77971 NOTE NUMBER 338 viewpoint PUBLIC POLICY FOR THE PRIVATE SECTOR FINANCIAL AND PRIVATE SECTOR DEVELOPMENT VICE PRESIDENCY APRIL 2013 Feed-In Tariffs or Auctions? Anton Eberhard Procuring Renewable Energy Supply in South Africa Anton Eberhard Fe e d - in tarif f s h a v e b e e n t he m o s t wid e ly us e d s up p o r t m e c h a n i s m (eberhard@gsb.uct.ac.za) is a professor at the University to e ncourage the g r o wt h o f g r id - c o nne c t e d r e ne wa b le e ne r g y . B u t of Cape Town’s Graduate could comp e titiv e t e nd e r s o r a uc t io ns o f f e r lo we r p r ic e s wh i l e s t i l l School of Business. p rovid ing ad e q ua t e inc e nt iv e s f o r m a r k e t e nt r y b y r e ne wa b l e e n e r g y sup p liers? This No t e lo o k s a t r e c e nt d e v e lo p m e nt s in S o ut h A f r i c a , which initially ex p lo r e d f e e d - in t a r if f s f o r r e ne wa b le e ne r g y b u t then turne d inst e a d t o c o m p e t it iv e t e nd e r s . I nit ia l o ut c o m e s a r e encouraging: the r e ha s b e e n m uc h m a r k e t int e r e s t , a nd s ub se q u e n t b id d ing round s ha v e s e e n p r ic e s f a ll. C o uld t he r e b e le s s o ns f o r o t h e r countrie s? South Africa relies more on coal for electricity Tariffs were designed to cover generation costs production than any other country. But in the plus a real return on equity of 17 percent and face of climate change concerns it has embarked would be fully indexed for inflation (NERSA on a transition to lower-carbon-emitting technol- 2009). Initial published feed-in tariffs—15.6 ogies. Its most recent electricity plan included, cents per kilowatt-hour for wind, 26 cents per for the first time, ambitious targets for renewable kilowatt-hour for concentrated solar (troughs, energy: 18,800 megawatts of wind and solar, out with 6 hours’ storage), and 49 cents per kilowatt- of a total projected system capacity of around hour for photovoltaics—were generally regarded THE WORLD BANK GROUP 90,000 megawatts, by 2030. To expand renew- as generous by developers.1 But considerable able energy supply, South Africa first explored uncertainty remained, including the legality of the option of renewable energy feed-in tariffs feed-in tariffs within South Africa’s public pro- (REFITs) before choosing instead to pursue curement framework and delays in finalizing competitive tenders. Its experience may offer les- power purchase agreements and interconnec- sons for other developing and emerging market tion agreements with the national utility, Eskom. economies. In March 2011 NERSA unexpectedly released a consultation paper with lower feed-in tariffs, The birth and death of the REFIT program arguing that a number of parameters—such The National Energy Regulator of South Africa as exchange rates and the cost of debt—had (NERSA) approved a REFIT policy in 2009. changed. The new tariffs were 25 percent lower FEED-IN TARIFFS OR AUCTIONS? PROCURING RENEWABLE ENERGY SUPPLY IN SOUTH AFRICA for wind, 13 percent lower for concentrated and an upper limit was set for different tech- solar, and 41 percent lower for photovoltaics nologies—for example, 50 megawatts for con- (in nominal rand terms). Moreover, the capital centrated solar and 140 megawatts for a wind component of the tariffs would no longer be fully project. Another 100 megawatts was reserved for indexed for inflation. Importantly, in its revised small projects below 5 megawatts. Price caps were financial assumptions NERSA did not change the specified for each of these technologies at levels required real return for equity investors of 17 not dissimilar to NERSA’s 2009 REFITs, all of percent (NERSA 2011). them much higher than Eskom’s average genera- More policy and regulatory uncertainty was tion tariff of around 5 cents per kilowatt-hour 2 to come. After receiving legal advice that feed- at the time. Standard 20-year, local-currency- in tariffs were inconsistent with public finance denominated power purchase agreements were and procurement laws, the Department of Energy offered for the different technologies, with the announced that a competitive bidding process off-taker being Eskom. Up to five discrete bid- for renewable energy would be launched, known ding rounds were envisaged, at more or less six- as the Renewable Energy Independent Power month intervals, with the first round of bids due Producer Procurement (REIPPP) program. in November 2011. Subsequently, the regulator abandoned feed-in tariffs: not a single megawatt of power had been Qualification criteria signed in the two years since the launch of the The bid evaluation