In Focus: South Africa’s pioneering REIPPPP developments

First movers for adopting renewable energy generally experienced higher costs and prior to 2010 projects were often made feasible through a range of subsidies and incentives. As markets for renewable energy have matured, deployment is increasingly occurring due to favourable economics compared to conventional generation options.

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These favourable economics are clearly quantifiable by looking at the cost of externalities, short run marginal costs, and levelised cost of electricity of the various generation options. Countries that adopted renewable energy most recently therefore benefit from cost reductions that have materialised due to early-stage subsidy based programmes in countries such as Germany, Spain, the United States, Japan, and Italy. These countries hence accelerated cost reductions and deployment. A range of approaches for early-stage support were used from tax credits and Renewable Portfolio Standards (RPS) seen in the United States to the Feed-in Tariffs used in multiple jurisdictions across Europe

The timing of renewable energy deployment in any given country therefore has some impact on the prices observed when those particular procurement programmes are first launched. This effect is also reflected in the renewable energy prices seen in South Africa since the beginning of the REIPPPP in 2011. Figure 1 below shows that solar PV prices in South Africa started at above 0.3 USD/kWh and have decreased over 80% with the most competitive bids in the latest procurement windows reaching less than 0.05 USD/kWh. A similar trend is seen with onshore wind. Given these notable price decreases, policy-makers may question the merit of the first projects closed under the REIPPPP and perhaps even conclude that South Africa suffers an economic loss paying for higher priced projects in the earlier REIPPPP bidding windows.

Multi-Year Price Determination Process

From 2011, in line with policy goals of supply diversification and reducing emissions, renewable energy was introduced into the South African electricity mix in earnest and it was clear to most stakeholders that tariffs in the early REIPPPP bidding windows were high. Despite this, the high tariffs encountered over the first 3 bidding windows were catered for in the third Multi-Year Price Determination (MYPD3).

This MYPD submission did not foresee any contribution from renewable energy in terms of avoided diesel fuel costs and avoided load shedding. The only fuel saving anticipated was from reduced coal-based generation. The assumptions underpinning the MYPD3 application therefore serve as a baseline for assessing how renewables have performed against expectations. Looking at what has transpired over the years that the MYPD3 covers (i.e. 2014-2018), there have been two major deviations from the baseline assumptions and expectations:

Projects from the first bidding window of the REIPPPP came online during a period of frequent load-shedding in South Africa thus magnifying their benefit to the country
Projects from the second and third bid windows were cheaper than was forecasted in the MYPD3 submission. When MYPD3 was submitted, bids from Windows 2 and 3 had not been procured yet. As a result, the average tariffs assumed under the MYPD3, which encompass all payments for Bid Windows 1 to 3, include higher costs for renewable energy than what they actually turned out to be. The MYPD3 applicant is therefore overcompensated for “pass through” costs associated with paying for projects under the REIPPPP. This is something that should be rectified in the next Regulatory Clearing Account (RCA) applications.

Quantifying the benefit of renewables

From about 2014, construction on the first group of renewable energy projects under the REIPPPP was being completed and it became possible measure the electricity output of these projects. The cost to South Africa for procuring this electricity could therefore be compared to the savings of avoided supply interruptions and avoided generation from other conventional generation options (i.e. coal, natural gas). Using this approach, an estimate was developed on the financial benefits of renewable energy which amounted to approximately 800 Million rand for 2015. The supply side constraints in the electricity network meant that renewable energy projects were displacing electricity production from diesel powered plants which have high fuel costs. This magnified the financial benefits attributable to renewables.

The comparison of renewable energy tariffs to avoided fuel costs from conventional generators can be a useful approach to analyse the impact of decisions made by policy-makers. In applying this approach, the specific context of each country should be kept in mind to ensure that the correct conclusions are reached regarding the merits of investing in and deploying new build generation options. In South Africa’s example, under the electricity supply constraints of 2014 and 2015, the value of renewables is maximised due to displacement of expensive fuels used in peaking plants. The same analysis may show that the electricity supply system suffers a certain loss if the fuel savings are not sufficient to offset the tariff costs of procuring electricity from renewables.

In particular, this approach may be used to show that renewable energy projects ostensibly caused a financial loss in the unconstrained supply situation that South Africa has enjoyed after 2015. Comparing full levelised or tariff costs with fuel-savings of the existing fleet will (almost) always lead to a “loss” for any new-build decision. Under such an analysis, if one expected the fuel saving to exceed the new build tariff costs before making the commitment to construct new capacity, one would never build any new power station until one runs into load shedding. This fuel saver approach is therefore clearly not optimal for determining whether to build new capacity. There needs to be a broader outlook and perspective on such long term investments.

Decisions to pursue a particular mix of technologies for electricity supply are taken a with long term view—typically 20 to 50 years. For a developing country such as South Africa this takes on even greater significance given the electricity demand growth that is still to come. Estimates are that electricity demand may reach between 60GW and 80GW over the next 20 to 30 years and this places projects in the first REIPPPP bidding windows, amounting to several hundred megawatts, into proper perspective.

Moreover, a substantial portion of currently existing generation capacity in South Africa is to be decommissioned over the next 10-15 years implying that South Africa now finds itself at a turning point where the initial stages of a complete electricity sector re-configuration are taking place. In light of this, any introduction of new generation options should be evaluated, not only in terms of avoided fuel cost or other short term effects, but also in terms of an investment that is made to place South Africa on a sustainable 20-30 year path.

