Here are three ways to help small countries get the energy they need
Complex, carefully managed financing structures can provide the funding needed for island states and others seeking to develop energy projects.
Solomon Islands, with a population of 610,000 and annual per capita income of US$2,200, has one of the highest retail electricity tariffs in the world – US$0.82/kWh in 2019. Only 9% of the country’s population has access to grid-connected electricity, which is nearly 100% supplied by diesel generators. The annual cost of diesel imports alone exceeds SBD180 million and the heavy reliance on import fuel is exposing the country to a significant fuel price risk.
High electricity bills are an endemic problem in many less-developed countries, particularly remote ones like Solomon Islands. While the replacement of diesel generation capacity with renewable energy can provide a long-term solution, getting the needed financing and private sector expertise to develop and maintain energy generation capacity as part of a bankable deal structure is not always easy in these countries.
Indeed, as an alternative to costly diesel-fired power plants, the Solomon Islands Government decided to develop the 15-megawatt Tina River Hydropower Project in 2006. A public-private partnership was introduced for the first time in the country so that private sponsors using their expertise could construct, operate and maintain the project under a long-term power purchase agreement with a backstop guarantee from the Solomon Islands government. Nonetheless, the project, which could reduce electricity prices for consumers and diversify energy sources, languished for more than a decade.
Unfamiliarity with Solomon Islands meant fewer private sponsors’ interest in a competitive tender and typical project financing would have made the project unviable due to prohibitively high financing costs. Added to the difficulty mobilizing financing for the project, customary land owned by various indigenous groups made it difficult to complete the land acquisition, which caused delays.
In December 2019, the project finally reached financial closing after 13 years of effort by the Solomon Islands government, with assistance from various development finance institutions. Construction of an access road followed by a power plant will begin soon with a target operation in 2024. When completed, the project is expected to reduce the Solomon Islands’ retail electricity tariff by almost 60% bringing the current tariff level to $0.33/kWh and accounting for nearly 70% of renewable generation capacity in the country, along with proposed solar projects.
The secret to achieving financial closing for this project with a less than 1% per annum interest rate was a hybrid financing structure, which combined blended financing (upstream financing) with conventional project financing (downstream financing). Using a sovereign (government) guarantee, the Ministry of Finance and Treasury of Solomon Islands was able to mobilize $201 million in concessional loans and grants from six development finance institutions; and on-lent this to Tina Hydropower Limited, the company created for the project.
Involvement of several development financiers ramped up the complexity of the transaction as each offered differing grace periods, amortization schedules and maturities, interest rates, treatment of interest during the construction period and covenants in addition to specific components eligible to fund and funding sequences. Indeed, these loans and grants with various terms and conditions were aggregated as a loan with a single tenor, interest rate and comingled covenants and was on-lent to the project company.
The following three key lessons provide clues on how to potentially benefit from this complex financing structure and break the bottlenecks preventing small countries from getting the energy they need.
First, boost government capacity to handle complex transactions. In December 2018, ADB’s Office of Public-Private Partnership (OPPP) received a request from the Permanent Secretary of the Ministry of Finance and Treasury to provide fund administration assistance. In response, OPPP sought a significant amount of capacity building/post-transaction monitoring grants from the Asia Pacific Project Preparation Facility and assigned its transaction advisory services staff to top up the grants and expedite financial closing.
Financed by the grants, a loan administration expert and two legal experts were mobilized to form a team. Once engaged, ADB assisted the finance ministry to take the following initiatives: (i) conform all terms and conditions of six development finance institution loans and grants as much as possible. All relevant parties including the Ministry of Finance and Treasury, Ministry of Mining, Energy and Rural Electrification and its project office, each development finance institution and the private sponsors were consulted in this process; (ii) negotiate bilateral loans so that the commercial terms aligned; and (iii) prepare an operations manual for the use by the finance ministry and staff of relevant ministries and government agencies. The manual was designed as the first point of reference for administration of the funds for the project. With the assistance of the Asia Pacific Project Preparation Facility and OPPP, the Ministry of Finance and Treasury was able to significantly increase its understanding of and capacity to administer the complex financing structure.
Second, the hybrid financing structure also meant unique risk-sharing schemes. While financiers of conventional project financing typically take multi-fronted project risks, development finance institutions in this transaction took the credit risk of Solomon Islands after being given the Ministry of Finance and Treasury repayment guarantee. While finance institutions’ credit exposure is limited to the Solomon Islands government, the unique features of the concessional loans – such as a gender action plan, community development plan and environmental covenants – were transposed on the project company. The implementation of these plans and covenants will need to be closely monitored and the introduction of a technical advisor on behalf of the Ministry of Finance and Treasury was recommended by ADB.
With technical advisor’s presence, any variation orders and/or waiver requests could be also reviewed, providing level understanding to all concerned parties. Additionally, in absence of the commercial lead arranger and intercreditor agreement among co-financiers, the Office of Public-Private Partnership acted as an official coordinator, which is identical to book runner/syndication role for concessional financiers for the project and led the signing of a memorandum of understanding among co-financers and the Ministry of Finance and Treasury.
The process raised all parties’ awareness of the syndicated nature of the project’s financing arrangements and is expected to ensure smooth fund disbursement among the co-financiers among other required coordination.
Third, on-the-ground support for clients and involvement of the right expertise at the right times with close engagement of the government. Given that the Tina River Hydropower project is the first PPP project in Solomon Islands, project finance expertise is rare in the country. Hence, posting the foreign expert in Honiara at the Ministry of Finance and Treasury office was critical so the ministry staff could “learn by doing.”
Also, daily face-to-face discussions between the expert and ministry staff, and communication back to ADB headquarters, substantially increased effectiveness and timeliness of the PPP office’s ability to address and resolve any outstanding issues, bringing the project closer to financial closing.
Also, legal expertise was essential in documenting the transaction and reflecting the results of negotiations among various parties and putting a security structure in place for the transaction. Finally, the Ministry of Finance and Treasury will have an opportunity to observe how a professional third-party firm out of Australia runs the syndicated loans interacting with relevant stakeholders supporting the ministry as an administrative agent. After 18 months of observation, the Ministry of Finance and Treasury can decide whether to retain the professional firm or replace the agent with its own staff, having evaluated the internal staff resources and budget.
This unique yet complex hybrid financing structure may not be a solution for all countries, as they have different priorities for use of sovereign guarantee and infrastructure projects, as well as financing needs. Nonetheless, the Tina River Hydropower Project exhibits one way to tackle the financing issues for small countries where achieving the tariff reduction through low financing cost is the utmost priority.