While there is much focus given to the state of Eskom’s aging coal-fired power stations, an equally big problem is the electricity grid’s capacity challenges given inadequate investment into the grid in the past three decades and the changing generation mix in South Africa.
Many independent power producers (IPPs), in particular those developing projects in the Eastern and Northern Cape have been unable to secure a connection for their power generation projects due to a lack of connection capacity. The issues surrounding Bid Window 6 and the bidding delays in Bid Window 7 of South Africa’s renewable energy programme clearly illustrate just how important grid capacity is to facilitate the connection of new renewable energy sources. These constraints are jeopardising the success of the government programme and affecting IPP projects that are being developed for the private offtake market.
Eskom has indicated that it plans to unlock grid capacity in certain areas by implementing a curtailment framework and has recently also indicated that it wishes to obtain approval for grid connection capacity to be reserved for IPP’s looking to participate in government programmes. Both of these concepts have yet to be tested and it appears likely that they will have limited impact. Ultimately, new powerlines and substations will have to be added at pace to avoid grid constraints continuing to negatively impact the roll out of renewable energy generation.
In 2023, the Presidential Climate Commission commented that PPP funding models for transmission have been shown to be low cost and effective. They concluded that alternative investment models, including PPPs, could be used to expand and strengthen South Africa’s electricity grid at speed and scale. The commission proposed that the private sector be involved by helping to finance, build and operate newly expanded grid infrastructure under the auspices of the National Transmission Company, which is being established as part of the plan to unbundle Eskom into separate generation, transmission and distribution entities.
National Treasury announced in early 2024 that a request for proposals would be released by the end of July 2024 for a pilot project involving off-balance-sheet financing to accelerate private-sector investment in transmission, without negatively affecting Eskom’s balance sheet and the fiscus. A programme such as this would enable direct participation by the private sector in financing, building, maintaining and operating grid infrastructure.
The pursuit of alternative investment models make sense. In the same way that project finance has been deployed for road, rail and other infrastructure-related PPPs, there is no reason that it could not be utilised to expand South Africa’s electricity grid. With the right political will, a PPP model, with the funding being provided by way of project finance, would be a fitting solution to facilitate expansion of the grid where it would fall to private party developers to build and operate the transmission infrastructure and to raise funding for the transmission infrastructure.
Project finance involves funding of infrastructure and other long-term, capital-intensive projects by way of borrowings from commercial and development banks, with the balance being made up of equity. Project finance is commonly used to fund public infrastructure. Utilising a non-recourse or limited recourse financial structure, the debt and equity used to finance the project are required to be paid back from the cash flows generated by the project.
Grid infrastructure is costly and neither government nor Eskom have the means to directly finance an expanded grid rollout. However, grid infrastructure lends itself to being financed on a build, operate and transfer basis and project finance is an ideal and well understood way of funding it. For their part, Eskom and the South African Government have already proved that project finance can work in the energy generation space given the successful renewable energy programme. They also have a good understanding of what is required for projects to be bankable. Lenders, sponsors and equity providers in South Africa are well versed in the ways of project finance and would be very comfortable navigating structures such as this so long as they are bankable.
Similar to the 30-year contracts granted to private party concessionaires in road concessions, the contract period for private grid partners to build and operate transmission lines would likely need to be between 20 to 30 years to ensure their viability and in order to provide a sufficiently attractive return on investment to investors. It seems likely that Eskom would pay the private partner by way of an availability fee but there may be other, more innovative revenue models too.
Critically, the overall project configuration needs to be fir for purpose and attractive to private sector investors. Questions arise as to Eskom’s ability to provide guarantees to back stop its obligations. It has also previously been reported that it takes up to seven years to negotiate right of way agreements with landowners for transmission lines. These right of way negotiations and land acquisition generally should likely remain Eskom’s responsibility.
South Africa has experience in implementing successful PPPs. Amongst the earliest PPPs was the cross border N4 Toll Route concession linking South Africa to Maputo, a groundbreaking success story. In recent years, there has been a decline in the number of PPPs that have been brought to market by the South African government. This is despite healthy private sector interest in PPPs. The decline has been due to a number of reasons including capacity constraints, outdated legal and regulatory frameworks, rigid and cumbersome PPP processes and a lack of a centralised approach to screening infrastructure investments for PPP suitability.
Increasing South Africa’s grid capacity has to be a priority to grow and develop the country’s economy and ensure its long-term sustainability. Project finance is the perfect tool to facilitate this.
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