Top Investment Opportunities in Ethiopia and Tanzania’s Renewable Energy Sector
What are our favorite three to five ideas for the decade ahead regarding the potential for private finance and delivery of public infrastructure in our sector in these cities?
Broadly, our favorite ideas for investment can be stack ranked by capacity and divided between on-grid and off-grid opportunities as illustrated in the this diagram.
Wind turbine facilities will be the first IPP entrants because the country has excellent wind resources, the authoritarian government has extraordinary powers to rezone suitable project sites, and long-term operating requirements for wind farms are manageable by trained domestic workers. Wind will outpace solar and geothermal as the renewable source of choice for private projects: geothermal requires risked capital to drill before the reservoir is well understood and the process complexity of an operating geothermal facility is prohibitively high. Utility-scale solar would be preferable to wind if operations and maintenance were the only criteria, but currently the cost to import the panels and balance of system materials drives the project capital cost above wind for the near future.
Although the first round of projects will be large, led by international developers, and feature limited local content, we believe that these projects will pave the way for domestic developers in 5-10 years. Following a series of larger projects, the IPP process will streamline as the government develops an expertise in cultivating private investment. A well-oiled IPP process will encourage domestic developers to deliver smaller wind projects in a distributed and equitable fashion across the culturally diverse regions. Skilled Ethiopian workers who trained on the larger projects will form their own development groups and employ a larger portion of Ethiopian nationals in the development and implementation process. We expect this iteration of IPP projects to be on the order of 20-100 MW, given the reduced regulatory burden, lack of domestic developer track record, and initial hesitance of private financiers. In seeking private finance, these domestic developers will be able to point to the functioning IPPs within Ethiopia as a demonstration for what financiers may expect. In a similar fashion to the first iteration of IPPs, we expect the negotiated tariff to be sufficient for cost recovery. Instead of requiring power exports to subsidize domestic consumption, we believe that the Ethiopian utility will have incrementally escalated the domestic rate over the preceding 5-10 years in order to match expected IPP cost recovery rates.
In parallel to the development of grid-connected IPPs, we expect that off-grid residential solar, farm-scale biogas systems, and district microgrids will flourish while rural citizens wait indefinitely for access to the grid. These systems, sized on the order of 1 kW to 1 MW to 20 MW respectively, are available for deployment today as they do not require torturous regulatory approvals by the government. Minimally capitalized NGOs and domestic startups will creatively pair new technologies (e.g., low complexity manure digesters to produce home cooking gas) with new business models (e.g., microfinance, mobile money) in a way that works best for rural Ethiopian citizens to participate en masse. We believe that microfinance solutions will help to mitigate the high upfront costs of these systems and mobile payment platforms such as Kifiya can be an effective mechanism for payment collections from a large, disperse customer base.
Although both countries share similar urban/rural proportions, Tanzania’s utility TANESCO is far more organized and transparent about its near term plans for grid extension. Given Ethiopia’s bottom-up, haphazard, and opaque approach to grid planning, we expect a smaller total install base of off-grid solutions as private players feel uncertainty about deploying assets into a rural location that faces an uncertain likelihood of receiving grid access in the next few years.
Tanzania is more welcoming to private investment and has a higher retail electricity rate than Ethiopia (approximately $0.12/kWh in Tanzania vs. $0.025/kWh), which should help spur larger scale renewable energy project development and operating opportunities for independent power producers. The opportunity to own and operate these facilities will be a significant opportunity for private investment.
Once TANESCO reduces its debts and restores faith in its creditworthiness (though this may take many years), private investors will find a welcoming market for a diverse set of renewable energy projects, as Tanzania lacks local expertise to develop these technologies and TANESCO will not be able to independently finance these facilities. The most recently issued Power Systems Master Plan lays out a five-year plan with 450 MW of wind development (350 MW specifically in the Singida area), followed by 200 MW of solar development and 300 MW of geothermal within 7 years. However, these totals are diminutive in comparison to the planned 4.8 GW of hydropower, 2.7 GW of natural gas, and 1.4 GW of coal. While most of Tanzania’s generation needs will be sourced from traditional sources like natural gas and coal, Tanzania’s excellent wind and solar resources combined with declining equipment costs worldwide will enable large-scale projects to be developed quite economically relative to retail rates. In addition, renewable sources offer Tanzania additional diversification and protection from hydro variation. TANESCO is incentivized to procure these renewable energy systems because they are proactively building out high voltage transmission lines to be able to deliver this power to load centers and to export to neighboring countries. Once Tanzania has available power delivery capacity, opportunities for cost-effective power generation development will open up.
