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© IRENA 2016

Preparing Renewable Energy Power Purchase Agreements

in the Middle East and North Africa:Questions to Ask

2

© IRENA 2016 3

INTRODUCTION

» Countries in the Middle East and North Africa (MENA) are diversifying their energy resources to include renewable energy (RE)

» As part of the RE transition, Governments are engaging the private sector by implementing projects on an independent power producer (IPP) basis

» Power Purchase Agreements (PPAs) are an essential component of engaging RE IPPs

» A PPA is the long-term contract between the power producer (IPP) and the power purchaser (offtaker) that governs the sale and purchase of power

» This presentation outlines the important questions a government should consider if it is starting, or in the early stages of, an RE IPP process

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CONTENTS

» Before you begin…» General PPA structure» Risk allocation» Additional considerations» Disputes and termination» Additional terms» Institutional considerations

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BEFORE YOU BEGIN…

Why engage the private sector?

» Allows the government to implement renewable energy projects without paying up-front capital costs. This frees up scarce governmental budget for investment in other sectors

» Brings in private sector skills and capital for construction, operations, and maintenance

» Brings in the private sector to make technology choices (both initial choices and upgrades during the operational life of the project) and manage procurement

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BEFORE YOU BEGIN…

How do you allow private investment in vertically integrated power market structures?

» Three are three common ways to incorporate private sector participation in the power market:

» Utility owns the system and contracts a private sector participant to either construct or operate and maintain the system (through EPC contracts, turnkey construction contracts, or O&M contracts)

» A private developer owns and operates a power plant and sells energy to the market (either distribution companies or individual customers)

» A private developer owns and operates a power plant and sells energy to a single bulk purchaser (the single buyer entity)

» A PPA is needed in the third case (and can be in the second case) to set out the rights and obligations of the developer and a single buyer

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BEFORE YOU BEGIN…

Under what kind of market structure is a PPA needed?

» Single buyer market structure: generators sell to a single bulk purchaser, who then sells to distributors and other large customers

» Competitive wholesale market structure: generators sell directly to distributors, to other large customers, and/or into a spot market

» PPAs are used in a single buyer market structure or with direct customers» A PPA sets out the rights and obligations of the developer and the single

buyer» Establishes a clear price for energy for the duration of the contract

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BEFORE YOU BEGIN…

What are some examples of PPAs in MENA?

Type of Generation

Project Country Year Contract Price (US cents/kWh)

Solar PV 200MW Sheikh Maktoum Solar Park Phase II Dubai, UAE 2015 5.85

Solar PV Sheikh Maktoum Solar Park Phase III – first 200MW Dubai, UAE 2016 2.99

Solar PV 50MW Al-Aflaj Saudi Arabia 2015 4.9

Solar PV 50MW Mafraq Jordan 2015 6.9

Solar PV 30MW Adenium Energy Capital Jordan 2014 16.9

Solar PV FiT Program Egypt 2015 11.8 – 14.3

Solar CSP 160MW Noor 1 Ouarzazate CSP Morocco 2012 18.9

Solar CSP 200MW Noor 2 Ouarzazate CSP Morocco 2015 14.0

Solar CSP 150MW Noor 3 Ouarzazate CSP Morocco 2015 15.0

Wind 301MW Tarfaya Wind Farm Morocco 2014 5.2

Wind 850MW Tanger, Tiskrad, Laayoune, Jbel Lahdid,Boujdour, Midelt

Morocco 2016 3.0 (avg)

Wind FiT Program Egypt 2015 9.6 – 11.5

Combined Cycle Gas Turbine

Carthage Power Tunisia 2002 Confidential

Coal Hassyan coal power plant UAE 2015 4.5

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GENERAL PPA STRUCTURE

How should prices be determined?

