Power Purchase Agreement (PPA) Guidelines Zambia Lusaka August 7 to 11 2017
I. Objective of the PPA Guideline II. Length of the Agreement III. Commissioning Process IV. Sale and Purchase V. PPA Pricing VI. Operational Curtailment VII.Transmission Issues VIII.Creditworthiness IX. Risk Structure X. Insurance XI. Milestones and Defaults XII.Environmental Attributes or Credits XIII.Resolution of Disputes XIV.End of PPA Contract Arrangements XV.Regulatory review of a PPA Power purchase agreements Presentation outlines 2
Objectives of PPA guide line I. Objective of the PPA Guideline is to: PPA definition; A power purchase agreement (PPA) is a contract to buy the electricity generated by a power plant; provide the COMESA member States with harmonized guidelines; facilitate PPA harmonization in the COMESA region; facilitate private sector engagement in investment in infrastructure; and provide outline contents expected in a standard PPA These agreements are a critical part of planning a successful renewable energy project because they secure a long-term stream of revenue for the project through the sale of the electricity generated by the project; Securing a good PPA is often one of the most challenging elements especially for any RET project development. 3
Length of agreement II. Length of the Agreement PPAs are long-term agreements PPA is usually legally binding once it has been executed by representatives of both the seller and the purchaser, subject to early termination rights, if certain events occur, The end date of the PPA is usually measured in the number of years from the Commercial Operation Date COD, The COD is the date the seller has met all the conditions necessary to deliver energy to the purchaser, a renewal term beyond the initial stated term of 15 to 25 years, such as an additional 5 years may be included Subject to price and terms included in the initial stated term will apply during the renewal term, or may provide for an indexed or renegotiated price, 4
Length of agreement cont TERMINITION clause of the PPA may allow one or both parties to terminate PPA prior to the COD if: i. the seller s or purchaser s internal approvals, or any required regulatory or third party approvals, are not received; ii. permits necessary for the construction and operation of the project are not obtained; iii. the seller has not entered into an acceptable interconnection agreement; iv. in some cases, financing is not available; v. transmission access is not secured; or vi. site control is not secured 5
Commissioning Process III. Commissioning Process Conditions for commercial operation (CO) may require the seller to demonstrate to the purchaser that: i. the seller has completed all testing required by the financing documents; ii. an officer of the seller has certified that the equipment installed at the facility has a maximum designed output equal to the agreed megawatts; iii. the facility has achieved initial synchronization with the interconnection provider s system; iv. the communications systems reliably communicates with the purchaser s systems; 6
Commissioning Process cont v. certified by an independent engineer that the facility has been completed in accordance with the PPA; vi. the facility is performing under the interconnection agreement at a generation level acceptable to the interconnection provider; vii. a separate agreement is in effect to deliver energy to the facility to allow for RE facility start-up and shut down and maintenance; viii. security arrangements have been made; ix. certificates of insurance have been obtained; and x. all permits, consents licenses, approvals and authorizations required by any government authority have been obtained. 7
Commissioning Process cont 8
Commissioning Process cont Concession/Implementation Agreement: Grants the producer the right to develop, finance, construct and operate the power plant, including the right to sell power to the off taker. Grid Interconnection Agreement: Governs the connection of the power plant with the power grid, Fuel Supply Agreements/Bulk Supply Agreement: Establishes the availability of fuel supply and quality FOR NON RE TECHNOLOGIES, Fuel Transportation Agreement: Provides for transporting the fuel from the fuel supplier to the power plant, Engineering, Procurement and Construction Agreement (EPC Agreement): Sets the terms and conditions for the design of the power plant, the procurement of materials and equipment, and the construction of the power plant. The obligations created under this agreement can also be divided among multiple contracts that include one or more of these scopes, Operating and Maintenance Agreement (O&M Agreement): Governs the rights and responsibilities of the entity that will operate the plant and be responsible for its maintenance, Long Term Service Agreement (LTSA): Provides for servicing the plant at regular intervals during the Getahun operation Moges Kifle of DG Ethiopian the PPA. Energy (By equipment suppliers) 9
