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Reading between the lines: The Department of Energy does not think Renewable Energy is the answer to South Africa’s energy needs

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On Friday, 1 September 2017, the Minister of Energy announced that Eskom will sign the long-delayed power purchase agreements (PPAs) with all preferred bidders from Round 3.5 and Round 4 of the Renewable Energy Independent Power Producer Procurement Programme (REIPPPP) by 28 October 2017.

However, such signature by Eskom is subject to the bid tariffs being capped at 77c per kWh. Our view is that this announcement represents a clear decision by the Department of Energy (DoE) to materially reduce the long-term use of alternative energy in South Africa.

Before analysing the impact of this announcement on future projects, it should be noted that previously existing projects still enjoy the DoE guarantee of all Eskom’s obligations. As such, we consider all the Round 1, 2 and 3 projects appropriately protected from legal and regulatory risks and we continue to consider the existing projects to be a good long-term investment for retirement funds. In effect, the Minister’s price-cap represents a renegotiation of the price after a clear and transparent competitive bidding process. Thus, while at first glance the pending signature of the PPAs seems positive, a review of the preferred bidder bid tariffs in Round 4 indicates that the 77c per kWh tariff (fully indexed price) is a difficult hurdle to overcome.

Bid Tariffs Round 3.5 & Round 5 

 

Contracted Capacity (MWp)

Fully indexed price (ZAR/kWh)
April 2014 base date
(ie Bid)

Fully indexed price (ZAR/kWh)
Today's money

Solar      

Aggeneys Solar

40

0.78

0.98

Droogfontein 2 Solar

75

0.83

1.05

Dyason's Klip 1

75

0.77

0.97

Dyason's Klip 2

75

0.78

0.97

Konkoonsies II Solar

75

0.79

0.99

Sirius Solar PV

75

0.77

0.97

Bokamoso

68

0.86

1.08

De Wildt

50

0.87

1.09

Greefspan 2

55

0.84

1.05

Solar Capital Orange

75

0.83

1.04

Wateroo

75

0.86

1.08

Zeerust

75

0.86

1.08

Total Solar

813

0.82

1.03

       
Wind      

Copperton

102

0.70

0.88

Excelsior

32

0.73

0.91

Garob

136

0.75

0.94

Golden valley

118

0.58

0.73

Kangnas

137

0.67

0.84

 

 

 

 

Oyster bay

140

0.61

0.77

Perdekraal East

108

0.76

0.95

Roggeveld

140

0.56

0.70

Karusa

140

0.67

0.84

Nxuba

139

0.67

0.84

Soetwater

139

0.70

0.88

Wesley Ciskei

33

0.75

0.95

Total Wind

1,363

0.67

0.84

       

Total

2,176

0.72

0.91

As can be seen in the bid-prices, none of the Solar PV projects will meet the 77c per kWh cap while only three wind projects (Golden Valley, Oyster Bay, Roggeveld) will do so. Thus, out of the 2,176MWh capacity which was awarded preferred bidder status, only 398MWh (18%) may meet the new cap.
The remaining 82% of the projects will be faced with headwinds to meet the indicated average bid-tariff reduction of 15%, exacerbated by likely increases in project development costs due to the two-year delay since the original announcement of the preferred bidders. Further, these projects were already aggressively structured (e.g. gearing levels, financial covenants) with little room for additional cost savings. More specifically:

  • While there has been a steady decrease in the cost of Solar-PV and Wind technology (in USD terms), the ZAR has weakened by +/-20% since the bids were submitted;
  • The risk-free real rate has increased by 60bps since bid submission, which results in an increase in funding costs for those projects funded using CPI debt. Nominal swap spreads have reduced by a similar amount over the period, which provides funding cost relief;
  • Debt funding terms (term, interest margin, required buffers) have already been stretched close to their limits, with very little room to manoeuvre; and
  • Projected equity returns are at low levels already.

This does not bode well for the likelihood of a successful negotiated outcome if the inflationary impact on the project development costs over the last two years is not taken into account when negotiating the cap on the tariff to be paid by Eskom. Thus, a key question is whether the base date for the 77c per kWh tariff is April 2014 (the original bid base date) or the date of signing the PPA expected in October 2017.
Additionally, the Minister announced that all future programmes will be put on hold until the Integrated Energy Plan (IEP) and Integrated Resource Plan (IRP) process is concluded. In our view, this is a bigger threat to the South African Industry as it introduces further policy uncertainty.

With this uncertainty, multinational developers with the required expertise to grow the South African renewable industry will look to other jurisdictions to develop projects. These jurisdictions include Saudi Arabia, which has recently committed to construct 9.5GW of solar and wind power plants by 2023 with a total investment of between $30bn and $50bn.
Without this much needed expertise, further growth of the renewable industry in South Africa will be severely crippled and the ability of renewable energy to form a significant portion of South Africa’s energy landscape in future will be limited.