The Renewable Energy Law Review: South Africa

Introduction

The fundamental driver for renewable energy projects in South Africa remains the Renewable Energy Independent Power Producer Procurement Programme (REIPPPP) launched by the then Department of Energy (DoE) (now known as the Department of Mineral Resources and Energy (DMRE)) on 3 August 2011 in terms of a document entitled 'Request for Qualification and Proposals for New Generation Capacity under Tender no. DOE/001/2013/2014'. This Request for Qualification and Proposals document has been updated or reissued from time to time. The REIPPPP is a competitive tender process that has been designed to facilitate private sector investment into grid-connected renewable energy generation in the Republic of South Africa. Under the REIPPPP, independent power producers (IPPs) are invited to submit bids for onshore wind, solar photovoltaic, concentrated solar power (CSP), small hydro, biomass, biogas or landfill gas projects. Submitted bids must first qualify for evaluation by meeting minimum compliance requirements, after which they are evaluated based on price and economic development criteria. Between the years 2011 and 2015, four such bidding rounds have been completed, generally referred to as 'bid windows', with an additional round for CSP only. An expedited bid window was run in 2015. This was designed primarily to provide bid projects that had been unsuccessful during prior rounds, with a second opportunity to bid. A total allocation of 1,800MW was made available for tender under the expedited bid window, with bid submissions in November of 2015. Moreover, the Small Projects IPP Procurement Programme was introduced in 2013, which aims to procure 200MW from projects between 1MW and 5MW each. This programme aims to be simpler and less expensive for bidders so as to encourage participation from small and medium enterprises in the Republic of South Africa, which are often unable to compete effectively with larger players. In October 2013, the Small Projects IPP Procurement Programme offered 50MW for tender. After a pre-qualification phase in March of 2014, 29 bids totalling 139MW were received in November 2014. Of those, 10 projects totalling 49MW were awarded in October 2015. A further 10 projects were awarded as at January 2017.

The year 2020 brought with it immediate change and a positive turnaround in the South African energy sector. One of the major stand-out developments was the launch of the Risk Mitigation IPP Procurement Programme (RMIPPPP) for new generation capacity initiated by the DMRE on 23 August 2020. The RMIPPPP was designed with the intention of procuring 2,000MW of emergency power for South Africa. Bid submissions for emergency power under the RMIPPPP closed on 22 December 2020 and attracted a total of 28 bid responses with a potential contracted capacity of 5,117MW. Much like the REIPPPP, the RMIPPPP follows ministerial determinations issued by the Minister of the DMRE in terms of Section 34(1) of the Electricity Regulation Act, 2006 (Act No. 4 of 2006) (the ERA) from time to time, and is implemented in accordance with the regulations promulgated under the ERA. Pursuant to the ministerial determination made by the Minister of the DMRE as gazetted on 7 July 2020 in Government Gazette No. 43509, the Minister of the DMRE indicated that it was necessary to ensure energy security, and that approximately 2,000MW is to be generated from a range of energy source technologies in accordance with the short-term risk mitigation capacity allocated under the heading 'Others', for the years 2019 to 2022 in Table 5 of the Integrated Resource Plan for Electricity 2019 to 2030 (published as GN 1360 of 18 October 2019 in Government Gazette No. 42784 (the IRP 2019)). The RMIPPPP has been designed to procure new generation capacity derived from different types of dispatchable power generation projects that will enter into power purchase agreements (PPAs) with Eskom. Dispatchable power generation projects may utilise fuel to produce the energy output and may be comprised of more than one facility and project site. The selected projects will contribute toward socio-economic development and sustainable economic growth, while enabling and stimulating the participation of independent power producers in the electricity supply industry in South Africa. Projects submitted under the RMIPPPP may comprise of any of the following:

  1. a single facility using a single technology solution, on a single project site;
  1. multiple facilities using different technology solutions (i.e., fuel and non-fuel-based generation), on a single project site; or
  1. multiple facilities using different technology solutions, on multiple project sites.