Commissioning Process cont Loan Agreement: Creates the obligation of the lender to make a loan to the producer to finance the power plant, as well as the obligations of T he producer/borrower to comply with various covenants in the agreement. Equity Contribution Agreement: Obliges the owners of the power plant to make equity or subordinated debt contributions to finance the portion of the power plant not being financed by third party lenders. Sovereign Support Agreement: May include sovereign guarantees, comfort letters, and other forms of sovereign support that enhance the creditworthiness of the off taker and other government entities involved in the project. Credit Support Agreement: May include Partial Risk Guarantees (PRGs), letters of credit and bank guarantees from commercial banks, escrow agreements, and sponsor support. Direct Agreement: governs the relationship between the lenders and the parties involved in the project. These rights are referred to as step-in rights. The direct agreement will be entered into by the off taker, the project company, and the lenders, and establishes a direct contractual relation ship between the lenders and the off taker. 10
Commissioning Process cont Overview of Project Finance vs. Corporate Finance Project finance refers to the financing of a project based on (1) the projected cash flows of the project and (2) the value of the asset, lenders have re course to the assets of the project it self, but they have no re course to the owners of the project. project finance re quires a complex set of highly-tailored agreements; security interests; and the heavy involvement of lenders in the decisions of the project, including with respect to cash flows and capital investment decisions, this can impose high trans action costs, including lawyer's fees for the creation and negotiation of these agreements. 11
Commissioning Process cont Corporate finance; Is based on the balance sheet of the entity receiving the financing. Lenders have re course to all assets of the entity, but they do not have a security interest in any as sets, There have typically no (or very few) restrictions on cash flow. Documentation is relatively light, Raising funds through corporate finance may be cheaper than through project finance, corporate finance is only available to fairly credit worthy borrowers, capital markets are un likely to take construction risk, in particular 12
Sale and purchase/ppa pricing IV. Sale and purchase; Price terms are very important to project development, as the PPA allows investors to estimate the total revenue available over the life of the project, If the price is too low, the project may not have a positive cash flow or the investors may be unable to earn a reasonable rate of return, Conversely, purchasers have a keen interest in keeping the price low to ensure the utility can deliver low-cost electricity to its customers. V. PPA Pricing Predictable price of electricity over the life of a 15 to 25 year contract, The electricity rates are predetermined, explicitly spelled out in the contract, and legally binding, The most common pricing scheme is the fixed escalator where the electricity is sold at a price that increases at a predetermined rate, usually linked to the Consumer Price Index or inflation. 13
PPA pricing The PPA price will most likely be higher than the utility rate at the beginning; however, over time, the utility rate is expected to overtake the PPA price such that the PPA generates savings over the life of the contract, The parties may agree for a periodic [5 years] pricing formulae review; the review should, however, be limited to ensuring that the profit margins or return on investment remains at the level that the parties intended at the time of contracting, A less common PPA pricing model involves the PPA price based on the utility rate with a predetermined variation, however this undermines the pricepredictability advantage of a PPA 14
Tariff Structures; PPA pricing Dispatchable; off taker can (and in deed must) deliver instructions to the project company that directs it to generate a specific quantity of energy (or power) during each settlement period; capacity and energy charge applicable capacity and energy payments to better protect producers against demand volatility and consumers against the need to pay for energy that is not needed (and is there fore not generated), Capacity-based tariffs were developed to address the drawbacks that are inherent in the energy only and take or pay charge, Non-dis patchable; are fed into the net work as and when the energy is avail able, only energy charge is applicable 15