involved a two-step pro- REFIT program (although it is probably fair to cess. In the first, bidders had to satisfy certain admit that a practical procurement process was minimum threshold requirements in six areas: never implemented). These developments were environment, land, commercial and legal, eco- met with dismay by many renewable energy proj- nomic development, financial, and technical. For ect developers that had secured sites and had example, wind developers were required to pro- initiated resource measurements and environ- vide 12 months of wind data for the designated mental impact assessments. But it was these early site and an independently verified generation developers that were later ready to benefit from forecast. Project developers were responsible for the first round of competitive bidding. identifying appropriate sites and for paying for measurement and early development costs at The birth and early life of the their own risk. Wind turbines had to be certified REIPPP program for compliance with the international technical The Department of Energy, with the assis- standard IEC 61400-1. tance of the National Treasury’s Public-Private The economic development requirements in Partnership Unit and a phalanx of international particular were complex, incorporating 17 sets of transaction advisers, commenced work on bid minimum thresholds and targets (table 1). For documents. A request for qualification and pro- wind projects, for example, at least 12 percent posals was issued in August 2011. A compulsory of the project company shares had to be held by bidders’ conference was held in September of black South Africans and another 3 percent by that year and attracted more than a thousand local communities. At least 1 percent of project participants, many from abroad. A total of 3,625 revenues had to go to socioeconomic contribu- megawatts of new power capacity was offered, tions. The minimum threshold for local content with overall procurement caps for specified tech- was set at 25 percent, with a target of 45 percent nologies, mainly wind and photovoltaics, but also being encouraged. smaller amounts available for concentrated solar, Bid bonds or guarantees had to be posted, biomass, biogas, landfill gas, and small hydro (see equivalent to US$12,500 per megawatt of name- table 2 below). plate capacity of the proposed facilities, and the The tenders for different technologies were amount was doubled once preferred bidder status held simultaneously. Bidders could bid for more had been announced. than one project and also for different technolo- Bidders that satisfied the threshold require- gies. Projects had to be larger than 1 megawatt, ments then proceeded to the second step of Table Economic development thresholds and targets for wind projects in South Africa’s REIPPP program 1 Factor and criteria Threshold (%) Target (%) Job creation South Africa–based employees who are citizens 50 80 South Africa–based employees who are black citizens 30 50 Skilled employees who are black citizens 18 30 South Africa–based employees who are citizens from local communities 12 20 Local content Value of local content spending 25 45 Ownership 3 Shareholding by black people in the project company 12 30 Shareholding by black people in the contractor responsible for construction 8 20 Shareholding by black people in the operations contractor 8 20 Shareholding by local communities in the project company 3 5 Management control Black top management n.a. 40 Preferential procurement Broad-based black economic empowerment (BBBEE) procurement spending n.a. 60 Procurement from small enterprises n.a. 10 Procurement from women-owned vendors n.a. 5 Enterprise development Enterprise development contributions n.a. 0.6 Adjusted enterprise development contributions n.a. 0.6 Socioeconomic development Socioeconomic development contributions 1.0 1.5 Adjusted socioeconomic development contributions 1.0 1.5 Note: n.a. = not applicable (no threshold set). Source: South African Department of Energy, REIPPP program bid documents and press releases (http://www.ipp-renewables.co.za). evaluation, where bid prices counted 70 per- reviews). The evaluation resulted in 28 quali- cent with the remaining 30 percent weighting fying bids, amounting to 1,416 megawatts of given to composite scores on job creation, local new capacity (table 2). For the first round, a content, preferential procurement, enterprise deadline of July 2012 was set for financial close development, and socioeconomic development. (the date was later extended), and a deadline Bidders were asked to provide two prices: one of the end of 2014 