renewable energy financing issues in developing countries for review
TRANSCRIPT
Renewable Energy Financing Issues in Developing Countries: The Case of Uganda’s
Renewable Energy Sub-Sector.
By: Atipo Ambrose Peter1 [email protected]
Abstract:
Renewable Energy continues to attract a great deal of global interest. Much as it has already
taken root in the developed countries, a lot still has to be done to fully develop and entrench the
same in developing countries. RE has traditionally had hydro as the major source category;
however, with the recent developments in the sector, large gains have been realized in the other
categories as well, which among others include solar, wind, geothermal, biomass and Biofuels.
Developing countries have the benefit of skipping the learning phase of RET development and so
can analyse all options and chose to adopt what has worked and what is working in the advanced
RE markets, and could also be made to work for them.2 Development of RE is very capital
intensive and attracts high initial/upfront costs still yet with high risk profiles specific to the
individual categories of RE and specific areas of development, which risk profiles have to be
structured and managed effectively. In all this, finance still plays a very major role in the
development of RETs and it is for this reason that private and public finance initiatives both have
a very big role to play in the development of the subsector. Each of the categories, be it private
or public are, on their own, limited in scope and applicability hence the need to have either
category complementing the other where shortfalls are imminent. These tools come either in pure
private finance or pure public finance or jointly through public private partnerships and other
innovative financing tools. Developing countries are faced with several financing challenges for
RETs among others.
1 The author is an international Legal and Policy Expert in the fields of Energy, Oil & Gas and Infrastructure Finance and is currently the Head of
the Energy, Natural Resources and Infrastructure Practice at Kiiza & Kwanza Advocates, a Ugandan Law Firm. He can be reached at
2 The learning phase is usually characterised by invention with trial and error through experimentation which either proves successful or not. The advantage the new RE economies have is that, they can easily sieve and chose to adopt what works and what has worked as far as RETs are concerned.
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TABLE OF CONTENTS
Contents Page
DECLARATION……………………………………..…………………………………………...2
DEDICATION………………………………………..……………………………..………….…3
APPROVAL………………………………………………………………………..…………......4
ACKNOWLEDGEMENT………………………….…………………………..…………...........5
TABLE OF CONTENTS……………………………………………………..………….…….…6
LIST OF TABLES AND FIGURES……………………………………..…………………….…8
ACRONYMS…………………………………………..…………………..……………..............9
ABSTRACT……………………………………………………….…………………………......11
Chapter 1: Introduction.................................................................................................................12
1.2 OBJECTIVES OF THE STUDY ...........................................................................................21
1.2.1 General objective.................................................................................................................21
1.2.2 Specific objectives...............................................................................................................21
Chapter 2: Review of Uganda's Energy Sector.............................................................................23
2.1 Review of energy sector policies and laws.............................................................................23
2.2 Different sources of renewable power and estimated Mega watts.........................................27
2.3 RE Policy Position on PFIs and PPPs................................................................................29
2.4 Sources of finance for renewable energy in Uganda............................................................32
2.5 Challenges Faced In Development of Renewable Energy In Uganda....................................36
2.5.1 Limited technical and institutional capacity.........................................................................36
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2.5.2 Weak and Inadequate Financial Sector ................................................................................37
2.5.3 Limited Stakeholder Involvement.........................................................................................38
2.5.4 Lack of standards and quality assurance...............................................................................39
2.5.5 Lack of proper laws to integrate bio fuels in the economy...................................................40
2.5.6 Lack of diverse risk mitigation and management tools........................................................40
CHAPTER THREE: RE SPECIFIC ISSUES................................................................................42
3.1 RE SPECIFIC ISUES.........................................................................................................42
3.2 Risk in RE..........................................................................................................................44
3.2.1 Risk Management ...........................................................................................................47
3.3 RE in Rural Electrification .................................................................................................53
3.4 General Financing Options......................................................................................................57
3.4.1 Debt ......................................................................................................................................59
3.4.2 Equity ...................................................................................................................................63
3.4.3 Sales and Lease Back............................................................................................................65
CHAPTER 4: PFIs and PPPs in RE...............................................................................................67
4.1 Financing Structures................................................................................................................67
4.1.1 On Balance Sheet Financing.................................................................................................68
4.1.2 Off Balance Sheet Financing ...............................................................................................69
4.2 PPPs.........................................................................................................................................73
4.3 Specific RE Category Issues....................................................................................................79
CHAPTER 5: General Recommendations and solutions...............................................................86
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CHAPTER 6: Conclusion..............................................................................................................93
Bibliography ................................................................................................................................94
LIST OF TABLES AND FIGURES
CONTENT PAGE
Table 1: Sources of renewable power and estimated Mega Watts (MW).............................28
Table 2: A Bar Graph showing Sources of Renewable Power and Estimated Megawatts...28
Table 3: Sources of finance for renewable energy technologies in Uganda..........................33
Table 4: Power Project Lending Banks..................................................................................35
Table 5: The general investment costs and risk element for the different sizes of RE
projects.....................................................................................................................................44
Table 6: Specific RE Risks.......................................................................................................47
Table 7: Typical project finance structure for RE project.....................................................70
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ACRONYMS
ADB African Development Bank
BUDS Business Development Services Programs
CDM Clean Development Mechanism
EACA East Africa Custom Act
ERA Electricity Regulatory Authority
ERT Electricity for Rural Transformation Program
FITs Feed in Tariffs
GEF Global Environment Facility
IAs Implementation Agreements
ITC Investment Tax Credits
IRR Internal Rate of Return
Kw Kilowatt
KwH Kilowatt Hour
MOEMD Ministry of Energy and Mineral Development
Mw Megawatts
Mw Hr Mega Watt Hour
PEAP Poverty eradication Action Plan
PFIs Private Finance Initiatives
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PSF Private Sector Foundation
PSP Private Sector Participation
PSR Power Sector Reform
PTC Production Tax Credits
PPAs Power purchase agreements
PPP Public Private Partnerships
REA Rural Electrification Agency
RE Renewable Energy
REA Rural Electrification Agency
REB Rural Electrification Board
REF Rural Electrification Fund
RETs Renewable Energy Technologies
ROI Return on Investment
SCOUL Sugar Corporation of Uganda Limited
UECCC Uganda Energy Credit Capitalisation Company Limited
UNEP United Nations Environment Program
UIA Uganda Investment Authority
URA Uganda Revenue Authority
VAT Value Added Tax
WB World Bank
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1. Introduction
Uganda’s renewable energy policy is quite elaborate and presents a focused and quite robust
approach in dealing with the national renewable energy issues. It presents a detailed, integrated
and specific highlight of issues, opportunities, challenges, targets and solutions for the local RE
sector i.e. power generation, energy efficiency, modern energy services, rural and urban poor
electrification access, waste to energy and Biofuels. The policy even goes ahead to create the
necessary infrastructure for its implementation. The RE Policy vision is, “to make modern
renewable energy a substantial part of the national energy consumption by increasing the use of
modern renewable energy from 4% at the time of inception of the policy in 2007, to 61% of the
total energy consumption by the year 2017.3 This ten year vision presents an achievable but
ambitious challenge for Uganda, especially if the prevailing legal, political, social, economic and
financial set up conditions of the Ugandan economy, and how they impact on the enablement of
RE investment and development at all levels, are to be considered. The policy document terms
these conditions, “Barriers to Renewable Energy Development”.4 These conditions are high
upfront costs, inadequate legal and institutional framework, limited technical and institutional
capacity, lack of financing mechanisms, lack of awareness, underdeveloped markets,
unsustainable use of biomass, lack of standards and quality assurance, lack of sufficient data on
resource base, lack of integrated resource planning, limited stakeholder involvement and
inadequate attention to research and development.5 Of all these barriers, this paper gives special
emphasis to the barriers that directly impact on financing of RE and these are;
i) High upfront costs
ii) Inadequate legal and institutional framework
3 MOEMD, “The Renewable Energy Policy for Uganda” at http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.54. The overall objective of this policy is to diversify the RE supply sources and technologies in the country. 4 ibid p.515 ibid. Research and development should not only concentrate on technology but also on creation of innovative workable financing structures.
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iii) Lack of adequate and appropriate financing mechanisms for such projects
iv) Underdeveloped markets for RE
v) Lack of sufficient data on resource base and
vi) Lack of integrated resource planning.6
Though not the major hindering factors, these five are very paramount to the development of
renewable energy not only in Uganda but internationally because they form the basis of the
development and operation stages of the projects.7
The policy highlights certain specific areas of interest for development namely, small RE
investment through the creation of a stable and predictable environment using among others the
regular publication of FITs and introduction of a standard PPA for the various RE categories8 as
measures. This is supposed to go a long way in creating, “predictability and stability”, in the
sector, which conditions many an investor will always seek in an investment environment. The
emphasis on small RET development has the potential of having the country get electrified faster
than it would ordinarily have, since it is substantially faster to bring these small projects to
commissioning stage, and also cheaper than it is for large projects in terms of overall cost though
more expensive in terms of unit cost of development. The objective of the government is to have
more projects come on board in the shortest time possible, an attribute the big power projects
have been seen to traditionally lack.9 In Uganda, just like in other developing countries, majority
of small and mini power projects that would ordinarily get commissioned within less than a year
or within one and a half years at most, do not fit the above mentioned standard. The reasons for
project delays in reaching timely commissioning mainly arise from delays in obtaining
approvals10 and sourcing for finance. For large projects, it is even more difficult than it is for
small projects mainly because of the stringent terms attached to the conditions of raising equity
and debt for projects, which projects in many cases do not ordinarily have a large and reliable
market, a factor which often results in several guarantees and subsidies from the government.
6 Ibid p.527 These stages provide the basis of the financing mechanism as well.8 supra9 Big projects especially hydro usually take no less than two years to commissioning.10 Delays in obtaining approvals most times stem from a lack of technical and skilled personnel to prepare the project, and if they are there, most project developers find the real professionals expensive to contract.
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In Uganda, the strategy of promoting small power development has paid off as five small hydro
power projects were being developed by January 201011 and all these have a combined estimated
planned capacity of 46.995mw12.
Hand in hand with this strategy are the publication of a standardised PPA and the frequent
publication of FITs. This frequent publication of tariffs by ERA after consultation with stake
holders serves as a confidence booster for investors in the sector and has been going on for some
time now. However, some of the promoters of power generation projects have expressed concern
about the perceived unfairness and non transparency by ERA in arriving at the FITs.13 This is
why ERA, attempts to involve all stakeholders to discuss the tariff review reports prepared by the
appointed consultant before effecting any recommendations. This tariff review process is done
frequently i.e. every 3-5 years, and always takes into account the development strides the sector
has achieved. For developers, the generation tariffs and feed in tariffs are of particular interest.
An analysis of the tariffs for the different power projects in the country reveal a difference in
tariffs for different power projects. This is mainly due to the different sizes and costs of
production that the developers and government taken into account when developing these
projects. Generally, the tariffs are high because of the high cost of financing,14 explaining the
heavy subsidies provided by the government especially in rural areas. Attempts to standardise
terms have resulted into standardised PPAs.
The standardised PPA attempts to create a more predictable environment in regard to the terms
of engagement of power producers with the government who is the main off taker, yet different
projects would require different conditions of power purchase, and more still, since the PPA is
used as a risk management tool often times than not, the standardised PPA should be more of an
indicative guide than a rule of thumb strict document imposed on investors. The standardised
PPA should thus be promoted as such. The FITs in Uganda have for a long time lacked the
11 ERA, “Status of Electricity Projects under Development” http://www.era.or.ug/Pdf/Status%20of%20Electricity%20Projects%20under%20Development.pdf pp.2-312 ERA, “Small Hydro Power Projects” http://www.era.or.ug/Pdf/Status%20of%20Electricity%20Projects%20under%20Development.pdf13 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.514 The cost of financing not only considers the interest rates but also considers the risk element and how it is managed. Because of the high risk profile of developing countries, the cost of financing is generally higher than it is in developed economies.
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backing of an inbuilt escalation clause15 in the PPA to account for variations in costs of
production, a factor which discourages investment despite the fact that it may create
predictability yet power development and generation is a business and a positive cash flow
would serve to attract financiers. Therefore, FIT escalators in PPAs should not be ignored, at
least as a risk management tool for the benefit of the financiers, the project sponsors and the
project in general. Escalators would serve in improving the bankability of a project.
Another strategy is the development of solar energy technologies through the creation and
enactment of legislation which will mandate urban dwellers, middle income households and
commercial building owners to use solar energy technologies.16 This legislation is to help in
creation of energy efficiency and increased use of RETs in low consumption areas. The low
consumption areas are mainly the rural areas, urban dwellers, middle income households and
commercial buildings as mentioned earlier. Solar energy technology development in Uganda has
attracted mainly off grid and stand alone premise based systems which have recorded
tremendous success in terms of installation numbers. Several microfinance schemes have
developed based on the provision of solar PV stand alone systems for rural based communities,
reaffirming the very pivotal role microfinance plays in rural electrification and renewable energy
development among others.
For large solar systems however, only one licence was awarded in August 2006 to, Energy
Systems for Africa Limited for the production of 50mw of solar-thermal generated power yet
nothing much in terms of development has been achieved to date, as the licence application
process is still incomplete.17 The FITs that have been available for a while now are the FITs for
mini hydro and co-generation plants with the evident absence of FITs for solar technologies,
hence the assumption that there are no special FITs for solar as is the case with mini hydro and
co-generation. This serves to discourage investment in the solar aspect of RE, however, in the
ongoing tariff review process, it is hoped that favourable FITs for solar developers will be
developed and approved.
15 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.516 ibid17 ERA, “Solar Licensed Projects” http://www.era.or.ug/SolarLicencedProjects.php
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With regard to mini solar, another company Micro Power Group is in the process of obtaining a
licence for 0.24 mw Solar-PV generated power for the districts of Arua, Mbale and Lira as well
as micro-grids in several other places in the country.18 This is an indication that large scale
development of solar technologies in Uganda still faces several challenges; however with a law
in place that obligates the use of solar for specified low consumption activities, solar would form
the base load power for general lighting and the other specified low consumption purposes in all
premises countrywide. The law supposed to realise these minimum standard obligations for
domestic and commercial premises is yet to be enacted, however, work is going on behind the
scenes to ensure the enactment of this law, which would also go a long way in strengthening the
national energy efficiency and conservation policy.
The development of Biofuels through the establishment of a policy that obligates fuel dealers to
blend biofuels while also providing incentives for biofuel producers to increase their investment
and production is propounded by the policy as a strategy that can be used to develop the biofuel
industry in the country. Further, development of a testing centre at the UNBS and enactment of
legislation to obligate a minimum 20% blend of biofuels in all fuel as propounded by the policy
is expected to promote the development of biofuels for use in transport and power generation.19
So far, there is no Biofuel Law in place yet, however, there is a great deal of work going on to
have the law come on board sooner than later. With this law, a more predictable and stable
investment environment will be created, which stability and predictability would in turn go a
long way to attract and encourage investment in the sector. There is great potential for biofuel
production from among others the four sugar factories in the country20, beverage processing
plants and paper mills to mention but a few.
A biofuel company, African Power Initiative (API) has since 2008 been involved in the planting
of more than 2500 acres of jatropha a high yielding biofuel plant which yields up to five times
more than soya per hectare. The company is the biggest biofuel plantation owner in the country
and has positioned itself as the promoter of biofuel production in the country, with plans to build
sub regional plants in all regions where they have plantations and a biodiesel refinery in 18 ERA, “Status of Electricity Projects under Development” http://www.era.or.ug/Pdf/Status%20of%20Electricity%20Projects%20under%20Development.pdf p.819 ibid20 SCOUL, Kakira, Kinyara and GM sugar are the only four sugar factories in the country of which only two are producing power under co-generation.
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Kampala the capital and main business district. The residue from the process will be used to
generate biomass for power, fertilisers and chemicals.21 The benefits from biofuels are immense
even besides the residual benefits such as power production among others, yet a law setting
certain minimum blending obligation standards when enacted would result in a predictable
environment that would encourage financiers to put their money in the development of biofuel
projects, which are also capital intensive and traditionally require heavy equity financing. Fast
tracking the process to enact the biofuels law is therefore paramount if investment in the sector is
to be realised.
Since biomass accounts for 92% of domestic energy consumption, with wood and charcoal for
cooking taking up the larger chunk of that, a lot still has to be done to ensure that modern
utilisation of biomass is promoted.22 This is the reason why the RE policy moots for formulation
of a policy that will encourage the growing of high energy crops in addition to utilisation of
biogas and the use of energy efficient stoves and burners for energy efficiency purposes. The
policy further advocates for legislation that will ensure that all waste is not just burned but the
energy content first extracted before disposal,23 a move that will realise increased availability of
modern biomass energy in the country. The potential for modern biomass is high with registered
progress in Kinyara Sugar Ltd where there is production of 3mw of power under co-generation
using bagasse, and another 18mw produced under the same circumstances by SCOUL.24 Other
biomass generation projects are not yet on board with several of them still in permit and license
application stage.25 Biomass has attracted other applicants for permits namely Sesam Energy Ltd
for a 33mw “waste to Energy” biomass project in Kampala the capital, Kabale Energy Ltd for
30mw Peat power project in Kabale the Southwest of the Country, and Apac Energy for Agro
Processing Centres (U) Ltd. All these projects are in different stages of development26, however
none of them has reached commissioning stage as yet. The potential for biomass power is very
21 “Uganda Bio-diesel refinery opens” http://www.greeneconomyinitiative.com/news/226/ARTICLE/1317/2008-12-14.html22 Uganda National Development Plan 2010/11-2014/15, p.14923 MOEMD, “The Renewable Energy Policy for Uganda” at http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.824 ERA, “Co-generation/Biomass/Waste Projects” http://www.era.or.ug/Co_Generation.Php of the 18mw produced, only 6mw are used by the factory and the rest sold to the national grid. There have arisen issues to do with late payments to the generator, however, in the overall, co-generation has been a success.25 ERA, “Status of Electricity Projects under Development” http://www.era.or.ug/Pdf/Status%20of%20Electricity%20Projects%20under%20Development.pdf p.726 Ibid p.8
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high and can be promoted as a waste disposal management system that creates power and adds
value to the various companies. Most of the financing under this arrangement would be in the
form of adding a co-generation plant unit, hence the high likelihood of corporate finance in the
financing of the projects save for the independent ones.
