May 23, 2024

FINANCING RENEWABLE ENERGY PROJECTS IN NIGERIA

Introduction

As the name indicates, renewable energy refers to energy that is generated from natural sources which replenishes itself at a rate higher than the rate of consumption. They are also referred to as clean energy. Examples of this class of energy include solar energy, wind energy, geothermal energy, hydropower, and bioenergy. In contrast to renewable energy, fossil fuels are non-renewable sources of energy that are limited in nature and contribute to carbon emissions which harm the ozone layer.[1]

Renewable energy resources have existed before fossil fuels. However, the technology to commercialize its use grew exponentially in the 21^st century.[2] The clamour for this source of energy is largely attributable to its ability to replenish itself coupled with its minimal carbon footprint. Countries around the world are sharing a need to adopt more renewable energy sources. According to Ember Climate, an energy think-tank report in 2021, renewable energy accounted for 38% of the world’s electricity.[3] Although these natural energy sources are revolutionizing the energy space, the technological infrastructure required for its effective deployment is often capital intensive, forcing developers and investors in the renewable energy space to seek creative ways of raising financing for renewable energy projects. This article will examine the various funding options available to developers, investors, and other stakeholders in the renewable energy ecosystem.

Before discussing these funding options, we consider it apposite to first provide some insight into the legal and regulatory framework for the renewable sector in Nigeria.

Legal Framework for the Renewable Energy Sector in Nigeria

The Nigerian Electricity Act 2023 (the “Act”) is the principal legislation
governing the administration of renewable energy in Nigeria. It empowers the
Nigerian Electricity Regulatory Commission (“NERC”) to superintend over the entire
value chain of power generation, transmission and, distribution in Nigeria.[4] Although the Act does not
define renewable energy, it highlights the development of renewable energy in
its long title in a bid to integrate renewable energy into the country’s energy
mix. Furthermore, the Act provides the framework for the development of clean
energy in Nigeria. For instance, Section 3 of the Act, provides for the
adoption of the National Integrated Electric Policy and
Strategy Implementation Plan (the
“Policy”). The Policy, which is expected to be reviewed every five years, was
set up to establish frameworks for the advancement and exploration of
alternative methodologies to utilize the various sources of clean energy and
address the financial barrier the sector faces. Again, Section 142 of the Act
set up the Rural Electrification Fund (the “Fund”) which is managed by the
Rural Electrification Agency (the “REA”). The Fund is designed to engender the
promotion, provision and support of renewable energy investment and projects in
rural and underserved areas in Nigeria.

Other than the Act, the Climate Change
Act of 2021 (the “Climate Change Act”) plays an important role in governing
renewable energy in Nigeria especially as it concerns achieving lower greenhouse
gas emissions and fostering economic growth through climate change actions. The
Climate Change Act establishes the National Council for Climate Change to
coordinate sectoral targets for clean energy projects[5],
approve and oversee the implementation of the Action Plan[6],
administer the Climate Change Fund[7]
as established under the Climate Change Act amongst other things.

The renewable energy sector is administered by policies formulated by
the NERC, the National Council for Climate
Change, the Federal Ministry of Power, the Federal Ministry of Water
Resources, the Federal Ministry of Environment, the REA and the newly
established National Hydroelectric Power Producing Area Development Commission [8].

Financing Options for Renewable Energy Projects

As we have highlighted above, due to the relatively novel nature of renewable energy projects, there is a tendency for the development of such projects to be capital-intensive. To mitigate this, we have identified below, various funding options available to the stakeholders in the renewable energy space in Nigeria:

1. Project Finance

Project financing refers to a funding arrangement where the financing of a project is secured on the future cash flow the project is estimated to generate and not on the balance sheet of the project sponsors.[9] It is also known as off-balance sheet funding. This funding arrangement allows developers of renewable energy projects to access funding from lenders who would then recoup their investments from the project’s performance over a period of time. Typically, the repayment terms are structured in such a manner that the funding from the project financier is spread out over the cycle of the project in order not to stifle the development of the project. Project finance comes with a higher risk/transaction cost as what the investor can rely on is the project performance. Despite the risks, the use of project finance in renewable energy projects has increased considerably in recent years[10], leading to long-term investment prospects with potentially high returns.

To mitigate the risks associated with this funding option, it is advisable for the parties to such transactions to ensure that adequate protections are infused into their contracts to minimise any exposures.

2. Mezzanine Financing

Mezzanine financing is an effective debt instrument intermediate between bank lending and equity capital. It represents an intermediate layer of funding positioned between senior debt and equity within a company. This form of financing can be structured as preferred stock or unsecured debt, offering investors the opportunity to convert to equity ownership. Typically utilized to support growth initiatives like acquisitions and business expansion, mezzanine financing serves as a flexible financial tool.

