Mark Schmaman: A gas-powered Nigeria – the deals behind $900m Azura project

Nigeria continues to struggle against constant blackouts, and anyone visiting the country, will know first hand that it’s a constant switch between main power supply and backup generators. The government has been reforming the power sector since 2005, and one of these projects is the 450MW gas-fired Azura-Edo electricity project. Rand Merchant Bank was part of a group of five core-lending institutions responsible for the day-to-day structuring responsibilities. The project was also the country’s first greenfield Independent Power Producer project under the new regulatory framework. Biznews’ Alec Hogg sat down with RMB’s senior transactor Mark Schmaman to get all the ins and outs behind the deal. – Stuart Lowman

This special podcast is brought to you by RMB whose senior transactor, Mark Schmaman joins us now to talk about the Azura Project. It’s a gas-fired electricity project in Nigeria. Mark, we’re going to have a lot of insights into what it’s all about in a moment but just tell us how did RMB get involved here in the first place?

The initiative, I suppose would go all the way back to 2005 when the government embarked on their plans to reform their energy sector in Nigeria more generally.

They needed to, didn’t they at that stage, given that there is such a shortage of power in the country?

Yes, there are some fascinating statistics around that. Nigeria is one of the most populace countries in the world and yet has one of the lowest energy consumption per capita. In recognition of that and generally the chronic power shortages experienced in-country and the effect that that has on economic development the initiative was undertaken to try and address that and as I say, that goes back to the unbundling of their state utility which then was the Power Holding Company of Nigeria.

That is their version of Eskom, if you like.

Exactly, the Power Holding Company vertically integrated. It covered all the aspects of power delivery from generation distribution transmission to the end user. This effectively split up that utility. I think there were around 16 or 18 successor companies, which eventually resulted in a number of new entities such as the bulk energy trader, which is the equivalent of the role that Eskom play in the Renewable Energy Programme in South Africa as the purchaser of power from independent power producers.

Has it worked breaking it up in that way?

There’s general recognition that it is a massively ambitious initiative. As I say it was conceived going back to 2005 when the Electric Power Sector Reform Act was passed into law and the experience has been a very positive, it’s been a tremendous learning curve for all the stakeholders involved. That would include the relevant authorities, the federal government and independent power producers themselves, the transmission companies, distribution companies, the fuel suppliers and the associated distribution arms and then of course the financing institutions who have been very closely involved.

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Before we go into the project itself, can you give us some colour on how the Nigerian power equation actually stacks up at the moment? You said that they don’t have much electricity relative to the size of the population, but how far behind would they be to a country like South Africa?

Their installed capacity and their potential is currently at around 4000 megawatt hours, that’s not the nameplate capacity of the plant that they have in country. However I stand corrected but I think they may have around 8000 megawatts. South Africa by comparison is close to 50 000 megawatts, so you can kind of see the difference and even in the South African context that amount of capacity is insufficient as experienced with the blackouts over a number of years.

The ambition in Nigeria is to transform that situation quite rapidly. They would like 20,000MW by the turn of the decade and it’s been good progress but I think fair to say, quite slow. What we expect to see from here, given that Azura is the first independent power producer to reach financial close and the new reforms in the country (and we have pretty good sight of the power plant of projects that will be following in its wake)… We think over the next couple of years, it’ll be a very exciting time in country and one in which they would make very good inroads at achieving their objectives.

It’s getting momentum?

Absolutely. Over the last number of years there have been other projects similar to Azura that have also been progressing their own development, but the market has been really watching the Azura case as a guinea pig and with very good interest. In the Azura example, we have a mix of funding institutions, commercial banks, and development finance institutions. Once we reached financial close that was seen by the market as effectively an endorsement of the investment framework that have been put in place through this unbundling process and effectively trail blazed the path in which we expect the other independent power producers to be following close behind.

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It’s a $900m project generating 450 megawatts, five percent of the installed capacity, I guess in the country on the 8000 that you used but surely, this is the starting point. What ambitions do they have in the Azura area or in the Edo Province if you like to take this 450 higher?

The Azura Project is the first phase of an overall facility that the developer will be constructing at the site. There should be a second phase and we expect a similar size plant to follow in the years to come. The Edo State is to some extent one of the hotbeds of activity within Nigeria. It’s very close to an important modal point of the high voltage transmission infrastructure. In Nigeria, it’s very close to the Escravos Lagos pipeline system, which is an important gas distribution network. So often, it’s the case. These large facility scale plants are often located very close to their fuel source for obvious reasons and the head of state, the governor, the community has been very welcoming of the project and has really helped to build the momentum and have the dialogue and put the structures in place that help to get the projects over line. We do see potential further projects in that area.

You mentioned the gas pipeline. This is a gas fired electricity producer. Is there lots of gas in Nigeria? In other words, are they rather focused on producing from gas than coal?

