Wheeling dealings

South Africa remains in the grip of a seemingly inexorable electricity generation shortfall. So severe was this shortfall in the first six months of 2023 that scheduled power cuts – known locally as ‘load shedding’ – had to take place on all but one day, according to Statistics South Africa. Solutions to the country’s energy deficit are, naturally, complex, but slow progress is being made regarding both liberalising the South African energy market and in procuring battery storage projects.

Market liberalisation has largely taken the form of streamlining the permitting process for utility-scale wheeling projects, which are procured by private-sector offtakers and developed by IPPs. The projects are almost exclusively renewables assets and dispatch power to the grid, paying a wheeling charge for use of the transmission network. The charge is payable either to national utility Eskom or to a local municipality, depending on the ownership of the relevant grid infrastructure.

Offtakers enter into PPAs with the IPPs and therefore pay a different rate for all or part of their electricity from the standard rate charged for electricity from the grid, although they do not generally use the actual electrons generated by wheeling projects. Power delivered to the grid by wheeling projects effectively translates into credits on offtakers’ bills.

In recent years, modernised regulation has made wheeling projects of any size exempt from applying for a generation licence. Instead of obtaining a licence, projects must register with the National Energy Regulator of South Africa (NERSA) – a process that is considerably more straightforward. This crucial regulatory adjustment has led to a steady pipeline of project financings for wheeling projects, such as the recent ZAR1.54 billion ($83.8 million) deal for the 69MW Msenge Emoyeni wind farm.

Demand for wheeling projects is growing rapidly among both offtakers and developers. Offtakers are afforded more predictable electricity prices, while developers can potentially generate higher returns from wheeling projects than from renewables projects that fall within the government’s hyper-competitive REIPPPP scheme. Most offtakers are corporate and industrial players with large-scale energy needs.

Regulatory standardisation needed

Wheeling projects are being developed at pace, but regulation is, at present, failing to keep up with the requirements of what is becoming an increasingly liberalised electricity market. A key issue is the way in which credits are allocated by Eskom for power generated by wheeling projects. These credits are only applied to a given offtaker’s bills when the generator notifies Eskom that that specific offtaker has been supplied with a certain amount of power. This poses a risk to the offtaker if the generator and Eskom do not co-ordinate effectively.

Unless credits are applied to the offtaker’s bill, the offtaker pays Eskom for 100% of its electricity usage and also pays the generator under the terms of the private PPA. Disputes between the generator and the offtaker are a risk to the project and, ultimately, to lenders financing the project. South Africa does not yet have an established merchant electricity market, meaning that project financings for wheeling projects depend on the solidity of the corporate PPAs that underpin such deals. If a corporate PPA is terminated, the project in question must generally secure another PPA in order to generate revenue.

Additionally, there is a risk to the generator if a dispute arises between the offtaker and Eskom. For wheeling to take place, the generator and Eskom enter into an amended Electricity Supply Agreement. However, the generator is not party to this agreement and is unable to intervene should there be a disagreement between Eskom and the offtaker. If any such disagreement leads to the termination of the PPA, this is a major risk to the project, as corporate PPA termination payments are typically far smaller than those available through the REIPPPP scheme.

A further layer of complexity is added if the energy is purchased by a trader and sold on to one or more customers. Although electricity trading in South Africa in its infancy, players such as Enpower Trading, POWERX, the Energy Exchange of Southern Africa, and Etana Energy are actively attempting to establish a market presence. As energy trading becomes more common, traders will likely have to provide generators with information about where credits need to be allocated. This data will then be passed to Eskom for application to offtakers’ bills. Such a multi-stage process is administratively burdensome – particularly given that traders will often sell power to multiple offtakers – and increases the risk of billing errors.

Another area of concern is the lack of uniform regulations when it comes to the involvement of municipalities in wheeling. In areas in which municipalities own the transmission/distribution infrastructure, these municipalities buy electricity from Eskom and then sell this electricity to end users. In a wheeling arrangement, Eskom and the municipality must engage in a billing reconciliation process, as Eskom receives the benefit of additional electricity on the grid, but the municipality needs to add credits to offtakers’ bills. So complex is this process that some municipalities do not permit wheeling due to a lack of clarity as to how to implement it.

Where municipalities do allow wheeling, there is little consistency as to how offtakers earn credits for purchasing energy from a wheeling project. For example, while Eskom calculates the credits it owes offtakers at the end of each month, the City of Cape Town does this on a half-hourly basis. Eskom still awards credits if power was generated by a wheeling project during load shedding, factoring in the time of power generation when credits are calculated. However, the City of Cape Town accounts for power from wheeling projects on a ‘use or lose it’ basis, meaning that offtakers do not accrue credits for power that cannot be used as a result of grid shutdowns during load shedding.

New wheeling rules in progress

There are signs that the government is moving to address the issues affecting wheeling projects. The National Energy Crisis Committee (NECOM) is pushing for wheeling projects to be subject to standardised regulations in all areas and a set of wheeling guidelines is in the process of being drafted. These guidelines would ensure regulatory alignment between Eskom and municipalities on the management of wheeling projects. It is also possible that municipalities will be under some obligation to allow wheeling. At the very least, municipalities should have some guidance as to how to incorporate wheeling projects into their billing processes.

It is also possible that Eskom will move to allocate credits to generators rather than offtakers. Eskom would bill offtakers for 100% of their usage and it would be the responsibility of generators to pay credits to offtakers. Particularly in instances in which there are multiple offtakers, this would aggregate the credit allocation from Eskom’s perspective, thereby lessening the administrative burden and making the payment of credits solely a matter for offtakers and generators.

