ABSA

Partner Showcase – Gold Partner | ABSA

Energy security is crucial to any business’s long-term planning and achieving its growth ambitions. In South Africa, however, businesses have felt the effects of unreliable energy first hand. In November 2019, the country was forced to load shed to an unprecedented Stage 6 due to failures of the existing power generation capacity. This lack of guaranteed supply has sped up the transition we are seeing where companies do not want to buy power from only one producer.

Over the past decade, solar photovoltaic (PV) has become a strong competitor in terms of cost but it’s not just in South Africa’s Renewable Energy Independent Power Producers Programme (REIPPP) where we are seeing investment. Commercial and industrial Power Purchase Agreements (PPAs) are gaining traction. This long-term agreement between an Independent Power Producer (IPP) and a business to buy power is becoming more popular with listed and privately held companies.

A benefit of private capital rolling out new generation capacity is that the public sector is not the source of capital, which is an important factor as the debt of the local utility is putting South Africa’s sovereign investment grade debt rating at risk. There are no guarantees required from the South African National Treasury and any risks are borne by the private sector. While this segment of the market is relatively small, there has been promising traction in the last year.

“While this segment of the market is relatively small, there has been promising traction in the last year”.

SUPPORTIVE REGULATORY ENVIRONMENT

Over the last 12 months the Department of Energy and the National Energy Regulator of South Africa (NERSA) have shown policy support for renewable energy and a transition to include diverse sources in the total energy generation mix. The support extends not only to utility-scale projects but also smaller installations by households, business and IPPs.

While the pace of change has been slow from a regulatory and government perspective, there are local companies and IPPs that are setting strong bases to capitalise if continued supportive measures towards renewable energy unfold. One positive aspect of support is the less than 1 megawatt (MW) rule (where small-scale embedded generators of less than 1MW do not require a generation licence; simply a registration with NERSA or the local utility). There are requests to relax this rule in South Africa and increase the value to 10MW. The more likely scenario is that licences will start to be given for 1-10MW installations, which will be very supportive of these IPPs and the commercial and industrial PPA market. This will decrease the cost to build (in rand per watt terms) and allow for lower tariffs to be offered to counterparties but is still likely to increase the bankability of projects.

SECTION 12JS AND PRIVATE EQUITY

The pending signing of the new integrated resource plan and regulatory processes by NERSA for small-scale embedded generation registration saw local IPPs and investors seeking out new opportunities in this environment to build a base of portfolios.

South Africa has seen a few positive drivers for investment in renewable energy from National Treasury and the South African Revenue Service. Firstly, companies can write off their investments into solar PV against their tax bill. Secondly, private investment has also been driven through section 12J venture capital companies (12Js).

12J is a tax incentive for South African taxpayers to invest in the economy, allowing them a tax deduction (100% of their investment into the 12J). If an individual invests ZAR2.5 million in a 12J, they receive ZAR1.125 million (45%) tax relief in the year of the investment. If a company invests the same amount, it receives ZAR0.7m (28%) tax relief in the year of the investment.

12Js may invest in a variety of investments including agriculture lodges, manufacturing, mining and renewable energy. This has been one of the mechanisms that has driven investment into solar PV by private investors, allowing the democratisation of energy production and individual investors to own stakes in power production. For example, you could own a stake in the power resource that is being produced by the solar panels providing shade for you by means of a rooftop solar system as you shop at your local retailer.

FUNDS TAKING SHAPE IN THE CHANGING ENERGY ENVIRONMENT

Broadreach Capital is one of the funds that has invested in the renewables sector from various avenues ranging from 1-10MW solar projects, to energy efficiency and commercial and industrial PPAs. Adam Bekker, CEO of Broadreach explains: “[…] We have started and built our own IPP that develops, owns and operates renewable energy plants. We have invested our own capital alongside that of our investors into this business, and aim to continue growing it into a substantial player in the alternative, green energy industry.”

Through their investments, Broadreach has not only saved their customers on energy costs but also enabled them to invest in expansions (where there was not enough electricity supply to allow a new shopping centre to proceed) as well as reduce their carbon footprint to meet their customers’ sustainability requirements.

INVESTMENT C&I PPAS GAINING TRACTION

Another fund manager that makes use of the 12J structure is Nesa Investment Holdings who has built a portfolio of over 40 solar assets nationally and recently acquired Makro’s carport solar PV systems at stores countrywide.

“We cover the installation cost of the solar PV systems and maintenance over 20 years to ensure optimal performance, offering clients immediate savings in energy costs with zero capital expenditure,” said Peter Frolich, Nesa Investment Holdings director. The electricity generated is sold to Nesa’s clients at a discounted rate to their current municipal tariffs, escalating annually at fixed rates and protecting against abnormal tariff hikes.

BANK FUNDING GIVES MORE SCOPE FOR GROWTH

Although 12J and institutional equity has been used to build up these portfolios, bank funding has enabled further investment and leveraged returns. Traditionally you think of terms such as project finance, investment banking and utility-scale projects when discussing PPAs. However, with changing energy markets, democratisation of generation and smaller projects being rolled out, traditional bank lending has had to evolve as well.

PPAs are long-term in their nature and offer a predictable stream of cash flows. These contractual cash flows form the basis on which lending is based. Therefore, longer term funding, looking at serviceability rather than the value of the physical assets, is required.

Long-term relationships with a shared journey of portfolio growth (it may start relatively small but when regulation allows even bigger projects with larger individual projects these portfolios should scale) are the aim. Commercial and industrial PPA portfolios like those mentioned have been funded purely against the cash flows with no initial limits being placed on customers for lending quantum (at the lower limit).

This combination of private equity plus bank funding allows for further reach, allowing these IPPs to assist companies that are looking to reduce their carbon footprint (to meet their customers’ sustainability requirements), reduce their cost of energy and in time support their energy security requirements. This coming together of private sector capital, fund managers, IPPs and bank funding to drive investment into a new set of energy assets should see strong growth in the years to come.

About the author, Justin Schmidt, Head: New Sector Development | Retail and Business Banking, ABSA

Justin heads New Sector Development in Retail and Business Banking at Absa where Renewable Energy, Tourism and Manufacturing are focus sectors in this portfolio. He is responsible for these sectors’ strategy, customer value proposition and achieving the growth targets aligned to these key growth sectors for the South African economy.