8 Key Features in a Power and Energy Purchase Agreement (PPA)
A Power Purchase Agreement (PPA) are generally entered into by a party who is the power producer and the purchaser or /”offtaker”. The power producer would have a Concession or maybe an Independent Power Producer.
Power producers generally enter into Build Own and Transfer (BOT) or Build Own and Operate (BOO) contracts for a power generation plant and once the plant is completed the Owner / contractor wishes to sell the power produce to a purchaser or “offtaker” ( normally a state-owned electricity utility) under the terms of a PPA. A PPA generally secures the payment stream between the purchaser “offtaker” and a power producer.
PPAs are long term contracts and last for at least 20 years and they need to provide for changing circumstances over the years. Following are some key features that should be included in them:
1. Sale of Capacity and Energy : The power producer under the PPA agrees to make available to the Purchaser / Offtaker, the contracted capacity of energy and deliver the energy in accordance with the PPA.
2. Charges for Available Capacity and Electrical Output : the charging mechanism in the PPA is generally a pass through arrangement: the price charged for the power will consist of a charge (availability charge) to cover the project company’s fixed costs (including a return on equity for the project company) plus a variable charge to cover the project company’s variable costs. The availability charge relates to the availability of the power plant and the variable charge is calculated according to the quantity of power supplied. As purchaser wants guarantees for long-term output from the project and so the producer will levy an availability charge, which typically is the minimum that it will be paid, provided that the plant can be shown to make sure power available. For this guarantee the power producer will want a “take or pay” clause inserted into the PPA, where the offtaker will have to pay the availability charge even if he does not need or take the power.
3. Third Party Sales – The purchaser might want the ability to make third-party sales which can enhance the finance ability of the project and cushion the purchaser against risks such as a reduction in the purchaser’s monthly tariffs. This advantage here is that, given the long-term nature of the PPA, if the market is deregulated at a later date then the PPA may not need to be completely replaced. However, purchasers are often nervous about allowing third-party sales as they want to be sure that all capacity is available to them at all times and so the PPA may include an exclusivity period during which all power producer is be supplied to the purchaser. Flexibility may need to be incorporated into the PPA to ensure that this exclusive period is not an impediment to future development/ deregulation of the electricity market. Exclusivity provisions in PPAs can create challenges for development of energy markets.
4. Underperformance and Delays by Power Producer – the PPA may provide sanctions or require the power producer to pay liquidated damages if the power producer fails to deliver power as promised; in particular, if the construction of the project is not completed on schedule or does not perform as required when completed. Lenders will be concerned to ensure that liquidated damages do not have too damaging an impact on debt coverage ratios.
5. Force Majeure or Purchaser Breach of Contract – the power producer is usually not required to pay damages for delays resulting from events beyond its control.
6. Testing Regime – this should be objective and designed to confirm levels of contracted capacity, reliability and fuel efficiency or heat rate, ideally certified by an independent engineer.
7. Termination – the PPA will need to provide for what happens on termination (whether at the end of the term of the agreement or early termination for default etc), including obligations of the power producer on hand-over of assets, calculation of buyout price for IPP (if this is contemplated), what happens to employees of power producer if IPP transferred to purchaser on termination.
8. Change of Law – PPA should address impact on tariff in event of a change in applicable law and the mechanism for tariff adjustment. Lenders will be anxious to ensure that the cash flows of the project required for debt service are protected against changes in law.
In conclusion, the PPA needs to be carefully negotiated with the above clauses inserted to avoid future problems and as they say “better to be safe than sorry”. PetroKnowledge’s intensive 5-day training course on Understanding Energy Contracts will provide an in-depth exposition of the several energy contracts and understand the rationale behind them and acquire essential skills to negotiate sound well thought out energy contracts. Join this training workshop in London and gain a competitive advantage.
