ENERGY REGULATION BOARD

ENERGY REGULATION BOARD Stakeholders Guidelines for the Review of Power Purchase and Supply Agreements

Table of Contents 1. BACKGROUND 2 2. LEGAL AUTHORITY 3 3. OBJECTIVE OF REGULATORY REVIEW 4 4. PPA/PSA REGULATORY PRINCIPLES 4 5. TARIFF CONSIDERATIONS 5 6. TRANSMISSION OR WHEELING CHARGES 6 7. TARIFF ESCALATION (INDEXATION) 6 8. PPA/PSAs REGULATORY RISK ASSESSMENT 7 9. REVIEW OF CROSS-BORDER PPA/PSAs 10 10. PPA/PSAs REVIEW WORK FLOW PROCESS CHART 10 11. DETAILED REVIEW OF THE PPA/PSA AND FINANCIAL MODELS 12 11.1 General 12 11.2 Legal review and provisions 12 11.3 Technical review 13 11.4 Financial and Economic Review 15 12. ERB - ENGAGEMENT WITH APPLICANT 17 13. BOARD DECISION AND COMMUNICATION 17 1

1. BACKGROUND The Energy Regulation Board (ERB) is a statutory body created by the Energy Regulation Act of 1995 Chapter 436 of the Laws of Zambia, to regulate the energy industry. The specific functions of the ERB as provided in the Act are; i. To issue licences; ii. iii. iv. To monitor the efficiency and performance of the undertakings, having regard to the purposes for which they were established; To receive and investigate complaints from consumers on price adjustments by any undertaking, and regulate such adjustments by the attachment of appropriate conditions to licences held by undertakings or by such other means as the Board considers appropriate; To receive or investigate complaints from consumers and licenced undertakings on services provided by the undertakings and regulate such services by the attachment of appropriate conditions to the licences held by undertakings or by such other means as the Board considers appropriate; v. To approve the location and construction of, and receive and investigate complaints concerning the location or construction of any common carrier or any energy or fuel facility or installation or the carrying out of any works by any undertaking, and regulate such location and construction by the attachment of appropriate conditions to licences held by undertakings; vi. In conjunction with the Zambia Competition Commission established under the Competition and Fair Trading Act: a. Investigate and monitor the levels and structures of competition within the energy sector with a view to promoting competition and accessibility to any company or individual who meets the basic requirements for operating as a business in Zambia; and 2

b. Develop and implement appropriate rules to promote competition in the energy sector. vii. viii. ix. In conjunction with the Zambia Bureau of Standards, established under the Standards Act, design standards with regard to the quality, safety and reliability of supply of energy and fuels; In conjunction with the Environmental Council of Zambia established under the Environmental Protection and Pollution Control Act, formulate measures to minimise the environmental impact of the production and supply of energy and the production, transportation, conversion, storage and use of fuels and enforce such measures by the attachment of the appropriate conditions to licences held by the undertaking; and To make recommendations to the Minister as to the measures to be taken through regulations to be made under the ERB Act The ERB is required to grant regulatory consent to utilities to enter into power purchase or supply agreements (PPAs/PSAs) as they pertain to the purchase and supply of electricity in bulk. The purpose of these guidelines is to guide the stakeholders on how the ERB reviews the PPAs/PSAs submitted to it for regulatory approval. 2. LEGAL AUTHORITY The ERB draws its mandate to review PPAs/PSAs from the Electricity Act Cap 433 section 27 of the laws of Zambia which provides as follows: The Minister or the Board may, for purposes of this Act, require the operator of an undertaking to provide information relating to the activities and operations of the undertaking, including such records, documents and agreements relating to the purchase and sale of electricity as the Minister or the Board may require. Further, the licence issued by the ERB to utilities engaged in the supply of electricity requires a licencee to submit to the ERB for approval all contracts 3

for the supply of electricity entered into by the Licencee with any other customer. Section 18 of the licence to supply electricity stipulates as follows: 18.1 The Licencee shall provide for the ERB s prior review of all contracts and agreements: (a) (b) (c) With other licencees or with retail or wholesale customers; For the import or export of power or energy; For the transmission or the purchase or sale of bulk power or energy, including any and all contracts or agreements for the purchase or sale of electricity being entered into for the purposes of enabling or securing financing for new or expanded capacity. 18.2 Any such Contracts or Agreements concluded without the ERB s prior approval of their pricing provisions shall be considered null and void for the purposes of the ERB s determination of tariffs. 18.3 The ERB has the right to retain copies of such Contracts and Agreements. The licensing conditions require that the regulatory review and approval be conducted ex-ante to the two parties signing the agreement. 3. OBJECTIVE OF REGULATORY REVIEW The overall objective of conducting a regulatory review of PPAs/PSAs is to ensure that the terms of the PPAs/PSAs are fair and balanced to all parties who will be directly and indirectly affected by these transactions. This is in tandem with the ERB s motto; We Safeguard Your Interests. 4. PPA/PSA REGULATORY PRINCIPLES The Zambian ESI is evolving with new players coming on the market in the generation and distribution/supply sector. Independent Power Producers 4

