Business Day Renewable Energy Dialogue: Part 1

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"Welcome to the Business Day Renewable Energy Dialogue, a conversation between high-powered people on issues that really matter to SA."

There are lively debates springing up all about South Africa, driven mostly by single issues and aimed at influencing public opinion. The Business Day Dialogues series is much broader in scope than these current debates, and aims to influence policy as well as the man and woman in the street.

The Joburg Green Map brings you an extract of the dialogues relating to their Renewable Energy debates, which you can view below. In this, the first part, energy experts talk about the business part of the government's renewable energy procurement programme and the benefits of involving the private sector alongside the public sector.

The debate held in Johannesburg in partnership with Nedbank Capital comes after the Department of Energy announced its approval of 17 clean-energy projects worth R33bn in the third round of its renewable energy procurement programme.

Visit Business Day Dialogues for the full dialogue as well as video content.

Watch the video here...

Transcript excerpts:

Hilary Joffe (Deputy Editor, Business Day):  I am Hilary Joffe and with me is a very high-powered panel of people from the energy industry, from government, the private sector and academia. We’re hoping the issues will be freely and frankly discussed, because renewable energy is something which arouses great excitement in some and great caution in others, so we hope that the debate will be spiky, pointed and interesting.

Director-general, I’d like to start by asking you why we need renewable energy at all, firstly, but also what the process is — can you give us the flavour of the process by which you have brought all these new private sector producers into the industry to produce wind and solar power for us?

Nelisiwe Magubane (Director-general of the Department of Energy): Let me take you back to 2009 when the idea of reducing our emissions was first mooted by the president of the country. You’ll recall he made a commitment in Copenhagen that as one of the biggest polluters in the world we needed to change the way we do things. As you are aware, almost 98% of our energy, electricity in particular, was generated from coal. So we then did a planning process — the now well-known Integrated Resource Plan (IRP). The plan had to make a number of assumptions — the biggest that we were going to reduce emissions. It was our considered view that renewable energy would play a significant role in ensuring that we cut emissions.

After it was approved by Cabinet on March 25 2011, we started implementing the plan almost immediately. We concentrated mainly on the renewable energy programme because in the Integrated Resource Plan it’s very clear what kind of power is going to be needed and when — which year.

I must confess that at first it did have challenges. You’ll recall that We started by having what was called a Refit (renewable energy feed-in tariff) at the time, which was done devised by the National Electricity Regulator of SA.

However, when we then did our own due diligence and realised we would be acting outside the law. Therefore, we had to look at the best way to execute the programme and also look at the best way it could attract investment  — while also making sure we tried  to keep our electricity costs as low as possible.

Therefore, between ourselves and the Treasury, we agreed that we were going to embark on a PPP — a public-private partnership — and we already had a feasibility study that showed there would be value for money for government.

Together with the National Treasury, we agreed we needed transactional advisers as we were new to this. The rest is history.

Hilary Joffe: It is quite an interesting history which must have been quite challenging. There’s been a lot of talk of public-private partnerships, but in the last year there’s actually been very little from the government in the way of public-private partnership. So this must have been quite a big challenge to work out how you do bring the private sector into the energy industry, which has largely been public-owned forever.

Nelisiwe Magubane: Absolutely, and one of the lessons we learnt very early was the issue of creating certainty. In other words, we had to make sure we had very clear electricity regulation for acquiring new generation capacity.

Those regulations were published for public comment and they were commented on quite extensively. By the time we finalised them we had a very good idea of what was expected of the department.

What we also needed to do was to make sure that the risk-sharing mechanism was given to the person who could actually handle the risk. As government officials we decided up front we were not in the business of construction, so we’re not taking that risk. We also indicated that, as technocrats, we’re not in the business of banking, so we are staying out of that risk. We looked at the risk that we can manage and that was the basis of the agreements that were crafted by some of the most esteemed lawyers in the country.