As a financing option for renewable energy projects, it can be structured as an investment fund with subsequent participation in the business under agreed terms by the parties.[11] It is mostly structured to be a lower form of debt financing that will match the cash flow generated from the project without interacting with the existing structure. It is advantageous to both investors and borrowers as they can benefit from stable long-term cash flows and can redeploy the proceeds into new projects while retaining ownership of the asset. The structure of mezzanine financing has the flexibility to accommodate the operational and financial needs of early growth stage companies in the renewable energy sector and lowers financing costs by improving financing terms. Common Mezzanine finance structures include revenue participation loans, convertible loans, and loans with a redeemable warrant feature.

3. Private Equity

This funding option entails raising funds from investors in exchange for an equity stake in the company. As such, the investors are not merely providing funding but would be acquiring equity (shares) in the renewable energy company. The renewable energy company would then inject the funding received from investors into the development or expansion of existing renewable energy projects. This funding arrangement is particularly attractive to investors who would like to adopt a more hands-on approach with regard to the management of the renewable energy company as they have the option of participating in the decision-making process of the company.

Venture capital funds and Infrastructure funds are similar in form to private equity; however, private equity typically has a shorter investment horizon with higher returns thus presenting investors with medium risk appetite with a unique opportunity for enhanced returns[12].

4. Debt Financing

This is a type of financing that occurs with the issuance of debt instruments such as bank loans or bonds as a means of raising funds. Repayment of the principal is made at a future date under specific terms with periodic interest. In liquidation, payment to debt instrument holders takes priority over equity holders. Lenders traditionally bear lesser risk compared to the shareholders. Debt financing can be obtained from private finance and public finance channels which range from Multilateral Development Banks (MDBs) to National Development Banks, Commercial Banks, and Bilateral agencies. The Nigerian government finances Renewable energy projects mostly through fiscal allocations to federal and state governments through instruments such as green bonds. Administratively, public financing of decentralized clean energy has been led by the REA through the Fund. The Fund is typically financed through allocations in Nigeria’s federal budget or through loans obtained from MDBs.[13] However, its limited focus on off-grid electrification of rural and unserved communities serves as a barrier to mobilizing the amount of capital needed for utility-scale renewable energy projects for a rapid energy transition.

National Development Banks such as the Bank of Industry (“BOI”) and the Development Bank of Nigeria(“DBN”) are becoming significant actors in achieving a clean energy transition in Nigeria through debt financing activities. In 2023, the BOI announced that it was disbursing €100 million for green energy financing[14] which is a significant improvement from the N852 million Naira issued in 2021. Likewise, the DBN signed a Memorandum of Understanding (“MOU”) with the REA in August 2021, to collaborate on providing affordable debt financing options to facilitate renewable energy projects. The DBN offers incentives to participating financial institutions to increase lending as well as specialized green products and offerings for green finance to MSME[15]. In the area of private debt finance, commercial banks in Nigeria have seemingly taken the back seat in providing financing to the sector. This may be attributable to the banks’ relative lack of experience in managing renewable energy portfolios as well as the volume of the cost of capital to long-term credit scarcity ratio.[16]

Impact investment firms, on the other hand, have taken the bull by the horns with respect to providing the much-needed financing to galvanize the renewable energy sector. For instance, in 2023, Empower Project NGR Limited entered into agreements with First Watt Renewables Limited to advance up to $13 million Dollars to First Watt Renewable Limited, an indigenous renewable company in Nigeria (which AO2LAW represents), for the solarization of over 200 telecommunication sites across the county.[17]

5. Green Bonds

Bond financing generally refers to fixed-term securities issued by corporations or the government that entitles the bondholder to receive interest. Green Bonds are specific fixed-term securities for the purpose of financing climate and environmentally friendly projects. They can also be classified under debt financing instruments. Green Bonds often take the structure of a conventional bond instrument; however, they are issued by governments and corporations for clean energy projects such as energy efficiency projects, pollution prevention and control projects, clean transportation projects, and green building projects among others.

The Federal Government of Nigeria (FGN) in 2017 and 2019 issued a debt security for a N150bn Sovereign Green Bond programme through the Debt Management Office in a bid to meet its Nationally Determined Contribution (NDC) target.[18] Also, as part of its Green Bond process, the FGN had set up the Green Bond Advisory Group (GBAG) made up of public and private sector institutions to provide high level oversight to the Green Bond process.