(IPPs) have become an important part of the generation-mix in Zambia. Objective review of Agreements between IPPs and their contracting parties and their large/bulk customers will enhance transparency and competitiveness in the ESI. In the review of PPA/PSAs, the ERB shall be guided by the following principles: i. Cost Reflectivity; ii. iii. iv. Promotion of security of supply in the electricity industry; Conformity to technical requirements of the ESI and the Grid Code; Ensure local demand is met or satisfied before exports; v. Consistence with the Electricity Act, Energy Regulation Board Act and Other legal provisions and the Laws of Zambia in general; vi. vii. Consistence with National Energy Policy; and Need for financially and economically viable projects and the Industry as a whole. 5. TARIFF CONSIDERATIONS As a general guide, the PPA/PSA tariff is usually composed of fixed and variable charges. The capacity charge and energy charge constitute the fixed and variable charges respectively. It is not however, uncommon to have other charges usually set to recover any other costs (such as start-up costs), or for providing any other services (such as reactive support, reserve energy, and back-start capability). Different PPAs will contain a different balance of fixed and variable charges, and therefore pricing terms need to be converted into an average cost for a meaningful comparison. The two parties entering into the PSA are allowed to negotiate and agree on the PPA/PSA including the tariff. The ERB reviews the effective average tariff to ensure that it is fair to both the purchaser and the vendor. The PPA tariff review is guided by the tariff determination principles and methodology set by the ERB anchored on Revenue Requirement, which ensures cost recovery, 5

reasonable return and prudential costing that only include costs associated with the generation, transmission, distribution and supply of electricity. The export PPA/PSA tariff is benchmarked with the Southern African Power Pool (SAPP) market tariffs as appropriate. The agreed tariffs must meet the minimum benchmark ERB computed tariffs for each year as per the Cost of Service tariff Migration path. 6. TRANSMISSION OR WHEELING CHARGES The ERB s role in regulating wheeling charges between contracting parties will follow the parties negotiations and mutual agreement. As for wheeling transactions that transcend Zambian borders, the ERB will be guided by SAPP power trading guidelines as well as the RERA cross-border power trading guidelines. For export PPAs, the wheeling charges are benchmarked also with the prevailing wheeling charges in the SAPP. Further, cross-border wheeling will be treated in terms of the SAPP rules as contained in the SAPP Agreement between operating members and the SAPP Operating Guidelines which governs trade between SAPP members. Charges for incremental losses incurred as a result of these wheeling transactions will also be treated according to these SAPP rules. ERB requires that transmission asset owners/operators avail their transmission infrastructure to parties other than their own customers, usually competitors in the provision of the relevant services, is done on commercial, timely and non-discriminatory terms negotiated by the contracting parties and approved by the ERB. 7. TARIFF ESCALATION (INDEXATION) In order to take into account inflationary movements and maintain tariffs at cost reflective levels over the life of the PPAs, the ERB will allow tariff escalation. A key feature of PPA pricing schemes is the fixed escalator where the electricity produced by the generator is sold to the transmission system operator or national utility at a price that increases at a predetermined rate, 6

usually linked to a reference Price Index (PI) or inflation. For United States Dollar denominated tariffs the US Producer Price Index (PPI) is used while for Kwacha denominated tariffs the domestic CPI-X 1 maybe used. The PPA will also stipulate the escalation period which is usually annually. The ERB will also review the elements for automatic pass through in the PPA in the light of a Multi-Year tariff. This will be done with reference to the Multi- Year Tariff Framework and Methodology currently under consideration. The table shows the indexation formula used by the ERB. PPA Indexation for Energy and Capacity Charges Energy Charges ECT (i) = ECT (i-1) x (1+ USPPI (i)); Capacity Charges EMCT (i) = EMCT (i) x (1+ USPPI (i)). Where ECT (i) ECT (i-1) EMCT (i) EMCT (i-1) USPPI (i) = Effective Energy Tariff for the current year = Effective Energy Tariff for the preceding year = Effective Monthly Capacity Tariff for the current year = Effective Monthly Capacity Tariff for the preceding year = Annual percentage variation in US Producer Price Index 8. PPA/PSAs REGULATORY RISK ASSESSMENT PPA/PSAs are usually signed for long periods of time with huge financial implications for the contracting parties as well as the consumers. These factors implicitly mean assumption and imposition of risks on contracting parties and other stakeholders. In view of the foregoing, Regulators can play a critical role in mitigating the risks via regulatory oversight of these PPA/PSAs. According to the World Bank s Energy Sector Management Assistance Project report (2008), two (2) key risk areas have been identified that regulators are concerned about, these are Construction period risks and Operation period risks. Construction Period Risks: Risks during the construction period for the PPA cover the following six principal risk factors in the case of a new fossil-fueled power generation plant: 1 Where, X is an Agreed factor as Utility costs do not usually increase at exactly same rate as CPI factor 7

