Current need and opportunities
The International Finance Corporation (IFC) and the Emerging Africa Infrastructure Fund recently co-invested in a US$97.6 million social bond issuance to support access to electricity in Ivory Coast. African countries, however, need around US$28 billion of investment each year for the next seven years if they are to meet the ‘Access to Energy for All’ target under the United Nation’s (UN) Sustainability Development Goal 7 (SDG) by 2030.
Africa’s energy deficit is a multi-billion-dollar challenge which presents a real opportunity if some of the barriers to accessing funding can be managed by a combination of early-stage deal structuring advice, regulatory reforms, and risk protection mechanisms. With these market pillars aligned, Africa would be well placed to tap into international capital markets funding and improve access to electricity for its 1.2 billion population.
Electricity is a critical asset class capable of generating profits to reward investors adequately. Africa has the fastest growing population in the world, with an expanding urban youth population of middle-income earners for whom electricity is a critical utility and not just a luxury. Therefore, Africa has a ready consumer market to bring in the cash flow required to generate an acceptable margin on investment returns for investors. A bond issuance funded by capital market investors to improve access to electricity using a conventional bond structure can therefore be a win-win for originators and investors. The proceeds from the issuance can be used to expand grid connections or develop off-grid power solutions to improve access to electricity.
At this year’s Global Steering Group for Impact Investment summit held in Malaga, local experts from Africa leading on panel discussions mentioned that they are working increasingly with various stakeholders to improve deal execution efficiency in capital raising projects. Intermediaries with development finance and project management experience in the region, spanning more than two decades are using technology to provide market intelligence to support government agencies, local entrepreneurs and end-users in designing investable debt financing programmes. The next step should be to market actively the programmes designed, using on-line platforms to gauge investor appetite. This should reduce the time spent in deciding whether a product is a good fit for any given group of investors and provide the necessary information required to determine the programme’s return and exit profile early on in the process.
The continent has natural gas reserves and good conditions for wind and solar electricity generation, which can all be monetised to invest in its energy needs. A good example of how Africa’s wind and solar resources can improve global access to clean energy and generate a good return for investors is Xlinks’ US$22.6 billion wind and solar farm project which aims to cable link Morocco with the UK and power 7 million homes in Britain by 2030. The energy will be transmitted using an undersea interconnector and, upon completion of the project, the facility is expected to generate 20 hours of renewable electricity per day using a combination of sunshine and windy night-time conditions.
Access to international capital market is required in order to scale up investment. Africa’s domestic markets alone are not big enough to fund the kind of projects needed to transform the continent’s energy sector and realise the product’s profit-making potential. Big ticket energy projects require funding from international investors, Development Finance Institutions (DFIs), Multilateral Development Banks (MDBs), government agencies and a strong private sector.
Existing financing and access to funding in international capital markets
While development bonds (DB) and public-private partnerships are all viable funding structures to tackling Africa’s energy deficit, a pooled or blended financing approach that includes access to international capital markets is needed to scale up and increase deal origination and financing volumes. For this to happen, the continent should improve on: deal efficiency, regulatory landscapes and granular political risk assessment, as the political risk blanket approach that investors tend to apply across the board to all 54 nations results in a premium on deal pricing.
Repayment of the recently issued IFC-Ivory Coast social bond is secured on the receivables of revenues generated from electricity tariffs. The social bond issued is a capital market regulated instrument, and it demonstrates how Africa’s energy sector can access and benefit from secondary market investment opportunities. The World Bank and the IFC launched the Joint Capital Markets Program in 2017 to help the West African Economic and Monetary Union and six priority countries develop and deepen their capital markets.
Similar to a conventional bond, a social bond is a loan from an investor to a borrower on which the borrower will pay interest and the original amount of principal back over an agreed period. A key difference from a conventional bond is that the return is entirely based on the achievement of a prescribed social outcome.
There is, of course, the deal pricing aspect to consider in debt financing transactions. Is the deal available at the right pricing point i.e., is the return offered worthwhile? Deal pricing scores high on the list as one of the main reasons why most debt financing programmes in Africa are aborted at the conceptual or proposal phase. The key driver of the deal pricing tends to be the perception that the risk involved in doing business in the continent is higher than in other regions due to political instability. This perceived political risk is applied to all 54 nations across the board even though political instability is in fact a country specific risk. As a result, Africa debt financing programmes usually attract a premium margin (referred to casually in some quarters as the ‘Africa premium’).
Building and supporting capital market infrastructure will improve access to capital. A lack of robust regulatory framework to support secondary trading in many African countries makes it more challenging for the continent to access international capital market funding opportunities through public bond offering. That said, a mix of leading regional financiers and international investors continue to invest in private, unlisted and unrated bonds to fund a range of products from trade receivables to microfinance institutions.
COP 28 and future development
More generally, affordable financing solutions for developing countries to fund clean energy initiatives is one of the four paradigms on the agenda at the UN’s 28th Climate Change Conference or the Conference of the Parties (COP 28) to be held in Dubai, UAE from 30th November to 12 December 2023. Global leaders and financiers attending COP 28 will consider solutions to the current “fragmented” international financial architecture as a means to unlocking the US$2.4 trillion of annual investment developing counties require by 2030 to meet the SDG 13 climate action target.
Overall, an innovative and transparent regulatory environment, human capital, credible market intelligence and commercial partners with deep pockets in cash funding and not just grants are what Africa requires to transform and monetise its energy sector across all its 54 nations. Electricity is a necessity and so there is a ready market for the product output if the challenge in balancing the deal pricing point with market potential can be overcome.