International Energy Agency has released a report titled “Africa Energy Outlook 2022“. REGlobal provides an extract covering the status of finance in Africa’s energy landscape.
While Africa accounts for almost one‐fifth of the world’s population, it attracts less than 5% of global energy investment. This is spread unevenly across the continent. Ten countries accounted for 90% of private investment in energy and electricity infrastructure on the continent over the last ten years, South Africa alone accounting for nearly 40% (World Bank, 2021). Total energy investment in Africa was already declining prior to the pandemic and fell even more quickly in 2020, by over 20%. The USD 73 billion invested in 2020 was equal to just 3% of Africa’s GDP. In 2021, spending is thought to have recovered to just below its 2019 level.
Historically, fossil fuel supply has accounted for the majority of energy investment in Africa, driven by oil production. However, since 2016, capital spending on fuel supply has fallen by more than a fifth with a shift to less risky projects elsewhere. Clean energy investment has failed to make up the difference, with around 60% of total spending still going to fossil fuel supply over the past five years. The clean energy transition in Africa depicted in the SAS requires not just a shift in investment flows away from fossil fuels, but also a near doubling of total capital over 2026‐30 compared with 2016‐20. This pushes up energy investment’s share of GDP to 6%, slightly above the average for emerging economies as a whole. Investment averages about USD 190 billion per year across all segments of the energy sector, including access, over 2026‐30.
Clean energy investment, mainly in the power sector, increases sixfold, taking its share of total investment to 70% (Figure 3.30). The heightened call on capital in the SAS comes at a time when African governments are confronted by financial pressures, made worse by Covid‐19‐related debt, meaning private markets will have to play a key role.
There is a major reallocation of capital to the power sector in the SAS (Figure 3.31). The achievement of universal energy access and rapid growth in electricity use drives a near tripling of investment in the power sector over 2026‐30 compared with 2016‐20. The power sector’s share of total energy investment jumps from around one‐third to over half. Investments in fossil fuel supply continue to decline, though they remain significant in the producer economies of North Africa, accounting for 40% of energy investment over the current decade. Natural gas investments ramp up to account for nearly half of fuel supply investment, as new gas discoveries move ahead in Senegal and Mauritania and existing fields are developed further. LNG terminals and supporting infrastructure also come online to support exports in Mozambique.
The shift in spending to power is most pronounced in sub‐Saharan Africa, where roughly a third of investment in that sector over 2021‐30 is needed to expand electricity access. End‐use investment jumps nearly sevenfold driven by a surge in purchases of more efficient appliances, cooling systems and vehicles. New financing structures that prevent customers taking on unsustainable costs will need to accompany this rise in spending.
Financing costs – capitalised interest on debt and equity returns – also increase due to the shift in investment from fossil fuels to power, which is more capital intensive, though the additional costs are largely offset by savings on operating costs, notably fuel in power generation and energy savings in end‐uses. With the shift to more capital‐intensive projects, the cost of capital becomes an important determinant of total investment costs. In the SAS, financing costs for power generation capacity rise from 2% of electricity generation costs in 2016‐20 to 10% in 2026‐30.
The weighted average cost of capital (WACC) for energy projects in varies, with actual and perceived risks resulting in an average cost of up to seven‐times higher in Africa than in Europe and North America. The equity risk premium and country default risk in some leading African economies were declining before the onset of the Covid‐ 19 pandemic, but have rebounded due to growing public debt and increased investment risks. Were the WACC for solar and wind projects in Africa to fall to the average level in the advanced economies, financing costs would be reduced by USD 3.8 billion in 2030, lowering the levelised cost of generation of electricity supplied to households by USD 3.4 per megawatt‐hour (MWh), or 4% (Figure 3.32).
Policy action targeted at energy projects could help reduce their WACC. Measures include competitive tendering, contract enforcement and revenue support mechanisms, such as guarantees, together with measures to improve the credit worthiness of off‐takers. But they would not be sufficient to bring down the WACC to levels prevailing in the advanced economies due to underlying, economy‐wide factors related to macroeconomic stability, private ownership rights and underdeveloped financial systems. Macroeconomic conditions and the general investment climate have worsened across the continent since the start of the pandemic resulting in the downgrading of 18 sovereign credit ratings covering African countries since the pandemic began.
