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Basics of PPA Negotiations

Eng. David M. Mwangi, Individual Energy Consultant


Nairobi, Kenya
Introduction
Power Purchase Agreements (PPAs) are
commercial/legal documents necessary for
financing of power projects
A PPA is usually signed between a power
producer (seller) and a buyer, commonly known
as off-taker
The off-taker may be a re-seller e.g. utility, an
end-user of the power, or just a middleman
Most PPAs are long-term agreements with
tenures of 10-30 years
Parties to a PPA & Other Stakeholders

Direct Parties
Seller
Buyer
Indirect Parties
Financiers/Lenders
Government
Transmission services provider
Matters governed by the PPA - 1

Operating procedures
Operational targets
Sets out penalties for operational defaults
Commissioning and Testing
Operation and Dispatch Procedures
Repair and Maintenance
Metering
Matters governed by the PPA - 2

Sale and Purchase of Electricity


Invoicing and Payments
Fuel Supply
Insurance
Dispute Resolution
Termination and Default
Key principles of PPAs

Bankability
Proper Risk Allocation Each allocated to party
best placed to manage it
Security of Cash Flow
Repayment of project debt within tenure of PPA
Step-in/buyout rights for lenders
Financial viability of off-taker
Key issues in PPA negotiations
Agree on implementation Schedule

It is necessary to agree on:


Conditions Precedent
Key milestones
Well defined longstop dates, by which if certain
conditions are not met, PPA can be terminated
Penalties for delays or bonuses for earlier
completion
PPA should contain flexibility to accommodate
possible delays in Engineering, Procure, Construct
(EPC) contract delivery dates
Connection arrangements

How the power plant will be connected to the


grid
Is there need for additional interconnection
facility?
Who pays for the cost of such facilities?
How to deal with transfer of assets e.g. where
facilities are to be installed by the seller and
transferred to the off-taker
Procedures

Procedures include:
Commissioning and testing procedures
Operation and dispatch procedures
Metering procedures
Maintenance procedures
The procedures define level of performance
expected and how this can be measured
important, especially where capacity payments
or take or pay arrangements are involved
Operational targets and penalties for
default

Agree on clearly defined operational targets and


penalties for not meeting them
Availability of capacity
Guaranteed capacity tests
Payments and interest on delayed payment
Availability of off-takers system
For renewable energy, especially wind power,
issue of curtailment/deemed generation
Clear definition of Events of Default

Buyers Events of Default


Sellers Events of Default
Cure periods for defaults that are curable
Step-in by off-taker to remedy
Lenders step-in rights
Fuel procurement
Fuel Procurement is important in thermal plants
as fuel represents a large portion of the O&M
costs.
Issues considered include:
Type of fuel to be used, which has an implication on
cost
Party responsible for procurement / involvement of
other
Levels of security stock of fuel - has an impact on tariff
How the cost of fuel is determined.
Due to volatility of fuel prices, it is usual to make fuel
cost a pass through element in PPAs.
Proper definition of Force Majeure

Usually, theres a distinction between political


force majeure (FM) and commercial FM
Commercial FM usually insurable, whilst there
is limited coverage for political FM, by
Government, MIGA, ATI
Lenders/developer would prefer off-taker bears
FM risk - negotiate such that each party bears
FM risk affecting it
Need to ensure FM provisions are consistent
with industry standard
Direct Agreement

Lenders will require the off-taker to sign a Direct


Agreement giving them step-in rights in case the
seller fails to perform its obligations
Political risk

This is a special risk arising from action or


inaction of Government or a governmental
authority

A special provision is required to protect the


project from such action or inaction
Provision for change in circumstances

This includes, inter alia:


change in law
change which can have significant impact on
project cost
provision for adjustment of prices arising from
change in circumstances is required to protect
parties from the cost impact.
Parties may agree on threshold change above
which price adjustment would kick in
Dispute Resolution

PPA, being long-term, requires a dispute


resolution mechanism that allows parties to
resolve issues and continue with the agreement,
or agree to terminate it on specified terms
Dispute resolution mechanisms include:
Coordinators - representatives of the parties
meeting to resolve the dispute
Use of experts
International arbitration
Level and Structure of Tariff - 1

Level of tariff needs to cover all cost


components of the project/plant over the tenure
of PPA
Tariffs are usually in 2-3 parts namely;
Capacity Charge, Energy Charge and, for plants,
Fuel Charge
Fuel cost is usually a pass through component,
but typically with an efficiency adjustment e.g. an
agreed specific consumption parameter
Level and Structure of Tariff - 2

Costs usually covered by capacity charge:


