Some background on long-term PPAs
An agreement for the sale of electricity generated by a power station is usually called a power purchase agreement (PPA). In most jurisdictions, PPAs are typically entered into on a long-term basis in order to provide security to the developer and financiers regarding revenues of the project during at least the period required to repay project financing liabilities. However, PPAs can also be used for medium and short-term electricity sales if the parties feel that a more detailed contractual arrangement is still required despite the shorter-term arrangement.
The relationship between long-term PPAs and power project financing is generally less prevalent in Myanmar, where issues in respect of bankability mean that limited recourse project financing by external lenders is comparatively rare. Financing of infrastructure projects in Myanmar typically requires a high degree of self-funding by the developer. Where external debt is procured, it is more likely to be done offshore at a parent or holding company level without direct recourse to the project vehicle. However, long-term PPAs still provide greater certainty and stability of project revenue streams over time. Further, Myanmar does not have any electricity trading market and the only offtaker for grid-connected power projects in Myanmar is the Electric Power Generation Enterprise (EPGE), a State-owned enterprise under the Ministry of Electric Power (MoEP). As, in effect, a public utility, the EPGE also requires long-term PPAs for certainty of supply – and for permitting purposes (as described below). The long-term structure therefore still remains prevalent for PPAs in Myanmar, despite issues with formal project financing.
Another relevant consideration in Myanmar that the MoEP does not usually issue electricity generation permits per se, but rather provides a licence to construct and operate grid-connected projects via the entry into a long-term PPA for the project as a government contract. This approach will not necessarily have a significant effect on the commercial and technical content of a long-term PPA. But it does underline the importance of the long-term PPA structure in the Myanmar context.
The following are some summary points on seven of the most important issues in the effective planning and negotiation of long-term PPAs.
1. Conditions precedent
A PPA will typically set out conditions that must be satisfied for the provisions to become fully effective. These are sometimes referred to as ‘conditions precedent’. A long-term PPA is likely to contain conditions precedent regarding construction and commissioning – including specifying a commercial operations date (COD) and what the operator needs to do to achieve COD – financing, and regulatory approvals.
The parties should consider whether the conditions are clearly set out to avoid any confusion as to whether a party has met its obligations, in particular in relation to commissioning and testing. The PPA provisions should also be clear on the consequences of failing to meet a condition, including whether extensions of time can be sought, whether one party can terminate the PPA if the other party fails to meet a condition, and whether there will be potential liability.
2. Electricity output and entitlement
For a grid-connected power facility in Myanmar, the EPGE as the sole offtaker will usually be entitled to all of the output from the facility. However, in other markets, or connection configurations, the offtaker may have the right to nominate the quantity of electricity it wishes to buy in respect of specified delivery periods; and the operator may have the right to sell any other electricity to other buyers. The parties will need to consider such issues as the following.
- Whether the operator will give any form of guarantee regarding the availability or output of the facility?
- Whether the offtaker will be exclusively entitled to all of the electricity generated by the facility, or only a portion of it?
- Whether the offtaker will be entitled to nominate quantities of electricity for delivery to it during specified periods, or is required to buy all of the output from the facility? If nominations will apply, will there be mechanisms for the operator to notify the offtaker of the output expected to be available in the delivery period? Will the offtaker and/or the operator be able to adjust any nominations or notifications?
- If the offtaker is only entitled to a portion of the output from the facility, will there be any restriction on the operator selling the additional electricity to a third party?
The operator will of course need the price under the PPA to be sufficient to enable it to pay operating costs and any debt service payments, and also provide a reasonable return on equity. Costs will increase over the life of a long-term contract and the PPA pricing provisions must also adequately deal with future cost rises and allow for price increases.
The following are some particular issues to consider in the PPA pricing structure.
- Will the offtaker pay for only for actual electricity delivered by the operator, or will the PPA price also include a payment to the operator for the capacity or availability of the facility?
- Will the PPA be structured as a ‘take-or-pay’ contract, whereby the offtaker is required to pay for a minimum quantity of electricity even if it does not elect to take delivery of that quantity?
- Does the PPA contain provisions allowing for increases in fuel costs, including renegotiation of pricing if fuel costs escalate more rapidly than the parties could reasonably have expected?
- Will the offtaker pay or contribute directly to any costs incurred by the operator?
