With the number of investment opportunities in the renewable energy sector rapidly growing in new locations across Africa, pre-construction stage funding will be crucial in supporting developers on their journey towards achieving project feasibility, bankability and development1. These projects often face unique challenges, such as an under-developed regulatory environment, lack of local precedent or expertise, and insufficient funding. Eversheds increasingly sees how funders like InfraCo Africa can offer both financial and technical solutions to support renewable energy projects through successful development.
A challenging environment
Many project opportunities suffer significant delay and even abandonment for lack of sufficient early stage investment. Often local entrepreneurs secure land rights or rights to develop a project but lack the expertise, experience or sufficient funds to carry out the necessary feasibility study, the increasingly often extensive environmental and social impact assessments and the tendering processes for project contractors and suppliers that senior funders now require. Governments get impatient that promises made to them are not being realised fast enough and investors want to see quick progress in this increasingly competitive marketplace. Investors are typically unable or unwilling to take on balance sheet the financing costs for these projects and so traditional project finance remains important for moving renewable power projects forward in Africa. But the risk sensitivity of project finance lenders and the requirements for full project documentation prior to financial close also means that these projects may not be able to support the timing and cost implications of these more complex structures and the lengthier negotiations that project financing involves without additional finance to carry the project through this extended period.
A unique solution?
InfraCo Africa seeks to mobilise investment into sub-Saharan infrastructure projects, including renewable energy projects, by either funding teams of experienced project developers or by investing directly into early-stage projects. As part of the Private Infrastructure Development Group (PIDG), InfraCo Africa is a privately managed but publicly funded company, supported by the governments of the UK, Switzerland, Austria and the Netherlands. The organisation prioritises the poorest and most fragile countries in sub-Saharan Africa where infrastructure can have significant positive developmental impact. It also prioritises pioneering projects that have the potential to become bankable but first need InfraCo Africa’s support. Ultimately, InfraCo Africa aims to reduce the risk and cost associated with early stage project development, ensuring that projects develop from concept to bankable investment opportunity.
Current InfraCo collaborations
In 2015, InfraCo Africa committed US$36m to five new infrastructure projects, three of which Eversheds provided advice on: Corbetti Geothermal (Ethiopia), Djermaya Solar (Chad) and Redavia (Tanzania).
Ethiopia: Corbetti geothermal
Eversheds advised on various due diligence matters in relation to a geothermal power project in the Corbetti Caldera, Ethiopia. Located on a greenfield site, the project is expected to be the first privately financed geothermal IPP in Ethiopia. When InfraCo Africa started to invest, the project was still very high risk as the availability of suitable geothermal brine had not been confirmed by exploration drilling. Early stage funding is structured to reward investors who take early risk and gradually reduce the reward as key milestones are achieved. This creates incentives for investors to fund the project while limiting the exposure if the project struggles to achieve the earliest, often the hardest, breakthroughs. As lawyers, it is important to recognise that there will be challenges faced by projects in these difficult markets and to help devise practical approaches to deal with them.
Chad: Djermaya solar
This was key to the approach taken by Eversheds in relation to the joint development agreement for the Djermaya Solar project in Chad, signed in December 2015 among InfraCo Africa, CDEN Sarl and the JCM Clean Power Development Fund LP. Eversheds advised Aldwych Africa Developments Limited, as for a developer of InfraCo Africa, in relation to this transaction. The project, an IPP, will develop a 60MW Solar PV plant 30km north of Chad’s capital N’Djamena. The project will be developed in two phases, each constructing 30MW of installed capacity, with power first becoming available to Chad’s national grid in 2018.
Containerised solar: Redavia Tanzania
Redavia Tanzania Assets Ltd (Redavia), is a containerised off-grid solar PV rental business. The business has deployed three containers but needs a significant injection of capital to enable the business to grow and achieve commercial scale. InfraCo Africa’s investment into the company is structured as a convertible debt* instrument with disbursements being linked to the achievement of key project milestones.