The policy also addresses the issue of sustainability in the development of RETs in general and
highlights the important role of the government in ensuring this sustainability through among
others, the continuous acquisition and dissemination as well as publicizing of technical data to
create awareness on investment opportunities and consumption options to consumers and
investors alike. It also recognises the need to develop institutional capacity and coordination of
efforts to develop the sector through the creation of a dedicated department of RE and Energy
Efficiency at Ministerial level and National Energy committees at all levels from national down
to district level. This establishment of dedicated RE institutions goes a long way in coordinating
efforts for widespread RET development and offers coordinated efforts to ensure quick access to
financing for RET project development. The Energy Resources Department at the Ministry of
Energy currently handles development of energy resources including renewable energy under the
RE Division in this department. The continuous acquisition and dissemination of technical
information is ongoing, however the information that the government can afford to get is basic
and is to be used as indicative information pending further feasibility by the developer. This
poses a challenge to small power producers who hope to get financing based on the basic
information obtained by the pre-feasibility studies carried out by the government. None of these
studies can be used as a basis to obtain finance for the projects hence the need for further
research by the prospective developer mainly because the standards set by the government for
feasibility studies are below the standards set by the banks and other financiers for projects in the
sector. In that regard, aligning the standards with those of financiers would serve to create
sustainability in the development of RETs.27
In the promotion of R&D for the RET sector, the policy recognises that innovation is what will
drive efficiency while lowering the costs of RETs, a factor that would go a long way in making
RETs more acceptable while lowering the costs of set up. Even still, when local manufacturing
capabilities are greatly supported, increased widespread development would be expected to 27 This is an area an institution such as ERA or any other, could take up, to ensure smoothness in the process.
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follow. The private and public sectors would work well together in this regard to realise
maximum gains.28
In addition the policy recognises the government’s role in adopting and setting up financing
mechanisms such as the Credit Support Facility and Smart Subsidies with the objective of
scaling up investments in RE and rural electrification.29 Programs such as the WB funded ERT I
& II with the BUDS project, REF, and the recently capitalised UECCC Ltd initiative among
others, have achieved big gains in terms of rural electrification especially. Under ERT Project,
transactional advisory services as well as partial funding of the cost of feasibility studies is
provided to RE project developers with projects of under 20mw and with a rural electrification
element. The UECCC Ltd initiative involves the disbursement of capitalisation credit to
renewable energy projects to enable them achieve a good level of financing to enable the projects
proceed in a timely manner. The credit is disbursed through financial institutions at low interest
rates in the form of debt. It also provides partial risk guarantees among other risk mitigation
tools. This initiative will play a very important role in solving the financing challenge faced by
energy project developers and sponsors as well as ensure that projects reach commissioning in a
timely period. The company is currently involved in a PSP Hydro joint initiative with GTZ,
PSFU and REA to offer financial and technical support to mini-hydro power plants of up to 1mw
and with a rural electrification component.30 The success of this initiative can be used to promote
the same for projects of up to 20mw.
The company will obtain financing and technical expertise from various donors and funds for
green financing should not be an exception. The tapping into and utilisation of some of the
international green financing resources would play a big role in increasing the available finance
for development of RETs locally.
It is important to note that the achievement of operationalisation of some of the measures under
the objectives of the RE policy could only be made possible with the enactment of appropriate
legislation which takes into account financiers interests in sector projects. These categories of 28 The Uganda Industrial Research Institute and the Presidential Initiative for Development of Science and Technology would play a very pivotal role in this regard.29 MOEMD, “The Renewable Energy Policy for Uganda” at http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.830 The support involves providing a 25% conditional grant attainable on completion of the project, 60% low interest rate long term loans and partial risk guarantees.
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legislation would address specific issues as recognised by the policy namely; FITs, compulsory
solar for specified low consumption functions, Biofuels production and blending, adoption of
alternative technologies, regulation of charcoal production and transportation, institutional
frameworks, fiscal and financial incentives for RE investment and environmental protection.31
Therefore, it follows that this paper discusses these aspects in light of the financing aspect of RE
projects with special attention to PFIs, PPPs and other innovative fiscal and financial
arrangements that could be employed or developed for purposes of making renewable energy
development a great deal easier. However, it is imperative to note that because of the complex
nature of renewable energy projects, which complexity arises from various factors such as those
mentioned above as well as the scattered and isolated nature of the renewable energy sources, the
novelty of technology involved and the unreliability and unpredictability of some of the fuel
sources used, such as wind and solar among others,32 renewable energy development a couple of
years down the road, has not attracted much in terms of tangible alternative renewable energy
projects coming on board, save for the traditional hydro at both mini and large levels.
The renewable energy categories of wind, solar, biomass and geothermal have not attracted the
requisite investment to make them an important aspect of the generation mix due to several
factors, important of which include, the high upfront costs, which condition is not made any
easier due to a dearth in available financing for such renewable power projects especially in
developing economies such as Uganda’s.
The varied legal, regulatory and technical reasons for underdevelopment of the RE sector are
quite diverse. This paper will identify the role of finance, as one aspect, in the promotion of RE
projects in developing countries, with special emphasis on Uganda, through both private and
public finance initiatives.
Chapter two will review Uganda’s power sector with emphasis on the potential and challenges
facing the sector in light of RE and its connection with Rural Electrification, while emphasizing
the abundance of renewable/green energy options as the naturally occurring alternative option
due to an abundance in their natural occurrence country wide. Under the same chapter, the
31 Ibid p.1032 All these issues are key when structuring a financing package for the project.
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existing policies that bear on the development of RE and Rural Electrification will be considered.
It will also highlight and analyze the renewable energy policy’s position on PFIs and PPPs as
financing tools for renewable energy development in Uganda. Still under this chapter, the
hindrances the policy and the Ugandan situation in general pose, in relation to the use of PPPs
and PFIs in the renewable energy sector development, will be considered.
Chapter three will analyse the nature of renewable energy highlighting how RE works, the
common RE issues, how RE projects are ordinarily financed and the major RE risk issues
common to RE projects and how they are ordinarily dealt with. The objective of this chapter will
be to identify opportunities and challenges in offering solutions to the existing bottlenecks in the
Ugandan power sector, as will be tackled in the subsequent relevant chapter.
Chapter four will introduce the concepts of Private Finance Initiatives and PPPs while
highlighting their roles in power sector development. Here, the nature of the two tools will be
highlighted with emphasis on their possible role in encouraging general power sector
development and the role the government can play in ensuring that the same tools are effectively
used to encourage sector development while also highlighting their role in RE.
Chapter five will attempt to offer solutions to the problems highlighted in the previous chapters
while also suggesting alternative financing mechanisms for renewable power projects in light of
the hindrances identified earlier in the paper. Under the same chapter, the role of legislation and
regulation in encouraging the use of PPPs, PF and other financing tools to encourage
development in the sector will be considered.
Chapter six will conclude by showing that the two financing tools, though very vital, may also be
insufficient and sometimes irrelevant in certain situations as far as renewable power development
is concerned hence the need for a mix and match arrangement for RE financing.
1.2 OBJECTIVES OF THE STUDY
1.2.1 General objective
To establish issues in Renewable Energy Financing in Developing Countries
1.2.2 Specific objectives 16
1. To examine the policies and laws on renewable energy financing in Uganda
2. To find out the sources of financing for renewable energy in Uganda
3. To investigate the challenges faced in financing of renewable energy in Uganda
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CHAPTER TWO: REVIEW OF UGANDA’S POWER SECTOR
This chapter, will give a review of Uganda’s power sector with emphasis on the potential and
challenges facing the sector in light of RE and its counterpart, Rural Electrification, while
emphasizing the abundance of renewable/green energy options as the naturally occurring
alternative option due to an abundance in their natural occurrence country wide. Under the same
chapter, the existing policies that bear on the development of RE and Rural Electrification will
be considered. It will also highlight and analyze the renewable energy policy’s position on PFI
and PPPs as financing tools for renewable energy development in Uganda. Still under this
chapter, the hindrances the policy and the Ugandan situation in general pose, in relation to the
use of PPPs and PF in the renewable energy sector development, will be highlighted.
2.1 Review of energy sector policies and laws
Uganda’s energy sector is a very important and vital component of the Uganda economy. It
constitutes a major income earner for the government in the form of taxes, fees, levies and duties
among others, while also taking a large part of government and public expenditure through
budget and sector support. With liberalization of the energy sector, private participation in the
sector has increased tremendously with a big majority of energy investments constituting private
sector finance.33
Since its liberalisation in the late 1990’s, the electricity network in Uganda has achieved great
strides in terms of development, coverage and maintenance despite the power cuts the country
has been facing for much of the last five years.34 The country currently still faces a huge
electricity supply deficit with a very large part of the population still unconnected to the
electricity grid implying that those who have access to modern power are connected to isolated
grids and stand alone systems among others.
Much of the new generation is attributed to independent power producers (IPPs) who have
tremendously contributed towards electrification of the country. These IPPs have generally
33 UIA, “Investing in Uganda’s Energy Sector” at http://www.ugandainvest.com/energy.pdf p.234 These power cuts were attributed to the low levels of power production caused by low water levels due to the long drought that the country experienced. The cuts were curtailed by the introduction of expensive thermal fuel generators in various parts of the country and increased water levels.
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thrived globally as a result of the liberalisation and unbundling of the power sectors in various
countries.
Uganda’s electricity sector like several others was unbundled, during the power sector reforms of
the 1990’s, from the vertically integrated government utility, UEB, that handled the three roles of
generation, transmission and distribution simultaneously.35 It was unbundled into three separate
independent functions namely generation handled by UEGCL, transmission handled by UETCL
and distribution handled by UEDCL. The generation and distribution functions were
concessioned out to, ESKOM (U) Ltd36 and UMEME37, respectively. The independent power
regulator, ERA oversees and regulates the country’s electricity sector.38 All these above
mentioned functions have achieved great strides in terms of performance and greatly contribute
to the positive development of the sector.
In 2002, the government came out with an Energy Policy after several years of relying on
Ministerial Policy Statements.39 The Energy Policy 2002 was a sign of the government’s
commitment towards development of the energy sector on a long term basis approach. This
energy policy highlighted and brought about several changes in the approach the government
was using to bring about development of the power sector. These changes are identified and
discussed later in this paper, with particular emphasis on the roles of renewable energy and
finance in the development of the sector.
The policy goal of the 2002 Energy Policy is to meet the energy needs of Uganda’s population
for social and economic development in an environmentally sustainable manner.40 The policy
takes into account the linkages between the energy sector, the international arena and the rest of
the domestic and regional economy. It further recognises that the sector is constrained by
inadequate financing and as such further recognises the role of globalisation in ensuring that the
country is in compliance with several conditions in the development dynamics of this time and
age, and in this regard, the need to set up a conducive environment that can attract private 35 S.6, Cap. 145 Laws of Uganda (2000 Edition)36 It is a wholly owned subsidiary of ESKOM Group of South Africa a leading power service provider in Africa.37 A consortium of Globleque and ESKOM38 Established under s.4(1) cap 144, Laws of Uganda39 MOEMD, “The Energy Policy for Uganda, 2002” at http://www.energyandminerals.go.ug/pdf/EnergyPolicy.pdf p.440
Ibid p.1
19
finance and encourage energy trade and other aspects of partnerships, is propounded.41 However,
the policy also recognises that there is a need to strengthen the institutional and legal framework
in which the sector operates especially for RE among others. The government has put in place
diverse and varied measures in this regard with several projects being promoted to ensure the
achievement and realisation of such a conducive investment and operating environment and
appropriate legal and institutional framework.
The policy further recognizes the country’s abundant natural resource base and hence the vast
potential for renewable energy production from such biomass sources which biomass has always
been the leading source of Uganda’s energy needs.42 Solar, wind, geothermal and bio-fuels are
also identified as the other renewable energy categories with good potential for development;
however, hydrological resources are the most abundant and have attracted the most in terms of
development and private sector interest.43 Uganda’s main source of power is hydro with an
installed capacity of 2.154 billion kilowatt hours as per 200844 of which a minimum of 70% is
attributed to large hydro, and the rest to mini hydro. Mini hydro is predominant in rural areas
mainly due to the rural location of the mini hydro sites. This makes it a very important aspect in
the Rural Electrification Process. The other categories of RE are also predominant in rural areas,
explaining why RE is a key element in Rural Electrification.
RE and Rural Electrification are intertwined and cannot be separated. In Uganda’s case, most of
the country’s RE sources lie in the rural areas, which factor makes them a very vital component
under the relevant respective policies. Uganda developed the Rural Electrification Strategy and
Plan, which covers the period 2001 to 2010, as a special program for rural electrification as
required by the Electricity Act of 199945.
41 Ibid p.542 MOEMD, “National Biomass Demand Strategy 2001-2010” at http://www.energyandminerals.go.ug/pdf/BEDS-Contents.pdf p.4. According to the BEDS, biomass accounts for 93% of the energy mix in Uganda.43 Private sector participation has been key in bringing several power projects to fruition. In mini hydro, private sector involvement is the norm as government does not take part as an investor in the development of power projects of less than 20mw.44 These figures are according to the EIA country statistics at http://tonto.eia.doe.gov/cfapps/ipdbproject/iedindex3.cfm?tid=2&pid=33&aid=12&cid=&syid=2004&eyid=2008&unit=BKWH 45 S.63 of the Electricity Act, 1999, Cap. 145, Laws of Uganda.
20
Under this plan, one of the most important strategies that have been successful in overcoming
some of the barriers to rural electrification is the establishment of an appropriate institutional
framework which framework comprises a number of institutions charged with the management
of the rural electrification process. One of these bodies is the Rural Electrification Agency
(REA) whose mandate is to ensure implementation of the Rural Electrification Strategy and Plan,
through Public Private Partnerships.46 The REA works as the secretariat of the Rural
Electrification Board47 (REB) whose role is to oversee the implementation of the strategy and
management of the Rural Electrification Fund (REF)48. The Rural Electrification Master Plan49 is
another of the framework strategies designed to overcome the barriers to Rural Electrification
among others.
All these bodies and functions work together to ensure that power projects are developed in the
rural areas. These projects are all regulated by the Energy Regulatory Authority (ERA) which
also decentralizes its regulation role in certain appropriate circumstances as highlighted later in
this paper.
With a progressively demand driven approach to development, government’s role is the
preparation and determination of policy, while promoting investments, with set targets, and
provision of guidance to investors. On the other hand however, all capable sponsors such as
private companies, local authorities, NGOs and communities among others are all able to initiate
electrification projects and where these are not desirable for private sector initiation, government
gets involved by promoting PPPs so as to ensure electrification in these areas in realistic time.50
This shows that government does not only stop at enablement through policy but also goes ahead
to take decisive effort to ensure that the electrification plan goes on as planned. This aspect raises
an interesting solution to one of the challenges to financing renewable energy under rural
electrification (also read imperfect markets). It is worth noting that government is the major
player in ensuring the success of a rural electrification drive in any economy because of its
46 REA Overview, at http://www.rea.or.ug/?p=site&s=2&pg=247 The REB is part of the implementation framework48 The REF is also part of the implementation framework and allows for the provision of grants and subsidies on investment costs for Rural Electrification Projects. These grants are provided especially to cover part of the cost of feasibility studies and transactional costs, and subsidies are provided to reduce the cost of power to the rural consumer.49 Its role is to provide information on investment opportunities.50 www.energyinstug.org/...com.../file,Others%7CRural+E+Plan.pdf/ pp 6-7
21
central role as creator and promoter of policy and law and also as an active participant as
subsidizer and guarantor for most if not all private sector led power development projects.
The RE policy also further recognizes that Uganda currently suffers from energy poverty51 which
in Uganda is characterized by low consumption levels of modern energy forms such as electricity
and petroleum products, inadequacy and poor quality of electricity services in addition to the
dominant reliance on wood fuel sources.52 This is the situation that the policy sets out to change
for the better, so much so that the country will be characterised by high consumption levels of
modern energy among others.
2.2 Different sources of renewable power and estimated Mega watts
Uganda has considerable renewable energy sources for energy production and provision of
energy services. These resources include hydro, mini-hydro, solar, biomass, geothermal, peat,
and wind. However, with the exception of biomass whose contribution is very significant, the
remaining renewable sources contribute about 5% of the country’s total energy consumption.
This limits the scope and productivity of economic activity in different parts of the country, yet if
these resources were to be fully tapped into, they would go a long way in making the different
categories of RE a major source of Uganda’s power. Currently, hydro is the main source of
renewable power for Uganda with large hydro being the biggest source, followed by the mini
hydro sites which also provide a considerable amount of power, though in comparison terms
mini hydro provides about 10% of what large hydro provides. Thermal fuel generators provide a
considerable amount of power which is slightly more than the amount of power provided by mini
hydro in terms of megawatts. It is however not an RE type hence will not be discussed further in
this paper.
Solar PV accounts for the third largest source of power in Uganda in current production terms,
which however is very low. The figures for the potential of Uganda’s renewable energy are
tabulated below and seem to be in consonance with the current production by source as
mentioned.
51 MOEMD, “The Energy Policy for Uganda, 2002” at http://www.energyandminerals.go.ug/pdf/EnergyPolicy.pdf p.8. Energy Poverty is
defined as “the absence of sufficient choice in accessing affordable, reliable, quality, safe, and environmentally benign energy services to support economic and human development”52 ibid
22
Table 1: Sources of renewable power and estimated Mega Watts (MW)
Energy source Estimated mega watts
Hydro 2000
Mini-hydro 200Solar 200
Biomass 1650
Geothermal 450
Peat 800
Wind -
Total 5300
Source: Alternative energy sources assessment report 2004, national biomass assessment study.
Table 2: A Bar Graph showing Sources of Renewable Power and Estimated Megawatts
23
0
1000
2000
3000
4000
5000
6000
Mega Watts
Hydro
Mini -hydro
Solar BiomassGeothermal
Peat
Wind Sources
Source: Alternative energy sources assessment report 2004, national biomass assessment study.
