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Solutions to the electricity power problems (Part 2)
25/10/2015 00:00:00
by Chiichiri Muzita
 
 
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Read the first part of Chiichiri Muzita’s article here.

Problem Nº 6: Mega power projects are capital intensive and subsequently risk averse

MOST power plants require funding hybrids of an 80:20 capital to equity ratio, which means 80% as a bank loan and the other 20% as equity from investors. So these IPPs would normally have to approach the big banks and lending institutions that I mentioned earlier such as the DBSA, AfDB, PTA Bank, IDC South Africa etc. All these banks are African, and unfortunately all of them are owed money by our dear government. This is why they would be reluctant to lend to IPPs tied in to supply electricity to ZESA, unless of course the IPP had an air tight plan on how to pay loan back.

Going back to the previously used example, a 500MW gas or thermal power plant will normally take between 24 to 36 months to construct. One important factor for most IPPs, when drafting their financial analyses, is that they have to factor in depreciation of the power plant on their earnings sheet. The US$500 million power plant will depreciate in value by US$20 million per year over a 25-year period until the plant has to be decommissioned, as after such a long period most of the plant equipment is not salvageable and outdated. This also affects the finance model analysis used to secure finance.

This US$500 million for the construction of the power plant is normally financed in phases, for example 10% is paid on the issue of a bank guarantee by the IPP, 25% is paid on the main engineering completion, 50% is paid on the delivery of equipment and materials to site, 10% is paid on completion of construction and the final 5% is paid on successful commissioning and at least one year of uninterrupted operation. So the bulk of this US$500 million, about 95%, has to be “sunk” into the project before the power plant actually begins to operate. This long construction period of 24 to 36 months leaves the IPPs extremely exposed, as they have to start paying the amortization on the loan during this period, even though they are not receiving any form of income.



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Solution

Due to the high risks involved in such endeavours, the GoZ needs to reward these high risks by providing incentives. On paper the GoZ has stated that “national projects”, such as the Lupane CBM gas project, can import all material and equipment required to construct power plants duty free, however, they need to draft a Statutory Instrument, or bill, which confirms the same. This incentive should apply to all power projects nationwide, whether these are small, large or national projects. The government also needs to legislate tax holidays exempting IPPs from paying corporate tax for the first 5 years of power plant operation, in exchange for lower electricity tariff rates. This will enable IPPs to have a shorter payback period to come out of the red and recoup their investments. Such a set up would make it easier for IPPs to secure loans for such power projects.

After the tax holiday, the corporate tax will kick in as most power stations should be operating in the black by then. These IPPs will then be able to invest in the expansion of their power stations, increasing their generating capacity to the benefit of Zimbabwe as a whole. Those who invest in these types of infrastructure projects are in it for the long term, as the real benefits are only reaped after at least 10 years of operation. The GoZ also needs to look into reducing the corporate tax for Multi-National Corporations (MNC) in the high tech sectors, which are keen to set up base in Zimbabwe and transfer technology. I think a 12% corporate tax in the proposed Special Economic Zones will have MNC’s beating a path to our door.

Problem Nº 7: Understanding how risk is calculated and its impact on capital intensive project funding

After the 2008 global financial crisis, Risk Management emerged as an indispensable decision aiding tool for project financing. The sequential order for project finance approval is normally a project financial feasibility study, due diligence report, then lastly, and most critically, comes the risk assessment which gives the final “GO/NO-GO” instruction for the release of funds by the lender. The GoZ is absolutely clueless as to what Risk Management actually entails, how it is calculated, and how it affects projects costs. Let me explain how Risk Management works in laymen’s terms.

There are three general methods for carrying out a risk assessment on any project. The most common method used for the mega projects (US$100 million above) is simply getting a group of experts together, having them brain storm, then draft a comprehensive list of all the possible risks (or opportunities) that may be encountered during the project life cycle. Historical data is also drawn from to include any other unforeseen risks in the final list. This group of experts is normally selected according to their expertise in different fields which will affect the project.

So it’s common to find lawyers, finance people, project planners, cost controllers, engineers, project directors, HSE personnel and QC personnel in such a group. The next step is for the group to choose a suitable scale for the probabilities, which can be taken from international norms i.e. ISO, PMI or any other standard. A five tier system is normally recommended. So for example the group of experts will choose a scale of 0.05 (5%) for a Very Low Probability, 0.25 (25%) for a Low Probability; 0.5 (50%) for an Intermediate Probability; 0.75 (75%) for a High Probability and 0.95 (95%) for a Very High Probability of an event occurring.