There are an abundance of gas molecules but the constraint actually comes in terms of the gas infrastructure in place to process those gas molecules and then transmit them or distribute them. That has been one of the significant challenges of the Azura Project in that it doesn’t exist at an island within the power generation landscape. In order to progress the Azura Project’s development and to achieve financial close, the stakeholders including lenders required certainty of gas supplies to the project in order to do that that required parallel investment in upstream infrastructure about third parties, in this case, Seplat as the big gas supplier.

Therefore, it’s very much a symbiotic type of relationship where in order to have one form, an investment in the form of a power plant; you require parallel investment or synchronistic investments in upstream infrastructure. Hence, the benefit that something like Azura does bring is that once an infrastructure is developed upstream the hope and intention is the other projects can also benefit from the implementation of those assets.

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As far as the financing is concerned, $900m is a lot of money for a country like Nigeria. Is there some kind of a template now that you have worked out for the Azura Project that can also be used for others?

Yes, exactly the project financing is non-recourse financing. It’s a very specific type of discipline that suits infrastructure assets. It requires very long-term financing commitments both from their providers such as ourselves as Rand Merchant Bank as well as the shareholders to the project. In order to do that what’s required is certainty of the investment framework. What I mean by that is the basis on which the plant will sell electricity, the basis on which the government will provide support towards the project in respect of the political risks etcetera that the project might face the permits and the regulation that is put in place by the energy regulator.

These are all aspects that make up a framework that ultimately encourages and facilitates the participation of the private sector in the energy space. Once those are put into place and remembering it was the first time that the federal government has done this in Nigeria under the new reform there was an enormous learning curve that all of the stakeholders were facing in order to achieve that objective.

While we were going about negotiating the typical aspects of a project financing, risk allocation, pursuing due diligence work streams etcetera, there was also quite a bit of collaboration in coaching, I suppose on behalf of all the parties in order to try and land on a structure that works for this project but can also be used then as a template for other projects and I do suspect there’ll be refinements and etcetera going forward but certainly we would expect a lot of projects to follow this model in the near future and even beyond the borders in Nigeria. I think the West African region generally will be looking at what was achieved on the Azura Project and perhaps looking to adopt some of the learning and experiences that we managed to achieve on that deal.

It’s a template, a bit of a cookie cutter that you could use elsewhere?

Yes, exactly. I think as some of my project finance colleagues will… no two deals are ever alike but certainly once you have the framework in place you are much, much closer towards implementation. If you take these renewable projects, for an example that most people are familiar with, there we’re almost capable of closing out around of financings every year based on a framework that was implemented and slightly refined year on year and we hope to see the same progress in Nigeria.

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Mark, Nigeria has many resources. We know about its oil and clearly about the gas as well. Does this mean that in time if you can get the funding right, that it could be a pretty low cost producer of electricity?

Yes, I think that the important qualification, as you said is time. Infrastructure, to evacuate the power, to get the power to the end user is always going to be a constraint. There are other initiatives in country as we see in many sub-Saharan African countries regarding renewable energy that’s quite exciting where you can have a generation of electricity much closer to where it’s consumed ultimately by the end user. We think we’ll see continuous developments, more investment by the private sector, not only in gas-fired power plants perhaps in smaller, more nimble renewable energy plants, PB plants etcetera but in time perhaps Nigeria could be an even more important player in the West African power pool.

You did mention the independent Power Producer Project in South Africa, which you have been involved in. Is there anything you learnt there that you were able to apply in the Azura-Edo Project?

Absolutely, project finance as a discipline has certain key concepts that are true and that are fundamental to any type of infrastructure financing and it is actually quite fascinating because prior to the renewal or Energy Programme in South Africa, there were project financings being concluded. The private sector and banks were funding infrastructure assets in South Africa but what the Renewable Energy Programme did importantly is they brought flow and it being fascinating, ten years ago we weren’t seeing, as I say a frequency of transactions but certainly over the last five, six years it’s really mushroomed and it’s almost beautiful to see the industry that it’s created locally and the skills that have become available.

Not just in a financing space but in the technical space in the legal world, the advisors, new developers, local manufacturing capabilities, job creation, so a lot of that positivity but what’s also interesting is that Nigeria hasn’t looked at the South African programme and tried to copy that. I think they recognise that they are their own jurisdiction with their own nuances, their own requirements. Of course, it has a fuel supplier rather than a renewable resource such as solar or wind or hydro. That brings a layer of complexity but every jurisdiction is different. More and more so, we are seeing across sub-Saharan Africa, Kenya is a good example as well where the private sector is becoming increasingly evolved in assisting with the challenge of energy generation.

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It makes me think a little of the uncovering of the human DNA. It took many, many years to get to one percent but then very quickly thereafter, literally within a few months they managed to get to 100 percent of the human DNA because it just took so long to get it in place. Is it a similar situation here that it takes a long time to get the basics, to get the structure together, to get the templates there but once it’s installed and once you get the first project the others come very quickly?