for the commercial operat- fully indexed for inflation and the other partially ing date. indexed, with the bidder allowed to determine Although bidders could not know for certain the proportion that would be indexed. the total capacity that would be bid, they prob- ably assumed that the tight deadlines and chal- Round one outcomes lenging threshold qualification criteria would A total of 53 bids were received initially, amount- result in less capacity being bid than was made ing to 2,128 megawatts. A large legal, technical, available in round one. Accordingly, the prices financial, and governance evaluation team was bid were mostly uncompetitive and only margin- assembled in a high-security environment with ally below the caps specified in the request for 24-hour voice and CCTV monitoring. The team proposals. Implementation, direct, and power included local legal firms (Bowman Gilfillan, purchase agreements were signed in November Edward Nathan Sonnenberg, Ledwaba Mazwai, 2012 between the government, Eskom, and Webber Wentzel, and BKS) as well as inter- each of the 28 successful bidders, resulting in national firms (Linklaters for legal, Mott a total investment of close to US$6 billion. Much Macdonald for technical, and Ernst & Young of the debt component was provided by local and PwC for the financial and governance South African commercial banks. FEED-IN TARIFFS OR AUCTIONS? PROCURING RENEWABLE ENERGY SUPPLY IN SOUTH AFRICA Renewable energy capacity made available for bids and allocated to preferred bidders in South Africa’s REIPPP program Table (megawatts) 2 Technology Available in round 1 Allocated in round 1 Available in round 2 Allocated in round 2 Remaining in round 3 Wind 1,850 634 650 562.5 653.5 Photovoltaics 1,450 631.5 450 417.1 401.4 Concentrated solar 200 150 50 50.0 0 Small hydro 75 0 75 14.3 60.7 Landfill gas 25 0 25 0 25 Biomass 12.5 0 12.5 0 12.5 Biogas 12.5 0 12.5 0 12.5 Total 3,625 1,415.5 1,275.0 1,043.9 1,165.6 Source: South African Department of Energy, REIPPP program bid documents and press releases (http://www.ipp-renewables.co.za). Round two outcomes wind power fell from 9.8 cents per kilowatt-hour The design of the second bidding round incor- in 2009 to 8.5 cents in 2010 to 6 cents in 2011. porated lessons from the first, with less capac- The same source cites 6.9 cents per kilowatt- ity (1,275 megawatts) being offered in order to hour for wind and 12 cents per kilowatt-hour stimulate more competition. The second round for photovoltaics in Peru. South African prices closed in March 2012. This round brought 79 bids, might be higher because of local content and totaling 3,255 megawatts. Of these bids, 51 met the economic development criteria. In addition, qualifying criteria, and 19 of them were granted interviews suggest that the initial bidding round preferred bidder status (doing so for the next-best involved high transaction costs in terms of advis- bids would have resulted in more than the full ers and financing. These costs fell in round two window being allocated). Wind and photovoltaics (along with equipment prices) and are likely to prices in the second round were much more com- fall further in subsequent rounds. petitive, falling on average by 20 percent for wind and 40 percent for photovoltaics (table 3). The What are the lessons? range of prices bid was also wider, with prices vary- The South African REIPPP program is not only ing from 10 to 12 cents per kilowatt-hour for wind the largest renewable energy program in Africa; and from 17.5 to 22 cents per kilowatt-hour for it is also the largest IPP program of any African photovoltaics. The price for concentrated solar country and probably the most complex public- fell by 7 percent, with one preferred bidder taking private procurement ever run on the continent. up the remaining available capacity. There was According to Bloomberg New Energy Finance, little competition in small hydro, with only two South Africa ranked among the top 10 countries qualifying bids, both at the capped price. on clean energy investment in 2012, ahead of The round two preferred bidders also offered Canada, Brazil, Spain, and France. This is all the better local content terms, with average local con- more remarkable given South Africa’s previously tent for photovoltaics rising from 28.5 percent to dismal record in IPPs and the dominance of its 47.5 percent, for wind from 21.7 percent to 36.7 national utility. Eskom, on the government’s percent, and for concentrated solar from 21 per- instruction, had attempted to run a number of cent to 36.5 percent. The deadline for financial IPP procurements before, all