After that they will then go through the complete list of risks again, estimate the impact (in cost, time or both) and assign the probability to each of these events occurring. The final step will be to simply multiply the probability by the impact (cost or time, or both) of each event, and sum up the totals in cost in time for the whole project. The point of this exercise is to provide a reasonably accurate contingency reserve for the project budget and delivery schedule.

To see how this works in practice, let’s take the Indigenization Law as example, which says that all foreign companies should cede 51% to indigenous locals. Let’s assume a foreign IPP chooses to secure a loan of US$500 million to build a 500MW thermal power plant. After securing the loan, completing the construction and beginning to generate electricity, what would the impact be of having to cede 51% of the US$500 million under the Indigenization Law? The impact would be losing 51% x US$500 = - US$255 million.

Now, what is the probability that this will happen? If you look at the historical data in Zimbabwe, all foreign companies large (e.g Implats, Standard Chartered) and small have had to comply with this law, so we can safely choose a “Very High Probability of 95%” for this particular event. Then you simply multiply the probability by cost impact, or 95% x US$255 million = - US$242 million. Then you have to ask, can this risk be avoided, can it be mitigated, can it be transferred, or can it be assumed by the IPP? Most IPPs will choose to “transfer” this risk to the financiers by placing a contingency reserve Of US$242 million in the budget, which means that the total project budget for the power plant would now go up from US$500 million to US$742 million.

Now honestly speaking, which sane bank or lender would loan an IPP US$742 million for a project which should cost US$500 million. This is why all these so called mega projects being touted in Zimbabwe cost about 50% more than they should do. I’ve shown an example of the significant cost impact that just one risk, due to GoZ policy, can have on a power project in Zimbabwe. You need to keep in mind that mega power projects tend to have hundreds of risks, from management, technical, operational, meeting guarantees, legal and legislative framework, financial, environmental and so on.

Each of these risks have their own cost and/or delivery impact which will also have to be reflected in the contingency reserve if they cannot be mitigated. It is now also common practice for a Monte-Carlo Simulation to run on mega projects, which helps in predicting how the project will eventually unfold, and what measures can be taken to address the risks involved. It is at this final stage of risk assessment that the finance falls through for most projects in Zimbabwe.

It is unfortunate that in Zimbabwe there are more idiots in positions of power (IIPPs) than independent power providers (IPPs), which is why we are wandering about in the dark, both metaphorically and literally. Some of these IIPPs even allegedly hold computer engineering degrees, whose validity is questionable to say the least.

Solution

IPPs need capital to finance power projects, as there is no local capital, they have no other option that to turn to external finance, hence the need for “foreign direct investment” or FDI. Now FDI is the umbrella term used to describe equity investments, loans, lines of credit or other finance vehicles from outside our borders. It has nothing to do with imperialism as some imbecilic Zanu PF sycophants genuinely believe.

The GoZ should invest in hiring independent risk management consultants who can analyse the legislative framework and policies which should be repealed or amended, to reduce the risk associated with investing in Zimbabwe, which in term will lead to lower project costs across the board, lower interest rates, and more investment in Zimbabwe.

Problem Nº 8: Property Rights and Rule of Law

The issue of property rights will continue to come up, and until we understand what it entails and deal with it effectively, we will continue to go around in circles. “Property Rights” is an economic and legal term, which generally refers the rights of an individual over their property. Their property is anything from financial capital, intellectual ideas, buildings, companies, technology, music, songs, patents, land, resources etc. It refers to absolutely anything that can be deemed to belong to an individual.

Now, Zimbabwe’s history is littered with the gross abuse of property rights and the rule of law. The issue should be contextualized in the correct timeframe beginning from the colonial times in 1890, where the property rights of native Zimbabweans were violated under the Land Apportionment Act 1930, and the Land Tenure Act of 1969, in the first case of “land-grabs”. If the issue of compensation vis-à-vis the more recent land reform programme should ever come up, or be applied in retrospect, then it should be from the year 1890 and not 1980. With the land reform exercise, most sensible people will not argue with the need for social justice to “right” colonial wrongs.

However, where Zanu PF lost the plot completely was when they decided to apply this same jambanja philosophy to other sectors. One of the most publicized cases, which was dragged through British courts, was the SMM case, whereby Mutumwa Mawere was expropriated of a US$367 million mining empire under a “just-for-you” act drafted by parliament called the “Zimbabwean Reconstruction of State-Indebted Insolvent Companies Act”.

The GoZ’s case was thrown out by the British courts, with the judge describing it as “grotesque extravagance”, yet the GoZ went ahead and expropriated SMM anyway, leaving 6,000 people out of work, which of course had a knock on effect on their families, and Zanu PF subsequently ran SMM into the ground. I still don’t understand the point of the whole exercise, was it spite, greed, madness, stupidity, or all of the above?

