PRIVATE INVESTMENT

IN TRANSMISSION
Four business models for emerging markets
Table of contents
Four business models to facilitate 3
private investment in transmission

An introduction to independent 9
transmission projects

Allocating risks in independent 13

transmission projects

Concessions part one 17

Concessions part two 23

Concessions part three 29

 Four business models to facilitate
private investment in transmission
There is currently a need for significant additional investment in
transmission on the continent of Africa. This need is unlikely to be met
through the existing sources of funding for the sector.
As things stand, 52% of people who live in sub- Finally, transmission infrastructure is essential to
Saharan Africa currently live without access to support the transition towards energy systems
electricity.1 Investment in new power generation that are less carbon intensive. Investment in grid
over the past few decades has not been matched stability is necessary to support an increased
with corresponding investment in electricity percentage of intermittent renewables in the
networks, and this is now a major constraint on generation mix, and a larger transmission network
increased access. Africa has fewer kilometres will be necessary in most countries to connect
of transmission lines per capita than any other areas of high renewable generation potential with
continent. areas with demand. The investments Egypt made
As well as the energy access imperative for between 2014 and 2020 illustrate the scale of the
transmission investment, it is also critical to investments that could be required to integrate
economic development. Numerous studies have renewable energy resources. Between 2014
demonstrated the economic value of increasing and 2020 the Egyptian Electricity Transmission
investment in electricity transmission systems.2 Company commissioned over 3,600 km of 500 KV
Access to reliable and affordable power for transmission lines. At the end of 2020, the length
businesses is critical for the industrialisation of of their 500 KV transmission system was 2.5
developing countries and suitable capacity on a times its length in 2014. Much of this investment
well-maintained high voltage transmission was necessary to connect new renewable energy
backbone is a prerequisite to this that is missing projects in the south to load centres in the north.
in many countries. The International Energy Agency has estimated

3 Private Investment in Transmission

 NIGERIA
in the wake of the coronavirus pandemic, have
compounded this problem as many nearer term
KENYA
projects that had been earmarked for government
support have now stalled.
MOZAMBIQUE Until the 1990s, state-owned utilities were
responsible for investments in transmission in
ZAMBIA most emerging markets. That decade saw a wave
of restructuring across Latin America, along with
ZIMBABWE
many members of the OECD, which led to new
business models for developing and financing
AFRICA
transmission infrastructure.4 At least one of these
models—the independent transmission project
COLOMBIA
model—was successful enough at decreasing
costs and reducing project implementation risks
PERU
that it has subsequently been employed in the US
SOUTH AFRICA
and the UK even though the transmission systems
of both countries are, by and large, privately
BRAZIL owned networks. In the UK, the Office of Gas and
Electricity Markets (Ofgem) estimated that using
CHILE that model resulted in cost reductions of between
23% and 34% in relation to approximately
FRANCE ₤3 billion of investment in transmission related
to new offshore wind projects.5 In the US, a recent
UNITED STATES report estimated that competitive transmission
100 200 300 400 500 600 700 800
development processes can be expected to yield
Kilometres of transmission lines per million people cost savings ranging from 20% to 30% on average,
when compared to non-competitive development
that achieving Africa’s electrification ambitions by incumbent transmission owners.
will require investments of approximately $120 In many respects it is not surprising that private
billion per year, “with the vast majority of those funding has not yet been utilised for transmission
investments going to low-carbon and grid in Africa to the extent it has in other continents.
networks.”3 Investment in generation is usually considered
Historically, the vast majority of investments to be easier to structure and organise and
in transmission on the continent have been significant private investment in generation
made by state-owned utilities. For the most did not begin in Africa until the late 1990s.
part, these investments have been funded by Agreeing roles and responsibilities between a
government, or with support from government private investor and state-owned utility is more
through sovereign backed loans from multilateral difficult with transmission assets which are often
development banks. This source of funding for closely integrated with the existing network.
the sector has not kept pace with the need for Transmission networks are usually centrally
transmission infrastructure, and the bottleneck planned and organised to a very high degree
created by this represents a major economic by the government or state-owned entities and
development challenge and a climate problem. it can feel like a loss of control to open up the
Without additional sources of funding for the network and involve third parties for the first
sector, Sustainable Development Goal 7 (access time, particularly for governments, which still
to affordable, reliable and sustainable energy for often consider transmission infrastructure as
all), and 2050 net zero climate commitments set strategically significant. However, in the current
by governments will not be met. Growing pressure fiscally constrained economic environment, it
on African governments budgets, particularly is clear that the governments in Africa that can

Private Investment in Transmission 4

 unlock new sources of funding for the energy across a wide variety of circumstances.
sector will be the governments most likely to
succeed in expanding electricity access, improving
the provision of power to industry and improving
sector sustainability. There are many transmission
Whole of network concessions
projects without funding at present which have the In a typical whole of network concession, the
potential to build critical infrastructure with a clear owner of the transmission system grants a long-
accretive financial case. National development term concession over the existing transmission
plans depend on this infrastructure being built, system, typically for 20 to 30 years. The private
and the global energy transition relies on suitable investor awarded the concession is then
network infrastructure existing in order to unlock responsible for operating and maintaining the
renewable energy sources. existing transmission network and for financing
and constructing new investments in transmission
At least four different business models could
infrastructure in the service territory over the
be used to facilitate private investment in
term of the concession. Although this model has
transmission infrastructure across most of Africa
resulted in significant investment by the private
(and in emerging markets more generally). Those
sector, significant loss reductions, and significant
four business model are:
improvements in key performance indicators in
• whole of network concessions,
countries outside of Africa, there has not been
• independent transmission projects (ITPs), much experience with this model in relation to
which are also known as independent power transmission in Africa. A few key challenges
transmission projects, must be overcome before this model can be
• privatisations (a sale of shares by a implemented successfully. These challenges are
government in a state-owned utility or identified below.
transmission company), and
• merchant lines. 1. Regulation
Network industries require significant levels of
These four models are described, in the most
on-going investment. In addition, operations and
general of terms, below. In subsequent articles,
maintenance costs are likely to vary significantly
we will examine some of these models and the
over the term of a typical concession as the
issues they present, in more detail. As is the case
network expands and connections to the network
with independent power projects, and public-
increase. As a result, it is not feasible for investors
private partnerships more generally, these models
to bid an availability payment or use of system
are flexible and can be tailored to better address
charge that will apply over the term of the
unique needs, constraints, and challenges. As
concession. Instead, the business is regulated
a result, the models described below should be
using cost of service or performance based
taken for that are—archetype-like models that
ratemaking concepts. Both of these forms of
can be modified so that they can be implemented
regulation rely on periodic determinations of the
regulated asset base (the quantum of investments
made by a utility on which the utility earns a
return and which are recovered by the utility by
including a depreciation charge in the utility’s
annual revenue requirement), the cost of debt,
the cost of equity, and the cost of operations and
maintenance that should be recoverable by the
utility.
As a general rule, investors and lenders are
reluctant to rely on an independent regulator
to establish rates based on cost of service or
performance based ratemaking concepts unless

5 Private Investment in Transmission

the regulator has an established track record of nationalisations, and expropriations.6 Although
fairly balancing the interests of consumers and these types of events can, in theory, be policy
investors. Few regulators in Africa have had an driven and completed under a pre-agreed process
opportunity to establish such a track record. The which protects the legitimate interests of an
fact that rates paid by consumers are not cost- investor on the one hand, and the government
reflective in the vast majority of African countries on the other, this is not always the case.
significantly heightens perceived risks regarding Early termination is not usually the result of a
the stability of regulatory frameworks and the successful concession arrangement and it carries
practical ability of regulators to balance the significant risk for both the investors and the
interests of consumers and investors. government. These experiences have caused
investors to carefully consider a country’s political
2. End of term payments economy, how a whole of network concession
Because network industries require significant may be perceived in that political economy, and a
levels of on-going investment, the investments country’s long term level of commitment to such
made by the private sector will not have been an arrangement.
fully depreciated by the end of the term of the
concession no matter how long that term is.
As a result, the state-owned utility (or the host
country) will need to make a sizeable payment
Independent transmission
to the concessionaire at the end of the term (a projects
buy-out payment). A state-owned utility or host In contrast with a whole of network concession,
government could raise the capital required to an ITP involves the construction and maintenance
make such a buy-out payment by entering into of a single transmission line or a package of
another concession at the expiration of the first transmission lines. In emerging markets, these
concession and requiring the new concessionaire transactions are implemented under a long-term
to pay an up-front concession fee that contract, generally between the state-owned
corresponds to the size of the buy-out payment utility that is responsible for transmission and
owed to the first concessionaire. A state-owned the (private) project company that is established
utility or host country could also raise the buy-out to undertake the project. Such a contract may be
payment by issuing bonds or borrowing from other known as a transmission purchase agreement or a
sources. In either case, the likelihood that the transmission service agreement.
state-owned utility or host government may not be
Unlike a whole of network concession, in an ITP
able to close on such a transaction may be high
enough—or may be perceived by investors and
lenders to be high enough—to make it difficult for
a concessionaire to raise debt financing.
It is worth noting, however, that similar issues
have been successfully overcome in relation to
concessions in the distribution sub-sector that
were awarded in sub-Saharan Africa, a sub-sector
in which the same risks are present. So although
this risk may be difficult to overcome, experience
has shown that it can be overcome.

