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Wednesday, 18 October 2017

Lake Turkana gets up to speed

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  • Figure 1 - lake turkana wind power financing structure

At more than Ksh70bn Kenyan shillings – €623m/US$775m – Kenya’s Lake Turkana wind power project is the largest single private-sector investment in Kenya. At up to 310.25MW, it will be the biggest wind farm on the entire African continent. By Kaushik Ray, partner, Trinity International LLP.

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Wind experts hail the reliability of the quality of the wind (as to speed, direction and consistency) as amongst the best in the world. The low-cost electricity produced by the plant and provided to the Kenyan national grid will be equivalent to nearly 20% of the currently installed generating capacity of Kenya.

What started out as a camping trip in 2006 by some Dutch farmers in the north of Kenya near Lake Turkana (they found it too windy to pitch a tent) evolved, after several years of collecting wind data, to discussions with both government and the Kenyan offtaker, Kenya Power (KPLC) (with whom a power purchase agreement was initially signed in 2010), mandating financial advisers, procuring turbine suppliers and other contractors, mandating lead arrangers, finding equity partners to negotiating both debt and equity financing – a process that altogether lasted some eight years – and finally culminated in first equity, then debt financial close in late 2014.

The project comprises 365 wind turbines (each with a capacity of 850kW) manufactured by Danish supplier Vestas. In addition to the wind turbines, an electric grid collection system, a village (given the remoteness of the site) and a high voltage substation also form part of the overall project. In addition, road upgrades (to ensure smooth delivery of the sensitive wind turbine parts and gears) to more than 200km of Kenyan roads, as well as internal access roads on the project site, make up what is being paid for and financed by the project company, Lake Turkana Wind Power Limited (LTWP).

Initial challenges – Evacuate the power

The project site is some 428km away from the nearest existing substation, necessitating the construction of a transmission line (the T-Line) to deliver the electricity produced by the wind farm and to connect it to the national grid. The government-owned Kenya Electricity Transmission Company Ltd (Ketraco) has agreed to procure the construction of the T-Line. The chosen contractor is Spanish company Isolux, bringing with it concessional funding from the Spanish Government. A number of existing and planned geothermal power plants fall along the T-Line route, making the line key to the electrification of some remote parts of Kenya and bringing cheap renewable power on to the grid.

However, due to certain uncertainties in Kenyan law as to the application of export credit funding (under which the T-Line was to be funded), the implementation of the T-Line was delayed by several months in 2014 while the Kenyan Parliament passed clarifications to its Public Finance Management Act to allow commercial loans (ostensibly as part of government-to-government funding) to be paid to contractors directly. With the ultimate support of government, Parliament passed the relevant amendments to existing legislation and Ketraco was able to issue its notice to proceed to Isolux in late summer 2014, the funding having been secured.

As far as the wind project is concerned, under the terms of the power purchase agreement with KPLC, LTWP does not take transmission risk: its obligations to deliver electricity falling to the substation at the end of the project site. T-Line construction risk therefore remains with Ketraco and ultimately with the Government of Kenya under its letter of support to LTWP and lenders. Given the linked nature of the T-Line and the project – particularly due to the Government’s financial obligations linked to late delivery of the T-Line – the delays to its funding caused knock-on project cost increases for the project that nearly threatened its continuation.

Role of political risk guarantee

In order to help mitigate the risk of delays, African Development Fund applied its first partial risk guarantee to the T-Line. The African Development Bank approved the PRG instrument (for €20m) in October 2013. Documentation for it was signed in December 2014.

The T-Line delay PRG reduces the construction risk of the T-Line and associated substations by mitigating a portion of the risk that the Kenyan Government is unable to meet payment obligations under its support letter to the project company and its lenders.