of which failed. close for round two was extended from the end Ultimately, the Department of Energy and the of 2012 to May 2013. National Treasury had to wrest control of the The remaining 1,166 megawatts are being REIPPP program from Eskom. made available in the third bidding round, which Although projects still have to achieve com- will close in August 2013. mercial operation, the South African REIPPP While prices have fallen in South Africa, they program can be considered a success in terms are not necessarily as attractive as those achieved of attracting a multitude of private project in other countries. For example, Maurer (2012) developers and investors. In its second round reports that in Brazil average auction prices for the program has also fostered competition with Renewable energy prices in South Africa’s REFIT and REIPPP programs Table (South African rand per kilowatt-hour) 3 REFIT program REIPPP program Round 1 Round 2 Technology 2009 tariff 2011 tariff Bid cap average bid average bida Wind 1.25 0.94 1.15 1.14 0.90 (11) Photovoltaics 3.94 2.31 2.85 2.76 1.65 (21) Concentrated solar 2.10 1.84 — 2.69 2.51 (31) Small hydro 0.94 0.67 1.03 — 1.03 (13) 5 Note: Prices assume full inflation indexing over a 20-year contract. — = not available. a. Numbers in parentheses are prices in U.S. cents. Source: South African Department of Energy, REIPPP program bid documents and press releases (http://www.ipp-renewables.co.za). consequent, and impressive, falls in prices, which However, the announcement of the REFIT would in all likelihood not have happened in a program two years before the launch of the REFIT program. And it has achieved results in REIPPP program contributed to early market record time: bidding in the first round closed interest, and a number of bidders had already three months after the request for proposals was identified sites and begun resource measure- issued, preferred bidders were announced within ments. Before issuing the request for propos- a month, and contract signing and financial close als, the Department of Energy had also issued were achieved 10 months later, even though as an earlier request for information from pro- many as 28 projects, employing different tech- spective project developers, which confirmed nologies of different sizes at different sites, had significant market readiness. to be processed in parallel. Q Flexibility in the design of subsequent bidding rounds meant that lessons could be incorpo- Factors in the REIPPP program’s success rated to improve the competitiveness of bids Several elements have contributed to the success and prices. For example, it became apparent of the REIPPP program. that the capacity made available in round one Q The procurement process was well designed. exceeded the capacity of the market to deliver, Recognizing that there was little institutional and the capacity tendered in round two was capacity to run a sophisticated, multiproject, reduced to induce more competition. multibillion-dollar international competitive Q The renewable energy sector is potentially bidding process for renewable energy, South highly competitive, given the diversity of Africa’s Department of Energy sought the energy sources, the modular nature of most assistance of the National Treasury’s Public- of the technologies, and the number of project Private Partnership Unit, which in turn relied developers. When South Africa ran its first extensively on local and international transac- competitive tender for IPPs—two large gas tion advisers. turbine peaking plants—it received only two Q High standards were set for the bidding pro- bids, one of which was later withdrawn. It is cess, and apart from necessary clarifications, perhaps no accident that the first successful the government stuck to the announced international competitive tender for power in schedule and core bid requirements (although South Africa has been in renewable energy. the deadline for financial close slipped a few Q Subsequent bidding rounds have incorpo- months as the government finalized financial rated more stringent threshold as well as target security arrangements). Despite a tight time criteria for local content objectives, which will schedule and tough qualification criteria, the result in employment creation. REIPPP program attracted 53 bids in round Q The local capital market has responded posi- one and 79 in round two. A large number of tively to the opportunity presented by the these met the minimum qualification thresh- REIPPP program, which will involve total olds: 28 in round one and 51 in round two. investment approaching US$15 billion