3. Expropriation and nationalisation risks

Thirty-three whole of network concessions
in the transmission and distribution sectors
in 16 emerging market countries have been
reversed through the termination of concessions,

Private Investment in Transmission 6

 the project company is not obligated to which privatised all of its transmission
expand the transmission line(s) it will networks in three separate transactions
construct, own, and operate. As a result, in 1990. Experience with this model in
the host government, regulatory authority, relation to transmission in emerging
or state-owned utility may conduct an markets is limited.8 Although there is
auction to establish an annual revenue much to recommend this approach,
requirement or monthly availability as is the case with a whole of network
payment. Although a portion of the concession, the requirement for
annual revenue requirement or monthly independent regulation and the perceived
availability payment that corresponds risk of expropriation or nationalisation
to the operations and maintenance may render this option difficult to achieve
expenses the project company will incur in practice in many emerging markets. In
may be indexed, the majority of the addition, discussions with
annual revenue requirement or monthly officials in many emerging market
availability payment will be fixed for the countries has shown that many countries
term of the project. are reluctant to implement a transaction
In order to support the ability of the that would, in their minds, result in
project company to raise long term debt a significant loss of control by the
at attractive rates—which ultimately government over assets that play such a
benefits consumers by lowering cost central role in the deliver of an essential
of the capital required for the project service.
and thereby lowering the availability
payment to the project company—the
project company should be paid for Merchant lines
the availability of the transmission line
Merchant lines are transmission lines
regardless of the quantity of power that
constructed by private investors who
flows over the line. In many cases, the
seek to profit by transmitting electricity
auction that is conducted to select the
from areas in which the cost of power
investors is conducted by the regulatory
is low to areas in which the cost of
authority, as is the case in Brazil, where
power is higher. Many of these lines are
the electricity regulator (ANEEL) conducts
dispatchable high voltage direct current
the auctions. Between 1999 and 2017
lines.
Brazil conducted 38 tenders for ITPs,
resulting in the award of 211 projects Although several successful examples
with a combined length of over 69,000 of merchant lines exist, some merchant
km.7 lines have been adversely affected by the
growth of the transmission systems they
connect, which reduced or eliminated the
opportunity to profit by arbitrage. In many
Privatisations emerging markets, the risk that organic
A privatisation by a sale of shares expansion of the existing transmission
involves the sale of some or all of the system may reduce or eliminate the
shares in a state-owned enterprise to profits that can be generated by a
private investors. In the context of merchant line is particularly high given
privatising a utility in the transmission that the networks are not fully developed
business, it would involve selling shares and are likely to grow.
in that utility to private investors. In addition, a host country would need to
This model has been adopted by many affirmatively elect to allow the owners of
high-income countries, including the UK, a merchant line to earn returns that are

7 Private Investment in Transmission

significantly in excess of the returns that would capital for whole of network concessions
ordinarily be earned by a regulated network utility. using project finance. Fundamentally, project
For these reasons, we see merchant lines as an finance separates out the cash flows and the
interesting business model that may be attractive risks that are related to a particular investment
in unique circumstances but is not likely to be from the cash flows and the risks that are
attractive—to either investors or host countries—in related to other investments. Single
most cases. transmission lines or packages of
transmission lines offer much better
opportunities to separate cash flows and risks
than do whole of network concessions.
Which models are most likely to
• Independent transmission projects allow
succeed in Africa? countries to conduct competitive tenders
For the reasons described above, our view is in relation to discrete projects as the need
that widespread private sector participation in for those projects arises. This means that
the transmission sub-sector in most countries countries can gain valuable experience
in Africa is unlikely to arrive in the form of the in structuring projects and conducting
privatisation of existing state-owned transmission tenders. Likewise, investors gain confidence
utilities or merchant lines. as a country establishes a track record of
Whole of network concessions offer many conducting well-structured and transparent
benefits. They may be particularly attractive tenders, leading to lower costs for successive
to countries that need to fund significant projects.
extensions, upgrades, and expansions of In part because of these advantages, significant
national transmission systems and would like to investments have been funded using the ITP
harness private sources of capital to fund those model. Over 50,000 km of transmission projects
extensions, upgrades, and expansions. Whole of have been constructed using the ITP model in
network concessions may also be attractive to Brazil alone. Peru, India, Chile, and other countries
governments that believe that a privately-owned have also successfully implemented these
concessionaire would be better placed to maintain projects at scale. Significantly, the experience in
and operate an existing transmission network, these countries has demonstrated that ITPs are
which would increase the overall availability of often implemented at a fraction of the anticipated
the system, improve the overall efficiency and cost. In Peru, for example, the capital cost of ITPs
utilisation of the network, and thereby decrease was, on average, 36% less than the expected cost.
costs to consumers on a per-unit basis. Brazil’s experience with ITPs resulted in similar
While whole of network concessions offer many cost reductions.
benefits, they also require host countries, investors, Given these factors, we view ITPs as a promising
and lenders to overcome what can be significant avenue for private investment in transmission in
issues in the context of many countries in Africa. Africa, followed by whole of network concessions.
Those issues include the three we highlighted In subsequent articles, we will examine some of
above and some additional issues we will explore in the considerations that go into structuring both
a subsequent article. ITPs and whole of network concessions.
In contrast, ITPs offer several advantages. Some
of the principal advantages follow.
• The first two risks we highlighted in relation 1 See https://www.iea.org/data-and-statistics/charts/
people-without-access-to-electricity-in-sub-saharan-africa-2000-2021.
to whole of network concessions (economic 2 For a summary of various studies see Pfeifenberger and Chang, Well-Planned Electric Transmission
Saves Customer Costs, June 2016, pp. 5-14. For a discussion of this topic in relation to Africa in
regulation and buy-out payments) can be particular see Power Africa’s Transmission Roadmap to 2030, a Practical Approach to Unlocking
avoided altogether. Electricity Trade, November 2018.
3 IEA Africa Energy Outlook, November 2019, pg. 10.

• It is more practical to raise capital for ITPs 4 See Linking Up: Public-Private Partnerships in Power Transmission in Africa, World Bank, 2017.
5 See Extending Competition in Electricity Transmission: Impact Assessment, 2016, by Ofgem.
using project finance techniques than it is to 6 See Rethinking Power Sector Reform in the Developing World, Vivien Foster and Anshul Rana, 2019, pg.
14.
7 Linking Up, pg. 39.
8 Id.
Private Investment in Transmission 8
 An introduction to independent
transmission projects

Overview responsible for overseeing the electricity sector,

or the regulator, grants a license to the project
Although experience with ITPs in Africa is virtually
company to carry out transmission activities.
non-existent, they have been used extensively in
Latin America, India, the US, and the UK. An ITP is Unlike a broader whole of network concession,
a good way to attract capital into the transmission in an ITP the project company is not obligated
sector to fund key infrastructure and to transfer to expand the transmission infrastructure it will
risk (such as construction risk) to the private construct and own. This means that an ITP can
sector. To implement an ITP, a host country grants be a relatively narrow intervention in the electricity
a project company established by an investor or sector. A discrete project can be scoped and
group of investors the right, and the obligation, allocated to an investor or developer. Although the
to construct, own, and maintain a specific piece aim of many countries is to reach a point where
of transmission infrastructure. This is most a transmission utility may conduct an auction
commonly a single transmission line or a group of for packages of lines, in order to drive down
transmission lines, but the principle can be applied construction and financing costs to the lowest
equally to substations or storage assets. This possible level, it’s likely that the first such ITPs
grant of rights (and obligations) can take a number in many jurisdictions will be bilaterally sourced.
of forms but is usually set out in an agreement Many transmission utilities in sub-Saharan Africa
between the state-owned enterprise that is are at present bilaterally sourcing a portion of their
responsible for transmission (the “state-owned transmission infrastructure under an EPC, plus
transmission company”) and the project company. financing a model in order to pass development
The most common names for such an agreement risk to the private sector, which is also responsible
are a Concession or a Transmission Services for conducting feasibility studies and scoping
Agreement. At the same time, the ministry that is the project. This model can be applied to the
financing of ITPs and there are helpful fiscal policy

