An overview of power project financing

THE completion of most successful power projects is often a result of the concerted effort of a multiplicity of players. The main participants in a power project are the project company (PC), the shareholder, the operator, the power purchaser (offtaker), the lenders, the contractor, the fuel supplier, and the host government.

The PC sits at the centre of this universe of players and every other player must consummate contractual relations with it.

The PC is almost always a special purpose vehicle incorporated in the country where the project is undertaken for the singular purpose of building and operating the project.

Its shareholders usually include the Contractor engaged to construct the Power Station, the Operator who will operate the station upon completion, a local partner or consortium of partners and the Power Purchaser.

The Power Purchaser or offtaker is usually a state-owned utility. In Zimbabwe, independent power producers generally sell their electricity to the Zimbabwe Electricity Transmission and Distribution Company (ZETDC) through long term Power Purchase Agreements.

To enable it to secure the necessary finance to develop a power plant, a PC will conclude an assortment of agreements with numerous lenders.

The bulk of the debt capital for infrastructure projects is provided by domestic and foreign commercial banks and other financial institutions.

Usually, two or more banks and financial institutions provide a loan to a borrower known as a syndicated loan.

Lenders may also include bilateral and multilateral lending agencies and export credit agencies. International and regional financial institutions like the World Bank have been known to provide loans, guarantees or equity to privately financed infrastructure projects.

In most developing countries, the approval of the host government is critical to the finalisation of power plant projects. Invariably, the government will be expected to render some form of support to the project company and possibly to the shareholders and lenders.

The exact form of this support frequently depends on the nature of a given project.

Generally, however, the host government can also be a direct or indirect source of financing.

The government can loan funds to the project company. As an indirect source the government may also provide tax relief, tax holidays, waive duties for project equipment and provide currency exchange guarantees, among other freebies.

The participation of a host government brings with it a host of advantages. These include reducing the impact of leverage, subordination and foreign exchange burden on the project sponsors.

Government support also decreases political risk, which can assist in attracting private capital.

In thermal power generation where the operation of the power station depends on the availability of fossil fuels such as oil, coal or liquefied natural gas (LNG), the PC must concern itself with acquiring adequate fuel supply for the plant.

In order to achieve this, the PC has a number of options at its disposal. For instance, unless the PC is certain that it will be able buy sufficient fuel in the market as and when required for the duration of the Power Purchase Agreement (PPA), it will contract with a fuel supplier for a guaranteed supply.

Alternatively, the PC can conclude a tolling agreement which transfers the responsibility for procuring fuel to the offtaker.

The nature and structure of an Independent Power Project (IPP) requires the conclusion of manifold agreements with various and independent parties.

The central document in any IPP is the PPA. The PPA is the document in terms of which the PC will receive adequate revenue to settle its debt and provide its return on equity. In most cases, the duration of a PPA is twenty to twenty-five years from the commissioning of the power station.

The contractor who builds the power station is engaged through a construction contract.

This construction contract is often referred to as the Engineering, Procurement and Construction Contract (EPC). This form of contract spells out the relationship between the owner and the contractor for the provision of professional or technical services.

Under an EPC contract, the principal or owner enters into a contract with the EPC contractor, who will, in turn, conclude various subcontracts with subcontractors for the performance of specified portions of work.

They will be responsible for not only the engineering aspects of the project, but also procurement of equipment and design and construction of the facility, plant or project.

EPC contracts are often referred to as turnkey construction contracts because they allow the owner to simply “turn the key” for the plant to be fully operational.

As stated above, depending on the nature of the power project, the PC must enter into a fuel supply arrangement.

Thus in the case of a thermal power station the PC will need to make provision for fuel supply. Therefore, there may or may not be a Fuel Supply Agreement (FSA).

Generally, FSAs bind the fuel supplier to provide a minimum quantity of fuel to the project.

This can be a monumental guarantee to the project. In the same vein, the PC may also be enjoined to take or pay for a certain amount of fuel.

As far as the daily operations of the power project are concerned, the PC will usually engage an Operator through an Operation and Maintenance Agreement (O&M Agreement).

The O&M Agreement regulates the operations, maintenance and management of a completed project.

Also central to the success of any IPP is the Shareholders’ Agreement. A shareholders’ agreement is a contract concluded by shareholders of a company which sets out the shareholders’ rights, privileges and obligations.

It also stipulates how the company will be set up, managed and operated. It often deals with such issues as maintenance of shareholdings and the timing of equity subscription.

The narrative will be glaringly incomplete without mentioning the Credit Agreement(s). These establish the loan terms in project financings and regulate the relationship between the lenders and the PC.

Generally, the lenders and the other project creditors will take security over all the project company’s assets.

This includes, for example, the power station itself, the benefit of all the project contracts, and the insurance in the security documents.

One of the most important agreements in an IPP is an Inter-creditor Agreement which kicks in whenever project financings involve a consortium or syndicate of lenders.

It is an agreement by and between the project lenders who are providing the financing to the project company. It governs the common terms and relationships by and among the lenders in respect of the borrower’s obligations.

Finally, depending on the perceived country-specific political risks, most IPPs in developing countries will include a Government Support Agreement (GSA) also referred to as the Implementation Agreement.

Implementation agreements provide for direct contractual obligations and undertakings between the government and the PC.

A typical GSA may include provisions relating to the granting and maintenance of licenses, exemption from duties and exchange controls and disapplication of legislation.

Government support is necessary where the PC is concerned that the utility might not or may not have the financial standing to fulfil its obligations.

In Zimbabwe, Government support usually comes in the form of a guarantee provided by the Reserve Bank of Zimbabwe.