How to break Africa’s barriers

Although Africa currently makes up approximately 3 percent of the global economy, 28 out of the 52 countries on the continent are expected to see annual average growth rates of 5 percent or more over the next five years.  Tremendous opportunities for investment in infrastructure exist in Africa.

Decades of under-investment and mis-management have resulted in poor performance in many sectors, with the electricity sector being a particularly telling example. Half a billion people in Africa lack access to electricity, and electrification rates of less than 10 percent are not uncommon in Sub-Saharan Africa.  Unreliable and inadequate electricity adds to the cost of doing business as firms must either pause production during blackouts or pay for expensive back-up generation. Electricity problems also encourage the continued use of fuel sources such as charcoal and kerosene that result in deforestation, disease and carbon emissions.

The governments of many African countries are, however, gradually taking the types of actions that are required to turn their countries into desirable investment destinations. In many cases, the electricity sector is one that deservedly receives much of their attention.

Uganda provides a compelling example. For several years it has suffered from a shortage of generation capacity. The resulting rolling blackouts and sharp rise in electricity prices caused the government of Uganda to resort to paying millions of dollars per month in subsidies. Together these issues are estimated to have reduced Uganda’s economic growth by around 5 percent per year.

On August 1 2012, the $900 million, 250-megawatt Bujagali Hydroelectric Dam – the largest private sector investment ever undertaken in the region – achieved commercial operations, signifying a monumental change for Uganda’s power generation.

Formidable obstacles

Uganda, its government-owned electricity utility, the project’s sponsors, and their advisors worked for over a decade to overcome the formidable obstacles that stood in the way of the successful development of the project. Many financial institutions, including the World Bank, aggressively advocated structural reforms to the electricity sectors of developing, emerging, and least developed countries. They concluded that the process of establishing electricity tariffs had to be de-politicised before utilities would be able to charge cost-reflective tariffs. To accomplish this, they advocated the establishment of independent regulators that had an explicit mandate to regulate the sector in a manner that balanced the interests of consumers and investors. 

As such, the first step in the project’s development was to undertake a complete restructuring of the Ugandan electricity sector. In 1999 the government of Uganda split the Uganda Electricity Board (the UEB) into three separate utilities with clear focus areas: owning and operating generating plants, the transmission system and the distribution system (which was privatised before work on the Bujagali project commenced). The Ugandan Parliament also passed the Electricity Act 1999, which established the Electricity Regulatory Authority of Uganda and granted the Authority the power to regulate the now separate generation, transmission, and distribution sectors.

Yet these changes alone only went some of the way towards balancing the various interests involved in such a complex project. Indeed, while many emerging countries established independent regulators in the 1990s, many were not effective at de-politicising the tariff-setting process and balancing the interests of investors and rate-payers as politicians, investors, and rate-payers had hoped. 

By 2003, it had become clear that independence was not enough, and that a clearly specified regulatory contract must be negotiated by the political authorities for projects to gain public acceptance and retain it for the long term.

Detailed methodology

In January 2004, the government of Uganda launched a request for proposals (RFP) seeking investors to develop the project. The RFP contained a detailed set of formulae that collectively established a detailed tariff methodology that was annexed to the Power Purchase Agreement (PPA). The tariff methodology contained cost openers for the capital cost of the project and for costs associated with the servicing of the project loans. 

This structure offered several distinct advantages over the alternatives. It enabled the project’s sponsors to undertake a truly competitive bid to procure an EPC contract after the PPA had been executed, it enabled geo-technical risks to be allocated primarily to rate-payers, which avoided a risk premium being priced into the EPC contract, and it enabled the sponsors to arrange the financing after the PPA had been executed. Collectively, these advantages heightened private sector interest in undertaking the project.  Given the tariff’s structure, the bid evaluation criteria included an explicit internal rate of return on the equity invested in the project, a cap on the development costs the sponsors would seek to recover, and a fixed monthly operations and maintenance charge.

The Bujagali Hydroelectric Project has demonstrated that regulation by contract can be successfully applied to independent power projects. Uganda successfully avoided the trap into which many countries with newly established regulators fall. This was possible largely as a result of the willingness of Uganda’s Electricity Regulatory Authority to engage in a dialogue as to the types of tariff structures they felt would be consistent with their obligation to balance the interests of consumers and investors, but to ultimately permit that tariff structure to be embodied in a contract that is subject to international arbitration.

The strength of this structure is evidenced by the number of debt providers that ultimately lent to the project company.  Lenders on the project include the IFC, the EIB, KfW, DEG, AfDB, Agencie Francaise de Developpement, Proparco, FMO, Standard Chartered, and ABSA Capital. The commercial loans are supported by a Partial Risk Guarantee issued by the International Development Association. MIGA provided political risk insurance.

Uganda’s efforts have paid off. The Economist has identified the country as one of a select few that are at the forefront of reform, and Uganda’s economy is now expected to achieve growth rates of between 7.5 percent and 10 percent during the 2012 to 2016 period.

Rwanda makes it simple

Rwanda is another example of a country that has made tremendous strides in implementing reforms that promote investment. As an example, in Rwanda, four steps are involved in the establishment of a new company and the process can be completed in just a few days. In Kenya, the same process requires that an investor perform around 30 steps.

With a capacity of only 85 megawatts, Rwanda’s electricity system currently serves approximately 10 percent of its population. The country’s utility Energy, Water and Sanitation Authority, has ambitious plans to connect another 40 percent of the population to the electricity system and to expand generation capacity to almost 1,000 megawatts by 2017.

The KivuWatt project is an example of the creativity the country is using to meet these objectives. Lake Kivu is one of a handful of lakes in the world that is subject to periodic violent overturns that release the carbon dioxide and methane gas that are dissolved in its deep waters. The KivuWatt project currently being developed by Contour Global will capture methane gas from the lake and use it to generate electricity, thereby helping to solve two problems.

In addition, Rwanda is, together with Energies des Grands Lacs (EGL) (a regional organisation for cooperation in the energy sector of the Great Lakes countries), Burundi, and the Democratic Republic of Congo (DRC), developing a 145-megawatt cross-border regional hydroelectric project on the Ruzizi River, which forms the border between the DRC and Rwanda. EGL and the three countries have opted to develop the project under a long-term PPA with a tariff structure that is similar to that used for the Bujagali Hydroelectric Dam. Ruzizi III Regional Hydroelectric Project is thought to be one of the first cross-border IPPs in Africa to involve three off-takers.

These projects demonstrate that creative solutions to solve the chronic problems that under-investment in infrastructure have created are waiting to be found by governments and investors with the creativity to reach for them. The rewards of faster economic growth and a commensurate reduction in poverty are within reach and are gradually being realised.

Ryan Ketchum is a partner in the energy and infrastructure team in the London office of law firm Hunton & Williams,