6. Understanding_Transmission_Financing.pdf

Understanding Power Transmission Financing

Since 2013, the U.S. Government’s Power Africa initiative has marshalled technical, legal, and financial resources toward the goal of doubling access to electricity in Sub- Saharan Africa by 2030. Through a network of public and private-sector partners, Power Africa works alongside African governments to facilitate the development of power projects on a scale necessary to meet the continent’s power deficit. I am particularly proud of the leading role the U.S. private sector plays in this development effort and consider Power Africa to represent one of the best models of collaboration between the U.S. Government and the private sector to achieve positive commercial and policy outcomes.

One of the most important aspects of Power Africa is the free exchange of information between public and private sector partners. As part of this effort, Power Africa has developed a series of open-source handbooks to establish a common understanding of best practices around successful power project development. It is my honor to present the newest addition to the Understanding handbook series – Understanding Power Transmission Financing. In keeping with Power Africa’s focus on accessibility, this newest entry continues a focus on plain-language explanations of the financing structures for transmission systems. It is intended to be a trusted resource for both seasoned professionals as well as those who are new to these complex projects.

Power Africa’s role in supporting Africa’s transition to a more sustainable, renewable, and cleaner energy future is key to advancing the Administration’s ambitious climate action plan. Under the U.S. International Climate Finance Strategy, released by the Biden Administration, transmission financing will deliver against an even bigger and more focused set of climate finance goals. Understanding how it works and why it is important could not be timelier. As generation capacity expands across the continent, there is an urgent need for transmission capacity to dispatch that electricity and cross-border lines to connect underutilized generation in one country with unmet demand in another. Transmission is a key enabling infrastructure for renewable energy sources: investments in transmission will contribute substantially to decarbonizing Africa’s growing energy market.

As with the previous editions, the development of this handbook, which was coordinated by the U.S. Department of Commerce’s Commercial Law Development Program (CLDP) and the African Development Bank’s African Legal Support Facility (ALSF), was a collaborative process involving U.S. Government agencies, African governments, multilateral institutions, and private-sector stakeholders. It is notable that the authors were volunteers and that they collectively contributed over 2,000 pro bono hours in a virtual setting to produce a resource that reflects their collective wisdom on how to meet the challenges of building transmission infrastructure. I am deeply grateful for their contribution and for the essential role the U.S. Department of Commerce played in delivering this resource to readers around the world.

Sincerely, Gina M. Raimondo U.S. Secretary of Commerce Gi i d

C O N T E N T S

1. INTRODUCTION

Background A Guide to the Guide

2. FINANCING STRUCTURES AND CAPITAL SOURCES

Introduction Corporate Finance

Project Finance

Corporate Vs Project Finance Sources of Capital

Commercial Banks

Equity Summary of Key Points

3. COMMON FUNDING STRUCTURES IN THE

AFRICAN MARKET

Introduction Public Sector-led Funding Structures

Features of Public Sector-led Funding Structures

Private Sector-led Funding Structure Summary of Key Points

4. INTRODUCTION TO PRIVATE FUNDING

STRUCTURES

Introduction Key Considerations

Approach to Risk Allocation

The Role of Key Stakeholders for Privately Funded Structures

5. INDEPENDENT POWER TRANSMISSION

(IPT) PROJECTS

Introduction

IPT Business Models Enabling Environment

How It Works

Stakeholders Contractual Structure

Risk Allocation Matrix

Financing Structure Other Considerations

Summary of Key Points

6. WHOLE-OF-GRID CONCESSIONS

Introduction

Concession Models

How It Works Stakeholders

Contractual Structure

Risk Allocation Matrix

Financing a Whole-of-grid Concession Other Considerations

Summary of Key Points

7. OTHER PRIVATE FUNDING STRUCTURES

Introduction

Merchant Transmission Line

Industrial Demand-driven Model Privatisation

Summary of Key Points

8. GOVERNMENT SUPPORT AND CREDIT

ENHANCEMENT

Introduction

Government Support

Sovereign Support for Termination Payments Summary of Key Points

9. PLANNING AND PROJECT PREPARATION

Introduction Power System Planning

Integrated Resource Planning

Transmission Development Plan (TDP) Route Identification

Transmission Project Selection

Project Preparation

Funding for Project Preparation Procurement and the Private Sector

Direct Negotiations

Summary of Key Points

10. LAND ACQUISITION

Introduction

Planning for Rights-of-way Phases for Route Identification

Environmental and Social Impact Assessment (ESIA)

Acquisition of Land for Rights-of-way Role of the Private Sector

Expropriation and Eminent Domain

Summary of Key Points

11. COMMON RISKS

Introduction

Financial Risks Technical Risk

Interface Risks

Technology Risks Social and Environmental Risks

Political and Regulatory Risks

Dispute Resolution Summary of Key Points

12. REGULATORY FRAMEWORK

Introduction Definition of an Independent Regulator

How Transparency Can Be Achieved

Functions of a Regulator Market Regulations and Compliance

Regulatory Implications for the Private Sector

Summary of Key Points Deep Dive into Transmission Pricing

13. CROSS-BORDER INTERCONNECTION PROJECTS

Introduction What Are Cross-border Interconnection Projects?