2.3 RE POLICY POSITION ON PFIS AND PPPS
The RE Policy recognizes the very important role PPPs have to play in promoting investment in
the RE sector. The utilization of PPPs as a financing and development tool can be achieved
through the provision of a conducive policy, legal and regulatory framework environment which
is expected to contain among other things tax rebates for investors in the sector, favorable forex
exchange conversion terms, incentives such as guarantees or other risk hedging mechanisms and
favorable power purchase pricing terms and subsidies among others.53 These are particularly
intended to address the problem of high investment costs and risk in these investments, which
factors have a very important bearing on financing for RE projects. The role of the government
in proactively implementing desirable projects which would erstwhile be undesirable to the
private sector is recognized under a recommended strategy aimed at encouraging the private
sector to invest at a later project stage when the initial undesirable stages such as exploration for
feasibility purposes, have been carried out by the government. The private sector involvement is
through direct participation in management, operations and development of the project.54
The policy further provides for the establishment of an appropriate financing and fiscal policy
with the ultimate objective of attracting investment into the subsector and enabling RETs to
penetrate different markets.55 Under the aspect of establishment of an appropriate financing and
fiscal policy, the RE policy recognizes that, PPPs and other innovative financing mechanisms
such as targeted subsidies, can be used to stimulate market penetration by RETs.56 The
encouragement of market penetration deals with some of the challenges facing development of
the sector. The current financial and fiscal regime in Uganda does not support low interest rates
and long term lending57 which can be attributed to a small and under developed financial sector
53 MOEMD, The Renewable Energy Policy for Uganda, at http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.5554 ibid55 Ibid p.5856 ibid57 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.7 Uganda’s lending rates are considered the highest in the world in real terms.
24
characterized by low capitalized financial and capital markets.58 This subsequently leads to a
situation where there are very limited options for finance and a high demand for the prevailing
long term and high interest rate lending. Furthermore, the previous absence of a credit reference
service meant that most of the borrowers were considered high risk which factor further
compounds the problem of high interest rates and short lending terms.
The introduction of specific tax regimes for RE, such as accelerated depreciation, tax
exemptions, preferential tax treatment and the adaptation of tax on other energy generation
categories, in such a way as to encourage renewables, is another of the strategies proposed in the
RE policy.59 Much as this strategy is mainly to encourage RE penetration in the market, it also
has an important role it plays in the financing of RE projects as it impacts on the amortization
period as well as the types of investors who could actually invest in the RE projects as utilities
and financial institutions among others, as is explained elsewhere in this paper. In Uganda, there
is VAT exemption for power development projects; however, this has not been effective because
of some issues that touch on the mechanism of recovery since the exempted developers are still
charged VAT by their non exempted suppliers hence causing problems even in recovery of the
same by the investors. This hurts the suppliers and developers alike, ultimately leading to a
situation where local contractors are not actively involved in development of power projects
since there is no mechanism for them to recover their VAT besides increasing prices which in
turn ultimately leads to high costs for the developer thus negating the VAT exemption. 60
In addition to the VAT exemptions for project development, Uganda Revenue Authority (URA)
also offers 5 year minimum tax holidays for projects and developers who are registered with
Uganda Investment Authority (UIA) as investors. This 5 year tax holiday exempts the developer
from tax liability for the entire first five years of operations. However, many of the small and
mini power developers have not taken advantage of this tax holiday due to a lack of information
in regard to the same.
58 The lending capacity of local development financial institutions is limited by their limited net worth while commercial banks prefer short term lending because of the good returns at low risk that accrue from the same 59 MOEMD, The Renewable Energy Policy for Uganda, at http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.5560 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.27 The GOU Contracts make it obligatory for developers to use local contractors and local materials as much as possible.
25
The policy further recognizes that risk is an important factor that influences investment in, and
financing of RE projects, and thus goes on to suggest the implementation of innovative credit
enhancement instruments and risk mitigation mechanisms to make investors more comfortable to
invest their money in RE projects in the country. This strategy is mainly mooted for the rural
development programs;61 however it also has a big bearing on the investment in projects
generally. The common risks identified by power developers in Uganda are several and include
legal risks which arise from a lack of or limited awareness by the developers of the legislation
and regulations relating to the power sector as well as a lack of confidence in the court system by
some investors.62 In addition, regulatory risk is another category of risk that investors in the
sector raise as a matter of concern. The regulatory risk is considered high and of paramount
concern to the project developers and financiers especially. For the case of Uganda, this risk is
due to the perceived political and government interference particularly in the end-user tariff
setting process, despite that however, ERA is generally considered to be independent.63 Political
risk of investing in Uganda is considered to be moderate due to the political stability the country
has had for over the last 20 years. However, the recent election violence in neighboring Kenya
and few incidences of political violence in the country’s recent past makes the developers and
financiers cognizant of the fact that drastic changes can occur very quickly. Another category of
risk recognized by investors in the power sector is infrastructure risk which ranges from
telecommunications, roads and transmission infrastructure which are considered to be slow,
inefficient, unsecure, inaccessible or inadequate64 for the purposes for which they are meant.
These risks are low profile among developers save for transmission infrastructure risks which
directly bear on the project.
The above mentioned are some of the risk investors in the power sector in Uganda are concerned
about. The issue of risk is dealt with in detail later in the paper.
61 MOEMD, The Renewable Energy Policy for Uganda, at http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.5562 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.19 The legal risk is quite low and does not pose much of a problem in project development decision making.63 Ibid p.26- The lending for the projects is mainly premised on the PPA and license as the main collateral, so government interference in tariff setting exposes the lenders to significant risks 64 Ibid
26
Because of the unique challenges posed by different situations in different economies, financing
mechanisms for RE may also vary and as such, the policy suggests the development of financing
schemes that are adapted to the local needs and traditions65 of the various communities in which
the projects are likely to take place. Some of the schemes cited include the use of revolving funds
to enable market development for small, appropriate RETs for rural development as well as
microfinance for certain small scale domestic and community projects. These revolving funds,
because of their revolving nature, would work best for short term return projects, hence the need
to complement them with other longer term financing tools. Much as microfinance is useful, it is
also limited in scope and cannot be used to sustain large projects, hence its utilization in the
development of small projects especially those that involve provision of small turnkey RE
systems such as solar PV for home use among others. Microfinance can be utilized effectively
for larger projects than the traditional small projects, by ensuring that the microfinance funds are
mixed with other bigger funds with longer amortization periods in the financing structure for
projects and this would go a long way in ensuring the widespread development of RE in
developing countries.
With ever increasing global concern about green house gas emissions and the large carbon
footprint created by the industrialized countries and also many of the non green fossil fuel based
energy projects, some innovative tools and mechanisms were created to help reconcile the need
to develop with the need to preserve the environment. The RE policy proposes the need to
benefit from the different opportunities that are offered by the Kyoto Protocol, CDM, Emission
Trading, Joint Implementation Programs and the Carbon Credits Scheme.66 All these
mechanisms can be effectively utilized so as to greatly reduce the financing burden on the RE
project investors, as some of these mechanisms can be employed to secure green financing
incentives, provided an appropriate supporting legal and regulatory framework is in place.
65 MOEMD, The Renewable Energy Policy for Uganda, at http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.5566 ibid
27
2.4 Sources of finance for renewable energy in Uganda
A number of players have been attracted into the RE power sector especially in generation with
several of them acquiring concessions for existing and self developed generation plants at both
large and mini levels.
Since the local finance sector is weak overall and the banks and other financial intermediaries
have no experience with project financing in electrification, not much has been achieved in terms
of having RE projects come on board save for the large hydro and fuel thermal generation
segments.67 The pay-back period on these investments dose not correspond to the short term loan
maturity period offered by most local financial institutions. However, donor finance is in plenty
though inadequate and more still, undesirable where it does not reflect the market dynamics of
demand and supply.
Below is a table showing the sources of finance for RETs in Uganda.
Table 3: Sources of finance for renewable energy technologies in Uganda
Financial source Projects
Government of Uganda
Multilateral and bilateral organisation
Private Equity Funds
Bujagali
World Bank Various Renewable energy projects
African Development Bank Bujagali interconnection project
IMF Some renewable energy projects
Private partners Renewable energy projects
67 Both have been successful in receiving finance because of the government’s heavy involvement in their development through the direct procurement of project feasibility studies and the provision of very favourable guarantees, tariff and investment terms so as to have these projects quickly developed. The developers for these projects are also highly capitalised with a good reputation and thus attract the requisite financing easier.
28
Source: “Energy for water – health – education, national consultation workshop, Uganda, 15 th
November 2005”
This table shows that the large majority of the finance for RETs in Uganda mainly comes from
the category of public sources in the form of government and development partner financing.
These play a very big role in bridging the financing gap in developing countries where there are
few alternative private finance sources.
The development Banks operating in Uganda are only three namely AfDB, EADB and UDB of
which AfDB is the most capitalised followed by EADB and finally UDB. AfDB has extended
support to several power projects in the country especially through the EADB and direct
government loans. The interest rate for AfDB is based on the 6 months LIBOR plus 2-4
percentage points with an appraisal fee of 0.5% of the amount requested, which should in any
case not be less than US$ 40,000, and this appraisal period is for a period of between 6 to 9
months.68 The rates and appraisal periods are typical and have to be accounted for when
structuring the financing deals.
The average cost of borrowing from development banks is 7% for foreign currency loans, with
an added margin of 1-3% depending on the perceived risk of the borrower, however, on the
shilling loan; it is in the region of 17% plus a margin of 1-3% depending on the perceived risk as
well.69 This implies that it is more expensive to borrow in local currency than it is to borrow in
US. Dollars due to several reasons which include among others the currency risk associated with
the Shilling as opposed to the dollar. This however has an effect on the projects that would
ordinarily opt for the cheaper option of borrowing in dollars, in that they would have to hedge
against currency and exchange rate risks since the projects would be earning in shillings and yet
have to pay back the debt in dollars.
EADB with a capitalisation of approximately $200 million, on the other hand is popular among
mini hydro power developers in the country with most of the loans extended to them having a ten
year maturity period70 which period is short for such projects because of their long term nature,
68 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p. 2369 Ibid 70 Ibid p.22
29
hence the need to employ innovative financing mechanisms to ensure a long general amortisation
period. EADB charges 1% of the amount as loan arrangement fees of which 75% will be
refunded if the project appraisal is unsuccessful.71
The project developers also benefit from lines of credit from AfDB, EIB, ExIm Bank of India
among others72 which all constitute main sources of funding.
The UDB on the other hand has not been approached by any power developers because of its low
capitalisation of $20 million73 which would hardly build any serious power plant. This is
therefore not considered an available source of funding for power projects in the country.
Commercial banks in the country also actively lend to energy projects, however, two factors
determine how much a commercial bank can lend and these are, the exposure limit of the bank
which should be anything no more than 25% of their paid up capital and made available to a
single borrower, and secondly is, the nature of commercial bank liabilities which support short
term lending with a 5 year maturity period being the preferred lending term for several of the
commercial banks.74 The commercial banks active in lending to power projects in Uganda are
DFCU, Stanbic Bank and Standard Chartered Bank. Some of the banks have resorted to
syndication as well as partnering with their mother banks to co-finance projects so as to manage
their exposure limitations among other factors.
Here below is a table showing some of the banks that lend to power projects in the country
together with their interest rates and other charges.
Table 4: Power Project Lending Banks
Name of Lender Base lending rate on
Forex
Base lending rate on
Shillings
Other Charges
AfDB, EADB 7% (base lending rate) +
1-3%
17% (base lending
rate) + 1-3%
Lead arrangement fee,
appraisal fee (1% at
71 Ibid p.2372 ibid73 ibid74 ibid
30
EADB/ 0.5% at
AfDB), etc.
UDB 9% 17-19% Approval fess 2% of
the loan.
Stanbic 7.5% 16% Arrangement fee 1-
2%
DFCU 8.5% 19%
Barclays Bank 16-19%
Standard
Chartered
8% 18.5% Arrangement fees 1-
2% of the loan.
Commitment fees
50% of arrangement
fees on unutilised
amount.
Source: Constraints to Investment in Uganda’s Electricity Generation Industry75
Other financiers of energy projects in Uganda include NORFUND, DED/KFW, PROPARCO,
EAIF, IDA through ERT, UECC through local commercial banks and Uganda Carbon Bureau
for carbon credits among others.
2.5 CHALLENGES FACED IN DEVELOPMENT OF RENEWABLE ENERGY IN
UGANDA
Despite Uganda’s vast hydro power potential estimated at 3000MW, lest than 10% of this
potential is exploited thus curtailing commercial and domestic energy supplies. What has always
been projected in financial year plans cannot be met due to underdeveloped financial sector
which makes it difficult to efficiently and appropriately finance projects and manage the various
75 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p. 23
31
risks presented by RE. However, other RE sources are also still not fully tapped into due to
certain constraints that are institutional, legal and policy oriented. The major constraints to
development and financing of RE in Uganda are discussed below.
2.5.1 Limited technical and institutional capacity.
In Uganda, like in any other developing country, there is limited technical and institutional
capacity, which cuts across both private and public sector, to implement and manage renewable
energy investments. In Uganda however, great strides have been taken to tackle this technical
and institutional inefficiency and thus several institutions have been put in place to deal with the
various aspects of RE.
The recent rural electrification programs for instance demand that there should be enough public
and private involvement in the energy business. However lack of adequate local skills to address
the various roles, needs and decision making, has hindered renewable energy development in
Uganda76. The country faces scarcity of experienced qualified personnel to effectively manage
the RE development process. This lack of experienced personnel leads to the employment and
contracting of foreign firms at expensive rate which many a local developer would shy away
from. The use of local contractors also presents problems with the financing institutions since the
local contractors are often times small and undercapitalised and hence cannot raise the relevant
performance guarantees and also do not have the requisite experience to handle large magnitude
projects, as required by some multilateral and bilateral financing institutions.
There has for a long time been a lack of a standard procedure and legal instruments for new
renewable energy investments causing some bit of frustration among would be investors and
financiers due to the uncertainty of the entire outcome of the negotiation and development
process. However, this has changed due to the publication of a standard PPA and FITs which
create an element of certainty which certainty is important in creating bankable projects. The
ERA has streamlined procedures for power development and operation which is going a long
way to promote development of the sector.
76 MOEMD, “The Energy Policy for Uganda, 2002” at http://www.energyandminerals.go.ug/pdf/EnergyPolicy.pdf p.51
32
2.5.2 Weak and inadequate financial sector
The financial sector has hindered development of RE in Uganda. The lack of appropriate
financing mechanisms to facilitate the development and promotion of RETs has for a long time
frustrated efforts to develop RE projects. Commercial banks currently are not providing long
term lending required for RETs, the capital market is small and thrives on short term capital
instrument listings due to the small size of the capital market sector. Renewable energy
technologies are still characterized by high upfront costs, which local developers as well as
others may find unaffordable. Mechanisms for consumer financing to address this problem are
still inadequate. The lack of domestic finances for energy sector projects has led to undue
reliance on external financing. There is need to further stress that new resources (capital,
technology, human resources) from the domestic private sector, financial institutions are still
lacking to implement and support the renewable energy sector in Uganda77. However, the
proposed liberalisation of the Pension Fund sector and, the recently created East African
Common Market are bound to increase the capitalisation for the local capital markets and will go
a long way in increasing available finance for RE projects among others. The recent
capitalisation of the UECCC Ltd will also greatly contribute to solving this financing challenge
as UECCC Ltd is a local initiative by the Ministry of Energy and understands the local market
problems the industry faces, and for this reason, would greatly work towards solving the
financing issue.
The inadequate and unpredictable nature of financing energy schemes in Africa cannot be
underscored. The ADB estimates that financing of energy schemes in the entire continent for the
next 12 years will require a minimum $3 billion per annum, which though a big figure in itself, is
small considering the entire continent needs to benefit.78 It is also noteworthy that funding in the
energy sector is generally done on a case by case or project by project basis as opposed to using
a general long term financing strategy within the national and regional programs.79 Long term
solutions to energy poverty are simply unthinkable without adequate access to investment which
77 Forum of Energy Ministers of Africa, “Report on the FEMA Ministerial Meeting”, Entebbe, Uganda, august, 3, 2005
78 “Energy Poverty in Africa” at ww.ofid.org/workshops/ Energy Poverty/ Energy PovertyinAfrica.doc
79 Uganda’s approach has been yearly contributions to long term strategies in that the National Energy Fund receives budgetary contributions annually save for the 2010/2011 budget where the contributions were conspicuously absent.
33
access is created by a good investment environment, implying that the role of the state in
encouraging investment is quite paramount. Experience shows that market incentives and
business innovation can provide new pathways for energy poverty solutions. Therefore, the need
to maximize entrepreneurship, transfer skills and capacities as well as encourage public-private
partnerships is crucial.80
2.5.3 Limited stakeholder involvement
There has been limited stakeholder participation in the planning and implementation of
renewable energy projects in Uganda, leading to poor sustainability of investments. Furthermore,
with the Power Sector Review (PSR), the need for holistic program development and
management, involving the various bodies and stakeholders in the power sector is even more
pressing. In the past, energy planning emphasized the addressing of supply side issues, especially
for commercial sources of energy, and not the demand side issues. This approach tended to
favour the urban population, which is the major user of commercial fuels, while marginalizing
the energy needs of majority of the population, which live in rural areas and depend mainly on
biomass. The rural areas also contain over 85% of the population with the largest majority of this
proportion actually living below the poverty line.81 The new strategy of involving all
stakeholders and having specialised programs for the different areas of the population will go a
long way in ensuring electrification of the country as the issues for the different areas are
understood and tackled specifically as opposed to generally as was the case in the past. The
specialised programs take into account the different development and financing dynamics of
power projects in the various areas, which is very important as developers and financiers take
into account the local market situation among others in making a financing decision. Power
development projects in rural areas for example will require subsidisation because of a lack of a
reliable market among other factors. The segregation of the markets is one way to identify and
better deal with financing issues for power development among others.
80 ibid81
ENABLE, “Energy Sector Policy Overview Paper” at www.enable.nu/publication/ Energy _ Policy _ Overview _ Uganda .pdf
34
2.5.4 Lack of standards and quality assurance
There are lack of adequate standards and mechanisms to monitor and ensure quality of RETs.
The different solar technologies on the market are not known to the general public their
effectiveness is equally not standard. Similarly hydro, wind, modern biomass and biofuel
opportunities and standards of investment and operations are not known to the general public.
This is not only a Ugandan problem but a problem in most of the developing countries, and as
such, approximately one – third of the estimated 1.6 billion people living without access to
electricity worldwide live in Africa.82 The Uganda National Bureau of Standards (UNBS) is
increasing its coverage and mandate to the energy sector as well t help in the standardisation of
some local industry operations and qualities. Standardisation of the process an investor has to go
through in order to invest in a power plant among others has also been standardised except that
there still exist some conflicts especially in regard to certain roles such as building the power
evacuation system for on grid projects among others.