6. Carbon Credits

Carbon Credits, also known as carbon allowances, are tradable components of clean energy projects that allow companies to compensate for Greenhouse Gas (GHG) Emissions. One credit is equivalent to one tonne of Carbon dioxide and this scheme is aimed at funding GHG projects on the one hand and reducing poisonous gas emissions on the other hand.

Carbon credits are often used interchangeably with carbon offset but while the former represents regulatory compliance credits, the latter refers to voluntary offsets sold to other companies in the carbon market to offset their carbon footprint. Carbon credits are issued by national or international governmental organizations and cap-and-trade programs for the regulation of trading activities and are operational in countries like Canada, the EU, the UK, China, New Zealand, Japan, and South Korea. In Nigeria, the carbon market is still in its development phase with the National Council on Climate Change (NCCC) anchoring the process. The NCCC stated that Nigeria\’s engagement with carbon markets must be strongly linked to its development priorities as contained in its NDCs and evolving government policies/developmental agendas that will be progressively formulated.[19] For more information on Carbon Credits, please see our articles on “Carbon Credits in Nigeria”[20] and “Exploring the Viability of a Carbon Exchange System for the Development of a Structured Emission Trading System in Nigeria”[21]

The Future of Renewable Energy in Nigeria

For years, Nigeria has generated electricity from hydropower sources. However, the potential of clean energy has frequently been eclipsed by the overdependence on non-renewable energy sources. As earlier discussed, the transition to renewable energy presents a lot of economic, industrial, and environmental potential to Nigeria but there are several challenges that must be addressed to meet those transition goals. These challenges stem from politics, infrastructure, finance, and technology.

To develop a policy that encourages investment, the FGN through the Electricity Act, 2023[1], charged the Ministry of Power to prepare the Policy[2], which will include provisions for the optimal utilisation of renewable energy sources; off-grid and mini-grid systems; supply infrastructure; and fostering public-private partnerships to drive the growth and sustainability of the power sector[3]. The timeline for the development of this Policy is one (1) year from the enactment of the Electricity Act, 2023 which means it is expected that the Policy should be in place by June 2024. It is our view that the aggressive implementation of the Policy would catalyse the much-needed development of the renewable energy sector in Nigeria.

Tax incentives have also proven to be a powerful tool to stimulate renewable energy projects all over the world and Nigeria is adopting a similar strategy to encourage investments in renewable energy projects and foster a more sustainable future. Some of these tax incentives are the Pioneer Status Incentive, Accelerated Capital Allowances, VAT Exemption for Renewable Energy Equipment, Green Bonds and Sustainable Financing as introduced by the Finance Act 2022. The Electricity Act 2023 also offers investment incentives by granting the state government, private entities, and individuals the authority to engage in the energy value chain, diminishing the exclusive control previously held by the federal government of Nigeria. In the first quarter of 2023, Nigeria announced its plans to implement a Carbon Tax Act and Credit Policy[4] but has failed to do so to date. The lack of implementation of the Carbon Tax Act further disincentivises investments in renewable energy projects. It is hoped that this will be addressed in the near future.

In a recent report,[5] the International Renewable Energy Agency and the African Development Bank estimate Africa’s solar photovoltaic (PV) technical potential to be 7,900 GW, suggesting Africa possesses some of the globe’s greatest potential for solar power generation. This is in addition to its potential for hydropower (1,753 GW), and wind energy (461 GW). Generally, one can argue that Nigeria has the resource potential to transition to a functional renewable energy sector and deemphasize its dependence on fossil fuels. As such, with the right policy framework and financing in place, the future appears bright for the renewable energy sector in Nigeria.

[1] Section 3(1) of the Electricity Act, 2023.

[2] The National Integrated Electricity Policy and Strategic Implementation Plan.

[3] Ibukun Konu, The Future\’s Bright? The Outlook for Renewable Energy in Nigeria 2023

[4] Premium Times Nigeria, Climate Change: FG to unveil carbon tax system for Nigeria

https://www.premiumtimesng.com/news/more-news/581752-climate-change-fg-to-unveil-carbon-tax-system-for-nigeria.htl , February 2023. Accessed, May 23, 2023

[5] IRENA and AfDB, Renewable Energy Market Analysis: Africa and Its Regions, International Renewable Energy Agency and African Development Bank, Abu Dhabi and Abidjan, 2022.