Fixed operating and maintenance cost
Fixed Costs (construction costs etc)
Fixed fuel costs e.g. for security stock
Reserves for major maintenance
Debt service and return on equity
Level and Structure of Tariff - 3

Energy charge usually covers variable O&M


cost

Other Charges
Fuel Charge - pass through, efficiency-
adjusted
Any other Pass through costs
Start up charges
Level and Structure of Tariff - 4

Price escalation is critical in tariff design and


structure due to inflation over the life of a project
Escalation is based on the relevant CPI
depending on the applicable currency, e.g. US
CPI for US$-denominated and EURO CPI for
Euro tariff
Need to agree upfront on tariff components to be
escalated e.g. energy charge and 15% of
capacity charge. This percentage may be
agreed to change over time
Evaluating Unsolicited Proposals - 1

Typical approaches to benchmark value for money of


unsolicited proposals include:

Open book processes Developer makes full


disclosure of financial model

Acceptable and pre-determined rates of return

International and local benchmarking of prices, risk


allocations, and terms (where feasible)
Evaluating Unsolicited Proposals - 2

Ensuring that developer competitively procures


essential contracts for supply of project inputs (such
as the EPC contract and finance)

Pre-specifying an acceptable capital structure


(typically debt/equity 75/25)

Pre-specifying maximum interest rate and minimum


repayment period of loans, (e.g. 7%, 14 years)
Security Package

Security package could be in the form of:


Letter of credit; or
Escrow account covering agreed # of invoices; or
Sovereign guarantee

Important issues to consider in this case:


Sustainability on the part of the purchaser/offtaker
Bankability of the project on the part of the seller
PPA Termination Options
Some PPAs have provisions for the off-taker to
purchase plant for any of the following reasons:
Defaults by the project company under the PPA;
Force Majeure;
Public interest (where the off taker is a publicly
owned distributor)
The PPA may also be terminated by the seller in
the event of off-taker default
Need to agree upfront on how termination
compensation will be determined in each case
Project risks allocation in PPAs and their
mitigation (Case of Kenya) - 1
Project risks allocation in PPAs and their
mitigation (Case of Kenya) - 2
Some tips on win-win
negotiations generally
Know your BATNA before starting

BATNA - Best Alternative to a Negotiated


Agreement

Results matter:
Dont settle for less than you could achieve
without an agreement.
Seek to improve BATNA.
Focus on interests

Distinguish between issues, positions, and


interests
Dont get locked in; consider multiple options
Use objective criteria.
Seek joint gains

Be creative
For sustainable agreements, avoid one-
upmanship
Look for differences in relative priorities
Seek to achieve as much of your interests as
you can, while giving the other side more than
their BATNA
Reach implementable or sustainable
agreements:

Where interests of both parties are satisfied


Which are technically sound
Which are politically feasible (ratified)
Where incentives or penalties reinforce
compliance
Which are can be reopened when necessary
Good process and Satisfaction
Triangle

Negotiations have several stages


Create the conditions for effective problem
solving
People have three interdependent needs that
must be carefully considered in order to achieve
agreements and decisions that will last
The 3 needs are represented in the following
diagram, termed the Satisfaction Triangle
The Satisfaction Triangle - 1

Adapted from Center for Dispute Resolution, Boulder Colorado


The Satisfaction Triangle - 1

Procedural Needs are about:


the opportunity to have a "fair go"
the opportunity to put forward own point of
view
the opportunity to both listen and be listened
to
having confidence in information, protocols
and meetings.
The Satisfaction Triangle - 2

Emotional Needs are about:


personal and emotional aspects people bring
to the negotiating table
how people feel about what is being
negotiated for
how people feel about themselves during and
after the negotiations.
The Satisfaction Triangle - 3

Substantive Needs:
the material things and issues people are
negotiating about
can be both tangible, e.g. money, time, rights,
possessions; or intangible, e.g. respect,
consideration. People are very often just
focused on what they need to negotiate and
how to negotiate isnt seen as really that
important.
Negotiation steps - 1

1. Be clear about your objectives


2. Focus on interests (yours and theirs)
3. Propose criteria for evaluating options
4. Consider BATNA (yours and theirs)
5. Invest in Preparation
6. Involve all affected interests
7. Agree on the terms for negotiation
8. Keep your constituency informed
Negotiation steps - 2

9. Devise strategies for joint fact-finding


10. Plan for implementation
11. Share information
12. Find joint gains
13. Create a problem-solving process
-agree on scope of issues
-ask questions
-Listen!
-generate multiple options
Negotiation steps - 3

14. Know what sources of power you (and


others) have and use them effectively
15. Reach agreements that stick
Thank You

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