April 27, 2022
By Ryan Ketchum and Chris Flavin. Ryan is a partner at Hunton Andrews Kurth LLP. Chris is Head of Business Development at Gridworks Development Partners, a development and investment platform principally targeting equity investments in transmission, distribution and off-grid electricity in Africa.
The first article in this series discussed the need to increase the level of investment in electricity transmission systems to reduce costs, facilitate the transition to energy systems that are less carbon intensive, increase system stability, and reduce the level of generation reserves that are required to maintain system stability. It also briefly introduced four business models that can be used to unlock new sources of capital by facilitating private investment in transmission infrastructure across most of Africa (and in emerging markets more generally). Those four business models are:
Subsequent articles in the series discussed ITPs in further detail. In this article, we will examine whole of network concessions, including the circumstances in which a whole of network concession may be attractive to both host countries and investors and some of the challenges that are typically encountered in structuring these transactions.
A concession is a right to develop, construct, operate and maintain an infrastructure project and to earn profits paid from a share of the revenues generated by the project. Concessions are typically granted by a government, public authority, or state owned enterprise. A concession may be granted pursuant to a concession agreement, a lease, a lease and assignment agreement, a project development agreement, or similar agreement. In most countries, the name of the agreement that grants the concession is not important. Instead, the rights and obligations created are the defining features of a concession. Although the name of the agreement is not important, we will refer to it as the concession agreement.
A concession may be appropriate if a host country desires to:
A concession may be less attractive to a host country that:
Although there are a number of whole of network concessions over unbundled electricity distribution companies in Africa, the authors are not aware of a transmission company that has been the subject of a concession save for in Cameroon where a combined transmission and distribution concession was granted in 2001 before transmission was taken back into state control in 2021. Given the very significant funding required to expand the transmission networks in many African countries to meet energy access targets and transition to an increased share of renewable energy in the generation mix, it is likely that this form of private sector participation will be used in some markets in the foreseeable future.
A whole of network concession would be a significant change to a sector if implemented in most countries. If a government considers that a concession is an appropriate tool for achieving its objectives, it will also need to consider how the role of electricity sector participants will be changed by the concession, how stakeholders will be affected, and how to engage with those stakeholders to build support for the transaction.
Network industries require ongoing investment. As a result, even a concession over of a transmission system that does not require significant expansion will require the concessionaire to incur capital expenditures to replace worn-out equipment, restore and refurbish existing equipment, and upgrade the transmission system as a whole over the term of the concession. In most African jurisdictions, it is likely that a concessionaire will be required to commit significant funds to expand the transmission network over the course of the concession to meet energy access targets. As a result, the rates that are charged by a concessionaire for transmission service cannot be set and fixed at the beginning of the concession.
Instead of establishing rates for the term of the concession at the outset, one of two approaches is usually adopted. The most common approach is for a concessionaire to be subject to technical and economic regulation by an independent regulator. The regulatory approaches regulators use to regulate utilities generally, and concessions in particular, will be covered in a separate article. These approaches require that a regulator articulate the methodologies it intends to use to regulate the concession in a set of tariff guidelines or a tariff methodology.
In the alternative, a government support agreement or concession agreement may include an annex that describes a regulatory methodology in essentially the same terms in which a set of tariff guidelines or a tariff methodology would describe it. The parties to the government support agreement (the host country and the concessionaire) or the concession agreement (the state owned transmission utility and the concessionaire) will then be responsible for applying the regulatory methodology following the terms of the contract. If and when an independent regulator is established, that regulator can play a significant role in applying the regulatory methodology if the government support agreement and concession agreement contemplate that outcome. This system is known as regulation by contract.1
Regulation by contract is more likely to be used in a market where there is insufficient regulatory capacity at the point when a concession is granted. Regulatory risk (including lack of regulatory track record) will be a key factor for investors in deciding whether they can support a transmission concession, and the level of returns that they will require. The returns required by an investor (often described as the cost of capital) have an impact on end user tariffs and it is therefore normally in both the government’s and the investor’s interests to reduce regulatory and tariff based risks as much as possible.
Legislative frameworks will very from country to country, and as described above, there are a number of legal forms that a concession can take. However, it is often the case that the legislative framework and other aspects of the enabling environment in which a concession will be implemented would include:
However, as the discussion above as to how to use regulation by contract to achieve the seemingly impossible task of implementing economic regulation in a country that has not established an independent regulator shows, with enough creativity, a sector that lacks some of the above features of an enabling environment can still implement the concession model.
In a typical transmission concession, a state owned utility that owns a transmission system (the “grantor”) grants a concession over its transmission network to a project company established by the investors to act as the holder of the concession (the “concessionaire”). At the same time, the ministry that is responsible for overseeing the electricity sector, or the regulator, grants a transmission license to the concessionaire. In addition, the host country may enter into a government support agreement, implementation agreement, or similar agreement (a “government support agreement”) with the concessionaire to provide certain identified types of support to the transaction.
Collectively, the concession agreement and the transmission license typically provide that:
The participants in a concession and their contractual relationships are shown in the diagram that follows.
The above diagram assumes that the grantor does not also function as a single-buyer (the purchaser under all power purchase agreements) and the supplier to distribution companies, industrial consumers, and other load serving entities. If it does, then either the grantor may continue to serve that function or the concessionaire could assume that function by entering (i) into a bulk supply agreement with grantor (under which it would purchase the capacity made available by, and the energy generated by, generators from the grantor), and (ii) separate bulk supply agreements with the distribution companies, industrial consumers, and other load serving entities to which it supplies energy. Both approaches involve some complexities that are outside the scope of this article. For our purposes the important point is that these complexities exist but can be overcome.
As the concessionaire constructs and installs new equipment and facilities and those facilities become part of the transmission system, legal title to the new equipment and facilities vests in the grantor so that the grantor remains the owner of the entire transmission system during the term of the concession. If, for example, the concessionaire needs to acquire additional rights of way, easements, ownership interests, or leasehold interests in land to expand the transmission system, the concessionaire acquires those interests in the name of the grantor, and those interests become subject to the leasehold interest and access rights created by the concession.
The concessionaire will be responsible for operating and maintaining the transmission system. If the legislative framework provides that the holder of a transmission license is responsible for dispatching generation and balancing the system, then the concessionaire will be responsible for those functions. If the legislative framework contemplates that those functions will be performed by a separate transmission system operator, then those functions will be performed by the entity that holds the license to act as the transmission system operator. It is important to think about the transmission system operator role as being possible to separate from the role of investing in and maintaining the network, because some governments regard the TSO role as being strategically sensitive.
The concessionaire will recover its ongoing operations and maintenance fees from the use of system fees it charges for transmission. It will finance capital expenditures to upgrade and expand the transmission system with a combination of debt and equity. Equity will be contributed by the shareholders in the concessionaire or created through the retention of earnings by the concessionaire. The concessionaire will raise debt by borrowing from lenders or by issuing bonds or preferred shares. The concessionaire’s ability to raise capital in the form of equity, debt, and preferred shares is highly dependent on several factors. Of these, the most important are:
These topics will be explored in subsequent articles.
1 See Tonci Bakovic, Bernard Tenenbaum, and Fiona Woolf, Regulation by Contract – A New Way to Privatize Electricity Distribution?, 2003.