Operational curtailment/ Transmission issues VI. Operational Curtailment During negotiation of a PPA, the parties must decide who will bear the financial risk for losses that arise when the purchaser, transmission owner or transmission authority exercises its curtailment right, PPAs are structured as take-or-pay agreements, Other PPAs, the purchaser pays for available capacity only if the purchaser exercised its discretionary curtailment right, VII. Transmission Issues Transmission provisions are becoming an increasingly important part of PPAs allocating both responsibility for securing adequate transmission access and the costs for any required transmission upgrades sometimes sellers negotiate for the right to pass some or all of these costs on to the Getahun purchaser Moges Kifle DG Ethiopian Energy 16
Credit worthiness VIII. Creditworthiness Both sellers and purchasers face risks associated with the credit of the other party Purchasers require sellers to provide some form of credit enhancement to cover expected damages to the purchaser if the project does not meet construction milestones, Since sellers are often special purpose entities whose only assets are the project assets, purchasers may be concerned about their ability to recover damages to which they are entitled if the project is not completed on time, This credit enhancement may take several forms, including guaranties by credit worthy affiliates, cash collateral or escrow accounts, irrevocable standby letters of credit or performance bonds, the costs of meeting these requirements can significantly increase the overall project costs or alter the arrangements between the developer and the financial partners 17
Risk structure Sellers may also require purchasers to provide a security fund or letter of credit to assure payment for electricity produced by the project, The requirement for the purchaser to provide a letter of credit is usually triggered if the purchaser s credit rating is downgraded by a major credit rating source (such as Standard & Poor Rating Group or Moody s Investor Services, Inc.) to a level determined in the PPA, IX. Risk Structure Risk sharing principle is same whoever associated to its origin can better manage the risk, Risk are generally allocated according to the negotiating power of each party, And must also take into consideration the interests and concerns of the project lenders 18
Risk structure cont Risk mitigation strategies are effectively financial strategies Completion risk; Mainly by the construction contractor - it will be liable for liquidated damages for late completion, Cost overrun risk; Shared by Project owners and the Project company. The Project Company must lock certain costs such major plant equipment and commodity costs as early as possible, Design risk; Project company & main plant / equipment supplies. Performance tests must be before full hand over, Construction risk (Greenfield Projects) The EPC company. Exchange rate/forex risk; The lenders will want to see appropriately robust hedging arrangements or some other mechanism to manage currency exchange risk such as price increase that is link to foreign exchange variations, 19
Risk structure cont Force majeure and change in law; The lenders will want to review the force majeure and change in law provisions in the project documents and ensure that they are back to back (as far as possible) with the concession agreement Interest rate; If lenders are unable to provide fixed rate debt and no project participant is willing to bear the risk, hedging or some other arrangements may need to be implemented to manage the risk that interest rates increase to a point that debt service becomes unaffordable to the project Market/demand risk This market risk is usually assigned to the off taker in PPAs Price risk; the price and escalation factor is stipulated in the contact and the risk is borne by the off-taker, which passes on to the consumer. Volume risk; The operational aspect of volume risk is on the plant operator or expropriation. 20
Operating risk; Risk structure cont Operating costs can be locked in, to some extent, through hedging and futures contract and through input agreements but there are likely to be some costs that are not hedged and the lenders will want to be sure that these are limited. Political risks; Political risk should be managed in the project agreements with the government taking some of the risk in terms of compensation to be paid in the case of unilateral termination Regulatory risk; Government particular in the case where prices are not adjusted as per agreement. Resource risk (including climate change); Resource risk must be shared or borne by the host utility or government, depending on the Agreement. It could also be borne by the project developers / owners 21