On 1 June 2021, Scatec was awarded preferred bidder status by the DMRE under the RMIPPP on three projects totalling 150MW of contracted capacity. The three projects in total consisted of 540MW solar and 225MW/1,140MWh battery storage, located in the Northern Cape Province of South Africa. The projects awarded to Scatec are the only projects with preferred bidders status exclusivity using renewable energy technology, making it arguably one of the largest single site solar and storage hybrids in the world.2

On 19 March 2021, the DMRE issued the much-anticipated Round 5 Bid Window for the procurement of new generation capacity, which aims to procure a total capacity of 2,600MW (1,600MW for onshore wind and 1,000MW for solar photovoltaic). The appropriateness of the REIPPPP for procuring biomass, biogas and landfill projects is currently under consideration. Due primarily to their technology-specific requirements and small size, it is believed that those technologies may better suit the Small Projects IPP Procurement Programme, or an alternative focused procurement programme. As such, these technology specific requirements have been excluded from more recent bid windows, including under Round 5.

Prior to the formal launch of the REIPPPP in August 2011, the local renewable energy market was fairly inconsequential. A lot has changed since then, with the REIPPPP being heralded globally as a shining example of how to successfully implement renewable energy auction programmes. The success achieved by the REIPPPP has, however, not been without its challenges. Eskom Holdings (SOC) Limited (Eskom), the state-owned national utility and sole offtaker of electricity from projects under the REIPPPP, historically refused to sign any further PPAs with IPPs. However, Eskom's monopolistic stronghold over the energy sector loosened during 2018, when Eskom signed 27 PPAs with a combined investment value of 56 billion rand and capacity of 2,300MW from bid windows 3.5 and 4 of REIPPPP.

Eskom's historical monopoly on generation in South Africa has been gradually challenged by IPPs that are able to deliver generating assets largely on time and on budget – key features that have been somewhat lacking in Eskom's skillset for some time, leading to above-inflation increased costs of electricity to the end users (while the tariff prices under the REIPPPP continue to drop dramatically in each procurement round/bid window). Eskom is in a financial 'death spiral', owing over 400 billion rand to its creditors. In addition, by the end of 2018, South Africans were hard hit by rolling blackouts that were implemented to protect the grid from total collapse or blackout. The lack of energy capacity is because of Eskom's poor management; lack of funding or misappropriation of funds; and maintenance and labour issues. Further, the expensive and overdue operation of Medupi and Kusile coal-fired plants have resulted in the grid operating on the edge and the government of South Africa being forced to consider the unbundling of Eskom. This will result in Eskom being unbundled in three divisions – namely, generation, transmission and distribution – which will positively kill Eskom's monopoly, but millions of taxpayers will face the cost of implementing this. However, as at the date of this publication, the unbundling of Eskom has not yet taken effect and our intelligence in the local market indicates that the unbundling of Eskom is expected to be completed by December 2022. Eskom's credit rating has also hit rock bottom, with a Standard & Poor's credit rating below sub-investment grade.

The unbundling of Eskom may make it easier for renewable energy plants to supply electricity to the national grid and the Integrated Resource Plan (IRP), which was approved in October 2019, provides that the energy mix by 2030 will consist of coal (46 per cent), 1,860MW of nuclear (2 per cent), 4,696MW of hydro (6 per cent), 2,912MW of pumped storage (4 per cent), 7,958MW of solar photovoltaic (PV) (10 per cent), 11,442MW of wind (15 per cent), 11,930MW of gas (16 per cent) and 600MW of concentrated solar power (CSP) (1 per cent). The rooftop solar market is growing at a fast rate. The Mall of Africa's solar PV system is the largest rooftop solar PV system of its kind in the southern hemisphere and the tenth largest in the world, covering an area of approximately 45,000m2. The solution is estimated to produce 78,000MW annually, at a construction cost of over 50 million rand. Although the regulatory regime in South Africa does not currently allow for excess energy to be sold back into the grid, as is the case in certain parts of the United States, the sponsors (Solareff, Attacq and Atterbry) together with the National Energy Regulator of South Africa (NERSA) and Eskom successfully worked through a lengthy legal process to ensure lawful compliance and successful synchronisation of the system with the national grid through Eskom's grid access framework. The Mall of Africa has no doubt been a game changer for rooftop PV in South Africa, and a change in the regulatory regime allowing excess energy to be sold back into the grid would be most likely to stimulate the rooftop solar market.

