In the past two decades, hydropower development has picked up after a substantial decrease in the 1990s. Though most construction was in Asia, the potential for hydropower is greatest in Africa. Only one-third of Africans have access to modern energy, and the population is growing rapidly. This is an investment opportunity for all kinds of power technologies, but especially for hydro, since only 8 percent of Africa’s vast hydro resources have been developed.
CEO - Africa50
Vice President for Power, Energy, Climate Change and Green Growth - The African Development Bank
Large hydropower projects can become important drivers of sustainable economic growth in Africa. With useful lives of more than 50 years, they are an excellent complement to shorter-lived thermal plants and can provide greater and more predictable power than solar and wind, while providing benefits such as flood control, irrigation, and steady water supply. Hydropower plants can also act as “peakers,” using their reservoirs to store water and generate electricity at peak hours or when intermittent sources such as solar and wind are not producing. However, they are complex undertakings with a number of constraints and challenges.
Contrary to thermal plants, which are standardized and pose few construction risks, hydropower plants are site specific, with high geological and hydrological risks that need to be shared equitably among private developers, lenders, and utilities, as well as governments when sovereign guarantees are required. They also generally require significant land area, with commensurate mitigation and compensation for environmental and social impacts. In addition, the construction phase is unpredictable and lengthy, and represents a significant project risk.
For these reasons, hydropower requires a long and complex development phase. To be successful, developers must have the requisite experience and a thorough understanding of the challenges, and work with equally strong and experienced stakeholders, including construction contractors. This is crucial for minimizing risks to obtain the best possible financing, since construction costs are high, with frequent overruns that can represent a big percentage of original estimates.
Challenges to financing hydropower projects
Many private investments in large hydro projects in emerging markets have shown that there is a disconnect between the lifespan of hydro plants and the debt maturities that are offered by their financiers. While plants can be exploited for more than 50 years, debt tenors from development finance institutions (DFIs) and commercial institutions have rarely been longer than 15-18 years. Therefore, tariffs have been heavily front loaded to meet debt service obligations, with debt-equity gearing driven down to preserve higher debt-cover ratios. This has made privately funded hydro power less competitive than many other power sources.
These private financing challenges are key constraints that explain the limited number of private investments in hydropower in Africa. The only large privately financed hydropower project is the Bujagali plant in Uganda, which reached financial close in 2007 under a complex project financing structure. By contrast, many publicly financed projects have been and are being successfully implemented (Grand Renaissance, Inga 1 and 2, Gibe III, Adjalara, Isimba, Manantali, Kaleta, etc.). These often benefit from concessional financing with long maturities, which results in nominally lower tariffs.
Conversely, when debt servicing has been completed, hydro becomes disproportionately inexpensive, to the point that other forms of generation may not be able to compete. This can distort tariff structures and inhibit the development of other types of power plants. Clearly, no new plants can compete with the likes of Aswan (Egypt) or Akosombo (Ghana) which, at the half-century mark, have long been amortized. They can deliver power at a fraction of the cost of potential replacements, with decades of operations to go.
Lengthening loan tenors to make private hydro projects more attractive
At a time when there is a growing consensus to increase private investments in infrastructure, more efficient financing structures are needed for private investment in hydropower to better align debt maturities with the useful life of plants. Extending loan tenors for private or public-private partnerships (PPP) hydropower from the typical 15-18 years to 25-30 years would enhance the attractiveness of such projects for all stakeholders, since it would lower generation and end-user tariffs. Longer loan tenors would also allow higher debt-to-equity ratios that would provide room for further tariff reduction. We estimate that, under the new financing framework we are proposing for hydropower, tariffs could decrease by approximately 20 percent. For a hydropower project with a cost in the $500 million range, this could represent a $20 million annual saving for the first 10-15 years of operations.
One way to convince lenders to extend loan tenors is through increased risk mitigation by DFIs, for example, by using partial risk or credit guarantees. Many DFIs operating in Africa are familiar with the structures that have been used to extend debt maturities in project finance transactions, particularly for local currency funding. It is possible to build on these or design new ones that would enable maturity extensions to the required 25-30 year range. Some of the new approaches may require crowding-in institutional investors with long-term investment horizons and appetite for infrastructure assets, as well as deepening local capital markets to enable the issuance of long-term securities to fund these projects.
This will require cooperation by all hydro stakeholders. Governments should grant longer-term concessions and Power Purchase Agreements; private sponsors, investors, and lenders should accept longer-term commitments; and all parties should accept a fair allocation of residual risks stemming from the implementation of these structures (e.g., refinancing risks).
All this is possible and can be done. The Bujagali project, which is currently restructuring its debt, significantly lengthening the tenor, demonstrates the need to structure longer tenors during project design to avoid costly, unplanned refinancing later.
Africa50, with almost $1 billion in capital and substantial project development experience, can help implement these structures, working closely with the African Development Bank, which can take the lead in arranging project debt financing and the required credit enhancement instruments with the features advocated in this piece. This would secure the much-needed longer debt maturities to generate reliable and affordable electricity to power homes and industries.
We are ready to catalyze a change in the current hydropower funding framework for the benefit of all Africans.