Hilary Joffe:  You’ve now just completed three rounds of going out to identify private sector producers who could come into the industry. What would you count as the biggest achievement of that process so far?

Nelisiwe Magubane: The biggest achievement is that the projects are not only being constructed ahead of schedule, but most of them have experienced few challenges. Most construction sites come with their own challenges: strikes, delays … all kinds of challenges.

We have seen some community members raising some challenges with the developers and the developers have had the maturity to handle most of those problems.

When construction started, we were probably receiving complaints almost daily, but that has subsided now, we’re beginning to see progress. The communities are beginning to see the benefits, which for us from a service-delivery point of view, is quite positive. That’s basically what we’re about — service delivery.

But we are also beginning to see manufacturing capacity being developed locally, because there is more certainty on the programme, and more faith in it. That’s significant.

That has been the most exciting between window one and window three — it’s also local economic development.

That local economic development has moved from a minimum of about 20% (local content) up to about 53%. It tells us that projects like this programme are going to yield local economic development.

We have also seen quite a number of jobs being created.

Naturally you create a lot of jobs during construction and they taper down later on but there are no less than 25,000 people on site, as we speak, on the programme.

Hilary Joffe:  Mike Peo, there’s been huge interest from the banks, I know, in this programme. What’s the attraction?

Michael Peo (Head Infrastucture and Energy, Nedbank Capital): Banks, generally, have been very supportive of the whole PPP programme from probably 2002-03 when we legislated for public-private partnerships, but there has been a lack of deal flow.

Three things bring banks into the equation.

One, there was a very well thought out process in terms of how this procurement would happen, so what the director-general has just spoken about, from the inception of bringing in a massive team of advisors — I don’t think we’ve ever seen that number of technical, legal, insurance, modelling type specialists assembled to evaluate a programme.

All the right things were done at the outset to give people confidence that all the issues had been properly thought through, that we wouldn’t find ourselves in a situation where in particular developers would spend an incredible amount of money developing projects only to be told later “we’re cancelling the programme because we forgot to consider one aspect of public policy” or anything else.

Second, there's obviously a good economic return for the banks.

Banks are there to make money, so the economic return is balanced against the risks of the programme.

With the orderliness of the programme and the government support and the Eskom support these deals have been eminently bankable, so there have been very few projects where developers have been unable to secure financing on what, I believe, are still very good market returns.

Third, from Nedbank’s perspective, we really do believe in projects that are sustainable, that have long-term developmental effect. So this is not just an investment in something transient. We are probably the largest bank lender into long-term infrastructure projects in SA.

So we live with the deals for 20 years, whatever the funding terms are — anywhere from say, 15 to 20 years, we’re involved in the project.

To us the social upliftment — the job creation, the localisation — they’re all fundamentally important parts and Nedbank has signed up to that.

So when we present to our board it’s not just a pure mathematical calculation, it’s “what are we really doing, what are we building in the country?” and I think the bank does believe in that.

Hilary Joffe: Anton Eberhard, the banks are earning very good returns on these projects — is that a good or a bad thing for the country? Are we, as a country, carrying the cost of banks making huge profit on these projects and is that a good thing?

Prof. Anton Eberhard (Infrastructure Specialist, UCT Graduate School of Business): Mike (Peo) said an important thing — returns are balanced against risk, and probably that balance is appropriate in these projects. But I’d point to prices, and the price outcomes.

That’s what consumers are interested in. We’ve seen remarkable price reductions over the two years, over the three rounds. The figures for PV —  that’s photovoltaics, solar photovoltaics — they have come down 68% between round one and round three and are now sitting below a rand!

The cheapest is 88c/kWh. Wind energy has dropped 42% over three rounds and is sitting on an average of 74c/kWh.

In fact the cheapest project was from Mark (Tanton) sitting over there — Red Cap, with 66c/kWh. Now that’s approaching grid parity, in fact below grid parity…

Hilary Joffe:  Explain that, Anton.

