FUTUREGROWTH: Expert Opinions: Edition October 2019 / January 2020


Renewable energy investments:
What to ask your manager

Written by Paul Semple, Portfolio Manager (Power Debt Fund)
@ Futuregrowth Asset Management

As SA transitions from fossil fuels to a more diversified energy mix, the contribution of renewable energy is expected to grow. No longer is there a trade-off between clean and least-cost energy. The updated Integrated Resource Plan envisages that renewables will dominate the build-out of new energy over the next 30 years. Here are some useful questions for an investor when reviewing a renewable energy asset:

The general profile of the renewable energy project

– In what technology is the project invested? The simplest technology to install, operate and maintain is Solar Photovoltaic (PV), followed by Wind, Biomass, Hydro, and, lastly, Concentrated Solar Power (CSP). Most expensive is CSP but can store energy for peak hour demand;

– Does the project have a signed Power Purchase Agreement (PPA) with Eskom? This contract ensures an off-take of power by Eskom at an agreed inflationary-linked tariff for a minimum of 20 years;

– At what stage of the Renewable Energy Independent Producer Power Procurement Programme (REIPPPP) process is the project? Prior to tender, the project is in development stage until it is bid-ready. If selected under REIPPPP, it is awarded a Preferred Bid, followed by a signed PPA, project construction and, finally, operations – once the Commercial Operation Date (COD) is achieved;

– What is the size of the project’s capacity in megawatts (MWs)? One MW is sufficient to power around 650 homes. Wind projects are measured by the number of turbines; smaller projects have fewer turbines, a higher risk of concentration and a disproportionately bigger impact on output if any one or more turbines fail.

The stakeholders in the renewable energy project

– How much experience does the developer/lead sponsor of the project have in prior bid windows of the REIPPPP? Given the increasingly competitive nature of each successive bid window, the experience of previous preferred bidders should benefit the prospects of a project;

– What is the track record of the technology supplier in SA? Equipment might have fared successfully in other regions but has failed in SA due to the harshness of our climate;

– Who is the shareholder of reference in the project and is it a strategic entity with a sufficiently strong balance sheet and energy experience, such as having built and operated energy projects internationally?

– What is the Black Empowerment stake in the project and how broad based is it? In order to win a preferred bid in the REIPPPP, the minimum stake required under the last bid window was 30%. Project location and resource strength

– Where is the project located, and what is its distance from the grid? Many areas, such as the Northern Cape, are over-concentrated with solar PV projects and grid capacity is inadequate to connect new projects unless significant expenditure is made by Eskom to upgrade the grid infrastructure;

– Over what period of time has the strength of the resource been tested? A longer period is better, as many projects have failed to meet budget because of inadequate resource test data that has resulted in inaccurate resource strength predictions and consequent underperformance of projects.

Debt terms and project metrics

– How long is the debt repayment term? As the PPA is limited to 20 years, a longer debt repayment term results in a shorter ungeared tail in the project. Free cash flow spikes when the project debt is settled and a shorter ungeared tail results in a smaller cash buffer to cover a protracted debt redemption;

– What are the forecast minimum and the covenanted financial metrics in the project, such as the minimum debt service cover ratio (DSCR) and the minimum loan life cover ratio (LLCR)? These ratios are important measurements of the amount of cash available to cover the debt repayment obligations;

– How sensitive is the cash flow to a stress test of the assumptions behind the forecast energy production and revenue generation? If assumptions such as the cost of construction or operational overheads increase, or if completion is delayed or resource strength is lower, the debt repayments should remain adequately covered;

– How experienced is the lender consortium and which party has arranged the finance package? Debt structuring experience is important and the arranger should be aligned with the lenders by way of a coinvestment on the same terms and conditions.

Social and enterprise development

– What is the extent of engagement by the project with the local community and is there a clear social and enterprise development plan with measureable outcomes and buy-in by the community? Labour unrest and local community protests about unmet expectations from a REIPPPP investment have elevated energy production risk in some projects.

The replies to these questions will help investors to assess some of the key risk factors in a renewable energy project and those that could have a direct bearing on the returns from their investment.

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