Benefits of Cross-border Projects

Hurdles to the Development of Cross-border Projects Varying Domestic Regulatory Frameworks

Private Sector Participation in Cross-border Projects

Summary of Key Points

APPENDIX

Acronyms

Glossary

1. Introduction

1. INTRODUCTION

Background The Critical Deficit of Transmission Capacity

The group of authors who donated their expertise (and time!) to this book came together for a simple and collective intent: to address the critical deficit of transmission capacity in Sub-Saharan Africa. It is stated that roughly half the population of Sub-Saharan Africa (or 600 million people) lack reliable access to electricity. The lack of electricity access is particularly stark at a time when the global number of persons without access to electricity is falling.

While there is no adequate information on the breakdown between generation, transmission, and distribution, historically investment in generation has been roughly four times higher than transmission and distribution combined. Furthermore, the distribution sector has also attracted more investment than transmission, leaving this segment of the African energy market as the most impacted by a lack of both public and private investment.

The critical nature of transmission infrastructure to the overall function of an energy market cannot be overstated. As generation expands, transmission is needed to bring electricity to the demand centres. Additional transmission capacity (including cross-border) can also provide access to large power generation sources and connect them to unserved demand.

Transmission across national borders, often referred to as interconnection, enables economies of scale that bring down the cost of power and allow for greater efficiency in matching production with consumption.

Current estimates place the total investment requirements for the period 2014-2040 at $80-$140 billion, which equates to $3.2–$5.4 billion per year.

UNDERSTANDING POWER TRANSMISSION FINANCING

Of the 38 Sub-Saharan African countries, 9 have no transmission lines above 100 kilovolts (kV). The scale of the transmission deficit is also significant when one considers that the combined length of transmission in the 38 Sub-Saharan African countries is about 112,196 km, less than the length of the domestic transmission network of Brazil. The following Figure 1.1 helps further illustrate the transmission deficit in Sub-Saharan Africa as compared to energy markets around the world.

Figure 1.1: Transmission lines per capita (Source: World Bank, 2017:

Linking Up: Public-Private Partnerships in Power Transmission in Africa)

At a time when the world is coming together to address the threat of climate change, it is also important to note that transmission infrastructure is essential to the transition towards a less carbon-intensive power market.

Without it, many grid-connected utility-scale renewable energy projects cannot be implemented. More importantly, developing and maintaining highly optimised transmission systems that can manage the intermittent nature of renewable energy helps to reduce technical losses and avoid the need to build additional generation or storage capacity.

The critical lack of development of transmission infrastructure in Sub- Saharan Africa, despite the increased investment in other segments of the power value chain, naturally leads to two important questions: How did the situation become so dire? and how can we overcome the transmission deficit to widen the access to energy? The first question demands an intense inquiry into economics, politics, sociology and geography that is beyond the capacity of the authors of this handbook. The second question, however, can be answered constructively and is the focus of this book.

The Need for Private Sector Investment

Virtually all development of transmission infrastructure in Sub-Saharan Africa remains within the responsibility of fully or partially state-owned utilities. One reason is that it is difficult to prioritise and justify transmission projects when transmission costs are not clear and transparently allocated within the sector. As a result, the utilities that currently manage transmission infrastructure often require public subsidies to counter operating losses that arise when costs are not properly allocated and recouped. These subsidies usually take the form of direct budget support from the government. The effect is that state-owned utilities are not incentivised or able to invest in new projects.

This vicious circle of generating losses and failing to invest in new infrastructure is not inevitable. There are numerous examples around the world where energy markets have been able to overcome this transmission deficit through a combination of concerted regulatory reform and partnership with the private sector. This book presents these examples as case studies distributed throughout the chapters. The common narrative across the experiences from other markets is as follows: if the existing market actors (government, utility, regulator) can bring clarity and predictability to the transmission sector, the private sector can deploy its expertise and capital to overcome the infrastructure gap.

It is important to note at the outset of this book that the primary constraint on private investment is not the lack of the availability of capital (see chapter 2. Financing Structures and Capital Sources). The key constraint is, rather, the ability to access that funding through market regulations and project structures that provide the predictable operating conditions and revenue that are fundamental to any commercial investment. This book is intended to outline how public officials can satisfy these expectations from the private sector through a general description of transmission sector regulation, planning and operation, and a detailed explanation of the structures for private investment in the transmission sector.