Anton Eberhard: Well, it’s certainly cheaper than consumers are paying on their electricity bills, but I think a fair comparison because this is grid connected. Does it compete with new generation options for Eskom? Certainly it does.

All the estimates for Medupi and Kusile are substantially more than that. Of course, wind and coal are not entirely comparable…

Hilary Joffe:  What sort of proportion of the time can we expect the wind to blow?

Anton Eberhard:  We don’t know what, on average, this will mean. This is important research and important modelling that needs to be done. But the projects are spread around SA, certainly a proportion of wind would be base load, but there will be some variability.

So the issue of appropriate generation mix is also relevant.  Almost certainly we would need to balance wind with gas — gas power can be ramped up and down very easily and so it complements wind well.

Hilary Joffe: I want to come back to that question: what sort of energy mix do we need?  But I have to ask Mark (Tanton), why is your project so cheap and why are the others not equally cheap?

Mark Tanton (Managing Director, Red Cap):  There are various reasons the project is such good value for — we started with a very good wind resource…

Hilary Joffe: Which is where?

Mark Tanton: It’s in the Eastern Cape, south of Port Elizabeth. It surrounds the proposed nuclear power plant at Thyspunt — one of the most consistently high-wind areas in SA.

So we started with a good resource. That is going to bring the tariff down. We then found amazing partners in Enel Green Power, an Italian utility. They had a very competitive cost of capital, they were willing to go so far as to finance 40% of the project ownership — it’s owned by the local community.

They were supported by Mike (Peo) and his team at Nedbank. One more important point — it was all done on balance sheet. So Nedbank gave a loan to the community which was backed by Enel, but at the end.

of the day it wasn’t a project-finance deal — and if you don’t do a project-finance deal, you can bring the cost of the transaction down quite significantly. So it was a combination of all of that.

Hilary Joffe:  So you’re saying that you’ve done this in a very different way to a lot of other projects? The way you’ve done it, if that’s giving us a cheaper price and more ownership by the community by the sound of it — is this something which others could or should do?

Mark Tanton: I don’t want to sound like a politician when I answer this, but you have to take a step back. As was pointed out by Nellie (Magubane), and then Anton (Eberhard), we’ve had three rounds of procurement, but done in two years. We have projects under construction now but we don’t have megawatts, we don’t have electrons going into the grid, so from a bank perspective it’s understandable that the commercial lenders are saying “we haven’t seen what the real risks are”.

With all due respect to commercial lenders in SA, they’ve had limited experience with these kinds of projects. So they can’t start pricing in efficiencies and a learning curve, and that’s understood.

When you do it off balance sheet and you are a utility, by the very definition of being a utility you know how to run, construct and maintain and operate a power plant. You are very aware of what the risks are so when you price those risks in it’s easier to price it in than a lender sitting here in Sandton, who’s also looking at a portfolio of risks.

It’s a good model to get a cheaper price. Is it a sustainable model? Probably not, because as a utility, you run out of liquidity at a certain point. The banks are clearly central for providing liquidity to the market.

What I think is very good is it’s hopefully given commercial lenders a wake-up call that they should be more competitive and there are people out there with balance sheets who can do it on their own without support from banks, so there should be this commercial tension to your question of “have banks made too much money?”

Up until round three it was quite cosy for banks in SA. Round three changed that — Nedbank was very innovative in getting in on all the Enel deals. But there were some losers in round three that were big winners in round one. Overall it’s good for the market because we hope to see some competition now.

Hilary Joffe: The foreign investors who’ve come into the market — Mark (Tanton) talks about Enel — and some other big foreign players who will bring a lot of foreign investment, and in some cases they have, perhaps, made it more commercially viable to do these projects. Is that a pure undiluted good for SA? Or should we ask whether these are players we want in the market? Do we have enough local versus foreign, what is the balance right?

Johan van den Berg (Chief Executive, SA Wind Energy Association): To some extent that answer resides in government. It’s a policy question ultimately, so I can only answer it from the perspective of the industry.

