Designed by KfW Entwicklungsbank (the German development bank) and the African Union Commission, the Geothermal Risk Mitigation Facility will provide between €20 million and €50 million to surface studies and exploration drilling of geothermal prospects in Kenya, Uganda, Tanzania, Rwanda and Ethiopia.
Investment in power sector infrastructure in East Africa has been poor, with most recent infrastructure investments dominated by the telecommunications sector. It is estimated that Africa’s power sector requires US$40.8 billion of investment each and every year, but actual investment is far below these levels due to financial, regulatory and institutional constraints.
Financial issues are characterised by limited availability of local finance, limited access to international markets due to poor sovereign credit ratings, competition for funds and project specific risks of currency exposure, high inflation and low electricity tariffs.
Investors require confidence that regulatory structures protect their investment. These include aspects such as minimum service standards, adjustment mechanisms, access to networks, entry and exit conditions for participants and investment obligations. In particular, enforcement and revision of tariffs in offtake agreements are crucial to attracting investment.
While East African governments often lack the institutional capacity to establish the necessary legal and financial conditions, power sector reforms have been initiated in many countries. Reform laws have been passed leading to unbundling of state monopolies, some privatisation, increased regulatory autonomy and greater private sector participation.
Investment in East Africa’s geothermal sector
Hydropower and thermal generation currently provide more than 95 per cent of electricity in East Africa. Years of sustained droughts have reduced the generation available from hydropower resulting in supply shortages, instigation of emergency diesel generation and increased power prices. Despite an estimated geothermal resource potential in East Africa of more than 7,000 MWe, there are currently only two operating plants, the 200 MW Olkaria development in Kenya and the 7 MW Aluto Langano plant in Ethiopia. Utilisation of geothermal resources has the potential to provide firm baseload generation for the region, improve security of supply, increase access to electricity and reduce the frequency and severity of energy price fluctuations. Many international and regional organisations, both public and private, have recognised the potential of geothermal in the region, yet progress remains slow.
Geothermal development in the region is hampered by:
- Poorly explored and understood resources
- High up-front capital costs and long lead times
- Limited availability of human/technical resources
- Insufficient pricing support
- Insufficient enabling environment for private sector
- Inadequate regulatory framework particularly around mining and concession rights
- Lack of specific geothermal provisions in national policy
- Competing priorities in the energy sector, eg oil and gas
- Competing government priorities, eg health and education
- Geothermal fields located distant from the electricity grid
- Limited capacity of local utilities to participate in new geothermal developments
The complications and cost of proving the size and quality of a resource mean that accurate assessments of resource potential and hence project design and specific costs cannot be determined until drilling has taken place. This can result in lead times of several years and high up-front costs to prove the resource to the point where finance for subsequent development can be secured. To address such issues, different types of risk mitigation schemes have been developed.
International experience of risk mitigation schemes
It is commonly cited that the main financial barrier to geothermal development is the high up-front investment required to drill and prove the resource in order to demonstrate that there is a potentially viable project. Geothermal risk mitigation schemes aim to remove this barrier.
The risks associated with geothermal drilling are:- Technical drilling risk, comprising problems during the drilling process. Usually this can be covered by standard market-based insurance.
- Resource exploration risk, the potential to not find an economically viable geothermal resource.
It is the second of these that risk mitigation schemes seek to address by providing developers with the financial security needed until completion of drilling works and successful well testing.
Risk mitigation schemes have different designs based on the physical and institutional settings, the desired outcome from the scheme and the current stage of industry development. In some cases, the objective is to stimulate commercial geothermal development in a known geological setting with readily quantifiable risks. Therefore, the emphasis is on successful production rather than innovation. In contrast, the emphasis of others is more on exploration and proof of technical concepts, so projects that test a range of geological settings are favoured.
Schemes fall into three categories: grants, loans or insurance. Loans may have differing interest rates depending on the success of the project. Some schemes are set up as a revolving fund in that successful projects replenish the fund by repaying loans, while if the projects are unsuccessful, the loans are not repaid and become a grant. Grants and insurance schemes are more favoured than loans, because of the impact on the developer’s credit rating if the loans are not repaid even where that is an intrinsic part of the risk mitigation scheme, ie loans are not repaid if the well is unsuccessful.
