Enabling Renewable Energy in South Africa Assessing the Renewable Energy IPP Procurement Programme

Enabling Renewable Energy in South Africa Assessing the Renewable Energy IPP Procurement Programme WWF RE Finance Report Launch IDC Offices, Sandton 29 August 2014

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Introduction

Introduction Background to the Report Introduction An assessment of key successes, challenges, and developments Recommendations for improvements where applicable Objectives Generate debate and constructive dialogue between stakeholders Promote sustainability of RE development and financing Consider future of REIPPPP in face of uncertainty Structure Non-financial aspects: process and procurement policy Financial aspects: financing landscapes and key funding themes Sources Discussions with major stakeholders: Eskom, financiers (banks, DFIs, PE funds), government entities, developers, technology companies, contractors, advisors Publicly available research and information 4

Section 1 Non-financial aspects of the Programme

Section 1: Non-financial aspects of the Programme Overview of non-financial themes Non-financial themes Summary 1 Price discovery process Round 1 bid tariffs received at or just below caps with no true price competition. 2 Financial burden on private sector Time-consuming and costly process with limited chance of success deteriorating risk/return profile. 3 Ambitious pace of development Ambitious timelines for nascent RE market with limited resource capacity. 4 Grid connection challenges Time and cost inefficiencies for both Eskom and RE developers, leading to project delays in some instances. 5 6 Standardisation of PPA terms Local content requirements Setting standardised PPA terms limits ability to capitalise on market efficiencies. Local content remains an evolving policy which is hotly debated trade-off between cost and economic development. 6

Section 1: Non-financial aspects of the Programme Tariff (R/kWh) Theme #1: Price discovery process Round 1 undersubscribed Tariffs bid at or just below price caps premium to fair market prices in Round 1 Necessary for investor confidence/incentive, but increased risk of retroactive tariff setting Round 2 oversubscribed Tariffs declined 22% and 40% for wind and solar PV respectively Round 3 & 4: tariff caps removed for wind and solar PV Market equilibrium reached? Evolution of REFIT and REIPPPP tariffs 1,2 R4.00 R3.50 R3.00 R2.50 R2.00 R1.50 R1.00 R0.50 REFIT REIPPPP REFIT 2009 REFIT 2011 Round 1 Round 2 Round 3 Notes: (1) Due to changes in tariff structure, CSP tariff comparison between Round 2 and Round 3 are not directly comparable (2) Prices are averaged and fully-indexed based on April 2011 for comparison purposes Wind Solar PV Solar CSP Cap: Wind Cap: Solar PV & CSP Source: DOE Presentations 8

Section 1: Non-financial aspects of the Programme Success rate Theme #2: Financial burden on the private sector Significant funds invested at risk for bid submission to be carried by developers Considerable capital deployed which is not converted into RE generation Increased competition and downward pressure on tariffs deterioration of risk/return profile Uneven playing field in respect of access to capital (bid costs as % of capital available) RFP in Round 4 reduces time and cost requirements of bids (e.g. returning compliant bidders ) Evolution of bidder success rates Estimates of development costs for unsuccessful projects 60% 40% 20% 0% # Bids: 52.8% 24.1% 18.3% Round 1 Round 2 Round 3 53 79 93 Assumptions: Development cost per bid R2.5 bn R2.0 bn R1.5 bn R1.0 bn R0.5 bn R10m / bid R20m / bid R30m / bid Total development costs for unsuccessful bids: R4.8bn R3.2bn R1.6bn # Successful: 28 19 17 R0.0 bn Round 1 Round 2 Round 3 Source: DOE Presentations, author calculations 10 10

Section 1: Non-financial aspects of the Programme Theme #4: Grid connection challenges Eskom required to deliver reliable cost and timing estimates at bid, but can only commence approval process at preferred bidder stage Significant resource demands on Eskom Grid connection delays beginning to emerge Disconnect between IPP budgeting requirements and Eskom s planning needs Conversion rate of Eskom Cost Estimate Letters to Preferred Bidder Status IPP Project 1 IPP Project 2 IPP Project 3 IPP Project n???? Eskom?????? 600 500 400 300 200 100 270 >500 190 28 19 17 12% 10% 8% 6% 4% 2% 0 Round 1 Round 2 Round 3 0% IPPs need date-certain connection with as close to fixed price as possible Eskom needs visibility on total MW actually fed onto the grid, when and where Eskom CELs Conversion rate (RHS) Successful projects Source: Eskom presentation 13 13