There are currently no significant tax incentives or other government-led programmes that mirror those in the United States or the European Union that have fostered the growth of renewables to such an extent in those markets. However, in 2019, South Africa introduced a carbon tax aimed at reducing the emission of greenhouse gases and thus indirectly incentivising a shift towards more renewable energy incorporation in the South African energy mix. Large-scale retailers (such as the Mall of Africa) are now installing large rooftop solar facilities to reduce their reliance on Eskom as a supplier and what is perceived as ever-increasing above-inflation tariff costs. Furthermore, reflecting international market trends, a number of international corporate entities are looking at renewable off-grid solutions. We expect this off-grid market to continue to grow, which presents a challenge for Eskom as its customer base continues to shrink.

The year in review

The year 2020–2021 brought with it positive change in the way of a transformation in the South African energy sector in relation to renewable energy. As previously mentioned, the DMRE has issued the much-anticipated Bid Window 5 under the REIPPPP aimed at increasing South Africa's renewable energy generation capacity by 6,800MW.

The largest renewable energy facility located in the Northern Cape of South Africa has commenced construction of a 100MW concentrated solar power (CSP) project. The facility will be equipped with a 12-hour thermal storage system that will deliver clean and reliable electricity to nearly 200,000 households around the clock. Commencement of operations is scheduled for the last quarter of 2023.

The City of Johannesburg (CoJ) has also announced plans to seek funding of about 38 billion rand for the development of the city's renewable energy sector. The municipality intends to issue a request for information in September for the construction of:

  1. 150-megawatt solar plant;
  2. 50 megawatts of rooftop solar panels; and
  3. the refurbishment of an idle gas-fired plant that could generate 20 megawatts.

In May 2019, the Minister of the DMRE gave permission for NERSA to licence 500MW of small-scale embedded generation (SSEG) projects, sized between 1MW and 10MW, without the need for the Minister of the DMRE to sign it off. NERSA subsequently, in September 2020, released a list of municipalities with approved SSEG tariff structures. Twenty-nine of South Africa's municipal electricity utilities already have aspects or components of an SSEG tariff structure in place to incorporate SSEG generation into their electricity networks.

Moreover, the Minister of the DMRE gazetted amendments to the Electricity Regulations on New Generation Capacity on 16 October 2020, which enables municipalities in good financial standing to develop their own power generation projects. The Gazette notice amends the Electricity Regulations on New Generation Capacity in terms of Section 35(4) of the ERA. The recent amendments to the regulations clarify the regime applicable to municipalities when requesting determinations under Section 34 of the ERA. An internal standard operating procedure has been introduced at the DMRE to ensure that requests for Section 34 determinations are attended to in the shortest possible time. These amendments extend the procurement of new renewables, cogeneration, baseload, mid-merit, peak load, energy storage and cross-border generation capacity to organs of state 'active in the energy sector', which includes municipalities. A municipality must, however, apply to the Minister of the DMRE to procure or buy new generation capacity in accordance with the IRP, as well as the municipality's own Integrated Development Plan (IDP). A feasibility study must also be submitted in instances where a project is being funded internally, while a municipality must submit proof that it has complied with the provisions of Section 120 of the Local Government: Municipal Finance Management Act, 2003 (Act No. 56 of 2003), and the Municipal Public–Private Partnership Regulations in those instances where the electricity is being procured from an IPP. This will ensure an orderly development that is in line with the applicable IRP and municipal IDPs.

The CoJ recently set a 35 per cent renewable energy target by 2030 and is in the process of seeking proposals from IPPs by August 2021. This comes off the back of the government of South Africa's amendments to the ERA that permit municipalities to establish or procure electricity from companies other than state power utility, Eskom. Renewable energy would be procured by gauging interest from private producers and using municipal funds to pay for it. In addition to renewable energy sources such as solar energy and biogas from landfills, the CoJ is considering the use of hydrogen fuel-cells and natural gas. Discussions over gas-fuelled power have been held with potential suppliers including DNG Energy, a liquefied natural gas company. The Kelvin Power Station, which already supplies coal-fired power to the municipality and is controlled by Harith General Partners, intends to switch to gas.