9 Private Investment in Transmission

advantages to using private sector models rather An ITP may be appropriate if a host country:
than traditional forms of financing that require • is, as a general matter, pleased with the
sovereign guarantees. performance of the state-owned transmission
In order to support the ability of the project company and desires to see the state-owned
company to be financed at attractive rates—which transmission company continue to operate in
ultimately benefits consumers by lowering cost its current form;
of the capital required for the project, which in • desires to construct a significant transmission
turn lowers the payment made to the project project or a group of transmission projects
company— the project company is typically paid without assuming the construction risk for
for the transmission line regardless of the quantity those projects;
of power that flows over the line. These fixed • would like to use private capital to fund those
payments mean that only limited regulation is transmission project(s);
required once a project is established.
• would like to unlock sources of debt financing
Arrangements for the maintenance of the line for that are not available to the state-owned
the duration of the Concession or Transmission transmission utility; or
Services Agreement will be agreed when
• would like to avoid on balance sheet
the project is designed and this may be the
borrowing by structuring the projects to
responsibility of either the project company or
achieve off balance
the state-owned transmission utility. If it is the
sheet treatment.
responsibility of the project company, then the
cost of maintenance will be reflected in payments
made to the project company by the state-owned
transmission facility. In this case, the payments
may also be based on the “availability” of the
line for the duration of the concession so that
the project company is rewarded for maintaining
the line appropriately and penalised if the
infrastructure is not available to be utilised at
the agreed level. If the project company is not
responsible for maintenance then payments for
the line are more likely to be characterised as
lease payments
or an annuity.
A unique feature of ITPs is that they are operated
as part of an integrated transmission system,
not by the project company. The state-owned
transmission utility or transmission system
operator (if those functions have been separated)
operates a transmission line developed as part of
an ITP by dispatching generation and balancing
the system of which the transmission line is a part
just like it would operate any other transmission
line. This feature may be particularly attractive
where there is some reluctance to allow the
private sector to control the dispatch of generation
resources.

Private Investment in Transmission 10

 useful, clearly defined codes that govern
An ITP may be less attractive to a host the conduct of sector participants (such
country that: as a grid code, a distribution code, or a
• has access to sufficient funding to dispatch code) are not required either. As
meet its sector financing needs on a result, the independent transmission
suitable terms; or project model is inherently flexible and
can be deployed in countries that would
• is looking for a new operating model
find it far more challenging to implement
for the wider network because its
a concession or a privatisation.
existing system operator has not
been able to achieve performance
indicators, service levels, or other
commonly used performance Contractual structure
benchmarks.
There are many similarities between an
As a country considers whether an ITP ITP and an independent power project.
is an appropriate tool for achieving its Both structures involve a single project
objectives, it should also consider how (a generation plant or transmission
electricity sector participants and other infrastructure), or a small group of
stakeholders will be affected, and how to projects in the case of an ITP. Both
engage with those stakeholders to build structures are designed to separate a
support for the transaction. stream of cash flows, rights, obligations,
and risks in order to facilitate the use
of project financing techniques. Given
these similarities, it should not come
Enabling environment as a surprise that there are similarities
One of the benefits of ITPs, particularly between the contractual structures for
in comparison to concessions or ITPs and independent power projects.
privatisations, is that they can be Given the widespread market acceptance
implemented in enabling environments of independent power projects across
that would present some challenges Africa, we suggest that the following
for concessions or privatisations. In contractual structure would, as a general
other words, the requirements on the rule, be appropriate for the ITPs in Africa.
enabling environment are significantly In such a structure, the Transmission
easier to meet. Ideally, the legislative Services Agreement or Concession
position in the country and other aspects would, among other things:
of the enabling environment would
• obligate the project company to
include a suitable licensing regime and
design, engineer, procure and
a clear authority from government to
construct,
the sector regulator or the state-owned
the project;
transmission utility to award ITPs to
project companies. • obligate either the project company
or the state-owned transmission
Note that an independent regulator is
utility to maintain the infrastructure;
not necessary. Neither is it necessary
for the host country’s utilit(ies) to have • obligate the project company to make
been unbundled into separate utilities the capacity of the transmission
responsible for generation, transmission, infrastructure that constitutes the
and distribution. Although they would be ITP available to the state-owned
transmission utility; and

11 Private Investment in Transmission

 • obligate the state-owned transmission utility state-owned transmission utility.
to purchase the transmission capacity and The government support agreement would
make the payments that are specified in contain terms that are similar to those found in
the Transmission Services Agreement or a government support agreement entered into in
Concession. relation to a generation project. The agreement
The state-owned transmission utility would would also include appropriate termination
be obligated to purchase and pay for the payments. Those termination payments could
transmission capacity made available regardless take the form of a put option and a call option of
of the quantity of energy that is actually the type that would typically be found in a put and
transmitted by the project. call option agreement. For a discussion of put
If the project company is responsible for and call option agreements and how to calculate
maintenance, then the payments that are payable termination payments and purchase prices, see
by the state-owned transmission utility would our Africa Projects resource centre.
be reduced to the extent transmission capacity Like all projects that are financed using project
is not made available. The reductions to the finance techniques, allocating risks properly—to
availability payments would be weighted by the the party that is best able to manage the risk and,
amount of time the transmission line(s) are not to the extent that no party is best able to manage
available and, in the case of a partial de-rating of a a risk, to the party that is best able to bear the
transmission line, the extent of the de-rating. This risk—is essential to attracting debt financing on
type of mechanism will facilitate the use of project terms that will result in good value for money
financing techniques and ensure that the project to the offtaker (in this case, the state-owned
company has an appropriately firm incentive to transmission utility).
properly maintain the transmission line(s) and
make transmission capacity available to the

INVESTORS

HOST
Equity contributions, Government COUNTRY
shareholdings support
agreement

EPC PROJECT STATE-OWNED

CONTRACTOR Engineering, procurement COMPANY Concession or transmission UTILITY
and construction contract services agreement

Loan and security

documents

LENDERS

Private Investment in Transmission 12

 Allocating risks in independent
transmission projects
Allocating risks will be a range of approaches to each of these
issues.
One of the benefits of ITPs is that they can be
structured to take advantage of project finance There are many markets where ITPs have been
techniques. Some of the advantages of properly successful in significantly reducing transmission
structured project financed transactions are (i) the costs. Where ITPs are rolled out at scale in a
ability for a project to be financed with higher debt country, the risk allocation matrix used is likely
to equity ratios, and (ii) the ability for the project to be set by Government and tendered to bidders
company to achieve longer loan tenors. These under a centrally managed tender process. In
advantages have the effect of lowering the cost such examples, the host Government will need
of the services delivered by the project (in this to invest resources in developing the individual
case transmission capacity). One of the keys to transmission projects to a point where they are
raising debt for project financed transactions is capable of being tendered. This will typically take
an appropriate allocation of risks. Risks should be at least three to four years to carry out detailed
allocated to the party that is best able to manage feasibility studies and appoint transaction
each risk, and if no party is best able to manage a advisers to design and run a transparent tender
particular risk, it should be allocated to the party process. The competitive market for funding large
that has the most to gain from the project. As a scale transmission in Africa remains untested and
project is structured, all of the parties involved there are therefore no precedents for
in the project should seek to identify and assess this yet.
the risks that may arise. In practice this means For these reasons, and also because there
that most of the parties involved in a project are many urgent transmission projects which
will engage a wide range of advisors—including have stalled due to lack of available funding,
technical, financial, and legal advisors—to identify the authors believe it is likely that the first
and assess those risks. The risk matrix you can transmission projects on the continent will be
download below illustrates how a range of risks bilaterally negotiated ITP projects that establish
might be allocated in a typical ITP transaction a precedent for future investment in the sector.
where principles followed in other markets are These are likely to give rise to bespoke risk
applied to sub-Saharan Africa. In practice there allocations which reflect the specifics of individual

13 Private Investment in Transmission

projects and financier’s appetite or ability to financially accretive projects which improve
manage certain risks in comparison to a host system performance and allow more power to be
national transmission utility. They are also likely to sold is important to sector finances. Significant
pass more early stage risk and cost to developers further transmission investment is
than would be possible for a tendered project. also necessary to support increased renewables in
Regardless of the process used to develop the the generation mix in most countries as part of
first ITPs in Africa, it is likely that they can be used a transition to clean energy. ITPs are perhaps
to improve sector sustainability in many markets the best near term model in many markets for
by providing a flexible and efficient solution in a achieving this level of investment since they can
market which has not yet received the same level be implemented relatively quickly and do not
of investment as power generation. Unlocking typically require material sector reform.

Who bears the

Risk Comments
risk?

Financial

Demand risk State-owned Demand risk is effectively allocated to the state-owned

transmission transmission company through the use of an availability
company, Consumers payment. In a well-regulated sector, the demand risk would
be reallocated to consumers by the tariff methodology that is
used to regulate the state-owned transmission company or to
establish the rates paid by consumers.

Credit risk Host government Unless a state-owned transmission company has an investment
grade credit rating—which is highly unusual in emerging
markets—some form of credit support for the payment
obligations of the state-owned transmission utility will be
necessary. This may take the form of a sovereign guarantee, a
partial credit guarantee, partial risk guarantee, or a put and call
option agreement combined with liquidity support. Each of these
forms of support is likely to have a different fiscal treatment.
The more robust the form of support available, the lower the
credit risk and therefore it is likely that a lower cost of capital
will be available to fund the project. In many African countries
sovereign debt capacity is a limiting factor for expansion of
transmission networks at present and offering a put and call
option agreement with liquidity support to mitigate credit risk
may be a good solution to support private investment.