Section 1: Non-financial aspects of the Programme % Local content Theme #6: Local content requirements Minimum thresholds increased from 25% to 40%+ Prescriptive criteria and high penalties adds to bid compliance costs Government working to optimise policy Reduce potential for circumvention; identified key components for local manufacture Arguments for local content requirements Significant socio-economic benefits Lack of local manufacturing support tantamount to subsidisation of foreign imports Arguments against local content requirements Higher tariffs bid Local components not cost competitive with foreignsourced components Increased costs not justified by RE jobs created Local content: minimum requirements and targets versus actual content achieved Round 1 Round 2 Round 3 70% 60% 50% 40% 30% 20% 10% 0% 70% 60% 50% 40% 30% 20% 10% 0% Desired targets Minimum compliance threshold PV CSP Wind PV CSP Wind PV CSP Wind Source: DOE presentations 16 16

Section 2 Financial aspects of the Programme

Section 2: Financial aspects of the Programme Debt capital committed (R bn) Overview Major finance stakeholders (1/2) ~R120 billion of capital committed across three rounds Estimated split ~R83 billion debt and ~R35 billion equity Majority of debt (>75%) taken up by commercial banks, followed by local DFIs International DFIs becoming more active Major debt providers 20 15 10 17.6 16.5 16.3 15.6 Large portion of IDC and DBSA debt used to finance equity investments (e.g. BEE shareholders) 13.1 12.2 Round 3 Round 2 Round 1 5 3.8 0 Nedbank RMB Standard Bank Absa Investec IDC* DBSA* No. of projects: 23 11 16 14 4 22 20 Note: Source: Round 3 funding commitments likely to increase due to FX movements from bid submission Discussions with debt providers 18 18

Section 2: Financial aspects of the Programme Typical terms in South Africa s RE project finance market Typical project finance terms and covenants have been incorporated In some cases, more favourable terms than other project finance transactions (e.g. mining and resources) given lower market/commodity risk and financial strength of off-taker (RSA) Key terms and financial covenants Typical ranges Minimum Senior Debt Cover Ratio 1.25x 1.40x Minimum Senior Loan Life Cover Ratio 1.30x 1.45x Equity Lock-Up Cover Ratio 1.10x 1.20x Default Cover Ratio / Trigger Event 1.05x 1.15x Gearing 1 60% 80% Tenor 1 Grace Period Availability Period (Drawdown) 1,2 All-in Margin 1 FX Hedging Interest Rate Hedging 15 18 years Potentially up to 1 year Wind / PV: 12 24 months CSP: 24 36 months 270 400 bps (incl. liquidity premium of ~120 bps and statutory costs of ~30 bps) 90% 100% during construction 90% 100% during construction 40% 70% during operation Notes: (1) Dependent on technology and project risk profile; (2) Dependent on construction schedule and longstop dates 19 19

Section 2: Financial aspects of the Programme Estimated equity invested (R bn) Overview Major finance stakeholders (2/2) Average equity shareholding split ~50:50 between international and local shareholders Foreign investors dominated by leading RE developers Top 10 equity investors contribute ~50% of total equity invested Major equity investors Estimated equity investments based on estimated capital cost per project, debt:equity splits, and shareholdings as disclosed in presentations to NERSA No. of projects: 2 10 7 6 10 4 2 3 4 2 2 2 2 3 1 1 3 3 2 3 5 3 000 2 500 2 816 2 610 2 000 1 741 1 500 1 000 500 0 1 461 1 355 1 204 1 175 1 007 859 859 760 728 686 655 538 538 530 530 451 448 436 Local investors Foreign investors Source: NERSA presentations and publicly available information, author estimates 20 20

Section 2: Financial aspects of the Programme Overview of financial themes Non-financial themes Summary 1 Market movements at financial close Significant hedging activity in narrow windows has a pronounced effect on FX and swap markets. 2 Foreign exchange risk FX exposure presents significant risk to both government and projects. 3 Interest rate risk Volatility of swap market places projects at risk of failing to close in the absence of tariff adjustments. 4 Diversification of funding sources Alternative funding sources / structures needed to reduce cost of debt and therefore tariffs bid. 5 BBBEE financing vehicles Limited options for BBBEE financing have put upward pressure on tariffs. 6 Refinancing restrictions Easing refinancing restrictions over time may provide benefits to projects / developers and reduce tariffs. 21 21

