Exploring new opportunities in the energy sector: Key considerations to underwriting successful projects

The energy sector represents a bold new frontier for export credit agencies (ECAs). Increased involvement in this sector makes good business sense. With an estimated 1.1 billion people globally living without access to electricity and another 2.9 billion relying on dangerous and polluting biomass for their daily needs, – the social and environmental imperatives are quite high.

This article is written from the perspective of the African Trade Insurance Agency’s (ATI) areas of operation and experience. The intent is to focus on areas that we feel must be addressed in underwriting energy sector transactions.

ATI is a multilateral institution operating in and based in Africa. Each of the countries in which we operate has a unique investment environment and a few common denominators:

• Many of our countries are under developed economies;
• The regulatory framework is often poorly developed or undergoing significant change; and
• Often, payment obligations are being insured but additional political risks may be included.

Underwriting energy projects is not an exact science. Several considerations are specific not only to the nature of the transaction but also to the country in which the project is being undertaken and the parties to the project – especially the client(s). The underlying transaction is often based on a key contract, e.g. a power purchase agreement. The clauses of this contract need to be critically assessed when underwriting the transaction.

Based on our experience, there are three areas that require scrutiny:

1. Nature of the transaction

Energy transactions are often long-term infrastructure-related projects structured for project financing. This is an important consideration because recourse is often limited to repayments from a single offtaker. The ability of this offtaker to meet their obligations is critical. In our countries there is a large variance in the track record and reputation of each off-taker. Partial solutions can be structured e.g., escrow accounts, liquidity guarantees or reserve accounts. We have found it prudent to cover default on an arbitral award rather than straight nonpayment.

2. The client

Typically the transactional client will either be a lender or equity investor. In some cases, both will seek insurance. It is important to consider the insured’s due diligence to key issues likely to delay or deter the project. Examples include:

• Carrying out pre-feasibility and feasibility assessments that address all concerns such as the social, environmental and technical aspects. For environmental aspects, more often than not, complying with national requirements is not enough. It may be necessary to benchmark against global standards;
• Sound contracts for implementation and operation of the plant; and
• Negotiating a bankable agreement with the off-taker. Many African governments try to avoid back-stopping infrastructure projects undertaken by their agencies. In the absence of the preferred government guarantee, investors may instead be given a diluted form of sovereign support. It is important to assess not only the tangibility of this support but also its legality ; and

3. Other players

Other parties can also have an important role in underwriting considerations. The existence of donor funding, multilateral agencies, ECAs and development finance institutions, all contribute to both appetite and the pricing of a transaction.

Summary

I would like to leave you with some specific areas to consider when underwriting energy transactions namely:

i) Project structure;

ii) Financial strength and track record of the off-taker or buyer;

iii) Contractual agreements between the insurer and risk party, with specific emphasis on standardization, tariffs, definition of force majeure, immunity, governing law, dispute resolution including arbitration, termination and termination payments, assignment, offtaker/ buyer payment support, transmission/interconnection risks. Without experience, developers and equity investors could overlook some of these aspects so the underwriter will need to double check their assumptions;

iv) Credit enhancements and risk mitigation instruments including guarantees, swaps and liquidity facilities;

v) Possible success and failure factors;

vi) Environment and social aspects; and

vii) The rights of the insured and whether these can be subrogated to the underwriter;

Conclusion

We end as we started. Energy specialist underwriting is not a science. No two projects will be the same and always expect the unexpected!

Benjamin Mugisha

Senior Underwriter - Africa Trade Insurance Agency (ATI)