Policy Research Working Paper 9299 Attracting Private Solutions and Participation in the Power Sector in Sub-Saharan Africa Findings from a Survey of Investors and Financiers Benedict Probst Richard Holcroft Joern Huenteler Ani Balabanyan Andrew Tipping Peter Robinson Energy and Extractives Global Practice June 2020 Policy Research Working Paper 9299 Abstract This paper develops a classification of investor risks and that the average investor is forward-looking, as neither the surveys 51 private investors and financiers in the power track record of the power sector nor the firm’s personal sector in Sub-Saharan Africa. The paper aims for a better track record is as important as the growth potential in understanding of what can be done to attract private solu- the market. The paper uses the findings to reality-check tions to fill the investment gap. It finds that the average data-based measures of regulatory readiness, namely the investor assigns more weight to power sector policy and Regulatory Indicators for Sustainable Energy and Power regulatory framework risks than to the wider sector and Sector Reform Index and analyzes which elements correlate country context risks. And, despite many challenges, inves- best with investor sentiment to optimize and streamline tors perceive three segments as ready for private solutions these indexes accordingly. The results provide important in Sub-Saharan Africa: power generation, off-grid elec- lessons for governments and development partners to devise trification, and mini-grids. Investors see lower readiness appropriate de-risking instruments tailored to the risks that in distribution, transmission, and retail. The paper finds matter most to investors. This paper is a product of the Energy and Extractives Global Practice. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at jhuenteler@worldbank.org. The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. Produced by the Research Support Team Attracting Private Solutions and Participation in the Power Sector in Sub-Saharan Africa — Findings from a Survey of Investors and Financiers1 Benedict Probst1, Richard Holcroft2, Joern Huenteler1,3*, Ani Balabanyan3, Andrew Tipping2, Peter Robinson2 1University of Cambridge 2Economic Consulting Associates 3The World Bank, Energy & Extractives *Corresponding author: jhuenteler@worldbank.org; +1 202 458 8646. Keywords: Private investment; investment risks; electricity; financial viability; developing countries; emerging markets JEL codes: F21, L94, L98 1 Any views presented here are the authors alone and should not be attributed to the World Bank or any other person or institution. The authors are very grateful for financial support from the Energy Sector Management Assistance Program (ESMAP). The team is grateful for peer review comments from [Vivien Foster, Arnaud Braud, and Sudeshna Banerjee]. Any shortcomings are the sole responsibility of the authors. 1. Introduction Sub-Saharan Africa faces investment needs in the hundreds of billions to achieve affordable, reliable, sustainable, and modern energy for all by 2030. Fifty-seven percent of the population—around 600 million people—do not have access to electricity, and continuous power outages constrain the economic performance of those already connected to the grid (IEA, 2018; Blimpo and Cosgrove-Davies, 2019). Tax revenue and development finance are unlikely to be sufficient to close this investment gap, and rising concerns about debt distress in the developing world limit the scope to take on more public debt (Gaspar et al., 2019). It is widely understood that private solutions—defined here as private sector participation in service delivery or private financing—can contribute to filling the resulting investment gap, if appropriately structured to minimize sovereign obligations and contingent liabilities to governments (Eberhard et al., 2016). For example, a well-established literature shows that privately-run utilities score higher on corporate governance 2 than public utilities, which in turn is correlated positively with service delivery (Foster and Rana, 2019). Apart from private service delivery, private finance also plays an important role in the power sector, often making use of different funding instruments that underpin the capital structure of power projects,3 including equity, debt and hybrid instruments (with both debt and equity) (IRENA, 2016). What is less widely understood is what constitutes suitable conditions for attracting private solutions in the power sector, including the relative importance of different risk factors related to the policy and regulatory framework, the sector context, and the country context (Waissbein et al., 2013). Yet, understanding the relative importance of these risk factors to private investors and financiers is critical to devise public instruments that can effectively and efficiently attract private sector solutions in the power sector. Existing studies that investigate the factors that allow countries to attract private capital into their power sector commonly focus primarily on investors from industrialized countries, even though it is well documented in the literature that investors from developing and emerging economies have been playing an increasingly important role in providing finance and service delivery (see Table 1 for an overview of the literature). Furthermore, existing 2 This could be partly, as Foster and Rana (2019; p.12) underscore, because “boards of private utilities enjoy almost complete decision-making autonomy, whereas those of public utilities have limited freedom on critical matters of finance and human resources—particularly with respect to raising capital and appointing the chief executive officer. Public utilities also suffer considerable interference in the appointment and removal of board members. Overall, public utilities tend to be less rigorous in staff hiring, with more limited use of standard good practices, such as advertising, shortlisting, interviewing, and checking of references.” 3 These often take the form of independent power producers, which are defined as: “power projects that are, in the main, privately developed, constructed, operated and owned; have a significant proportion of private finance; and have long-term power purchase agreements with a utility or another off-taker”(Eberhard et al., 2017; p. 391). Yet, private finance also features prominently in publicly-owned companies, either through pure lending instruments or acquiring a stake in the public power project or company (e.g., public-private partnerships). 