Feed-in Tariff (FiT) Competitive Tender

Description • Price is usually set by the regulator for a defined term

• All developers who begin commercial operations or start construction by a certain date are eligible for FiT

• International competitive tender among pre-qualified bidders, with winning bidders selected on price

Best Used • To provide the most transparency and certainty in pricing

• To allow market access for newer and smaller IPPs• To develop many small to medium-sized projects,

where it is more efficient to have a standardized contract across all of them

• To increase chances of getting the lowest price possible through competition among qualified bidders

• To promote bids by credit-worthy IPPs with a proven track record

• For large projects or for a few specific project sites

Considerations • Because the price is administratively set rather than competitively bid, FiT may not result in the least-cost projects

• When costs are declining, FiTs risk setting tariffs too high

• Competitive tenders can take more time and institutional capacity to implement

• It is possible to specify project sites for developers to bid on

» In either case, a long-term PPA guarantees the IPP a pre-determined price over a defined period of time

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GENERAL PPA STRUCTURE

How long should the contract be for?

» Contracts typically run from 15 to 30 years from the date of commercial operation, though 20 years is typical. The PPA can include an option to extend or renew the term, or to transfer ownership to the offtaker

» The term of the PPA must exceed the term of the loan. Lenders will not offer terms longer than the term of the PPA.

» The IPP is responsible for securing financing and therefore for negotiating a PPA term that will allow for a reasonable loan term.

Technology Type System Useful Life (years)

Solar PV 25 – 40

Wind 20

Biomass CHP 20 – 30

Biomass heat 20 – 30

Solar water heat 10 – 25

Solar ventilation preheat 30 – 40

Ground source heat pump

20 (interior components); 100

(ground loop)

http://www.nrel.gov/analysis/tech_lcoe_re_cost_est.html

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GENERAL PPA STRUCTURE

How should energy prices be structured?

» Mostly importantly, tariff calculations must be clear and well-defined for the length of the contract

» Adjustment mechanisms must be agreed in advance » Energy prices can be flat, escalating, or decreasing over the life of the project

» Fixed-price scheme: recommended when utility rates are expected to change significantly

» Fixed-escalator scheme: price increases at a pre-determined annual rate » Tariffs can also be indexed to annual inflation (e.g. CPI, PPI) or changes in

foreign exchange

Solar tariffs have decreased over time…

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GENERAL PPA STRUCTURE

How should tariffs be structured?

» The offtaker should bear the risk that either the capacity of the power plant or the energy generated is:

» 1) not necessary (market risk)» 2) curtailed because of operational issues with the grid» 3) curtailed because the offtaker purchases energy from other sources

» However, the offtaker should not have to pay for capacity that is not made available by the IPP

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GENERAL PPA STRUCTURE

How should tariffs be structured?

Take-and-Pay Take-or-Pay

Description Offtaker pays a fixed tariff that includes a capacity charge (for available capacity, not dispatch) and output charge (for energy actually delivered)

Offtaker is required to take and pay a fixed tariff for all energy delivered. If the offtaker cannot physically take the energy, the offtaker pays based on curtailed (deemed) energy

Benefits Capacity charge allows IPP to cover fixed costs and repay capital investments with a reasonable return to investors. The offtaker only pays for capacity plus energy that is actually dispatched

IPP is compensated for curtailed production due to grid constraints, emergencies, or the offtaker purchasing energy from other lower-priced sources

Considerations IPP may be allowed to sell excess power to third parties to mitigate revenue risk and ensure it is able to meet debt obligations

Usually offtaker only pays for curtailment losses over a predetermined threshold Important to have reliable measuring equipment and agreed upon deemed generational formulaOfftaker force majeure conditions must be clearly defined

When to use it Typically used for dispatchable technologies (hydropower)

Typically used for non-dispatchable technologies (wind and solar)

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RISK ALLOCATION

How does a PPA address risks?

» RE PPAs are long-term in nature and thus face numerous types of risk during the term of the PPA. Risks need to be thoroughly identified and allocated to the party that is most capable of managing the risk

» Main risks that IPPs face are demand and pricing. PPAs address these risks by establishing a long-term purchase obligation and a tariff formula that reflects the true cost of generating power. This guarantees a certain revenue stream over the term of the contract.

» The higher the risk, the higher the tariff IPPs will demand. IPPs will require a greater return on investment for bearing more risk

» A PPA should not push all risk onto one party or another, but allocate each type of risk to the party that is most capable of managing the risk

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RISK ALLOCATION

Who should take on risks related to transmission of power and interconnection to the grid?