Inflation Consumers Inflation is normally reflected in increased power costs to

consumers over time. The extent to which it needs to be
specifically apportioned to a party under ITP Project Contracts
will depend on the structure of payments. The most obvious
example of where inflation may become a risk is in the situation
where a project company is required to carry out O&M of the
transmission infrastructure that it owns. If this is the case,
the O&M component of the availability payment will typically
be adjusted for inflation by a regulator over the term of the
contract.

Private Investment in Transmission 14

 Foreign exchange State-owned In markets with strong availability of long-term local currency
rates transmission debt it may be possible to denominate part of the availability
company with payment in local currency.
risk passed on to In practice, long term local currency debt is a challenge in many
Consumers through Africa markets and availability payments are therefore likely
tariff changes to be made in a hard currency or in local currency but with a
regular adjustment for exchange rates.

Who bears the

Risk Comments
risk?

Land

Land acquisition State-owned The cost of acquiring the rights of way, easements, and other
transmission interests in land that are required by the project may be borne
company by the state-owned transmission utility or the project company,
regardless of which of them is responsible for acquiring those
interests. The acquisition of all of the required interests in land
would typically constitute a condition precedent to the first
disbursement of the project’s loans.

Technical

Construction and Project company The project company is responsible for constructing and
commissioning of commissioning new assets.
new assets

Operations and State-owned The maintenance of the assets can either be the responsibility
maintenance, transmission of the state-owned transmission company or the project
technical company or project company. Factors in determining which is the best approach
performance company may include
(i) how closely integrated the assets are in the existing
transmission network maintained by the state-owned
transmission company, (ii) how effective the state-owned
transmission company is with current O&M operations, (iii) the
scale of the assets, and (iv) Government policy in this respect.
How the payment under the Transmission Services Agreement
is calculated (and the extent to which it may be variable)
will typically depend to some extent on whether the project
company is responsible for maintaining the assets and ensuring
their availability or whether its responsibilities are narrower and
only pertain to developing, funding and constructing the assets.
The variability of payments based on availability/performance
are the means through which risk is passed to the project
company if it is responsible for maintenance. It is likely that the
project company will also take risk on variations of the cost of
providing these services over the period of the Transmission
Services Agreement, subject to periodic adjustments for
inflation.

Licences and permits

Initial issuance of Government, state- The project company must apply for and diligently prosecute its
licenses and permits owned transmission applications for all licenses and permits. Significant licenses are
utility, and project granted prior to financial close and usually have a term that is
company the same as the term of the transmission purchase agreement.
If a public authority fails to grant a license or permit when the
applicable requirements have been met, that failure would
typically be treated as a political force majeure event.

15 Private Investment in Transmission

Renewals, modifications Government, A failure to renew a license or a modification to the terms of a license that
state-owned effectively prevents the project company from performing its obligations
transmission utility or exercising its rights under the concession will constitute a change in
law which will normally be dealt with as described below.

Who bears the

Risk Comments
risk?

Social and
environmental

Social and Project company The project company will typically be responsible for conducting
environmental social and environmental impact assessments, complying with
impacts the stakeholder consultation and environmental laws of the
host country, and, if the project company’s lenders are party to
the Equator Principles, for complying with relevant performance
standards issued by the International Finance Corporation.

Occupational health Project company The project company is responsible for complying with the
and safety occupational health and safety laws of the host country, and,
if the project company’s lenders are party to the Equator
Principles, for complying with relevant performance standards
issued by the International Finance Corporation.

Extraordinary events

Changes in law Consumers, Changes in law that increase the costs incurred by the project
government company or decrease the revenues earned by the project
company should be addressed through changes to the
availability payments or by one-time payments, depending
on the nature of the change in law. To the extent they are not,
they should be addressed through a change in law clause
in the government support agreement, which will typically
provide certain remedies to the project company in respect of
changes in law. Those remedies may include the payment of a
termination payment and transfer of the assets to Government.

Changes in tax Consumers, Changes in tax that increase (or decrease) the tax obligations
government of the project company should be addressed through changes
to the availability payments. To the extent they are not, then
they should be dealt with through a change in law clause in the
government support agreement.

Force majeure events Project company, The project company must mitigate the effects of force majeure
consumers events to the extent possible. Where it is practical to do so, the
project company will be required to insure against these risks.

Political force majeure Consumers, If the project company is prevented from performing its
events government, state- obligations or exercising its rights under the project agreements
owned transmission in a manner that is material due to the occurrence of a political
utility force majeure event and the effects of such events continue for
a prolonged period of time, an event of default may occur under
the transmission purchase agreement and the government
support agreement.

Disputes

Resolution of disputes n/a Disputes arising under the project agreements are resolved
under contracts by international arbitration to the extent they are not resolved
informally.

Private Investment in Transmission 16

 Concessions part one
Overview are required to expand, reinforce, and upgrade
the transmission system; and
A concession is a right to develop, construct,
• use private capital to finance significant
operate and maintain an infrastructure project and
improvements to, or significant expansions
to earn profits paid from a share of the revenues
of, a transmission system, while retaining
generated by the project. Concessions are typically
ultimate ownership over the transmission
granted by a government, public authority, or state-
system and the ability to terminate the
owned enterprise. A concession may be granted
concession if the concessionaire fails to
pursuant to a concession agreement, a lease,
perform its obligations under the concession
a lease and assignment agreement, a project
agreement.
development agreement, or similar agreement. In
most countries, the name of the agreement that A concession may be less attractive to a host
grants the concession is not important. Instead, country that:
the rights and obligations created are the defining • has an existing transmission utility whose
features of a concession. Although the name of performance equals or exceeds international
the agreement is not important, we will refer to it benchmarks;
as the concession agreement.
• is able to raise funding on suitable terms
A concession may be appropriate if a host country (either based on the balance sheet of the
desires to: existing transmission utility or though public
• leverage the experience and know-how of the resources)
private sector to improve the performance of a to fund any network investment required; or
transmission utility; • is mainly interested in raising financing for a
• increase budget certainty by transferring the discrete transmission project or a package of
responsibility for financing capital expenses discrete transmission projects (which may be
from the public sector to the private sector; achieved more quickly and efficiently using
• reduce the risks borne by the public sector by other models such as the IPT model).
transferring responsibility for the development, Although there are a number of whole of
financing, and construction of projects that network concessions over unbundled electricity

17 Private Investment in Transmission

distribution companies in Africa, the authors articulate the methodologies it intends to use to
are not aware of a transmission company that regulate the concession in a set of tariff guidelines
has been the subject of a concession save for or a tariff methodology.
in Cameroon where a combined transmission In the alternative, a government support
and distribution concession was granted in 2001 agreement or concession agreement may include
before transmission was taken back into state an annex that describes a regulatory methodology
control in 2021. Given the very significant funding in essentially the same terms in which a set of
required to expand the transmission networks in tariff guidelines or a tariff methodology would
many African countries to meet energy access describe it. The parties to the government
targets and transition to an increased share of support agreement (the host country and the
renewable energy in the generation mix, it is likely concessionaire) or the concession agreement
that this form of private sector participation will be (the state-owned transmission utility and the
used in some markets in the foreseeable future. concessionaire) will then be responsible for
A whole of network concession would be a applying the regulatory methodology following
significant change to a sector if implemented in the terms of the contract. If and when an
most countries. If a government considers that independent regulator is established, that
a concession is an appropriate tool for achieving regulator can play a significant role in applying
its objectives, it will also need to consider how the regulatory methodology if the government
the role of electricity sector participants will be support agreement and concession agreement
changed by the concession, how stakeholders contemplate that outcome. This system is known
will be affected, and how to engage with those as regulation by contract.1
stakeholders to build support for the transaction. Regulation by contract is more likely to be used

Enabling environment
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

Private Investment in Transmission 18

 in a market where there is insufficient regulatory regulator, or the state-owned transmission
capacity at the point when a concession is utility to
granted. Regulatory risk (including lack of award a concession over the transmission
regulatory track record) will be a key factor for assets;
investors in deciding whether they can support a 3. an independent regulator which issues
transmission concession, and the level of returns licenses to utilities that operate in the
that they will require. The returns required by electricity sector and regulates those utilities;
an investor (often described as the cost of capital)
4. utilities that have already been functionally
have an impact on end user tariffs and it is
unbundled into generation, transmission, and
therefore normally in both the government’s and
distribution (as opposed to a single vertically
the investor’s interests to reduce regulatory and
integrated utility);
tariff based risks as much as possible.
5. independent power projects (which will have
Legislative frameworks will vary from country given the host country, the regulator and other
to country, and as described above, there are a sector participants experience with private
number of legal forms that a concession can take. sector participation in the electricity sector);
However, it is often the case that the legislative and
framework and other aspects of the enabling
6. clearly defined roles for generation,
environment in which a concession will be
transmission, and distribution and clearly
implemented would include:
defined codes that
1. an Act (such as a Public-Private Partnership govern their conduct and establish technical
Act) that (i) establishes the framework under standards (such as a grid code, a distribution
which public-private partnerships are studied, code, and a dispatch code).
structured, and awarded, (and (ii) clearly
However, as the discussion above as to how
defines the role of contracting authorities and
to use regulation by contract to achieve the
the government in structuring and awarding
seemingly impossible task of implementing
public-private partnerships;
economic regulation in a country that has not
2. clear authority for the government, the sector established an independent regulator shows, with
enough creativity, a sector that lacks some of the

