In May 2016, Zambia awarded the first two World Bank Group-designed Scaling Solar projects: one to a partnership of France’s Neoen and US company First Solar and the second, to Italian energy company Enel. It had only sent out requests for proposals (RFPs) in October the previous year. Under normal circumstances a project like this might take six years to get from an RFP to financing rather than the six months Zambia achieved.
“Business as usual in Africa is something we really wanted to avoid,” says Linklaters lawyer John Pickett, who has been advising the World Bank on the Scaling Solar programme from the beginning.
Zambia’s price of US$0.602 per kWh, the lowest to date in sub- Saharan Africa, made everyone in the market sit up and take notice. Senegal and Madagascar had signed up for a Scaling Solar auction before Zambia had even finished its process and the Ethiopian government has signed up for an auction of its own. Having completed the bidding for its first two projects, Zambia is embarking on a second tender even though the building of the first two projects has yet to start. Until they do, cynics may snipe about whether the projects will actually come into operation but there is
little doubt that Scaling Solar has the potential to transform the sector.
“It is potentially disruptive and potentially transformational,” says Pickett.
“It’s still early days. The two Zambian projects have to get themselves built. There have to be more projects. Senegal and Ethiopia have to do it. But yes, it really can provide a meaningful contribution to part of the problem. Powering Africa is a very complex and big problem. It can’t do all of it but it can provide a meaningful contribution.”
So what is Scaling Solar? In simple terms, it is a template designed by the World Bank Group’s private sector arm, the International Finance Corporation (IFC), the Multilateral Investment Guarantee Agency (MIGA) and the World Bank, which can be used by governments across Africa to conduct an auction process for solar power projects.
It has been designed to provide security to governments, bidders and financiers. The Scaling Solar team will do all due diligence using donor funds rather than expecting the bidders to do their own. What’s more, the World Bank will provide a partial risk guarantee, which means governments do not need to provide a sovereign risk guarantee to satisfy financiers although the template does include a government support agreement with direct government undertakings.
The World Bank’s team has tried to completely de-risk the project and it wants that de-risking to be reflected in the price.
“We are basically saying to bidders: ‘All you have to do is turn up, sharpen your pencils and give us your best price. We have done all the work for you,’” says Dan Croft, a senior investment officer at the IFC, who helped design Scaling Solar.
Putting in the hard yards
It all sounds too good to be true, which is part of the reason why the critics think it is. However, Zambia’s six-month auction and six cent price is the end result of several years of hard work that the IFC has put into the programme. If the speed of the auction makes it sound like corners have been cut then think again.
Scaling Solar began to take shape nearly four years ago when IFC chief investment officer Jamie Fergusson, principal investment officer Yasser Charafi and Croft, who was then working in the IFC’s advisory division, realised they were all working on a similar concept but coming at it from different angles.
Croft, Fergusson and Charafi believed that solar projects were fundamentally straightforward. Projects had been banked all
over the world. The technology is established and well understood. The cost drivers are simple: capital costs are largely the same for any bidder and the sun shines just the same for every bidder. The main variable is the cost of capital.
“We noticed that a lot of traditional power developers were seeking the same kind of rates of return on a solar PV project as they would on a hydroelectric project but they have very different levels of complexity and we thought
that it ought to be possible to get governments a better deal in solar,” explains Croft.
The team looked at why solar deals were not getting done in Africa and how they were getting done elsewhere. The successful auctions had three things in common: scale, repetition of the process, and competition.
South Africa provided a good example. It had developed its own solar procurement programme.
The South African government had a grid much bigger than many smaller African nations and would be buying more gigawatts of power than most of them. Furthermore, the depth of South Africa’s financial markets meant that the government could check its documents with the country’s four big banks to guarantee they would lend against the document set. It made sense to invest some time building a procurement process and the input of the banks meant they could tell developers that the terms were non-negotiable.