2 studies commonly do not distinguish between domestic4 and international investors when investigating the relative importance of risk factors. Yet, their risk preferences might differ due to the exposure and sensitivity to different risk classes. In terms of power sector segments, there is limited research investigating the differences between the different segments (generation, transmission, distribution, retail, off-grid, and mini-grid), even though there are likely differences between segments. With the increasing importance of index data to track power sector liberalization efforts, there is a growing need to ground-proof data and provide weighting of different factors (i.e., what is most important to actors in the power sector) (RISE, 2019). Lastly, there is a wide array of risk categories used across studies, increasing the need for a standardized risk assessment approach that can be easily replicated across different countries and regions. This paper contributes to filling the existing gaps in the literature by first condensing the wide array of existing risk categories into a comprehensive and coherent framework. We then used this framework to survey 51 equity investors and lenders in the power sector in Sub- Saharan Africa between January and May 2019. We used a risk factor-based framework to structure the survey, which is described in detail in Section 3 (Waissbein et al., 2013). This framework distinguished 10 risk factors, grouped into three categories, to evaluate the attractiveness of investment environments in the power sector. The survey focused on three sets of questions: (1) How important are different risks when evaluating a new power sector investment? (2) How ready are different segments of the power sector for private solutions? (3) How are different countries in Sub-Saharan Africa perceived in terms of past investment experience and prospects for new investments? This paper is organized as follows. After reviewing the existing literature in Section 2, in Section 3 we introduce the aforementioned framework, sample and survey methodology, and Section 4 presents the results. Section 6 then ‘reality-checks’ the existing, data based assessments of countries’ readiness for investment by comparing it to the results from the investor survey. Section 6 provides a summary and lessons for policy. 4 A further challenge is the definition of what constitutes a ‘domestic’ investor. For our purposes, we define domestic investors as those investors that are incorporated on the African continent. 3 2. Literature Review 2.1. What Are the Factors That Make a Sector Attractive for Private Solutions? Existing studies emphasize several risk-factors that influence the provision of private sector solutions in the power sector. Table 1 provides an overview of the coverage, time frame, sector, methodological approach and main findings of the 16 reviewed studies, grouped by methodological choices (with each section presented in chronological order). Most studies emphasize the importance of adequate power sector policy and regulation. For instance, Lamech and Saeed (2003) survey 48 international equity investors and find that the rule of law, a respect for the rights of investors, and a fair and transparent regulatory framework are the most important factors when investing in the power sector of a given country. High-level econometric studies point to similar factors. Banerjee, Oetzel and Ranganathan (2006) provide evidence from 40 developing economies in private participation in infrastructure that institutional quality and property rights are predictive of investment. The literature also points out the importance of the track record of the power sector (such as past experience of the company, current size and growth prospects) and the wider country-context. For example, Singh (2007), investigating power sector policy and regulatory reforms in Argentina, Brazil, India, Mexico, China and Thailand, underscores that macro- economic stability played a key feature in the reform process and its ability to attract foreign investment. Similar findings emerge from studies on African countries, such as Ghana and Kenya (Pueyo, 2018). This paper fills three gaps in the existing literature. First, relatively few studies focus on the peculiarities of countries at lower levels of income. Most existing studies that investigate the factors that allow countries to attract private capital into their power sector commonly focus on investors from industrialized countries, even though it is well documented in the literature that investors from developing and emerging economies are playing a greater role (Ettinger, Dellacha and Hahn, 2005). There is also hardly any research that distinguishes between domestic and international investors, even though their risk preferences might differ due to differing competitive advantages (i.e., domestic investors might be better placed to assess country risk). Second, there is little research investigating the differences between the different segments of the power sector, with most existing research focusing on power generation, even though there are likely differences between on-grid, off-grid and other segments. Third, with the increasing prominence of publicly available indices to track the power sector, there is a need to ground-proof the data and provide weighting of different factors (i.e., what is most important to actors in the power sector). 4 Table 1: Overview of Study, Coverage, Time, Sector, Methodological Approach and Main Findings of the Respective Studies Methodologic # Study Coverage Time Sector Main determinants of investment al approach Overview SSA and  Quality (not just existence) of independent regulator comparative evaluation of Eberhard et Country case  Adequate power sector expansion planning by an 1 Kenya, Nigeria, South 1994-2013 Power al (2017) studies independent system administrator Africa, Tanzania, and  Risk mitigation against key risks (i.e., off-taker risk) Uganda Comparative evaluation of policy and regulatory  Macro-economic stability Country case 2 Singh (2007) reforms in Argentina, 1993-2003 Power  Pace and sequencing of reforms studies Brazil, India, Mexico, China  Independent regulator and Thailand.  Access to human capital Ahlborg and National and international  Adequate planning Country case 3 Hammar( power sector actors in 2011 Power  Access to donor funding study 2014) Tanzania and Mozambique  Low profitability deters greater private sector involvement Ghana  Off-taker risk  Macroeconomic imbalances 20 interviews with  Quality of regulation Pueyo investors and other Country case 4 2015 Power  Access to finance (2018) stakeholders in Kenya and studies Kenya Ghana  Power demand  Quality of distribution and transmission infrastructure  Social acceptance 31 interviews with Bhamidipati Country case  Appropriate off-grid institutional framework 6 government, private firms, 2017 Power et al (2019) study  New financing mechanisms (pay-as-you-go frameworks) and development actors 5 Banerjee, Power, natural gas, 40 developing economies Oetzel and telecommunications, Econometrics  Property rights 7 across Latin America, 1990-2000 Ranganatha transport, and water (Pooled OLS)  Bureaucratic quality Europe, Africa and Asia n (2006) supply and sanitation Lüthi and 63 European photovoltaic Econometrics  Duration of administrative process, 8 Wüstenhage developers investing in 2008 Power (Choice  Feed-in tariff level and price cap n (2012) Europe and abroad experiment)  Size of the service sector is most important predictor for PPI deals from 133 low- Power, Econometrics PPI Mengistu ( 9 and middle-income 1995-2008 telecommunications, (Cross-country  SSA countries with common law origins substantially 2013) countries water and sanitation panel) more likely to get PPI (likely, due to more developed financial markets and property rights) 48 international equity Lamech and investors from mainly  Overall regulatory quality (rule of law, respect for rights 10 Saeed industrialized countries 2000-2003 Power Survey of investors and judicial processes free of political (2003) investing in developing interference) countries Power, water and  Adequate cash flow Noel and 8 equity investors Survey other local  Adequate contractual framework 11 Brzeski ( investing in Europe and 2003-2004 (informal