Up to this point, where we are now, the foreign involvement in SA has been extremely useful for us. If we just go back to how this all started, we really took a long time to get renewable energy up in SA.

Wind power, we stumbled from zero to 10MW in 10 years — despite many people trying. And then for that period where we had indications that this was going to happen, there was a big international interest suddenly and we got sophisticated people — with experience and money coming into SA — wanting to be here and do business.

So when the model changed, those people were still here and they’ve enabled us to learn from lessons learned elsewhere and not make the same mistakes over again. So now we’re maybe at a logical conclusion of that process where, as you’ve said, really large players have come in and the third bidding round, the winners were concentrated in quite a small circle.

Whether that’s good or bad is something that we can debate for a long time, but from the perspective of the industry, we’d like to see low prices and simultaneously we’d like to see a nice diversified group of people being involved in this and many of them being South Africans.

Ultimately up to this point, if you take it over the three rounds, we’re doing OK but we wouldn’t necessarily just want to perpetuate what happened in the third round, or further rounds coming…

Hilary Joffe: Brian, what’s your take on this process of bringing private sector producers in, bringing more renewable energy in — are we going in the right direction? Could this be a model for developing the industry in future?

Brian Statham (Chairman, SA National Energy Association): The success of these three rounds has been incredibly important for SA Incorporated, as it’s established our credibility in the international community — not only in the renewable fraternity — it’s established our credibility as a country that can handle major projects, engage foreign investors and do it in a sensible and rational and — most importantly, and the director-general alluded to it, in a way that gives investors the certainty they need in order to do these investments.

So the spinoffs from this programme are going to extend way beyond simply the renewable energy sector in SA.

But we’ve also heard notes of caution. We haven’t yet got any projects actually delivering the megawatts…

Hilary Joffe: Not one megawatt yet?

Brian Statham: Not yet. So the risk…

Hilary Joffe: We have the first seller…

Brian Statham: Slightly yes… we don’t really know what the performance is going to be, whether the assumptions, the technical assumptions that have been made in terms of the load factors in the plant are going to be validated, we don’t yet know what the impact on the national grid is going to be with having renewables on here and what not.

So there are still a number of unknowns and that’s something we need to be aware of and we need to be alert to.

The experience that we’re now getting from Europe particularly is that you have to be careful about putting all your eggs in one basket. So we are going to need to maintain an energy mix. Renewables will be important, but we should not throw opportunities for gas, nuclear and coal out of the window. We need a balanced portfolio — what’s an ideal mix today is only predicated on our state of knowledge today, and our state of knowledge tomorrow might be quite different.

So you always have to have that ability to be flexible and robust against whatever scenarios might come at you in the future.

Hilary Joffe: Director-general, if we look at what the economics of the energy industry might be in 10 years’ time, if we’re going to look back at this process and at the prices that have come out of it and at the kind of players that we’ve brought in, are we going to say “this is really brilliant” or might we say “gosh, it was really expensive, actually”?

Nelisiwe Magubane: I cannot agree more with what Brian (Statham) has said with regards to an appropriate energy mix. Definitely if you look at window three today, we are beginning to think “oh, my goodness, window 1 was pretty expensive”.

Maybe we should have waited a little longer so that we could get the benefit of the price. But, having said that, the benefit of the price is a mixture of certainty because what happens is that people price what they don’t know.

If we’ve got one big unknown, you’re going to say “I’m not so sure what I’m going to get out of this”. So you are likely to push your price higher to make sure that you cover that. So it would be very difficult to predict 10 years from now if we didn’t go through this process, what would have happened.

But my sense is that in 10 years, renewable energy is going to be a lot cheaper. The technologies are going to be more advanced, and just like any other technology, we’re going to see smaller programmes and projects, more distributed across SA. We might see significant changes in that, but I don’t believe we can say that what we have done was inappropriate.

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Courtesy: Business Day 

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