Private partners, not funders

As previously noted, the existing transmission gap in Sub-Saharan Africa is driven in large part by the inability to fund new infrastructure through public budgets or finance public infrastructure due to a history of operating losses. Thus, the first motivating factor for using private capital to fund transmission infrastructure is to mobilise finance over and above what the public sector may be able to provide. The private sector is not, however, simply a source of capital. It is also a partner in project management, cost control and risk mitigation. With the appropriate set of incentives, the private sector can be an extremely efficient implementation model for transmission projects at a low cost and on schedule. Successful private transmission projects have been implemented in India, Latin America, the Philippines, United Kingdom, and elsewhere. Brazil alone has financed over 50,000 km of transmission lines through private investments.

Inviting private investment in the transmission sector can also bring innovation through the utilisation of state-of-the-art technologies which are transforming the energy landscape. For example, smart grid technologie introduce new capabilities and provide opportunities for more efficiency, as well as new services (energy management, distributed generation, internet and telecoms).

Increasing role of the private sector in transmission

While private investment is not as widespread in transmission as in power generation, there is substantial experience worldwide. In addition to well-functioning power markets in OECD countries (e.g., United Kingdom), private transmission has become common in the last twenty years across Latin America and in countries such as India, Kazakhstan, and the Philippines. Just in the period 2000-2015, multiple projects materialised in Latin America as summarised in Figure 1.2.

Figure 1.2: Examples of private participation in transmission infrastructure between 2000-2015

Similarly, India has developed more than 500 km of 400kV and 765kV lines through private investment. Kazakhstan has a privately owned and financed transmission system, and the Philippines privatised their existing transmission system through a 25-year concession in 2009.

Sub-Saharan Africa was able to leverage the experience from other markets to adopt new business models and avoid legacy infrastructure (for example, deploying wireless data/voice systems rather than installing landlines). In the same way, the African energy market can learn from the recent experience in peer markets around the world to move past the traditional focus of publicly financed transmission infrastructure and instead foster a dynamic market place that is driven by private investment.

A Guide to the Guide Who is this book for?

This handbook would benefit all stakeholders involved in the power sector and more specifically in the development of transmission infrastructure.

The book is intentionally designed to benefit all levels of readers:

Beginner: The book provides an overview of the fundamental regulatory structure of transmission markets, the planning and procurement of transmission systems and the core principles of contracting and finance that are required to attract private investment. The intent is that with this essential background information in mind, the detailed explanation of private investment models will be easier to understand.

Utility/Regulator: The observations and guidance in this handbook are presented from the perspective of a public official in an utility or a regulator. Specifically, the assumption is that such an official has already recognised the need to bring private-sector investment into the market.

Further, the book assumes that the official is considering the required adjustments to the existing regulatory framework and the specific obligations in any partnership with a private-sector investor to develop transmission infrastructure.

Procuring Agency/Negotiator: Perhaps the greatest value that we can convey in this book is the collective experience of the authors in planning, procuring and negotiating transmission projects. As a result, the book contains significant detail on the structuring of private transmission projects, the allocation of risks and obligations within those structures, and related considerations around financing and regulatory compliance.

In addition to the public sector readers described above, this handbook should also be helpful to other sector participants including the transmission companies, transmission system operators, regulators, investors, and financial institutions as it presents a diverse set of considerations that those parties must address in their role in the development of private transmission projects.

Who are the authors?

The knowledge and guidance presented in this book are not intended to represent the opinion of any one author. As emphasised throughout this book, the development of transmission infrastructure through a partnership between the public and private sector requires close collaboration between stakeholders and the application of expertise from many disciplines. To hold to this guiding principle, the development of this handbook also brought together a diverse group of stakeholders and experts. Our group of authors, who each contributed their time on a pro-bono basis, includes contributors from governments, development banks, investment funds, project developers, universities and leading international law firms. Equally important is that our group includes engineers, economists, lawyers and regulators who collectively have over 200 years of experience in the energy sector. Our sincere hope is that the collective wisdom and dedication of this group demonstrates how important it is to make progress in addressing the infrastructure gap in Sub-Saharan Africa and that our contribution will make a meaningful impact on that effort.

How was this book developed?

The unique conditions for the preparation of this handbook are notable since they differ from the rest of the Understanding series. As with previous books, this handbook was produced using the Book Sprint method which allows for the simultaneous drafting, editing, and publishing of a complete book in a short period. For the previous handbooks in this series, our authors were able to gather together in the same place and produce a book in five days. Since coming together in person was not possible under current conditions, our group of authors instead agreed to come together virtually. In just two weeks, across seven time zones and through the collective will of our authors (and generous patience of others in our households), we were able to generate the same dialogue, critical thinking and joint decision making that had made the previous books such a trusted resource. As always, there was a surprising amount of consensus on some topics and an unexpected level of debate on others. The outcome is a product that reflects this diversity of opinions rather than the personal opinion of any one author or the institution they represent.

