The unfolding landscape for IPPs in South Africa

As legal experts in the energy sector, Cliffe Dekker Hofmeyr (CDH) has been instrumental in steering key projects though to commercial operation in South Africa and sub-Saharan Africa. CDH directors Andrew van Niekerk and Tessa Brewis weigh in on the challenges and opportunities in the South African Independent Power Producer (IPP) arena.

By Alastair Currie

The growing instability of South Africa’s power distribution network presents a major socioeconomic risk and needs an accelerated approach. Within this context, the growth of the IPP market presents a viable addition to offset Eskom’s ageing coalfired generation network, and the operational teething problems faced by its more recent Medupi and Kusile power stations.

This was the motivation for the launch of the Renewable Independent Power Producers Procurement Programme (REIPPPP) by the Department of Mineral Resources and Energy (DMRE). Introduced in a phased approach since 2012, Bid Window 5 is the most recent development, with 25 preferred bidders announced on 28 October 2021.

Bid Window 5 will add 2 583 MW, either via wind farm or solar PV plants, at an estimated investment value of around R50 billion. This is welcome news but, depending on the scale, larger projects are anticipated to take a minimum of 36 months to reach their COD (commercial operation date). The DMRE says it expects to conclude financial close on these agreements by Q2 2022. Part of this process includes the conclusion of a power purchase agreement (PPA) with Eskom, as well as an implementation agreement with government, which is standard practice for IPP activation.

According to the DMRE, 93 IPP agreements have been concluded since the start of Bid Window 1, equating to some 7 308 MW. Of these, 89 (including Bid Window 4 projects signed in 2018) are now connected and feeding 6 855 MW into the national grid.

Alongside this are the 11 preferred bidder projects – amounting to some 1 995 MW – announced in terms of government’s Risk Mitigation Independent Power Producer Procurement Programme (RMIPPPP), which was launched in August 2020. The signing of these commercial agreements is scheduled to take place in Q1 2022, with COD anticipated some 18 months later.

As an independent transaction advisor, CDH has been involved on Windows 1 through 5, both for IPPs and general investors like pension funds securing a stake in projects.

“Despite the recent stop-start nature of the REIPPPP, Bid Windows 1 through 4 have successfully proven the value of going this route to secure South Africa’s future power security,” says Van Niekerk, who has been involved in more than 30 renewable energy projects.

“In the past five years or so, traction did slow. One of the key reasons was a general reluctance from the market to conclude new PPAs given the challenges experienced by Eskom. However, Window 5 signals renewed investor appetite, and a positive longer-term view for the power parastatal’s eventual restructuring,” Van Niekerk continues.

As CDH’s sector head: Projects and

Andrew van Niekerk, director and sector head: Projects and Infrastructure, Cliffe Dekker Hofmeyr Tessa Brewis, director, Cliffe Dekker Hofmeyr

Infrastructure, Van Niekerk – along with his team – provides specialist EPC, publicprivate partnership (PPP), and IPP-related legal services in the infrastructure, energy, mining and resources, transport, and real estate domains.

Within the energy space in Africa, Van Niekerk’s recent PPP and IPP project references include work for: - Zimborders Limited as concessionaire and sponsor counsel in respect of the Beitbridge

Border Post Modernisation PPP Project in

Zimbabwe. This was recognised as one of the best deals of 2020 by Global Trade

Review. It is also the first border post PPP project to achieve financial close in sub-

Saharan Africa. - Bio2Watt (Pty) Ltd in respect of a private

IPP biowaste-to-power project. This is the first private sector seller and buyer biowaste IPP project to achieve financial close in South Africa.

RMIPPPP

Within the unfolding IPP framework, it’s important for government to be technology agnostic – in other words not biased towards the use of specific technologies. In this respect, the urgency of the RMIPPPP presented huge opportunities for hybrid power solutions that could come online within much shorter time periods compared to larger-scale REIPPPP projects and provide cheap power. Examples include a combination of solar PV, battery energy storage systems, and standby diesel/ gas generators. However, in the case of the RMIPPPP, some two-thirds of the allocation ended up going to three liquefied natural gas (LNG) powerships.

“Discussions around the development of LNG gas-to-power stations in South Africa have been debated for some time. One of the key hurdles at this stage is that LNG needs to be imported, and the necessary infrastructure at scale is not yet in place,” says Van Niekerk. “However, once security of supply has been addressed, and there’s a distribution network in place, there’s a definite market as part of a broader energy mix that includes wind and solar.”

100 MW threshold exemption

A key breakthrough for the energy sector came in August 2021 following the DMRE's announcement that IPPs would be exempt from applying for a generation licence up to 100 MW. Amendments to Schedule 2 of the Electricity Regulation Act (No. 4 of 2006) were officially gazetted in August and October 2021. The initiative supports government’s objective to add more immediate power to the grid by encouraging smaller-scale generation with faster commissioning times.

“We expect a strong IPP uptake below the 100 MW threshold, with projects expected to come online in the next year or so,” says Brewis.

While IPPs are exempt from the requirement to obtain a generation licence below 100 MW, further clarification is still needed on the requirement for IPPs to register with the National Energy Regulator of South Africa (Nersa).

“Nersa has published guidelines for the registration of small-scale embedded generation facilities. It’s likely that they will publish something similar for IPPs below 100 MW,” adds Brewis.

Municipalities

Amendments to the electricity regulations on new generation capacity, passed in October 2020, enable municipalities in good financial standing to develop their own power generation projects and/or to buy power from IPPs.

Municipalities like the City of Cape Town and eThekwini have sent out proposals for interested IPP investors to engage. These developments are still at the feasibility stage, but it demonstrates a recognition by municipalities that private generation and/or IPPs are part of their future.

“Contractual timeframes to financial close, COD and PPA approval are hugely dependent on the chosen technology and who the offtaker will ultimately be. PPPs are an option, as well as build, own, operate and transfer schemes, but the present regulatory hurdles are immense and time-consuming. The reality is that it’s up to IPPs to fill the gap right now, but that comes with conditions,” Brewis adds.

Funding and PPAs

At present, bulk power supply agreements are run through Eskom, or municipal power utilities. For IPPs, a key factor is to ensure that their generation and revenue projections are achievable, and that there is no contractual risk should curtailment (or load-shedding) occur.

“In most cases, an IPP will probably not operate on an autonomous, localised grid. So, if there’s a significant risk of curtailment, that will present a major hurdle in getting to the point of financial close,” Van Niekerk points out.

Historically, municipalities buy electricity from Eskom and resell to local end-users. Electricity is also one of the main revenue sources for municipalities. For this reason, IPP tariff structures will inevitably have to be structured so that municipalities receive some form of financial compensation, such as via a levy. This would probably include a capacity charge to help fund the maintenance of the municipal distribution network.

“It’s uncharted territory, as is the recommended approach in future when it comes to managing residential and commercial rooftop solar installations. These continue to grow in number as consumers seek off-grid solutions in the wake of constant Eskom power outages. Using smart technologies, homes and businesses might also be able to sell surplus power back to the grid. How this might work in practice still needs to be determined,” Van Niekerk explains.

“Either way, it’s all about scalability and the urgent need for decentralisation and deregulation of the electricity sector, so South Africa can meet its sustainability objectives with affordable power,” Van Niekerk concludes.