» The IPP or the offtaker may be required to pay for transmission and interconnection costs:

» If the IPP pays, the contract should be competitively tendered to secure the best price

» The offtaker/government typically will have lower construction costs for transmission lines, but may not have sufficient funds or may not want to risk paying liquidated damages if transmission line construction is delayed

» In a bundled system, the offtaker takes on transmission risks because the offtakeris responsible for power purchasing, transmission, and distribution

» In an unbundled system, the offtaker also usually takes on transmission risks because the offtaker and transmission company are both government-owned. The offtaker then acts as guarantor of the transmission company’s obligations

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RISK ALLOCATION

How should currency risk be allocated?

» Most lenders require the offtaker to take on these risks

» General principles:

» The payment currency should be easily converted to the debt currency

» Can set up an offshore debt service reserve account

» Can substitute other commodities for cash payment

» Can obtain political risk insurance for currency inconvertibility

» There should be no limit or additional approvals required to transfer funds abroad

» The offtaker should provide security for its timely payments to the developer

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RISK ALLOCATION

What are ways to mitigate currency risks?

» If possible, PPA should be denominated in or benchmarked to the IPP’s debt currency

» If this is not possible…

» Ways to mitigate short-term exchange rate risk:

» Denominate all tariff components in the debt currency and offtaker pays in the local currency equivalent

» Derivatives and future currency swap arrangements

» Ways to mitigate catastrophic devaluation risk:

» Currency hedge

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RISK ALLOCATION

How should legal and regulatory risks be allocated?

» Changes in law or the tax regime can impact the IPP’s returns

» Most lenders require the offtaker to take on these risks

» General principle is the IPP should be no better or no worse as a result of a change in law, policy, or regulations

» If the IPP is disadvantaged, should receive reimbursement or an appropriate tariff increase

» If the IPP benefits, should have an appropriate tariff decrease

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ADDITIONAL CONSIDERATIONS

How should land use and siting be addressed?

» Land use is typically the IPPs responsibility to secure, with the offtaker and/or government assuming more responsibility if either party must make the land available to the IPP

» Lenders will insist that project site availability is secured for the term of the PPA

IPP Offtaker/Government

Land use Typically IPP’s responsibility to secure, unless it depends on government approvals

Should facilitate permitting if the offtaker/government is required to grant access, lease land, etc.

Site Suitability If the IPP selects the site If the offtaker/government selects the site and bidders have limited ability to review the site

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ADDITIONAL CONSIDERATIONS

How can grid connection and grid upgrading costs be allocated?

» If a deep connection charge method is used, the IPP bears grid connection and upgrading costs. Costs may be prohibitively high for IPPs.

» If a shallow connection charge method is used, the IPP bears the grid connection costs only.

» It is possible to have a mixed charge in which the IPP pays for a portion of upgrading costs based on its proportional use of new grid assets. However, it is difficult to determine an exact and fair allocation of grid extension requirements and costs for an individual IPP.

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ADDITIONAL CONSIDERATIONS

What are other system operation costs to consider?

Type of Cost Description

Profile Costs

Capacity/adequacy costs Reduced need for backup capacity during peak load times for variable renewable energy

Reduced average use of thermal power plants

Reduced full-load hours for dispatchable power plants, reducing the annual and life-cycle generation per capacity

Curtailed VRE generation Generation is curtailed because of grid constraints

Balancing Costs Technology upgrades and additional costs to ensure that other power plants can ramp up when VRE generation drops, and vice versa

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DISPUTES AND TERMINATION

How should disputes be settled?

» The dispute resolution process must be clearly specified in the PPA

» Best practice is offshore arbitration under internationally-accepted rules, such as:

» The World Bank International Centre for Settlement of Investment Disputes

» The International Chamber of Commerce

» The United Nations Commission on International Trade Law

» The London Court of International Arbitration

» Independent engineer to settle disputes

» Non-binding mediation, for example by a regulator

» National bodies (such as the Ministry of Energy or regulator) should not be responsible for settling disputes because of the risk of bias

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DISPUTES AND TERMINATION

Under what circumstances can either party terminate the contract?