While the T-Line itself does not form part of the Lake Turkana Wind Farm Project, as an ancillary (or associated) piece of infrastructure, ensuring that it was also given oversight (both from a contractual perspective but also from the point of view of way-leave acquisition and environmental and social management) by both LTWP and its lenders (and particularly DFI lenders that need to look at adverse environmental consequences for associated infrastructure, even if not being financed directly by them) was one of the key pieces to the overall jigsaw. Fortunately, way-leave acquisition is nearly complete and construction has now well and truly started on the T-Line.

Financing structure

The Lake Turkana financing structure – shown in Figure 1 in brief detail (and reflecting information in the public domain) – was finely balanced and negotiated over a period of years. The various elements are described in further detail below.

Figure 1

Senior debt

African Development Bank (AfDB) was instrumental in arranging the senior debt. Nedbank Ltd and Standard Bank of South Africa were appointed as co-mandated lead arrangers in 2010 and together with AfDB secured a DFI-led financing as well as appointing key co-advisers for technical and other advice. African Development Bank was keen in ensuring African DFIs were also involved in the deal, so smaller regional players such as PTA Bank have played an important role.

The European Investment Bank (EIB) remains the single largest lender to the project; it has also been instrumental in giving a thorough environmental and technical review of the project, alongside the lenders’ technical adviser Mott MacDonald. Other European DFIs lending senior funds include Proparco and FMO; both have significant ticket sizes.

Given the Danish content, Danish export credit agency Eksport Kredit Fonden (EKF) offered to issue guarantees (of around DKr1bn) to the two lenders behind the project: EIB and AfDB. The commercial banks also provide certain limited guarantees to EIB.

Equity

The initial developers of the project, KP&P Africa, is  a consortium of Dutch and Kenyan businessmen. In 2009, they joined hands with Aldwych International (which had experience in delivering IPPs in Kenya already, with the Rabai thermal power plant already in operations by then). A collection of Nordic development finance institutions (DFIs), including the Industrial Fund for Developing Countries (IFU), Finnish Fund for Industrial Cooperation Ltd (Finnfund) and Norwegian Investment Fund for Developing Countries (Norfund) make up the balance of the equity, together with turbine supplier Vestas as well as a minority local shareholder. Aldwych will oversee the construction and operations of the power plant on behalf of LTWP. Vestas, under a separate agreement to its turbine supply, will provide the maintenance of the plant with LTWP.

Securing equity for a project of this nature: self-sourced (ie, not publicly procured); with enormous contractual and construction interface risks; geographically challenging, was never going to be easy, least of all on the equity side. There may be investor appetite post-construction of the project and a number of significant players have expressed interest in the equity. The progress in the construction period of the project will be key to ensuring this interest is maintained.

The good old viability gap

There remains a “gap” in the financing of renewables IPPs, particularly in Sub-Saharan Africa (particularly given the existence of subsidised fuel, which distorts electricity tariffs for thermal plans that do not reflect the real cost of capital). The gap itself is that between the revenues needed to make a project economically and commercially viable and the revenues likely to be generated by end-users – who, if they are poorer customers in a frontier or developing market, may not be able to afford to pay those rates or charges.

Financing this gap (via viability gap funding or VGF) has the aim of reducing the high upfront capital costs of privately funded (but publicly necessary) infrastructure investments by providing some kind of subsidised funding for project or construction costs. This kind of funding helps mobilise private-sector investment for the development of projects while at the same time ensuring that the risks of construction and delivery of the infrastructure are shared with the private sector.

Equity, the government or some form of mezzanine or subordinated debt, typically needs to backstop this gap. This has not prevented the successful development of IPPs – and indeed there are a greater number currently in development around the world than ever before – but it is clear that a solution to the VGF issue would be a major catalyst to the development of IPPs in emerging markets. Whether DFIs and multilaterals or the governments of developed nations can provide the solution is yet to be seen. There are several initiatives that aim to plug this gap, from GeTFiT and Green Africa Power to the EU-Africa Infrastructure Trust Fund (EU-AITF).