Morocco has been downgraded from investment to junk grade, leaving only Botswana and Mauritius in the former category. All countries in Africa rank below the average for the advanced economies in the World Bank’s Doing Business (World Bank, 2020). International investors are often deterred by the prospect of long project lead times due to inefficient bureaucracies, the lack of energy expertise within the workforce and higher corruption and contract risks than in their home markets. Cross‐cutting risks primarily stem from weak governance, poor policy design and a lack of administrative capacity, as well as market designs that favour state companies and skewed pricing arrangements, including subsidies.
African governments are seeking to lower these risks. For example, the Moroccan Agency for Sustainable Development was created as a tendering agency, an intermediary offer‐taker and a hub for most project‐related inquiries to improve the tendering and interconnection process for independent power projects. Pricing reforms are also underway, with countries such as Egypt and Tunisia, reforming fossil fuel subsidies, and South Africa, Côte d’Ivoire and Senegal either implementing or reviewing the possibility of carbon pricing. That said, some of the more fundamental risks – such as the lack of available skilled labour – are likely to prove more time consuming and complex to fully resolve.
Creating a pipeline of bankable projects for a range of investors is one of the biggest tasks in scaling up energy investment in Africa. The high level of perceived and actual risks in Africa raises the bar for projects to be considered viable by financiers, particularly for projects with smaller transaction sizes that already struggle to attract finance from major international capital providers. Using concessional finance for technical assistance, project preparation and early stage project development are vital to creating such a pipeline.
Structure of energy finance
The way energy investment in Africa is financed must evolve to support the more than doubling of energy investment by 2030 and a shift towards low‐carbon projects as in the SAS pathway (Figure 3.33). This includes the type of capital provider, instrument, origin of the provider and financing structure.
- Capital providers can be private or public sector. The private sector accounted for over 60% of total energy investment in Africa in the 2016‐20 period. Public sector entities, such as public utilities and national oil companies, play a larger role in energy sector investment in Africa than in other regions. State‐owned enterprises, particularly utilities, often face high debt levels. In recent years this has required repeated capital injections either from the state or from public finance institutions (PFIs), which reduces their ability to finance higher investment. State enterprises need to continue to play an important role as co‐investors, but private sector participation will need to grow, particularly in the power sector. Regulatory barriers to private sector participation are assumed be lowered in the SAS, including through a larger role for PFIs to provide blended financing to reduce perceived risks and financing first‐of‐a‐kind projects. PFI financial flows grow to account for 10% of overall investment by 2030, helping to leverage more private finance.
- Instrument: Debt financing makes up less than 40% of energy investment in Africa today, reflecting the prevalence of equity‐based financing from IOCs. The high share of equity compared with the global average persists in the SAS, due to the perceived risks of investing in domestic projects, nonetheless, reliance on debt financing rises. Given concerns about the sustainability of public debt, this will require increasing the availability of privately sourced debt, which is generally constrained in Africa. Commercial banks, which have a preference for short‐ and medium‐terms loans, and institutional investors often lack the institutional expertise to assess infrastructure credit risks.
- Origin of finance: International financial flows, which went mainly to oil and gas projects over 2016‐20, shift to power and end‐use sectors, requiring an unprecedented level of international private capital. This hinges on an increase in international concessional financial flows through new sources of climate‐related finance and regulatory reforms that attract more private capital. Domestic capital also expands in absolute terms, almost doubling by 2026‐30 compared with 2016‐20, but like international private capital, often requires concessional finance to de‐risk projects, opening participation by African pension plans and commercial banks. This expansion of domestic financial participation also remains key to hedging against currency and inflation risk, which may remain high in the near term, and can help cultivate local capital markets. Direct foreign investment from Chinese firms has played a major role in African infrastructure investment.