Then came the ingenious “Foreign Currency Externalization Law” of 2004 I think, which in October 2008 led to about 20 business leaders being arrested on charges of externalizing foreign currency. From Mutumwa Mawere, James Makamba to Chris Kuruneri, all were either locked up or had to go into exile. What image did this paint to foreign investors when the GoZ could do this to their own indigenous business people?

Then of course there was the infamous Africa Consolidated Resources (ACR) case, which was also dragged through the UK courts and gained bad publicity. ACR’s special mining grant for the Marange diamond fields was revoked, by the then mines minister Obert Mpofu, to allow the ZMDC to mine diamonds. And the US$16 billion dollar question is “where did the diamond money go”? Then of course there was the raiding of Foreign Currency Accounts (FCA) by the RBZ under Gideon Gono, which again was sheer madness. A country’s central bank was literally stealing money from personal and company accounts. Only in a banana republic is there such contempt for property rights and the rule of law.

The most recent case is the Telecel saga which continues to unfold, and will be another litmus test to see if property rights and the rule of law, as enshrined in our new constitution, will be respected and adhered to. These are a few cases I have highlighted out of hundreds. What the GoZ fails to realise is the gravitas that such past actions have on current events. It is not only about the bad publicity and negative perception in foreign media; these past actions have been extensively documented, and are actually used as a historical data base to draft their feasibility studies, due diligence reports and risk assessments. This is why our risk indices are high and why it is too expensive for any IPP in Zimbabwe to borrow from external sources.

For IPPs, property rights and the rule of law are fundamental in securing finance, even more when it comes to mega projects. The IPPs that engage in thermal power plants for example, need property rights over the coal reserves to fuel the power plant, property rights over the land on which the power plant will be built, property rights over the power plant equipment, buildings and infrastructure, property rights over the electricity generated and property rights over the revenue generated from the electricity sales. The IPPs need to be assured that if any disputes arise, they will have recourse to fair arbitration from local or international courts under the rule of law.

Solution

The best solution would be for the current Zanu PF led government to simply step down, and let competent people run the country, as they have shown consistent contempt for property rights and the rule of law. As this is not going to happen anytime soon, stop gap measures may be introduced whereby the GoZ could provide incentives such as free land for the construction of power plants, with title deeds included. The wording in the current Special Mining Grant’s for coal, gas and other minerals seems to imply that the GoZ or Mines Ministry can revoke the special mining grant at their leisure.

And they have revoked grants in the past, from ACR’s diamond mining grant, to reducing the area of Implats platinum concession, and more recently Zimasco will have some of its chrome reserves taken over. This is just adding to the litany of a of property rights violations out in the public domain. By simply rewording the Special Mining Grants to ensure security of coal or gas reserves for the IPPs, for at least the period of power plant operation (25 years), this will go a long way in helping the IPPs secure the investments or bank loans required. The cost of US$100,000 per year for leasing the special mining grant for coal or natural gas is prohibitively high and should be reduced by at least 10 fold.

With regards to the rule of law, most African countries (Zimbabwe included) have adopted modern arbitration laws based on the UNCITRAL Model Law, but a significant number do not have modern arbitration laws. According to the World Bank, “The ability to enforce arbitral awards is one of the important factors driving investment decisions, and one of the issues faced by parties entering into contracts with African parties is how likely it is that foreign arbitral awards will be recognised and enforced by African courts”.

It is interesting to note that at the height of the land-reform exercises, in defence the GoZ stated that it will not enforce an award that is in “breach of the rules of natural justice”. This may have been morally right, but what natural/moral justice is there in the other cases I highlighted above. Progressive countries such as Mauritius have gone as far as to not only adopt arbitration legislation based on the 2006 UNCITRAL Model Law, but Mauritius is now also trying to use its offshore location and international business links to establish itself as the leading arbitration centre in Africa.

The recent announcement that the International Council for Commercial Arbitration (ICCA) will hold its 2016 Congress in Mauritius is a boost to those ambitions and reflects international interest in developing an arbitration centre in Africa. If only Zimbabwe had such leadership, and was not led by an incompetent and clueless kleptocracy, it would have been an ideal location for such an arbitration centre.

Conclusion

The current electricity power blackouts being experienced in Zimbabwe were avoidable and can be resolved. Unless there is a new government in place, that actually knows what it is doing and is genuinely committed to working for the common good of Zimbabweans in general, then the current electricity and national economic crisis, will continue to deteriorate with no end in sight.


 
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