in FEED-IN TARIFFS OR AUCTIONS? PROCURING RENEWABLE ENERGY SUPPLY IN SOUTH AFRICA its 3,725 megawatts of renewable energy. Q All the successful bidders in round one have Commercial banks have been willing to reached financial close and have begun con- finance construction, and some are on-selling struction. It remains to be seen what propor- debt to insurance companies. Given compet- tion of preferred bidders in round two will ing demands in other infrastructure sectors achieve financial close. The aim of the REIPPP in South Africa, however, funding further program is lower prices, but projects must still REIPPP programs would stretch local banks, be bankable. A successful bidding process and other sources of funding, such as pension should have a low attrition rate among pre- funds, will need to be mobilized. ferred bidders. Bid prices need to be realistic. 6 Q Real returns to equity in round one were close Q Specifications on what constitutes local con- to the 17 percent (in local currency) that was tent could be improved, including more focus envisaged in determining the original feed-in on those parts of the value chain that maximize tariffs. Equity returns dipped slightly in round local employment. two for wind and probably more substantially Q A balance needs to be struck between the pro- for photovoltaics. Dollar returns in the range motion of economic development and prices. of 12–13 percent have been reported. Economic development threshold and target Q Project bidders are required to incorporate a criteria are more stringent than in most other tax of 1 percent of project revenues that will go countries (and, indeed, more stringent than in into a government renewable energy fund to previous public-private partnerships in South support subsequent procurement programs. Africa). The South African renewable energy market is small by international standards, and Potential areas for improvement investment in local manufacturing capability While much has gone well in the REIPPP pro- is not necessarily competitive. International gram, hindsight suggests that some areas could benchmarks indicate that South African have been better designed and managed. renewable energy prices are high. Q The size and readiness of the local renewable Q In some areas there is inadequate transmission energy market were initially overestimated, grid capacity and otherwise viable and attrac- resulting in less capacity being bid than was tive projects have to compete for access. There made available. There was thus limited com- have also been complaints about the lack of petition in round one, and bid prices were responsiveness of Eskom transmission plan- close to the price cap. Use of the single-price ners. Integration of planning, procurement, and offer (rather than a dynamic reverse auction contracting functions in the proposed indepen- as employed, for example, in Brazil) also dent transmission, system, and market operator restricted competition. would make it easier to resolve these constraints. Q The size and complexity of the REIPPP pro- Q The transaction costs for the REIPPP program gram stretched available legal and financial were high for both the government and the advisory services to the limit. Some firms bidders (certainly higher than for a REFIT were permitted to offer advisory services to program). The government has had to rely both the government and private bidders on external transaction advisers. But there and funders as long as they created adequate is potential to transfer skills and experience “Chinese walls” within the firm. Some bid- in future procurement rounds and to build ders complained that legal and financial capacity in the proposed independent system firms were offering a “one size fits all” ser- and market operator. vice, which was not always appropriate for Q The levelized energy costs that were calcu- specific projects. lated for the initial feed-in tariffs served as Q The above two points suggest that it might the departure point for the REIPPP program. have been more prudent to start smaller and Some other countries, such as Tanzania, have then gradually ramp up the program, with used avoided costs as their starting point. larger blocks of capacity being offered in sub- Q In October 2012 the minister of energy sequent rounds. announced that another 3,200 megawatts of renewable energy projects would be tendered, good design and evaluation should not be under- with a target for the commercial operating estimated. Development assistance programs, date between 2017 and 2020. South Africa’s including those from development finance insti- power market