Risks to Bankability; Risk structure cont Term: The term of the PPA should be long enough to allow the debt to be repaid; Tariff: Lenders will require certainty with respect to the tariff payable under the PPA; Changes in Law and Tax: Lenders are not in a position to take any risk related to changes in law or taxes over the life of the project; Offtaker Creditworthiness: If the offtaker is not sufficiently creditworthy, lenders will require other broad forms of credit support that create additional costs and complications for the project ; Sponsor Quality: The lender and offtaker will consider the experience, reputation and financial strength of the owners of the special purpose vehicle, Billing and Payment: The billing period from the offtaker to the producer should be frequent enough to minimize the level of unpaid energy and ensure that the schedule of debt service payments are adhered to. 22
Risks to Bankability; Risk structure cont Currency/Calculation: PPA payments and calculations are most often made in the same currency as that needed to repay the debt. If not, there will need to be a plan for foreign exchange hedging and/or exchange rate indexation and a true-up mechanism. In addition, are there any convertibility issues with the payment currency? If so, the lenders may require payment to be made in a different currency, or the off-taker or the host government will need to guarantee conversion, Termination: Lenders do not want the offtaker to be able to escape the long-term purchase obligation under the PPA, Lenders will pay particular attention to ensure that seller events of default and force majeure events do not allow the offtaker to prematurely terminate the project. If termination does occur, lenders will also want assurances that the project debt will be satisfied, Lenders Rights: Lenders will typically make provision for step-in rights and taking a security interest over project assets via the loan and direct agreements. 23
Over view of PPA obligations Risk structure cont Buyer Seller Primary Obligations Make payment Build and operate power plant; deliver agreed energy Security Payment security Performance security Transmission/interconnectio An n Transmission/Interconnectio n (bundled and some unbundle) Transmission/Interconnectio n (some unbundled) Arrangements with Lenders Direct agreement Financing Permits Land Assistance with permits? Certain buyer approval Grant of land/assistance with obtaining land Obtaining permits Obtaining land Insurance Force majeure, business Force majeure, currency, etc. Local Content N/A Labour, materials, equipment Decommission N/A Decommission. cleanup 24
x. Insurance Insurance The PPA will usually require that the parties [seller and offtaker] that the risk is allocated to maintain, at their expense, specific insurance policies, Commercial general liability insurance; worker s compensation insurance for seller s employees; automobile liability insurance; builder s risk insurance; all-risk property insurance; and business interruption and extra expense insurance, The business interruption and extra expense insurance covers lost revenues or increased expenses needed to resume operations after a claim under the property insurance policy, Some of the risk is not insured by commercial insurance companies; Some measures must be considered to enhance Bankability of the project, these are: 25
Sovereign Guarantee and Indemnity Insurance cont In order to attract private investment (under rather low off taker tariff), it is necessary for the investors and credit financiers to get some guarantee that the off-taker will honor its take-or-pay obligations, The guarantee often comes in the form of sovereign guarantee and indemnity where the Government commits to pay the seller in the event the electricity company is unable to pay the seller under terms agreed in the PPA, Bilateral Investment Treaties / Guarantees The distinctive feature of many BITs is that they allow for an alternative dispute resolution mechanism, whereby an investor whose rights under the BIT have been violated could have recourse to International arbitration, often under the auspices of the International Center for the Settlement of Investment Disputes, rather than suing the host State in its own courts, BIT act as guarantees that are offered by the country that will make the investment. Political Risk Insurance Providers; institutions that offer political risk insurance 26
MULTILATERAL Insurance cont Multilateral Investment Guarantee Agency, which covers: Breach of Contract Currency Inconvertibility and Transfer Restriction Expropriation War, Terrorism, and Civil Disturbance Non-Honouring of Sovereign Financial obligations REGIONAL/BILATERAL The African Trade Insurance Agency is a multilateral financial institution providing financial products to help reduce the business risks and costs of doing business in Africa. export credit insurance political risk insurance investment insurance Expropriation Transfer Restriction War, Civil Disturbance or Civil Commotion Embargo; Arbitral Award Default 27