- Financing structure: The majority of primary financing for energy investments both globally and in Africa currently comes from capital incorporated into a company’s balance sheet or from consumer assets. Oil and gas projects and electricity grid investments are almost exclusively funded through the balance sheets of the developer. In the SAS, improved policy and regulatory frameworks strengthen the reliability of returns on clean power assets, allowing the share of off‐balance sheet or project financing to double to over 20% of energy investment by 2026‐30. Important measures include introducing auctions and standardised power purchase agreements, such as under the GET FiT scheme in Uganda and Zambia, and allowing private participation in regulated networks in more established markets. Energy service contracts, such as those used in Morocco, or aggregation of small‐scale assets, including access solutions based on PayGo models, help to strengthen off‐balance sheet structures for end‐use sectors, but remain highly dependent on the financial situation of particular countries.
Tapping into new sources of finance
Mobilising the required level of finance will mean taking advantage of new sources of financing for clean energy. Since the signing of the Paris Agreement in 2015, global climate commitments have resulted in a new avenue for financing energy transitions in Africa. Meanwhile, economic development in Africa is driving up the pool of available domestic capital, though most domestic financial markets remain underdeveloped and ill‐equipped to channel this capital into clean energy projects.
Climate finance is an increasingly important source of financing in the SAS. Developed countries jointly provided and mobilised USD 79.6 billion in climate finance in 2019, of which roughly US 5 billion, or 7%, went to energy projects in Africa (OECD, 2021). In order to catalyse the increase in clean energy investment projected in the SAS, we estimate that annual climate finance flows from developed countries to Africa would need to increase fivefold in the 2026‐30 period compared with 2019 (Figure 3.34). Reaching this target will depend on developed countries continuing to direct concessional financial support to climate mitigation and on balancing this long‐term priority with the urgent need for debt relief and emergency support to guard against skyrocketing food and fuel prices.
Carbon markets could help African countries develop mitigation projects and receive further climate‐related investment. COP26 agreed the rules for Article 6 of the Paris Agreement, which enables countries to pay for GHG reductions or removals in another country to meet and go beyond their domestic emissions reduction commitments. This can be done bilaterally through Article 6.2 using internationally transferred mitigation outcomes (ITMOs), or through a new international carbon market, known as the Article 6.4 mechanism.
Twenty‐four African countries have signalled their strong interest or intention to take part in carbon markets under Article 6 in their latest NDC submissions (Michaelowa et al., 2021). ITMOs could generate USD 225‐245 billion in net financial flows to African countries and prevent the emission of 3,500‐3,850 Mt CO2 over 2020‐30 (around 22‐24% of Africa’s total energy‐related CO2 emissions over the period), and USD 1,130‐1,865 billion and 14,750 Mt CO2 over 2020‐50, compared with scenarios without Article 6 co‐operation (Yu et al., 2021). This implies the implementation of Article 6 mechanisms could deliver financial flows that exceed 20% of investment in clean energy in Africa by 2030 and reach roughly 30% by 2050 in the SAS (Figure 3.35).
African countries need to develop new systems, institutional frameworks and monitoring procedures in order to exploit Article 6 opportunities. Article 6.2 bilateral trading of ITMOs can already take place, with Ghana, Morocco and Senegal having signed cooperation agreements with Switzerland (BAFU, 2021). Issuing credits under the Article 6.4 mechanism may take up to two years. Two new coalitions, the West African and Eastern Africa Alliances on Carbon Markets and Climate Finance, aim to foster sub‐regional co‐operation and enhance readiness for implementing Article 6, with pilot activities in African countries already underway (Climate Finance Innovators, 2020).
African capital markets remain small, despite growth in recent years. Many financial systems in Africa do not have sufficient liquidity to provide long‐term financing, which results lending for short time periods (70% of lending is less than five years). However, sovereign wealth funds (SWFs) and pension funds are growing sources of long‐term capital, with total assets under management (AuM) for SWFs estimated at USD 80‐90 billion, almost 90% of which are in oil‐producing countries in North Africa (IFSWF, 2021; Murgatroyd, 2020). The AuM of African pension funds was last estimated at over USD 300 billion in 2019 but are projected to grow significantly (BrightAfrica, 2019).