» Termination should be limited to very significant events, with a pre-determined period to remedy the situation

» Failure to obtain internal, regulatory, or third party approvals» Failure to obtain necessary permits » Failure to enter into an acceptable interconnection agreement» Failure to secure transmission access or site control» Failure to commence operations (e.g. after 180 days)» Abandonment of project (e.g. for over 30 days)» Failure to secure financing (e.g. after 90 days of financial close)» Repeated breach by IPP in delivery of energy (e.g. within 90 to 180 days of

notice of breach)» Offtaker failure to pay (e.g. within 90 to 180 days of notice of breach) » Bankruptcy or solvency issues for either party

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DISPUTES AND TERMINATION

What should be the rights and obligations in the event of termination?

» In the event of termination, lenders want to make sure project debt will still be satisfied

» If offtaker terminates the contract without cause, the offtaker should provide a termination payment that at least covers the full amount of the IPP’s remaining debt and present value of cash flows

» If the IPP terminates without cause, government would take over the project and the IPP would pay whatever engineering costs are required to get the project operating again

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DISPUTES AND TERMINATION

What happens in the event of force majeure?

» Force majeure does not necessarily mean the contract must be terminated. Both parties should aim to resume the terms of the contract as soon as possible after the force majeure event is over

» Extensions should be granted, and deadlines adjusted, for delays due to force majeure

» If force majeure affects the offtaker, the PPA should have provisions to maintain payments to the IPP

» If force majeure affects the IPP, payments may be continued (for local political events) or suspended (for natural or foreign political events)

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DISPUTES AND TERMINATION

What types of insurance are available?

» Some events are covered under common types of business insurance for the IPP, such as:

» Fire and flood» Mechanical malfunctions» Business interruption» Business liability

» MIGA offers political risk insurance policies for equity investors and lenders that covers:

» Currency convertibility and sufficient foreign reserve risk» Legal and tax change risk» Cancellation of permits and/or concessions risks» Expropriation risk

» Not all force majeure risks can be covered by insurance. These risks are, by definition, outside of both parties’ ability to manage. Therefore, the key is to be clear about how these risks are allocated between the IPP and the offtaker

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ADDITIONAL TERMS

What are common additional terms that can be included in a PPA?

» Liquidated damage regime: requires the IPP to pay the off-taker a certain amount of money for each day of delay in operations

» Minimum capacity and availability requirement: requires the IPP to guarantee a minimum level of capacity and availability (minimum level should be lower for non-dispatchable renewables because the IPP cannot control changes in weather)

» Maximum purchase obligations for the off-taker: any excess energy generated beyond the maximum may be purchased at a lower price or at spot prices (if there is a spot market)

» Conditions for sale or transfer of ownership should be clear to ensure risk-free transfer of obligations

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INSTITUTIONAL CONSIDERATIONS

How can governments build capacity to negotiate renewable energy PPAs?

» As renewable energy becomes more competitive with conventional generation and governments procure more renewable energy IPPs, agencies will need the capacity to negotiate multiple renewable energy PPAs at the same time

» Organizations like IRENA can provide technical assistance to help with the initial negotiations and with drafting standard renewable energy PPAs for RfPs

» It is important for the off-taker to have qualified legal counsel when drafting and negotiating a PPA

» Sections of PPAs can become more standardized as more PPAs are concluded

» With this technical assistance, agencies can build internal expertise over time

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INSTITUTIONAL CONSIDERATIONS

What should be the role of the regulator?

» Regulators are important to establish a level playing field for renewable energy IPPs to compete with conventional generation

» The regulator should review and approve PPAs, ensuring that:» The PPA ensures a safe and reliable supply of electricity at a reasonable cost» The PPA protects consumers and ensures the long-term financial

sustainability of the IPP» The PPA terms are consistent with the grid code, interconnection agreement,

and generation license » The regulator can proactively develop standards which can be incorporated into

PPAs» People need to have confidence that the regulator is acting in the best interest of

consumers. This means:» The regulator should act as an independent third party to enforce the terms

of the PPA» It is important to minimize regulatory lag

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INSTITUTIONAL CONSIDERATIONS

How do PPAs impact a government’s ability to shift towards competitive wholesale markets and regional approaches?

