Unlocking Africa’s Energy Puzzle

Energy stakeholders within African countries have a difficult task. To provide electricity to their citizens who currently lack access, they must increase their energy infrastructure by an order of magnitude. This means not only building out gigawatts of generation per country but also the transmission and distribution networks necessary for delivering the power. 

To fulfill this task, the various ministries of energy and state-owned public electric utilities must solve a challenging economic puzzle. To avail as much energy to their populace as possible, African governments often direct the utilities to charge a lower tariff to retail customers than cost, effectively subsidizing part of the expenses for generation as well as the transmission and distribution infrastructure. These subsidies sit on the balance sheet of the utility, creating inefficiency through no fault of their own. 

A priority for African governments and their energy stakeholders is to attract large industrial companies. While the government cares about job creation and boosted tax receipts, the utility sees a predictably paying large consumer of electricity. Such industrial customers who require large amounts of electricity want to see conditions met to set up operations. While Africa has abundant resources for manufacturing and a large, affordable, workforce, the lack of electrical infrastructure can be an insurmountable hurdle. 

These collective factors create a negative feedback loop for energy stakeholders. To attract more paying customers, they require more infrastructure. To pay for the infrastructure though, they need more revenue. To break this cycle, there are two options: 1) take on debt to build the infrastructure, or 2) engage Independent Power Providers (“IPP”) to build and operate generation assets and sell electricity to the utility. 

To secure debt for this type of infrastructure, there are very few options. These projects range in cost from hundreds of millions to billions of dollars. The terms given to these countries are 3.75% plus the secured overnight financing rate (“SOFR”) and include line items for political risk insurance, front-end and commitment fees, and an arranger surcharge, among others. The net effect is that a 30-year loan with interest (current as of 30 September 2024) and fees would cost more than 275% in interest above principal. For context, a 30-year fixed-rate mortgage in the United States would cost a homebuyer approximately 150% in interest over the course of the loan.

This less-than-ideal debt option leads to utilities turning to IPP energy producers. The most common IPP business model is the “Build, Own, Operate, Transfer” (“BOOT”) model. Under this model, the IPP will sell electricity to the grid operator from a generation asset that it is responsible for building in the host nation. The IPPs usually insist on a “take or pay” clause in the power purchase agreement (“PPA”), which is often two or even three times the subsidized tariff that the utility charges their retail customers, building in a negative margin from the beginning. The IPP will transfer the asset to the utility after a certain period, typically 30 years, and the utility hopes to eventually eliminate the subsidy to make the investment economically viable.

This dilemma will exist for African energy stakeholders until the vicious cycle of customer profile, unpredictable revenue, subsidies, cost of capital, and take or pay contracts is broken. One way to break the cycle is partnering with a different type of customer leveraging a novel technology.