Insurance cont World Bank Partial Risk Guarantees; Partial risk guarantees cover commercial lenders for a private sector project against default arising from a government-owned entity failing to perform its obligations. The types of risks covered may vary, including: currency risk (inconvertibility) political force majeure risks material adverse government action government contractual payment obligations (e.g., termination payments) regulatory risk; change of law and regulations. contractual performance of public counterparties frustration of arbitration; and certain force majeure évents which laks insu rance Maret PRGs can be provided in both IBRD (middle income) and IDA (low income) countries and require a government counter-guarantee. 28
Mile stones and defaults XI. Milestones and Defaults PPAs often address milestones to be met to reach commercial operation, Construction or development milestones are intended to allow the purchaser and seller to track the project s development progress, PPA may identify a variety of milestones, including: acquisition of all permits needed for construction; execution of a construction contract; commencement of construction; evidence of the seller s purchase of the RET key equipment [for example turbines for wind energy]; and, ultimately, Commercial Operation Date, If the PPA addresses milestones, typically the seller must meet the dates established in the PPA for each of the milestones or risk paying delay damages, Delay damages are often calculated by multiplying a purchasing amount by the number of MWs of contracted capacity for each day the seller fails to meet a milestone, 29
Mile stones and defaults cont PPA may also include a provision that allows the seller to recover any delay damages paid to the purchaser for earlier missed milestones if the seller is able to deliver the project by the milestone for commercial operation, PPAs include detailed sections related to events of default, Events of default are situations where the action or inaction of one of the parties significantly jeopardizes the overall project, Some events of default may be considered incurable and allow for immediate termination rights, Liability for damages due to a delay or event of default are often capped, and sellers and purchasers negotiate over what the appropriate caps should be in different situations, The liability cap for delay damages may be substantially less than the cap for overall damages following an event of default, When negotiating a PPA, the parties acknowledge that there may be circumstances beyond the parties control that could prevent them from performing under the PPA, that is, for events of force majeure, If a force majeure event occurs, the agreement will excuse both parties from responsibility and liability, 30
Environmental attributes or Credits/Resolution of disputes Most agreements will require that the party asserting force majeure to provide the other party with notice, Often, sellers and purchasers negotiate over how broadly or narrowly to define what constitutes force majeure XII. Environmental Attributes or Credits Most PPAs include provisions that assign ownership of the environmental attributes or renewable energy credits, to the purchaser who typically is keenly interested in meeting applicable green energy requirements, Sellers usually are fine with allocating these credits and attributes so long as they are compensated for the sale of the credits 31
Resolution of Disputes, XIII. Resolution of Disputes, Mutual Discussions (amicable resolution) PPA should provide for the parties to attempt to settle such dispute in the first instance by mutual discussions within a specified period - Mediation the PPA may provide for either Party to elect to proceed with the mediation through the mediators (providers of dispute resolution service) prescribed in the PPA or acceptable to both parties Arbitration dispute (regardless of its nature) may be submitted by either party to arbitration and finally settled in accordance with agreed Arbitration Rules, Ideally the PPA should specify the ICC Rules of Arbitration which are used worldwide to resolve business disputes through arbitration. In choosing to follow these rules, the parties involved in PPA are assured of a neutral framework for the resolution of cross-border disputes 32
End of PPA contract XIV. End of PPA contract The PPA may also provide the purchaser an opportunity to extend the PPA to include a renewal term beyond the initial stated term of 15 to 25 years, This option may state that the price and terms included in the initial stated term will apply during the renewal term, or may provide for: an indexed price or even a renegotiated price, At the end of the contract the investors are expected to have fully recovered their investment, If the asset is still operational, the main costs are operation costs and limited capital investment on some of the equipment, A new PPA would be required to continue supplying to the offtaker, The ownership of the asset at the end of the PPA depends on the PPP structure. 33
