South Africa’s infant renewable energy industry appears to be running out of steam after a galloping start. The Renewable Energy Independent Power Producer Procurement Programme kicked off on a high note after being approved in 2011 and quickly attracted huge interest from investors, thanks to the generosity of state-owned power utility Eskom, which bought solar and wind energy from independent power producers (IPPs) at high tariffs in the early bidding rounds of the programme.
For a short while the high tariffs ensured impressive investment returns, particularly for solar projects. Since then investment returns on renewables have fallen sharply in tandem with tariffs due to aggressive bidding by IPPs to the point where uncompetitive industry players are being knocked out of the game, ending their participation in future projects.
Disappointed by IPPs
Interestingly, Eskom has reservations about the programme from an efficiency and cost-effectiveness point of view. Last week, at the company’s quarterly State of the System briefing in Cape Town, Eskom chief executive Brian Molefe said he was disappointed by the IPPs’ contribution to the national grid. That should be a source of concern for investors, who have pumped R194 billion into the programme.
Molefe was quoted by Moneyweb as saying that Eskom was purchasing renewable energy at a higher tariff than its own cost of generation, even though it had excess capacity of its own, implying that the programme made little commercial sense.
To drive his point home, he said Eskom was not only obliged to sign 20-year power purchase agreements with the IPPs, but was also forced to take over the solar and wind farms after the agreements had expired, by which time their technologies would be old, obsolete and useless.
“We will be like somebody who has an old phone, while everybody else has an iPhone,” Moneyweb quoted him as saying, adding that there was currently a mismatch between what the programme was supposed to achieve and the reality on the ground, where IPPs were only delivering electricity during the day when it was least required and not during peak hours when the need was the greatest.
Although he said Eskom was still interested in renewables, Molefe’s brutal frankness could not be further from the buoyancy and enthusiasm that investors still had for the programme.
About a week before Molefe made his remarks about the renewable industry, I witnessed Nonkululeko Nyembezi-Heita, the former ArcelorMittal chief executive, waxing lyrical about the lucrative investment opportunities in renewable energy to a business delegation from Dubai, which was in South Africa on a trade mission.
“In South Africa, we came in late in the renewable energy game, but when we came in, we came with a bang. We have seen private sector money flowing into renewable energy,” she told the Dubai delegation.
Had the delegation listened to Molefe’s presentation, it would have been left with the impression that there was no profit to be made in South Africa’s renewable market. While Nyembezi-Heita talked up the industry, the picture on the ground is not as rosy as it is made out to be.
In the solar energy segment of the renewable market, tariffs started swinging down after Enel, Italy’s largest power producer, introduced an innovative but disruptive funding model for its window 3 solar farms.
Assets as collateral
Unlike other solar IPPs, Enel opted to finance its solar farms off its balance sheet, by putting up its assets as collateral, pushing down the cost of funding for its projects. The upside of this funding strategy is that it allowed the power giant to borrow cheaply, allowing it to bid at low tariffs and significantly undercut its competitors. The downside is that in the event its solar farms go belly up, the funders will attach the assets put up as collateral to recover their losses.
On the other hand, Enel’s competitors did not finance their projects off their balance sheets and opted for project financing. In this context, project financing means that lenders took on more risk and put their faith in IPPs paying back the loans on the back of the 20-year power purchasing agreements signed with Eskom.
Project-based funding is more expensive than balance sheet funding, which means that Enel’s rivals have little room to cut tariffs to a level that matches or outbids the Italian power company, which operates in 32 countries across four continents.
The tariffs have to be high enough to service the debt while at the same time generate profits for IPPs. However, if the IPPs bid too low, their renewable energy farms become unbankable and will struggle to attract equity investment.
Since the advent of the renewable energy sector in South Africa in 2011, average solar tariffs have dropped from R2.75 per kilowatt-hour (kWh) in window 1 to R1.65/kWh in window 2, a fall of more than 40 percent, and to below 89c/kWh in window 3, a further drop of more than 50 percent. The trajectory for returns in window 4 is also low due to depressed tariffs.
Some industry experts have warned that declining tariffs could create a situation similar to California, where up to 70 percent of projects fail due to unsustainably low tariffs. Nonetheless Eskom has already connected 46 out of more than 100 renewable farms to the national grid.
According to the government’s Integrated Resource Plan (IRP 2010), South Africa requires more than 56 000MW of new electricity capacity by 2030 to meet projected demand and provide adequate reserves.
Declining returns
The renewable energy industry is expected to supply about 18 000MW (17 percent of the country’s energy mix) of power to the national electricity grid by 2030, helping with the effort of reducing South Africa’s carbon emissions by 34 percent by 2020 and 42 percent by 2025.
Given the declining returns, it remains to be seen if South Africa is going to hold on to its top 10 ranking in the Wiki-Solar survey, which ranked it behind the world’s leading solar power producers like the US, China, Germany, India, Spain, UK, Italy, Canada and France.
* Andile Ntingi is the chief executive and co-founder of GetBiz, an e-procurement and tender notification service.
** The views expressed here do not necessarily reflect those of Independent Media.
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