Standardisation of the regulatory element is also considered important as for small systems with
generation of less than 2MW or sales of less than 4 GWh; the Electricity Act contains provisions
which allow ERA to delegate its regulatory powers to competent local authorities. This is in
order to prevent conflicts of interests arising from any local authority entering into the role of
project concern and also to prevent regulatory bottlenecks from discouraging investment in the
sector as this delegated regulation is usually less stringent83. This standardisation of procedures
as well as quality ensures a predictable operating regime which is what would make financiers of
projects more comfortable.
2.5.5 Lack of proper laws to integrate bio fuels in the economy
The responsible and sustainable production of biofuels ensures that the environment is conserved
in the promotion of RETs. As noted, traditional biomass constitutes the major source of energy
for Uganda and it is the government’s objective to ensure that its use is modernised. With
modernisation definitely comes the enactment of appropriate policy and legislation to create a
predictable environment. As noted earlier, Uganda is still in the process of coming out with a
82 Yinka Adeyemi “About 650 million Africans may lack access to electricity by 2030, delegates told at CSD4” at www.uneca.org/eca_resources/news/102605sdd_dna.htm 83 citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.131.2796...
35
biofuel law which law would facilitate investment in the sector as it will lead to a predictable and
stable investment and operation environment.
2.5.6 Lack of diverse risk mitigation and management tools
The local risk mitigation and management market for power project related risks among others is
still small and shallow. The insurance market which constitutes a major player in this market is
no exception to this especially in the tools and risk management and mitigation packages they
offer for energy sector related projects. Like most other developing countries, the appetite of
investors and off shore capital markets is impacted by the country’s risk ranking. The country’s
risk ranking is determined from several factors and political risk in all its forms is the commonest
form of risk that is used as a benchmark to determine the country’s risk profile. The legal and
regulatory regime including but not limited to negotiations for Power Purchase Agreements
(PPAs) and guarantees through implementation agreements (IAs), all form a basis for investor
influx into the energy sector84. The UECC which offers partial risk guarantees for small hydro
projects of up to 1mw under the PSP Hydro initiative is a good step in the development of tailor
made risk mitigation measures through PPPs.
All in all, these challenges all present opportunities to make the sector better in terms of
predictability and stability of the investment and operation environment so as to attract financiers
who like predictability and stability in areas where they may wish to invest their money.
84 Godfrey R. Turyahikayo, “Investment opportunities in the power sector in Uganda”, Uganda Business investment Forum, Cedar Park, Hotel,
Johannesburg, 2nd October 2008 at www.tpnetworks.co.za/.../Investment_Opportunities_in_UGANDA.pdf
36
CHAPTER THREE: RE ISSUES
This chapter will offer an analysis of the nature of renewable energy highlighting how RE works,
the common RE issues, how RE projects are ordinarily financed and the major RE risk issues
involved in RE projects and how they are ordinarily dealt with, citing prominent examples of
different renewable power projects where necessary. The objective of this chapter will be to
identify opportunities and challenges in offering solutions to the existing bottlenecks in the
Ugandan power sector, as will be tackled in the subsequent relevant chapter.
3.1 RE SPECIFIC ISUES
RE projects are different from other projects in the energy sector, first because of the cost
element. RE Projects are characterized by high upfront costs which cover the aspects of
development and investment, while maintaining low running costs for the project after
commissioning. It is this nature that makes RE unique especially in regard to the financing aspect
since many sponsors would not have the initial moneys to fully invest in the projects hence
seeking debt. Another reason for the high costs is that most RETs are still in the cost reduction
stage and therefore have not yet settled at low market prices; however, how soon this happens is
dependent on how fast RE is embraced at a global scale. In Uganda, most if not all RE projects
have relied on more debt than equity in their financing. The capital intensive nature of RE
projects makes them very sensitive to the conditions of capital cost financing hence the need to
carefully structure the projects to take care of any contingencies.37
RE being quite novel in most areas and not having reached its full development potential even in
the developed world means there is insufficient data for prudent project analysis. This problem is
accentuated by a lack of accurate data on the “fuel” supply side.85 Much of the fuel in RE comes
from nature which fuels could be in the form of wind, sunshine or water among others. These
sources all pose unreliability issues because of their nature aspect i.e. being uncontrollable by
man. This makes RE unique in that the fuel element is unpredictable and the arising risk should
be adequately dealt with and managed in the structuring of the project if the project is to be made
bankable.
The risk profile of RE is difficult with an elevated ratio of high risk factors or unclear risk. 86 This
is due to uncertainty in regard to certain factors such as fuel source and a lack of control of such
essential factors as fuel which in turn lead to problems in determining projected output thus
affecting cash flow projections yet many financiers would want to see a good projected cash
flow before financing a project. This aspect makes structuring RE projects even more complex
than other ordinary projects and also highlights the need for innovative financing. Uncertainty
can be dealt with by the use of proper feasibility studies and employment of adequate risk
mitigation tools. Geothermal in the African Rift Valley has benefitted from a $18 million PPP
arrangement called African Rift Valley Geothermal Development Facility (ARGeo) where
UNEP and WB through the GEF are financing the feasibility studies for geothermal power
generation in the rift valley as well as recommending appropriate technology to ensure lower
costs of production than would ordinarily be the case, with the ultimate objective of underwriting
risks of drilling in the countries of the Great Rift Valley.
Most if not all RE projects have a life span spread over a long period of time and are therefore
exposed to risk for too long. With this high risk exposure period, the risk management expenses
increase thus increasing the cost of the project. This is one of the reasons RE projects are
expensive and require a lot in terms of risk mitigation by the parties to the project.
RE finance differs for the different types of RE technologies and is even more segmented by the
type of the debtor and the size of the projects. Project finance is used for large RE projects,
85 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p 486 ibid
38
corporate finance for small on-grid RE projects, and consumer and microfinance for small off-
grid RE projects.87
Below is a table showing the general investment cost and risk element for different sizes of
different RE projects.
Table 5: The general investment cost and risk element for the different sizes of RE projects
Source: "Financing Renewable Energy-Instruments, Strategies, Practice Approaches"88
3.2 RISK IN RE
In order to successfully develop RE projects, risk has to be adequately and properly managed so
as to be able to have well structured bankable projects that are competitive on the market and
appeal to prospective risk sensitive financiers so as to easily attract finance. However, RE
87 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.688 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38 (Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.19
39
projects are very risky because of the high technological and resource risk involved, not
competitive per se because of the economics involved and entail a more complex financing and
operational structure than ordinary projects. This is all based on the premises that each and every
factor of a project has an element of uncertainty which poses a threat to the success of the project
and the risks have to be undertaken by some party either willingly or unwillingly with or without
a premium in return.89
RE projects present the following risks as common to the RE sector;
i) Fuel Supply Risk-This is the risk that the fuel (source of energy) which could be
wind, water, sunshine or feedstock for biofuels and co-generation among others, will
be unreliable consequently leading to the project’s inability to generate energy in a
manner that is predictable and dependable leading to a distortion of the cash flow and
subsequently the payback schedule. Many of these projects rely on the supply of
nature for fuel without a chance of substitution when the fuel source fails, hence its
importance in RE projects. With Uganda’s case, hydro is the main source of power
and faces large hydrological risks due to the effects of climate change. This
hydrological risk is a large concern for financiers who prefer90 that the government
undertakes such risk.
ii) Demand Risk- This is the risk that the energy produced by a project will not be
needed and as such will not be bought as anticipated or predicted by the projections.
This risk is very high in rural settings and hence poses a very big challenge for
financing RE in rural areas and developing economies. This risk is also known as
market risk and is addressed as mentioned earlier in the paper by way of issuance of
payment guarantees by the state and in the case of Uganda, interconnection of power
grids in the entire country and East African market.
iii) There also exist macroeconomic risks which risks arise as a result of changes in the
wider national economic conditions and include issues such as inflation, currency
devaluation and increased interest rates among others. In circumstances where the
89 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.2390 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.29
40
state is involved, this risk is borne by the state because of its ability and capacity to
control such risks, which makes the state the best party to handle such risk.
iv) Regulatory Risk poses problems for many RE projects and attempts to highlight the
uncertainty that the sector faces. This is the risk that the government interferes in the
regulatory process and future laws and regulations when reviewed or changed will
alter the benefits or burdens to either party. This is usually managed by way of
contract through a stabilisation clause and the risk is borne by the state, which has the
means and capacity to control and manage such risk. Since RE is of utmost
importance and high on the political agenda of all countries, it is prone to be affected
by politics hence its high political and regulatory risk profile.
v) Performance Risk is the risk that the generating plant will not operate in accordance
with the prescribed requirements in terms of time and quantity. This risk is usually
allocated to the equipment supplier who gives a performance guarantee.
vi) Political Risk is another of the more important risks faced by RE projects especially
in developing countries with weak democracies and a propensity, however low, to
convertibility, expropriation and political violence among others. By its very nature,
this risk is allocated to the government together with the project developer obtaining
political risk guarantees.
vii) Force Majeure is the risk that unforeseeable circumstances out of the control of the
parties to the project will occur and either renders the project worthless or unable to
perform to expectations. This risk is usually dealt with by way of force majeure
clause and insurance. The insurer undertakes this risk, because of its very nature and
in most circumstances, the insurer is in the best placed position to effectively manage
and mitigate the force majeure risk.
viii) Environmental Risk is the financial risk stemming from both existing environmental
regulations and the uncertainty over possible future regulations. With the ever
increasing global importance of environmental protection and preservation,
economies are bound to regularly update their environmental laws, policies and
regulations thus affecting the project’s position. Stabilisation clauses do well in this
regard and the state undertakes this risk in most cases, though usually because of the
41
importance of environmental matters and the need for conformity, the terms under
this are usually renegotiated to take into account any new changes.
3.2.1RISK MANAGMENT
Risk management is a very important element in the deployment of RE as it influences the
availability or non availability of commercial financing to the projects91 by also determining the
competitiveness and cost of RE. Risk management for RE projects and commercial investment
projects may come in the form of either one or several of the following tools viz; contracts,
insurance, credit enhancement instruments, alternative risk transfer instruments and reinsurance
among others, which can be used to reduce the costs of the project by transferring some of the
major and expensive risks away from the lenders and investors.92 Risk management is necessary
to make the financial structure of any commercial project such as RE projects viable, otherwise
they would require increased capital costs, more equity or the project would be unviable. RE risk
management is largely reliant on nature and its random character93 thus posing special RE risks.
Below is a table illustrating the typical risk allocation profile for RE Project
Table 6: Specific RE Risks
Renewable energy types Key challenges
Geothermal Drilling expenses an associated risks
Exploration risks
Critical component failures such as pumps breakdowns
Solar thermal Technological risks as project sizes increase
91 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.2392 UNEP-SEFI “Financial Risk Management for Renewable Energy Projects” at http://www.unep.fr/energy/activities/sefi/pdf/RE_Risk_Manag.pdf p.3. These are mainly characteristic of developed and well established financial markets, hence may not all be available to be effectively employed in developing countries with shallow undeveloped markets.93 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.25
42
Hydro power Flooding
Annual resource variability
Wind power High upfront costs
Critical component failures
Wind resource variability
Offshore cable laying
Biomass Resource price variability
Environmental liabilities associated with fuel handling and
storage
Biogas Resource risk
Source: UNEP – Financial risk management instruments for renewable energy projects,
Summary document 2004
Insurance is the typical risk management tool and requires a certain amount of accumulated
experience while only becoming available when technology reaches a certain maturity. However,
for the case of RE, other standard risks may not be covered by insurance, due to a lack of a
general interest, in principle, to deal with RE under the concrete circumstances.94 It is noteworthy
that insurance, though included under financial risk management tools, is actually a financial
compensation and not a protection against the damage and loss that could occur against a
project.95 There are various categories of insurance for different risk elements.
Credit risk insurance is utilised to protect manufacturers, merchants and other suppliers of
goods and services from non payment by their customers and clients who have been supplied
with credit facilities. It can also be used effectively, in RE, to allocate risks among various
parties since it allows for the transfer of risks to a professional risk taker ultimately lowering the
94 Ibid p.2695 ibid p.28
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financial risk profile of the project.96 Under this, the risks that would benefit from the insurance
are commercial which include bankruptcy, insolvency, breach of contract, refusal to pay among
others and political which include expropriation, confiscation, nationalisation, exchange rate
inconvertibility, currency transfers and export /import embargoes among others.
This credit insurance can be offered by either private entities or public entities with private
entities offering flexibility, high discretionary credit limits, economic as opposed to political
motivation, non requirement of domestic content products and low buyer underwriting
percentage.97 This private credit insurance is scarce generally but more readily available in
developing countries.98
Another category is political risk insurance99 which is utilised to take care of political risk
concerns. It comes in three classic types namely coverage offering protection against restrictions
on the transfer and convertibility of currency, damage to project assets as a result of political
violence, and expropriation of project assets. The other type offers coverage against certain
changes in the legal and regulatory regime directly negatively affecting the project in issue
through creeping expropriation or even breach of contract by a host state.
This category of insurance is mainly offered by four groups of which three are considered major.
They include MIGA, OPIC, export credit agencies and private insurers. Political risk insurance
provision by the different highlighted players in the market is dependent on several factors such
as the host country of the project, the project’s ability to comply with certain environmental and
social standards such as the equity principles among others. IN Africa ATI is also offering the
same.
The responsibility of the state in ensuring the achievement of a low political risk profile cannot
be underscored.100 One of the ways is by ensuring that long term clear and precise policies and
laws are put in place for the RE sector at large so as to create predictability and reliability. This
96 ibid. A lowered financial risk profile increases the project’s chances of being financed.97 ibid p.2998 ibid99 This can be used to give the project an investment grade rating even in situations where the issuer country’s foreign currency rating is sub or marginal investment grade. 100 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.33
44
would go a long way in curtailing the perceived and real political risk common to developing
countries.
Partial Risk Guarantees are designed to mitigate the risks of sovereign contractual obligations
or long maturity loans that private lenders are not equipped to evaluate or will not bear in
developing countries.101 They have been used with hydro projects, and much as they are an
instrument used to mitigate project risks, they can also be used to enhance credit worthiness,
provide additional leverage with government and encourage risk sharing. They are typically
provided by multilateral agencies such as MIGA and as their name suggests, effectively cover
only the parts of the financing which they are specifically designed to cover such as risks
concerned with rule of law, licences, termination amounts, regulatory frameworks, and
interference in arbitration process, expropriation and rights of way.102 Partial political risk
guarantees are used to cover creditors for specified sovereign risks that may arise from a
government’s default on contractual obligations, or the occurrence of certain force majeure
events of a political nature.103 This tool has been used in the Bujagali power project in Uganda.
A partial credit risk guarantee on the other hand covers creditors in circumstances where there is
default and it provides cover up to a certain capped amount such as 40 percent of the initial
principal, irrespective of the cause of the default.104 These are increasingly being used to manage
currency risk and raise finance through facilitating local currency financing. UECCC provides
partial risk guarantees to small hydro projects of up to 1MW under the PSP Hydro joint initiative
and are due to expand the facility to bigger projects as their capitalisation is increased.
Another type of risk management tool is the weather insurance or weather derivatives105
which are used to hedge or protect against weather related damage in weather sensitive sectors
such as RE and agriculture. This tool is increasingly being offered under a structured finance
101 UNEP-SEFI “Financial Risk Management for Renewable Energy Projects” at http://www.unep.fr/energy/activities/sefi/pdf/RE_Risk_Manag.pdf p.37102 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.30103 UNEP-SEFI “Financial Risk Management for Renewable Energy Projects” at http://www.unep.fr/energy/activities/sefi/pdf/RE_Risk_Manag.pdf p.37104 ibid p.37105 A general guide in regard to derivatives is that, the more transparent a product, the cheaper it will be to use. This is why it is important to reduce the information gap in the sector. Cheaper weather satellite systems are increasingly evolving in various parts of the world and would go a long way in creating more predictable weather profiles at a cheaper cost.
45
package or “quanto” hedges that may include currency and power derivatives.106 Much as this
tool has experienced a lot of trade in temperature related derivatives, it is also very popular in
wind projects because of the substantial record wind power has, thus making it possible to
calculate risks. This tool can help manage volume risks that cannot be managed in any other way
so as to realise projects with a raised return on equity, higher gearing and reduced cost of
capital.107 These weather derivatives and weather insurance tools are scarce in developing
countries, however the Global Weather Risk Facility (GWRF) is working towards making these
tools available to developing countries as well. Since weather is a part of most RE projects, the
cash flow streams of these projects are highly dependent on effective management of the weather
risk which risk entails variability in wind, precipitation and temperature.108 This effective
management in turn creates financial certainty which in turn makes the project more bankable.
Besides insurance, the capital and financial markets also offer other financial risk management
tools which are generally quite expensive, complex and complicated and are essentially used to
manage structural challenges posed by different projects.
Contingent Capital is used to ensure that funds committed to the risk seller are available on
demand i.e. whenever a loss event occurs. It is an appropriate tool that promotion agencies could
use to cover the risk that would otherwise have deterred a private investor from investing funds
in the RE project.
Pledge of shares for start-up capital is necessary to secure an underlying debt obligation, where
a private company may require taking over the shares of another in the event of default in the
company’s obligations. It works best as a collateral instrument especially in instances where the
company structure and company laws are quite clear amidst unclear, risky and complex land,
property rights and mortgage laws.
Exchange risk instruments come mainly in the form of a SWAP, which is an agreement
between two counterparties. The objective of the agreement is to exchange one thing with
106 UNEP-SEFI “Financial Risk Management for Renewable Energy Projects” http://www.unep.fr/energy/activities/sefi/pdf/RE_Risk_Manag.pdf p.33107 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.33108 UNEP-SEFI “Financial Risk Management for Renewable Energy Projects” at http://www.unep.fr/energy/activities/sefi/pdf/RE_Risk_Manag.pdf p.31
46
financial value for another thing with financial value as well. In instances of exchange risk, cross
currency SWAPs allow for, the exchange of principal amounts of money in different currencies
between two parties, typically the off taker and the project sponsor, the payment of interest based
on the exchanged amounts over a certain determined time frame and the re-exchange of the
principle amounts at maturity.109 This instrument is available for the more advanced financial
markets and is therefore lacking in developing countries, however it is an effective and
reasonably priced, exchange risk, management tool. The developing countries are thus left with
fixed exchange rates, exchange rate guarantees, public sector lending in local currency, escrow
accounts, liquidity facilities dedicated to risk mitigation such as standby credit facilities for
devaluation, regulatory risk mitigation, inflation index and foreign exchange index among
others.110
Securitization of credits is a financing technique that involves transferring the risk of loans to
assets into marketed assets. It is a process that involves the originator pooling a number of
roughly similar assets which are sold to an SPV which in turn issues securities which are sold in
either public or private placements with the help of a banking consortium.111
Credit enhancement through the involvement of reputable official lenders and risk managers
such as IFC, WB, MIGA and other bilateral insurers could greatly boost the credit ratings of a
project by reducing the perceived credit and political risk a stigma a number of developing
countries deal with regularly. This tool has proven quite successful in attracting a lot of FDI into
developing countries.112
All these risk management tools are put together in the PPA and IA as the foremost risk
management tool which plays a very crucial role in making the project bankable as several
financiers would want to see a long term PPA preferably with a take or pay clause before they
can approve funding. The terms of the PPA would need a skill in drafting and structuring for the
entire project, if the project were to become bankable.
