Basics of PPA Negotiations Eng. David M. Mwangi, Individual Energy Consultant

Nairobi, Kenya

Outline of the Presentation

Introduction

Parties to a PPA and other stakeholders

Matters governed by a PPA

Key principles of a PPA

Key Issues in PPA negotiations

Some tips on win-win negotiations generally

Introduction - 1

Power Purchase Agreements (PPAs) are

commercial/legal contracts usually entered into

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 supplier

Thoughtful negotiations are essential as the PPA is:

the key initial step to making the power projects

bankable;

the heart of BOT, BOO or BOOT types of power

generation projects to be undertaken by

Independent Power Producers (IPPs)

Introduction - 2

Most PPAs have tenures of 10-30 years, typically

20 years, during which Buyer buys energy, and

sometimes also capacity and/or ancillary services,

from the Seller

The PPA secures the long-term revenue stream

through the sale of electricity from the project and

provides evidence that the electricity is needed by

the Buyer

While recognizing current regulatory environment,

the PPA needs to have anticipatory language to

capture and accommodate future regulatory

regimes, even as it locks in price and quantity

Introduction - 3

The PPA specifies relevant dates of the project

coming into effect, when the project will begin

commercial operation, and a termination date after

which the contract may expire or be renewed

All sales of electricity are metered to provide both

Seller and Buyer with the most accurate information

about the amount of electricity traded

Rates for electricity are agreed upon in the

agreement between both parties to provide an

economic incentive to both parties of the PPA

To the Seller, the PPA is a key ingredient in the

project’s cost structure, economic and financial

success as well as profitability

Introduction - 4

To the Buyer, the PPA impacts the cost of its

electricity sales on the short, medium and long run

Any understanding between the parties should be

properly recorded and detailed clearly to prevent

misunderstandings in future (since people who originally

negotiate PPAs may not be involved later in the operating

period of the project)

The only thing that matters is what the document

says (no matter what conversations the parties might

have about provisions, terms and arrangements)

Any changes desired in the agreement should

therefore be negotiated before signing. (After that all

parties are legally bound to fulfill their part).

Introduction - 5

Buyers may be told that the agreements they are

being asked to sign are standard contracts and the

terms are typical and the same everywhere for

everyone

Even though this may be partially true, until an

agreement is signed, any and all of the agreement

provisions are negotiable and should be clearly

understood and agreed by both parties

Parties to a PPA & Other Stakeholders

Direct Parties

Seller

Buyer

Indirect Parties

Financiers/Lenders

Government

Transmission services provider

Operating procedures

Operational targets

Penalties for operational defaults

Commissioning and Testing

Operation and Dispatch Procedures

Repair and Maintenance

Metering

Matters governed by the PPA - 1

Sale and Purchase of Electricity

Invoicing and Payments

Fuel Supply (for thermal plants)

Curtailment and Deemed Generation (for

renewable energy, especially wind)

Renewable Energy Credits (RECs)

Insurance

Dispute Resolution

Termination and Default

Matters governed by the PPA - 2

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

Define the Delivery Point

How will the power plant 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-taker’s system

For renewable energy, especially wind power,

issue of curtailment/deemed generation

Clear definition of Events of Default

Buyer’s Events of Default

Seller’s 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, there’s 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

Have a competent PPA negotiating team

PPAs are so important that each party should have

a competent negotiating team, with expertise in:

Technical matters (engineering, O&M,

environmental, etc);

Financial analysis;

Legal aspects

In-house competence is built progressively through

training and actually negotiating PPAs – there is

no shortcut to experience!

If you do not already have in-house capacity for

negotiating, it is wise to initially hire external

support

Some tips on win-win

negotiations generally

Know your BATNA before starting

BATNA - Best Alternative to a Negotiated

Agreement

Results matter:

Don’t settle for less than you could achieve

without an agreement.

Seek to improve BATNA.

Focus on interests

Distinguish between issues, positions, and

interests

Don’t 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

isn’t 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