Navigating South Africa’s electricity challenges in the era of market liberalisation

The intricacies of Eskom’s demise and issues have been extensively documented. However even in the absence of this, the country would face a huge challenge in meeting its renewable energy targets given the historic generation base being so heavily dominated by coal. The importance of energy transition to shift towards a lower emission economy is a critical point when considering core export industries for the South African economy – the global market for commodities is increasingly demanding that such commodities are produced in a responsible manner. Couple this with the current lack of firm energy supply from the grid and you reach a complex intersection of energy demands, economic growth, and environmental sustainability.

The mining sector is probably more exposed than most to this intersection – a historic driver of the South African economy, it is a key player and a critical stakeholder in shaping the future of the country’s energy landscape. As an energy intensive industry, the sector can also play a key role in helping to relieve some of the pressure on the South African grid, whilst it works towards its own objectives of energy security and a cleaner supply chain.  Multiple private power procurement processes have come to the market over recent years however we are now seeing further development in the thinking around these issues, which opens up several interesting questions around how the South African (and perhaps regional) electricity landscape may evolve in the coming years.

Envusa Energy is a jointly owned renewable energy venture between Anglo American, a globally diversified mining company with a strong presence in Southern Africa, and EDF Renewables (South Africa) a leading renewable energy IPP in the region. Envusa Energy’s intrinsic objective is to decarbonise Anglo American operations across Southern Africa. However, it seeks to do so by essentially building a private supply business that can benefit from the same diversity of supply and demand as other utilities have access to. Envusa Energy is therefore taking a long position on the successful liberalisation of the South African electricity market. The company has recently closed the first leg of a development of up to 5 GW of clean energy projects by 2030. A critical milestone for Envusa Energy, it demonstrates a different path to electricity trading and financing renewable energy projects in South Africa, as well as contributing to the continued health of the strategic mining sector.

To date most private power procurement transactions have been relatively straightforward, adhering to a traditional model involving a single generator, a single offtaker, and good demand-side credit, backed by guarantees as required. However, as the reforms of Eskom gather pace, this presents an opportunity to think differently. A fully liberalised model is not going to arrive tomorrow in South Africa, but some key reforms are already steering the market in this direction:

• The policy change from 2022 that removed the 100 MW threshold for generation licenses has had profound implications, removing barriers for private PPA and actively promoting South Africa’s energy transition and the deployment of renewable energy
• The ongoing amendment of the Electricity Regulation Act is transforming the South African electricity market with the establishment of a national regulatory framework for the electricity supply industry
• The recent appointment of the National Transmission Company of South Africa board is an important milestone in the ongoing unbundling of Eskom

There is a clear direction from the government to increase private generation and to facilitate wheeling. Nonetheless, some residual challenges remain to ensure reliable and stable electricity supply. The development of renewable energy projects under a wheeling framework agreement ultimately requires a strategic approach to overcoming obstacles in the grid connection landscape in South Africa. To its credit the current government seems to be aware it should now prioritise grid upgrades and expansion initiatives, but more momentum is needed here. Without investment in grid infrastructure progress on private sector generation solutions will always be driving with the brakes partially applied. This involves the development of additional physical infrastructure such as substations and transmission lines.

Envusa Energy’s position on this has been to set up the business today in anticipation of future development, prioritising operational flexibility to react and benefit from positive changes, whilst recognising the need to finance its projects in the environment of today. It’s a difficult balancing act but in pushing the boundaries and challenging the status quo, the business’s goal has been to anticipate the evolution of the energy system in South Africa.

In purchasing energy from a diverse portfolio of renewable energy assets and on-selling it to a diversified portfolio of offtakers (Anglo American’s mines, smelters and refineries for now), the company will manage both supply and demand risk. The renewable energy projects will not only provide secured energy to its offtakers at a competitive Levelized Cost Of Energy (LCOE) but will also free up electrical capacity for other consumers on the grid and most importantly, help in creating a precedent for other entities who seek to reduce their own dependency on Eskom. By using the wheeling framework, the competitive LCOE also then allows lenders to look at a wider demand on the transmission network to get comfortable with the long-term buyer risk despite Envusa Energy not having a long track record or deep balance sheet. This approach lays the groundwork for a growth platform to integrate future projects and offtakers.

The experience of taking Envusa Energy to its first financial close process, raises a number of interesting questions, not least how do we expect the electricity sector in South Africa to evolve? Longer term, we do expect the South African energy market to tend towards being heavily liberalised, with a combination of traders who can match demand to supply, an increasing prevalence of shorter-dated and even staggered PPAs, and generally more sophisticated and competitive instruments that allow for more market competition and merchant trading. We also expect lenders to become increasingly comfortable with the idea of finding alternative offtakes.

Stakeholders in the energy sector are already speculating and preparing for the next step in the market evolution, with considerations in the medium term of how to structure offtake agreements with the next wave of offtakers. Moving down the ladder to engage with entities that have lower or no credit ratings poses counter party risk to the generator and lenders, which in turn limits the viability of providing price-competitive agreements or even raising the required capital to fund the construction. We think that a diversified and responsible approach to trading electricity (which if priced competitively is an essential commodity for nearly all businesses) will play a large part in answering this.

Whilst the market enters this new stage of flux, we are excited about the role we can play.  There is a lot of complexity to be waded through, particular as the industry will need competitively priced capital in order to achieve the competitive LCOEs necessary for it to succeed. Our global experience in corporate PPAs with private offtakers and different electricity systems, has led us to understand the importance of analysing each situation’s specifics, but also to keep the bigger picture in mind. Strategic objectives and strategic importance to stakeholders cannot be set aside either. PPAs have been developed for several years in various regions globally, with financing structures tailored to address the specific risk profiles listed above. As the South African financing environment becomes more used to financing renewable energy outside of the state-led procurement process, we think an increasing focus on risk allocation will be necessary and expect to lean heavily on our experiences of navigating these challenges in other markets as we assist clients in South Africa.

The stone age did not come to an end because we ran out of stones, and we think that South Africa will see a shift away from coal well-before the last lump is mined. This is exciting as it presents opportunities for many involved in the South African electricity sector, and we hope will be positive for all South Africans in the end. This year’s election process will add further intrigue, but we are already excited to see government and private sector working collaboratively to enable the liberalisation of the electricity market which itself is a quantum shift for the country. With this, hopefully we will see a restoration of the nation’s trust in the energy sector and most importantly, the South African people and economy will benefit from this for years to come. We have our sleeves rolled up and we look forward to continuing to write history for the electricity industry in South Africa. If you see a challenge or opportunity in this shifting market where you think we can support, then don’t hesitate to reach out.