infrastructure (not  Policy risk 2005) Central Asia survey) specified)  Exit possibility for first-round equity investors Akampurira,  Regulatory and legal framework 28 responses (19 Root and  Access to finance 12 government entities, 9 2007 Power Survey Shakantu(  Swift approval process, private sector) in Uganda 2009)  Social acceptance 60 venture capital and Bürer and private equity funds 13 Wüstenhage 2007 Power Survey  Security of cash flow mainly from North n (2009) America and Europe 6 93 European from various Masini and investor types (Venture 14 Menichetti 2009 Power Survey  Technological risk Capitalists, Investment (2013) Funds etc.). Kruger, 6 solar PV developers and Stritzke and 15 investors in South Africa 2017-2018 Power Survey  Site-specific risks Trotter and Zambia (2019) Mahbub and 25 private companies 16 Jongwanich conducting FDI in 2015-2016 Power Survey  Regulatory quality (2019) Bangladesh 7 2.2. How Can Risk Factors Be Organized into Analytical Frameworks? Several frameworks have been developed to synthesize various sources of investors’ risk and their role in determining the attractiveness for private investment in the power sector. The risk frameworks analyzed in this study can be found in Table 2. The frameworks contain between 7-9 major risk categories, which in turn are divided into 13-27 underlying barriers. Liebreich and Young (2005) use different stages of power project development to identify risks specific to the phase, ranging from planning to the eventual decommissioning of the project. This makes their framework particularly appropriate for project developers, but less applicable for wider power sector risks and actors not directly involved in developing projects (e.g., financiers). In turn, Waissbein et al. (2013) use different stakeholder groups, such as policy makers, end-users, and project developers to identify risks that are specific – and therefore, they argue, independent – to each of the stakeholder groups. This stands in contrast to other approaches, such as Akampurira, Root and Shakantu (2009) that feature overlapping and non-mutually exclusive risk categories. Yet, overlapping risk categories are particularly problematic if frameworks are used to survey participants, as strongly correlated risk categories undermine the frameworks’ quantification process. Table 2: Background, Composition, and Operationalization of Different Frameworks to Capture Investors’ Risk Framework Framework Framework composition background operationalization # Framework Survey Survey Source Specific risk categories components method participants 1 Lamech and 9 major risk 1. Government and legislative process Rating 48 Saeed categories and 2. Economy (1-4) (2003) 5 27 underlying 3. Sector’s current status barriers 4. Political economy 5. Investment process and support 6. Revenue factors 7. Operational factors 8. Regulatory factors 9. Government support and performance 2 Liebreich 4 major risk 1. Planning and permitting NA 6 NA and Young categories and 2. Construction (2005) 14 underlying 3. Operating risks 4. Decommissioning/Repowering 3 Akampurira, 23 underlying No specific aggregation of underlying Rating 28 Root and barriers barriers into risk categories (1-5) 5 First, firms were first asked to rank categories 1-5 in decision to invest in a developing country. Second, each firm was asked to rank categories 6-9 for best and worst investment experience. Each factor could be ranked from 1-4. 6 Merely conceptual article without empirical grounding. 8 Shakantu (2009) 4 Waissbein 9 major risk 1. Power market risk Rating 35 7 et al. (2013) categories and 2. Permit risk (1-5) 20 underlying 3. Social acceptance risk barriers 4. Resource and technology risk 5. Grid/transmission risk 6. Counterparty risk 7. Financial sector risk 8. Political risk 9. Currency macro-economic risk 5 Gatzert and 7 risk categories 1. Strategic/business risk NA NA Kosub, and 13 2. Transport/construction/completion (2016) 8 underlying 3. Operation/maintenance barriers 4. Liability/legal risks 5. Market/sales risk 6. Counterparty risk 7. Political, policy, regulatory risk In terms of the operationalization of the framework, some of the frameworks have been developed without directly using the structure of the framework to survey investors (denoted as NA in Table 2). For those frameworks that have been directly applied, all existing studies use rating methodologies, which allows the surveyed participants to rate each item from 1 to x (where x commonly is the highest possible ranking that can be given). Ranking survey methodologies stand in contrast to ranking methodologies, which presuppose an implicit order of importance between categories, which can be elicited. The average number of participants ranges from 28 – 48. Section 3 combines relevant parts of the frameworks discussed above and develops a framework to evaluate different risk categories, while also containing non-overlapping categories that allow for a robust quantification of the framework. 7 The report by Waissbein et al. (2013) states that for the assessment of the risk environment 14 informal interviews and 21 structured interviews were conducted for four case studies used in the report to illustrate the framework. 8 Specific focus on risks in off-shore wind. 9 3. Framework to Evaluate Investment Environments in the Power Sector We use a risk-based framework to approximate the factors that investors employ when making decisions. As many developing and emerging economies are constrained to take on more debt, and the financial situation of many utilities is troubling, understanding effective ways to mitigate risk is crucial (Waissbein et al., 2013; Polzin et al., 2019). In order to arrive at a framework to survey the investors, we rely on a twofold strategy: top-down and bottom up. From the literature review in Section 2.1, we identify three main over-arching risk categories that are most commonly found in the literature. Through this top- down approach we settle on: 1) policy and regulatory framework, 2) power sector context risk, and 3) country-context risk. For the bottom-up approach, we collect all possible barriers to private sector investment and group them into 10 risk mutually exclusive and collectively exhaustive (MECE) 9 risk factors. Then we allocate these 10 risk factors to three risk categories identified via the top-down approach. 9 We are of course aware that a completely MECE framework is difficult to achieve. 10 Figure 1: Framework of 10 Risk Factors, Grouped in Three Categories, to Capture the Attractiveness of Investment Environments We therefore use a risk factor-based framework to structure the survey (Waissbein et al., 2013). This framework distinguished 10 risk factors, grouped into three categories, to evaluate the attractiveness of investment environments in the power sector (Figure 1). First, policy and regulatory risk factors, including the ease of market entry and exit, the clarity of investment priorities, and the certainty of cash flows. Second, risk factors related to the wider sector context, including the sectoral track record of private solutions, sectoral growth (demand and supply), and the private investors’ own track record in the sector. Third, country context risk factors that capture the wider governance and political environment, the macro- economic framework, general access to international finance, and the state of domestic banking and capital markets. The framework is shown in Figure 1. 