The authors would like to thank our Book Sprint facilitator Barbara Rühling for her ability to adapt the Book Sprint process to a virtual format and for her patient guidance throughout the hours of staring at our confused faces on a computer screen. The authors would also like to thank Henrik van Leeuwen and Lennart Wolfert for turning our rushed scribbles into beautiful and meaningful illustrations. The tireless work of Book Sprints’ remote staff Raewyn Whyte and Christine Davis (proofreaders), and Agathe Baëz (book design), should also be recognised. It is also important to recognise the considerable planning and development that went into the conceptualisation of this handbook before the drafting process. In particular, our deepest appreciation goes to Elizabeth Clinch https://www.google.com/url?q=http://www.booksprints.net&sa=D&source=editors&ust=1618820794331000&usg=AOvVaw1ep_I6wsVv2JRgXSCAPUuA

(International Program Specialist, CLDP) for the original research at the outset of the concept development and for her tireless work to bring our group together in a virtual space. The authors would also like to recognise the following individuals and institutions that helped focus dialogue to build a consensus around the need for a handbook focused on transmission financing: Jennifer Baldwin (Power Africa); Megan Taylor (Power Africa);

and Kenyon Weaver (Commercial Law Development Program). The authors would also like to thank the generous funding and logistics support from the United States Agency for International Development’s Power Africa programme and the African Legal Support Facility.

How may I use this book?

To continue the tradition of open-source knowledge sharing that is at the core of the Understanding series, both as a standalone reference guide and as a jumping-off point for further discussion and scholarship, the book is published under the Creative Commons Attribution-NonCommercial- ShareAlike 4.0 International License (CC BY NO SA). In selecting this publication license, the authors welcome anyone to copy, excerpt, rework, translate and/or re-use the text for any non-commercial purpose without seeking permission from the authors, so long as the resulting work is also issued under a Creative Commons License. The handbook is initially published in English with translated editions soon to follow. The handbook is available in electronic format at http://cldp.doc.gov/Understanding as well as in print format. Many of the contributing authors are also committed to working within their institutions to adapt this handbook for use as the basis for training courses and technical assistance initiatives.

How does this book relate to the Understanding Series?

This handbook is the fifth in the Understanding series published by Power Africa. The first handbook, Understanding Power Purchase Agreements, focused on the legal and financial considerations in a Power Purchase Agreement (the PPA handbook is now in its Second Edition). The second https://www.google.com/url?q=https://cldp.doc.gov/sites/default/files/Understanding_Power_Purchase_Agreements.pdf&sa=D&source=editors&ust=1618820794332000&usg=AOvVaw0qH9_9pwcqLQYCn7raDHS1 handbook, Understanding Power Project Financing, focused on the financing structures and mechanisms that can be employed to finance private independent power projects. The third handbook, Understanding Natural

Gas and LNG Options, was developed by the US Department of Energy and is an in-depth guide on upstream and downstream development of natural gas. The fourth handbook, Understanding Power Project

Procurement provided an overview of the mechanisms and strategy behind successfully procuring privately-owned power projects.

Figure 1.3: Cover page of the "Understanding" series (some are also available in Amharic and French) https://www.google.com/url?q=https://cldp.doc.gov/sites/default/files/UnderstandingPowerProjectFinancing.pdf&sa=D&source=editors&ust=1618820794332000&usg=AOvVaw23XbaXGLv81CnKs3n29g8r https://www.google.com/url?q=https://www.energy.gov/sites/prod/files/2017/11/f46/Understanding%2520Natural%2520Gas%2520and%2520Lng%2520Options%2520October%252011%25202017_1.pdf&sa=D&source=editors&ust=1618820794333000&usg=AOvVaw2_o4KNGkbmuEj-5eiWAUST https://www.google.com/url?q=https://cldp.doc.gov/sites/default/files/UnderstandingPowerProjectProcurement.pdf&sa=D&source=editors&ust=1618820794333000&usg=AOvVaw3ObOJRKIdjLl8U8cBbSDii

The Authors

Reason Abajuo Legal Counsel African Legal Support Facility

(Côte D'Ivoire)

Samson O. Masebinu Development Assistance Specialist:

Energy Finance USAID/Power Africa (South Africa)

Mohamed Rali Badissy Professor of Law Penn State Dickinson Law (USA)

Subha Nagarajan Managing Director Global Capital Advisory (USA)

Christopher Flavin Business Development Director Gridworks (UK)

Gadi Taj Ndahumba Head of Power Sector

African Legal Support Facility (Côte D'Ivoire)

Jay Govender Projects and Energy Sector Head Cliffe Dekker Hofmeyr Inc.

(South Africa)

Kaushik Ray Partner Trinity International LLP (UK)

Ryan Ketchum Partner Hunton Andrews Kurth LLP (UK)

Stratos Tavoulareas Energy Advisor and Visiting Scholar George Washington University (USA)

Julius Kwame Kpekpena Chief Operating Officer Millennium Development Authority (Ghana)

Omar Vajeth Principal Corporate Relations Officer African Development Bank

(South Africa)

Mohammed Loraoui Attorney Advisor (International) U.S. Department of Commerce (USA)

2. Financing Structures and Capital Sources

2. FINANCING STRUCTURES AND CAPITAL SOURCES

Introduction The business models used to finance transmission infrastructure are heavily impacted by sources of funding for the sector. Before introducing the different business models, it is necessary to understand the various external funding options and their criteria, which this chapter explores.