“The government was able to go to market knowing these documents were bankable,” says Croft. “We tried to replicate the South African approach by developing a non-negotiable bidding process and provide that implicit guarantee of bankability.”
Doing it differently
Croft, in the advisory division, would not normally be working with two investment officers. If the advisory services division is helping the government on its tender, the last thing it wants is to be accused of rigging the bid for its colleagues, who are offering finance to private sector parties looking to participate in a project.
“We turned that paradigm on its head,” says Croft. “One of the key things that governments need to do when tendering for projects is to go to market confident that the project is bankable.”
Unlike South Africa, most African governments do not have access to banks willing to guarantee the financing of these projects. So, this is where the IFC stepped in and said it would guarantee to back a project if the government used the standard documentation it was developing. The IFC would offer every qualifying bidder a credit-approved term sheet for debt financing as well as World Bank guarantees and political risk insurance from the Multilateral Investment Guarantee Agency, another World Bank institution.
However, the bidders do not have to take the IFC’s offer of financing. The IFC has to put forward its financing offer first, which means that bidders can shop around for cheaper debt from other lenders. However, the
IFC’s offer gives the government a guarantee of bankability.
“The debt is not a condition, it’s an option,” says Pickett.
The theory was all well and good but Croft, Fergusson and Charafi had to see if it would work in practice. This is when Pickett at Linklaters first got involved. Pickett was called in to referee a dummy negotiation.
First, he drafted a summary of how different countries such as Uganda, India and Pakistan allocated risk. That was the starting point. A draft power purchase agreement and a government support agreement were written and then battle commenced. Croft and his legal colleague took the role of the government and Fergusson and Charafi and their legal advisors acted as bidders/banks/ developers.
“We negotiated as if our lives depended on it,” says Croft. Pickett concurs. Both of them laugh when they recall the arguments that were played out. Croft calls it “entertaining” but one gets the feeling it was a fairly fraught process. Once it was complete they wanted a second opinion and called in another law firm – Norton Rose Fulbright – to check whether the underlying risk allocation was fair for the government and bidders and to check whether it was bankable for lenders.
The preparation was not yet done though. The IFC trio had to sell their approach to all the other parts of the World Bank – particularly those needed to offer the partial risk guarantee. Building a consensus within the World Bank Group was no easy task.
One of the most engrained approaches to emerging markets projects is that even if a private sector concessionaire defaults, ultimately the lenders will get their money back. Equity holders will lose their equity but debt holders will get their money back. Big multinationals and emerging markets lenders have been holding this position for years but emerging market governments hate it.
Linklaters did some benchmarking and found that there were many projects with a form of seller default that had been tendered and never got through to close. However, of all the projects that had gone ahead, seller default was much less common. It sparked a big debate within the World Bank, which went up to the highest levels.
“We ended up saying that the things you could be terminated for, for default, were very limited. In other words, you had to really mess up to get terminated,” explains Pickett. “But if you did really mess up then you don’t get paid.”
The partial risk guarantee was also a big issue. The World Bank brought in a third London law firm (Herbert Smith Freehills) to do its own review. Five developers were also consulted (including Actis, which has been critical of Scaling Solar) to give their input.
“The internal process at the IFC was very rigorous,” says Pickett.
The entire auction process was thrashed out within the World Bank Group over a period of two years to come up with a document that could be used by any government and any bidder and any bank. If Zambia’s six-month auction seems too good to be true, it was because two years of groundwork had already been put in.
While the World Bank was testing its theories, Zambia was experiencing the reality of a severe energy deficit and crisis during 2015, due to drought and subsequent low water levels for adequate hydro power generation from the Kariba Dam facility. Zambia’s President Lungu, who also acts as chairman of the Industrial Development Corporation (IDC), a private company owned by the government, instructed the Corporation to develop and procure up to 600MW of solar PV power
into the national grid as a matter of urgency and priority.
When Croft met with Chitalu Chisanga, one of Industrial Development Corporation’s senior investments analysts, the timing was propitious.
