East Africa's need for infrastructure
According to a World Bank study, 365 million people in Africa are without electricity access and 558 million lack access to clean cooking. Eastern and Southern Africa alone account for more than half of the world's unelectrified population (675 million) and nearly a quarter of the global population without access to clean cooking (2.4 billion).
In response to these challenges, East African governments, alongside international donors such as the World Bank, the United Nations Development Program, the African Development Bank and the European Union, have increased their focus on promoting rural electrification programs. These initiatives have played significant roles in supporting energy transitions in their respective countries.
To meet the Sustainable Development Goals (SDGs) and reduce carbon footprints, Multilateral Development Banks have also stepped-up efforts to facilitate the provision of renewable energy sources. These include solar power, wind power, hydropower and geothermal energy. The World Bank Group aims to connect 250 million people to electricity through distributed renewable energy systems both on and off the distribution grid . Consequently, there are substantial opportunities for private investment in grid-connected renewable energy needed to power East African economies for growth.
In light of the concerted efforts by East African governments, international donors, various bilateral aid agencies and the introduction of the African Continental Free Trade Area Agreement, there is a burgeoning market for energy projects in the region. However, despite these promising opportunities, numerous pitfalls and challenges have impeded the successful completion of many of these projects.
Six common pitfalls in East African projects and how to avoid them
1. Payment arrears
Payment issues are undeniably one of the most common causes of disagreement in the East African construction industry, particularly with large-scale energy projects. When payment is not made on time or as expected, the project is easily distressed.
Energy companies in East Africa often face delayed payments or arrears from state utilities. For instance, Symbion Power encountered significant payment issues with the Tanzania Electric Supply Company (Tanesco), leading to financial strains which were ultimately resolved through multiple arbitrations. In 2016, Tanesco unilaterally suspended a 15-year power purchase agreement with Symbion Power Tanzania Limited. This resulted in legal proceedings at the World Bank Group’s International Centre for Settlement of Investment Disputes (ICSID). However, in May 2021, the case was dropped, highlighting the challenges in resolving such disputes.
Therefore, to avoid costly project disruption caused by payment disputes, parties may benefit from:
- Ensuring that project contracts from the outset include clear payment terms, dispute resolution mechanisms and penalties for late payments;
- Building strong relationships with the contracting party from the outset of the project;
- Addressing any animosity or conflict between the contracting parties quickly and carefully;
- Reviewing the project contract to determine what provisions apply and can be used to helpfully resolve the payment issue; and
- Negotiating and discussing the issue, keeping communication between the parties open so that mutually agreeable solutions can be found.
2. Cancellation of agreements
High rates of interest and inflation have given rise to many East African projects being scrapped. Governments are doing what is necessary to counter any economic uncertainty by cancelling power purchase agreements (PPAs) or delaying licensing processes and in some instances withdrawing from the EPC construction project for the delivery of energy altogether. In Kenya, a moratorium was placed in 2021 on the negotiation of PPAs between the Kenya Power and Lighting Company (KPLC) and Independent Power Producers (IPPs) to address high electricity costs. Although the ban was lifted a year later, investor uncertainty still lingers.
Bureaucratic delays in receiving tariff approvals, certificates, licenses and letters of support from the government can also hinder project progress and threaten the bankability of the project, meaning that the risk of cancellation is high.
To reduce the risk of project cancellation, parties should consider:
- Whether obtaining insurance may help to mitigate the risk of project cancellations or government interventions;
- Structuring agreements with flexibility to adapt to policy and law changes and include termination compensation clauses;
- Actively engaging and maintaining relationships with policymakers and stakeholders to align project objectives with national energy goals;
- Ensuring that project agreements properly address pricing and the potential for price escalation so that there is certainty of costs so far as possible;
- Working closely with government agencies to understand regulatory requirements and streamline approval processes;
- Factoring potential delays into project timelines and budgets to accommodate bureaucratic hurdles; and
- Collaborating with local partners who have established relationships with government bodies to facilitate faster approvals.