HOST
REGULATOR
COUNTRY

Government Licence, DISTRIBUTION

GENERATOR Support Agreement Tariff Guidelines
Transmission Transmission COMPANIES
Service Service
Agreement Agreement

INDUSTRIAL
GENERATOR CONCESSIONAIRE
Transmission Transmission CONSUMERS
Service Service
Agreement Agreement
OTHER LOAD
GENERATOR SERVING
Transmission Transmission
Service
Concession
Service ENTITIES
Agreement
Agreement Agreement

STATE-OWNED
TRANSMISSION
UTILITY

19 Private Investment in Transmission

above features of an enabling environment can • the concessionaire will expand, reinforce,
still implement the concession model. and upgrade the transmission system to
the extent required to provide transmission
service within the service territory, and to the
Contractual structure extent that expansion projects are approved
In a typical transmission concession, a state- by the regulator in accordance with the tariff
owned utility that owns a transmission system guidelines.
(the “grantor”) grants a concession over its The participants in a concession and their
transmission network to a project company contractual relationships are shown in the diagram
established by the investors to act as the holder on page 18.
of the concession (the “concessionaire”). At
The diagram assumes that the grantor does not
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 grantor will retain ownership of the existing
transmission system and lease the existing
transmission system and related assets to
the concessionaire;
• the grantor utility will lease or sell to the
concessionaire all of the state-owned
transmission utility’s moveable property,
equipment, and inventory of spare parts;
• the grantor will transfer some of the contracts
to which it is a party—which may include
on-going service contracts, contracts for the
supply of goods and equipment, and contracts
for the construction or supply of new assets
that will become a part of the transmission
system—to the concessionaire;
• the concessionaire will pay a concession
fee, which may be structured as a one-
time payment, on-going payments, or a
combination thereof;
• the concessionaire will use the leased
assets and the transferred assets to provide
transmission service within the service
territory described in the transmission license;
• the concessionaire will improve, repair,
operate and maintain the transmission
system;

Private Investment in Transmission 20

 The diagram assumes that the grantor does not The concessionaire will be responsible for
also function as a single-buyer (the purchaser operating and maintaining the transmission
under all power purchase agreements) and the system. If the legislative framework provides
supplier to distribution companies, industrial that the holder of a transmission license is
consumers, and other load serving entities. If responsible for dispatching generation and
it does, then either the grantor may continue to balancing the system, then the concessionaire
serve that function or the concessionaire could will be responsible for those functions. If the
assume that function by entering (i) into a bulk legislative framework contemplates that those
supply agreement with grantor (under which it functions will be performed by a separate
would purchase the capacity made available by, transmission system operator, then those
and the energy generated by, generators from the functions will be performed by the entity that
grantor), and (ii) separate bulk supply agreements holds the license to act as the transmission
with the distribution companies, industrial system operator. It is important to think about
consumers, and other load serving entities to the transmission system operator role as being
which it supplies energy. Both approaches involve possible to separate from the role of investing
some complexities that are outside the scope in and maintaining the network, because some
of this article. For our purposes the important governments regard the TSO role as being
point is that these complexities exist but can be strategically sensitive.
overcome. The concessionaire will recover its ongoing
As the concessionaire constructs and installs operations and maintenance fees from the use
new equipment and facilities and those facilities of system fees it charges for transmission. It
become part of the transmission system, legal will finance capital expenditures to upgrade
title to the new equipment and facilities vests and expand the transmission system with
in the grantor so that the grantor remains the a combination of debt and equity. Equity
owner of the entire transmission system during will be contributed by the shareholders in
the term of the concession. If, for example, the the concessionaire or created through the
concessionaire needs to acquire additional retention of earnings by the concessionaire. The
rights of way, easements, ownership interests, concessionaire will raise debt by borrowing from
or leasehold interests in land to expand the lenders or by issuing bonds or preferred shares.
transmission system, the concessionaire The concessionaire’s ability to raise capital in
acquires those interests in the name of the the form of equity, debt, and preferred shares is
grantor, and those interests become subject to highly dependent on several factors. Of these,
the leasehold interest and access rights created the most important are:
by the concession. • how the concessionaire is regulated;
• how the buy-out payment (a payment that is
payable by the grantor upon the expiration or
termination of the concession in respect of
the undepreciated portion of the investments
made by the concessionaire) is structured;
and
• how risks are allocated.

1 See Tonci Bakovic, Bernard Tenenbaum, and Fiona Woolf, Regulation by Contract –
A New Way to Privatize Electricity Distribution?, 2003.

21 Private Investment in Transmission

Private Investment in Transmission 22
 Concessions part two

Economic regulation: those objectives and to balance the interests of

investors and consumers.
a brief overview
As discussed in previous articles in this series,
The central problem that economic regulation
the role of the regulator in a typical ITP Project
must solve is to ensure consumers of power are
is likely to be limited to reviewing a project prior
protected from the ability of a monopoly to charge
to financial close, licensing it, and ensuring that
prices that are not reasonable, while assuring
any licensing conditions or KPIs are adhered to.
investors that their long term investment will be
In contrast, the role of an electricity regulator in
fairly rewarded and that they will be protected
a sector with a whole of network transmission
from populist pressure to reduce prices to a level
concession is much more substantial. Whole
which does not allow for this.
of network concessions are a more complex
As a general rule, legislative frameworks business model. The concessionaire will be
that govern electricity sectors establish an responsible for operating, maintaining, and
independent regulator – a separate and usually also expanding the network to meet
independent legal entity that is responsible for the transmission needs of customers in the
technical and economic regulation. Although the concession area over a long period of time. The
government may establish policy objectives for costs associated with this (including operating
the sector, the regulator is responsible for ensuring costs, capital investments and financing costs)
efficiency, transparency, and fairness in the are dynamic over that period of time, and tariffs
management of the electricity sector and benefits will need to be adjusted to recognise changes
from the discretion that is required to achieve in these costs. Tariff guidelines will typically be

23 Private Investment in Transmission

in place when a concession company makes approach is to determine the annual revenue
investments in the network and the regulator requirement for the utility being regulated. The
will be responsible for applying those guidelines, annual revenue requirement is the total amount
approving operating costs and capital investment of revenues that the utility must earn to recover
plans, and monitoring the transmission utility’s its costs and earn a reasonable return on its
performance. The concept of regulatory investments. The basic formula for establishing
independence and discretion mean that a the annual revenue requirement is as follows:
regulator may also be permitted by law to modify
its tariff guidelines at any time.
Where:
Risks around regulatory discretion and the track
record and experience of the relevant regulator are ARRy = (RateBasey x WACCy) + Depreciationy + O&My +
a major factor for investors in deciding whether Taxy
they can fund a transmission concession, and if
so, what the risk premium applied to calculate ARRy means the annual revenue requirement for
their returns should be. As a result, a government year ‘y’;
support agreement is usually entered into in
relation to a whole of network concession, and it RateBasey means the value of the assets of the utility
that are useful in delivering the service
usually containing a change in law clause which provided by the utility and are used by the
provides that if (i) the regulator modifies the tariff utility for that purpose at the beginning of
guidelines, fails to apply the tariff guidelines, or year ‘y’;
issues decisions that are contrary to the tariff
guidelines, and (ii) the action (or inaction) of the WACCy means the weighted average cost of capital
approved by the regulator for use during year
regulator decrease the revenues earned by the
‘y’;
concessionaire or increase the costs incurred
by the concessionaire without affording the Depreciationy means the amount of depreciation that the
concessionaire a reasonable opportunity to utility will recognise during year ‘y’;
recover those increased costs, then the host
country will compensate the concessionaire. O&My means the expenses that an efficient utility
That compensation may take the form of a would incur to operate and maintain the
assets in the rate base and otherwise perform
one-time payment or an ongoing subsidy to the
the function of delivering the utility’s services
concessionaire, depending on the nature of the to its customers during year ‘y’; and
action taken by the regulator.
The frameworks that are used to regulate network Taxy means all of the taxes incurred by the utility
during year ‘y’, including ad valorem taxes,
industries can be classified into two general
corporate income taxes, and other taxes.
approaches—the cost-of-service approach and
performance-based regulation. Although many
These terms are further explored below.
of the concepts involved in these approaches
are similar, there are some key differences that
are worth highlighting as we explore these two
approaches. The rate base
As a general rule, at least in the context of cost-of-
service regulation, the rate base is determined by
Cost of service regulation using the historic acquisition cost of each asset
within the rate base and subtracting the depreciat
The traditional cost-of-service approach to
ion that has accumulated since the asset was
regulation was developed in the U.S. at the
placed into service, usually using straight line
beginning of the 20th century. The first step
depreciation.
in determining rates using the cost-of-service