11 The survey was issued to 70 entities that are active investors in the power sector of SSA. 51 surveys were completed by individuals at 48 of these entities, resulting in a response rate of 69%. It contains four sections: 1) Investor details: Participants provided contact details, their area of work within the power sector, and their favored segment of the supply chain. 2) Investor experience: Participants listed countries in which they have invested in the power sector, the segment of the supply chain they invested in, and their overall investment experience (positive, mixed, negative) in each case, 3) Investor perceptions: Participants rated the readiness of the regulatory arrangements of each segment of the supply chain in SSA and of countries in SSA (positive, mixed, negative). 4) Importance of risks to investors: For each risk category, participants ranked constraints according to how important they are when making an investment. They also ranked the three risk categories. Aggregate data were collected from various public sources, including Aisenman et al’s (2010), Kojima and Trimble’s (2016) and the World Bank’s RISE and WDI indicators. Data were also collected from internal World Bank documents. Using the survey data, we produce the following statistics on investors’ priorities when making an investment decision: First: Overall risk category score (between 0-10) to answer the question whether – on the highest level of risk aggregation – policy and regulatory risk, power sector context risk, or country context risk is the most important risk category. Second: Risk factor scores – disaggregating the three risk categories into the 10 underlying risk factors – to further understand what drives the importance of risk category scores (e.g., whether the importance of the policy and regulatory environment to investors is driven by concerns around the ease of market entry, clarity of investment priorities or the certainty of cash flow). Third, risk constraints – on the lowest level of aggregation – which describe for each risk factor, the underlying investment constraints (e.g., are worries surrounding the certainty of cash flow driven by a lack of a government support mechanism or insufficient tariff-setting guidelines?). Hence, these three sets of statistics allow us to provide a high-level picture, while drilling into the driving factors behind each aggregate result. Using the survey data, we produce the following statistics on investors’ priorities when making an investment decision: 1) Constraint scores: Within each risk category of our framework, a score is allocated to each constraint for each survey participant (between 0 and 10, where 10 is the most important constraint to the investor). 2) Risk scores: Within each risk category, a score is allocated to each risk for each survey participant (between 0 and 10). 3) Risk-category scores: A score is allocated to each risk category for each survey participant (between 0 and 10). We then use the risk category score to weigh each risk and constraint score, as we assume that the relative importance of each risk and constraint score is determined by the overall importance of the specific risk category score. The sample covered all segments of the power sector: power generation, transmission, distribution, off-grid and mini-grids and both international and local investors (see Figure 2). Half of the survey respondents are incorporated in Africa, which reflects the increasing importance of investors of developing and emerging economies in the power sector (Ettinger, 12 Dellacha and Hahn, 2005). The majority of surveyed investors are active in the generation and off/mini-grid sector, but around 25% were active in distribution, transmission and retail. As the majority of the literature has focused on equity investors (see Section 4), our research also includes debt providers. Yet, these constitute only 7 of 51 surveyed investors, as development finance institutions (DFIs) 10 still provide a substantial part of financing for power projects in SSA (Eberhard et al., 2017). Figure 2: Overview of Characteristics of Participants a) Half of survey respondents are b) Participants are mainly active in incorporated in Africa generation and off/mini-grid Middle East Retail Asia Unknown Generation Transmission 6 Americas 2 11 12 5 34 16 51 survey 26 Africa Distribution 51 survey participants participants* 16 Europe 24 25 Mini-grid Off-grid c) Most participants are equity investors Financiers 7 51 survey participants 44 Equity investors *Investors can be in multiple categories so total adds up to more than 51 In rating the readiness of each country and supply-chain segment, participants could choose which countries and segments to rate. The reasoning was that participants may be uninformed on the readiness of some countries or segments. While this ensures participants do not provide inaccurate data, there is a potential for selection bias. For example, participants might only provide their opinion for the most extreme cases. However, our 10 DFIs were not included in the survey as they are not fully commercial. 13 results indicate that the willingness of an investor to rate a country is not correlated with its perceived or experienced readiness. 4. Results This section provides the main results from our investor survey. This section is structured along the three main research questions set out in the introduction. Section 4.1 therefore sets out the importance of different risk factors when evaluating power sector investments, whereas Section 4.2 gives an overview of the readiness of different segments of the power sector for private solutions. Section 4.3 then reviews the results in terms of the readiness of different countries. 4.1. Ranking of Risk Factors When Evaluating Power Sector Investments Investors and financiers assign the greatest importance to policy and regulatory risks (average (avg.) 6.8), followed by country context risks (avg. 4.6) and risks related to the wider power sector context (avg. 4.0). Among power sector policy and regulatory risks, the certainty of cash flow (avg. 7.4) is the most important for investors, with ease of market entry (avg. 6.6) and clarity of investment priorities (avg. 6.5) following closely behind. In the category overall power sector context risks, investors see the sectoral growth potential as the most important (avg. 4.7), whereas neither the sectoral track record nor the investors’ own track record are as important (avg. 3.6 and 3.7, respectively). In terms of country context risks, governance and political risks are the most critical for investors (avg. 6.7), followed by the general business environment (avg. 5.6), and the macro-economic framework (avg. 4.3). Risks related to domestic banking and capital markets are not considered important (avg. 1.7). These results underscore that even in difficult country and sector contexts, policy makers have the power to attract private solutions, by putting in place policy and regulatory frameworks that make projects attractive for private solutions. By far the most important risk category score is the certainty of cash flow, which relates to the investors’ ability to recover its costs and investment returns, enforce payment discipline of the off-taker or customer, and the kind of government and possibly multilateral support that is provided to secure investors’ cash flows. Yet, governance and political