The first REIPPPP procurement window yielded projects with tariffs of approximately 0.3 USD/kWh and 0.15 USD/kWh for solar PV and onshore wind respectively. These tariffs apply over an allocation of about 1.5 GW which amounts to less than 3% of all generation capacity that will exist in South Africa post 2030. Assuming a capacity factor of 30% across all solar and wind projects mentioned above, 750MW of solar PV and 750MW of onshore wind over a 20 year Power Purchase Agreement period would represent an “investment” of approximately 15 billion USD over a 20 year period. This rudimentary estimate indicates the scale of investment which in reality lies between 15-25 billion USD given that tariffs in the REIPPPP did not plateau until the most recent procurement windows in 2015. It is important for policy-makers to assess what they have received in return for this 20-year investment over and above the well-documented immediate benefits which include job creation, foreign direct investment, and avoided economic loss in 2014 where South Africa was experiencing electricity supply shortages.

A new option

The most important contribution of the REIPPPP is to introduce a ready-made mechanism that can be easily employed for supply of cheap electricity to the country. The cost-effectiveness of renewable energy is now commonplace in so many markets that it may be taken for granted. Low prices for renewables come about not only through lower technology costs from global economies of scale, but also through sound policies within individual countries that make the risk profile of projects acceptable to investors and IPPs.

South Africa now understands how that optimal risk profile looks like and how to drive the deployment costs down. This knowledge benefits the country for decades to come and the interest that other countries have shown in replicating elements of the REIPPPP shows the value created. The higher priced renewable energy projects implemented from the first bidding windows represent less than 3% of the 240 TWh that currently make up the South African electricity supply. As electricity demand grows, the cost significance and impact of this small group of projects will diminish while their contribution as a blueprint for procurement and future development of the electricity system will expand.

In terms of the timing of bringing renewable energy onto the South African grid, there is a point to be made that REIPPPP Bid Window 1 could have been smaller and implemented later—especially for solar PV which exhibited much deeper cost reductions than onshore wind. This would have decreased the upfront “investment” for the country even further as it learned how best to procure and deploy renewables.

A common criticism of early stage REIPPPP projects is that the financial resources used to procure electricity from these higher priced projects flowed to shareholders outside of South Africa. The financial outflows may be a result of the procuring the generating asset (i.e. compensation to the EPC company) or a result of procuring the electricity (i.e. compensation to shareholders of the IPP). Outflows from procuring the asset will occur regardless of the generation technology chosen if the technology is not developed in South Africa.

It is therefore incorrect to characterise renewable energy as a technology that inordinately leads to outflow of revenues. When procuring electricity (as opposed to the electricity generating asset), the financing of the project also takes centre stage. Procurement rules may prescribe percentages on local or foreign shareholders and this may be used to control where the returns on the project flow to and ensure that they remain in South Africa. In competitive auction procurement processes as we have in South Africa, placing restrictions on participating shareholders may drive up the cost of procured electricity since shareholders that can offer cheaper equity or debt may be excluded from the programme. In light of such trade-offs, it is important for policy-makers to clearly define where the emphasis should lie when developing the electricity supply system. Put simply: Should the emphasis be on shareholding? On localisation? On cheap electricity? Or on something else? And how do the steps taken in the early stages of the REIPPPP support or shed light on these points of emphasis?

The primacy of cost-effective supply

Energy procurement programmes may be used as platforms for any number of objectives: job creation, localisation, and technology development to name a few. Each of these approaches leads to benefits across multiple sectors.

The provision of electricity, however, touches every sector of the economy by being an input cost to the production of all goods and services. The greatest benefit to the country will therefore come from producing electricity at the lowest cost possible and this is the metric that should be central to evaluating the investment made in renewables. As deployment costs for renewables continue to decline, many countries are taking up the challenge of introducing higher penetrations of renewable energy into their national electricity systems as they come to common conclusions on what the least cost path looks like.

In a country like South Africa which has multiple priorities, it is certainly necessary to adjust long term power system plans in line with national policies and this may sometimes lead to departures from the modelled least cost path in favour of other developmental objectives. Notwithstanding this reality, South Africa ranks among the countries that have designed a sound mechanism for fully exploiting a least cost path.

This favourable position was achieved efficiently with an investment that represents less than 2-3% of the total investment that will be required over the 30-40 year horizon of the Integrated Resource Plan.

Moreover, technology costs are still in flux and the optimal mix of generation options may look different in the long term. For this reason, the deployment mechanism under the REIPPPP offers yet another advantage that is often forgotten – planning flexibility. With an operational lifetime or purchase agreement of 20 years, an added level of flexibility is available to policy makers who may see it fit for adjust the mix at 20 year intervals to always update according to new least cost mixes as opposed to locking in a technology mix for 40-80 years.

The value that renewables have delivered

The high prices that South Africa paid in the early stages of the REIPPPP mirror the experience of many other countries. Looking beyond comparisons of fuel savings and tariffs alone, there is a great deal of value that those early projects have delivered for the country. In essence, the first renewable energy projects may be likened to a “learning fee” that has positioned the country to understand and very effectively exploit a least-cost path.

South Africa was very fortunate to also receive a “discount” on this learning fee given the added benefit of avoided diesel fuel costs and avoided load shedding that renewable energy contributed in 2015. With the first 5 bidding windows of the REIPPPP recently completed, the first bidding windows may look expensive but, over decades to come as the country moves forward on a platform of cheaper electricity and an efficient procurement process, the learning fee will be seen in proper perspective as being a modest amount that delivered much value for the country.

Figure 1: Evolution of solar prices in various markets 2010-2016 (IRENA Auctions summary 2016)

Figure 2: Evolution of on-shore prices in various markets 2010-2016 (IRENA Auctions summary 2016)

Dr Tobias Bischof-Niemz, Dominic Milazi and Crescent Mushwana

Peer reviewed by Brent Goliath - NCPC-SA

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