3. Changes in laws and policies
East African countries often invoke frequent changes in laws and policies as well as impose new obligations on sponsors and investors mainly to protect the economic interests of the country. However, such changes can in turn lead to increased financial burdens and operational challenges.
To reduce the risk of changes in law/policy adversely impacting a project, parties may benefit from:
- Keeping abreast of legislative developments to anticipate changes and adjust strategies accordingly;
- Engaging legal experts qualified within the East African jurisdiction to navigate new laws and ensure project compliance with evolving regulations; and
- Anticipating the need for flexibility and adaptability to policy changes without significant disruption.
4. Lack of long-term financing
Private investment in East African energy projects can often be limited due to a lack of available long-term financing options, high lending rates and regulatory uncertainties.
An investment term that falls significantly short of the term for constructing and implementing projects means that the exposure to risk for parties left operating the project in the longer term is often too high. To mitigate the risk of short-term investment, it can be helpful to:
- Explore alternative financing options, such as green bonds or public-private partnerships, to secure long-term funding; and
- Implement measures to mitigate risks and enhance project bankability, such as securing government guarantees.
5. Land-owner risk
Securing land in East Africa for energy projects can be complex. Land governance is multifaceted: from addressing ancestral land claims to tackling wealthy urban property-owners seeking to sell their land at extortionate prices. Disputes over land use rights are therefore increasing with the rising demand for infrastructure. For example, a wind farm project in Lamu was nullified in 2020 by the county government for failing to adhere to resettlement agreements .
To avoid protracted land disputes and delays to the commencement of a project, parties may benefit from:
- Conducting comprehensive assessments of land ownership and usage rights before project commencement;
- Engaging with local communities early to address concerns and secure buy-in for the project;
- Developing clear resettlement plans and compensation agreements to prevent disputes and ensure compliance with local regulations; and
- Conducting detailed market assessments to provide insights into fair land values, enabling project developers to identify and challenge unreasonable pricing.
6. Currency risks
Due to the size and scale of East African energy projects, they often require foreign investment. If local currencies weaken, the cost of repaying foreign loans and purchasing imported materials can increase, squeezing profit margins. Additionally, economic instability can lead to higher inflation and interest rates, increasing operational costs and reducing the attractiveness of investing in the region. This uncertainty makes it more challenging for East African project developers to secure financing, negotiate favourable terms and achieve financial sustainability, ultimately affecting the overall success and growth of the energy sector in East Africa. To mitigate these risks consider:
- How the use of financial instruments might help to hedge against currency risks and protect project revenues;
- Conducting thorough economic analysis to understand potential risks and adjust financial models accordingly; and
- Exploring local currency financing. Local currency financing can help mitigate the challenges of currency fluctuations and economic instability in energy projects in East Africa by reducing exchange rate risk. When projects are financed in local currency, the need to convert local revenue into foreign currency to repay loans is eliminated, protecting against losses from currency devaluation. This stability makes financial planning more predictable and can lower the cost of capital by reducing the risk premium investors might demand for exposure to currency fluctuations.
Concluding thoughts
The energy sector in East Africa offers vast potential and substantial opportunities for investors, financiers and other stakeholders willing to engage in this dynamic region. Despite the six common pitfalls discussed, adopting robust risk management practices, fostering strong relationships with government entities and leveraging innovative financing solutions, stakeholders can capitalize on the burgeoning market for renewable energy projects.
The successful realisation of these projects not only promises attractive returns but also contributes to the socio-economic development of East Africa by expanding energy access, enhancing economic growth and promoting sustainable development.
Therefore, with concerted efforts from governments, multilateral development banks and parties within the private sector to properly apportion risk at the outset of a project and cooperatively deal with issues arising during the life-cycle of a project, East Africa's energy landscape is poised for transformation, offering a resilient platform for impactful investments and long-term growth.
Our Construction team understands the issues our clients are facing. Please contact us if we can assist you.
Written by Paula Ochango and Yolanda Walker
Paula Ochango is Legal Counsel for Mota-Engil Africa.