Some schemes provide grants for successful drilling (eg Australia), but most compensate for failure within completion of an agreed programme, eg a kind of insurance. Most schemes require a definition of failure on which payments may be made. Typically, this comprises key technical characteristics of the resource (temperature, pressure, flow, etc), which are verified during testing at completion and may be aggregated over one or more wells.
The Geothermal Risk Mitigation Facility for East Africa
The Geothermal Risk Mitigation Facility for East Africa (GRMF) was designed to stimulate early stage geothermal investments by drawing on the experience of other risk mitigation schemes, the needs of the sector and the views of stakeholders in the region.
The existing regional scheme (ARGeo) provides exploration risk insurance. The KfW GRMF seeks to broaden the reach of risk mitigation schemes, by offering an alternative for developers in East Africa and by supporting surface studies. This increases the likelihood that developers will find a risk mitigation approach that suits their requirements, which in turn increases the likelihood of successful resource development in the region.
As such, the overall design principles included:
- Availability of substantial grants to encourage competition between applicants
- Incentives to encourage successful exploration drilling
- Clear criteria for acceptance and grant provision
- Simple and rapid application and assessment procedures
- Low compliance costs
There are a number of regional benefits to ensuring that the GRMF is open and competitive. These include attracting the “best” geothermal prospects and developers; supporting the regional objectives of the East Africa Power Pool to diversify regional power supply; collection of regional information to reduce exploration risks in the future; using drilling rigs in an efficient manner and development of capabilities across the region.
The objective of the GRMF is to encourage public and private investors to develop geothermal prospects for power generation in East Africa by providing grants for two types of activity:
- Surface studies to determine the optimal location of exploration wells at the most promising geothermal prospects
- Drilling of exploration wells at the most promising geothermal prospects to assist developers secure finance for subsequent exploration or appraisal wells
As such, the GRMF encourages developers to make every effort to exploit resources by rewarding successful drilling. Support comprises of direct grants for drilling of exploration wells whether they are successful or not. In addition, in order to provide additional incentives for resource development, the GRMF will also provide contingent grants if the developer secures finance for subsequent exploration or appraisal wells within a certain period of time after programme completion.
While the GRMF’s vision is to support East African Rift System countries, initially the facility will be a pilot and focus on geothermal prospects in Ethiopia, Kenya, Rwanda, Tanzania and Uganda due to availability of funding. It is envisaged that the GRMF will be expanded to other countries as it attracts additional funding.
The selection of a host to manage and administer the GRMF was fundamentally important as the host would be required to fulfil the needs of the funders along with internal organisational requirements in the areas of governance, management, process administration, technical, legal, commercial, quality assurance and auditing aspects of GRMF management.
The African Union Commission (AUC) was selected as the host given its strengths in the following areas:
- Organisational objectives and mandate to host the GRMF
- Existing relationships with geothermal stakeholders
- Mandate to operate in the energy and geothermal sectors
- Alignment with Funders objectives
- Potential to expand GRMF to all countries in the East African Rift System
The main bodies of the GRMF will be the Oversight Committee, the AUC’s Regional Geothermal Co-ordination Unit, a Technical Consultant and an Auditor.
Figure 1: Organisational structure of Geothermal Risk Mitigation Facility
Application process
The GRMF will provide grants to developers through a competitive, transparent and rigorous selection process. Applications from developers will be accepted by a specified closing date each year. Exploration drilling applications will be evaluated against criteria such as:
- Exploration experience and expertise
- Indication of geothermal resource based on results from previous studies/drilling
- Robustness of plans and schedules for exploration drilling
- Value for money that costs are consistent with the market norm
- Appropriate concession agreement, environmental and any other relevant permits in place
- Offtake agreement or equivalent in place or under negotiation
- Robustness of business case for development of geothermal resource and power plant
- Likely installed capacity of envisaged geothermal power plant
- Financial, management and organisational capability
Applications that score above a pre-defined threshold will be evaluated in more detail and may be asked to provide further information. Of these, the highest-scoring applications will be invited to negotiate the details of the grant agreement including upper limits for grants and milestones definitions included in plans for surface studies/exploration drilling.
SKM was appointed by KfW to design the Geothermal Risk Mitigation Fund.
Courtesy of SKM
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