There is a global rise in renewable energy sector activity. Governments have established policy tools like Feed-In Tariffs to make “green” projects more bankable for investors and lenders from around the world have allocated sizeable portions of their portfolios to green projects. As more private stakeholders enter this unique space within the energy sector, they will all be looking to raise finance, recover capital costs and earn a return.
One of the keys to achieving the above aims is a well-structured offtake agreement namely, the Power Purchase Agreement (“PPA”). A PPA is the primary contract which underpins a power sector Private-Public Partnership (“PPA”). It is typically between a public sector purchaser ("offtaker") and a private sector/independent power producer (“IPP”). It regulates the terms under which power is purchased from the IPP and is usually the primary revenue stream for the long-term PPP.
As a contract that provides for revenues, the PPA is central to the bankability of a renewable energy project. Since renewable energy projects have a lifespan of 20-30 years, the structure of, and risk allocation under, the PPA determines the IPP’s ability to unlock finance at the start of the project and its ability to generate a return on investment over the life of the project.
[The following section is a brief overview of the renewable energy landscape in Namibia. Readers who are familiar with such landscape may skip forward to the ‘Power Purchase Agreements’ section.]
BRIEF OVERVIEW OF NAMIBIAN RENEWABLE ENERGY LANDSCAPE
Namibia has substantial renewable energy potential. Namibia receives over 3000 hours of sunlight yearly and more than 7 m/s in average annual wind speed in Lüderitz. This potential is balanced against the fact that Namibia imports about 60% of its energy demand and 45% of the Namibian population lacks access to electricity.
The government has recognized the potential of the renewable energy sector to meet local energy demand and further grow that demand by providing electricity to those currently living without it.
The government opened the Namibian market to private sector players in 2019 by adopting the “Modified Single Buyer” market model, which allows for up to 30% of Namibia’s electricity demand to be met by IPP’s with generation licenses (obtained under the Electricity Act 4 of 2007) and for excess energy to be exported.
The above opening of the market has sparked a flurry of activity in the sector. Most recently, the government has signed a Memorandum of Intent for a 2GW - 5GW concentrated solar power plant, in partnership with Botswana. The government has also made massive efforts to the Green Hydrogen Initiative, which is expected to generate over 5GW of renewable energy across a string of projects.
NamPower further plans to bring a 20 MW PV solar power project; a 40 MW wind power project and a 40 MW biomass power project online. The above projects will all require PPA’s, and familiarity with the considerations outlined below will prove vital for all stakeholders.
POWER PURCHASE AGREEMENTS
Over the decades, certain considerations have come to be major negotiation points in the conclusion of a PPA and a standard allocation of risk between the parties has also developed. A few of the key considerations outlined below are (1) availability, (2) long-term price formulae, and (3) compensation on default, termination, or delay.
Availability – Although it is understood that the offtaker pays the IPP for power, renewable energy projects are known for their intermittent power production because of changing weather patterns over different months and seasons. This intermittent power production would mean intermittent cashflows if money was paid upon delivery of power.
For projects to be considered bankable, the amounts payable under a PPA must be predictable. Lenders are unlikely to provide project financing if the project company is only paid for what it actually generates. For this reason, the capacity or availability charges under the PPA must, generally, be payable whether or not the project company is generating or whether or not the offtaker actually takes electricity from the project company.
The above is executed with the use of a take-or-pay clause and other supporting contractual mechanisms. This component is typically designed to provide a revenue floor for the project and is the primary channel through which each project would recover its fixed costs.
Under most PPAs, the availability charge will sometimes be payable even though the power plant is not capable of being dispatched. This is the concept of "deemed availability" and is the main way that risk can be transferred from the project company to the offtaker under the PPA. However, even with the concept of deemed availability, there will still be a minimum amount of power that must be generated on a quarterly or yearly basis for the offtaker to have a balanced deal.
Long-Term Price Formulae - Over the life of a power project there needs to be certainty amongst the parties to the project that the power price will remain predictable, and that there is a mechanism for the sharing of price risk. For this reason, formulae are used in conjunction with certain fixed prices to make ensure that there is a metric by which any price fluctuations can be governed. The mechanisms used also include price escalation formulae and price review clauses.
Compensation on Default, Termination, or Delay - If a PPA is terminated because of a default by the offtaker, then it is generally accepted that both the banks and the project company's shareholders should be compensated. If a PPA is terminated because of a default by the project company, then no compensation is usually payable to the offtaker.
The PPA may provide sanctions or require the project company to pay liquidated damages if it is delayed in its delivery of the power or underperforms in this regard. Common examples include liquidated delay damages if the construction of the project is not completed on schedule or tariff reductions where the power plant does not meet agreed performance standards during the operational phase. Project sponsors and lenders will want to ensure that there is a limit to the impact that liquidated damages will have on their ability to recover their capital investments and earn a return.
In any event, PPA's will usually exclude liability on the part of either party for "consequential" losses, i.e. loss of profit. The only exception may be if consequential losses are caused by gross negligence or wilful misconduct.
CONCLUSION
The above three considerations, among others, directly impact the risk profile of an energy project, thus impacting the lender's likelihood to provide funding on terms that are desirable to project sponsors.
The considerations fit perfectly into the core objective of lenders: to not lose money. These considerations determine the ability of the project to produce a predictable cash flow (to service the debt), the ability of the project to maintain stable economics over a long-term period despite fluctuations in prices (which will impact cash flows), and the ability of a project to protect itself from large financial penalties or liability upon termination, delay or default (which will impact cash flows).
As Namibia continues to tap into its renewable energy potential, PPA’s with the correct risk allocation will prove to be a valuable tool over the 20-30 year period that they govern projects. PPA’s will continue to be a determining factor in whether lenders choose to provide funding or whether investors choose to buy a stake in a project at a later stage (in the event that the existing shareholders want to exit).
About the Author
Zach Kauraisa holds an LLM in International Oil and Gas Law and Policy from the Centre for Energy, Petroleum, Mineral Law and Policy. He is currently a Candidate Attorney at Koep & Partners in Windhoek Namibia. For inquiries, email: kauraisaz@gmail.com