i. Increases in construction costs; ii. iii. iv. Increases in financing costs; Delay in completion of the power plant; Delay in completion of associated facilities; v. Failure of plant to meet performance specifications at completion tests; and vi. Government actions; Operation Period Risks: Risks during the operation period for the PPA cover the following thirteen principal risk factors in the case of a new fossil-fueled power generation plant; i. Constraints on plant operation; ii. iii. iv. Increases in operating costs; Non availability/non convertibility of foreign exchange; Forced outage/derating or temporary shortfall in capacity; v. Deterioration in heat rate below the rate(s) specified in the PPA; vi. vii. viii. ix. Increased fuel costs and variable operation and maintenance costs; Prolonged outage of the plant due to major damage to equipment; Failure of purchaser to perform its obligations under the PPA; Failure of the seller to meet its obligations under the PPA that is caused by the plant operator; x. Environmental incidents caused by the seller/operator; xi. Control over the seller s rights to assignment of the PPA; 8

xii. xiii. Termination of the PPA in case of an event of default ;and Resolution of disputes between the seller and the purchaser. Generally, the other risks may fall into the following categories: Market Risk: risks associated with estimations of the long term value of the project or PPA; Commercial Risk: risks associated with the ability of the buyer to pay for the product over an extended period (particularly relevant where there is a limited number of potential alternatives); Regulatory Risk: risks associated with potential changes in the structure and regulation that could adversely affect the contract performance; External Risk: Events outside of the control of the contract counterparties that may frustrate the contract, frequently covered with force majeure clauses war, natural disasters etc; and Political risk: Events associated with radical changes in policy that could adversely affect the contracts or projects. Risk assessment analyses the risk exposure to increases in costs for all the parties under the PPA/PSAs. The ERB adopts the balancing approach to allocate the risk to the party that bears the best ability to manage it. The ERB has a legal mandate to protect the interests of captive electricity consumers whose demand is interrupted first times in times of load-shedding or capacity shortfalls. The PPA/PSA customers usually have firm agreements with power suppliers and so may not suffer intermittent power disruptions. The current market structure is de-facto single buyer model. The ERB therefore assess risks implications for the Government as the sole shareholder in ZESCO. It is common for Government to offer Guarantees to power project developers. Recognition of such guarantees makes PPAs comparable in terms of tariff composition and the cost of capital. Such guarantees are normally not stated in the PPA but would be provided for in other Legal documents such 9

as the Implementation Agreements or Investment Protection Agreements. The Role of the ERB is therefore to identify and quantify such risks and their implications for the parties. 9. REVIEW OF CROSS-BORDER PPA/PSAs The ERB is responsible for making decisions within Zambia in relation to cross-border electricity transactions such as issuing licences, approving PPAs, transmission wheeling arrangements, allowing cost recovery in regulated tariffs and mandating access to transmission and distribution systems. The ERB will also ensure that Technical issues such as system security have been appropriately considered in line with the provisions of the Zambian Grid Code, Statutory Instrument no. 79 approved in October 2013. The ERB will take into account regulatory decisions and practices in the other countries involved in a cross-border transaction and work to ensure compatibility of regulatory decisions as provided for under the RERA Cross-Border Power Trading Guidelines approved by the Board in May 2011. To promote the compatibility of national regulatory policies directly affecting cross-border electricity trading, when making regulatory decisions the ERB will take into account any other decisions or recommendations or rules and regulations of regional organisations, such as RERA and SAPP as approved from time to time. 10. PPA/PSAs REVIEW WORK FLOW PROCESS CHART PPAs/PSAs require the ERB s review within the shortest period of time as they impact on the timely and smooth execution of power trading, ensuring security of supply as well as the smooth implementation of projects. In some instances, the agreements are required by the parties in order to reach financial closure on funding for the project (generation projects especially). Review of the PPAs/PSAs is vested with the Economic Regulation (ER) Department with support from other Departments. Inputs are sought from the Legal and Technical Regulation Departments to ensure that the review of the PPA is comprehensive. 10