risk also feature prominently for investors, likely because changes in that domain can have substantial consequences for the certainty of cash flow. Least importance to investors are domestic banking and capital markets, which suggest that investors largely rely on external sources of capital and there is still a long way to go for the development of local markets for infrastructure financing, which will certainly be needed as the market matures and scales up. 14 Figure 3: Average Importance of Risk Categories and Risk Scores across all 51 Surveyed Investors. Standard error as error bars. While Figure 3 provides evidence on the average risk assessment of surveyed investors, Figure 4 provides evidence on extreme cases – namely, which of the risk categories and risk category scores are considered deal breakers and which were the factors most often ranked as the ‘most important factor’. For both the ‘deal breaker’ and the ‘most important factor category’ those risks that received the highest average risk assessment were also commonly the most important deal breaker categories and most often named as the most important factor. Yet, it is important to note that while the business environment was ranked as the most important factor by only 16% of investors, 35% ranked it as a deal breaker, possibly because without access to international sources of financing a project will not materialize. In contrast, 39% of firms ranked the firm’s personal track record as the most important factor, but only 19% consider it a deal breaker. This might suggest that while firms prefer markets where they have a track record, 81% of surveyed participants would not consider it a deal breaker and therefore might consider venturing into new markets if fruitful opportunities arose. 15 Figure 4: Average importance of risk categories and risk scores across all 51 surveyed investors in terms of deal breaker and most important factor per category. We further differentiate the risk categories and risk categories scores into the underlying constraints in Figure 5-7. We will discuss the risk categories by order of appearance in our Framework. Policy and regulatory risk is composed of three risk scores, namely ease of market entry (avg. 6.6), clarity of investment priorities (avg. 6.5) and certainty of cash flow (avg. 7.4). Further disaggregating in the underlying constraint scores shows that rules on entry and exit is the most important constraint score (avg. 8.2), followed by tariff setting guidelines (avg. 8.0) and national plan for the respective power sector segment the investor is interested in (avg. 7.9). The three major constraints are distributed evenly across the three risk scores, even though the risk categories have different aggregate scores. By far the least important factor is whether the segment of interest is unbundled. It appears that it is much more important whether the government has clear rules on entry and exit, a predictable plan for the expansion within the power sector segment and transparent rules on setting prices. 16 Figure 5: Average importance of policy and regulatory risk categories and risk scores across all 51 surveyed investors. Standard error as error bars. The least important overall risk category is power sector context risk (avg. 4.0), which is composed of the sectoral track record (avg. 3.6), sectoral growth (avg. 4.7) and the firm’s personal track record (avg. 3.7) (Figure 6). Not surprisingly, the future growth potential of the sector is the most important risk score in this risk category, because it determines the potential future earnings potential. Yet, further disaggregating the risk scores into the respective constraints shows that private sector presence (avg. 4.2), access to decision makers (avg. 3.9) and the personal network in the country (avg. 3.7) are also important factors. Yet, all of these factors are less important than those determining the sectoral growth potential. These findings suggest that the average investor is forward-looking as neither the track record of the power sector nor the firm’s personal track record are as important as the growth potential in the market. 17 Figure 6: Average importance of power sector context risk categories and risk scores across all 51 surveyed investors. Standard error as error bars. The second most important overall risk category score is the country context (avg. 4.6). We further differentiate that overall risk category into governance and political risk (avg. 6.7), the business environment (avg. 5.6), the macro-economic framework (avg. 4.3), and banking and equity markets (avg. 1.7). Within the overall risk category, the three most important constraints are all concentrated in governance and political risk. Specifically, important to investors where the rule of law (avg. 7.9), political stability (avg. 7.6) and control of corruption (avg. 6.1). Level of domestic inflation appears not to be a major concern as many countries denominate the power purchase agreements in USD. Yet, this can pose a burden to the off- taker if the domestic currency depreciates relative to the USD increasing the cost to the off- taker, increasing the likelihood of default. This can, in turn, affect the certainty of cash flow, which is the most important overall risk score (avg. 7.4). The least important factor is domestic debt (avg. 1.9) and equity markets (avg. 1.5), probably because many investors rely on international financing institutions (avg. 5.6) for funds and equity. 18 Figure 7: Average importance of country context risk categories and risk scores across all 51 surveyed investors. Standard error as error bars. Disaggregating the average numbers in Figure 5-7 again to analyze extreme cases, namely deal breaker categories and the most important factors, Figure 8 provides an overview of the results. This shows that while the constraint rules on entry and exit received the highest aggregate score (avg. 8.2), only 8% of investors considered it the most important category and only 35% a deal breaker. In contrast, ‘no legal restrictions’ received a lower aggregate score (avg. 7.9), 51% of investors considered it a deal breaker and 26% the most important category – both scores the highest in the risk category ‘policy and regulatory risk’. A similar picture emerges for the risk category score certainty of cash flow. While tariff-setting guidelines received the highest average score in this category (avg. 8.0), only 37% ranked it as a deal breaker and 12% as the most important category. In contrast, a government support mechanism to recover cost or cover tariff shortfall received a lower average score (avg. 7.8), but 50% of investors considered it a deal breaker and 16% as the most important constraint. Another interesting fact is that while surveyed participants did not consider access to decision makers particularly important, yet access to decision makers actually ranks relatively high as a deal breaker (which is not necessarily a good sign for governance). 