In the next chapter 3. Common Funding Structures in the African Market, we discuss the status quo of transmission infrastructure financing in the African continent — the public sector structures generally used to finance these types of projects at present. We then look to business models involving the private sector in chapters 4. Introduction to Private Funding

Structures, 5. Independent Power Transmission (IPT) Projects, 6. Whole-of-grid concessions, and 7. Other Private Funding Structures.

Transmission projects will go through a detailed planning phase before a source of financing and a business model are selected. Chapter 9. Planning and Project Preparation explains this process.

The risks highlighted in chapter 11. Common Risks must also be considered as these will impact sources of funding as well as business models. The funding decision will have implications for the introduction of the private sector or continued reliance on public sector funding, and together these will inform the business model selected.

Below we set out the broad principles of financing that have been or could be applied to the funding of existing and future transmission infrastructure projects.

Corporate Finance Many businesses, especially large businesses in capital intensive industries, raise debt funding on the strength of their balance sheets, the stability of their revenues, and their ability to service their debts. They do not grant security over any part of their assets to lenders or bondholders, and they agree with each lender that they will not grant security over their assets to any other or future lenders. This type of financing — financing that does not involve the grant of security over a company’s assets — is referred to as corporate finance.

When considering corporate finance in the context of funding transmission infrastructure, the relevant entity procuring funding has historically been the national transmission company of the country. The financial health and liquidity of this entity’s balance sheet (assets and cash flows) will determine its borrowing capacity (which can be enhanced with government support). If the credit of the national transmission company does not allow it to raise debt, additional support from the government’s balance sheet will be required to secure external debt.

Project Finance In a project finance context, the funding is secured against the viability of a specific project. In this option, a project company is created for financing, constructing and potentially operating the transmission assets and is financed with a mix of equity and debt. In typical project finance funding structures, the project company also retains ownership of the transmission asset. A lender considers the revenue generated by the transmission project as the primary, and often singular, source of loan repayment. The projected cash flows after meeting operating expenses must be sufficient to service debt in terms of capital repayment and interest. The cash flows available after debt service should also provide a reasonable return on equity.

The predictability, sufficiency and certainty of cash flows will determine the project company’s borrowing capacity to finance the project. If the project underperforms and the borrower defaults on the loan as a result, the lender will have the right to enforce its security on the project company’s assets. If liquidating the project company’s assets is insufficient to recover the balance of loan owed due to default, the lender will have no recourse to the owner(s) of the project company for further compensation:

the sponsor's liability is limited to the investment it has made via its equity contributions. Therefore, the key to project finance is the underlying revenue stream generated by the asset in question (e.g., annuity, use of system or wheeling charges for a transmission infrastructure project).

If the transmission asset is not linked to a dedicated generation facility or a large industrial consumer, and there is uncertainty as to how well-utilised the transmission infrastructure will be, lenders will expect a payment regime similar to a fixed capacity payment or fixed availability payment.

Such payments are not vulnerable to changes in the amount of power flows on the transmission line.

Corporate Vs Project Finance Balance sheet flexibility

In the context of transmission infrastructure, an entity’s borrowing capacity via corporate finance is limited by its existing balance sheet, including how much existing debt it has (and the state of its revenues and assets). Any existing balance sheet constraints will limit the borrowing capacity of transmission utilities to fund transmission infrastructure using corporate finance structures. The state utility may have the opportunity to borrow further with government support. Project finance structures, however, do not look at the transmission company’s borrowing capacity because the debt capital raised is treated as off-balance-sheet financing.

Cost of funds

Under corporate finance, since repayment is divorced from a transmission asset’s underlying economic value or performance, repayment risk will be a function of a borrower’s existing level of leverage compared to the financial or market value of its total assets to determine its liquidity. A healthy balance sheet will attract a lower cost of financing (more efficient pricing). As the credit quality of an entity decreases, the cost of funding increases due to higher risk perception.

Under the project finance option, since repayment is secured via project revenue, lenders will focus on mitigating all risks to those cash flows.

Project finance transactions tend to be highly structured and complex, with emphasis placed on appropriate contractual allocation of risks that impact the underlying revenue stream. This adds to the time and cost of pulling together the number of stakeholders and related documentation. The pricing of the project is influenced by the perceived risk of the cash flows, the credit quality of the source of those cash flows, and if needed, the enhancement of these cash flows.

Business model considerations

Transmission networks require ongoing investment. Ongoing investment requires continuous capital injections in the business in the form of new projects or upgrades of existing assets. As a general rule, state-owned transmission utilities, whole-of-grid concessionaires, or privatised utilities will typically find it more practical to raise debt financing using corporate financing techniques. In contrast, a project company established to implement an independent power transmission (IPT) project will use project finance to allow for higher debt to equity ratios, longer tenor, and limited recourse for the shareholders in the project company. Given these factors, IPTs are likely to be financed using project finance techniques.

