Robert Brand and Mike Cohen
FIRMs funding R47 billion of local wind and solar energy projects are driving up prices to lock in long-term borrowing costs as they seek protection from fluctuating interest rates.
Payments to secure 10-year rates jumped 69 basis points to a four-month high of 7.13 percent on Monday from a record low in July. The premium of 10-year swaps over two-year contracts widened 18 basis points since October, indicating that demand for the longer-term contracts outstripped shorter-dated swaps. The spread for similar contracts in Russia has declined 32 basis points.
The Department of Energy signed agreements for 28 renewable energy projects this week, opening the way for bank financing deals to be struck. Borrowers are using swaps to convert floating rates to fixed payments to reduce the risk of rising repayments should interest rates increase. Higher swap prices may boost hedging costs for other local companies.
“The market is positioning itself ahead of the deals, which are expected to be done in the next week,” said Brigid Taylor of Nedbank investment banking. “You’ve seen a rally in the swap curve” amid speculation that as much as R12bn of swaps need to be hedged, she said.
South Africa has embarked on a renewable energy drive to lessen the country’s reliance on coal as it boosts generation capacity to avoid a repeat of power outages in 2008 that shut mines and plants. Eskom’s generation capacity is 40 000 megawatts (MW), mostly from coal. Eskom supplies 95 percent of the nation’s power.
The nation plans to generate 18 800MW more electricity from alternative energy sources by 2030. Forty-seven projects worth R73bn were approved in the first two bidding rounds that began last year.
“Most projects want to secure fixed interest rates,” Chris Hall of the SA Photovoltaic Industry Association said this week. “You want to try to bed down the cost as much as possible.” Hedging plans were being made by banks financing the projects, with the costs borne by developers, he added.
Most firms use debt funding to cover 75 percent of costs of projects at rates of 350 basis points to 425 basis points more than the Johannesburg interbank agreed rate, data show.
Loans to fund the projects, which stretch up to 15 years, were usually rated lower than asset-backed debt because of high risks with construction and delivery, Andrew Canter of Futuregrowth said last week.
Lenders “are forcing a minimum hedge from the project side”, pushing up swap rates relative to bond yields, he added.
The yield difference between 10-year swaps and government bonds of similar maturity had widened by 34 basis points since October 1 to 44 basis points on Monday. The swaps offer firms the opportunity to fix borrowing costs as investors reverse bets on further rate cuts.
Reserve Bank governor Gill Marcus said last week that investors should not assume that policymakers would “automatically” cut rates again to spur economic growth. The central bank’s primary responsibility was to control inflation.
The cost of insuring South African dollar debt over five years using credit-default swaps rose 1 basis point to 154 yesterday, indicating a deterioration in risk perceptions. The credit default swaps have climbed 27 points since mining strikes began at Lonmin on August 10, before spreading to other platinum mines and gold and iron ore plants. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower breaks debt deals.
The renewable energy projects were “brilliant long-term savings assets in that they have a natural inflation hedge”, Jurie Swart of Old Mutual Investment Group said this week.
The tariffs that plant owners are paid for their electricity would probably escalate by inflation-related levels, offering protection, he added.
Swap rates will probably continue to rise as the energy deals are closed.
“You’re going to see increased flow” in the swap market on the back of the energy deals, Quinten Bertenshaw of ETM Analytics said on Monday. “It definitely is going to increase the cost of corporate hedging if these swaps move up too aggressively.” – Bloomberg