Key Issues in Negotiating a Power Purchase Agreement (PPA)
A Power Purchase Agreement (PPA) is both a legal and a commercial document between a power producer as seller and the wholesale energy purchaser, as buyer/offtaker. The PPA is at the heart of any power generation project.
The PPA will state the obligations of the power producer to produce and deliver power to specified points and will further set out the price at which such power will be purchased.
The PPA will also contain terms relating to interconnection, metering, invoicing and payment, scheduled outages, force majeure exceptions(actual and potential transmission constraints and interruptions), dispute resolution and possibly buy-out options. Other operational key issues may also be addressed in a PPA like operational targets, dispatch procedures, commissioning and testing, and repair and maintenance.
For renewable energy projects, the PPA will contain additional clauses regarding environmental attributes of the project, particular risks of such projects, and depending on jurisdictions, provisions relating to renewable energy credits (RECs). In countries having RECs, like the USA, it is critical to estimate the total revenue stream available over the life of the project. RECs or tax credits for power plants entail limitations on disposal and/or buyouts so that control does not change,for the project to still avail itself of the tax credits or the energy credits, where applicable.
Renewable energy presents several challenges in the negotiation process. The intermittent and highly unpredictable nature of wind and solar power should be considered when setting demand and performance requirements. A commonly used mechanism is a multilayer look-back with credits accumulation for performance above the minimum levels to be offset during underperformance. Geothermal and biomass plants however do not suffer from intermittency issues. Geothermal PPAs should address uncertainties linked with the quantity of geothermal resourceby requiring the geothermal resource to be measured and certified at the commercial operation date and periodically thereafter. Similarly, because of the strategic locations of power plants, there can be significant transmission costs which would need to be addressed when discussing the economics of the project during negotiation of the PPA.
A key issue of discussion in a PPA is the pricing; pricing will ensure the cash flowsand allows a forecast of the revenue over the lifetime of the project. Historically, pricing has been at a flat rate but we note an emerging trend with renewable energy; the offtaker making a part prepayment or making an investment in the power project. For non-renewable power projects, fuel costs is a major cost component and fluctuation in fuel prices would need to be addressed in the PPA, for instance by using pass-through elements, to make the project viable and profitable.
Another important discussion will revolve around the development milestones, implementation schedule and commercial operation date of the power project. The advantage with renewable energy projects is that additional turbines or solar panels can be added subsequently making the commercial operation date easier to achieve than say a traditional power generating plant. Key milestones and longstop dates for certain conditions including penalties for delays would require particular attention. Delays are mainly caused at the EPC (Engineering, Procurement and Construction) stage.
To a lesser extent, connection to the grid and the need for interconnection facilities, would also be discussed. Another related issue is that of constraints of the transmission system which may result in the offtaker curtailing the supply of power to the grid. It is imperative to decide, at the outset, who will bear the costs of such curtailment.
Finally, consideration must be given to the technology being used and its performance attributes, inasmuch as a PPA is a long-term commitment and technologies change rapidly.
Although the direct parties to the PPA are the power producer and the offtaker, this document is equally relevant to lenders and equity investors of the energy project. They would want the project to be creditworthy and may further want to restrict the ability to assign or transfer the PPA. The PPA allows the power producer to secure a revenue stream from the electric generating facility, which is necessary to finance and/or to repay for the project. Securing predictable cash flows is in fact one of the most important factors in obtaining finance for the project. As such, the economics of the project would revolve around the terms and conditions of the PPA, which go way beyond the mere purchase and sale of energy. Negotiating a financeable PPA therefore remains necessary notwithstanding the availability of other credit enhancement mechanisms like a corporate parent guarantee, performance bonds or insurance covers.
Many PPAs contain “early termination rights”, which allow any party to the PPA to terminate same if certain events occur. One such event is the seller’s failure to obtain the necessary financing. The problem however can be in situations where the power producer has invested massively but has not yet reached the commercial operation date and the offtaker terminates the contract.
The local independent power producers willing to invest either in Mauritius or in Africa should consider the above key issues whilst negotiating their PPA.
Arvin Halkhoree is a barrister at Juristconsult Chambers with particular interest in the energy and power sector. He attended a 3-days DLA Africa Energy Training Retreat in Rwanda in July 2014. Some of his key transactions in this field include (i) advising on the legal and regulatory issues around the placing of exploration risk policies with regard to a geothermal project in Kenya, and (ii) advising a local consortium on the financing, construction, supply and commissioning of a major wind farm with an estimated project value of USD 79M.
By Arvin Halkhoree