19 These findings indicate that the risk factors can be put into three categories – analogous to findings from psychology 11 – which are: ‘hygiene factors’ that investors require to consider a market place – such as no legal restrictions on private sector involvement in the power sector – but once in place, the attention of investors shift to other risk factors such as certainty of cash flow. The latter category is ‘motivating factors’, which propel investors to actually enter a marketplace. There are other risk factors for the surveyed investors – that might be considered ‘non-factors’ in the current market set-up – such as domestic debt and equity markets, which only 7% of investors consider to be a deal breaker (the second lowest scores, only after segment is unbundled, which 4% of investors consider a deal breaker) and only 2% ranked as the most important factor (likely those that do not have international sources of financing). 11 Herzberg’s motivation-hygiene theory proposes that there are certain factors in the workplace, which cause satisfaction (so-called ‘motivators’) and those that cause dissatisfaction (so-called ‘hygiene’ factors). While hygiene factors need to be in place, they are not sufficient by itself. 20 Figure 8: Risk categories, risk category scores and constraint scores across all 51 surveyed investors for the categories: deal breaker and most important factor. 21 Yet, as noted in the literature review, it is important to further disaggregate risk preference by investor types as the exposure and sensitivity towards different risks may vary between investor types (Figure 9). We distinguish lenders and sponsors, off-grid and grid investors, as well as domestic and international investors. Investigating the importance of risk across investor classes, we see that for all investors (apart from on-grid) policy and regulatory risk is the most important risk category. For on-grid investors, in turn, power sector context risk is the most important risk category, potentially because the future expansion of the power sector determines to a large extent the investment opportunities that arise and retroactive changes to expansion these plans may pose a substantial risk. For instance, the recent change in the South African Integrated Resource Plan – the central policy document determining the future expansion of generation capacity – shifted much of the envisaged power generation expansion from 2020-2025 to 2025-2030, which creates a five-year delay for many investors. Figure 9: Risk categories, risk category scores and constraint scores for different investor classes In order to further delve into differences between international and domestic investors, we analyze to what extent international vs. domestic 12 lenders, sponsors, on-grid and off-grid investors have different risk presences. We find that overall domestic lenders attribute much 12 We consider investors ‘domestic’ if the company has been incorporated on the African continent. The majority of domestic companies surveyed are not subsidiaries of European, US or Chinese firms, but were founded in an African country. 22 more importance to policy and regulatory risk than international lenders. The latter investor category is more concerned about the power-sector context risk and the country-context risk. It should be noted, however, that only two respondents fall into the international lender category, 13 so the results should be considered with care. Domestic sponsors show largely the same risk preferences, although international sponsors also attribute more importance to the country risk, possibly because they are at a disadvantage to domestic investors in terms of local expertise. On-grid investors do not differ substantially between domestic and international lenders, possibly because the on-grid sector is tightly regulated and requires careful planning. For international off-grid investors, the country context is also substantially more important than domestic off-grid investors, possibly because government policy (e.g., expansion of the grid) has a substantial influence on the business model – and as for the other international investors – off-grid international investors might lack country-specific knowledge. Hence, it appears while overall the policy and regulatory risk category was most salient for the average investor, for international investors the power-sector context and the country-context play an important role. Yet, please note the statistical significance associated with the differences in group means, which are most pronounced between off-grid and on- grid investors. Figure 10: Differences in risk preferences between domestic and international lenders, sponsors, on-grid investors, and off-grid investors In the policy and regulatory risk category, certainty of cash flow is the most important risk score for lenders, sponsors, domestic and international investors. Yet, for on-grid the ease of market entry is most important, whereas for off-grid investors the clarity of investment priorities. For on-grid investors the entry into power markets in SSA, often dominated by a vertically-integrated utility, is often a challenge. For instance, in South Africa delays to interconnection done by the utility substantially dampened investors’ confidence. For off-grid investors, waning support to off-grid programs in Tanzania can be seen as a reason that the clarity of investment priorities is most pronounced. In terms of power context risk, for all investors (apart from lenders), sectoral growth is the most important category. In turn, for lenders, their firms’ personal track record in the country is the most important factor, potentially due to the importance of accurately performing a due diligence, which may rely substantially on their own experience in a given country. 13 Please note that we refer to ‘lenders’ as debt providers and not equity providers. 23 In terms of country context risk, the governance and political risk is most prominent across investor classes. Yet, for on-grid investors the business environment – and particularly access to international finance institutions – is the most important risk category, potentially because raising sufficiently large amounts of capital for on-grid generation plants is an important determinant in the financial viability of investment projects, whereas the capital intensity of off-grid projects is lower. Generally, lenders report the highest proportion of deal breaker categories (around 53%), whereas off-grid investors the lowest (39%). While lenders are the first in line to recoup their investment in terms of default, they also commonly provide around 70-80% of the capital needed for projects to materialize.14 Off-grid investors may have a higher tolerance for risk, because they often operate in remote areas, with less predictable future cash flow. The most important risk category – in terms of the proportion of investors considering it a ‘deal breaker’ – remains policy and regulatory risk. The country context risk is the most important deal breaker category after policy and regulatory risk for all investor classes, apart from domestic investors. For domestic investors power sector context risk is more important than country context risk, possibly due to a more substantive domestic network and more detailed knowledge of domestic risks. Figure 11: Deal breaker by investor class 4.2. Readiness of Different Countries and Segments We used two ways to evaluate the readiness of power sector in Sub-Saharan Africa for private solutions: We asked investors to rate their past investment experience in different segments of the power sector (Figure 12a) as well as their perception of prospective investment readiness in the next three years (Figure 12b). The survey results suggest that, on average, investors’ and financiers’ experience in the power sector in Sub-Saharan Africa has been relatively positive. When