denotes premium content | Jan 6 2009 
Feature
posted 23 Feb 2005 in Volume 8 Issue 4
As global demand for energy soars, investors are increasingly looking to areas such as Sub-Saharan Africa when sourcing commodities. Erika Morphy takes a look at recent developments and explores whether the region’s risk profile is changing.
A t $260m, it’s not as though Songas, the Tanzanian gas-to-electricity development project, is particularly large. And while it did involve multiple phases – including the construction of the Ubungo Power Plant in Dar es Salaam, a natural gas processing plant on Songo Songo Island and a 225km pipeline connecting the two – it’s not as though its construction was a particularly innovative feat of engineering.
But Songas, which was officially inaugurated on 6 October 2004 with Tanzanian president H. E. William Mkapa in attendance, is considered a major step forward for the country. For project finance in the region, its successful completion is even more meaningful.
“Songas represents a turning point for project finance in Sub-Saharan Africa,” says Robin Mizrahi, an associate in the London office of Chadbourne & Parke, which represented Globeleq, the majority owner of Songas. “It is not often you can get a project of this size to completion, on budget and where it can do so much for a country by using its own natural resources.”
Most important, he says, “I believe its success will entice other equity investors to look at the region.”
Growing interest
Equity investors, as it happens, are already becoming enticed. Mizrahi and his colleagues report a growing interest and comfort level in the region on the part of bankers and corporates. Perhaps an alternate way to view Songas is as an illustration of trends already underway in several countries – Angola, Kenya, Namibia, Nigeria, Tanzania – across Sub-Saharan Africa.
For starters, relatively new developments in the extraction and oil and gas industry are expected to accelerate growth in several countries.
“There are a large number of new oil producers coming up in Sub-Sahara,” says John MacNamara, managing director of structured trade & export finance for Deutsche Bank. “The entire band of countries from Mauritania through Chad will be producing oil in quite decent quantities over the next couple of years.”
At the same time, there is growing demand specifically for African sourced oil. MacNamara goes on to note that there has been a larger US presence in Africa over the last few years, in part because the Americans are seeking to diversify their oil sourcing. “They want to rely less on oil from the Middle East. Also the oil from the African West Coast is of higher quality than many countries in Latin America and Big American Oil has had the spare equity to invest.”
Then there is the growing pan-African investment flows, fuelled in great part by private banks and utilities in South Africa. Edcom, the country’s national electric utility, has been actively investing in neighbouring countries, including a power plant and electricity distribution facility in Uganda. Such moves are significant because, as one executive says, “Westerners have gotten used to the idea that Africa is waiting for them. But now there is real competition from local players.”
Not that potential investors are blind to the problems inherent with Africa – problems that, unfortunately in many cases, still trump the burgeoning interest in the region and possibilities that its natural resources offer.
Most investors need convincing to consider Africa as opposed to other emerging markets, such as Eastern Europe, say, or Latin America, says Ken Mackay, founder of MS Trade Finance, a registered placement agent for international trade finance transactions. MS Trade Finance originates deals from exporters or importers and taps institutional investors for financing. “But the pitch we use for African deals is, quite simply, its yield.”
In Eastern Europe, for example, “you might be talking about margins in Bulgaria or Poland, margins that are Libor plus 3% or 4%, depending on risk and maturity,” he says. “But in Ghana or Uganda or Kenya or Tanzania – you are talking about Libor plus 10% to 15%, depending on final maturity and terms of the deal.”
But even a tempting yield may not overcome certain difficulties. For instance, financing a trade transaction without a sovereign guarantee is still very problematic for most investors – even if the country in question has a rich source of natural resources, says Scott W. Wright, partner with law firm Reed Smith.
Wright tells of such a transaction on which he advised MS Trade Finance. A government in the region wanted to upgrade its medical facilities and began negotiations with a European exporter of turnkey medical facilities. Its terms included a tenor of three years with one year’s grace, amortised with equal semi annual repayments thereafter. The exporter contacted MS Trade Finance, which then arranged for third-party investors to provide the necessary financing.
“Yields [were] particularly attractive, especially in light of the country’s significant oil reserves and production revenues,” Wright says. But without the sovereign guarantee, the transaction could not be completed. “A further concern was the fact that the country is not rated and does not have sovereign bonds outstanding. This makes benchmarking [the deal’s risk and performance] extremely difficult.”
This particular deal worked out, he reports. “The transaction is documented using international format promissory notes, and supported by a formal guarantee from the country’s ministry of finance and a suitable legal opinion as to validity and enforceability. A major international bank will act as the settlement agent for collection of the proceeds and delivery of the promissory notes and related documentation.”
In a way, Wright’s example is typical of the bulldogged approach investors must take in the region: if something is not available, proceed to plan B. To be sure, it is an attitude that not all investors care to adopt, which is why many in the region are banking on Songas’ ultimate success.
At the very least, Songas “showed the investing world that Tanzania’s power sector is open for business,” says John Beardsworth, partner at Hunton & Williams, which represented the Tanzanian government in the project.