Alec, that’s quite right. I think as long as that and I think for that reason it warrants taking that extra time to make sure that due consideration is paid. These are, as I said, very ambitious undertakings not just for one project but for a sector generally and if you get that foundation right and you’re willing to kind of almost do a [hard yards? 0:15:31.9] pay the school fees, get it correct from first principles, certainly development from there on is much more rapid. Remember in this, as I say that this energy reform in Nigeria goes back to 2005, 11 years later the first IPP closed, and we certainly expect the next one to be much sooner than 11 years and hopefully in a couple of months and that’s been true of South Africa.

The first round of projects and the Renewable of Energy Programme took a while to get going, took a while to get off the ground. Since that’s been the case we’ve seen really good flow and ultimately benefit flowing to the end user and the consumer who’s paying a much lower tariff for renewable energy per kilowatt hour of renewable energy than they were even in the earlier round, and that’s in a very short space of time. I think the key ingredient is political world because the private sector cannot do it on their own and it’s a collaboration between the relevant authorities between the federal government in the case of the Nigerian project and the private sector and without that, we’d be wasting our time.

Is the World Bank involved at all in this project?

The World Bank had a very important role in this project. On the financing side, there were a mix of development finance institutions and the commercial banks. The World Bank played a role in really also facilitating the participation of the commercial banks because they helped to backstop some of the political risks that are being quite sensitive especially when looking at long-term financing required for infrastructure assets. Not only is the World Bank a provider of senior and mezzanine financing through the International Finance Corporation to the deal, but they also provide political risk support through their arms. For example, Omega and IBRD to the commercial banks as well as other risk guarantees within the financing structure that really helped to prop up the liquidity and the solvency of some of the stakeholders involved in the project.

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Mark it’s a fascinating project. You said you have visibility into the pipeline. How much might you be investing into Nigeria, not specifically yourself but talking about financial institutions generally in this project in the next say five years?

In this project, being a project financing, the funding is locked at financial close, so when we achieved financial close on the 28th of December last year the required amount of debts on $620m/$630m was committed, the mezzanine financing around $65m committed and then the balance committed by equity contributions. That is all that is available for this project. The project, from those funds needs to construct, they need to do so on time, they need to do some budget, and they need to achieve a design specification.

Failing to do that means that there will be a funding shortfall and that is not an acceptable position on a project where there is no recourse to further balance sheet. You can hear, just from that very brief explanation, how important it is that when we achieve financial close. We have the greatest degree of certainty possible, that this project will work and that the parties will deliver to their obligations. Failing to do so means that there would be very difficult conversations had in order to deliver the project but all the work that we do, all the due diligence, all the scenario analysis, the planning, the contingency work, that’s going to make sure that this project will stand on its own.

It’s already started. Has construction has begun?

Construction has begun. We are about six months into construction – 430 construction workers or so onsite and civil works underway. I must say what’s front of mind for myself on this deal is that this is a newer jurisdiction to do long-term infrastructure investment. As a dealmaker, you would do the transaction. You would get the financial close and you would almost move off and go and look to do the next one. What’s important is to actually stay close to the project, to observe its progress, and to recognise that this is really a partnership beyond from which, the legal documentation provided the partnership between all the stakeholders. Because of that, we actually look very closely at the project and every month I actually look at the progress on the transaction and so far it’s ahead of schedule which is very encouraging.

How many more, just to close off with, of these $900mn power projects are we likely to see in the next five years?

Hopefully many more, I would at least expect to see one or two closing a year. As I say, I think you would also see more renewable projects getting over the line. I think they would be perhaps not quite as big as $900mn. That really is a mammoth project and the nice thing about renewable energy, it can be a little bit small, a little bit more modular but certainly that the flow is there and I think what’s important to mention on this deal, we had 15 unique financing institutions representing, our last count, on nine different countries. We had shareholders from equally diverse backgrounds.

The interest is tremendous. There’s no denying the investment case for Nigeria. What’s important is that investors being the equity investors,(debt investors), really take the time to unpack and understand the investment proposition. To understand the investment horizon, to know with the greatest, certainly possible the challenges that and the patience that would need to be displayed to get over the line but really, with 15 financing institutions on the project financing that just shows the level of interest and the funding, is that it’s available for bank, all deals in this country.

Despite what happened with MTN?

Despite what happened with MTN, exactly. As I say, with this project, we’ll be in a partnership for a long time and that’s great. I think we have to be realistic that there will be speed bumps along the way, not unusual for any big construction undertaking but I’m confident that given all the challenges overcome, just in getting to financial close, that if the stakeholders display the same level of collaboration we’ll be okay.

Mark Schmaman is senior transactor at Rand Merchant Bank and this special podcast was brought to you by RMB.

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