109 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.35110Ibid p.37111 Ibid. The SPV is a trust or a corporation with the sole function of holding these assets. 112UNEP-SEFI, “Financial Risk Management Instruments for Renewable Energy Projects” at http://www.unep.fr/energy/activities/sefi/pdf/RE_Risk_Manag.pdf p.19
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3.3 RE IN RURAL ELECTRIFICTATION
RE and Rural Electrification, as mentioned earlier, cannot be separated as RE is a subordinated
part of the overall strategy for financing and organizing rural electrifications.113 The rural areas
in most if not all developing countries require a major boost in the form of special consideration
or what most may be referred to as affirmative action to ensure that they get electrified within
reasonable time. Uganda’s Rural Electrification Strategy and Plan 2001-2010 is the program that
seeks to achieve rural electrification in Uganda.
This strategy recognizes the role played by energy in the socio-economic development of the
country especially its role as an investment catalyst. It constitutes a framework for development
of the electrification process. The framework parameters are;
i) the broad national strategy for poverty eradication and development
ii) the national energy policy and
iii) The power strategic plan.
This strategy has its main result objective being the attainment of a rural electrification rate of
10% by the year 2010, which if translated to numbers would imply having at least 400,000 new
rural consumers being served114. A lot has been achieved in this light with the achievements
realised through the use of various strategies put in place and having the objective of overcoming
the major barriers to rural electrification.
The major barriers to rural electrification generally are:
i) The transmission grid is usually too far off from the rural areas.
ii) Several developing economies lack proper and workable incentives to encourage
private investment in rural electrification
iii) The high cost of RE technologies is a major deterrent yet still
113Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38 (Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.7114REA Overview, at http://www.rea.or.ug/?p=site&s=2&pg=2 It also has a vision to have all areas in the country have access to electricity by the year 2035. It is estimated that, of this 10% increase in coverage, 15% of the serviced households increase will come from higher connections to the existing grids outside of the urban triangle, 25% from isolated grids, 20% from photovoltaic solar systems and 40% from extension of the interconnected grid.
48
iv) There also exists a dearth in financing for rural electrification because of its complex
nature and
v) Most of the rural areas would require decentralised energy systems in the form of
isolated/independent grids which are too expensive to set up and maintain especially
in light of
vi) The low ability of most rural economies to sustain a power system without any form
of subsidy.115
These are the major but do not represent an exhaustive list of challenges to RE development
especially in rural settings. Rural settings present a myriad of challenges, and these include the
low population density of low income earners which directly translates into low consumption
levels, the difficult terrain in rural areas among others which all make it more costly and difficult
to implement rural electrification schemes since long distances for connection and transmission
lead to greater electricity losses, and more expensive equipment maintenance and customer
support which factors all call for the requirement of subsidies in order to make them financially
viable.116
This part of the discussion is more concerned with the financing aspect of RE in rural
electrification and will thus concentrate on the same.
It is notable that there exists a very big financing challenge for RE in rural electrification, yet the
promotion of RE is a very important aspect of most if not all rural electrification strategies, more
especially in Uganda where there exists an abundance of RE resources. RE in rural areas would
mainly fall under the off-grid category which also comprises stand alone generation which are in
most cases isolated. This isolation coupled with the other challenges such as the lack of a viable
sustainable market among others, makes rural electrification commercially unviable hence
unattractive to the private sector. This situation leaves the government and donors with the task
of ensuring the implementation of rural electrification programs, which creates different
financing dynamics since public moneys are involved.117
115 This is the major reason why private finance is almost impossible to obtain in circumstances where there are no subsidies116 Ray Tomkins, “Extending Rural Electrification-A survey of innovative schemes” at rru.worldbank.org/Documents/OBAbook/10ch5.pdf p.2117 Public moneys have a totally different financing dimension from private moneys because of the difference in the way public and private sector approach investment. Public moneys would usually want to satisfy socio-economic and political objectives whereas private moneys often times look for a good ROI
49
Developing countries such as Uganda are still working hard to achieve rural electrification under
their national electrification drives, while some other developed countries are comfortably
electrified.
RE development in rural areas poses a different set of challenges from RE development in
“urban” areas and hence financing challenges are also different. The difference in dynamics is
recognised by S.63 of The Electricity Act118, which spells out the government’s rural
electrification strategy, which in summary is aimed at the government supporting the provision
of rural electrification programs which programs attract both public and private sector
participation with the objective of achieving equitable regional electricity distribution and access,
grid expansion and off-grid solutions promotion, stimulation of innovation within suppliers and
the maximization of social, economic and environmental benefits of the rural electrification
subsidies.119
In financing RE for main-grid and rural electrification applications, reducing and minimizing the
upfront costs of project finance while still ensuring the financial sustainability of the RE
generators during operation respectively, are the key financing challenges.120
Since the sizes of RE technologies in rural electrification are smaller than in ordinary bulk power
markets, the unit cost per MW of power, in project development and implementation is higher in
Rural Electrification settings.121 Rural electrification power markets are commercially unviable
and often times non commercial, and for this reason, subsidies as a cost recovery system, play a
big role in ensuring that social equity is promoted. However, in the bulk power sector, subsidies
are unacceptable as they distort the markets with regulatory failure likely to arise in financially
weak sectors. The role of subsidies in financing RE in rural electrification is considered in light
of how much in electrification access can be created by the available subsidy amount, more than,
whether the subsidy is effective.122 This is because of the need to create a sustainable financing
118Electricity Act, 1999, Cap 145, Laws of Uganda119 MOEMD, “The government of Uganda, Rural electrification strategy and plan covering the period 2001 to 2010” at www. energy instug.org/...com.../file,Others%7C Rural +E+ Plan .pdf/ p.10120 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.20121 ibid122 supra
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model that will address the concerns of the financiers first and foremost while also addressing
the needs of the project sponsors in the short and long run. However, on the side of the
government and international development partners, there is a temptation to have the
effectiveness of the subsidy as the first and foremost concern because of the social impact
function and responsibility that they often champion. Subsidies for rural electrification in
Uganda come from donor support and a portion of the bulk power transmission levy under
UETCL. The West Nile Rural Electrification Company (WENRECO) power project123 received
subsidies worth $8.2m which subsidies were provided under the Energy for Rural Electrification
Project. However, these subsidies were made available only for the benefit of the HFO plant in
the form of fuel.
With three categories of projects under the rural electrification strategy i.e. grid extension, mini
grids and PV, it is easy to see how RE fits into all these categories, however, in light of the set up
of rural areas, there is no best solution, rather, each community or area will have a solution that
works well for it with each project category presenting its own challenges and resulting
solutions.
Under grid extension projects, the transmission grid is extended to cover new rural areas that
were erstwhile unconnected and presents the least cost solution, however only as far as the
volume and value of demand would justify the cost of the new transmission lines. The economics
and financials of most rural areas in Uganda do not justify extension of the transmission system
to these areas, however the national social and economic cost that the country would have to bear
as a result of the non electrification of some of these areas, is reason enough to justify the
extension of transmission grid lines to these economically unviable rural areas. This is why the
government would most times accept to bear the cost of transmission by creating policy which
allows for cross subsidies on the transmission levy between the non-grid connected rural areas
and the grid connected bulk transmission viable market areas such as the urban areas, among
others. With these cross subsidies, and the connection to the national transmission grid, a new
market is created which makes power projects including grid connected RE power projects in
rural areas even more bankable. For areas where demand is very dismal and the distance (also
123 The WENRECO off grid power project is complex as it involves the provision of HFO Power in the interim pending the completion of the hydro power plant.
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read cost) to connect to the grid is very high, a mini-grid project offers a very good cost effective
solution especially for relatively concentrated areas such as towns, industrial estates, large
facilities, etc.
Bank of Uganda, the Uganda Central Bank manages the Energy for Rural Transformation
Refinance Fund (ERTRF), which forms the basis of the loan component for the Energy for Rural
Transformation (ERT) program, through commercial banks. It has been working on developing a
financial intermediation for long term loan facilities for rural electrification124 to attempt to solve
the problem of lack of long term finance for the sector. This initiative has come in the form of
the UECCC Ltd which is expected to solve this financing problem that has hindered RE
development in the country for a very long time.
3.4 GENERAL FINANCING OPTIONS
There exist several financing options for RE, with both the public sector and the commercial
private sector also offering a wide variety of instruments for financing and risk coverage which
could be used for RET finance.125 In financing RE projects, it is imperative that the parties to the
project fully appreciate that the costs, of producing electric power, while utilizing RETs, are very
sensitive to financing terms hence the need to structure the financing package adequately. 126 The
RE sector especially in developing countries has project promoters and investors with limited
experience and track records in development of RE projects,127yet again, despite the different
sizes of investment, the costs are generally higher and are all characterized by high upfront costs,
yet the project promoters have very limited capital funds, be it credit or equity, hence opting to
access high amounts of external financing from advanced and developed financial markets at
favourable interest and maturity rates with the project cash flows acting as collateral for the loan.
This painted picture is characteristic of project finance which is the most popular financing
model for power projects and RE is no exception.128
124 MOEMD, ERT Fact sheet p.1125 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p. 13126 ibid127 Limited track record due to a general lack of successful RE projects save for the hydro aspect in countries such as Uganda128 It also sets a benchmark of checking how much the local financial system can accommodate financing of such projects with available funds and instruments. A lack of adequate financial instruments is the major undoing of the financial systems in most developing countries.
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There are several financing routes for the developer’s consideration and majorly include;
i. Use of personal financial reserves which could also include support from friends and
business associates. For big projects, this route can only be used to meet the required
minimum equity threshold for the financial structure of the project, however for small
projects; this route can be used to finance the entire project. In Uganda, it is unlikely that this
route can be effectively harnessed mainly because of the low levels of capitalisation amongst
the population and the long term period of investment before they can start earning, amidst
several different short term return investment opportunities.
ii. The use of bank loans that are secured against the developer’s assets, which falls under
the category of corporate finance. This option would thus require a developer with adequate
collateral and good financial reputation with their bankers. It however increases exposure of
the developer’s core business to the risks associated with and emanating from the project. In
Uganda, this has been used for projects such as co-generation in Kakira and Kinyara sugar
works mainly because the co-generation is an extension of the core business of sugar
production, however, if it’s to start from scratch as an independent project, it becomes very
expensive to rely on corporate finance to develop power plants.
iii. Co-development of the project with joint venture partners who are financially strong and
more readily able to raise finance is another option and popular especially in instances where
the initial developer wants to build a good reputation profile for the project. These joint
venture partners would often times be those who have experience in the project and have the
ability to raise finance from several sources as and whenever required. These joint venture
relationships result into a joint venture which often times is a separate special purpose
vehicle. This has been used in the recent development of the 250mw Bujagali Dam by
Bujagali Energy Limited which is a joint venture between IPS129 and Sithe Global Power
LLC.130 This consortium of developers together with the Government of Uganda has
provided equity to the tune of US $ 180M which is just a fraction of the entire project cost.
129 IPS is the Infrastructure division of the Aga Khan Fund for Economic Development130 This is an affiliate of the Blackstone Group which is a private equity firm with the ability to easily raise large finance on request.
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iv. Use of bank loans secured against the project assets and future cash flows also known as
limited recourse project financing which is the most popular route for power projects is
another option. Under this, some guarantees may be necessary especially from the state
among others. This has been used in majority of power development projects in Uganda
because of its appropriateness to power project development.
v. Leasing is also a very good option that would work well for RE however it is not
common in developing countries for lack of long term lease facilities. Under it, the lessee
uses assets financed and owned by the lessor for a consideration in the form of regular
payments to the lessor. This has not been used much in power project development because
of the lack of a mature leasing market in the country. However, Development Finance
Company of Uganda (DFCU) and the Shell Foundation have capitalised the Uganda Energy
Fund for this purpose.
The above together with some major finance categories (sources of project capital) which present
a major component of the financing structure are discussed in detail below.
3.4.1 Debt
Debt financing usually takes the biggest part of the financing profile for project financing of
power projects, with no exception to RE projects. Debt is generally lower risk than equity and
the most highly structured component of the financing. They are generally structured such that
the lender will get first priority on the returns of the investment or even at disposition, leaving
the equity investors to be taken care of after. The challenge in power, leave alone RE, is
packaging the debt in such a way that provides adequate assurance that the loan will be paid back
in a timely manner which is the lenders risk management assurance hence ensuring that the risk
is brought within levels acceptable to the lender.131 Debt financing is characterized by fixed
interest rates and strict repayment schedules which two issues are presented in various ways
dependant on the source of finance.132 Project debt is usually supplied by institutional investors
who are usually, either one bank, or a syndicate of banks. Just like is typical of PF, they lend
131 Edward. D. Einowski et al, Chapter Five, The Law of Lava, Penciling out: Project Finance for Geothermal Power Projects, (Stoel Rives LLP, 2009) P.1132 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.16
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against the cash flow of the project.133 Instead of relying on only bank loans, the project could
also raise some debt financing from the issue of bonds on the bond market. Usually it is
institutional investors who would take up most if not all of the bond on sale. These definitely
require mature financial markets, which factor poses a great hindrance to many of the capital and
finance markets of developing countries. These developing countries have capital and financial
markets that are not liquid enough hence they cannot be fully relied on as a reliable source of
project debt. In Uganda, the bond markets are short term in nature and usually do not exceed five
years, which period is way too short for power projects. In any case, most of the players on the
bond market are institutional investors who are conservative and traditional in their approach
towards investment in projects with only very reputable and proven institutions bond requests
being oversubscribed. With the liberalisation of the pension fund sector in Uganda and
establishment of the East African Common Market, the capital and bond markets are expected to
receive extra capitalisation which will greatly contribute to solving the problem of lack of
capitalised and developed financial and capital markets.
The term of the loans are dependent on government guarantees, certainty of project cash flows
and the rate at which the banks borrow money.134
Project debt falls under the following categories;
Project level debt which is also known as senior secured debt is debt that is secured by a lien on
the project. The project forms the collateral and is the most senior element in the capital
structure.135 This category of debt has been used in the structuring of several projects in Uganda
with the biggest being the Bujagali Power Project with project level debt worth $136m by IFC,
EIB, AfDB, German DEG/KFW and the Netherlands Development Finance Company among
others. In several other power plants, multilateral development institutions provide this project
level debt such as was the case with Buseruka Power plant in Western Uganda promoted by
Hydromax which received $6m as project level debt from the Preferential Trade Area (PTA)
Bank, $9m from AfDB. In another project, Bugoye power project, the Emerging Africa 133 US PREF, “Renewable Energy Finance Fundamentals” at www.uspref.org/.../USPREF_ Renewable %20 Energy %20 Finance %20 Fundamentals %20v2.1.pdf p3134 ibid135 DTI, DTI New & Renewable Energy Program, “Financing Renewable Energy projects: A guide for developers” at www.berr.gov.uk/files/file15118.pdf p.5 Such debt can also be secured by way of levered lease
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Infrastructure Fund Ltd (EAIF) provided purely loan financing of senior debt worth $14m for the
13mw $35m project in Kasese, Western Uganda that was commissioned in 2009.136 The EAIF
also provided senior debt of $14m to the 18mw Mpanga power project being developed by the
US based renewable firm Asia Energy Management Systems (SAEMS), while in the 6.5mw
Ishasha power plant, the IFC provided $4m of project level debt.
Another category is Holding company debt, which is incurred by the borrowing project
sponsors, however, the cash they expect to get from the projects they own, is what is used as
collateral for the borrowing. Such debt is attractive especially to large sponsors and utilities who
can borrow at the corporate level at low interest rates, a factor which also favours such
institutional investors even in Uganda where they can benefit from low interest rates when they
borrow at the corporate level. Hydromax in the Buseruka power project obtained some form of
holding company debt to contribute to the $8m equity contribution to the project.
Construction debt is another category which is arranged by sponsors through a bank loan to
fund the construction of the project since construction risk is unpopular among investors such as
term lenders and project equity investors who would usually be more willing to spend once the
project is up and generating income. Investors under this arrangement are also prone to
mezzanine financing after the construction phase has been dealt with.
Loan guarantees are also an important category of debt that is not so common especially in RE
projects. These can either be used for project level and holding company level debt categories.
Under this, the responsible government department guarantees a loan up to a certain high
percentage which percentage is usually more than 50% of the project cost.137 Under this category,
for unattractive project profiles such as those of new unproven technology, government may
provide the loan directly however, for those with profiles that do not have a problem with private
financiers; the government offers the said guarantee. Such a system could work as well in
developing countries, since the concept involves government substituting the creditworthiness of
the sponsor for its own creditworthiness. It could work well with governments that are
creditworthy. Uganda has an energy fund whose funds are to be used to support investment in
136 http://allafrica.com/stories/200811102627.html 137 In the US, the Department of Energy is the guarantor and offers loan guarantees of up to 80% of the project debt in circumstances where the banks are willing to lend to the project with its risk profile. Here the lender bears the 20% unguaranteed risk. However where the risk profile is unattractive especially due to technological risk issues, the government will not guarantee but actually issue loans to the prospective investors.
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the energy sector. The fund is currently undercapitalised and hence cannot fully support
investment in the sector. Further capitalization of the fund would serve various categories such
as RE, conventional fossil fuel, etc for purposes of direct investment, offering guarantees and
loans in the respective categories among others and will also serve in ensuring promotion of
energy projects. The fund will be used to meet start up costs and to expedite implementation of
energy projects138 especially the stages that may not readily attract investment capital. This
capitalization of the Energy Fund could also come from donor support, internal collections, tariff
subsidies, as well as annual budgetary contributions as has been the case save for in the
2010/2011 national budget where the Energy Fund contributions were conspicuously absent.
