The renewable energy programme run by the Department of Energy (DoE) has now proceeded through several rounds, including the recent announcement of preferred bidders for Round IV and the opening of the bid window for Round V. There are now renewable energy projects in different stages of completion, some still being subject to bid, some being at preferred bidder stage, some having achieved financial completion but still under construction, and, finally, the most mature projects where facility completion has been achieved and the project is selling energy to Eskom and receiving payment in return.
With the maturing of the renewable energy programme has come the development of a secondary market in respect of these projects. Several developers who entered the market with the aim of developing projects and then disposing of them are now looking to sell their interests. The return earned by these developers has been, and is, through a mixture of construction contracts and their equity interest in projects which they now looking to dispose of.
Due to the state of completion of several of these projects which are now being sold, potential investors do not necessarily need to have the technical know-how to develop and complete these themselves, but have the option of acquiring a complete project or a substantially complete project. This means there are several different options available to the Purchasers and the one which they select will depend on their particular risk profile and what they aim to achieve.
The first option is for those investors looking only for an equity return and an income stream – such investors would be looking to acquire projects which have achieved facility completion; the considerations here, of course, include that projects in the earlier rounds have considerably higher tariffs than those later rounds, but of course, due to this same fact, the amount which will need to be paid for an equity stake in such projects will be correspondingly higher. Completed projects from later rounds will be cheaper, as the tariffs paid by Eskom to those projects would generally be less, meaning a lower return for equity investors. The second option is to go for a project which has not yet reached facility completion and is therefore either in the preferred bidder stage or potentially has reached financial completion but is still under construction. Investors looking to invest in partially complete projects would need to understand that the level of risk and exposure in these varies according to the extent of completion of the relevant project in which they are investing, and will need to do a correspondingly detailed review considering the different risks to which it is exposed.
For example, a project which has reached financial close but is still in the construction phase is still subject to all the risks associated with reaching facility completion. Acquiring an interest in a project at this stage will mean having to investigate, in detail, all of the construction related risks. One should bear in mind that a developer who is both the construction contractor as well as an equity stakeholder will often be deriving its major benefit from the construction contract, and in negotiating the terms of its agreements it would often have leant toward preferring its position as a contractor rather than as an equity stakeholder. This means a detailed analysis of the construction contract risks is necessary to ensure that, should construction not be completed or be deficient, there is adequate recourse to the contractor for damages, loss of earnings or, potentially, a project that does not complete.
Projects which have not yet reached financial close have a considerably higher risk profile. There is the risk that financing will not be completed or that the project will not be closed within the window required by the DoE and so on. In the event that the project does not reach financial close, the equity value of the project is likely to reduce to nearly nothing. Anyone investing in such projects would be well advised to become properly involved in the process of negotiating and settling all of the project agreements, finance agreements, and the like, so as not to expose themselves to unfavourable terms in a project in which they have bought an interest, and, in addition, to have the right to recover some of their investment from a seller in the event that financial close does not occur.
Although the market has, as mentioned above, matured extensively, equity investors should not ignore the risks associated with these projects which were identified early in the renewable energy programme. These risks still exist and need to be adequately and properly dealt with by equity investors taking a stake in a project. The mere fact that these risks are now better understood (and in the case of many projects have not (at least not yet) eventuated) does not mean they have gone away. Obvious examples of this are where the award of the project was influenced by any corrupt act of a shareholder or the project company itself. Under those circumstances, there is a real risk that the DoE could terminate a project into which a great deal of money has been advanced. Equity investors will need to cover off this type of risk (which they would clearly have not been party to) by insuring adequate recourse to the person disposing of the equity interest to them.
Similarly, the financial arrangements in respect of the various projects vary considerably from one project to another. The risks associated with the financing put in place for a particular project needs to be understood and assessed before an investor can properly assess the investment that they are making.
One of the developments we do expect in this market is that, at some point, developers disposing of their interests in projects are going to adopt, by virtue of this developing into a relatively mature market, a take-it-or-leave-it approach to disposing of their interests. In other words, they will propose the terms upon which they dispose of the asset, and potentially give investors a limited ability to review the arrangements in respect of the project. Clearly this will require investors to have a particular risk appetite for this type of project, and they will need to develop mitigants for such risk, for example, by having a diverse portfolio of projects in which they are invested and requiring any person disposing of equity to retain an equity stake in the project so that they are exposed to the same risk as the new investor.