Sources of Capital The sources of capital for a transmission project will depend upon the outcome of the planning, risks related to the project, and a government’s and state utility’s balance sheets and the ability to raise finance. In chapter 3.

Common Funding Structures in the African Market, the existing model of government balance sheet financing for these assets is discussed in more detail, and in later chapters, we discuss some private sector finance models.

Below, we set out the typical capital sources — government budgetary allocation, debt, and equity — and indicative terms used in most funding models.

Government budgetary allocation

In the context of its annual budget, a government may choose to allocate a certain amount of the fiscal budget to the development of the country’s transmission infrastructure. When an allocation is made, the specific method of application of these funds is likely to vary from one government to another depending on the country’s laws and conventions for public procurement of infrastructure. In some jurisdictions, the funds will be managed and applied directly by the Ministry of Energy (or equivalent); in others, they may be channelled via a department of public works or the state-owned entity licensed to construct and maintain transmission infrastructure. Nonetheless, the source of these funds will invariably come directly from the government’s accounts or “balance sheet” as shown below, and thus the government’s ability to finance transmission infrastructure through a budgetary allocation will depend on the country’s priorities and fiscal constraints. Ultimately, the decision as to whether to use this model will depend on the government’s balance sheet (i.e.

availability of cash) and its expenditure priorities (based on its current policies) given a country’s wider infrastructure investment needs.

Figure 2.1: National budget approach to funding infrastructure project

In practice, financing transmission infrastructure through budgetary allocations is difficult and has become increasingly rare. The size of the investment puts significant pressure on a government’s budget and its available cash. The allocation can be structured in a way as to accumulate yearly until reaching the required amount, but depending on the size of the investment, the desired amount may take many years to be collected.

Furthermore, in addition to slowing down the development of the power grid, this approach requires significant fiscal discipline as the government needs to set aside the funds each year and resist the temptation to use them when a crisis or economic downturn arises.

Debt

Transmission infrastructure necessitates long-term funding, given the relatively high capital expenditure required for identification, development and construction. Given constraints in local commercial banking markets, public financial institutions are an important source of debt financing for transmission infrastructure.

The stakeholders and financial products described below cover both public and private sector debt financings — their application in real-world scenarios is dealt with in later chapters.

Concessional funding for balance sheet financing

Multilateral development banks (MDBs) and donor-backed funds can lend directly to governments on concessional or grant terms for identified projects which follow the MDB procurement guidelines, and can also be lenders for the financing of independent power transmission projects in the private sector.

Examples of MDBs, which provide concessional finance, include the African Development Bank, European Investment Bank, and the World Bank Group. Concessional in this context means that the terms of the loan are likely to include low or subsidised interest rates, extended grace periods, and long amortisation schedules that can extend beyond 30 years.

Typically these loans are provided to the government via the Ministry of Finance, and on-lent to the transmission utility. These loans are accounted for on the government’s balance sheet, typically as both an asset and a liability. The transmission company will own the asset, but repayment, if required, will be secured from the government's balance sheet. MDB and donor concessional money may be used to settle contractor invoices directly, but the government remains the obligor.

Transmission projects funded through MDB concessional funds can in some instances take longer to secure the funding and the necessary contractors. This is often the case where the government or the utility does not have the necessary capacity to manage the high degree of coordination, planning, and adherence to MDB procurement guidelines for such projects. In addition, MDBs have country and sector limits (often called “funding envelopes”) that are available to countries for this type of financing support which get revised based on the country’s capacity for debt and the requirements of the ministries. When the funding envelopes may be nearing their limits, countries will have to prioritise the infrastructure projects they want to support. Bilateral donor agencies can be another source of grant or heavily subsidised financing which can provide sector viability gap funding or support to an individual transaction.

Figure 2.2: Relationship between parties in a concessional funding for balance sheet financing

Private sector MDB funding The same MDBs have “private sector windows”, i.e., funding available for private sector projects, such as IPTs. These are loans granted on commercial terms rather than concessional terms, and for tenors up to 18-20 years. Importantly, private sector MDB loans are not captured on the government’s balance sheet, unless a government guarantee or financial backstop helps secure repayment. The structures under which MDBs participate in IPTs are set out further in chapter 5.

Independent Power Transmission (IPT) Projects.

Export Credit Agencies (ECA)

Export Credit Agencies (ECA) are institutions that are publicly owned financing agencies that help finance national exports by providing direct loans, guarantees, or insurance to overseas buyers, including entities such as transmission companies. ECA finance can be used in the public sector, in government balance sheet financing, and project finance involving IPT structures.