Mezzanine Finance is a mixed debt category, with capital attributes, that falls in the
subordinated level i.e. below the main debt in terms of priority of payment or in liquidation with
its principle and interest paid only after sorting out the interest and principle of the senior debt. It
is a higher risk loan as compared to other ordinary loans hence the returns are expected to be
high, a factor which explains the compensation these loans receive through participation in the
project profit and loss sharing. This high risk element presents problems in areas where the risk
profile139 is very high such as in developing countries and rural areas in particular hence deterring
such potential private investors who are usually on the lookout for high risk in favourably less
risk profile areas, and as if to add salt to injury, RETs are not on their own favourable attractors
of credit because of their novelty and unproven record in technology, which factors raise
pertinent issues in regard to high technological risks. Mezzanine debt has been noted to be
employed in circumstances where the prospective financier does not want to bear the initial
project risks such as construction and development risk and would thus come in after the
development or construction phase has been successfully implemented. This arrangement has
been noted in the Bugoye power project where one prospective financier agreed to put in
mezzanine finance only after the construction phase has been successful.140
3.4.2 Equity
138 “Uganda National Development Plan 2010/11-2014/15” p.55139 Especially credit risk140 This was for purposes of avoiding to deal with the construction risk.
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Available equity for RE projects from the project promoters is usually minimal and comes in the
form of direct investment of either personal finance resources, or as third party capital inputs by
venture capitalists or other interested investors and this is mainly due to the requirement by
prospective debt financiers to have a certain minimum amount of equity already availed to
projects they have to lend to.141 This is a form of risk management, which also demonstrates a
commitment by the project promoter to the project. With a minimum equity ratio of 20%142, the
project developers have a big challenge in raising the said equity amounts to contribute to the
whole financing package on their own, hence the need to attract additional equity investors who
will share in the benefits that accrue characteristic to equity investors.143 In Uganda, generally
equity ranges from 20%-30% as can be observed in the various power projects such as
WENRECO where equity was $3m, Bugoye $8m and in Bujagali $180m.
In the RE sector and particularly in developing countries, the ROI for RE projects is lower than
the 50%-60% target threshold usually preferred by venture capitalists which factor explains a
lack of enthusiasm by private venture capital to invest in RE projects. This low ROI is also
complemented by long payback periods with limited public exit routes, posing a real deterrent to
private capital investment in equity for RE projects.144 In areas where the growth of the sector is
promising and steady, alternative fund managers usually offer a lifeline in the form of finance to
projects which meet a minimum 20% IRR, with a minimum investment of 5-10 million pounds
and ability to fully recover input and profits within a maximum 10-15 year period. 145
Characteristically this paints a typical RE project return profile that would attract a seasoned
alternative equity investor. Therefore, if the developing countries such as Uganda are to attract
the required private investment into projects, such a profile has to be achieved as a minimum.
The advantage is that bilateral and multilateral financing institutions can still afford to lend
141 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) pg 14142 This is the usual industry standard, however each project presents its own financing challenges hence the ratio can change form project to project143 Such benefits include the potential for high unbounded returns from the project which is on the other hand accompanied by high risk. This explains why venture capital firm involvement may always require a high equity stake so as to maintain a high degree of control over their investments. It is however considered very expensive because it dilutes the equity for the project promoters.144 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p. 15145 ibid
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amidst such a profile, thus explaining the large number of bilateral and multilateral financing
institutions in power project financing in Uganda. Such institutions include NORFUND, WB,
IFC, AfDB and PTA Bank among others.
There also exist structured equity investors, who are usually institutional investors who want to
efficiently use the tax benefits from their investments.146 Such investors usually have a high
appetite for project risk, a levered balance sheet so that they can always offer competitive pricing
for the product and most of all, a predictable tax liability.147 These benefits may be in the form of
tax credits and accelerated depreciation among others, which the project developers may not
utilize in the short run before the project starts making profits, and yet deferring these benefits to
a future date may prove unworthy for the project developers, and for this reason such tax equity
investors come in handy. These tax equity investors could be utilities or other taxpaying entities
such as financial institutions, banks and insurance companies who are usually passive in the
investment, and are more interested in a return and the tax benefits they can obtain from their
capital investment in the project. Their levered balance sheets which put them in a better position
to offer competitive pricing can also encourage low cost power from such projects, which makes
them an invaluable player in the industry that should be encouraged by the government
incentives through law and policy. In Uganda, this type of investors have not been seen in the
financing of power projects mainly due to a lack of the type of tax incentives that would promote
such structured investment.
Project equity investments are highly customized and are best made through structures such as
partnerships and leases which provide a mechanism to efficiently transfer tax benefits to the
equity investor especially where the tax laws of a state provide for the same. Such benefits
include accelerated depreciation and tax credits which could be utilized at any time depending on
the tax regulations of the economy and the structure of the investment vehicle. Under
partnerships, the sponsor and equity investor form a partnership as the investment vehicle with
each partner contributing a portion of the project capital expecting to benefit and be liable in the
same proportions.
146 DTI, DTI New & Renewable Energy Program, “Financing Renewable Energy projects: A guide for developers” at www.berr.gov.uk/files/file15118.pdf p.3147 Ibid. The levered balance sheet arises from the investor having different sources of business income from various projects they might posses and as such can move money freely through the company operations.
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The other project structure that is used is the lease which is an instrument through which
sponsors can sell the project to a financial institution and lease the same back so as to transfer
their tax benefits148 to the leasing financial institution.
In order to encourage such investors to invest in equity for projects such as RE ones, it is
important that the government tax law or sector specific law, specifically provides for the tax
incentives to be obtained from such investments as opposed to the current general incentives as
provided for in the Income Tax Act149 and The Investment Code Act150 among others which
apply to all projects generally. This ambiguous generalization of tax credits and benefits does not
serve to promote investment interest in the sector as it does not provide any specific incentives
for those interested in such investment. However, special provisions were given for specific
power project categories151 by URA, which is a good step in the right direction and once fully
publicized and extended to other power categories, will lead to an increase in investment in the
sector or better still an appreciation of the incentives.
3.4.3 SALES AND LEASE BACK
Project financing has developed very interesting and innovative instruments to assist in the
financing and development of projects while managing risk. In developing countries, this
financing option could work well as the financing institution will maintain ownership of the
financed asset which potentially eliminates the need for other collateral, subsequently solving the
problem of credit risk to the extent that ownership of the financed asset remains in the financier.
Another reason is that, in developing countries which have financial systems that do not allow
for provision of long term loan facilities by local commercial banks152, leasing presents an
opportunity for these financial institutions to get into financing RE projects from the initial
project development phase.153 The Uganda Energy Fund entered in to an arrangement with
148 The Tax benefits include tax credits and depreciation benefits149 Cap 340, Laws of Uganda150 Cap 92, Laws of Uganda151 Under the URA Domestic Taxes Practice Notes issued on 05/02/2010, supplies in the form of goods and services, to hydro power projects among others, are exempt from VAT152 This implies that with their short term financing, these commercial banks cannot get into financing of RE projects and other long term projects at the initial project development phase.153 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.17
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DFCU to offer lease facilities for energy related projects. This is at least a step towards
promotion of leasing as a tool to finance expensive RETs. The power sector in Uganda is yet to
realise a lease developed project under this arrangement.
CHAPTER 4: PFIS AND PPPS IN RE
This chapter will introduce the concepts of Private Finance Initiatives and PPPs while
highlighting their roles in power sector development. Here, the nature of the two tools 154will be
analyzed with emphasis on their possible role in encouraging general power sector development
and the role the government can play in ensuring that the same tools are effectively used to
154 They will be looked at together with he risk element
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encourage sector development while emphasizing the role in RE. Each of the categories will be
briefly looked at highlighting the major issues associated with them with an elaborate discussion
on biofuels because of their increasing influence.
4.1 FINANCING STRUCTURES
There exist two different structures for financing RE projects namely Corporate Finance and
Project finance with the former constituting financing of a project and the latter constituting
financing for a project respectively.155
There are several factors which affect the financing decision, first from the point of whether
outside financing should be sought and if so, what form or mode of financing it should be, most
of all on whether limited recourse financing should be used or not.
The following questions should be addressed in order to eventually determine whether to opt for
limited recourse financing or on balance sheet financing which option would have subsequent
ramifications on how the entire project will be developed;
i) Whether the project sponsors have all the necessary financing for the project from
their own resources and if so, whether they are ready to employ the same in financing
the entire project
ii) Whether the magnitude or size of the project is right for purposes of attracting PF
lenders. This is important because there are several lenders who may not be ready and
willing to finance a project where the debt component is less than a certain minimum
threshold, save for special circumstances.
iii) Whether the project has several developers with different financing capabilities and
objectives, involved in the project
iv) Whether the size of the potential financial obligation would substantially damage the
financial health of the borrower, should the project go bust or fail
v) Whether the project is in a non-core business segment for the developer and offering
limited exposure to the company for the benefit of financial markets and
shareholders.
155 Ibid p.18
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vi) Whether there exist any specific project risks that the developer is not comfortable
with and would want to see them off loaded onto other third parties in a structured
manner.156
4.1.1 ON BALANCE SHEET FINANCING
This involves the provision of funds to an economic subject based on the balance sheet and
financial performance of the borrower and is more likely to be used by sponsors who are
financially strong. This is often referred to as recourse lending. This form of financing
presents the debtor as liable to the lender in their personal capacities as borrowers. Such
financing falls under the category of corporate finance, and is, cheap as far as the
arrangement costs, legal and annual fees are concerned, easy and quick to arrange and also
presents a flexible financing structure with a less tight network of contracts for risk transfer
and management which also leaves the sponsors in a position where they generally accept
majority of the project risk.157 The moneys involved under this category of financing are
usually small, hence attempts to use it with large projects that require large sums of money
renders it unviable since most of the players in the financing of large projects including RE
ones, would rather work with a more tailored financing structure.158 This kind is more suited
for financing small RE projects such as small scale PV, stand-alone systems and also projects
for first time developers among others. Small projects would usually only attract on balance
sheet financing and where there is no balance sheet to rely on, equity capital from the
sponsors and other sources such as family, friends, business associates, etc will be sought.
However, it is worth noting that the cost of capital for private equity is expensive and not tax
efficient.159 Another way for small projects that would not attract on balance sheet financing
due to a lack of balance sheet to rely on would be to enter into a co-development
arrangement with a financially strong partner.160 In Uganda, Kinyara and Kakira Sugar have
used substantial on balance sheet financing for co-generation development. Most commercial
156 DTI, DTI New & Renewable Energy Program, “Financing Renewable Energy projects: A guide for developers” at www.berr.gov.uk/files/file15118.pdf p.3157 Ibid p.6158 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p. 18159 DTI, DTI New & Renewable Energy Program, “Financing Renewable Energy projects: A guide for developers” at www.berr.gov.uk/files/file15118.pdf p.6160 Ibid
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banks in the country have the skill and expertise to deal with this form of financing as it is
the commonest.
4.1.2 OFF BALANCE SHEET FINANCING
On the other hand, off balance sheet or limited/non-recourse financing presents a more desirable
financing option for large projects. This form of financing allows for participation by many
participants and financing entities giving funds to a project and mainly relying on the project
cash flows to pay back the loan, and not the creditworthiness of the borrower as is the case with
corporate finance. It entails the lender being able to control the project cash and even under
certain adverse situations, such as when the project is either in default or not paying according to
schedule, step in and operate the project. This is the lender’s collateral and is known as taking
security over the projects assets and contracts.161 This financing structure allows for creation of
new entities usually referred to as SPVs which imply that the new created entity is separate from
its founders who have either no or limited recourse liability in regard to the SPV as far as the
lender is concerned. It comes with many advantages for developing countries especially as it
allows for structuring of the entire entity to provide room for creating an adequate management
structure, non standardized lending conditions that are tailored to a specific project. 162 This is
used for several large scale projects and in RE, resource risk issues are raised and are addressed
by incorporating additional mechanisms such as contingent repayment schemes and or reserve
accounts.163 For the equity investor, project financing presents an opportunity to maximize
equity returns, monetization of tax financing opportunities, and movement of significant
liabilities off balance sheet and protection of key assets.164
The parties usually involved in limited/non-recourse financed RET projects are several and are
linked together by a network of tight contracts. The principle parties are the shareholders and 161 DTI, DTI New & Renewable Energy Program, “Financing Renewable Energy projects: A guide for developers” at www.berr.gov.uk/files/file15118.pdf p.8 Taking security or collateral can involve assignment of priority rights to the project cash flow, bonding, contractual undertakings, insurance, mortgage or fixed and floating charges over the physical assets for the project which assets are not considered the major source of security but the project cash flow and last but not least, assignment of the project contracts.162 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) pg 18163 ibid pg 19
164 Chris Groobey et al, “Project Finance Primer for Renewable Energy Projects” at
www. bakermckenzie .com/.../na_projectfinanceprimer_article_jun08.pdf p. 1 This is why it is called structured finance
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lenders on one side and then the contracting parties namely fuel suppliers where necessary,
equipment suppliers, construction contractors and subcontractors, power purchasers, project
operators and network operators on the other side. Here below is a table showing a typical
project finance structure with the network of contracts between the parties.
Table 7: Typical project finance structure for RE project
“PROJECT COMPANY AKA “THE BORROWER”
Source: US PREF, Renewable Energy Finance Fundamentals165
For RE projects, the principle skill in structuring successful limited recourse project financing is
in transferring or allocating specific risk to external parties who are best able to mitigate, absorb
or manage the said risk in the most efficient manner. This is done while leaving the residual risk
which is usually modest, with the developer of the project.166
Risk in the circumstances is categorized into pre and post completion risk, which are dealt with
differently. These different risk categories are briefly explained below.
165 www.uspref.org/.../USPREF_ Renewable %20 Energy %20 Finance %20 Fundamentals %20v2.1.pdf 166 DTI, DTI New & Renewable Energy Program, “Financing Renewable Energy projects: A guide for developers” at www.berr.gov.uk/files/file15118.pdf p.11
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One of the pre-completion risks involved for RE projects is the Technology risk which is the
risk that the technology used will not perform to expectations. This risk in RET projects is
usually transferred to the contractor or equipment supplier who is considered to be in the best
position to efficiently manage the risk. This risk transfer is usually done contractually by having
the contractor or equipment supplier undertake liability to pay monetary damages in the event
that there is a technology performance shortfall. New technology is usually considered very high
risk for the reason that it hasn’t been consistently tested and for this reason, it is not popular with
lenders. This technology risk is managed by way of obtaining technology performance
guarantees from the technology and equipment supplier. This risk is not specific to developing
countries and is considered a general risk.
There is also the risk that there will be a delay in completion of the project and this is termed as
completion risk. This risk is usually allocated to two parties namely the contractor and the
insurer. The contractor by way of contract undertakes to be liable to pay monetary damages for
delay in completion of the project. This is coupled with insurance coverage where the insurer, for
an insurance policy or premium paid, undertakes to cover certain delay risks such as those due to
force majeure among others. This completion risk is considered high in Uganda due to a lack of
skilled contractors to develop power plants167 hence the use of foreign contractors who are more
familiar with the process of power plant development. Lenders in addition to use of qualified
contractors would require forms of completion guarantees to mitigate this risk.168
The other common pre-completion risk for RE projects is the capital cost overrun risk which is
the risk that the estimated budgeted costs will be insufficient to complete the project and would
thus require extra capital to enable the project reach completion and operation stage. This is
important since the security for the lenders is the project cash flow thus they would not let the
project die before it pays off the debt. The lenders place significant reliance on the contract to
ensure the project is finished on time and when finished will perform to expectations.169 The
fixed price turnkey contract is the risk allocation mechanism used to manage this risk. The
167 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.29168 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.7169 DTI, DTI New & Renewable Energy Program, “Financing Renewable Energy projects: A guide for developers” at www.berr.gov.uk/files/file15118.pdf p.9
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contractor who should be creditworthy, enters into a fixed price turnkey contract with the
developer, and undertakes to accept much of the capital cost overrun risk while also providing
completion cost guarantees in relation to either new technologies (equipment suppliers) or
contractors who are small or less known.170 The main contractor singly guarantees the
performance of other contractors and equipment suppliers so as to reduce the complexity of
having to specifically delineate the performance of each of the other parties yet that could be
done by the main contractor in the subcontracts. The Bujagali power project and the WENRECO
power project have faced capital cost overruns in their development with the cost of Bujagali
increasing from the expected $550m at the beginning of the project to over $700m.171
After completion of the project, there also exist what are termed post completion risks, the
commonest in RE projects are explained below.
Operating risk is the risk that the operator will not be able to efficiently operate the plant to the
required expectations so the employment of an experienced O&M operator is often required by
the lenders in addition to operation guarantees from the O&M operator.172
The political risk is also common and fits into the category of pre and post completion. This is
mainly in relation to the investment atmosphere and the non expropriation of project assets
including the project cash flow. This is usually mitigated by obtaining political risk guarantees
such as MIGA from WB and Africa Trade Insurance Agency173 among others. This political risk
deals with regulatory risk issues particularly political tariff setting which is perceived as high in
Uganda174, among others.
There is default risk by the off taker UECTCL, which is considered a bit high in Uganda and this
risk should be managed by the government providing a back to back payment guarantee for
payments175 due from the single off taker, UETCL.
170 Ibid p.11 This contract contains completion tests and liquidated damages payable in the event that the tests are not met as scheduled.171 The cost for Bujagali keeps on increasing and it is feared it will hit the $1bn mark, making it the most expensive hydro power project in the world.172 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.7173 Ibid p.49174 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.28175 ERA, “Constraints to Investment in Uganda’s Electricity Generation Industry” http://www.era.or.ug/Pdf/Report-Investments-Constraints_final_23-10-2008.pdf p.33
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The market risk is also high; as the available market is perceived not to be able to effectively
take the produced power either due to incapacity in terms of ability to pay or in terms of a lack of
a general market. This issue is expected to be mitigated by the interconnection to the general
East African market.