continues to be shaped by cen- tutions, should carefully consider the costs and trally managed power planning and procure- benefits of competitive tenders relative to those of ment processes. However, there are growing feed-in tariff regimes. Funding the higher initial political and stakeholder concerns around transaction costs will ultimately be more cost- rising electricity prices. And demand growth effective if lower power prices are likely. is lower than predicted. The sustainability of These lessons also apply in the main to auc- 7 the REIPPP program depends on volumes tions for renewable energy. Competitive tenders and predictable procurement processes. But generally incorporate a weighting of price and its sustainability will depend also on how nonprice factors while auctions are awarded quickly renewable energy prices fall and how solely on the basis of lowest price (sometimes competitive they become with prices for other after a number of rounds) among qualified bid- energy sources. ders. Running effective auctions might require even greater time, expenditure, transaction costs, Conclusion expertise, and capabilities than running tenders. South Africa’s REIPPP program provides a valu- Auctions might also encourage underbidding, able opportunity in learning how to procure with the risk of subsequent contract failures. But renewable energy projects effectively in devel- the experience with dynamic reverse auctions— oping countries. What are the lessons for other for example, for wind energy in Brazil—has been developing and emerging market economies? positive: competition has driven prices down dra- The South African experience suggests matically. It would be interesting to explore the that competitive tenders are a viable alterna- possibility of a hybrid design in which winning tive to feed-in tariff programs for renewable prices from a dynamic reverse auction are subse- energy and potentially offer better price out- quently weighted with nonprice factors. comes with fewer risks of excessive rents being appropriated by renewable energy suppliers. In developed countries the core rationale for introducing REFITs was to create market Notes certainty and simplify procurement processes The author would like to acknowledge the valuable in order to stimulate production and innova- comments of Katharina Gassner, Luiz Maurer, Mark tion in climate-change-mitigating renewable Pickering, and Sean Whittaker on earlier versions of energy technologies and markets, thus bringing this Note. prices down over time. But in many developing 1. Unless otherwise specified, values in cents are in countries, especially in Africa, the market for U.S. cents. Rand values have been converted using an renewable energy technologies is much smaller exchange rate of 8 rand per U.S. dollar. and this rationale does not apply. Indeed, for many smaller developing countries with low References carbon footprints, the argument for greater Maurer, Luiz T. A. 2012. “Renewable Portfolio Stan- use of more expensive renewable energy tech- dards and Competitive Procurement.” Presentation nologies needs to be balanced against other at Energy Sector Management Assistance Program development priorities. and International Finance Corporation Training While competitive tenders for renewable Course, Washington, DC, July 8. energy are potentially an attractive alternative NERSA (National Energy Regulator of South Africa). to REFITs, transaction costs are high and many 2009. “Renewable Energy Feed-In Tariff Guidelines.” small developing countries may lack the capacity Media release. http://www.sessa.org.za. or resources to run such complex and expen- ———. 2011. “Review of Renewable Energy Feed-In sive procurement processes. REFIT programs are Tariffs.” Consultation paper. http://www.remt generally simpler, although the requirements for project.org/FileDownload.aspx?FileID=56. viewpoint is an open forum to encourage dissemination of public policy innovations for private sector–led and market-based solutions for development. The views published are those of the authors and should not be attributed to the World Bank or any other affiliated organizations. Nor do any of the conclusions represent official policy of the World Bank or of its Executive Directors or the countries they represent. To order additional copies contact Naoki Ogiwara, managing editor, Room F 4P-256B, The World Bank, 1818 H Street, NW, Washington, DC 20433. Telephone: 001 202 473 1871 Email: nogiwara@worldbank.org Produced by Carol Siegel Printed on recycled paper This Note is available online: http://www.worldbank.org/fpd/publicpolicyjournal