» Competitive wholesale market: at every moment, generators compete on price to sell to the system operator

» Regional approaches: cross-border electricity trade requires a common regulatory framework, including synchronized grid codes and common pricing principles

» Under these approaches, long-term, fixed rate agreements through PPAs will need to be phased out over time as the term of the PPA ends. Enacting these policy shifts take time, however. The best way for governments to limit the impact of PPAs is to try to negotiate the best possible price

» Allowing third-party sales is another possible option to provide greater flexibility during the transition. However, the offtaker should ensure that it has priority

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CONCLUSION

» The renewable energy transition has already begun in MENA

» Engaging the private sector can help MENA countries harness their vast endowment of renewable energy resources

» Bankable RE PPAs are an essential part of engaging the private sector because they allow private sector developers to get an acceptable return on their investments while striving to provide the lowest possible prices for consumers

» As governments build capacity in this process, it is important to complement RE PPAs with an effective, efficient regulatory framework that balances customer protection with private sector needs

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REFERENCES

General PPA Info» http://ppp.worldbank.org/public-private-partnership/sector/energy/energy-power-agreements/power-

purchase-agreements#key_features» Reginal Center for Renewable Energy and Energy Efficiency (2012). User’s Guide for the Power Purchase

Agreement (PPA) Model for Electricity Generated from Renewable Energy Facilities. http://www.rcreee.org/sites/default/files/users_guide_ppa_reegf.pdf

» Power Africa (2015). Understanding Power Purchase Agreements. http://cldp.doc.gov/sites/default/files/Understanding_Power_Purchase_Agreements.pdf

» OPIC, ITA, USAID, and USTDA. Important Features of Bankable Power Purchase Agreements for Renewable Energy Power Projects. https://www.opic.gov/sites/default/files/files/10%20Elements%20of%20a%20Bankable%20PPA.pdf

» Lowder, D., Peters, K.T., and Soldani, D.A. (2014). Renewable Energy Projects: Negotiating Power Purchase Agreements. http://media.straffordpub.com/products/renewable-energy-projects-negotiating-power-purchase-agreements-2014-05-21/presentation.pdf

» National Renewable Energy Laboratory (2009). Power Purchase Agreement Checklist for State and Local Governments. http://www.nrel.gov/docs/fy10osti/46668.pdf

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REFERENCES (CONTINUED)

Developing Renewable Energy Projects » Eversheds and PWC (2016). Developing Renewable Energy Projects: A Guide to Achieving Success in the Middle

East. https://www.pwc.com/m1/en/publications/documents/eversheds-pwc-developing-renewable-energy-projects.pdf

» International Finance Corporation (2015). Utility-Scale Solar Photovoltaic Power Plants: A Project Developer’s Guide. http://www.ifc.org/wps/wcm/connect/f05d3e00498e0841bb6fbbe54d141794/IFC+Solar+Report_Web+_08+05.pdf?MOD=AJPERES

» ETSAP and IRENA (2015). Renewable Energy Integration in Power Grids: Technology Brief. http://www.irena.org/DocumentDownloads/Publications/IRENA-ETSAP_Tech_Brief_Power_Grid_Integration_2015.pdf

Feed in Tariffs and Competitive Tenders» Kreycik, C., Couture, T.D., and Cory, K.S. (2011). Procurement Options for New Renewable Electricity Supply.

http://www.nrel.gov/docs/fy12osti/52983.pdf

Costs» Knight, R. (2006). Proposals for a DG Connection Charging Framework in the EU. Integration of DG into

electricity networks workshop, Berlin. https://www.ecn.nl/fileadmin/ecn/units/bs/DG-GRID/Events/Berlin/dggrid-workshop2_connection-charging.pdf

» Ueckerdt, F., Hirth, L., Luderer, G., and Edenhofer, O. (2013). System LCOE: What are the costs of variable renewables?. https://www.pik-potsdam.de/members/Ueckerdt/system-lcoe-working-paper

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MODEL PPAS

» http://ppp.worldbank.org/public-private-partnership/sector/clean-technology/agreements-renewable-energy-projects-ppa (PPAs for different RE sources, together with laws devoted to those sources, from various countries—updated October 2013)

» Wind Power (Brazil, France, India, Sri Lanka, Pakistan, United States)» Solar Power (United States and US Virgin Islands)» Hydropower (Brazil, India, Southeast Asia, Balkans)» Biomass and Biofuel (Brazil, India, United States) » Geothermal (United States, France)

© IRENA 2016

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