Section 2: Financial aspects of the Programme Overview of non-financial themes Non-financial themes Summary 1 Market movements at financial close Significant hedging activity in narrow windows has a pronounced effect on FX and swap markets. 2 Foreign exchange risk FX exposure presents significant risk to both government and projects. 3 Interest rate risk Volatility of swap market places projects at risk of failing to close in the absence of tariff adjustments. 4 Diversification of funding sources Alternative funding sources / structures needed to reduce cost of debt and therefore tariffs bid. 5 BBBEE financing vehicles Limited options for BBBEE financing have put upward pressure on tariffs. 6 Refinancing restrictions Easing refinancing restrictions over time may provide benefits to projects / developers and reduce tariffs. 22 22

Section 2: Financial aspects of the Programme USDZAR USDZAR Trading Range (cents) Trading Range (cents) 15 Year Swap Rate 15 Year Swap Rate Trading Range (bps) Trading Range (cents) Theme #1: Market movements at financial close Round 1 R9.00 R8.80 R8.60 Chart 1: FX Rates and Trading Ranges Ratings Downgrade 50 40 30 7.5% 7.3% 7.1% Chart 2: Swap Rates and Trading Ranges Ratings Downgrade Offshore demand 25 20 15 R8.40 R8.20 20 10 6.9% 6.7% Prehedging? 10 5 R8.00 01-Sep-12 01-Oct-12 01-Nov-12 01-Dec-12 0 6.5% 01-Sep-12 01-Oct-12 01-Nov-12 01-Dec-12 0 Round 2 Chart 3: FX Rates and Trading Ranges Chart 4: Swap Rates and Trading Ranges R10.50 R10.00 R9.50 Fed tapering announced 40 30 20 9.00% 8.50% 8.00% 7.50% Fed tapering announced 50 40 30 20 R9.00 10 7.00% 10 R8.50 0 01-Apr-13 01-May-13 01-Jun-13 01-Jul-13 Range (cents) DOE Close Financial Close USDZAR 6.50% 0 01-Apr-13 01-May-13 01-Jun-13 01-Jul-13 Range (bps, RHS) DOE Close Financial Close 15 Year Swap Rate Source: Bloomberg 23 23

Section 2: Financial aspects of the Programme Tariff adj. required Theme #2: FX Risk RE is import intensive ZAR volatility presents significant risk to projects and government Government shoulders FX risk from bid submission to financial close ZAR depreciated 8.8% and 11.8% in R1 and R2 Potential cost increase of R4.0 bn R6.0bn over life of projects (R1 and R2) 15% 10% 5% 0% -5% -10% R16 R14 R12 R10 R8 ZAR Volatility ZAR monthly % change vs. USD and EUR ZAR daily closing rate vs. USD and EUR R6 2010 2011 2012 2013 2014 USD/ZAR EUR/ZAR Impact of ZAR movements Illustrative example of tariff adjustment required for change in FX rates 15% High FX exposure 10% 9.1% project (60%) Low FX 5% 4.7% 4.7% exposure 2.4% project (30%) 0% 0% 5% 10% 15% 20% 25% ZAR Depreciation vs USD Potential cost to Eskom of tariff adjustments Round 1 Round 2 Total Capacity (MW) 1,416 1,030 Avg. Capacity Factor (%) 30% 30% Annual Generation (GWh) 3,712 2,687 Average Premium (ZAR per kwh) (1) 0.07 0.08 Annual Premium (ZARm) (2) 282 251 Total Premium over PPA Life (ZARm) 10,062 8,927 NPV of Premium @ 8.5% (ZARm) (3) 4,108 3,645 Source: Bloomberg, author calculations 25 25 Notes: (1) Assumes fully escalated tariffs in 2011 figures (2) Annual Premium assumes two years' inflation escalation from 2011-indexed values to operations