Private Investment in Transmission 24

 The weighted average cost of The set of laws, rules, caselaw, and normative
expectations that makes the level of discretion
capital described above possible is generally referred to
The weighted average cost of capital may be as the “regulatory compact”. In those countries,
determined by the regulator using the following the regulatory compact has evolved and stabilised
process. over the course of 100 plus years. In markets
• First, the regulator establishes a target debt which may be putting a whole of network
to equity ratio for the utility, which may be concession in place for the first time (as would
expressed as X%:Y%. When expressed in that be the case in most countries in Africa) it is
form, X is the total debt of the utility divided by likely that neither investors nor lenders would
the total capitalisation of the utility (the sum be able to bear the risks that would be created
of debt and equity) and Y is the equity of the by granting that level of discretion to a regulator
utility divided by the total capitalisation of the without the same long-term track record. There
utility. is also the added complication that debt markets
are likely to be less liquid and will provide fewer
• Second, the regulator determines a cost of
obvious reference points. As a result, countries
equity for the utility. The cost of equity may be
that are seeking to implement a whole of network
determined by using the capital asset pricing
concession for the first time may need to reduce
model, which describes the relationship
those risks in order to incentivise investment. This
between the risk of investing in an enterprise
could be achieved by (i) allowing bidders to bid
and the expected returns. The capital asset
the return on equity, which would remain constant
pricing model starts with a risk-free rate of
over the term of the concession, and (ii) allowing
return and adds a risk premium (which is
the concessionaire to pass through the actual
based on the beta of investments in that
cost of debt available to the utility (as opposed to
sector, which is a measure of the volatility
the regulator setting the expected pricing). These
of investments in the sector compared to
are just two examples of the types of changes
the volatility of investments in a market
that could be made to reduce the risks borne by
generally) and, for investments that are not
investors and lenders. Additional steps may be
liquid (such as an investment in a closely held
required.
utility, as opposed to a publicly held utility),
a liquidity premium, to estimate the returns
the investment must generate to incentivise
investors to invest in the enterprise. Depreciation
• Third, the regulator determines the cost of The depreciation is calculated by applying the
debt for the utility. This may be determined depreciation methodology established by the
by benchmarking the cost of debt for similar regulator for that sector to the assets that
utilities or the cost of debt for large corporate constitute the rate base. Straight-line depreciation
borrowers generally, which can be estimated is often used to calculate the depreciation
by drawing comparisons to an index of yields component of the annual revenue requirement. To
on bonds issued by corporate borrowers (for take a simple example, a regulator may establish a
example). depreciation period of
30 years for an asset with a long service life, such
• Finally, the cost of equity and the cost of
as a transformer. In this example, a utility would
debt are weighted by X and Y to determine a
recognise depreciation equal to 3.33% of the
weighted average cost of capital.
historic acquisition cost of the transformer each
The steps described above are regularly used year over 30 years. Utilities maintain a register of
in mature regulated electricity markets with a all of their assets, including
history of privately operated utilities such as the historic acquisition cost of each asset and the
those found in North America, Western Europe,
Australia, and New Zealand to name just a few.

25 Private Investment in Transmission

 rates that are established using a mixture
depreciation it has recognised since the asset was of these concepts.
placed in service so that it can perform these
calculations. In a classic cost-of-service system, a utility files
for a change to its rates when it would like to
The expenses that an efficient utility would incur change the rates it is authorised to charge. In
to operate and maintain the rate base (the assets such a system, a utility’s rates remain in effect
used to provide the service) and otherwise operate until they are changed by the filing of a rate case
as a business can be determined by reviewing and the issuance of a decision by the regulator
the expenses incurred to determine whether they that authorises the utility to charge new rates.
were “prudently incurred”. Prudently incurred costs In practice, this expensive and time-consuming
can be described as those costs that are actually process often occurs annually.
incurred and that could reasonably be expected
to be incurred by a qualified, experienced,
responsible and financially sound utility, acting
reasonably, prudently, fairly and in good faith. Performance based regulation
Stepping back for just a moment, it is easy to see The cost-of-service approach is vulnerable to
the underlying rationale for the formula set out problems caused by information asymmetry.
above. Information asymmetry is a reference to the
The component (RateBasey x WACCy) provides a fact that the utility will always have better and
utility with a return on its investment. The more current information about its business than
component Depreciationy provides a utility with the the regulator. A utility can use this information
return of its investment. The components O&My asymmetry to find ways to earn returns that
and Taxy simply pass through costs incurred by exceed the returns it should earn.
the utility at the utility’s cost. This in turn means Performance-based regulation addresses this
that the only return on the investments made by and related problems by creating an incentive
the utility comes from the component (RateBasey for a utility to become more efficient and thereby
x WACCy). outperform the regulator’s expectations. It works
by establishing an annual revenue requirement
for a period that is longer than one year. Such a
period is known as the control period. Control
Allocating the annual revenue
periods generally fall within a range between
requirement to consumers three years and seven years. The annual revenue
After the annual revenue requirement has been requirements for each year during a control period
established, it is allocated to consumers through are established by the regulator in advance of
end user tariffs which will typically be collected by the control period. If the utility incurs costs that
a distribution utility and paid to the transmission are lower than the annual revenue requirements
concessionaire pursuant to a transmission approved by the regulator, it can retain the
service agreement or similar arrangement. The difference as increased earnings. Although the
annual revenue requirement may be allocated to utility may retain those earnings, the additional
consumers by the quantity of the service supplied earnings come at a cost—at least when viewed
to the consumer from the perspective of the utility—the utility will
(by the amount of energy consumed or have revealed to the regulator that it is capable
transmitted of operating more efficiently and will have
for example) or, in some cases, by a measure established a new benchmark for efficiency that
of the value of the assets that are dedicated to the regulator is unlikely to ignore when it approves
serving that consumer (in the case of charges that annual revenue requirements for the next control
are based on the peak demand of a consumer period. Conversely, if the utility incurs costs that
for example). In practice, the annual revenue
requirement is typically divided into charges and

Private Investment in Transmission 26

 are higher than the annual revenue requirements
approved by the regulator, the utility’s earnings will and maintain the regulated asset base and
decrease. This arrangement effectively requires otherwise perform its functions and a projection
a utility to compete against itself and rewards a of the utility’s tax liabilities.
utility for operating efficiently.
4. Annual revenue requirement
A regulatory regime that uses performance-based The regulator sets the annual revenue requirement
ratemaking could involve the following series of for each year during the regulatory control
steps. period by multiplying the regulated asset value
for that year by the WACC and adding the
1. Business plan efficient operations and maintenance costs and
The utility submits a business plan to the regulator
a projection of the taxes the utility will incur.
that:
Note that the regulated asset value for each
• identifies the outputs the utility will be year is set based on the then-current regulated
expected to deliver during the regulatory asset value, the expected depreciation, and the
control period (including such outputs as safe, investments carried out that have been approved
reliable and efficient transmission service to by the regulator and will increase the rate base, as
its existing customers, the connection of new outlined in the approved business plan.
customers in a non-discriminatory and timely
manner, the expansion of the system where 5. Rates
necessary, environmental improvements, The annual revenue requirement is used to
security improvements and other outputs); establish rates and charges in the manner
• reflects the views of stakeholders, as described above in the section on cost-of-service
determined by a consultative process regulation.
undertaken by the utility and the regulator; and
6. Smoothing
• contains a program of capital expenditures Rates are then smoothed from year to year,
that sets out the capital expenditures the resulting in a constant increase (or decrease)
utility plans to make to deliver the outputs. to rates over the regulatory control period.
These smoothed rates include an adjustment
2. Regulated asset base for projected inflation rates and account for the
The regulator establishes the regulated asset base
time value of money. They may also include an
(the rate base) for the first year in the regulatory
adjustment for projected changes to foreign
control period. The initial rate base may be
exchange rates.
established by privatisation or by the award of a
concession (depending on the structure of the 7. Inflation, foreign exchange
concession). The regulated asset base is then (i) adjustments
increased by the investments made by the utility, The projected inflation rates and foreign exchange
and (ii) reduced by depreciation. It is carried rates are replaced by actual inflation rates and
forward into each successive regulatory control foreign exchange rates during periodic interim
period. adjustments that occur at regular intervals during
the control period. This is important because
3. WACC, O&M, Taxes currency risks represent a major challenge for
The regulator establishes the weighted average
investors in African utilities where tariffs are
cost of capital the utility is permitted to earn,
collected in local currency, but financing is
the operations and maintenance costs that an
provided in hard currencies.
efficiently operated utility would incur to operate

