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Introduction to Private Funding Structures

Introduction

The purpose of this chapter is to introduce some private sector business models which have been applied to finance transmission infrastructure in other parts of the world. More detailed information on the different funding structures will be provided in the following chapters which dive into the details of each model. This chapter aims to provide tools to ensure that well-informed decisions can be made. More specifically, we will look at key considerations in determining whether these business models are, or could be, applicable in a particular country or market.

Which model is more suitable for a country or a specific project depends on many factors which are country and project-specific. A detailed assessment is recommended to identify all the relevant considerations and provide the advantages and disadvantages of the various options, so the government can make the best decision. Nevertheless, whilst private sector involvement in the transmission sector can take many forms, this book will discuss:

The two most applicable structures to the African context based on the current state of its electricity supply industry are the IPT and the whole-of-grid concession. For this reason, more details will be provided on these two models than on privatisation, merchant lines, and industrial demand-driven models.

Key Considerations

Ownership, control, and maintenance

An obstacle to privately financed transmission infrastructure is often the perception that the national power company or transmission system operator (TSO) will lose control over the sector. On the contrary, in many cases, the private investor builds the transmission project and turns over the operation of the assets to the TSO immediately upon completion of construction and project acceptance. In other cases, the private investor only owns and operates physical transmission assets without managing the electrical system and coordinating generation dispatch and power flows.

Another important consideration is that ownership and control do not have to be held under the same organisation. Who owns the transmission infrastructure may vary depending on whether it is an IPT or a whole-of-grid concession. It is also possible to find variations within the same model. For example, an IPT may be entitled to own the infrastructure which it constructs on a long-term basis, but it may also be a condition of the project documents or a condition of the relevant licensing regime that ownership of the assets is transferred to the state-owned utility or another state-owned entity at the end of a fixed period.

Furthermore, operation and maintenance can be separate as maintenance of the transmission assets (under the project) can be carried out by the private investor or a maintenance contractor or even be subcontracted to the national transmission company.

Depending on the objectives of the government, it is, therefore, possible to calibrate the degree of control retained in respect of the transmission asset as well as define the ownership of the asset during and after the duration of the core agreement.

Financing and risk allocation

Although there are many advantages to private funding, the nature of the financing will also carry constraints and requirements. When choosing a private funding model for financing transmission infrastructure, a government must be aware that it will require efforts in negotiating a complex commercial transaction often driven by well-established market standards. This is especially true when it comes to project finance which is typically the method of financing for IPTs.

Risk allocation is the key component of project financing and by extension may determine the success or failure of the privately-funded transmission project. While there is a natural tendency to attempt to shift risks to other parties, it is wise to keep in mind the golden rule of risk management: Each risk should be allocated to the party that is in the best position to first control/reduce it and then manage it. Imposing risks on the private investor, even though it is not in the best position to manage them, will typically result in a more expensive or even unbankable project. Allocating the risks to the party which is in the best position to manage them will help to de-risk and reduce the overall cost of the project and the final tariffs.

Regulatory framework

There may be concerns that the legal/regulatory framework may not be ready for some forms of private investments. Although this may be a genuine challenge, it is not an insurmountable obstacle. It is usually possible to put some of these models in place within existing frameworks. If legal change is required, the project could be structured to address the lack of laws/regulations (regulation by contract) and can be used as a testing ground to learn from and ensure that the laws/regulations which are finally approved are the right ones for the country.

Approach to Risk Allocation

As is the case with all power projects, transmission projects have many risks, some unique to transmission and others similar to all power projects. The most challenging risks in private transmission projects are: 1) land acquisition (“rights-of-way”) and 2) securing the revenue stream.

While each country and project have their own uniqueness which needs to be taken into account, some important lessons learned have emerged from the numerous transmission projects that have been implemented so far:

We would further note that countries that have successfully delivered IPPs may well choose to replicate some parts of the documentation structure of IPP models into the transmission sector. This may inform, for example, how the risk allocation between the government and the private sector is documented. In countries where political risks are taken by the government by way of a put/call options agreement (PCOA) for example, this documentation method may be replicated in the transmission sector. In other countries, political risks are dealt with in an “implementation agreement” or “concession agreement” and government officials may be more comfortable with both the nomenclature and risk allocation set out in these documents, as negotiated in the IPP space.

While it is important to be efficient and not “reinvent the wheel”, it is also crucial to take a fresh look at how risks are allocated as there may be particular differences in the risk allocation agreed in that country on the generation side that does not apply to the transmission side, due to the specific nature of a particular project.

The Role of Key Stakeholders for Privately Funded Structures

The private developer/investor can be responsible for some or all of the project preparation, design, financing, construction and operation of the project. Depending on how and when the project developer will come on board, it may have substantial project preparation activities to complete. This depends on the procurement approach to select the developer/investor (competitive bidding or sole source).

Financing will typically be provided by other organisations too, including equity and debt. The financial institutions will carry out due diligence of the project including review of the various contracts, as well as assessment of the risks and project “bankability”, ahead of financial closure. At financial closure, the lenders will commit to the project and their funds will be drawn down to fund construction.

The government may have a substantial role to play in the transaction, especially if the project is not commercially viable. The risk allocation matrix in fact should determine the role of each project stakeholder including the government. In an IPT, the investor and the government may enter into a Government Services Agreement (GSA) which supplements the agreement between the investor and the offtaker.

Often, the Multilateral Development Banks have a substantial role to play. In the case of a financially unsustainable power sector, the government might work closely with the MDB to develop a roadmap to power sector sustainability. This roadmap could be developed in parallel with the project but it should include specific milestones which should be monitored and may be linked to the project agreements. Also, the MDBs may provide:

Last but not least, bilateral organisations and donor agencies could play a catalytic role too. They may help with technical assistance in project planning activities, but also they may provide grants or concessional lending because the projects fulfil an important role in the country’s economy. Also, they may provide funding to close the viability gap (e.g., similar to KfW’s GETFiT programme). In this way, scarce grant funding can be used in a targeted way to unlock larger sums of private sector investment. Private sector procurement and management practices can also benefit projects which may otherwise have been solely donor-led or implemented by transmission utilities with capacity shortages or governance shortfalls.

Providing hybrid private sector/donor funding for IPTs, for example, can significantly boost the availability of funding to the sector. The provision of grant funding for a project may not have a positive or negative impact on investor returns since funding models for this asset class are typically fixed or capped. The impact of viability gap funding like this would simply increase the envelope available to multiply the number of projects which can be undertaken.

Resources

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