Examples of active ECAs in Sub-Saharan Africa include the Export Credit Insurance Corporation of South Africa, US Export-Import Bank, UK Export Finance, BPIfrance, SERV from Switzerland, Euler Hermes from Germany, and the Export-Import Bank of China. Some of these agencies can provide local currency solutions in certain jurisdictions, but for the most part, provide USD and Euro denominated loans.

To ensure financing discipline and promotion of fair and transparent trade practices, financial terms and conditions follow guidelines set by the OECD, called the OECD Arrangement on Officially Supported Export Credits guidelines. Eligible financing is typically up to 85% of the relevant export contract, with some allowances to cover a portion of local on-shore costs, but the expectation is that the government (or borrower) covers the 15% balance, usually in the form of a down payment in cash. Financing terms include longer tenors than commercial banks can competitively price or sometimes provide to borrowers in certain jurisdictions (up to 12 years for corporate finance and 14 years for project finance loans), but the cost of funds is generally more expensive than concessional borrowing.

For transmission infrastructure associated with a renewable energy generation project, the OECD Arrangement allows project finance loans up to 18 years, on an exceptional basis.

In the context of transmission infrastructure, ECAs can provide (1) corporate finance loans, underwriting the sovereign’s capacity to repay the loan, lending directly to Ministries of Finance, which helps to reduce the cost of financing, and (2) project or corporate finance loans to IPT special purpose vehicles (SPVs) or private companies, respectively.

Depending on the ECA, they can either lend directly or insure/guarantee (between 95-100%) a commercial bank that will provide funding, which will be reflected in the commercial bank’s lower cost of funds to the project.

Figure 2.3: Relationship between parties in an Export Credit Agency funding structure

Development Financial Institutions (DFIs)

Development Financial Institutions (DFIs) which include MDBs, are usually majority-owned by national governments and source their capital from national or international development funds, or benefit from government guarantees. This ensures their creditworthiness, which enables them to raise large amounts of capital from international capital markets and provide financing on very competitive terms. DFIs can provide up to 15 to 20 years, long tenor competitive commercial lending to projects with some degree of private ownership. Some examples of DFIs active in Sub-Saharan Africa include the Development Bank of South Africa, Development Finance Corporation from the US, the CDC group from the UK, Proparco from France, and FMO from the Netherlands.

Some DFIs can provide loans to state-owned utilities which demonstrate independent governance, depending on that utility’s balance sheet and ownership of assets. All DFIs can provide commercial project finance debt to a project company, which can be used in IPT transactions. The diagram below shows a DFI-funded project finance structure.

Figure 2.4: Relationship between parties in a Development Financial

Institution funding structure

In addition to lending, some DFIs such as the AfDB and the WBG can offer a guarantee and insurance products to help credit enhance a project structure by covering off certain credit or political risks. Guarantees include partial credit guarantees (PCGs) and partial risk guarantees (PRGs) to cover commercial lenders and investors against the risk of a possible government failure to meet contractual obligations to a project. Please see the Understanding Power Project Financing handbook, section 7.2 for an in-depth discussion of PCGs and PRGs.

Some DFIs provide political risk insurance (PRI) to mitigate and manage risks arising from the adverse action, or inactions, of governments that go against contractual obligations. PRI can also be used to backstop https://www.google.com/url?q=https://cldp.doc.gov/sites/default/files/UnderstandingPowerProjectFinancing.pdf&sa=D&source=editors&ust=1618820801977000&usg=AOvVaw1v3SrHRSFLfz22bpsm1M5R https://www.google.com/url?q=https://cldp.doc.gov/sites/default/files/UnderstandingPowerProjectFinancing.pdf&sa=D&source=editors&ust=1618820801977000&usg=AOvVaw1v3SrHRSFLfz22bpsm1M5R https://www.google.com/url?q=https://cldp.doc.gov/sites/default/files/UnderstandingPowerProjectFinancing.pdf&sa=D&source=editors&ust=1618820801978000&usg=AOvVaw0LpRrLFJlkwelGfP-prSxB https://www.google.com/url?q=https://cldp.doc.gov/sites/default/files/UnderstandingPowerProjectFinancing.pdf&sa=D&source=editors&ust=1618820801978000&usg=AOvVaw0LpRrLFJlkwelGfP-prSxB https://www.google.com/url?q=https://cldp.doc.gov/sites/default/files/UnderstandingPowerProjectFinancing.pdf&sa=D&source=editors&ust=1618820801978000&usg=AOvVaw0LpRrLFJlkwelGfP-prSxB https://www.google.com/url?q=https://cldp.doc.gov/sites/default/files/UnderstandingPowerProjectFinancing.pdf&sa=D&source=editors&ust=1618820801978000&usg=AOvVaw0LpRrLFJlkwelGfP-prSxB termination support under a government guarantee or other forms of government undertakings if the government is unable to pay as per its contractual obligation.