asked to evaluate prior investments, 42 percent of equity investors and financiers evaluate their investment experiences in the power sector in Sub-Saharan Africa as positive, compared to 15 percent who report negative experiences (43 percent reported ‘mixed’ experience; Figure 12a). Most respondents indicate past investment experience in the off-grid, mini-grid and generation 14 For smaller projects – such as mini-grids – equity commonly plays a more important role. 24 segments, while only few report experiences in transmission, distribution, or retail supply, but there is no substantial difference in the evaluation of the different segments (Figure 12a). In fact, the highest share of positive assessments of past experiences are recorded in distribution and retail supply (54 percent positive), transmission (50 percent), and off-grid (49 percent). However, it should be underscored that survey responses for distribution and retail supply and transmission are limited as only few investors have experience in these sectors (Figure 12a), likely due to their low perceived readiness (Figure 12b). Looking forward, the survey suggests that the ‘readiness’ for private sector solution in the power sector differs substantially between power sector segments. Grid generation, off- grid, and mini-grids are rated more ‘ready’ than retail supply, distribution and transmission (see Figure 9b). It should be noted that the positive prospective perception may partly be driven by the retrospective evaluation of the investment, and it is therefore likely biased upwards (except for transmission and distribution). Figure 12: Readiness for Investment of Different Power Sector Segments in Sub-Saharan Africa in terms of a) retrospective evaluation of investment experience, and b) prospective perception of investment readiness a) Retrospective evaluation of investment b) Prospective perception of investment experience readiness Off-grid Generation Generation Off-grid Mini-grid Mini-grid Mixed Mixed Negative Negative Retail Retail Positive Positive Transmission Distribution Distribution Transmission -40 -20 0 20 40 60 -40 -20 0 20 40 Rated by 46 participants. Rated by 51 participants. Yet, the assessment can further be refined: Over the last decade, several countries in Sub-Saharan Africa have attracted substantial private investments in their power sector. We asked investors to evaluate their experiences in countries they have invested in. Respondents report ‘positive’ or ‘very positive’ experiences in six countries: Kenya, Namibia, Nigeria, Senegal, South Africa, and Tanzania (Figure 13a). In the power-sector policy and regulatory framework, investors called for better de-facto regulatory independence (e.g. end arbitrary regulatory decisions in Sierra Leone), improvements to government support mechanisms and payment enforcement mechanisms (e.g. in Zambia and Tanzania), and improvements to entry and exit (e.g. speed up the regulatory process in Kenya and South Africa, improve license 25 terms in Nigeria, ensure mini-grid licenses available in Ethiopia, and prevent improper termination of contracts and licenses in Tanzania). Figure 13: Retrospective Investment Experience and Prospective Readiness in Sub-Saharan Africa Many of the surveyed equity investors and financiers plan to invest in the region in the next three years. When asked about the most attractive markets for investments over a three- year time horizon, respondents ranked nine countries as ‘positive’ on average: Côte d’Ivoire, Kenya, Mozambique, Nigeria, Rwanda, Senegal, South Africa, Uganda, and Zambia 15 (Figure 12b and 14b). Most of these countries have seen substantial power sector reform efforts, often over a decade or more, to provide adequate policy and regulatory frameworks for investment. Yet, many others have compensated for insufficient progress on power sector reforms by efforts to ‘ring-fence’ individual investments from the wider power sector policy and regulatory framework, for example through sovereign guarantees and external credit enhancement from international financial institutions—e.g., recently in the cases of Mozambique or Zambia (such guarantees and credit enhancement can mitigate risks during periods of policy and regulatory transition, but should not be seen as replacement for reforms). Figure 14 provides an overview of the retrospective and prospective readiness for each country in SSA. 15 Please note that as the survey was conducted between January and May 2019, it does not include recent changes in these countries, which may have substantially improved or deteriorated the investment conditions. 26 Figure 14: Retrospective Investment Experience and Prospective Readiness in Sub-Saharan Africa a) Retrospective evaluation of investment b) Prospective perception of investment experience readiness Tanzania Kenya South Africa Uganda Nigeria Rwanda Kenya South Africa Senegal Nigeria Namibia Côte d'Ivoire Zambia Zambia Uganda Senegal Rwanda Mozambique Ghana Ethiopia Togo Ghana Somalia Cameroon Mozambique Benin Mauritius Mixed Namibia Mali Negative Malawi Madagascar Madagascar Positive Sierra Leone Guinea Gabon Ethiopia Togo Burkina Faso Tanzania Zimbabwe Mauritius South Sudan Guinea Sierra Leone Botswana Niger South Sudan Malawi Seychelles Mixed Côte d'Ivoire The Gambia Cameroon Negative Lesotho Burundi Guinea-Bissau Positive Benin Cape Verde -10 -5 0 5 10 Burkina Faso Réunion Djibouti Comoros Angola Western Sahara Sao Tome and… Niger Liberia Equatorial Guinea Zimbabwe Sudan Mauritania Mali eSwatini Eritrea Congo… Chad Burundi Somalia Congo (Republic) Central African… -20 -10 0 10 20 30 27 5. How Well Do Survey Results Correspond to Data-Based Assessments? Besides understanding investors’ and financiers’ risk perception, a second motivation for the survey was to ‘reality-check’ existing, data-based assessments of countries’ readiness for investment. Figure 13a below shows that survey respondents’ perception of countries’ readiness correlates very well with Regulatory Indicators for Sustainable Energy 16 (RISE) 2017 scores (R2 of 0.47 for a sample of 35 countries). Ghana, South Africa, and Zimbabwe score much better on the RISE index than their perception is by investors, while the opposite is true for Madagascar, Mozambique, and Nigeria. But these are outliers, and overall, the strong correlation suggests that the RISE framework corresponds well with the private sector’s priorities. The Power Sector Reform Index (PSRI) also shows a substantial correlation with the survey data, albeit the correlation is slightly lower (R2 of 0.37 for a sample of 35 countries). It should be noted that RISE is intended to be a normative index of investment readiness, whereas the PSRI is a descriptive index that shows the extent to which the 1990s reform model has been adopted within a jurisdiction. Hence, it is therefore not surprising that overall, the RISE index shows a higher correlation with our survey results. 