EU-AITF financial instrument

The EU-AITF (created in 2007) has the objective of promoting infrastructure projects in Sub-Saharan Africa by blending long-term investments from development finance institutions (loans, risk capital, etc) with grant monies from the European Commission to gain financial and qualitative leverage in the delivery of projects (as well as sustainability). With one of its largest financial instruments to date, at €25m, the funding from the EU-AITF was crucial in securing the project’s financial go-ahead.

Subordinated debt structure

In addition to the EU-AITF monies, DEG and the regional bank East African Development Bank (together with PTA Bank and AfDB) provided subordinated debt financing. With a great amount of flexibility shown by the subordinated debt providers in terms of lender rights, the financing documentation was finally signed in March 2014.

Off-taker

Clearly, key to the bankability of any power project is the PPA. Fortunately, KPLC has experience in closing and negotiating IPPs, having signed a significant number of PPAs in the last few years with independent power developers. This has given KPLC an awareness of the requirements of the international lending community (albeit largely that of development banks). This means that KPLC’s team has familiarity with the lender positions on risk allocation for key areas such as force majeure, events of default and change of law protection.

In addition, the Government of Kenya is acutely aware of the political risk protection that is required to finance IPPs, particularly the compensation regime in the event of termination. What remains key (and is as true for KPLC as for any other public utility) is the ability to keep institutional knowledge from one deal to the next. In the early years of public sector utilities’ exposure to private sector development monies, knowledge and deal experience remain within a small handful of key individuals. It is important that it stays there.

In terms of creditworthiness, KPLC has an admirable track record of payments. However, with ambitious plans of the Kenyan Ministry of Energy to expand the power sector as part of the central government’s “Kenya Vision 2030” (which identifies and prioritises the energy sector as a key foundation for economic development), there will no doubt be challenges to the ability of KPLC to secure its own financing and confirm its creditworthiness for long-term payment obligations. The Lake Turkana project showed some innovation in how the liquidity risk was managed (by a combination of letters of credit and escrow account arrangements) that demonstrated some out-of-the-box thinking by government, sponsors and lenders alike.

Land issues

In between the granting of the project site and financial close, Kenya underwent two enormous changes to its laws affecting land rights.

First, the new Kenyan Constitution of 2012 – among other things – devolved certain central powers to new county governments and introduced new categories of land. New county governments replaced existing county councils. Unfortunately, the transitional arrangements that transfer powers between local governments – as well as specific legislation in relation to the administration and dealing of community land – has yet to be passed.

Second, a new Land Act and Land Registration Act in 2012 replace the existing land law of Kenya in its entirety and make a number of significant changes to the substantive law on land (Kenya’s previous land laws – in a colonial throwback that now seems quaint – included the 1882 Indian Transfer of Property Act). These changes impact upon all things relating to land in Kenya, including security. The implementation of the acts themselves is greatly unsatisfactory due to the lack of implementing regulations and subsequent legislation.

The above two changes leave Kenyan land law in somewhat of a vacuum. Nonetheless, the project company’s sanctity of title has been confirmed by the relevant authorities. Projects, including the Lake Turkana wind farm, are still being financed in Kenya despite the relative uncertainty noted above. It remains an issue to be watched for projects in Kenya.

Final thoughts

To mobilise nearly €625m of monies (the largest ever private-sector financing in Kenya) is no mean feat. Add to that no less than 10 European and African development finance institutions providing debt and equity, two commercial banks, two hedging banks, five main contractors, three government counterparties and changing laws.

It is of enormous credit to the Government of Kenya and in particular to the project’s main developers to have had the tenacity and willpower to see the project through from inception to financial close and the start of construction. Lenders, advisers and contractors have also had to keep the faith over a long period of time in order to achieve financial close (which had just been achieved at the time of going to press). Truly, the deal is life-changing for millions of Kenyans, economy-changing for Kenya and an example of development finance at its very best. Hope remains that this remains true throughout construction and for the life of the project.

 

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