South African economic growth is threatened by its power shortage and the country can ill afford many more instances like the cancelling of the $2.7 billion Coega aluminium smelter project, which Rio Tinto blamed on energy supply and rising price concerns.

Faced with a huge energy shortfall, Eskom, the state owned power utility, is concentrating its hopes of boosting capacity on two major coal fired facilities – the 4,800MW Medupi and the 4,800MW Kusile projects. The combined cost of these projects is Eu11.19 billion ($15.77 billion), with 53% funded by equity and 47% coming from loans sourced mostly from multilateral and bilateral agencies.

The government has issued a directive that the private sector should develop 30% of South Africa's new generating capacity. But realising this goal will difficult while IPPs depend on Eskom for their power offtake and uncertainty remains over both Eskom's internal politics and broader legislative context governing its PPAs.

The internal politics part of the problem came to a head in November with the resignation of both Eskom's CEO, Jacob Maroga, and its chairman, Bobby Godsell, who had fought over "competing visions of the company's future". Godsell blamed government interference for his standing down. The row rumbles on into 2010 with Maroga suing Eskom over his dismissal.

Eskom's difficulties also have an impact across the region with around 90% of the southern African power pool traded in South Africa. Developments like the $3 billion Mmamabula project, a 1,320MW coal-fired plant in Botswana, are held up as Eskom's internal politics are played out. With Eskom paying for its PPA in rand, negotiating the foreign exchange risk on cross-border IPPs – like Mmamabula and the Moamba closed cycle gas turbine project in Mozambique – holds these projects up even further.

Power policy contradictions

For the South African government as a whole, the problem is to somehow resolve the contradictions between Eskom's position and the Department of Energy's (DoE) Integrated Resource Plan (IRP), which the National Energy Regulator of South Africa (Nersa) is bound by.

On 24 February Nersa will deliver a ruling on Eskom's request to increase energy tariffs by 35% each year for the next three year. This is the most politically controversial issue facing the sector, and Eskom submitted its request in December after revising an original plan, submitted in September, to increase tariffs by 45% each year. Strong opposition remains even to the reduced tariff increase, and over the course of Nersa's public hearings on the hike numerous parties have been proposing alternative means by which Eskom can raise funds, including the sale of some of its existing assets.

Even this revised request carries strong inflationary risks for South Africa – the South African Reserve Bank factored in a 25% increase in power costs in its forecast for inflation to move into target range of 3-6% on sustainable basis. Industry is caught between rock and hard place: either it has to cope with supply shortages or inflation.

The scale of the shortfall facing Eskom is such that the utility is embarked on a R385 billion ($52 billion) five-year power supply expansion programme to meet it. It is currently facing a R80 billion shortfall in funds, and the utility had to make several changes to its strategy, which it presented to Nersa along with its revised tariff request. Financial constraints had already forced Eskom to cancel a R120 billion nuclear power project at the end of 2008.

Along with the revised request Eskom said it would have to delay Kusile for a year, and that its board had approved a restructuring of that project to involve the sale of a 30% to 49% stake to the private sector, with the intention of raising R40 billion in equity. A third coal-fired station at Ingula was intended to eventually follow Medupi and Kusile, but this now may be scrapped in favour of further IPP involvement.

Eskom did receive a boost in November with the news that the African Development Bank had approved a Eu1.86 billion loan for the first of its coal projects, the 4,800MW Medupi power plant in Limpopo Province, expected to be in commission by February 2012. Then Eskom received a further boost in December when it received loans totalling R8.7 billion ($1.18 billion) from KfW IPEX-Bank, HSBC, Bank of Tokyo-Mistubishi UFJ, Deutsche Bank, Standard Bank, Nedbank and Rand Merchant Bank for the second of these plants, the 4,800MW Kusile power station.

IRP an anti-climax

Meanwhile, the IRP, which was published in December, three months late, has proved a disappointment for private developers. It failed to provide much clarity on the country's future energy mix, and it set out a conservative target of just 1,100MW new capacity to come from renewable energy, cogeneration and conventional IPPs.

The sense of anti-climax is huge. The government had promised to publish the report in September – a supposedly urgent deadline if municipal governments were to have enough time to make budget provisions for it – and that there would be a public consultation. Instead, after a draft of the report was leaked, the government very quiet on it after it was met with a negative reaction. The cabinet approved it in December with no public consultation. The IRP only lays out plans until 2013, with the DoE promising public consultation on a new plan, IRP2, to be published in June 2010. IRP2 will outline the energy mix for 40,000MW of new capacity over the next 20 years.

Despite the confused current situation, there is a substantial pipeline of IPP projects waiting to go through once the legislative issues have been resolved. To help meet the government's 30% IPP target, Eskom is running three power purchase programmes covering a range of timeframes: the Pilot National Cogeneration Programme (PNCP), the Medium Term Power Purchase Programme (MTPPP) and the multi-site Baseload IPP Programme.