The policy and regulatory framework

i The policy background

There are very limited government-led regulatory and tax incentives for renewables. As already noted, the current regulatory regime in South Africa does not allow for excess electricity from renewable sources such as residential or rooftop solar to be sold back to the grid, and a reform to allow for this would stimulate and promote faster growth in the rooftop solar market. The situation is compounded by the absence of significant tax incentives or other government-led programmes to foster development of the renewables market. Nor are there any tariff top-up arrangements like those seen in renewable energy programmes elsewhere in Africa, such as the successfully implemented GET FiT programme in Uganda. Although feed-in tariffs were initially proposed in South Africa, these were superseded by the auction process now known as the REIPPPP, which has proved hugely successful, with each further round being heavily oversubscribed.

As from 1 January 2016, Section 12B of the Income Tax Act, 1962 (Act No. 58 of 1962) (South Africa) (the Income Tax Act) changed the three-year accelerated depreciation allowance on renewable energy (50 per cent to 30 per cent to 20 per cent) to an even quicker depreciation allowance of one year (100 per cent). This accelerated depreciation allowance came about from a proposal in the 2015 draft Taxation Laws Amendment Bill that the definition of solar energy be amended to distinguish between solar PV energy of more than 1MW, solar PV energy of less than 1MW and concentrated solar energy. The amended Section 12B provision now provides for an accelerated capital allowance of 100 per cent in the first year, in respect of solar PV energy of less than 1MW.

The reason for the change is to accelerate and incentivise the development of smaller solar PV energy projects, as these have a low impact on water and the environment. This is also intended to help address the energy shortages facing South Africa in a more environmentally friendly way.

Section 12B of the amended Income Tax Act provides for a capital allowance for movable assets used in the production of renewable energy. More specifically, it allows for a deduction equal to 100 per cent in respect of any plant or machinery brought into use in a year of assessment for the first time and used in a process of manufacture or any other process of a similar nature. Notably, the allowance is only available if the asset is brought into use for the first time by the taxpayer. In other words, the allowance is not limited to new or unused assets. The wording merely prevents the taxpayer from claiming the Section 12B allowance twice on the same asset.

With this incentive, companies can deduct the value of their new solar power system as a depreciation expense from its profits.

The Carbon Tax Act provides for a basic tax-free threshold of around 60 per cent of emissions and additional allowances for specific sectors that may result in tax exemptions for up to 95 per cent of emissions during the first phase until 2022. The full carbon tax rate is proposed to be 120 rand per tonnes (t) of carbon dioxide (CO2) equivalent (e) (tCO2e), after exemptions. The effective tax rate is expected to be between 6 and 48 rand per tCO2e.

The updated IRP has provided for a small allocation of 1 per cent to the CSP technology under the REIPPPP. The CSP technology is seen to provide much higher costs compared with solar PV and wind. The challenge of intermittency is likely to be solved by the ever-increasing introduction of battery solutions; it is unclear, however, on what scale this can be financed in the local marketplace.

ii The regulatory framework

In South Africa, the regulation of electricity from renewable sources falls under the jurisdiction of NERSA, one of three energy regulators established under the National Energy Regulator Act, 2004 (Act No. 40 of 2004) (NRA), which regulates electricity, piped gas and petroleum pipeline industries. Eskom's tariffs are regulated by NERSA under the ERA. These tariffs are based on Eskom's costs plus a reasonable rate of return.

The NRA, together with other key legislation regulating the relevant industries (in the case of electricity, the ERA) establishes the framework for renewable energy regulation in South Africa. That legislation, together with associated regulations, notices, rules and guidelines, grants expansive regulatory power to the regulators, including the powers to issue, amend and revoke licences, as well as to approve tariffs.

Under the ERA, a licence is required for each operation (i.e., for electricity generation, transmission and distribution facilities, and in respect of the import, export and trading of electricity – collectively, the licensed activities), but it provides exemptions for licences in respect of (1) any generation plant constructed and operated for demonstration purposes; (2) any generation plant constructed and operated for own use; (3) any non-grid-connected electricity supply other than for commercial use; and (4) any other activity relating to the licensed activities for which NERSA has determined that a licence is no longer required. In relation to the latter exemption, NERSA may require that persons undertaking the activity concerned nevertheless register it with NERSA.