One of the downsides of Tanzania’s approach is the low likelihood of transferring this expertise to domestic developers. Unlike Ethiopia, Tanzania will likely encourage development of a handful of large renewable energy projects, which provides limited opportunity for knowledge transfer to occur and for domestic developers or manufacturers to emerge.
Where there is significant opportunity for local employees and local industry is off-grid solar home or microgrid systems. Because these systems are much smaller in nature, they are also less technical and more electrically simplistic in terms of their installation, making the knowledge transfer for solar much easier. In addition, developing off-grid systems in a way that prevents electricity theft and is integrated and useful to the community requires local knowhow. These community-based projects create both temporary construction jobs and a couple longer term employment opportunities in each community.
Given the challenges around TANESCO’s creditworthiness, we believe that the off-grid opportunities are quite massive, allowing rural residents to leapfrog past traditional fuels as they wait for the grid to catch up. More than 50% of Tanzanians today have no access to electricity and in some communities, they are already paying upwards of $2-3/kWh for their power, more than a 10x premium to the grid’s retail rates. The higher cost of power helps compensate for the significantly higher cost of installing each of these small <100kW solar systems that are terrible at capturing economies of scale.
There are two major financing risks of these systems. First, TANESCO or REA might aggressively build out the grid, which would eliminate the premium rate charged by the microgrid. Second, there’s an uncertainty around consumption volume, as the system profitability depends on high utilization of electricity. To mitigate these risks, we believe that microgrid developers have a huge opportunity to leverage the successful connections they’ve made with the community to also provide other products and services at financed/lease rates. These private companies have direct access to their electric customer base, reducing marketing costs. Using these sales channels, companies can also offer microfinanced home appliances, commercial mill or sewing equipment, and/or water purification systems to enable consumers to access higher capex items at a lower ongoing rate. As citizens are more productive (e.g., with access to small agrimills), they can make more money, consistently consume more electricity, and afford more products/services, creating a virtuous cycle. These lines of revenue help protect the developer against the risk of grid electrification and supplement the project’s profitability.
Recommendations for the Private Sector
What are the key things that private investors and operators need to do to make these ideas into reality?
Within the next 5-10 years, private investors and operators looking to transform the aforementioned ideas into reality must:
- temper their expectations with patience and tenacity
- anticipate the financial and project risks of being a first-mover in an undeveloped sector
- leverage various international and government organizations to obtain financing
- decrease project costs and risks as well as receive project buy-in
As Ethiopia works to streamline the IPP process, private investors and developers must be patient while experiencing the pain points of being the first to go through the process. In doing so, private investors and operators will also have the unique opportunity to work closely with the government to refine the process which will undoubtedly have future benefits. Given that projects are rarely on schedule, investors and operators must also buffer their project timelines, budgets, and expected financial returns to reflect this reality. We suggest a minimum of a 12-month financing reserve and schedule buffer for potential problems such as deal stagnation. Private investors and operators should also heavily leverage agencies such as the World Bank’s IFC and the Ethiopian Investment Commission for financing to make projects more financially viable and improve expected returns. We believe that after 10 years, the landscape for private investors and operators will be much more developed and standardized, and the private sector will be able to model new projects based on successfully implemented projects and creatively differentiate themselves to win in a competitive tender environment.
Although the environment is friendlier in Tanzania, private investors and operators should take the same actions outlined above. Specific to Tanzania, we suggest that they look first to generating buy-in from the rural village leaders before seeking to start a project. This may take the form of completing some sort of goodwill for the community such as helping to establish roads or bridges. Establishing relationships with the village leaders, which can often be time-consuming upfront, will create a barrier for other investors and operators. It will also be instrumental in ensuring the safety of the investments and protection from theft of electricity or any of the other goods and services.
Additionally, private investors and developers should account for the future risks of TANESCO or REA eventually building out the grid in these rural areas and thus decreasing the prices in the long run (though this seems improbable within the next 5-10 years). Private investors should push developers to think more broadly about other basic community services they can provide, to help hedge the grid connection risks. Along those lines, private investors and developers should partner with commercial users who will become in-grid tenants for off-grid projects and provide revenue stability as well as commercial opportunities to grow the economy of the rural villages.
Power System Master Plan 2016 Update, United Republic of Tanzania Ministry of Energy and Minerals, http://www.ewura.go.tz/wp-content/uploads/2017/01/Power-System-Master-Plan-Dec.-2016.pdf, accessed January 2017.