27 Private Investment in Transmission

Options for establishing the guidelines or tariff methodology to be set out in a
schedule to the government support agreement
regulated asset base or implementation agreement. However, in
In many performance-based ratemaking systems, some jurisdictions such an arrangement is not
the regulated asset base is established based possible because it would contravene the legal
on the actual historic cost incurred minus framework that governs the sector by impairing
accumulated depreciation, as is the case with the independence of the regulator in a manner that
traditional cost-of-service regulation. In other is not consistent with that framework. In these
systems, the regulated asset base is revalued systems, the tariff guidelines or tariff methodology
at the end of each control period to account for should be articulated in a decision issued by the
the inflation incurred during that control period. regulator or in a license granted by the regulator.
In these systems, the weighted average cost of The government support agreement should
capital is calculated in real terms, meaning that include a change in law clause in which the host
it does not include a component for inflation country agrees that if (i) the regulator modifies the
expectations. In other systems, the regulated tariff guidelines, fails to apply the tariff guidelines,
asset base is adjusted at the end of each control or issues decisions that are contrary to the tariff
period based on an estimate of the costs an guidelines, and (ii) the actions (or inaction) of
efficient utility would incur to construct its the regulator decrease the revenues earned
facilities at the beginning of the control period, by the concessionaire or increases the costs
with an adjustment for the actual condition of incurred by the concessionaire without affording
those facilities. the concessionaire a reasonable opportunity
In the context of a concession for a utility to recover those increased costs, then the host
located in an emerging market, establishing the government will compensate the concessionaire.
regulated asset base based on the actual historic That compensation may take the form of a
cost incurred minus accumulated depreciation one-time payment or an ongoing subsidy to the
eliminates a few difficult problems that would be concessionaire, depending on the nature of the
created by the other two systems (inflating the action taken by
regulated asset base or revaluing the regulated the regulator.
asset base based on estimates of the then-current The requirement to file a business plan with the
cost of construction). The most significant of regulator is particularly helpful in the context
these problems is that the latter two systems of a transmission concession. The rationale for
tend to increase the value of the regulated asset implementing a transmission concession may
value over time. As we will see in the article on include using private capital to finance significant
buy-out payments, the undepreciated value of improvements to, or significant expansions of, a
the regulated asset base is used to calculate transmission system. Many African countries have
the buy-out payment a grantor must pay upon very low grid access and limited fiscal headroom
the expiration or termination of a concession. to use public finances to expand their networks.
As a result, increasing the value of the regulated A whole of network concession over all or part of
asset base increases the amount of the buy-out a country could be a good way of using private
payment. A further problem is that the latter two capital to unlock service provision and increase
systems increase the level of discretion granted to energy access. Having the concessionaire submit
the regulator in ways that tend to reduce investor a business plan to the regulator is useful because
interest and impair the bankability of concessions. it facilitates a discussion around system planning,
Regardless of whether a regulator intends to which impacts the capital expenses that will be
regulate using cost-of-service or performance- incorporated into the regulated asset base during
based regulation concepts, the methodology it the next control period. ■
intends to be used should be clearly articulated in
a set of tariff guidelines or a tariff methodology.
In some systems, it may be possible for the tariff

Private Investment in Transmission 28

 Concessions part three

Several issues are critical to the bankability of • the depreciation component of a utility’s
concession transactions. Those issues include annual revenue requirement provides
how investors with the return of its investment;
buy-out payments are calculated, some currency- • shorter depreciation periods increase
related considerations, and the allocation of rates over the short term by increasing the
risks among the parties to the transaction depreciation component of a utility’s annual
and consumers.There are few examples of revenue requirement but increase the overall
privately funded transmission concessions on returns paid by consumers because assets
the continent of Africa at present, so this article remain in the rate base for a longer period of
draws from the general principles applied to this time; and
model when it has been used elsewhere in the
• that many of the assets of a transmission
world. Specific concessions will normally have
utility have very long service lives and
targeted approaches to address a specific local
correspondingly long depreciation periods.
environment.
To use a simple example, let’s examine the
following fact pattern. A state-owned utility (the
Buy-out payments “grantor”) enters into a concession with a 20-year
In a prior article in this series that describes how term. The concessionaire places a transformer
network utilities are regulatedlearned that: with an acquisition cost of $1 million into service
on the first day of the concession. The regulator
• the component (RateBasey x WACCy) provides
requires the concessionaire to use straight-line
a utility with a return on its investment;

29 Private Investment in Transmission

depreciation and establishes a depreciation period This alignment results in consistency between
of 30 years for the type of transformer placed into decisions by the regulator regarding the regulatory
service by the concessionaire. At the end of the asset base and the amount of the buy-out
20-year concession, how much of the initial $1 payment.
million acquisition cost has been recovered by the In scenarios other than the expiration of the
concessionaire? term, the buy-out payment could be calculated
To determine the answer, we first convert a by applying a multiplier to the regulated asset
depreciation period of 30 years into annual base. In the case of a termination of the
depreciation of 3.33% of the acquisition cost. concession following an event of default by the
By multiplying $1 million times 3.33%, we can concessionaire, the multiplier would be less than
determine that the concessionaire will recognise 1.0. It may be 0.8 or 0.85 or 0.9, for example. In the
$33,333.33 in depreciation each year and include case of a termination of the concession following
that amount in the depreciation component of (i) an event of default by the grantor under the
the annual revenue requirement. Multiplying this concession agreement, (ii) an event of default by
number by 20 years gives us the answer, which the host country under the government support
is that the concessionaire will have recovered agreement, or (iii) the occurrence of a prolonged
$666,666.67 of its $1 million investment over the political force majeure event, the multiplier would
20-year term of the concession. be greater than 1.0. In this case, it may be 1.1,
In this example, the concessionaire will not have 1.15, or 1.2, for example. These multipliers can
recovered $333,333.33 of its investment by be tailored to suit the objectives of the host
the end of the concession. The concessionaire country, the concessionaire, and the lenders to the
will recover this remaining amount, which is concessionaire. The multipliers should provide
the undepreciated value of the transformer, by a reasonable incentive for all parties to perform
receiving a payment from the grantor at the end of their obligations under the project agreements.
the term of the concession. This type of payment They should not be viewed as, or sized in terms of,
is referred to as a hand-back payment, a buy-out a penalty, which could be enforceable under the
payment, or a buy-out price. We will refer to it as a laws of many host countries.
buy-out payment. Buy-out payments can be sizeable. The amount
The above example shows how depreciation is of the buy-out price is directly correlated
recognised in relation to one particular asset. with the amount of investments made by the
Building on this example, one might conclude concessionaire during the term of the concession.
that the best way to calculate a buy-out price One of the objectives of a concession is to
is by summing the undepreciated value of incentivise the private sector to make the
each asset that was placed into service by the investments that are required to upgrade and
concessionaire. There is, however, a much simpler
method of arriving at the same answer. The
regulated asset base (in a performance-based
regulation system, or the rate base in a cost-of-
service system) is itself the sum of all investments
made, less the sum of all depreciation recognised.
As a result, the buy-out price at the end of the term
of a concession can simply be set to equal the
regulated asset base as of the end of the last year
of the concession.
A significant advantage of this approach is that it
allows the regulatory accounting system
established by the regulator to be used to
establish both the rates and the buy-out payment.

Private Investment in Transmission 30

 expand a transmission system. As a result, if Often these adjustments are applied quarterly
the concession is appropriately structured and and may be implemented by the concessionaire
successfully achieves that objective, then the based on a formula contained in the tariff
investments made by the private sector will be guidelines without the need for the regulator to
sizeable. So will the resulting buy-out payment. issue a decision each quarter confirming the
A host government may find that a concessionaire calculations made by the concessionaire. The
has performed well over the term of the formula should be designed to escalate only those
concession and that there is little rationale for components of the annual revenue requirement
allowing a concession to expire. A concession that are denominated in a foreign currency.
agreement and government support agreement Those components may include the return on
may contemplate that the host country, the the regulated asset base and depreciation, in
grantor, and the concessionaire may which case the regulated asset base may also be
agree to extend the term of the concession before denominated in a foreign currency. The foreign
its expiration. If the term is extended, then the currency in which those items are denominated
need to pay a buy-out payment will be delayed. would be the foreign currency in which the
Further extensions may indefinitely delay the need concessionaire’s loan obligations and equity
to pay a buy-out payment. contributions are denominated.

If a host country is not satisfied with the The operations and maintenance component
performance of a concessionaire, it may raise and other components of the annual revenue
funds to pay the buy-out payment by awarding a requirement would be partially denominated
new concession that requires the payment of an in the same foreign currency and partially
up-front concession fee that matches the amount denominated in the currency of the host country.
of the buy-out payment. In the alternative, a host The percentage of those components that are
government in this position could re-capitalise denominated in the foreign currency would
the grantor by injecting equity into the grantor and correspond to the percentage of the costs incurred
causing the grantor to raise an appropriately sized that are denominated in the foreign currency. A
amount of debt to fund the remaining portion of large part of the operations and maintenance
the buy-out payment. A grantor could raise that costs incurred by a transmission utility is for labor.
debt by issuing multiple series of bonds with As a result, a large part of the operations and
tenors that correspond to the depreciation profile maintenance component of the annual revenue
of the assets that constitute the regulated asset requirement would usually also be denominated in
base, by borrowing from a syndicate of banks, or the local currency.
using a combination of these approaches.