/media/Files/IRENA/Agency/Publication/2022/Jan/IRENA_Market_Africa_2022.pdf?rev=bb73e285a0974bc996a1f942635ca556

Conclusion

Financial institutions operate on a risk-and-return basis, assessing each potential investment opportunity independently.[1] Project evaluation, documentation, and due diligence are conducted with the same rigour as investments in other sectors. Renewable energy projects offer a range of risk profiles that align with various financial institutions, including banks, pension funds, private equity, and venture capital firms. However, the renewable energy sector requires a clear policy environment to ensure project economics are attractive for attracting private debt and equity investment. The use of renewable energy often involves awareness of perceived needs and sometimes a change of lifestyle and design. Consequently, it is essential to develop and maintain an effective information exchange, sensitization, and training program for the sector.

Policy and regulation play a central role in ensuring the long-term stability of projects in terms of revenue and operations. In emerging markets and developing countries such as Nigeria, renewable energy projects face additional challenges due to factors such as unstable political regimes, volatile local currencies, and inadequate infrastructure. These risks can be mitigated through local partnerships and the application of public funding in the form of soft loans, bonds, debt financing and insurance programs. Coordination of policies between the various Ministries will also contribute to ensuring a smooth planning and implementation process. [2]

Nevertheless, the use of renewable energy resources almost certainly can provide a cleaner and more sustainable energy system than traditional energy sources. To seize this opportunity, Nigeria should develop renewable energy markets and gradually grow its sector experience with renewable technologies projects. Also, steps need to be taken to close the barriers to our clean energy transition program to meet our NDCs. This includes financial incentives to reduce upfront investment commitments and to encourage design innovation.[3]

[1] Elizabeth Morse, Renewable Energy, the National Geographic Society Encyclopaedia, 2024

[2] Ibid

[3] Dave Jones, Global Electricity Review 2022, Ember Climate Report 2022

[4] Although NERC would no longer be the regulator for states within the federation that have set up their own electricity market pursuant to the Electricity Act, 2023. Section 2(2)(c) and Section 230(2)(b) of the Electricity Act,2023.

[5] Section 4 (a-q) of the Climate Change Act, 2021.

[6] The Action Plan, also known as the Nationally Determined Contribution (“NDC’’) is formulated by the National Council for Climate Change in consultation with the Federal Ministry of Environment and the Federal Ministry of Budget and National Planning for every 5-year cycle. The Action Plan aims to cut emissions of Greenhouse gases into the atmosphere and adapt to climate impacts.

[7] Section 15 (1) of the Climate Change Act, 2021.

[8] Section 82, Electricity Act 2023

[9] Financely, Project Finance for Renewable Energy Projects, 2023, accessed on March 28, 2024

https://financelygroup.medium.com/streamlined-project-finance-for-renewable-energy-projects-df33d55c7dad

[10] Bjarne Steffen, The Importance of Project Finance for Renewable Energy Projects, Energy Economics Vol 69, 2018

[11] Mezzanine instruments incorporate both elements of debt and equity financing and can be considered a hybrid of institutional lending and private equity.

[12]Sophie Justice, Private Financing of Renewable Energy, a Guide for Policy Makers, Chatham House 2009.

[13] Edomah N, Ndulue G, Lemaire X, A review of stakeholders and interventions in Nigeria’s electricity sector, 2021.

[14] Victoria Chimezie, Bank of Industry Disburses €100m For Green Energy In Nigeria, Radio Nigeria, 2023

https://radionigeria.gov.ng/2023/11/09/bank-of-industry-disburse-e100m-for-green-energy-in-nigeria/

Accessed on March 26, 2024.

[15] https://rea.gov.ng/rea-collaborates-development-bank-nigeria-dbn/ Accessed on May 23, 2024.

[16]Isah, A., Dioha, M.O., Debnath, R. et al. Financing renewable energy: policy insights from Brazil and Nigeria. Energy Sustain Soc 13, 2 (2023).

[17] AO2LAW acted as transaction counsel to First Watt Renewable Limited. https://nairametrics.com/2023/10/02/watt-raises-13-million-to-power-renewable-energy-in-nigeria/

[18] Nigerian Sovereign Green Bonds by the Department of Climate Change, Federal Ministry of Environment

[19] Sandra Osinachi-Nwandem, Unveiling Nigeria\’s Carbon Market: Policies, Progress, And Prospects

Nigeria Bar Association – Section on Business Law 2nd Quarter Newsletter (NBA-SBL 4th Quarter 2023)

[20] https://ao2law.com/nigerias-energy-transition-watch-carbon-credits-in-nigeria/

[21] https://ao2law.com/nigerias-energy-transition-watch-exploring-the-viability-of-a-carbon-exchange-system-for-the-development-of-a-structured-emission-trading-system-in-nigeria/

Disclaimer: The foregoing should not be treated as legal advice. Kindly contact any of the key contacts if you need further clarification on this briefing note.

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