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Opportunities and risks in the African grid of the future

21 January 2024  |  By Ben Hugues, Investment Director & REPP 2 Manager, Camco

Africa is in the midst of a radical social and economic transformation that is already having significant implications for the rest of the world. UN projections show that more than half of global population growth between now and 2050 is expected to occur on the continent, with the population of Sub-Saharan Africa expected to double to two billion over the period, and to double again by 2100. Towns and cities are forecast to grow exponentially too, with the International Energy Agency (IEA) predicting that over the next two decades, Africa will undergo the largest process of urbanisation in the world’s history.

As the region undergoes this population boom, numerous African countries will witness unparalleled economic growth. According to McKinsey, 250 million Africans are expected to join the consuming class by 2030, potentially unlocking USD3 trillion in consumer spending.


The needs of Africa’s burgeoning economies and population can only be met with a corresponding increase in electricity generation. So much so that the IEA estimates Africa’s electricity demand will double as early as 2040, with some regions experiencing a tripling of demand.


This is at a time when Africa already has the one of the world’s fastest-growing carbon footprints per capita. Using the UN’s latest projections on population growth, if the average footprint per African was to match that of the average Indian person today by 2040, then Africa’s overall carbon footprint would grow by an amount equal to the whole of the EU’s current footprint. If by 2100 the footprint per capita increased to that of the average Chinese person today, then the continent would be emitting 28 billion tonnes of greenhouse gas emissions per annum, just 10 billion tonnes less than the entire world emitted in 2021.


Put simply, the world cannot win the fight against climate change unless the overwhelming majority of Africa’s new electricity generation is both clean and sustainable.


The African grid of the future


The African consumers of tomorrow will need a lot more electricity than is currently available. Approximately 600 million people in Sub-Saharan Africa still live without access to electricity and where people and businesses are connected to the national grid, the energy supply is often intermittent and unreliable.


The vast majority of investments in the region’s energy systems have until now been in centralised grids and fossil fuel or large hydroelectric power plants. Fossil fuels – particularly natural gas – will continue to be part of the energy mix at least in the short term; however, in most countries these centralised grids are underdeveloped and only reach a small proportion of the overall population.


Thanks to advances in decentralised energy technology and the plummeting cost of renewables in recent years, Sub-Saharan Africa has a unique opportunity to leapfrog the traditional path of power generation and distribution. Through scaling the deployment of decentralised and small-scale renewables, the region can establish a new energy system that responds directly to its 21st century needs and – critically – supports green growth and clean energy access to the millions of Africans joining the ranks of the consuming class. Such a transition could be compared to that of the telecommunications sector, where the proliferation of mobile phones has negated the need for installing thousands of miles of new telephone lines.


The good news is this shift has already started and is setting the stage for a more resilient and sustainable African power landscape.


A better solution for Africa


So, what makes decentralised and small-scale renewables so suitable for Sub-Saharan Africa? For a start, hundreds of millions of people live in remote and hard-to-access areas across the region. The time it would realistically take to roll out the centralised grid to all these communities is far too long, not to mention the logistical and financial challenges of making it happen.


Another critical factor is climate change itself, with centralised grids and large-scale hydroelectric plants more vulnerable to climate-related challenges, such as changes in rainfall patterns and the increased frequency of extreme weather events. In contrast, decentralised power assets are less susceptible to these issues and can adapt more readily to local conditions, making them more resilient to the worsening impacts of climate change.


Decentralised energy systems are more resilient to economic crises, too. For example, there are instances where large centralised independent power producers (IPPs) have struggled to get paid by the government for years, such as in Ghana where IPPs are currently owned USD1.6 billion collectively by the Ghanian government. This vulnerability of large IPPs further demonstrates the resilience of decentralised power since decentralised power producers sell their energy directly to end-users and as such they remain relatively insulated from political wavering and national economic crises.

Investing in a fast-growing sector

The proven potential of Africa’s decentralised and small-scale renewable energy sector to deliver green growth is presenting investors with many exciting opportunities. As a climate and impact fund manager, Camco has witnessed a huge upsurge in the number of developers, utilities and start-ups innovating in the sector to build the African grid of the future – and they all need capital to succeed. Indeed, McKinsey has estimated that around USD2.9 trillion of cumulative capital expenditure is needed between 2022 and 2050 to finance Africa’s energy transition, most of which is in renewables. Investors are increasingly looking at the space supported by publicly funded climate finance.


The sector offers a breadth of investment opportunities, from financing the construction of solar, wind and hydro plants to decarbonising the grid though the hybridisation of heavy fuel oil plants with solar, to investing in companies innovating in the off-grid sector and building the utilities of the future that are capable of powering e-mobility and productive uses of energy. Being supported in navigating the diverse landscape is important, and investing in a fund managed by a fund manager capable of identifying these opportunities is crucial.


Navigating the risks


While the opportunities in the African power sector are substantial, most investors are well aware of the inherent risks, especially around politics, currencies and innovative business models.


Political risk: There are 54 African countries in Africa, each with their own political challenges. Diversifying investments across several countries and sub-regions is paramount to ensuring that political changes in one region do not unduly impact the entire portfolio. Investing through a fund that covers a wide range of countries is a good strategy to ensure diversification. Funds that invest in assets which are relatively shielded from political risks or that can take out political risk insurance for key investments can protect returns for investors.


Currency risk: Emerging markets are more prone to currency fluctuations, which can be unsettling for investors. Diversification is key again here. The decentralised renewable energy sector has different market segments with varying degrees of exposure to local currency depreciation and ways to mitigate against it. A good variety of currency exposure and hedging mechanisms (whether natural hedges or FX hedges) is needed to protect investors’ returns.


Innovation risk: Africa’s renewable energy sector is in its nascent stage, which calls for innovative business models. Investors can mitigate innovation risk by diversifying their portfolios across numerous business models, including purely off-grid (mini- or metro-grids), purely on-grid (small IPPs), or a hybrid of approaches.


Of course, risks persist even with these mitigation strategies in place, which is where blended finance comes into play. Blended finance allows limited public finance to be used smartly to de-risk investments from commercially minded investors in the fund, thereby helping bridge the climate finance gap that is far too substantial for public funding to bridge alone.


To this end, Camco is currently developing numerous investment platforms and funds to support climate mitigation and adaptation in Sub-Saharan Africa and the Pacific that are structured as blended finance vehicles, and which will invest in a diverse range of projects and countries to ensure appropriate risk-adjusted returns to investors.


A brighter future, today


The African grid of the future presents a wealth of opportunities for investors, driven by economic and population growth and a shift towards decentralisation and renewables. However, it is crucial for investors to understand and manage the risks involved through diversification and various mitigation strategies. With blended finance models gaining traction, the African renewable energy sector is set to become an increasingly attractive prospect for investors, contributing to a more sustainable and resilient energy landscape for the continent.

This article first appeared on ESG Investor here.

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