4.2 PPPs
PPPs are a long term performance based approach used to procure public infrastructure and
involve a lot of private sector financing and risk sharing.176 The concept of PPPs is based on joint
initiatives developed, executed and managed by a public sector agency and a private sector
entity, both players having common goals and individual objectives.177 The public and private
sectors join forces to design, finance, build, manage and maintain infrastructure projects. PPPs
are characterized by shared goals, shared or complementary resources such as financial capital,
human resource, political influence, time, knowledge and expertise, and finally shared risks and
benefits.178 Every project might have a different PPP approach to it with the transactional
relationship and risk allocation being different for each. Since the integrated private player
assumes the financial and commercial risks under a long term contract thus also mitigating
public risk, these PPPs are best suited for large complex projects with managed maintenance and
construction schedules. The key benefit of these partnerships is shared economies of scale for
both parties, and for the partnership scheme to be successful, three important basic elements have
to be fulfilled;
i) The governments benefit of fulfilling a development imperative, political goal or even
social need should be considered seriously.
ii) The private sector benefit of generating a profitable revenue stream and or expanding
market access should be taken into account.
iii) Lastly, the consumer benefit which comes in the form of quality service delivery at
affordable less than unsubsidized market price in a normal business set up179 should
also be considered.
176 PPP Canada, 2008-2009 Annual Report, at http://www.p3canada.ca/_files/file/PPP-Annual-Report_EN.pdf p.6177
Md. Monwar Hasan Khan, “The role of public private partnership in renewable energy sector” at http://www.iim.uni-flensburg.de/sesam/upload/Asiana_Alumni/Manohar_PPP.pdf p.12178 Ibid p.13179 Ibid p.14
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They come in several forms, the commonest of which include service contracts, delegated
management contracts and construction support among others.180
Service contracts are used where the public sector wants to maintain the overall operational
responsibility for a project and thus gives the private player a contract to provide a bundle of
specific services which services include human and technical resources for all operational and
financial aspects of project management, and maintenance of the project facilities through an
O&M contract which could allow the private player to take over and operate the facilities. 181 In
Uganda’s power sector, these service contracts have been used in majority of the power projects
with ESKOM and UMEME concessions being typical of the same.
The delegated management contract is used where the public sector wishes to maintain the
overall ownership of the assets but does not want to get involved in the management of the same.
The public authority thus delegates the management function to a private player for a definite
long term period while maintaining an oversight supervisory role. This can be done either,
through an affermage of lease agreement, which gives the private player who is referred to as the
operator, the responsibility to maintain and renew the existing facilities in line with the
contractual terms, or though a concession. ESKOM management concession in Jinja at the
UEDCL power plants of Kiira and Nalubale is a typical example of a management contract in
Uganda. It is also important to note that this management contract has so far been successful.
Under the concession model, the public authority will maintain strict control over the service
terms while also maintaining the power to make all key decisions in regard to the applicable rates
and targets for the project, with the private player being given a long term right and
responsibility to manage the project and make all necessary investments.182 The concession
model is quite popular in the energy industry because of the long term given to the private
players to enable them get returns on their investment before handover of the project facilities.
This model can be made to work in certain RE categories. The concessions awarded to ESKOM
180 Stephen Thomsen, “Encouraging Public-Private Partnerships in the Utilities Sector: The Role for Development Assistance”, NEPAD/OECD Investment Initiative, Imperial Resort Beach Hotel, Kama Hal, Entebbe, Uganda, 25-27 May 2005 at www.oecd.org/dataoecd/29/45/34843203.pdf p.4181 ibid182 Ibid p.5
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by UEGCL and UMEME by UEDCL are typical concession model arrangements which
concessions have management and service contracts included in the whole arrangement.
The most popular form is the construction support which gives the private player a chance to get
involved in the design and construction phases of the infrastructure project while also sharing in
some of the risks involved. It has the Build Develop Operate (BDO), Build Operate Transfer
(BOT) and Build Own Operate (BOO) categories under it. Under BDO, the public authority
gives the private player a fixed term within which to design, construct and operate new
infrastructure. The private player does not own the infrastructure whose ownership remains in
the hands of the public authority. The private player assumes all risk related to the aspects
undertaken by it while also committing to an overall cost for the infrastructure development and
management, and is paid a fee by the public authority in return.
The other category is the BOT which has been used for several hydro power plants world over,
Uganda inclusive. It involves the private player undertaking the design, financing, building and
operation functions of the project. This is quite robust and is a very popular PF model, with
several interlinked contracts between various players; its use in PPPs should not be underscored
either. Its popularity stems from the long term periods given to allow the private player service
any debts incurred for the project development and to earn a suitable return on investment. Just
like in the previous category, formal ownership of the assets remains in the public authority or
the government. The third category is the BOO which, as its name suggests, has the private
player own the infrastructure facility while maintaining control of the project as well. This
arrangement has been used for virtually all power projects in Uganda since the liberalisation in
the 1990’s and most of the big power plants are on BOT arrangement with the smaller ones on
BOOT arrangement and all for a period of not less than 15 years which period is considered
adequate for the project to have paid its debt and received a reasonable profit. In Uganda,
government is involved as an investor in power projects of above 40 MW and has undertaken
PPP arrangement schemes in all that fit into this category.
PPPs, especially in developing countries provide a vehicle for FDI into public utilities and come
in various forms ranging from physical infrastructure development, provision of social and
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health services as well as public administration.183 Because of the inadequacy of public funds to
invest in physical infrastructure, developing countries such as Uganda, need to invite and
facilitate greater private participation in infrastructure project development. Traditionally,
financing ordinarily comes from donor assistance and domestic public finances. The challenge
for the private investment in infrastructure development is that it is not financially viable from a
private sector perspective especially in regard to returns on investment as well as the time frame
for the returns.
Generally, PPPs can be expanded with special reliance on donor aid to enhance the quality of the
projects, raise profitability and reduce risks.184 PPPs therefore have an important role to play in
improving on the risk profile of a project especially where a reliable donor is involved. In
addition, with donors such as the world bank that do not really look at profitability but offering
social-economic benefits to the recipient states, the private investor is left to enjoy much of the
profit which makes erstwhile less profitable projects more profitable. The involvement of the
WB in the different power projects in Uganda has boosted the projects profile and attracted the
requisite financing from other financiers accordingly.
PPPs therefore present a form of subsidy for private investors and this subsidy is based on
several factors but mostly on the presumption that the markets are not perfect. PPPs in
developing countries face several challenges, important of which include the lack of proper and
developed legal and regulatory framework and capacity, political and other non-commercial risks
and a lack of private rate of return for several projects with a high social rate of return. It is quite
important that the reason for PPPs is known before embarking on any PPP financing
arrangements.185 In Uganda, PPPs have been used for virtually all power development projects
directly for those above 40 MW and indirectly through various project support mechanisms for
those below 40 MW, because of the government’s involvement at various levels. The reason is
essentially to subsidise the private investors where necessary and to also attract private financing
into the project where government does not have adequate finance for the same.
183 Stephen Thomsen, “Encouraging Public-Private Partnerships in the Utilities Sector: The Role for Development Assistance”, NEPAD/OECD Investment Initiative, Imperial Resort Beach Hotel, Kama Hal, Entebbe, Uganda, 25-27 May 2005 at www.oecd.org/dataoecd/29/45/34843203.pdf p.3184 ibid185 It could be for efficiency purpose or funding purposes depending on the circumstances of each case.
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The PPP arrangements discussed earlier emphasize the public ownership and control of the
project assets. However, for commercial ventures such as RE, a lot of private control and
ownership is required if private finance is to be attracted. This can be through arrangements that
involve joint-ventures, Greenfield projects and divestiture and asset sale.186
Joint ventures would have both the public authority and private player jointly finance, own and
operate an infrastructure project. It is done on a strictly commercial basis which makes it even
more attractive to the private players who may have profit as their number one objective. Still
under the joint venture, the risks and responsibilities are shared in line with the equity stake in
the project and any contractual arrangements to that effect, entered into by the parties. The
Bujagali power project and WENRECO have benefitted from such an arrangement with the
government playing an active role as shareholder and equity contributor.
Greenfield projects are new projects that are usually built and operated by a private player who
undertakes to bear the commercial risks associated with the project, while other risks are either
undertaken by, or shared with, the public sector. The construction categories mentioned earlier
can be used under this arrangement. Most if not all power projects developed in the recent past or
undergoing development have been undertaken by the private sector majorly. Government’s
involvement has been in undertaking certain risks such as payment default risk by the off taker
through payment guarantees among others.
Divestiture and asset sale is another arrangement that can attract greater private sector
participation in infrastructure projects. Under this, state assets are sold to the private sector either
through the direct sale of the assets themselves or through initial public offerings. The state often
times remains the regulator and subsidizer of projects that the private sector deems unviable to
finance. These categories could include provision of power to poor rural communities among
others. It is a PPP because the state continues playing a role in the sector while the private player
also plays its part as described earlier. In Uganda, the government used this category during the
liberalisation period and divested and sold some of the assets of UEB to UMEME among others,
186 Stephen Thomsen, “Encouraging Public-Private Partnerships in the Utilities Sector: The Role for Development Assistance”, NEPAD/OECD Investment Initiative, Imperial Resort Beach Hotel, Kama Hal, Entebbe, Uganda, 25-27 May 2005 at www.oecd.org/dataoecd/29/45/34843203.pdf p.6
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so as to streamline the industry. Currently, the government of Uganda does not have much to sale
as far as RE is concerned rather its involvement is more in development of new projects.
All these three arrangements can be used by IPPs, however the commonest are in relation to
Greenfield projects and most if not all developing countries are actually focusing on private
power through IPPs as the solution to the electrification problem faced by several developing
countries187 and Uganda is no exception.
By government offering incentives to encourage investment in the renewable energy sector, the
government is already playing a role under PPPs. These incentives could be tax free imports,
subsidies, etc and serve to ensure that the service is made affordable to the consumer by
removing the project’s commercial cost burden from the consumer who will in turn receive an
efficient and yet affordable service, and also helps the private player recover investment costs in
a shorter period than would have been, had the incentives not been given188. These PPPs can be
used to bring RE to populations that hitherto did not have any power, in a shorter time due to the
short time that private players require for projects to start generating income when investing their
money. This in turn shifts the investment burden from the government to the private player.
PPPs would work best in areas where the private sector might not ordinarily desire to invest due
to the poor economics and financials that these areas such as rural areas present. The commercial
risks which involve forces of demand and supply are ordinarily borne by the private player while
the other risks such as legal, regulatory and political are borne by the government which is in a
better position to individually handle the respective risks. However, for these PPPs to work,
government has to take serious initiatives at policy level to address some issues such as
establishment of a proper legal and regulatory framework and environment for PPPs to operate
in, establishment of long term finance schemes for such projects, increase awareness and
promote the use of PPPs by all stakeholders and encouragement of decentralized power schemes
for isolated off-grid areas that are not economical to connect to the national grid, among others.
Another aspect of RE financing where PPPs would work is in the development of risk mitigation
tools for the sector. Since risk management is a part of the financing package, it is important that 187 Much of Private Participation in power goes into generation with the transmission function being retained by the government and the distribution function being given to one private player through concessions where there are small markets.188 On the basis of a fixed pricing structure
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innovative risk management tools are created. However, with insurance, which is the commonest
and most readily available of the risk management tools, there exists a problem of institutional
inertia, which simply means that, the sector does not invest in development of new insurance
tools rather in adapting the existing ones to different situations,189 partly due to a lack of big
budgets for R&D, a gap the public sector could always fill.190 This role of PPPs is seen in the
ARGeo project mentioned earlier in this paper. This project is a PPP initiative which underwrites
risks of drilling in the countries of Djibouti, Uganda, Kenya and Tanzania among other Great
Rift Valley countries. This initiative is receiving support from the governments of Iceland and
Germany among others.
The UECCC is another PPP initiative where the government and multilateral development
agencies work together with the private commercial banks to avail medium term financing as
well as risk guarantee instruments to private sector developers in energy projects.
4.3 PARTICULAR CATEGORIES OF RE
Mini hydro is in abundance in Uganda, with a potential capacity of 210mw191 which would
supply the national grid and also operate as isolated grids. Mini hydro has various liability covers
for it because of the general understanding of the technology involved as a result of the wide
scale use of large hydro. Mini hydro is thus easier to develop in Uganda than the other categorise
hence is abundance.
Geothermal is a reliable RE source that produces sustainable base load power with minimal
environmental impact192 and is multidisciplinary in use. Uganda’s renewable energy policy also
recognizes the importance of this category of RE, which has a generation potential of 450mw.193
Geothermal projects however face high upfront costs for exploration, well drilling and plant and
equipment installation. The issue with management of these risks is that the underwriters and 189 UNEP-SEFI, “Financial Risk Management Instruments for Renewable Energy Projects”, (Words and Publications, Oxford, UK, 2004) at www. unep .fr/energy/activities/frm/pdf/statusnotemarch08.pdf p.12. insuranceforRenewables.com is an example of a PPP initiative to provide project risk insurance for developing countries especially.190 Centre for Research in Energy Efficiency and Conservation (CREEC) is a public private partnership initiative at the Makerere University’s Science and Technology Faculty and is involved in research and development of Energy Efficiency and Conservation191 MOEMD, The Renewable Energy Policy for Uganda, http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.42192 Jerry R. Fisch, “The Law of Lava, Just Starting Out: Leasing, Siting, and Permitting Geothermal Projects: Chapter One, Lava Law: Legal Issues in Geothermal Energy Development”, Stoel Rives LLP, 2009, P.1193 MOEMD, The Renewable Energy Policy for Uganda, http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.45
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insurers always try to use the petroleum environment model that they are familiar with, yet the
two activities operate in different environments. This leads to a mismatch that does not really
serve the purpose of effectively managing risk. More still, geothermal projects have a long
waiting period from start till the project starts generating revenues and thus a high likelihood of
the project not being able to meet its debt obligations since things could terribly go wrong during
the waiting period. This is the concern of most if not all financiers for geothermal projects.
Drilling is a very important and vital aspect of geothermal and a lot depends on its success.
Unsuccessful drilling means the project will not generate power and thus there will be no
revenue made. The risk of increased costs arising from blow outs and controlling a well,
restoring and or redrilling a well, and the costs of remedial measures associated with seepage and
pollution are all high under operation risk and have to be managed well in order to make the
financiers of the project comfortable.
The exploration risk of not being able to achieve minimum economically acceptable thermal
water flow rates has been covered by the public sector but it is increasingly being shared through
public-private initiatives which provide insurance cover against the risk of not achieving
economically acceptable flow rates. This issue is being handled through a PPP initiative ARGeo
which has obtained financing to the tune of $18m for the GEF to underwrite drilling risk in the
Great Rift Valley countries including Uganda. It has financed certain techniques in Kenya such
as micro seismic and magneto telluric surveys which processes can achieve savings of up to
$75m on a 70mw installation. In Uganda, total geothermal power potential is 450mw with the
most promising geothermal sites at Katwe in Queen Elizabeth National Park, Burnaga in Semliki
National Park and Kibiro all in Western Uganda.
Wind is also another of the widely applied RE categories that has not attracted much interest
from investors quite contrary to the situation in Kenya. In Uganda, the wind speeds of 2 to 4
m/sec are only sufficient for small scale wind power generation and specialised applications such
as wind water pumps194 and irrigation systems among others. It can also be used for small
industries and rural areas as the capacity is in the region between 2.5kv to 10 kV.195 The capital
194 Ibid p.49195 Supra it has been used for small scale pump projects in Karamoja in the North East of the country
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costs per MWh for wind produced power are relatively high for the simple reason that wind
plants only produce power when the wind is blowing.196
Risk management is achieved through sharing risk with the project sponsor seeking to shift the
technology risk to the turbine manufacturer and the construction contractor, the lender typically
takes paramount positions in the project revenues and assets and in the process shifts the risks to
the project sponsor and third parties such as the construction contractor and turbine manufacturer
by getting the benefits of contractual obligations and warranties. All this is done through the use
of various legal undertakings by the parties involved. These undertakings include warranties and
contractual requirements for the work carried out in making the project operational and
equipment, mortgages and security interests granted in the project revenues, assets and key
project agreements, the work performed, guarantees for each party’s obligation from
creditworthy entities and the requirements for insurance cover for certain adverse risks.197 There
is also the risk of delay or non completion of the project, and this is the main concern for the
investors in the initial stage and they are covered by insurance policies that are comprehensive in
nature covering all aspects of risk in the construction stage. After the construction stage, the
operational stage is reached and it also presents its own operation risks such as turbine failure to
perform completely or to perform to expectations among others. This is covered by all
operational risk insurance cover. These are accompanied by warranties and guarantees from the
turbine manufacturers who should be creditworthy if the warranties are to be taken seriously let
alone be considered. Contractual Service Agreements are used in some parts of the developed
world and involve the turbine manufacturer undertaking to repair any defects or replace any
defective turbines for in exchange for earnings on every MWh of power produced.198 Wind
power has been developed on commercial scale in neighbouring Kenya due to the high wind
speeds and favourable wind FITs which support commercial wind power production.
Bio fuels are being promoted in Uganda mainly to feed the transport industry through provision
of bio fuels to blend in diesel and gasoline, with the benefits of the same being pitted as the
196John M. Eriksson et al, “The Law of Wind- Power Purchase Agreements and Environmental Attributes” (Stoel Rives LLP, 2009) Ch.6, p.1197 ibid198 UNEP-SEFI “Financial Risk Management for Renewable Energy Projects” http://www.unep.fr/energy/activities/sefi/pdf/RE_Risk_Manag.pdf p.27
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motivation for their promotion. Such benefits include reduction in C02 and toxic air emissions,199
greenhouse gas build up and dependence on imported fuel200
Like other renewable energy options, bio fuels, which usually come as either biodiesel or
ethanol, also require high initial capital injection, which capital generally comes in the form of
either equity or debt. Each of the categories has its own advantages and disadvantages and it is
quite important that the perfect mix of funds (categories of capital) is achieved, which mix is
unique for each project due to the unique nature of circumstances surrounding different projects.
It is noteworthy that, equity financing can come directly from the project sponsors or investors or
alternatively from other financiers as mezzanine debt among others. Debt financing on the other
hand could also come from project sponsors and other financiers as well. Equity financing,
obtained from investors, is generally considered to be more expensive for the project developers
than the traditional debt financing obtained from lenders.201 This is due to several reasons,
important of which is the resulting equity dilution that would occur, hence the need for project
developers to obtain equity financing to bring their projects to fruition.202
In order for the government or the energy policy to promote renewable energy development, it is
quite important to understand what the financiers of the project want. This is a vital step towards
achieving bankability of a project. Providers of equity finance for a biodiesel project just like
other PF projects would usually want stable and definite future earnings from the project hence
the common concern with the quality of applicable intake and off-take agreements.203
This paper’s main focus is on financing renewable energy hence will concentrate on the legal
and regulatory as well as fiscal regime elements of the biodiesel industry looking at them from
the aspect of how they will affect financing of RE projects.