Green/climate-backed financing There are many clean technologies and climate change donor-backed funds which can provide grant funding to support grid modernisation and transmission lines, if the infrastructure can be linked to projects and initiatives which promote and advance sustainable development and encourage the development of a more sustainable economy, for example, renewable energy generation. Given the emphasis that many countries are placing on decarbonisation to support countries on their journey to a green energy transition, it is expected that the EU and other publicly backed institutions will make more grants or highly concessional finance available to support these activities.

The advantage of these resources is that they provide subsidised financing, which, when combined with more commercial sources of funds, can help blend the cost of capital to reduce financing costs for transmission infrastructure.

Transmission is the enabling infrastructure for renewables, and, as such, it should be credited with greenhouse gas reductions and be eligible for green financing. In addition, the strength of the existing transmission and grid networks will determine how much greenfield renewable energy generation a country can support. Many emerging countries with mandates to significantly scale up renewable energy generation will need to simultaneously invest in upgrading and expanding their transmission network to support greater renewable energy penetration. While this is still an evolving field, greenhouse gas reduction calculation methodologies have been considered by numerous organisations and both governments and developers should monitor progress to identify potentially attractive financing options.

Commercial Banks In addition to DFIs, commercial banks provide debt financing to transmission infrastructure projects. Commercial banks are privately owned banks that participate and provide funding to a range of projects, including transmission projects. Commercial banks more typically lend to projects that have creditworthy cash flows or cash flows that are enhanced with cover via DFIs or ECAs.

Typically, commercial banks are financial institutions that are regulated by central banks and other international banking regulations which impact the level of liquidity, risk thresholds and pricing.

Blended finance Providing hybrid private sector/donor funding for IPTs, for example, can significantly boost the availability of funding to the sector. The provision of grant funding for a project is unlikely to impact returns for investors positively or negatively since funding models for this asset class are typically fixed or capped.

The impact of such funding would be to increase the number of projects which can be undertaken.

Equity In IPT and other project finance structures, lenders generally require project owners to invest an amount of equity in exchange for shares in the project company, usually for at least 20-30% of the total project cost. This form of long-term capital earns dividends over the life of the project which are paid from the remainder of cash flows after operating expenses and debt service obligations have been met. The capital structure and cash waterfall are intentionally aligned so that equity owners are incentivised to ensure that the transmission assets are constructed and perform as contractually specified, to generate and collect the forecasted revenue.

Equity providers for transmission infrastructure include:

Developers/Contractors: This includes developers or engineering, procurement and construction (EPC)/original equipment manufacturer (OEMs), who develop, build, and/or operate transmission assets and are interested in providing equity and/or subordinated debt in an underlying project if the long term economics are sufficiently attractive.

Infrastructure funds: There are many infrastructure funds or DFI-funded investment vehicles with a mandate to invest in the energy sector, which can include transmission infrastructure.

Development Finance Institutions: A few DFIs can provide equity funding for various types of power projects so long as the long term economics are sufficiently attractive.

Industrial sponsors: This includes sponsors who invest in the construction of dedicated-use transmission infrastructure to support their core business or power generation plants, such as mining companies.

In some instances, state-owned transmission companies or energy utilities also invest capital (or some other form of consideration) into a project company and acquire equity interest.

Summary of Key Points Corporate Finance is a way for an entity to secure an external debt by leveraging its balance sheet. The financial health and liquidity of the entity’s balance sheet will determine its borrowing capacity.

Project Finance allows an entity to raise external finance on a non-recourse basis where loan repayment is secured by cash flows generated by a project company’s assets.

Key considerations between raising debt via corporate or project finance structures include (1) creditworthiness of the obligor, which will determine the cost of funding and whether additional payment security is required, and (2) business model procurement strategy.

The most traditional source of capital to fund transmission infrastructure has been the government’s balance sheet.

Sources of external funding to support government borrowing include bilateral donors, MDBs, and ECAs.

External funding for IPTs and whole-of-grid concessions include DFIs and ECAs, along with commercial banks, generally with some form of credit enhancement from DFI or ECA guarantee or insurance product.

Green/Climate-backed financing can provide meaningful blended finance and viability gap funding for grid modernisation, critical for emerging markets who need to strengthen their transmission and grid networks to support greater renewable energy penetration.

There are providers of equity in the power generation space who could provide equity in IPTs assuming the economics and returns of the project are sufficiently attractive.

External funding sources and their criteria can impact the business model a government chooses in procuring new transmission infrastructure.

3. Common Funding Structures in the

African Market

3. COMMON FUNDING STRUCTURES IN THE AFRICAN MARKET

Introduction The purpose of this chapter is to set out, in a non-exhaustive fashion, some of the common methods of funding transmission infrastructure that are currently used on the African continent and to highlight some of their features.

Most of these funding methods are public-sector led. However, they are akin to corporate finance structures as the financing is based on the strength of the government or state-owned utility balance sheets and not on the viability of the cash flows from the transmission projects specifically. These methods include government borrowing/ECA financing and state-owned utility borrowing.