- Is the payment calculation set out clearly and correctly?
4. Facility not constructed to specifications
A long-term PPA is likely to contain a detailed description of the facility that is to be built by the operator. That facility will have a specified output capacity that the facility can produce without exceeding its design limits, referred to as the “nameplate capacity”. The final “installed capacity”, being the actual output capacity of the facility once completed, may differ from the nameplate capacity.
The PPA should specify what the consequences will be if the facility is not built as specified in the PPA, in particular if the installed capacity differs from the nameplate capacity.
If the installed capacity is higher than the nameplate capacity, should the offtaker be entitled to buy the excess output, and will the operator have the right to sell any excess that the offtaker does not want to take to third parties?
If the installed capacity is lower than the nameplate capacity, will the operator be required to remedy the performance shortfall and be granted additional time to do so? And will the offtaker be entitled to any liquidated damages or other remedies in respect of its costs and losses in relation to the shortfall in expected supply?
5. Facility operating regime
The optimal operating regime and running time for electricity generation facilities differs depending on the technology and fuel source used.
Some technologies – such as wind and solar – do not use an actual fuel source and are dependent on weather conditions. These types of technologies are usually referred to as “intermittent”. For intermittent facilities, the offtaker will usually take all of the output of the facility. The parties should consider what information the operator will be required to provide to the offtaker regarding the expected levels of output to assist the offtaker in managing the risk of energy imbalances.
For nuclear power facilities, continuous operation, usually referred to as “baseload operation”, is required. There may be some potential flexibility in practice regarding the maximum output of the facility. But the operator will want to prioritise the safe running of the facility and will usually not agree to provide for any output flexibility under a long-term PPA.
Thermal technologies that burn a fuel source to generate electricity, such as gas, coal or biomass, are usually capable of accommodating a flexible operating regime. Flexible facilities may nevertheless be continuously operated at baseload facilities, or may be operated in shifts to coincide with expected high demand periods each day. For flexible facilities, the parties should consider the following issues.
- Will the availability of fuel, the technology used, the facility configuration, or applicable environmental and planning conditions, have any effect on when and how the facility can be operated?
- Frequent starting and stopping and changes in facility output can affect the maintenance schedule and long-term reliability of the facility equipment. How will flexible operation be balanced with running the facility reasonably efficiently to manage wear and tear?
6. Suspensions of performance and payment
A long-term PPA will usually impose obligations on the operator to make the generation capacity available, with associated penalties applying where the facility is not available to generate. However, some allowances will be made for suspension of operations in limited circumstances – including in relation to force majeure events. The parties should consider the following issues.
- Are the PPA force majeure provisions clearly and accurately drafted to make sure that only events really beyond the control of the affected party are allowed as force majeure events? Will the parties actually be able in practice to distinguish between force majeure events and issues that arise as a consequence of poor planning or negligence?
- How much time will the operator be given to remedy a force majeure event before any payment deductions are triggered? Will the offtaker be required to continue to make capacity payments during any force majeure event? What termination rights and payments will apply if a force majeure event continues in effect for an extended period?
- Are other events for which the operator will be permitted to shut down the facility, such as routine maintenance, emergencies, or equipment breakdown, properly understood in light of the type of technology used and facility configuration?
7. “Back-to-backing” of obligations
For newly constructed power facilities, the operator will want to take account of its potential risks under various other project agreements – such as the construction agreement, fuel supply agreement, operation and maintenance agreement or turbine supply agreement – in negotiating the terms of the PPA. The operator may wish to do this by ensuring that relevant terms in these agreements are “back-to-backed”. That is, where there is a risk of liability to the operator under one project agreement, it has a means of recovery or relief under another agreement. The following are some key examples of provisions that the operator will typically seek to back-to-back.
- The operator will want to ensure that the definition and treatment of force majeure events is closely aligned or identical in each project agreement so that, for example, if the operator will not receive any revenue during a force majeure event under the PPA, it will not be liable for fuel supply payments under take-or-pay provisions in the fuel supply agreement.
- Obligations imposed on the operator regarding construction and commissioning of the facility under the PPA should be passed through to the construction contractor under the construction agreement.
- The operator will want to have the warranty given by the turbine manufacturer back-to-back with any guarantee of availability levels in the PPA.