Unlocking these sources for energy projects requires regulatory changes to increase their allocation towards infrastructure or to bring in concessional finance, such as grants, first‐loss loans or guarantees, to make energy projects investment grade. For example, in Kenya, the Retirement Benefit Authority increased the threshold for pension fund allocations to infrastructure assets from 5% to 10% in 2021, which resulted in the Kenya Pension Funds Investment Consortium committing to spending over Kenyan shilling 25 billion (USD 229 billion) on infrastructure over 2021‐26 (US Embassy Kenya, 2020). But there are still a number of cross‐cutting risks that deter domestic capital and few bankable projects, i.e. projects that have a viable financial, economic and technical plan and acceptable credit risk. Green banking institutions, often supported by international grants and concessional capital, can help to lower these risks.
Using public funds to mobilise private capital
Maximising the catalytic potential of public finance while not crowding out private capital is crucial to financing clean energy projects in Africa. Highly concessional capital, particularly grants, have been used for developing many projects that have struggled to reach bankable status in least developed countries. However, many projects that used to rely exclusively on grant financing, such as electricity access projects in remote villages, have begun to use models that rely on a mix of concessional and commercial financing. These models, which are forms of blended finance mechanisms, use limited concessional public capital to lower financing costs and attract private finance.
This approach gained traction in the 2010s and since 2015, blended finance transactions have averaged approximately USD 9 billion per year worldwide. Africa makes up the largest share of these, accounting for 60% of transactions in 2020 (Convergence, 2021). Several innovative approaches have been developed, including financial institutions using blending to increase their own lending base, as well as the more traditional use at project level.
Despite clear potential for blended finance, it does not always attract much private capital. Available evidence shows that blended finance is most often used by DFIs and multilateral development banks to de‐risk their own capital. The requirements for investment returns at these institutions result in most of their concessional support going to projects where they are the dominant financier, instead of targeting the concessional capital to de‐risk projects to a level that would be attractive to a private sector, particularly in the least developed countries (Attridge and Engen, 2019).
A lack of data on the amount of private capital mobilised by blended finance transactions also limits the ability to analyse which instruments have proven most effective under different conditions. This contributes to an over reliance on concessional loans, which are the most common instrument used and are therefore often the easiest for providers to analyse and prepare. Understanding where the private sector can take the lead versus where international public capital must continue to play the primary role is important to target limited concessional finance flows more effectively.
Ways in which blended finance solutions have been applied in Africa include:
- Enabling environment: Development aid has provided technical assistance grants, training, fund internships and personnel exchanges, and project preparation grants. Lack of technical expertise in government bodies and domestic financial institutions can delay project development and drive up financing costs.
- Energy access: Concessional and blended finance has supported mini‐grid development and solar home system connections in several countries, including DRC, Kenya and Nigeria. Connection costs for poorer households can be subsidised via grants and social impact bonds (a form of results‐based financing), or with innovative new carbon finance models, such as in Senegal. Grants can also be used to fund pilot projects for productive uses, e.g. irrigation pumps, cement kilns, as in Kenya, or to support bundling of small projects into one investable unit.
- Electricity networks: International concessional finance has been used to strengthen the health of utilities, such as in Kenya, or to support governments with reforms that will allow more private participation in grids, for example in Sierra Leone and Uganda. Private participation in transmission and distribution networks currently is not widely authorised in Africa, though new reforms are being tested in Kenya. Concessional capital can be used for demonstration projects of private sector participation in grid operation or development, lowering perceived risks to private investors.
- Clean power generation: Where renewables are less well established, concessional public funds have been used as a tool to de‐risk projects via blended finance vehicles with varying degrees of concessionality based on market readiness. For example, in established markets, public funds can be used to provide guarantees, including in the local currency, such as in Nigeria, to draw in more domestic investors.
- End‐use and efficiency: Grants have been used to support initial projects via the creation of super energy service companies (Super ESCOs) or cooling‐as‐a‐service companies, such as in Morocco and South Africa. In the transport sector, donor and impact focussed investor funded pilot projects have been successful in attracting private equity and venture capital in Rwanda and Nigeria, while affordable debt financing has been used for public transportation projects in Uganda.
- Domestic gas markets and low‐carbon fuel supply: Public bodies can provide guarantees to de‐risk investment in domestic infrastructure or fund research and development of low‐carbon gases, such as in Namibia. Constraints on finance for natural gas projects risk preventing the development of low‐carbon fuels for domestic markets.
The full report can be read here