16 The Regulatory Indicators for Sustainable Energy (RISE) index measures countries’ regulatory readiness for Sustainable Energy across three different domains: 1) Renewable Energy, 2) Energy Efficiency, and 3) Energy Access. We therefore disaggregate the RISE index to more closely correlate it with the sub-components that are relevant to our survey data. 28 Figure 15: Correlation of the a) RISE 2017 and Perceived Readiness from Survey Data, and b) Correlation of Power Sector Reform Index and Perceived Readiness from Survey Data 29 The RISE data can further be disaggregated into renewable energy (mostly on-grid) and energy access. We therefore correlate these two measures with investors that are active in the respective aforementioned sector. It should be mentioned that for some countries there are few data points, which reduces the overall correlation coefficient. Figure 16a shows that there is a positive correlation between the assessment of the grid investors and the RISE renewable energy data (R2 of 0.13 for a sample of 35 countries). For countries with data points the assessment of the investor is spread around the trend line on both sides in equal fashion, indicating that overall, the index is correlated well the investors’ perception. The off-grid RISE data tend to be more positive about countries than the investors’ perception (as many countries are above the trend line) and also exhibit slightly lower correlation (R2 of 0.11 for a sample of 35 countries). 30 Figure 16: Correlation of the a) RISE 2017 Renewable Energy and Perceived Readiness of Grid Investors from Survey Data, and b) Correlation of Power Sector Reform Index and Perceived Readiness from Survey Data 31 In order to provide inputs on fine-tuning the existing indices, we analyze which parts of the respective index – RISE and PSRI – is best correlated with investor sentiment. Further disaggregating the RISE scores in Figure 17 and 18 into its grid and off-grid components shows that they also correlate well with the assessment of the respective investor classes. Particularly the following components of the index show a high correlation with the subjective experience: For grid-connected renewable energy particularly clear network connection procedures, carbon pricing and regulatory support for renewable energy are well corelated with the perception of investors (correlation coefficient of 0.48-0.51, where 1 indicates perfect correlation). For off-grid investors the following three indicators are best correlated with the subjective experience of investors: existence of an electrification plan, consumer affordability of electricity, and the existence of a framework for stand-alone systems (correlation coefficient of 0.36-0.43). Figure 17: Correlation of perceived grid readiness with RISE 2017 renewable energy indicators 32 Figure 18: Correlation of perceived off-grid readiness with RISE 2017 renewable energy access indicators The PSRI shows that particularly the competition index is well correlated with the perceived readiness of investors (correlation coefficient of 0.64), whereas all other components are less strongly correlated (e.g., regulation, restructuring, and private sector participation). It should be noted that the strong correlation with the PSRI competition component may be partly spurious, because the competition index records whether IPPs are allowed by governments, which likely correlates with the positive assessment of IPPs of the readiness of certain countries. Yet, it should be noted that the perceived overall readiness score goes far beyond whether IPPs are allowed and – as described in detail in Section 3 – includes other regulatory, power-sector and country-context factors. 33 Figure 19: Correlation of perceived overall readiness with Power Sector Reform Index 2017 6. Conclusion Sub-Saharan Africa faces investment needs in the hundreds of billions to achieve affordable, reliable, sustainable, and modern energy for all by 2030. It is clear that government debt, tax revenue and development finance are unlikely to be sufficient to close this investment gap, and rising concerns about debt distress in the developing world limit the scope to take on more public debt (Gaspar et al., 2019). Hence, private solutions can contribute to filling the resulting investment gap. However, the risk return profile of many countries in Sub-Saharan Africa limits the attractiveness to potential private investors. This paper therefore first developed a framework to adequately conceptualize different risks and then surveyed 51 private investors and financiers in the power sector in Sub-Saharan Africa to better understand what can be done to attract private solutions. The key conclusions emerging from the paper are as follows. First, that the average investor assigns more weight to power-sector policy and regulatory framework risks than to power-sector context and country-context risk. Among power sector policy and regulatory risks, the certainty of cash flow is the most important for investors. The most important constraint for investors to determine the certainty of cash flow is whether there is a government support mechanism, which is credible and reliable, such as guarantees in case the off-taker runs into financial problems. 34 Second, important differences exist between investor types. For all investor classes – apart from on-grid – policy and regulatory risk is the most important risk category. For on- grid investors, in turn, power sector context risk is the most important risk category, potentially because the future expansion of the power sector determines to a large extent the investment opportunities that arise and retroactive changes to expansion plans may pose a substantial risk. International investors assign more weight to country-context risk than domestic investors, potentially due to better local connections. Third, there are striking differences between segments of the power sector. Investors perceive three segments as ‘ready’ for private solutions in Sub-Saharan Africa: power generation, off-grid electrification, and mini-grids. And when asked about the most attractive markets for investments over a three-year time horizon, respondents ranked nine countries as ‘positive’ on average: Côte d’Ivoire, Kenya, Mozambique, Nigeria, Rwanda, Senegal, South Africa, Uganda, and Zambia. Fourth, besides understanding investors’ and financiers’ risk perception, a central motivation for the survey was to ‘reality-check’ existing, data-based assessments of countries’ readiness for investment. We find that survey respondents’ perception of countries’ readiness correlates very well with RISE 2017 scores (R2 of 0.47 for a sample of 35 countries). A similar picture emerges for the Power Sector Reform Index (R2 of 0.37 for a sample of 35 countries). Further disaggregating the RISE scores into its grid and off-grid components shows that they also correlate well with the assessment of the respective investor classes. Particularly the following components of the index show a high correlation with the subjective experience of off-grid investors: existence of an electrification plan, consumer affordability of electricity, and the existence of a framework for stand-alone systems. For grid-connected renewable energy particularly clear network connection procedures, carbon pricing and regulatory support for renewable energy are well corelated with the perception of investors. In sum, despite many challenges, the survey underscores that past experience of power sector investments in Sub-Saharan Africa has been more positive than negative, and many of the surveyed equity investors and financiers plan to invest in the region in the next three years. Addressing the key concerns of investors – such as the certainty of cash flow, ease of entry and exit of the market, and clear investment priorities – can substantially increase the readiness of countries. 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