Risks
Currency considerations An appropriate allocation of risks is essential to
With the limited exception of countries that use a attracting investment in the form of both debt and
foreign currency to conduct financial transactions equity. The risk matrix that follows describes how
within their own economy and other very limited a range of risks might be allocated in a typical
circumstances, the rates that are paid by electricity concession transaction.
consumers are denominated in the currency of the
host country. In many emerging market countries,
capital markets and the market for loans from
local banks are not sufficiently liquid to fund the
debt component of the regulatory asset base of a
transmission utility. Where this is the case, rates
will need to be adjusted for changes in foreign
exchange rates regularly.

31 Private Investment in Transmission

 Who bears the
Risk Comments
risk?

Financial

Demand risk Consumers Demand risk is effectively allocated to consumers by the tariff
guidelines. The tariff guidelines usually provide that if the
concessionaire does not earn revenues equal to the annual
revenue requirement during a particular year due to errors in
forecasting the demand for transmission service, then the
portion of the annual revenue requirement not earned as a
result of the forecasting error is added to the annual revenue
requirement for the following year, with interest.

Credit risk Concessionaire, The risk that purchasers of transmission service may not pay for
consumers transmission service promptly is borne by the concessionaire
but may be mitigated by (i) the use in the tariff guidelines of
a target collection ratio that is less than 100% (typically only
suitable in a model with a high number of off-takers), and (ii)
a sovereign guarantee of payment by state-owned enterprises
that purchase transmission service, or another form of liquidity
support and/or support for termination payments in the event of
non-payment.

Inflation Consumers The O&M component of the annual revenue requirement is

adjusted for inflation. In general, the regulated asset base is not
adjusted for inflation.

Interest rates Consumers Rates are typically adjusted for changes in interest rates
regularly. The frequency of the adjustment may depend on how
the concessionaire raised, or could reasonably be expected
to have raised, debt financing. This can be a difficult risk to
apportion in a market with variable liquidity such as those found
in many African countries. The least cost approach to funding
transmission services will usually be to adjust for changes in
actual interest rates regularly.

Foreign exchange Consumers Rates are typically adjusted for changes in foreign exchange
rates rates regularly. These adjustments are usually made each
quarter.

Private Investment in Transmission 32

 Who bears the
Risk Comments
risk?

Land

Pre-existing Consumers The cost of remedying pre-existing environmental defects that

environmental are material in nature constitute a capital cost that increases the
conditions regulated asset base.

Pre-existing defects Consumers The cost of remedying pre-existing title defects on behalf of the
in title grantor constitutes a capital cost that increases the regulated
asset base.

Land acquisition for Consumers The cost of land acquired for new projects is included in the
expansions regulated asset base, usually when the asset is placed into
service.

Technical

Construction and Concessionaire The concessionaire is responsible for constructing and

commissioning of commissioning new assets.
new assets

Operations and Concessionaire If the concessionaire incurs O&M costs that exceed the O&M
maintenance, component of the annual revenue requirement approved by the
technical regulator, then the concessionaire will not achieve the cost of
performance equity established by the regulator. The risk of underperforming
against KPIs (see below) will need to be balanced carefully
against O&M cost overruns when a concession is designed.

Key performance Concessionaire If the concessionaire does not achieve the key performance
indicators, service indicators and/or the required service levels, it will incur
levels penalties, which may be used to reduce rates. For transmission
concessions, typical key performance indicators include
measure of the frequency and duration of outages and
measures of technical and commercial losses.

Licenses and permits

Initial issuance of Government, grantor, The concessionaire must apply for and diligently prosecute its
licenses and permits and concessionaire applications for all licenses and permits. Significant licenses are
granted at the commencement of the concession and usually
have a term that is the same as the concession. If a public
authority fails to grant a license or permit when the applicable
requirements have been met, that failure will be treated as a
political force majeure event.

Renewals, Government, grantor A failure to renew a license or a modification to the terms of

modifications a license that effectively prevents the concessionaire from
performing its obligations or exercising its rights under the
concession will constitute a change in law.

33 Private Investment in Transmission

 Who bears the
Risk Comments
risk?

Social and environmental

Social and Concessionaire The concessionaire is responsible for conducting social and
environmental environmental impact assessments, complying with the
impacts stakeholder consultation and environmental laws of the host
country, and, if the concessionaire’s lenders are party to the
Equator Principles, for complying with relevant performance
standards issued by the International Finance Corporation.

Occupational health Concessionaire The concessionaire is responsible for complying with the
and safety occupational health and safety laws of the host country, and, if
the concessionaire’s lenders are party to the Equator Principles,
for complying with relevant performance standards issued by
the International Finance Corporation.

Extraordinary events

Changes in law Consumers, Changes in law that increase the costs incurred by the
government concessionaire or decrease the revenues earned by the
concessionaire should be addressed through changes to the
annual revenue requirement. To the extent they are not, they
should be addressed through a change in law clause in the
government support agreement.

Changes in tax Consumers, Changes in tax that increase (or decrease) the tax obligations of
government the concessionaire should be addressed through changes to the
annual revenue requirement. To the extent they are not, through
a change in law clause in the government support agreement.

Force majeure events Concessionaire, The concessionaire must mitigate the effects of force majeure
consumers events to the extent possible. Where it is practical to do so, the
concessionaire may insure against these risks. The cost of
the insurance is included in the operations and maintenance
component of the annual revenue requirement. Capital costs
associated with the replacement or repair of asset affected by a
force majeure event are included in the regulated asset base to
the extent they are not covered by insurance proceeds.

Political force majeure Consumers, If the concessionaire is prevented from performing its
events government, grantor obligations or exercising its rights under the concession in a
manner that is material due to the occurrence of a political force
majeure event and the effects of such events continue for a
prolonged period of time, an event of default may occur under
the concession agreement.

Disputes

Resolution of disputes n/a Disputes arising under the project agreements are resolved
under contracts by international arbitration to the extent they are not resolved
informally.

Resolution of disputes n/a Disputes arising in relation to the application of the tariff
arising in relation to methodology may result in claims under the change in law
the tariff methodology clauses of the government support agreement. Disputes
regarding the proper application of such a change in law clause
are then resolved by international arbitration to the extent they
are not resolved informally.

Private Investment in Transmission 34

 About the authors
Ryan T. Ketchum
Ryan is a partner at Hunton Andrews Kurth LLP. His practice focuses
on energy and infrastructure projects located in emerging and
frontier markets.
Ryan is a frequent speaker and author on topics related to the
development and financing of renewable energy projects and
public-private partnerships. Clients quoted in Chambers Global
praise Ryan as “extremely efficient,” adding that, “his wisdom and
judgement of process is very good, as is his ability to handle deep-
heated situations,” that he is “very knowledgeable in private-public
transactions in the energy sector,”and that he “provides intelligent
counsel and knows how to get the deal done.”
Ryan focuses his practice on the development and financing of
energy and infrastructure projects worldwide. He has acted for
governments, sponsors, lenders, development finance institutions,
and other participants in the energy and infrastructure sectors.
Chambers Global guide has recognised Ryan since 2013. Before
joining the firm, he served as a law clerk for the Honorable Henry H.
Whiting of the Supreme Court of Virginia.

Chris Flavin
Chris is Head of Business Development at Gridworks Development
Partners, a development and investment platform focused on
investments in transmission, distribution and off-grid electricity in
Africa. Chris has extensive international project development and
M&A experience which spans Africa, Asia and Europe. Chris began
his career as a private practice lawyer advising a wide range of
institutional investors before joining Gridworks’ parent company,
British International Investment, in 2014. He was involved in the
strategy which led to Gridworks’ formation in 2019 and has served
on Gridworks’ senior management team since it was founded. Chris
is responsible for project development and investment activities
at Gridworks. Chris sits on the Board of a number of Gridworks
portfolio companies including Amari Power Transmission which
is developing the first privately financed transmission project
in Uganda. He is a regular contributor to publications and panel
discussions on the African Infrastructure sector.

35 Private Investment in Transmission

Acknowledgements
Although the views expressed herein are solely the views of the authors, we are very
fortunate to have worked with a larger group of authors convened by Power Africa, the
Commercial Law Development Program, and the African Legal Support Facility to write
a longer book titled Understanding Transmission Financing on these and related topics.
(Available here.) The support, encouragement, and feedback we received during the
development of Understanding Transmission Financing were instrumental in shaping our
thoughts on these topics. We would like to thank all three organisations and the other
authors of Understanding Transmission Financing for their contributions and support.

Private Investment in Transmission 36

Gridworks Development Partners
123 Victoria Street
London
SW1E 6DE

gridworkspartners.com