199 With 312 million litres of petroleum being replaced with Methyl Alcohol, a reduction of nearly one million tons of Co2 emissions will result’ this is based on a 25% and 60% compulsory blend with 385 million litres of gasoline and 360 million litres of diesel respectively, according to the 2010 estimates. 200 MOEMD, “ The Renewable Energy Policy for Uganda”, http://www.energyandminerals.go.ug/pdf/RENEWABLE%20ENERGY%20POLIC9-11-07.pdf p.38201Edward D. Einowski et al, “The Law of Biofuels-Financing your Biofuels Project”, (STOEL RIVES LLP, 2008) Ch.1- pg. 1202Ibid-Equity financing for biodiesel projects is becoming less available to project developers due to two major factors, namely the food versus fuel morality debate and the lag of second generation conversion technologies, yet equity investment into upstream and plant o8ptimization developments is on the increase.203ibid
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The issue of market risk should be addressed. This market risk is the risk that the Biofuels
produced will not find buyers on the market. Since Biofuels are not necessarily popular among
fossil fuel traders, it is necessary that the government, by law and regulation, set a certain
minimum standard for Biofuels.
This standard is two way;
i) That a certain minimum percentage of Biofuels should be blended in all gasoline and diesel that
is imported refined and also sold at pumps and fuel depots. In Uganda’s case, the percentage has
been put at 20%204 and this should apply to all gasoline and diesel importers and refiners to
ensure that all the gasoline and diesel traded in the country is blended with a respective bio fuel.
ii) The second way is to have obligated parties purchase a certain minimum obligated amount of
Biofuels, which purchases and use will in turn result into RECs for these parties. RECs could
work if there is a law, regulation or policy which provides for the benefits of accumulating
renewable energy credits and also penalises those that do not meet a certain REC amount. These
RECs should only be attributed to purchases of Biofuels and not also, those bought out rightly
from other parties as is the case in USA, mainly because Uganda is still a developing country 205
and if it has to benefit from biodiesel development and utilisation, such standards should be put
in place at least for the start as they would provide for a boost effect towards the development of
Biofuels.
With these obligations, the market for Biofuels is made more or less definite hence mitigating the
market risk to that extent.
However, on the other side of market risk is that the producers of Biofuels may not be able to
meet the market demand for Biofuels. This could to some extent go hand in hand with volume
risk, since volume risk, just like market risk is two way. However, it specifically deals with risk
that the producers of Biofuels will either meet the market volume demands or not. With
compulsory blending of a minimum of 20% Biofuels in all fuel imported or refined in the
country, an almost definite market is created which means that the amounts of bio fuels required
by the market are easily predictable.204 supra205 A developing country that need a boost towards the development and promotion of Biofuels, and this compulsory one sided REC source requirement could as well serve that purpose.
78
Biofuels are extracted from plants whose successful growth is highly dependent on the weather
or climate, of the farming area, among others. This is what we may refer to as climate/weather
risk which is ordinarily borne by the producer who may obtain insurance against the changes in
weather.
However, in putting together a financing package for a Biofuels project, other risks are
considered quite paramount and these are technology risk, operating risk, debt burden and
accounting liabilities.206 Because of the importance of these risks in a Biofuels project, each
participant fights hard to shift these risks away from themselves, which leads to the difficulty, as
mentioned above, in putting together a financing package.207
Through performance warranties, the developers and investors shift the technological risk to the
builder while the lender always seeks to shift these risks to the project owners by taking senior
positions in the project revenues and assets, while also shifting the same risks to third parties by
getting the warranties and contractual obligations of these third party participants. The ultimate
purpose of all this is to enhance the prospects of the loan being repaid on schedule208, since
on-schedule repayments are very important in satisfying the financing package requirements.
The role of the legal adviser in this whole financing package structuring is to ensure that the
desires of the parties in risk sharing among others are identified by way of negotiation and put
together by way of documentation in the form of legal instruments that bind the parties. Typical
in such financings are several interconnected contracts which are put together to form a
contractual matrix for the whole project. Legal instruments involved have instruments such as
mortgages and security interests granted in the project assets, equipment and performance
warranties as well as contractual obligations for equipment and work carried out in bringing the
project to the operation stage, revenue and key project agreements among others.
206Edward D. Einowski et al, The Law of Biofuels-Financing your Biofuels Project, (STOEL RIVES LLP, 2008) Ch.1- pg.1207 ibid208 ibid
79
CHAPTER FIVE: GENERAL OBSERVATIONS, RECOMENDATIONS AND
CONCLUSION
Chapter five will highlight general observations of the financing aspect of the and attempt to
offer solutions to the problems highlighted in the previous chapters while also suggesting
alternative financing mechanisms for renewable power projects in light of the hindrances
identified earlier in the paper. Under the same chapter, the role of legislation and regulation in
80
encouraging the use of PPPs, PF and other financing tools to encourage development in the
sector will be considered.
Framework conditions present the major hindrance towards the financing of renewable energy
projects in developing countries and generally. These are determined by policy and law that’s in
place. The framework conditions are affected by policy and legal framework, energy sector
competition & bias and financing.
Policy and legal framework can be used as a tool to encourage RE investment and development
by creating instruments that allow IPPs including those of RE to easily connect, but most
especially, to sell to the common power grids irrespective of their sizes. The inability to connect
to the power grids is one factor that discourages private investment in the RE sector, because
without that ability, the market is diminished. This is coupled with a lack of transmission access
which could either be brought about by exorbitant transmission tariffs or by a lack of enabling
law that allows for transmission and third party access for generators however small, in
liberalised sectors where the transmission role has been privatized and is owned by a private
player who may be vertically integrated. Even in government owned transmission regimes, there
may be limitations on the minimum amount of generated power to supply through the
transmission system, and this poses a threat to small power project development, yet some RE
systems can only generate so little.
All RE projects require siting and permitting approvals, and in many cases, these approvals may
have stringent qualifications attached to them, most of which stem from environmental concerns
especially where environment is categorized into the broad areas of physical, social and
economic. Much as the government owes a responsibility to protect its people, the role of
regulation should not be to stifle business development but to encourage responsible
development of the sector. Therefore win-win solutions should be developed so that even small
RE producers can be allowed to develop their sites in a responsible manner. This also puts a
responsibility on the developer to match up to the required standards or they have no business in
the sector, which standards should not be unduly constraining implying a workable and
manageable minimum threshold. Policy and law can therefore be used to make the permitting
81
and siting process less constraining than it is in many countries and this should be taken into
account when enacting the relevant laws and policies as discussed earlier in the paper.
The nature of the energy sector also presents its own specific issues in regard to how framework
conditions affect the development of the RE sector. Firstly, the sector benefits from a lot of low
cost energy from conventional sources yet RE is generally more expensive in certain instances,
this thus creates competition issues, in that RE will not be able to favourably compete on the
market. That’s why subsidies and special tax regimes directed towards RE are employed in many
of the power markets, however they have the negative effect of causing distortions in price
between RE and other power sources. These disparities could subsequently lead to a failure by
the market to value the public benefits of renewables or worse still lead to market failure. The
price disparities could also be somewhat regularized if the environmental cost of fossil fuels was
also put into account when pricing conventional energy sources that rely on fossil fuels as raw
materials. This will especially be important when the country starts using gas powered plants and
HFO plants with production of HF and gas from the country’s oil and gas fields, hence it should
be taken into account.
The core issue that affects the development of RE, after the legal and regulatory framework
conditions, is the financing aspect which also in itself is taken into account when determining
law and policy for sector development. A lack of adequate information on the RE sector denies
market access to would be development stakeholders while keeping financiers in ignorance of
what the sector provides in the form of financing opportunities, and would thus be considered
unattractive. One of the issues that make RE unattractive to developers are the high risk profile it
possesses, and worse still there are not many established risk management tools to cater for such
risk which risk is also not necessarily commensurate to the returns on investment.
The typical demand profile for RE financing is based on the fact that funds are required in order
to have the project materialize and also to ensure that, with an adequate and proper financing
structure, the advantages of competitiveness of RETs would increase since the cost of RE
electric power are also highly sensitive to the financing terms.209
209 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005)p.13
82
Since RE, in comparison to conventional energy, has widened the financial tasks to be solved,
the financial needs of RE exist at three levels i.e. household and community group levels which
need micro-credit, entrepreneurs who need long term patient capital which allows them time to
develop products and services based on RE and finally investors who require reduced or shared
credit risks up to a point where several track records of success and confidence in RE have been
achieved210 at a wider scale.
Some other sources of financing for small projects that could be tapped into could include
utility companies interested in diversifying their portfolios into generation projects. This is
common especially when the legal and regulatory framework provides for easy access to the
transmission grid for all sizes of projects with favourable tariffs. However, where there are
constraints to connection to the transmission grids with no favourable FITS in place, it presents
problems which make it unattractive for even utilities to invest in small generation projects. In
the US, utilities and other taxpaying entities are encouraged to invest in RE Generation projects
by the tax incentives in place. These tax incentives include production tax credits, investment tax
credits and accelerated depreciation. PTCs can encourage investment in long-life, high quality
and reliable equipment and machinery since the investor in the project would benefit from Tax
Credits on the production of the project for a certain long term duration fixed by the tax
regulations. In the US, it is 10 years of production from the commissioning date, however it can
vary from country to country but it would be important to strike a balance, by ensuring that it is
not too short a period so as not to attract the requisite interest, or too long a period for
government to lose out on much needed tax money. In Uganda, as mentioned, 5 year tax
holidays and VAT exemptions on the project as well as import duty waivers, serve in this regard
as far as tax incentives are concerned.
The introduction and utilisation of Investment and Production Tax Credits would go a long way
in filling the financing gap for RE in developing countries. Where ITCs are utilised, the ROI of
the project, once it comes on board, is boosted by the same percentage the project receives in
ITCs which makes investment in RE projects under such a tax regime even more attractive to the
private sector, seeing that an ROI of say 35% can be made in the first year of operation despite
210Ibid p.7
83
the project not making profits. Such an incentive would attract private finance from investors
who would otherwise have been deterred by the long lead times of such projects.
Equipment suppliers and contractors may also be interested in investing in small generation
projects in return for a contract to either supply equipment, or to construct among others. This is
common in the developed countries and is purely a business decision. It can also be employed in
developing countries such as Uganda, however the technical skills and capacities of the local
contractors who are more familiar and comfortable with the local market conditions as compared
to their international counterparts who even require expensive state guarantees, should be tapped
into and developed. This is where the training aspect in the development of RETs is utilised.
Local entrepreneurs and businessmen can also invest as co-development partners in such
projects. However in several economies especially the developing ones such as Uganda’s, it is
important that awareness of the sector is increased among the populace so as to make the
available prospective RE project investors aware of what is on the market and better still
understand investment in the RE sector. Much of the capital from business men and private
investors in our local economy can present a cheap and fast source of financing for several of
these RE projects which would offer a lifelong income and profits since the investors would own
the projects and would have their money work for them. However, due to a varied array of
opportunities to invest their money in and have quicker returns than in power where they would
have to wait for a minimum of 10 years before they start earning, it is unlikely that private
individual finance will play a big role in financing Ugandan power in the near future.
Another source that should not be under looked are the community finance initiatives which
involve the communities pooling money together so as to finance the RE projects for their
benefit and use. Through such schemes where all the power is to be used by the community, off-
grid projects present a better option that may prove cheaper than grid connected systems,
however, where excess power is envisaged, connection to the transmission grid is paramount as
it subsequently presents a source of income for the community who will benefit from selling
excess power to the national grid. These community finance schemes come in various forms
such as power cooperatives among others.211 Uganda’s communities have vast capital resources
211 These were used in the USA to boost their rural electrification program.
84
that can be pooled together through co-operative investment societies which are being promoted
by the government as SACCO’s. These societies present a magic bullet for community financing
of RE in rural electrification and should thus be promoted if gains in RET development in
developing countries are to be realised.
Carbon financing is also available for projects in the form of renewable energy, green or ethical
investment funds which may be tapped into for purposes of developing RE projects. These funds
are readily available for most RE projects as long as the project meets a certain prescribed
criteria so as to benefit from the funds. The Rural Electrification strategic plan recognizes the
need to tap into this source of finance for RE projects. This source presents various mechanisms
such as the CDM, JI and IETs among others. In Uganda, most projects are either too small to
attract green financing or do not have the skill to apply for the same. This is the reason for the
inception of Uganda Carbon Bureau which is supposed to be an umbrella for green projects of
various sizes and help them get financing for carbon credits generated. They also take care of the
entire process of application which makes it less cumbersome for developers.
The CDM is a mechanism which creates a market for CO2. It works in such a way that, a party,
usually an industrialized country under the UNFCCC and the Kyoto Protocol, buys emission
reduction credits arising from projects developed in developing countries which are also referred
to as Non-Annex One Countries. This market for CO2 involves the purchase of carbon credits
which are termed CER and are expressed in tones of CO2 equivalent.212 The Kyoto Protocol has
certain flexible mechanisms that can be used to leverage these benefits especially for Annex One
Countries to reap the benefits of emissions trading in a cost effective manner while ensuring
sustainable development for the developing countries. These three flexible mechanisms are the
Joint Implementation (JI), Clean Development Mechanism (CDM) and International Emissions
Trading (IET) with JI and CDM being project based. These two project based mechanisms
involve the development and implementation of projects that reduce GHG emissions so as to
generate carbon credits as a result. The resultant generated carbon credits can then be sold on the
carbon market as CERs. All RE projects are generally considered green as they play a role in
212 Allafrica.com, “Ghana: Carbon Finance And the Clean Development Mechanism (CDM)” at http://www.carbonoffsetsdaily.com/news-
channels/global/ghana-carbon-finance-and-the-clean-development-mechanism-cdm-17164.htm
85
reduction of GHG emissions through the provision of alternative non-fossil fuel based energy
such as hydro, geothermal, wind, solar, biomass and also bio-fuel projects among others.
Whereas JI is more concerned with development of projects in developed Annex One Countries
through the generation of credits referred to as Emission Reduction Units (ERU), the CDM is
concerned with generating CERs from projects in developing countries.
Projects that may want to benefit from the CDM must, as a prerequisite, undergo a very rigorous
documentation and approval process by a variety of local and international stakeholders. This
process is based on the specified CDM modalities and procedures. The process involves the
initial feasibility assessment and the development of a Project Design Documentation (PDD),
host country approval from a host country that has ratified the Kyoto Protocol through their
Designated National Authority (DNA), project validation and verification by the Designated
Operational Entity (DOE), registration, emission reduction verification and credit issuance by the
EB.213 Once the project passes the tests set for it, it becomes eligible to benefit from the CDM
which goes a long way in reducing on the project costs through provision of finance, efficient
technology and sustainable development. The problem is that there is no developed carbon
market in the developing countries of Africa especially since most of the carbon financing is
concentrated in Asia and the Americas.214 Establishment of proper legal and regulatory
environment Encouragement of the trading of CER is the way to go, in order to reap from the
benefits of CDM for RE projects215 particularly in developing countries that have a very low
carbon footprint.
In addition to the above discussed mechanism is the Global Energy Facility (GEF), which is an
intergovernmental fund with its main objective being environmental protection. It is comprised
of the WB, UNDP and UNEP. In its mandate to protect the environment, the fund offers non
reimbursable financing for the incremental costs in green projects which include RE projects.
The incremental cost principle essentially provides for the compensation of marginally
economically viable RE projects for the extra cost incurred over and above the would be cost of
a similar non green project, so as to have the RE project reach early completion and entry onto
213 ibid214 ibid215 This is through the attraction of FDI
86
the market.216 This arrangement has been used to fund feasibility studies in the Rift Valley for
geothermal power production purposes under PPP arrangement.
The promotion of the Uganda Carbon Bureau as well as promotion of other similar outfits while
strengthening their mandate in putting together green projects and making their accessibility to
green financing and carbon credit accumulation easier, would go a long way in making green
financing available. This should be done as a joint effort involving all stakeholders.
The creation of institutions based on PPP arrangements such as the Uganda Energy Credit
Capitalisation Company and further capitalisation of the same to offer a wide variety of
financing tools for a wider scope of power development in developing countries would go a long
way in solving the financing challenge faced by developers of power energy projects including
RETs in developing countries such as Uganda. The role of such an institution would be to bring
together all sources of finance and risk management instruments under one roof and make them
available to prospective developers either directly or through other financial institutions as is the
proposed model of disbursement by the UECCC Ltd.
CHAPTER SIX: CONCLUSION
216 Peter Lindlein et al, "Financing Renewable Energy-Instruments, Strategies, Practice Approaches" at http://www.kfw-entwicklungsbank.de/DE_Home/Service_und_Dokumentation/Online_Bibliothek/PDF-Dokumente_Diskussionsbeitraege/38_AMD_Renewable_Energy.pdf Discussion Paper 38(Kfw Bankengruppe, Group Communications, Frankfurt am Main, December 2005) p.69
87
From the foregoing discussion, it is noteworthy that developing countries have special financing
considerations because of their economic set up thus making dynamics of financing RE projects
in developing countries quite different from the traditional . With the developing countries
having underdeveloped and undercapitalised financial systems, very big limitations as far as
obtaining a full range of financing and risk management options from within and abroad do exist.
The government or the public sector as it were, has the paramount responsibility to ensure the
development of the sector and creation of an environment that will attract the full range of
options to wit; ensuring the prevalence of a favourable risk profile and enablement of movement
and availability of necessary finance and risk management tools for such projects. The private
sector on the other hand has a duty to ensure that the created environment is utilised fully and in
partnership with the public sector, to create lasting solutions that work. With each sector217
working on its own, it is almost impossible to create the environment that would enable the
improvement in the availability of financing and risk management tools for RE projects among
others. All that has to be created is an enabling environment that would be nurtured by public
and private sector participation through innovation to ensure workable financing solutions for the
diverse situations and scenarios taking into account the existing handicaps.
Important among the influencing conditions include the credit and risk profile rating of the
country, which have a very big bearing on whether finance will be availed to a project or not.
The role of the Public and Private sectors in solving the financing challenges highlighted is thus
paramount. The government, donors and private sector should work in consonance to ensure
favourable financing and risk management frameworks and incentives in the country. This
explains why PPPs are actually being championed as the vehicle through which infrastructure
projects should be developed. PPPs are not a silver bullet though and thus the role of PFIs such
as Project and structured Finance, and other innovative financing tools, in the development of RE
in these developing countries should not be underscored.
BIBLIOGRAPHY
217 Public or private sector
88
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