Regulatory review of a PPA XV. Regulatory review of a PPA PURPOSE OF REGULATORY REVIEW; is to ensure that the terms of the PPAs are fair and balanced to all parties who will be affected by these transactions, in particular, the prices paid by purchasers of power under the PPAs should be compatible with fair pricing to consumers supplied with power procured under the PPAs, in addition, the prices received by sellers of power (typically an IPP) under the PPAs should be sufficient to allow the sellers to finance the development and construction of their generation facilities and to earn reasonable returns on capital invested under efficient operation of these facilities, Power purchase agreements (PPAs) are central to the health of power sectors, particularly in countries that have opted for singlebuyer market structure, 34
Regulatory review of a PPA cont Importance of regulator review; challenge: create regulatory mechanisms to provide purchasers with incentives for good procurement of bulk power, providing IPPs with financial incentives to build and operate the plant efficiently, (risks in payment delay increases cost of financing) captive customers may not be exposed to high prices by means the purchases monopoly franchise, since the cost of bulk power supply, represents between 50 percent and 70 percent of the distributor s total costs of retail supply An ex ante review has the advantage of helping to minimize the level of regulatory intervention in market-based transactions, since a good review can reduce the need for regulatory intervention during the term of the PPA 35
Regulatory review of a PPA the regulator should be concerned, therefore, that the purchaser can afford to meet its payment obligations under the PPA in the context of the policies laid down by government, distributors will not find willing suppliers if the regulator sets an artificially low cap on pass through of power purchase costs, and; this is particularly the case in countries in which bulk power markets are in the early stages of development. 36
Regulatory review of a PPA REGULATORY REVIEW OF PPAS APPROACHIES i. Model PPA: Develop a model PPA or PPAs that can be used as the basis for testing contracts and that provides guidance for both buyers and sellers for future long-term power transactions, ii. PPA benchmarking: Performed on a parameter-by-parameter CONDUCT BASED or overall basis OUTCOME BASED iii. Competitive power procurement guidelines: Develop guidelines for Competitive Power Procurement for future long-term purchases by a single buyer or other entities (e.g., distribution companies) serving captive customers, 37
The main review tasks; Regulatory review of a PPA i. Assessment of a PPA s completeness, ii. Performance of the; average purchase price analysis, affordability analysis, and risk assessment of the PPA, iii. Application of the price-risk trade-off approach to assessing PPAs. 38
Regulatory review of a PPA i. Assessment of a PPA s completeness; A PPA should cover all critical subjects and not have omissions that might disrupt the operation of the PPA or cause costs for the seller or purchaser during the life of the agreement, Further analysis (of a PPA that is not complete in this respect) need not be followed through, 39
Regulatory review of a PPA ii. Performance analysis of the PPA : a/ average purchase price analysis, Average purchase price; Purchase charge FOR: Capacity; Energy; and Supplemental charges, The average purchase price is calculated from the purchaser s perspective under the PPA, b/ affordability analysis: A basic justification for the long-terms of PPAs is to reduce the seller s cost of capital, Bench marking methodology to assess the purchase is economical, cost. To this effect the review must be able to examine the revenues that will be earned by the purchaser and the possible impact of this purchase on regulated electricity tariffs 40
Regulatory review of a PPA c/ risk assessment; Analyses the reasonableness of a long-term PPA; A analyses the risk exposure to increases in costs for the parties under the PPA; Purchasers risk exposure is assessed by means of a two part procedures applied to each of risk factors: the relative weighting for each risk factor ; the rating of the purchaser s risk exposure to each risk factor 41
Regulatory review of a PPA iii. Application of the price-risk trade-off approach to assessing PPAs; The seller s analysis of the average purchase price and risk allocation for its PPA and the affordability analysis provides a set of values for these key variables, trade-off will usually occur between the average price of power purchased under a PPA and the amount of risk to which the purchaser is exposed under the PPA For well-developed PPAs, a lower purchase price will usually be associated with a higher risk exposure, and vice versa the objective of this analysis is to identify the PPAs with the best combinations of purchase price and risk 42 exposure.
THANK YOU FOR YOUR ATTENTION 43
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