In January, the African Development Bank (AfDB) launched the ‘New Deal on Energy for Africa,’ an ambitious plan to light up Africa. These efforts reinforce the new and increasing focus on private sector investment in power generation assets across the continent – see some of our other blogs on the topic here.
Attracting private investment to emerging markets requires a robust regulatory regime and adequate government support to make projects ‘bankable.’ There is an inherent tension within independent power producer (IPP) programmes in emerging markets: governments generally seek to minimize the level of sovereign liability and recourse for default while still attracting international finance and experienced developers.
There may be interesting lessons for African nations to learn, studying the evolution of government support for IPP projects in Indonesia, which has had an IPP programme in place since the 1990s.
Like most Southeast Asian jurisdictions, Indonesia does not have a spot market for electricity; revenues depend on long-term power purchase agreements (PPA) with the state-owned power utility, PLN. Since the cost of generating power is higher than the retail price, the government pays a subsidy to PLN to defray the costs. As a result, Indonesian IPP sponsors and lenders have traditionally sought government assurances that PLN’s payment obligations under the PPA will be met.
The method of assurance in the Indonesian market has evolved considerably over the years, initially consisting of a primary obligation from the Ministry of Finance (MoF) to ensure subsidy funding continued to flow to PLN. Subsequently, MoF became reluctant to provide guarantees on a project-specific basis, leading to an umbrella note confirming appropriate financial support to PLN in respect of IPP projects backed by the Japan Bank for International Cooperation.
When PLN rolled out the Fast Track I programme in 2009, the commercial debt and export credit market was not willing to finance projects without government support. Consequently, a new form of guarantee was issued directly in favour of the lenders, ensuring repayment of the debt for these projects.
More recently, in connection with the Fast Track II programme, we have seen the introduction of Business Viability Guarantee Letters under which MoF agrees to honour PLN’s payment obligations. Separately, MoF established the Indonesia Infrastructure Guarantee Fund (IIGF) to which it commits funds annually for the purpose of guaranteeing government agencies’ payment obligations in certain designated PPP infrastructure projects, including in the power sector.
The Indonesian Government has also continued to seek opportunities to reduce the level of sovereign guarantees and support to IPP projects. In December 2013, the 660MW Banten project became the first – and only – project to reach financial close without a government guarantee. It remains to be seen whether this will set a new precedent for IPPs in Indonesia given the project had strong sponsor support and a small bank group.
Currently, Indonesian power projects lacking some form of government guarantee struggle to attract the full range of bidders (particularly Japanese and Korean), export credit agencies and international banks unless they have a large appetite for risk. Nonetheless, we expect that eventually, the IPP market will be forced to accept the transition towards non-guaranteed projects, particularly if Indonesia’s economic outlook continues to improve and PLN maintains its investment grade rating.
As the IPP industry matures in Africa and the risk to developers declines, it will be interesting to see how the governments in those emerging markets address the government support issue. If the Indonesian example is an indication, it will be no surprise to see utilities moving to take a little off the negotiating table for future projects.