Elements of bankable solar Power Purchase Agreements
OWING to technological breakthroughs, progressive policies, plummeting costs, policies and growing determination to combat climate change, renewable energy has taken the centre stage on both the public and private agendas. Africa’s burgeoning population and economic progress has exponentially increased the demand for energy. Renewable resources available in Africa include, among others hydropower, solar energy, wind energy and geothermal energy, but this article will focus on solar.
Zimbabwe can harness modern renewable energy, particularly solar, to stem power shortages, bring electricity to rural areas, spur industrial growth and spawn entrepreneurship. Solar technology can accelerate cheap transformation to a cleaner power industry.
The downside is that, solar power projects require substantial amounts of capital and, sometimes, the Government cannot bear that onerous burden without the intervention of private capital. The upside is, Zimbabwean independent power producers (“IPPs”), more than ever before, have a unique opportunity to work towards sustainable energy development as a base for the country’s long-term economic well-being.
IPPs are private companies which own and/ or operate facilities to generate electricity and then sell it to a utility, central Government buyer and end users. IPPs invest in power generation technologies and recoup their investment from the sale of the electricity. In Zimbabwe, IPPs generally sell their electricity to the Zimbabwe Electricity Transmission and Distribution Company (ZETDC) through long term Power Purchase Agreements.
A Power Purchase Agreement (PPA) is an agreement between an IPP, who produces power for sale (the producer) and an off-taker (the buyer) who seeks to purchase power, usually a state-owned utility. It is often referred to as an Off-take Agreement. The terms of a PPA include commencement of commercial operation, schedule for delivery of electricity, sanctions for under delivery, payment terms and termination.
A PPA is extremely important to any power generation project because it is the principal contract which defines the revenue and credit quality of a generating project and is thus a crucial instrument of project finance. Negotiating and concluding a PPA is a very important step in the development of any energy project because it provides a long-term income stream through the disposal of energy. Securing a bankable PPA will be a condition to any equity and debt financing of the project.
A bankable PPA is an off-take agreement of long duration concluded with a creditworthy off-taker and having ample tenor to facilitate repayment of debt by providing a sufficient and predictable stream of revenue. For a PPA to be considered bankable it must include the key features summarised below.
1. Dispatch risk
Two structures are invariably accepted by lenders for mitigation of the risk that the offtaker may not dispatch the generating facility.
(i) Take or pay: A take-or-pay clause refers to a situation where a purchaser commits to either purchase a minimum volume of electricity or, if the purchaser chooses not to offtake the minimum agreed volume, to make an agreed payment pursuant to the producer.
(ii) Take and pay: A take-and-pay clause obligates a purchaser to both take a minimum agreed volume of electricity and to pay a contract price based on that minimum agreed volume. Should the electricity not be physically taken by the purchaser, the electricity will be calculated and paid for on a deemed delivery basis.
These clauses are meant to protect the producer by providing guaranteed revenue even if the off-taker does not use the electricity.
This affords the producer the assurance that the product will be sold thus making the project commercially viable. These clauses function as a form of commercial guarantee, without which investors and banks would be unwilling to finance energy infrastructure projects.
2. Fixed tariff
It is vital that the revenue of any PPA be a certain amount per kilowatt-hour generated to adequately cover the cost of running the facility, settle the debt and give a reasonable return on equity.
3. Foreign exchange
To protect the power producer from currency risk, the PPA must be denominated in or linked to an exchange rate of the currency of the power producer’s debt. Further, there should be no restrictions or additional approvals required to enable the producer to transfer funds to offshore accounts.
4. Change in law or tax
The PPA should address the impact on tariff in the event of a change in applicable law or tax regime and the mechanism for tariff adjustment. Lenders will be anxious to ensure that the cash flows of the project required for debt service are insulated against changes in law or tax. For PPAs to be bankable, most lenders prescribe that the off-taker must assume this risk.
5. Force majeure
The PPA should clearly classify force majeure events and specify the impact of each event on the obligations of the parties, in particular on the payment obligations of the power purchaser and the construction, completion, and operational obligations of the producer.
6. Dispute resolution
Dispute resolution provisions should provide for good faith negotiations followed by arbitration under internationally accepted rules in a neutral country. The provision should specify the applicable rules, the number of arbitrators, the seat of arbitration, the language of the proceedings, the nature and enforceability of the award, and the appointing and admin
istrating authority. In addition to arbitration, the PPA may allow referral of technical matters to an expert for speedy resolution.
7. Termination and termination payments
The PPA should explicitly state the basis on which either party may terminate the agreement. Termination by the off-taker may leave the project bereft of a market and should be limited to significant events.
The agreement should provide that if the PPA is terminated for any reason, and the facility is transferred to an off-taker, the off-taker shall provide a termination payment at least equal to the entire amount of the power producer’s outstanding debt, and in the case of the off-taker’s default, a return on equity.
8. Assignment
The PPA should permit assignment of the PPA to the power producer’s lenders coupled with the right to receive notice of any default and an entitlement to remedy that default. Generally, additional step-in rights are provided for in a separate direct agreement between the lenders and the off-taker.
9. Off-taker payment support
Depending on the size of the project and the creditworthiness of the off-taker and the
development of the energy industry in a given country, a short term liquidity instrument, a liquidity facility and/or a sovereign guarantee will be required to support the off-taker’s payment obligations.
10. Transmission or Interconnection Risk
The PPA should specify which party carries the risk of connecting the facility with the grid and transmitting power to the nearest substation. The more significant this risk, due to terrain and distance, the more the lenders will require the off-taker to bear it.
Any PPA that does not adequately address these key features may be considered unbankable and that will deter lenders and investors. However, it is important to note that each agreement is dependent on its particular circumstances. Therefore, what I have just provided are general guidelines, not rigid gospel. Like beauty, bankability is in the eye of the beholder and what amounts to bankability for one party may not be so impressive to another.