Eskom is also proposing to introduce ‘virtual wheeling’ to facilitate more efficient energy trading. In this arrangement, electricity traders would be refunded rather than the many offtakers to which the traders would sell power. The traders could then pass on this refund to individual offtakers. Eskom explains the wheeled energy refund methodology as follows: ‘The refund shall be processed at the end of a calendar month, and not necessarily aligned to each off-taker’s billing period. Eskom will not be responsible for the allocation of energy to each individual off-taker as the refund is done on an aggregated basis to the buyer and not at individual account level.’

A successful battery storage tender

In a process that is entirely separate from wheeling, South Africa has also recently concluded Bid Window 1 of its Battery Energy Storage IPP Procurement Programme (BESIPPPP). While South Africa has previously run a tender for solar-plus-storage projects through the RMIPPPP scheme, BESIPPPP is its first tender for standalone utility-scale battery storage assets.

A total of 513MW of battery storage capacity was procured and projects will provide capacity, energy, and ancillary services to Eskom under 15-year PPAs. The projects selected include EDF and Mulilo’s 77MW Oasis Aggeneis project at the Aggeneis substation; Scatec’s 103MW Mogobe BESS at the Ferrum substation; EDF and Mulilo’s 77MW Oasis Mookodi project at the Mookodi substation; and EDF and Mulilo’s 103MW Oasis Nieuwehoop project at the Nieuwehoop substation.

Under the terms of the RfP, bidders had to provide letters of support from banks, as is common practice. South African lenders have therefore had to do some preliminary due diligence on standalone battery storage assets for the first time. Market sources indicate that while most lenders were comfortable taking a 10-year view on the reliability of the battery storage assets, there was considered to be some technology risk associated with backing the projects for the length of the full 15-year PPA. Requesting a form of guarantee from the equipment supplier proved to be a popular strategy for lenders considering the BESIPPPP projects.

Explaining lenders’ approach to the battery storage projects, Bernard Geldenhuys, a member of the power and infrastructure team at Investec, notes: “It is not uncommon for offtakers in some markets to take part of the technology risk of BESS projects. This is not the case in South Africa, where technology risk for BESIPPPP projects is taken by the projects and, ultimately, by the sponsors and lenders. Lenders therefore need to look at ways to mitigate this risk, such as replacement programmes, insurance and guarantees from battery suppliers.”

The Proximo perspective

Both the battery storage tender and the intended reforms to wheeling regulation are sorely needed in South Africa and represent some progress towards ameliorating the country’s energy crisis. Battery storage projects are important to the energy transition in all markets, but such projects are absolutely crucial in South Africa in light of its energy deficit. Most new power projects being developed in South Africa are renewables projects and battery storage assets are necessary as a bulwark against intermittent renewables generation.

It remains to be seen what shape the structure of project financings for battery storage projects will take. At this stage, sources confirm that most banks appear willing to back transactions with tenors that run for the full length of the PPA. The use of a tail was initially considered by some banks, but South African energy deals tend to fund quite aggressively in what is a competitive environment for both sponsors and lenders and it is now less likely that BESIPPPP financings will feature a tail on the project debt.

Despite the fact that the RfP provides for two charging and discharge cycles per day, many lenders are expecting to bank the projects in a relation to a 1.5x cycle, as less power will be used over weekends. In that lenders are highly familiar with the counterparty risk associated with Eskom PPAs, technology risk remains among the most significant concerns for lenders. However, this should be addressed by measures such as guarantees from equipment suppliers.

In terms of changes to wheeling regulation, redesigning billing practices is an important step that will accelerate the growth of energy trading. Eskom does, however, remain an omnipresent force in the wheeling space, despite these adjustments. Allowing private utilities to bill consumers directly and creating a day-ahead merchant energy market would stimulate further private-sector participation.

Projects with multiple offtakers – such as SOLA Group’s 195MW solar project in the Free State province – are becoming more common and regulation will need to accommodate these projects. Risk allocation under corporate PPAs will be complex if Eskom shifts to awarding credits to generators or traders, rather than offtakers. Lenders may try to insist that generators only pay credit owing to offtakers once generators receive this from Eskom, but this will be the subject of negotiation between the various parties.

Standardising wheeling rules will allow far more offtakers in areas where the local grid is managed by municipalities to take advantage of wheeling. Municipal finances will have to be managed carefully as wheeling is introduced. Statistics South Africa estimates that in the first half of 2023, municipalities turned a profit of ZAR9.8 billion ($523.8 million) through electricity sales. This revenue subsidises other areas of municipal expenditure. Although municipalities will generate revenue through wheeling charges, consideration will need to be given to the solvency of municipalities as more wheeling projects are developed.

Along with regulatory changes, Eskom will need to undertake urgent work to upgrade South Africa’s grid, which is critically short of capacity. There are currently no new grid connections available in the Northern Cape, Eastern Cape, and Western Cape provinces – the three provinces with the country’s best wind and solar resources. Competition for grid connections is so fierce that connections are being awarded on a ‘first-ready, first-served’ basis, with little consideration for which project applied first.

The South African economy is in a truly parlous state, with unemployment sitting at 31.9% in late 2023 and GDP growth of only 1% forecast for 2024. The country’s shortage of power is a result of long-term mismanagement and is one of several key reasons for its economic decline. Power and renewables projects in South Africa have been shown to be eminently bankable, but it is essential that the government and, by extension, Eskom rapidly create a greater number of credible pathways for investment.