas monetisation dilemma in sub-Saharan Africa, given the existing and pent-up demand for power, as well as the need to provide cheaper and cleaner energy. Nonetheless, the development of gas-fired power projects introduces a number of commercial challenges into the equation. 

While LNG, fertilisers, methanol and other gas-derived commodities are sold to creditworthy international buyers – this is often a sine qua non condition for the financing of these capital intensive projects – power, given its inherent characteristics, can only be sold locally, which means mostly to financially weak utilities.

For these reasons – both the non-viability of many hard-currency earning monetisation options and the lack of domestic credit – the issue of enhancing the creditworthiness of the power off-taker is at the cornerstone of the development of a bankable power project.

As a pre-condition for sinking their capital into a power project, investors and lenders alike need to be confident that timely power payments will be made throughout the life of the project and cash flows generated from the project will repay the debt and provide a return on equity.

Government guarantees of the power off-take can strengthen the creditworthiness of a project. Many sovereigns, however, are not deemed creditworthy. Few sub-Saharan countries are rated, and even fewer have a credit rating higher than BB. In this context, the guarantee instruments provided by multilateral finance institutions such as the World Bank, the African Development Bank, the European Investment Bank or the Islamic Development Bank can play a pivotal role in attracting private capital into power projects in these non-investment grade environments.

The World Bank’s Guarantee (WBG) instrument, which can be structured to backstop the payment obligations of a public sector entity, may provide the needed credit enhancement required to catalyze private investments. While the WBG instrument requires some structuring, it also provides a solution to the creditworthiness dilemma. 

The Azito IPP project in Cote d’Ivoire provides a good example of the World Bank’s Guarantee ability to protect investors and ensure timely payment of periodic governmental obligations. Despite the 2010-2011 civil and political unrest, all payments under the WBG-backed Azito IPP’s Power Purchase Agreement (PPA) were made when due. A similar power project in Cote d’Ivoire, the CIPREL IPP, did not benefit from a WBG, and consequently, suffered the economic consequences of suspended PPA payments during the period of political unrest.

In addition to the PPA payment obligations, lenders and investors will need to be confident that in the event of project termination, early termination payments to cover the outstanding debt will be made to lenders, and that payments to the investors cover at least the amount of capital not yet recovered. 

There again, the World Bank’s Guarantee instrument as well as other insurance products, such as those provided by the Multilateral Investment Guarantee Agency (MIGA), can be obtained to cover against country and political risk events (eg breach of contract or non-honoring of a sovereign guarantee) and may provide the needed comfort to lenders and investors. 

Foreign exchange risk is another risk that power projects face that is usually not an issue in LNG, petrochemical or fertiliser projects.Foreign exchange risk has many different dimensions: convertibility risk, transfer risk, and exchange rate risk. While the first two risks are political risks and insurable in the market, the third is more complicated. Exchange rate risk, often the “the elephant in the room” of power deals in frontier markets, is difficult to address because it is never clear who should bear this risk. A number of text-book strategies to mitigate this risk, such as hedging, local currency financing, or exchange rate guarantees are simply not realistic in the context of most sub-Saharan African countries. Denominating power tariffs in dollars and indexing the tariffs are effective and common ways to deal with exchange rate risk, but may not protect an investor or lender in the event of dramatic currency devaluation. The financing of gas-to-power projects will require lenders and investors to accept the underlying uncertainties inherent to the foreign currency mismatch.

In addition to the credit and foreign exchange issues, the availability of transmission infrastructure, which enables power to be evacuated and reach the demand centers, is another major challenge for the development of gas-to-power projects in sub-Saharan Africa. Aging and inadequate transmission infrastructure is often a bottleneck to the development efforts. In many instances, power developers may need to rely on the concurrent development of transmission projects that will also need to be developed, financed and built. 

What’s next?

Recent gas discoveries in sub-Saharan Africa, coupled with an ever increasing demand for power, may be paving the way for a wave of gas-to-power projects. Financing and completion of these projects will require extensive structuring to address all of the project commercial and non-commercial risks, but most of all the counterparty credit risk. 

While credit enhancement provided through guarantees and insurance products may provide the adequate comfort to sanction some of these projects, investors and lenders should, nonetheless, take even greater comfort by the intrinsic creditworthiness of the project they are funding. As these gas-to-power projects will meet a demand so crucial to economic and human development, one may want to pose the following question: Will sovereigns default or allow their public sector utilities to default on a gas payment, if the alternative is to buy more expensive liquid fuels or to allow the country to “go dark”?”

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