This approach balances flexibility (in terms of disbursement and exit for InfraCo Africa) and predictability (in terms of total committed investment for Redavia).
On the Redavia Tanzania transaction, Eversheds worked with InfraCo Africa to ensure that the transaction structure is of a standard to satisfy InfraCo Africa both as a debt provider and potential future shareholder. By ensuring understanding of the different stages of Redavia’s business cycle, it was possible to suggest appropriate and balanced drawdown milestones and other ongoing covenants. Eversheds also advised InfraCo Africa on key issues such as appropriate controls over customer contracting, and conversion and default rights and circumstances.
Driving business growth
In the early stage of a project, it is necessary to strike a balance between ensuring the client is appropriately safe-guarded and understands the nature of the risks, while appreciating that, despite potentially years of commitment from local partners, these projects are not yet bankable and will require further development to mitigate risks and attract further investment. It is not possible or practical for legal advisers to take a full scale project finance due diligence approach in these circumstances, but instead it is important to ensure their investment is appropriately dovetailed with key project milestones.
Achieving bankability
Funders like InfraCo Africa also seeks to support projects by addressing the key potential issues of a future funder or investor, such as local currency depreciation and exchange control risk, change in law risk, force majeure, level of government support, expropriation risk and environmental and social risk. Eversheds regularly comes across projects with signed documentation, such as a memorandum of understanding or a power purchase agreement, which is not bankable for external finance or otherwise marketable to outside investors, but where the then current investors have a different view. It can be a difficult position to reverse, and parties need to be realistic about how quickly and easily they will be able to achieve necessary documentation changes. InfraCo Africa’s involvement at the outset can provide support to help avoid such a situation.
Potential external funders and investors will always be looking beyond technical risk and financial projections, particularly in jurisdictions they are entering for the first time and there are some key themes which will always needs to be verified, even for an early stage funder. The importance of clear land rights and permits, as well as an appropriate legal and regulatory framework cannot be underestimated from a timing and costs perspective. These would ideally be resolved prior to funding and following effective due diligence, but for initial early stage funding the parties may also settle for the local partner or government giving appropriate undertakings (with sufficient incentives to perform) to grant the necessary rights to the project company.
A practical approach
Eversheds continues to provide support in relation to these projects, seeking to develop a standardised approach to investment documentation into early stage projects on the African continent. Through this, the company aims to reduce legal costs while driving up standards on the ground, particularly while recognising the adverse impact that large legal bills and delays from protracted negotiations can have on the viability of renewable energy projects throughout Africa.
* Benefits of convertible debt
A convertible debt instrument enables funders to exit either by way of refinancing (e.g. by long-term project finance) or by converting its debt into equity and selling either to existing co-investors (if in place) or to new incoming investors. The equity component can also be important in evidencing a funder’s commitment to the successful transformation of the project. Where the project is under-performing and struggling to achieve long-term investment, instead of simply accelerating its outstanding debt in a default scenario and maximising its claim in a likely liquidation or waiting to see if other shareholders will repay the debt, a funder of convertible debt can elect to become a shareholder in the project vehicle, giving it more decision-making authority relative to other investors in deciding how to take the project forward. Interest does not have to be serviced during growth phase, but can be capitalised instead, thereby preventing the business from cash starvation.
1 This article looks at the unique challenges faced by renewable projects in the pre-construction stage and focusses on how funders like InfraCo Africa can offer potential solutions. While we use some examples of projects funded by InfraCo Africa, this article seeks to discuss pre-construction funding in general terms, and does not express any views on behalf of InfraCo Africa or on particular projects.
ABOUT THE AUTHORS
Lynne Wells is Principal Associate (Project Finance) at Eversheds LLP and Howard Barrie is Partner (Project Finance) at Eversheds LLP.
FURTHER INFORMATION
Eversheds LLP, http://www.eversheds.com/
InfraCo Africa, http://www.infracoafrica.com/