Bankability of Independent Power Producers in Tanzania

Tanzania's power sector is undergoing a major transformation as the Government seeks to expand electricity generation capacity, diversify energy sources, and attract private sector participation. Independent Power Producers (IPPs) play a crucial role in bridging the energy gap by developing projects in hydropower, solar, wind, and gas-based generation. However, securing financing for IPP projects requires them to be bankable, meaning they must present an acceptable level of risk and offer predictable returns to local and international investors, banks, and development finance institutions.

There are key factors that influence the bankability of IPPs, including a stable regulatory environment with consistent policies, the financial stability of the off-taker, and the structure of power purchase agreements. In this month’s legal update, we analyse the key factors influencing the bankability of IPPs in Tanzania, the challenges and potential solutions to improve the financial viability of IPPs in Tanzania.

Power Purchase Agreements

A well-structured Power Purchase Agreement (PPA) is crucial for securing financing for IPP projects, as it outlines the commercial terms between the IPP and the off-taker, primarily Tanzania Electric Supply Company Limited (TANESCO). In Tanzania, the PPA template is provided under the law and is provided by TANESCO/ the Ministry of Energy to the IPPs.

For a PPA to be considered bankable in Tanzania, several critical elements must be addressed, including regulatory approvals, tariff structures, location of the project, delivery points and payment security. One of the key challenges in structuring a PPA is the approval process, as tariffs must be reviewed and approved by the Energy and Water Utilities Regulatory Authority (EWURA). It is worth noting that, non-cost-reflective tariffs pose financial risks by making projects economically unviable. For the IPP and the offtaker, it is also important to consider the land ownership and who will hold those rights and by which method especially where the IPP is not a majority Tanzanian owned entity. 

Another major concern is payment risk. To mitigate these risks, PPAs should incorporate payment security mechanisms such as escrow accounts or sovereign guarantees to ensure timely payments. However, it is important to note that section 15(1)(b) of the Public Private Partnership Act [Cap 103 R.E. 2019] (as amended) prohibits the issuance of a government guarantee or financial support from the Government for unsolicited projects that are exempted from competitive bidding. 

To enhance financial security and project bankability, another option is for investors to seek third-party guarantees from institutions such as the World Bank’s Partial Risk Guarantee (PRG) program. Effectively addressing these challenges may improve investor confidence and facilitate the successful implementation of IPP projects in Tanzania.

Off-Taker’s Creditworthiness

As the sole public off-taker for IPPs in Tanzania, TANESCO’s financial health is a critical factor in shaping investor confidence and the overall viability of power projects. 

Furthermore, the introduction of private sector off-takers, such as large industries and mining companies, through wheeling agreements could provide alternative revenue streams for IPPs. Lastly, long-term utility reform, including restructuring and efficiency improvements, is essential to strengthening the offtaker’s  financial health and ensuring a more stable and reliable power sector in Tanzania.

Financing and Investment Challenges

In Tanzania, IPPs typically rely on a 70:30 debt-to-equity financing structure, making access to long-term, low-cost debt crucial for project viability. However, raising capital for energy projects presents several challenges. 

One of the primary obstacles is the high cost of local financing, as Tanzanian banks charge interest rates exceeding 15%, significantly increasing the cost of borrowing. Additionally, currency risks pose a major concern, as revenues generated in Tanzanian Shillings may not align with the repayment requirements of foreign-denominated loans, creating exchange rate volatility. Furthermore, limited infrastructure financing with few local banks having the expertise or capacity to fund large-scale energy projects further constrains investment. 

To overcome these barriers, several financing solutions can be explored:

1. Partnering with multilateral lenders such as the International Finance Corporation (IFC), the African Development Bank (AfDB), and the World Bank can provide access to affordable, long-term financing options. 
2. Tapping into green bonds and climate funds, such as the Green Climate Fund, targeted at renewable energy investments can offer alternative funding sources while promoting sustainable development.
3. Utilising blended finance models, which combine Government incentives with private capital to lower investment risks and attract more stakeholders to the sector. 

By leveraging these strategies, IPPs can enhance their financial sustainability and accelerate the growth of Tanzania’s energy sector.

Political & Macroeconomic Risks

Investors in Tanzania’s energy sector must carefully assess broader political and economic factors that can influence the long-term viability of their projects. Several key risks can affect investment returns and operational stability: 

1. Foreign exchange controls, limiting investors’ ability to access funds in foreign currency. 
2. Inflation can drive up project costs, while unexpected tariff adjustments may reduce projected revenues, creating financial uncertainty. 
3. Government policy shifts, as regulatory changes affecting IPPs can be implemented without prior consultation, potentially altering project conditions.

To mitigate these risks, investors can adopt several strategic measures: 

1. Political Risk Insurance (PRI), offered by organizations such as the Multilateral Investment Guarantee Agency (MIGA) and the African Trade Insurance Agency (ATI), can provide financial protection against adverse political developments. 
2. Structuring investments with flexible exit strategies, including dispute resolution mechanisms like international arbitration, ensures that investors have legal recourse in case of conflicts. 

By proactively addressing these risks, investors can enhance the resilience of their projects and maintain confidence in Tanzania’s energy sector.

The way forward

Improving the bankability of IPPs in Tanzania requires a coordinated effort from key stakeholders, including the government, financial institutions, and private investors, to address existing financial, regulatory, and operational challenges. 

Investors must take a strategic approach to mitigate risks and enhance project viability, such as:

1. Conducting thorough due diligence to identify potential legal and financial risks before committing capital.
2. Negotiating strong PPAs with clear and enforceable contract terms, payment security measures, and international arbitration clauses, to the extent legally possible.
3. Leveraging multilateral support from lenders such as IFC and AfDB to secure long-term, affordable funding.
4. Actively engaging with the Government and industry bodies to advocate for stable and transparent regulations that foster a predictable investment environment.

The Tanzanian Government also plays a crucial role in enhancing the attractiveness of IPP projects. It can:

1. Strengthen offtaker’s financial position through structural reforms, improved liquidity management, and debt reduction measures to build investor confidence.
2. Enhance regulatory clarity by streamlining licensing processes and ensuring cost-reflective tariffs to reduce bureaucratic delays and financial uncertainty.
3. Encourage and boost Public-Private Partnerships (PPPs) by offering fiscal incentives, risk-sharing mechanisms, and guarantees to attract more private sector investment into the energy sector.

By implementing these measures, Tanzania can create a more bankable and investor-friendly environment for IPPs, ultimately improving energy security and economic development.