The ERB will endeavor to undertake and complete the internal PPA/PSA review process within (thirty) 30 work days as illustrated in figure 1. This process will then result in a Board Paper that will be presented for consideration at the next sitting of the Board of the ERB. Figure 1: PPA/PSA review work flow process chart 11

11. DETAILED REVIEW OF THE PPA/PSA AND FINANCIAL MODELS The Applicant is required to submit to the ERB the proposed PPA/PSA together with the latest accompanying financial model. The ERB will undertake a detailed review of the submitted PPA/PSA and the accompanying Financial models generally for accuracy, completeness, prudence and consistency. The review will focus on financial / economic viability, technical soundness for compliance with the Zambian Grid Code and other standards and a legal review for consistency with laws of Zambia, licensing requirements and consistency. Key issues for consideration will include but not limited to the following under each review: 11.1 General i. Overview of the application ii. Name of applicant who has applied for regulatory consent iii. Buyer and seller of the power iv. Quantity of power v. Average Price vi. Duration of PPA/PSA 11.2 Legal review and provisions a. Contracting parties names and addresses of contracting parties; b. Legal entities the contracting parties should be legal entities under the laws of origin. For local entities, obtain company status from PACRA; c. Licensing do the contracting parties have necessary ERB licences or permits like the investment endorsement; d. Signing provision for signing should be made at the end of the agreement for the parties to sign after reaching closure; e. Duration of PPA this should be stated in the agreement. The start date and end date should be clear; f. Renewal the agreement should state whether its renewable or not; 12

g. Termination provisions the grounds for termination should be clearly stated and should not disadvantage any of the contracting parties h. Dispute Resolution the parties should endeavor to resolve disputes amicably and through negotiation and if it fails they should engage an arbitrator already identified in agreement. i. Transfer of ownership & obligations j. Permits and licensing k. The project should state whether any regulations, laws or institutional changes would be affected by the project and any recommendations for implementing the changes and their resultant effects. 11.3 Technical review The technical review should look at the technical configuration of the project. The following issues shall be considered: i). Project details: a). Location b). Size and plant ratings c). Plant capacity factors d). Primary energy source e). Indication of whether energy would be firm or non-firm f). Plant configuration base, mid-merit, peak etc ii). Key project characteristics: a). Technical description of the project and drawings should be provided b). Technology proposed Technology should be internationally acceptable and tried and tested. It should not be obsolete. 13

c). d). Feasibility study of the project - applicability and feasibility of the proposed technology, technical parameters and efficiency levels proposed. Least cost options project should consider least cost options of available resources and technology. e). Project implementation schedule indicate commencement and commissioning dates of the project iii). Impact of project on current electricity system a). b). Project statement on how the project will impact on electricity and other infrastructure. Dispatch and electricity flow evidence of studies undertaken to determine if the new project would cause congestion on the network and the measures proposed to minimise the congestion. iv). Compliance to the Grid Code a). b). Configuration of the project should be compliant with provisions of the Zambian grid code and the PPA/PSA should state this. Power Quality - Compliance with ZS 387, the Power Quality and Reliability standards, and Board Directives on Power Quality. v). Metering a). b). Metering & billing should conform to the metering standards, ZS 640 ZS 647 The meters should be at a point/s of common coupling as stated in the standard. vi). Environmental Impact Assessment (EIA) - If the project is new or being modified, extended etc, proof of approval from Zambia Environmental Management Agency (ZEMA) should be submitted by the applicant. 14

vii). Any other technical issues relevant to the project 11.4 Financial and Economic Review Financial and economic review should ensure that the project is financially and economically viable and that there is no crosssubsidisation and the tariffs are cost reflective. The following should also be taken into account: i. Project financing details that will be available for the project construction and start-up a. Total project cost; b. Breakdown or composition of financing; c. Sources of financing; d. Timing of financing ii. iii. Financial and project models detailed models should be provided for financial and economic analysis of the project. The financial analysis will focus on: a. Amount of electricity the amount of electricity to be sold or purchased should be stated in MW/kW b. Charges charges should be stated as either capacity or energy charge and or any other charge as agreed and the method of calculation applicable. c. Tariffs and the assumptions included like rate of return, inflation, indexation rates. d. Project Net Present Value, Internal Rate of Return, Average Debt Service Coverage Ratio, Loan Life Coverage Ratio, etc. e. Escalation or indexation of tariffs the escalation of tariffs should be stated in terms of: i. Period ii. escalation factor 15