A person obliged to hold a licence in terms of the ERA must apply to NERSA for the licence in the form, and applying the procedure, prescribed. The application must be accompanied by the prescribed licence fee. The information required for such an application includes, among other things:

  1. a description of the applicant, including any vertical and horizontal relationships with other persons engaged in the operation of the relevant licensed activity;
  2. the administrative, financial and technical abilities of the applicant;
  3. a description of the proposed generation, transmission or distribution facility to be constructed or operated;
  4. a detailed specification of the services that will be rendered under the licence;
  5. a general description of the type of customer to be served;
  6. the proposed tariff and price policies; and
  7. evidence of compliance with the IRP.

The process entails publication of notices of the application in appropriate newspapers or other media and the applicant responding to objections to the application being granted, and it culminates in NERSA making a decision on the application within the prescribed period.

Transfer of control and the assignment of a licence issued in respect of licensed activities, including generation licences issued to IPPs, are restricted by conditions imposed on the licensee by NERSA. Accordingly, each licence must be reviewed on a case-by-case basis to determine what specific approvals are required for its transfer. However, the ERA generally provides that a licensee may not cede or transfer its powers or duties under a licence to any other person without the prior consent of NERSA. The transfer of control and the assignment of licences issued to IPPs are further regulated by the implementation agreement between the South African DMRE and the IPP; that agreement provides for, inter alia, government support for the development and financing of relevant IPP projects.

The initial IRP sets out the South African government's strategy for the establishment of new generation and transmission capacity for the country for the period 2010 to 2030. It calls for the doubling of the country's electricity capacity from its 2010 level of 238,272GWh, using a diverse mixture of energy sources, mainly coal, gas, nuclear and renewables, and including large-scale hydro to be imported from other countries in the southern African region. The initial IRP further details how this demand should be met in terms of generating capacity, type, timing and cost. The initial IRP also serves as an input to other government planning functions, inter alia, economic development, funding, and environmental and social policy formulation; it is also a means to determine the requirement for further investment in electricity generation capacity for South Africa.

At the time that the IRP was initially promulgated, the South African government advised that the IRP should be viewed as a 'living plan' that would be revised by the DMRE every two years to ensure its relevance with regard to (among other things) technological and environmental developments in the global arena. An update to the IRP was provided for public comment in August 2018 and subsequently approved in October 2019. It became necessary to revise the initial IRP following capacity additions through ministerial determinations under Section 34 of the ERA, and to bring up to date key assumptions that have changed significantly since the promulgation of the initial IRP. Although the Minister of the DMRE released a draft of an updated Integrated Energy Plan (IEP), a subsequent draft has not been provided for public comment. The IEP serves as the government's master plan for the entire energy system, with its focus on the broader objective of reducing the country's energy footprint overall. The IEP regulates energy industries and promotes electric power investment, greater employer benefits and a more favourable environmental impact. The IRP on the other hand, being subordinate to the IEP, focuses specifically on electricity.

Renewable energy project development

Project finance transaction structures

A large percentage of the project financing activity for renewable energy projects has occurred within the framework of the REIPPPP and the Small Projects IPP Procurement Programme. While the project finance structure that has been adopted to date follows international norms, there are a number of unique features imposed on sponsors under the REIPPPP, including localisation requirements that cover the development of specific categories of people, enterprises and communities or economic sectors. The following broad categories are covered:

  1. job creation;
  2. local content;
  3. ownership;
  4. management control;
  5. preferential procurement; and
  6. enterprise development and socio-economic development.

In terms of documentation, these follow international norms, with financing documentation largely following Loan Market Association precedents. Security packages typically include the following:

  1. borrower guarantee and share pledge;
  2. borrower cessions of its rights, title and interests in respect of aspects such as the project documentation, insurance proceeds, claims, licences, permits and authorisations under the transaction;
  3. general notarial bond, which is a registered security over all the movable assets of the borrower;
  4. special notarial bond, which is a registered security over specified movable assets of the borrower; and
  5. mortgage bond, which is a registered security over the borrower's land rights.