“Being the first time a solar PV plant of such a scale was being implemented in Zambia, there was a lot of expertise needed to successfully implement it and the Scaling Solar initiative offered this expertise,” says Chisanga.
He also praises the open, competitive and transparent procurement model, which helps with getting the lowest possible cost.
“The IFC offers a one-stop-shop solution and package of advisory services, template contracts, financing, guarantees and insurance, drawn from across the World Bank Group. This initiative also facilitates price discovery as opposed to having to negotiate the tariffs without a basis on which the tariffs are derived,” continues Chisanga.
On July 20 2015, the IFC and the IDC signed a mandate giving the first Scaling Solar project the green light for the immediate development of two solar photo- voltaic (PV) plants of 50MW each for an initial total of 100MW out of the targeted 600MW.
“The other option included unsolicited bids,” says Chisanga. “However, the main objective of the IDC was the urgent procurement of Solar PV, and at the lowest tariff possible. Unsolicited bids have usually been known to achieve high and unsubstantiated tariffs.”
Croft, Fergusson and Charafi assembled a team of half-a-dozen IFC staff to work on the deal including a local technical lead and environmental and social speciailists. But the bulk of the Scaling Solar team would be completed by external consultants: Linklaters provided some continuity on the legal front; Parsons Brinkerhoff supplied technical analysis; Ernst & Young were tax advisors and JLT were brought in on insurance.
This crack team of advisors was funded by DevCo, the Infrastructure Development Collaboration Partnership Fund, an IFC managed facility, and by Power Africa, a US government initiative. The costs would be recouped from the winning bidder upon closure.
The pre-qualification process started in October 2015 and 48 bidders applied. Eleven of those were considered to be compliant with the pre-qualification requirements. In February 2016, the IDC issued the final request for bidders and received seven proposals for the two projects. The IDC had decided that it wanted separate providers for each project—in the event that one project failed, it did not want them both to fail.
“The auction went as planned, in fact we didn’t expect we would get such low tariffs,” says Chisanga.
In May 2016, the winners were announced though since then, matters have slowed because of issues related to land use.
“The biggest challenge was having to secure additional land for one of immediate development of initial total of 100MW out of the targeted 600MW the bidders to compensate for what was lost following a requirement by the [Zambian] utility company, Zesco, for a wayleave away from the existing 330KV line,” says Chisanga.
“There are things that you cannot avoid by templating and de-risking and these normally relate to land ownership and title and permits,” adds Croft. “[In such cases] you just need to go through the project pain that happens on any IPP.”
The Industrial Development Corporation has now issued a tender in Zambia for round two of up
to 200MW. Round three will follow to complete the implementation of the 600MW directed by the President. In Senegal, the pre-qualifying process has been completed and narrowed the field to 12 bidders. Then there is Ethiopia and Madagascar and
of course countries outside Africa can also benefit. But while other nations are following Zambia’s lead, the question arises whether other parts of the energy sector can learn lessons from the apparent success of Scaling Solar?
“We’re looking at other areas where we might be able to use staple finance and other credit enhancement PRG products ,” says Croft. “But whether templating works to the same extent in other areas is less certain.”
It is the simplicity of solar that makes this process possible —wind turbines and hydroelectric projects would likely need a lot more site- specific data, which would slow the deal down immensely.
“Because solar is so well understood, we feel much more comfortable putting our term sheet out there and saying that whoever gets through this process gets to ask us for money on these terms,” adds Croft. “With more complex technologies, we would want a more careful look at the technology and the solution for a specific site.”
There is clear enthusiasm for the model within the World Bank Group and on the ground in Africa.
“The intention was not to queer the pitch for others,” comments Croft. “The intention was to open up the solar space for the private sector in Africa; to allow developers to compete on a level playing field with full transparency; and to deliver the lowest possible cost of power to the end consumer, recognising the high levels of poverty in many of the countries in which we operate.”