Opinion Piece: South African renewable energy IPP project equity returns – are they still attractive?

Over the last 15 years, South Africa has seen significant growth in renewable energy Independent Power Producer (IPP) activity, with over 7,000 MW from 100 projects that are operational or being constructed under government off-take contracts. The trend is set to continue, with more than 18 000 MW projected generation according to the 2023 Integrated Resource Plan.

IPPs play an important role in diversifying the energy mix in liberalising energy markets, and equitable project risk allocation and associated equity returns are key for long-term competitive tension and ultimate value-for-money for end customers.

The start of RE and setting a “Baseline” for equity returns

The IPP growth trend was kickstarted by the SA Government’s Renewable Energy Independent Power Producer Procurement Programme (REIPPPP), which attracted significant local and foreign investment in renewable energy projects. The government programme, together with a favourable regulatory framework and government credit support, provided a stable and attractive environment for investors. The well-structured and timeline -conscious procurement programme created significant competition, resulting in equity IRRs just above long-term RSA government bonds – good for buyers of energy, bad for investors.

Sector growth is now transitioning to private off-take on the back of energy market liberalisation. Although the trend is currently limited to wheeling (via the Eskom grid), the market is expected to evolve to a fully liberalised day-ahead trading platform in the next few years.

Key metrics from selected projects

In exploring the article title, statistical analyses were conducted on project cash flow attributes from more than 54 large-scale (>75MW) wind and solar projects.  Average values were calculated for relevant project attributes including total gearing (70.8%); all-in senior debt rate (10.2%); nominal equity internal rate of return (12.3%) and shareholders loans as a percentage of total equity (44%).  Assuming that shareholders loans lie at the midpoint between ordinary equity return and all-in debt rate, the equity and shareholder loan returns are calculated as 12,9% and 11,6% respectively (the former being a far cry from the >17% equity returns contemplated in REIPPP 1 – back in 2013).

IRR value uplift options

Through participation in the various project lifecycle stages (including development, construction, and operations), there is still room for IPPs to increase their overall returns. Additionally, increased gearing and reduced spreads via refinancing and project securitisation can squeeze additional returns to local pension funds or equity investors; albeit not enough to satisfy international equity return requirements.

Long term – risk / return balance

In the medium term, we expect the private renewable energy space to migrate from large bi-lateral deals to generation and demand aggregation; we have already seen the establishment of aggregators and traders. The diversification associated with aggregation will allow flexible structuring such as shorter PPA durations, tailor-made energy supply curves, and specialised service offerings, like ancillary services, at higher margins. Intuitively, one could also see innovative or alternative solutions in the finance space such as portfolio funding, which could eliminate high cost and long lead times associated with individual project finance models. The latter trends and initiatives will have a positive effect on equity returns.

Where to from here for investors returns?

The current muted equity returns are a downside of a successful and highly competitive renewable energy industry in South Africa. There is still adequate margin for IPPs that participate across all the project stages. Also, changes in sector operational and possibly funding models could improve nominal returns to levels that entice international infrastructure equity investors.  Regardless, it is certainly an exciting time to be involved in the South African renewable space.