The PNCP and MTPPP are aimed at increasing capacity by 900MW and 3,000-4,000MW respectively in the relative short term, the proviso being that power from these projects should be in commission by 2013 and 2012 respectively. The chances of more than a fraction of either of these objectives being met, however, seem slim. Eskom has stalled both, as well as the Baseload IPP Programme, pending publication of the IRP and with it clarification of the costs it can expect to recover. Towards the end of 2008 Eskom pre-qualified 27 developers for the Baseload IPP Programme, which has a longer time frame than the previous two programmes and a requirement to increase capacity by 2,100MW and 4,000MW. However, Eskom failed to issue RFPs in 2009.

In parallel to this, developers in the renewables sector have also been waiting on the publication of the IRP, which will give shape to the IPP programme falling under the Renewable Energy Feed-in Tariffs (Refit). Electrawinds and Suez are two of the larger power companies developing wind projects in South Africa, while a 40MW wind project in Tsitsikamma, Eastern Cape, brings South African IPP Watt Energy into partnership with a local community development group and Exxaro.

Renewables developers will have been disappointed with the IRP when it did finally arrive, but ambitious targets promised by the South African government at the Copenhagen Summit make it likely that increased renewable energy targets will feature prominently in IRP2.
Suez is reported to have gone to the market for financing of the two peaking plants – 760MW in KwaZulu Natal and 342MW in Eastern Cape – tendered by the Department of Minerals and Energy (DME). This project has had a troubled history, initially being awarded to AES, which pulled out in 2008.

The South African energy minister has also reiterated the government's commitment to securing 20,000MW of nuclear power by 2020, even though Eskom had to cancel a 1,800MW project late in 2008 due to funding constraints.

And if the private sector doesn't get involved in Kusile there will likely have to be a large-scale baseload coal IPP to replace the one Eskom had planned in Ingula.

If a PPA can be agreed, Mmamabula would likely be the first regional IPP to close, hopefully in the first quarter of 2010. The project is sponsored by CIC Energy with International Power as an equity partner, and features a $500 million Chinese commercial bank facility and South African and ECA tranches arranged by Absa Bank and Standard Bank respectively.

Eskom's shortages have severely hampered Botswana too, which currently receives 350MW of a 500MW requirement from Eskom, but faces having its supply further reduced. As well as meeting some of South Africa's energy needs, Mmamabula could also supply 25% of its output to the Botswana Power Corporation. So the country is faced with a double blow if the project stalls. Respite for Botswana should eventually come from the country's $1.6 billion 600MW Morupule B coal-fired plant, which reached financial close in November 2009. But for Mmamabula, IRP1 has been as disappointing as it has been for other IPP developers.

Circling overhead

While liquidity in South Africa's banking sector may be down on its pre-credit crunch heyday, it is still good enough to support a large programme of IPPs, with one of the major bank players monitoring around 20 developers at present. Credit risk margin are around 230-240bp.

But for an IPP programme to move ahead new legislation is urgently required. The current situation is highly confused, with so many different ministries and government agencies involved, often working at cross-purposes. Existing laws are also unclear on the tendering process required for IPPs, with the 2004 National Energy Regulator Act and the 2006 Electricity Regulation Act contradicting each other on this point. This was one of the issues behind AES pulling out of the two peaking plants that then went to Suez.

"To the outsider looking in it is highly ambiguous," says Alistair Campbell, head of power at Standard Bank. "The biggest obstacle is the lack of a legal enabling framework to accommodate IPPs, with appropriate checks and balances."

There is a consensus among almost all involved that the current legal provisions for bringing in IPPs are unsatisfactory and that new legal provisions are required. This is a view held by the National Treasury Unit that has worked on South Africa's PPPs and is now working with Eskom on the IPPs, and even within Eskom itself, where officials argue that uncertainty over its funding model is the reason it can't close IPPs. The onus is now with the Department of Energy's to follow through with the necessary provisions.

A new legislative framework would need to come up with an acceptable form of PPA – with government support coming from the National Treasury – to make IPPs in South Africa bankable. It would also need to clarify where the PPA would reside, whether with Eskom or with a single buyer office outside Eskom. Such a move might even presage the break up of Eskom into separate production and transmission components, a move favoured by some in the government.

Some people are optimistic that the government, realising what is required, will work towards these ends. But this is tempered by the pessimism of others, who worry about the mixed messages they are getting. One of the main sources of mixed messages is the friction between the DoE, which Nersa is ultimately responsible to, and the Department for Public Enterprises, which controls Eskom.

There will definitely be IPPs happening in South Africa at some point, and until the IRP fiasco it had looked like 2010 would be a busy year with the Baseload IPP Programme coming into play. The question now is whether the government will act quickly enough on its own, without a new crisis like the one in 2008 forcing it to do so.

"The way I like to describe it is that we are caught in a Heathrow Terminal holding pattern, with lots of planes circling overhead," says Campbell. "Any one of them might land, but they can only circle for so long until they have to either go elsewhere or crash as investors suffer from project fatigue. The government is going to have to do something soon because load shedding in 2010 will put a lot of political pressure to clear the mist from the runway."

The cross-border Mmamabula and Muambo IPPs are the most advanced and therefore the first projects likely to close. Which of the many projects and policies circling will be the next to land – Refit, the peakers, the baseloaders, PNCP or MTPPP – is harder to guess.