Construction, operation and maintenance agreements also largely follow international norms with engineering, procurement and construction contracts and operation and maintenance contracts closely following what one would expect to see in established markets. Internationally accepted standard construction contracts such as a FIDIC Silver Book are common (amended though to tailor for market norms and certain testing and performance complexities relative to each renewable energy technology).

To date, the vast majority of debt has been provided by the large five domestic commercial lenders (Rand Merchant Bank, ABSA, Nedbank, Standard Bank and Investec) with some participation from development finance institutions and pension funds (DBSA, PIC, IDC, etc.). International institutions such as the International Finance Corporation and the Organization of the Petroleum Exporting Countries have also been involved with financing a number of large renewable projects.

Aside from a large number of Enel projects (the Italian national utility) in Round 3 of the REIPPPP, almost all projects have been financed on a limited or non-recourse basis.

While debt tenors vary, they are typically around 15 to 17 years (from commercial operation date) and spreads on the Johannesburg Interbank Agreed Rate are between 310 and 400 points (risk premium 250, liquidity 120 and statutory costs 30 points).

Distributed and residential renewable energy

Eskom, in its position as the national utility, is also the primary licensed distributor of electricity in South Africa. As was mentioned above, the current regime does not allow excess electricity to be sold back to the grid from renewable sources as it would be in jurisdictions such as the United States or the European Union, and a change in the regulatory regime would stimulate the rooftop solar market and allow it to grow far more quickly. There is also no regulated framework for use-of-system charges for embedded generators (connected to the distribution network). NERSA is, however, in the process of developing a framework for generators.

Generators that wish to wheel energy to third parties face a number of challenges related to the use-of-system charges.

Non-project finance development

The appetite in the market for on-balance sheet, corporate, full equity finance is extremely small. Almost all developers and sponsors of renewable projects in South Africa adopt a project finance structure.

Renewable energy manufacturing

The implementation of the REIPPPP resulted in a significant portion of the technical equipment being imported from Europe and China. However, the increased local demand has stimulated the desirability and growth of component manufacturing for the renewable energy sector in South Africa. More recently, there has been an increase in the number of wind turbine and solar panel manufacturing plants built in South Africa, and several of these manufacturers have taken full advantage of the benefits offered to entities operating within the specifically demarcated South African Special Economic Zones (SEZs). These specifically demarcated SEZs have been set up to encourage trade and investment that create employment opportunities in South Africa and ultimately benefit the South African economy, and there are SEZs that have positioned themselves for investment in renewable energy power generation and manufacturing plants, such as the East London Industrial Development Zone.

There is a small number of solar and wind turbine equipment manufacturers currently taking advantage of the favourable SEZ laws. The Coega Industrial Development Zone, which was formed in 1999 and is located 20 kilometres north of Port Elizabeth in the Eastern Cape province of South Africa has attracted three manufacturers of solar and wind turbine equipment, namely DCD Wind Towers, Electrawinds and Powerway. There are concerns that when these components are exported from these SEZs into South Africa, the customs and VAT levied on the components will be based on the value of the components, including South African raw materials and labour costs. This could result in a higher cost for South African customers as compared with components manufactured wholly offshore and imported directly into South Africa.

The Coega Industrial Development Zone is currently positioning itself to become the solar and wind turbine equipment hub for the Eastern Cape, as there are several renewable energy projects being proposed there. The East London Industrial Development Zone is also positioning itself to manufacture and supply electricity from renewable energy sources in the Eastern Cape Industrial Development Zones. This Industrial Development Zone has advertised that it has suitable land for electricity generation from both wind and solar facilities, with established relations with the top 100 users and the local authority for connection of the power plant to the grid and supply of electricity to the nearby Buffalo City metropolitan municipality.

Conclusions and outlook

The future looks very positive for renewable energy in South Africa with the publication of the much-anticipated revised IRP 2019. In addition, Rounds 6 and 7 are expected to be launched by DMRE in the fourth quarter of 2021, and in early 2022, respectively.

Footnotes

1 Lido Fontana is of counsel, and Mzwandile Khumalo and Yolanda Dladla are associates at Covington & Burling (Pty) Ltd.

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