iii. reference or source for escalation factors a. Review of charges the review period for charges should be stated. b. Take or pay terms c. Payment terms and period this should not exceed 30 days after invoice date. iv. Currency this should be in US Dollars, Kwacha or Rand. v. Taxation of output applicable taxes should be stated and who bears the tax. vi. The economic analysis will focus on: a. Cost and Benefit analysis of the project who benefits and who loses from the project? What are the costs and benefits of the project? b. Economic NPV and IRR? c. Regulatory determination of risks and financial viability of proposed project. Risk determination Risk allocation Risk mitigation process Financial viability d. Uncontrolled costs from IPPs should not be allowed such as: Over burden on rate-payers Demands for subsidies from government 16

Hardship on single buyer Uncertainty for IPPs and its economic configuration. e. Cost pass through should be mentioned and the criteria to be used. vi. Any other information that may affect proposed tariffs 12. ERB - ENGAGEMENT WITH APPLICANT The observations and findings highlighted during the review will be communicated to the Applicant within 10 working days of the application. The Applicant will be given 5 working days in which to provide clarifications or further information as the case maybe. After the clarifications have or have not been made, a Board paper will be drafted and finalised with appropriate recommendations on whether regulatory consent should be granted or not. The approval will be granted on the basis of what will be known at that material time. 13. BOARD DECISION AND COMMUNICATION The ERB Board will make a decision on a PPA/PSA application within a period of three (3) Months from date of such application and applicant will be informed of the Decision in writing within 48hours of the Decision. 17

PUBLIC NOTICE ENERGY CONSUMER TOLL FREE LINE 8080 The Energy Regulation Board (ERB) is a statutory body charged with the responsibility of regulating the energy sector in Zambia. Key functions of ERB include issuance of licenses, monitoring the efficiency and performance of utilities and ensuring they comply with relevant standards and license conditions. The regulator also receives, investigates and resolves complaints from consumers and utilities regarding price adjustments, quality of energy products and services including the location of energy facilities. The ERB is pleased to announce the launch of its Energy Consumer Toll Free Line 8080 to broaden its interaction with consumers and expedite complaints resolution effectively. Consumers can now call the ERB free of charge to: Lodge outstanding complaints on energy products and services; Report wrong doing among players in the sector; and Report energy related accidents and incidents. To access the regulator regardless of your geographical location call 8080 every Monday to Friday from 08:00 hours 13:00 hours and 14:00 hours to 17:00 hours. Remember, the toll free line 8080 is accessible on Airtel and MTN networks. For more details, contact ERB at the following addresses: Head Office Plot No 9330, Off Alick Nkhata Road, P O Box 37631, Lusaka, Zambia Tel: 260-211-258844 49 Fax: 260-211-258852 Copperbelt Office Plot 332, Independence Avenue, P O Box 22281, Kitwe, Zambia Tel: 260-212-220944 Fax: 260-212-220945 Livingstone Office Stand No. 708, Chimwemwe Road, P.O. BOX 60292, Nottie Broadie, Livingstone, Zambia Tel: +260 213 321562-3 Fax: +260 213 321576 Chinsali Office Plot No. 76 Mayadi, P. O. BOX 480052, Chinsali, Zambia Tel: +260-214-565170 Fax: +260-214-565171 Email: erb@erb.org.zm Website: www.erb.org.zm Energy Toll Free Line 8080 Call ERB, for free! We safeguard your interests 18 18

VISION A proactive, firm and fair Energy Regulator MISSION STATEMENT To regulate the energy sector in order to ensure efficient provision of reliable and quality energy services and products THEME To ensure cost recovery, diversification, investment, efficiency and compliance in the energy sector 19

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Head Office Plot No. 9330, Mass Media Off Alick Nkhata Road, P. O. Box 37631, Lusaka, Zambia. Tel: 260-211-258844-49 Fax: 260-211-258852 Copperbelt Office Plot No. 332 Independence Avenue P. O. Box 22281 Kitwe, Zambia Tel: +260 212 220944 Fax: +260 212 220945 Livingstone Office Plot No. 708 Chimwemwe Road Nottie Broadie P. O. Box 60292 Livingstone, Zambia Tel: +260 213 321562-3 Fax: +260 213 321576 Chinsali Office Plot No. 76 Mayadi P. O. Box 480052 Chinsali, Zambia Tel: +260 214 565170 Fax: +260 214 565171 E-mail: erb@erb.org.zm I Website: www.erb.org.zm Call Energy Consumer Toll Free Line 8080 Call Energy Consumer Toll Free Line 8080