But the project experienced its fair share of glitches along the way, and at one point earlier this decade, stalled completely over a legal matter that was finally resolved in court. “There were also concerns about whether there was enough liquidity in the foreign exchange markets to support the project,” he says. “Rate payers would pay their bills in Tanzanian currency, but the project’s costs were in dollars.”
Those worries were settled with the project’s successful launch, but will no doubt re-emerge with the next large infrastructure project in the region.
Globeleq fills equity void
However Beardsworth points to a more fundamental issue hindering investment: a lack of experienced equity players in Africa, especially in the power and utility sectors. Banks and multilateral investment agencies will not lend on a project unless there is at least 25% of equity invested as well, he explains. “Up until 2001 if there was a project under development you could count on a number of good-sized experienced firms that could bring equity into play,” he says, citing now bankrupt Enron, and other firms such as Cinergy and National Power.
Right now, he says, “we are not seeing big players going into the region, with the exception of Globeleq.”
Not quite three years old, Globeleq has quickly grown to dominate the emerging market project landscape. The Houston, Texas-based company was formed by the CDC Group, a UK-based private equity investor in emerging markets, to focus on the power markets in Africa, the Americas and Asia. CDC has a portfolio of approximately $1.5bn, diversified regionally and across sectors, including power, telecommunications, and financial services. Besides Songas, Globeleq now holds investments worth some $500m in 20 projects across 15 countries, according to the company.
“I’ve heard another European development organisation has a portfolio that includes power assets and is thinking of creating a separate company like Globeleq,” Beardsworth says. “I wish they would, that would be a good thing.”
But in the absence of another Globeleq, Beardsworth says a number of small groups have formed, none of which have a strong enough balance sheet to completely allay the fears of lenders.
Pinning hopes
It is yet another reason why Tanzania and the regional finance community hope Songas will be seen as what is now typical in Africa. Or at the very least, possible in Africa. “Once investors see these are stable markets with proven capacity,” Beardsworth says, “I believe the region will turn the corner and experience significant growth.”
And slowly, he is seeing anecdotal evidence that such a confluence of events is at hand. Even though they don’t have the resources of a Cinergy Corp for example, “banks are getting more comfortable with the notion that there are a consortia of equity investors that get together and move things forward”. In fact, Beardsworth predicts that a new equity investment model for Africa is developing along these lines.
Peter Clutterbuck, the London-based vice president of EastCoast Energy Corporation, which owns the Songas’ gas reserves along with the government, as well as operates the gas field and processing and distribution facilities, also senses a change in attitude among financiers.
“The business environment in Tanzania is looking more positive with every passing year,” he says. “And now that the [Songas] project has been successfully completed, I believe there will be even more interest in the country and related projects by both banks and investors.” EastCoast financed the equity for its investments internally, he explained. “But we do anticipate that we will be able to easily access trade finance and debt finance as [Songas] expands the infrastructure. Typically, we will expect to use our gas sale contracts as securities for those types of loans.”
Then there is Nabil Khodadad, a partner in the London office of Chadbourne & Parke, which also represents several Western and regional interests in Africa besides Globeleq.
“We have definitely seen more interest and comfort with Africa in the past couple of years,” he says. “Banks are a lot more willing to finance projects in Africa than they were three years ago and African countries are getting the respect and confidence of equity investors.”
For example, he says, there has been greater interest in investment in Angola, “a country that a couple of years ago lenders wouldn’t touch. And now several are looking seriously at projects there”.
In Angola, he says, several oil majors have invested in offshore exploration and subsequently discovered significant sources of oil. “So it is likely that soon they will be financing some of those offshore fields.” There is also growing interest in the diamond sector, he adds. And a similar interest is brewing in Nigeria. “The country has been plagued with corruption and unstable governing over the last couple of decades. Now, for various reasons, we are seeing people take it more seriously.”
Stefan Unna, an associate at Chadbourne & Parke, represented one of the participants in what he described as the first independent power project in Nigeria. “It was a milestone deal as well; in some part because I think people are used to seeing oil and gas projects in Nigeria.”
Other than that, the syndicated loan of $120m was a fairly straightforward transaction. An AES project subsidiary was the borrower, with several banks acting as lenders including a number of African banks, the African Export-Import Bank and the Dutch export credit agency Atradius.
The Bujagali dam
There is even renewed interest in Uganda, despite the fiasco of the Bujagali dam project; ultimately AES was forced to pull out of the project because of financial and other difficulties after investing a considerable sum, thus chilling the interest of other investors. Uganda received some bad publicity because of this, Mizrahi says. “But at the same time other projects are being done in Uganda and there are companies investing equity in the country.”
And Bujagali may well prove to be a winner in the end. According to Beardsworth, who also represents the Ugandan government, new proposals went out on 1 December 2004. Four firms are on the shortlist, with the winning bid expected to be selected in March this year. It will be, he says, one of the largest – if not the largest project – developed in Sub-Sahara this year.
It is a far riskier project than Songas, with higher capital costs. But it is, he says, an absolutely critical project for Uganda. “By the time this goes online – and it will take three to four years to build — the need for power in Uganda will be significant.” As will the equity opportunities, if current developments in Tanzania prove to be a reliable guide.