Section 2: Financial aspects of the Programme Impact on Equity IRR (bps) 15 Year Swap Rate Impact on Equity IRR (bps) Tariff adj. required Theme #3: Interest rate risk Interest rate and swap movements can have an equally big impact as FX movements Yet no cure provided by DOE CPI-linked debt could potentially reduce sensitivity of IRRs to inflation and interest rates 9.5% 8.5% 7.5% Movement in swap rates: Round 3 bid submission to date 6.5% Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14-100 -200-300 -400 Bid preparation -138 ~200bps Illustrative example of impact on equity IRR of increasing rates Change in interest rates (bps) +0 +50 +100 +150 +200 +250 +300 0-267 -386 Illustrative example of tariff adjustment required for change in interest rates to maintain equity IRRs 8% 6% 4% 2% 2.7% 5.3% 7.8% 0% +0 +50 +100 +150 +200 +250 +300 Change in interest rates (bps) Illustrative example of impact on equity IRR of changing inflation Change in inflation -1.5% -1.0% -0.5% 0.0% +0.5% +1.0% +1.5% 5.0% 3.0% 1.0% -1.0% -3.0% -5.0% Fully-indexed tariff, no CPI debt Fully-indexed tariff, 80% CPI debt Partially-indexed tariff (20%) Source: Bloomberg, author calculations 27 27

Section 2: Financial aspects of the Programme Theme #4: Diversification of funding sources Debt financing currently provided mainly by commercial banks Risk profile of projects and associated cost of funding therefore shaped by banks Key limiting factor to lower tariffs is currently cost of debt Need to diversify and increase competition amongst funding pool Consider alternative funding sources: Corporate financing (being increasingly used) Individual project bonds (e.g. Soitec) Green bonds (e.g. Nedbank; IDC) Earlier involvement of institutional investors (price in benefit of syndication) ECA finance (used but in a fairly limited capacity) Cross-currency swaps / foreign-denominated debt (expensive given current ZAR levels) Bridge financing for construction phase (may lower long-term cost of debt) Asset securitisation structures of multiple projects Listed vehicles / funds (increase access to institutional investors) Crowd funding platforms, tax equity, REITs and MLPs (used in international markets) 29 29

Section 2: Financial aspects of the Programme Theme #5: BBBEE financing vehicles Key successes Broad-based involvement Rural development and skills transfer Significant dividend flow to communities Potential for dedicated BEE RE funds? Key challenges Limited BEE financing options domain of DFIs Upward pressure on tariffs to meet vesting requirements Typical BBBEE Financing Structure Community Trust BEE investors Community HoldCo BEE Funders BEE HoldCo Strategic Equity Partners Developer Legend: Project Company BEE investors / beneficiaries BEE holding companies BEE funders Other equity investors Ordinary share investment Preference share financing 31 31

Section 2: Financial aspects of the Programme Theme #6: Refinancing restrictions Restrictions on refinancing for longer terms and/or increased quantum of debt Required to limit government s implicit liability in event of Eskom default Restrictions on sale of equity in project for first three years To avoid developers flipping projects No change in control for life of project Avoid risk of white elephants large projects with inexperienced or unqualified shareholders Restrictions should be eased over time to allow investors to recycle capital into new projects Significant capital tied up in projects, needed for future rounds and other infrastructure programmes Improved economics for projects New strategic investors may be able to improve plant performance and extend project life Some exceptions to restrictions have been made 33 33

Conclusion and outlook Conclusion and outlook REIPPPP has been very successful to date Scale and pace of procurement (from less than 10 MW to 4 GW procured in ~2 years) Coherent and well-constructed RFP boosted investor confidence Flagship PPP model for South Africa, and the rest of Africa Helping to alleviate Eskom s current power crisis while reducing national GHG emissions The South African RE market will continue to evolve and mature in the coming years A key focus will be the drive to reduce the cost of capital Reduced risk profiles of projects as investors become more familiar with REIPPPP Diversification and increased competition amongst funding sources Increased flexibility of REIPPPP, easing of RFP requirements and evolution of PPA terms Beyond REIPPPP, there is potential that South Africa may move towards establishing a partially privatised and liberalised energy market Subject of significant debate and unlikely to materialise in the near future REIPPPP has proven a positive step in the direction of encouraging more private sector participation in the generation of electricity in South Africa 34 34

END END THANK YOU Author and presenter: Pamela Papapetrou Director Arista Capital Advisors (Pty) Ltd pam@aristacapitaladvisors.com 35 35